Datasets:

gtfintechlab
/

ipo-text

+ RISK FACTORS THE PURCHASE OF OUR SHARES INVOLVES A HIGH DEGREE OF RISK. YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW BEFORE MAKING A DECISION TO BUY OUR COMMON STOCK. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCURS, OUR BUSINESS COULD BE HARMED. IN THAT CASE, THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE, AND YOU MAY LOSE ALL OR PART OF YOUR INVESTMENT. YOU SHOULD ALSO REFER TO THE OTHER INFORMATION IN THIS PROSPECTUS, INCLUDING OUR FINANCIAL STATEMENTS AND THE RELATED NOTES. EXCEPT FOR HISTORICAL INFORMATION, THE INFORMATION IN THIS PROSPECTUS CONTAINS "FORWARD-LOOKING" STATEMENTS ABOUT OUR EXPECTED FUTURE BUSINESS AND PERFORMANCE. OUR ACTUAL OPERATING RESULTS AND FINANCIAL PERFORMANCE MAY PROVE TO BE VERY DIFFERENT FROM WHAT WE MIGHT HAVE PREDICTED AS OF THE DATE OF THIS PROSPECTUS. THE RISKS DESCRIBED BELOW ADDRESS SOME OF THE FACTORS THAT MAY AFFECT OUR FUTURE OPERATING RESULTS AND FINANCIAL PERFORMANCE. BUSINESS RISKS WE INCURRED LOSSES FOR FISCAL YEARS 2003, 2002, 2001 AND 2000. We incurred losses of $2.7 million, $14.7 million, $28.9 million and $4.1 million in the fiscal years ended March 31, 2003, 2002, 2001, and 2000 respectively. The losses in the past four years have generally been due to difficulties completing sales for new application software licenses, the resulting change in sales mix toward lower margin services, and debt service expenses. We will need to generate additional revenue to achieve profitability in future periods. If we are unable to achieve profitability, or maintain profitability if achieved, may have a material adverse effect on our business and stock price and we may be unable to continue operations at current levels, if at all. WE HAD NEGATIVE WORKING CAPITAL IN PRIOR FISCAL YEARS, AND WE HAVE EXTENDED PAYMENT TERMS WITH A NUMBER OF OUR SUPPLIERS. At March 31, 2003, 2002 and 2001, we had negative working capital of $4.1 million, $5.3 million and $2.8 million, respectively. We have had difficulty meeting operating expenses, including interest payments on debt, lease payments and supplier obligations. We have at times deferred payroll for our executive officers, and borrowed from related parties to meet payroll obligations. We have extended payment terms with our trade creditors wherever possible. As a result of extended payment arrangements with suppliers, we may be unable to secure products and services necessary to continue operations at current levels from these suppliers. In that event, we will have to obtain these products and services from other parties, which could result in adverse consequences to our business, operations and financial condition, and we may be unable to obtain these products from other parties on terms acceptable to us, if at all. OUR NET SALES HAVE DECLINED IN RECENT FISCAL YEARS. WE EXPERIENCED A SUBSTANTIAL DECREASE IN APPLICATION SOFTWARE LICENSE SALES. OUR GROWTH AND PROFITABILITY IS DEPENDENT ON THE SALE OF HIGHER MARGIN LICENSES. Our net sales decreased by 16% in the fiscal year ended March 31, 2003, compared to the fiscal year ended March 31, 2002. Our net sales decreased by 5% in the fiscal year ended March 31, 2002 compared to the fiscal year ended March 31, 2001. We experienced a substantial decrease in application license software sales, which typically carry a much higher margin than other revenue sources. We must improve new application license sales to become profitable. We have taken steps to refocus our sales strategy on core historic competencies, but our typically long sales cycles make it difficult to evaluate whether and when sales will improve. We cannot be sure that the decline in sales has not been due to factors which might continue to negatively affect sales. OUR FINANCIAL CONDITION MAY INTERFERE WITH OUR ABILITY TO SELL NEW APPLICATION SOFTWARE LICENSES. Future sales growth may depend on our ability to improve our financial condition. Our past financial condition has made it difficult for us to complete sales of new application software licenses. Because our applications typically require lengthy implementation and extended servicing arrangements, potential customers require assurance that these services will be available for the expected life of the application. These potential customers may defer buying decisions until our financial condition improves, or may choose the products of our competitors whose financial condition is or is perceived to be stronger. Customer deferrals or lost sales will adversely affect our business, financial conditions and results of operations. OUR SALES CYCLES ARE LONG AND PROSPECTS ARE UNCERTAIN. THIS MAKES IT DIFFICULT FOR US TO PREDICT REVENUES AND BUDGET EXPENSES. The length of sales cycles in our business makes it difficult to evaluate the effectiveness of our sales strategies. Our sales cycles historically have ranged from three to twelve months, which has caused significant fluctuations in revenues from period to period. Due to our difficulties in completing new application software sales in recent periods and our refocused sales strategy, it is difficult to predict revenues and properly budget expenses. Our software applications are complex and perform or directly affect mission-critical functions across many different functional and geographic areas of the retail enterprise. In many cases, our customers must change established business practices when they install our software. Our sales staff must dedicate significant time consulting with a potential customer concerning the substantial technical and business concerns associated with implementing our products. The purchase of our products is often discretionary, so lengthy sales efforts may not result in a sale. Moreover, it is difficult to predict when a license sale will occur. All of these factors can adversely affect our business, financial condition and results of operations. OUR OPERATING RESULTS HAVE FLUCTUATED SIGNIFICANTLY IN THE PAST, AND THEY MAY CONTINUE TO DO SO IN THE FUTURE, WHICH COULD ADVERSELY AFFECT OUR STOCK PRICE. Our quarterly operating results have fluctuated significantly in the past and may fluctuate in the future as a result of several factors, many of which are outside of our control. If revenue declines in a quarter, our operating results will be adversely affected because many of our expenses are relatively fixed. In particular, sales and marketing, application development and general and administrative expenses do not change significantly with variations in revenue in a quarter. It is likely that in some future quarter our net sales or operating results will be below the expectations of public market analysts or investors. If that happens, our stock price will likely decline. OUR REVENUE MAY VARY FROM PERIOD TO PERIOD, WHICH MAKES IT DIFFICULT TO PREDICT FUTURE RESULTS. Factors outside our control that could cause our revenue to fluctuate significantly from period to period include: o The size and timing of individual orders, particularly with respect to our larger customers; o General health of the retail industry and the overall economy; o Technological changes in platforms supporting our software products; and o Market acceptance of new applications and related services. In particular, we usually deliver our software applications when contracts are signed, so order backlog at the beginning of any quarter may represent only a portion of that quarter's expected revenues. Application license revenues in any quarter are substantially dependent on orders booked and delivered in that quarter. Additionally, we have experienced, and we expect to continue to experience, quarters or periods where individual application license or services orders are significantly larger than our typical application license or service orders. Because of the nature of our offerings, we may get one or more large orders in one quarter from a customer and then no orders the next quarter. As a result of these factors, it is difficult for us to predict revenues and adjust costs as necessary. OUR EXPENSES MAY VARY FROM PERIOD TO PERIOD, WHICH COULD AFFECT QUARTERLY RESULTS AND OUR STOCK PRICE. If we incur additional expenses in a quarter in which we do not experience increased revenue, our results of operations would be adversely affected and we may incur losses for that quarter. Factors that could cause our expenses to fluctuate from period to period include: o The extent of marketing and sales efforts necessary to promote and sell our applications and services; o The timing and extent of our development efforts; and o The timing of personnel hiring. IT IS DIFFICULT TO EVALUATE OUR PERFORMANCE BASED ON PERIOD TO PERIOD COMPARISONS OF OUR RESULTS. The many factors which can cause revenues and expenses to vary make meaningful period to period comparisons of our results difficult. We do not believe period to period comparisons of our financial performance are necessarily meaningful, and you cannot rely on them as an indication of our future performance. WE MAY EXPERIENCE SEASONAL DECLINES IN SALES, WHICH COULD CAUSE OUR OPERATING RESULTS TO FALL SHORT OF EXPECTATIONS IN SOME QUARTERS. We may experience slower sales of our applications and services from October through December of each year as a result of retailers' focus on the holiday retail-shopping season. This can negatively affect revenues in our third fiscal quarter and in other quarters, depending on our sales cycles. WE HAVE RELIED ON CAPITAL CONTRIBUTED BY RELATED PARTIES, AND SUCH CAPITAL MAY NOT BE AVAILABLE IN THE FUTURE. Our cash from operations has not been sufficient to meet our operational needs, and we have relied on capital from related parties. A company affiliated with Donald S. Radcliffe, our former director, made short-term loans to us in fiscal 2002 and in fiscal 2003 to meet payroll when cash on hand was not sufficient. Softline Limited ("Softline") loaned us $10 million to make a required principal payment on our Union Bank term loan in July 2000. A subsidiary of Softline loaned us an additional $600,000 in November 2000 to meet working capital needs. This loan was repaid in February 2001, in part with $400,000 we borrowed from Barry M. Schechter, our former Chairman. We borrowed an additional $164,000 from Mr. Schechter in March 2001, which was repaid in July 2001, for operational needs related to our Australian subsidiary. We may not be able to obtain capital from related parties in the future. No officer, director, stockholder or related party is under any obligation to continue to provide cash to meet our future liquidity needs. WE MAY NEED TO RAISE CAPITAL TO GROW OUR BUSINESS. OBTAINING THIS CAPITAL COULD IMPAIR THE VALUE OF YOUR INVESTMENT. We may need to raise capital to: o Support unanticipated capital requirements; o Take advantage of acquisition or expansion opportunities; o Continue our current development efforts; o Develop new applications or services; or o Address working capital needs. Our future capital requirements depend on many factors including our application development, sales and marketing activities. We do not know whether additional financing will be available when needed, or available on terms acceptable to us. If we cannot raise needed funds for the above purposes on acceptable terms, we may be forced to curtail some or all of the above activities and we may not be able to grow our business or respond to competitive pressures or unanticipated developments. We may raise capital through public or private equity offerings or debt financings. To the extent we raise additional capital by issuing equity securities or convertible debt securities, our stockholders may experience substantial dilution and the new securities may have greater rights, preferences or privileges than our existing common stock. INTANGIBLE ASSETS MAY BE IMPAIRED MAKING IT MORE DIFFICULT TO OBTAIN FINANCING. Goodwill, capitalized software, non-compete agreements and other intangible assets represent approximately 73% of our total assets as of September 30, 2003. We may have to impair or write-off these assets, which will cause a charge to earnings and could cause our stock price to decline. Any such impairments will also reduce our assets, as well as the ratio of our assets to our liabilities. These balance sheet effects could make it more difficult for us to obtain capital, and could make the terms of capital we do obtain more unfavorable to our existing stockholders. FOREIGN CURRENCY FLUCTUATIONS MAY IMPAIR OUR COMPETITIVE POSITION AND AFFECT OUR OPERATING RESULTS. Fluctuations in currency exchange rates affect the prices of our applications and services and our expenses, and foreign currency losses will negatively affect profitability or increase losses. Approximately 12%, 9% and 8% of our net sales from continuing operations were outside North America, principally in Australia and the United Kingdom, in the fiscal years ended March 31, 2003, 2002 and 2001, respectively. Many of our expenses related to foreign sales, such as corporate level administrative overhead and development, are denominated in U.S. dollars. When accounts receivable and accounts payable arising from international sales and services are converted to U.S. dollars, the resulting gain or loss contributes to fluctuations in our operating results. We do not hedge against foreign currency exchange rate risks. HISTORICALLY WE HAVE BEEN DEPENDENT ON A SMALL NUMBER OF CUSTOMERS FOR A SIGNIFICANT AMOUNT OF OUR BUSINESS. Toys "R" Us ("Toys") accounted for 13% of our net sales for the six month period ended September 30, 2003, and 31%, 47% and 33% of our net sales for the fiscal years ended March 31, 2003, 2002 and 2001, respectively. QQQ Systems Ltd. ("QQQ Systems") accounted for 32% of our net sales for the six months ended September 30, 2003. In November 2003, Toys terminated their software development and services agreement with us. We cannot provide any assurances that QQQ Systems or any of our current customers will continue at current or historical levels or that we will be able to obtain orders from new customers. IF WE LOSE THE SERVICES OF ANY MEMBER OF OUR SENIOR MANAGEMENT OR KEY TECHNICAL AND SALES PERSONNEL, OR IF WE ARE UNABLE TO RETAIN OR ATTRACT ADDITIONAL TECHNICAL PERSONNEL, OUR ABILITY TO CONDUCT AND EXPAND OUR BUSINESS WILL BE IMPAIRED. We are heavily dependent on our Chairman and Chief Executive Officer, Harvey Braun, and our President and Chief Operating Officer, Steven Beck. We do not have any written employment agreements with Mr. Braun or Mr. Beck. We are also heavily dependent on our former Chairman, Barry Schechter, who remains a consultant to us. We do not have a written consulting agreement with Mr. Schechter. We also believe our future success will depend largely upon our ability to attract and retain highly-skilled software programmers, managers, and sales and marketing personnel. Competition for personnel is intense, particularly in international markets. The software industry is characterized by a high level of employee mobility and aggressive recruiting of skilled personnel. We compete against numerous companies, including larger, more established companies, for our personnel. We may not be successful in attracting or retaining skilled sales, technical and managerial personnel. The loss of key employees or our inability to attract and retain other qualified employees could negatively affect our financial performance and cause our stock price to decline. WE ARE DEPENDENT ON THE RETAIL INDUSTRY, AND IF ECONOMIC CONDITIONS IN THE RETAIL INDUSTRY FURTHER DECLINE, OUR REVENUES MAY ALSO DECLINE. RETAIL SALES HAVE BEEN AND MAY CONTINUE TO BE SLOW. Our future growth is critically dependent on increased sales to the retail industry. We derive the substantial majority of our revenues from the licensing of software applications and the performance of related professional and consulting services to the retail industry. Demand for our applications and services could decline in the event of consolidation, instability or more downturns in the retail industry. This decline would likely cause reduced sales and could impair our ability to collect accounts receivable. The result would be reduced earnings and weakened financial condition, each or both of which would likely cause our stock price to decline. The success of our customers is directly linked to economic conditions in the retail industry, which in turn are subject to intense competitive pressures and are affected by overall economic conditions. In addition, the retail industry may be consolidating, and it is uncertain how consolidation will affect the industry. The retail industry as a whole is currently experiencing increased competition and weakening economic conditions that could negatively impact the industry and our customers' ability to pay for our products and services. Such consolidation and weakening economic conditions have in the past, and may in the future, negatively impact our revenues, reduce the demand for our products and may negatively impact our business, operating results and financial condition. Uncertain economic conditions and the specter of terrorist activities have adversely impacted sales of our software applications, and we believe mid-tier specialty retailers may be reluctant during the current economic climate to make the substantial infrastructure investment that generally accompanies the implementation of our software applications, which may adversely impact our business. THERE MAY BE AN INCREASE IN CUSTOMER BANKRUPTCIES DUE TO WEAK ECONOMIC CONDITIONS. We have in the past and may in the future be impacted by customer bankruptcies. During weak economic conditions, such as those currently being experienced in many geographic regions around the world, there is an increased risk that certain of our customers will file bankruptcy. When our customers file bankruptcy, we may be required to forego collection of pre-petition amounts owed, and to repay amounts remitted to us during the 90-day preference period preceding the filing. Accounts receivable balances related to pre-petition amounts may in certain of these instances be large due to extended payment terms for software license fees, and significant billings for consulting and implementation services on large projects. The bankruptcy laws, as well as the specific circumstances of each bankruptcy, may severely limit our ability to collect pre-petition amounts, and may force us to disgorge payments made during the 90-day preference period. We also face risk from international customers who file for bankruptcy protection in foreign jurisdictions, in that the application of foreign bankruptcy laws may be less certain or harder to predict. Although we believe that we have sufficient reserves to cover anticipated customer bankruptcies, there can be no assurance that such reserves will be adequate, and if they are not adequate, our business, operating results and financial condition would be adversely affected. WE MAY NOT BE ABLE TO MAINTAIN OR IMPROVE OUR COMPETITIVE POSITION BECAUSE OF THE INTENSE COMPETITION IN THE RETAIL SOFTWARE INDUSTRY. We conduct business in an industry characterized by intense competition. Most of our competitors are very large companies with an international presence. We must also compete with smaller companies which have been able to develop strong local or regional customer bases. Many of our competitors and potential competitors are more established, benefit from greater name recognition and have significantly greater resources than us. Our competitors may also have lower cost structures and better access to the capital markets than us. As a result, our competitors may be able to respond more quickly than we can to new or emerging technologies and changes in customer requirements. Our competitors may: o Introduce new technologies that render our existing or future products obsolete, unmarketable or less competitive; o Make strategic acquisitions or establish cooperative relationships among themselves or with other solution providers, which would increase the ability of their products to address the needs of our customers; and o Establish or strengthen cooperative relationships with our current or future strategic partners, which would limit our ability to compete through these channels. We could be forced to reduce prices and suffer reduced margins and market share due to increased competition from providers of offerings similar to, or competitive with, our applications, or from service providers that provide services similar to our services. Competition could also render our technology obsolete. For a further discussion of competitive factors in our industry, see "Business" under the heading "Competition." OUR MARKETS ARE SUBJECT TO RAPID TECHNOLOGICAL CHANGE, SO OUR SUCCESS DEPENDS HEAVILY ON OUR ABILITY TO DEVELOP AND INTRODUCE NEW APPLICATIONS AND RELATED SERVICES. The retail software industry is characterized by rapid technological change, evolving standards and wide fluctuations in supply and demand. We must cost-effectively develop and introduce new applications and related services that keep pace with technological developments to compete. If we do not gain market acceptance for our existing or new offerings or if we fail to introduce progressive new offerings in a timely or cost-effective manner, our financial performance will suffer. The success of application enhancements and new applications depends on a variety of factors, including technology selection and specification, timely and efficient completion of design, and effective sales and marketing efforts. In developing new applications and services, we may: o Fail to respond to technological changes in a timely or cost-effective manner; o Encounter applications, capabilities or technologies developed by others that render our applications and services obsolete or non-competitive or that shorten the life cycles of our existing applications and services; o Experience difficulties that could delay or prevent the successful development, introduction and marketing of these new applications and services; or o Fail to achieve market acceptance of our applications and services. The life cycles of our applications are difficult to estimate, particularly in the emerging electronic commerce market. As a result, new applications and enhancements, even if successful, may become obsolete before we recoup our investment. OUR PROPRIETARY RIGHTS OFFER ONLY LIMITED PROTECTION AND OUR COMPETITORS MAY DEVELOP APPLICATIONS SUBSTANTIALLY SIMILAR TO OUR APPLICATIONS AND USE SIMILAR TECHNOLOGIES WHICH MAY RESULT IN THE LOSS OF CUSTOMERS. WE MAY HAVE TO INITIATE COSTLY LITIGATION TO PROTECT OUR PROPRIETARY RIGHTS. Our success and competitive position is dependent in part upon our ability to develop and maintain the proprietary aspects of our intellectual property. Our intellectual property includes our trademarks, trade secrets, copyrights and other proprietary information. Our efforts to protect our intellectual property may not be successful. Effective copyright and trade secret protection may be unavailable or limited in some foreign countries. We hold no patents. Consequently, others may develop, market and sell applications substantially equivalent to ours or utilize technologies similar to those used by us, so long as they do not directly copy our applications or otherwise infringe our intellectual property rights. We may find it necessary to bring claims or initiate litigation against third parties for infringement of our proprietary rights or to protect our trade secrets. These actions would likely be costly and divert management resources. These actions could also result in counterclaims challenging the validity of our proprietary rights or alleging infringement on our part. The ultimate outcome of any litigation will be difficult to predict. OUR APPLICATIONS MAY BE SUBJECT TO CLAIMS THEY INFRINGE ON THE PROPRIETARY RIGHTS OF THIRD PARTIES, WHICH MAY EXPOSE US TO LITIGATION. We may become subject to litigation involving patents or proprietary rights. Patent and proprietary rights litigation entails substantial legal and other costs, and we do not know if we will have the necessary financial resources to defend or prosecute our rights in connection with any such litigation. Responding to and defending claims related to our intellectual property rights, even ones without merit, can be time consuming and expensive and can divert management's attention from other business matters. In addition, these actions could cause application delivery delays or require us to enter into royalty or license agreements. Royalty or license agreements, if required, may not be available on terms acceptable to us, if they are available at all. Any or all of these outcomes could have a material adverse effect on our business, operating results and financial condition. DEVELOPMENT AND MARKETING OF OUR OFFERINGS DEPENDS ON STRATEGIC RELATIONSHIPS WITH OTHER COMPANIES. OUR EXISTING STRATEGIC RELATIONSHIPS MAY NOT ENDURE AND MAY NOT DELIVER THE INTENDED BENEFITS, AND WE MAY NOT BE ABLE TO ENTER INTO FUTURE STRATEGIC RELATIONSHIPS. Since we do not possess all of the technical and marketing resources necessary to develop and market our offerings to their target markets, our business strategy substantially depends on our strategic relationships. While some of these relationships are governed by contracts, most are non-exclusive and all may be terminated on short notice by either party. If these relationships terminate or fail to deliver the intended benefits, our development and marketing efforts will be impaired and our revenues may decline. We may not be able to enter into new strategic relationships, which could put us at a disadvantage to those of our competitors which do successfully exploit strategic relationships. OUR PRIMARY COMPUTER AND TELECOMMUNICATIONS SYSTEMS ARE IN A LIMITED NUMBER OF GEOGRAPHIC LOCATIONS, WHICH MAKES THEM MORE VULNERABLE TO DAMAGE OR INTERRUPTION. THIS DAMAGE OR INTERRUPTION COULD HARM OUR BUSINESS. Substantially all of our primary computer and telecommunications systems are located in two geographic areas, and these systems are vulnerable to damage or interruption from fire, earthquake, water damage, sabotage, flood, power loss, technical or telecommunications failure or break-ins. Our insurance may not adequately compensate us for our lost business and will not compensate us for any liability we incur due to our inability to provide services to our customers. Although we have implemented network security measures, our systems are vulnerable to computer viruses, physical or electronic break-ins and similar disruptions. These disruptions could lead to interruptions, delays, loss of data or the inability to service our customers. Any of these occurrences could impair our ability to serve our customers and harm our business. IF PRODUCT LIABILITY LAWSUITS ARE SUCCESSFULLY BROUGHT AGAINST US, WE MAY INCUR SUBSTANTIAL LIABILITIES AND MAY BE REQUIRED TO LIMIT COMMERCIALIZATION OF OUR APPLICATIONS. Our business exposes us to product liability risks. Any product liability or other claims brought against us, if successful and of sufficient magnitude, could negatively affect our financial performance and cause our stock price to decline. Our applications are highly complex and sophisticated and they may occasionally contain design defects or software errors that could be difficult to detect and correct. In addition, implementation of our applications may involve customer-specific customization by us or third parties, and may involve integration with systems developed by third parties. These aspects of our business create additional opportunities for errors and defects in our applications and services. Problems in the initial release may be discovered only after the application has been implemented and used over time with different computer systems and in a variety of other applications and environments. Our applications have in the past contained errors that were discovered after they were sold. Our customers have also occasionally experienced difficulties integrating our applications with other hardware or software in their enterprise. We are not currently aware of any material defects in our applications that might give rise to future lawsuits. However, errors or integration problems may be discovered in the future. Such defects, errors or difficulties could result in loss of sales, delays in or elimination of market acceptance, damage to our brand or to our reputation, returns, increased costs and diversion of development resources, redesigns and increased warranty and servicing costs. In addition, third-party products, upon which our applications are dependent, may contain defects which could reduce or undermine entirely the performance of our applications. Our customers typically use our applications to perform mission-critical functions. As a result, the defects and problems discussed above could result in significant financial or other damage to our customers. Although our sales agreements with our customers typically contain provisions designed to limit our exposure to potential product liability claims, we do not know if these limitations of liability are enforceable or would otherwise protect us from liability for damages to a customer resulting from a defect in one of our applications or the performance of our services. Our product liability insurance may not cover all claims brought against us. THE SAGE GROUP PLC (THE "SAGE GROUP") HAS THE RIGHT TO ACQUIRE A SIGNIFICANT PERCENTAGE OF OUR COMMON STOCK, WHICH IF ACQUIRED BY THE SAGE GROUP, MAY ENABLE THE SAGE GROUP TO EXERCISE EFFECTIVE CONTROL OF US. On November 14, 2003, the Sage Group acquired substantially all of the assets of Softline, including Softline's 141,000 shares of our Series A Convertible Preferred Stock, which are convertible into 18,700,185 shares of our common stock within 60 days of January 8, 2004 (the 18,700,185 shares consist of 18,478,789 shares issuable as of January 8, 2004 and 221,396 shares that will be issuable within 60 days of January 8, 2004 on account of accrued and unpaid dividends during that 60 day period), 8,923,915 shares of our common stock and options to purchase 71,812 shares of our common stock. The Sage Group beneficially owns approximately 41.7% of our outstanding common stock, including shares the Sage Group has the right to acquire upon conversion of its Series A Convertible Preferred Stock and exercise of its outstanding options. Although the Series A Convertible Preferred Stock is redeemable by us and 25,125,000 shares of common stock beneficially owned by the Sage Group are subject to an option held by Steven Beck, as trustee of a certain management group of the Company, if the Sage Group converts its Series A Convertible Preferred Stock, it may have effective control over all matters affecting us, including: o The election of all of our directors; o The allocation of business opportunities that may be suitable for the Sage Group and us; o Any determinations with respect to mergers or other business combinations involving us; o The acquisition or disposition of assets or businesses by us; o Debt and equity financing, including future issuance of our common stock or other securities; o Amendments to our charter documents; o The payment of dividends on our common stock; and o Determinations with respect to our tax returns. THE SAGE GROUP'S POTENTIAL INFLUENCE ON OUR COMPANY COULD MAKE IT DIFFICULT FOR ANOTHER COMPANY TO ACQUIRE US, WHICH COULD DEPRESS OUR STOCK PRICE. The Sage Group beneficially owns a significant percentage of our common stock. In addition, two of the current members of our board of directors are employed by a subsidiary of the Sage Group. The Sage Group's potential effective voting control could discourage others from initiating any potential merger, takeover or other change of control transaction that may otherwise be beneficial to our business or our stockholders. As a result, the Sage Group's potential effective control could reduce the price that investors may be willing to pay in the future for shares of our stock, or could prevent any party from attempting to acquire us at any price. OUR STOCK PRICE HAS BEEN HIGHLY VOLATILE. The market price of our common stock has been, and is likely to continue to be, volatile. When we or our competitors announce new customer orders or services, change pricing policies, experience quarterly fluctuations in operating results, announce strategic relationships or acquisitions, change earnings estimates, experience government regulatory actions or suffer from generally adverse economic conditions, our stock price could be affected. Some of the volatility in our stock price may be unrelated to our performance. Recently, companies similar to ours have experienced extreme price fluctuations, often for reasons unrelated to their performance. For further information on our stock price trends, see "Price Range of Common Stock." WE HAVE NEVER PAID A DIVIDEND ON OUR COMMON STOCK AND WE DO NOT INTEND TO PAY DIVIDENDS ON OUR COMMON STOCK IN THE FORESEEABLE FUTURE. We have not previously paid any cash or other dividend on our common stock. We anticipate that we will use our earnings and cash flow for repayment of indebtedness, to support our operations, and for future growth, and we do not have any plans to pay dividends in the foreseeable future. Holders of our Series A Convertible Preferred Stock are entitled to dividends in preference and priority to common stockholders. Future equity financing(s) may further restrict our ability to pay dividends. THE TERMS OF OUR PREFERRED STOCK MAY REDUCE THE VALUE OF YOUR COMMON STOCK. We are authorized to issue up to 5,000,000 shares of preferred stock in one or more series. We issued 141,000 shares of Series A Convertible Preferred Stock in May 2002. Our board of directors may determine the terms of subsequent series of preferred stock without further action by our stockholders. If we issue additional preferred stock, it could affect your rights or reduce the value of your common stock. In particular, specific rights granted to future holders of preferred stock could be used to restrict our ability to merge with or sell our assets to a third party. These terms may include voting rights, preferences as to dividends and liquidation, conversion and redemption rights, and sinking fund provisions. We are actively seeking capital, and some of the arrangements we are considering may involve the issuance of preferred stock. FAILURE TO COMPLY WITH THE AMERICAN STOCK EXCHANGE'S LISTING STANDARDS COULD RESULT IN OUR DELISTING FROM THAT EXCHANGE AND LIMIT THE ABILITY TO SELL ANY OF OUR COMMON STOCK. Our stock is currently traded on the American Stock Exchange. The Exchange has published certain guidelines it uses in determining whether a security warrants continued listing. These guidelines include financial, market capitalization and other criteria, and as a result of our financial condition or other factors, the American Stock Exchange could in the future determine that our stock does not merit continued listing. If our stock were delisted from the American Stock Exchange, the ability of our stockholders to sell our common stock could become limited, and we would lose the advantage of some state and federal securities regulations imposing lower regulatory burdens on exchange-traded issuers. DELAWARE LAW AND SOME PROVISIONS OF OUR CHARTER AND BYLAWS MAY ADVERSELY AFFECT THE PRICE OF YOUR STOCK. Special meetings of our stockholders may be called only by the Chairman of the Board, the Chief Executive Officer or the Board of Directors. Stockholders have no right to call a meeting. Stockholders must also comply with advance notice provisions in our bylaws in order to nominate directors or propose matters for stockholder action. These provisions of our charter documents, as well as certain provisions of Delaware law, could delay or make more difficult certain types of transactions involving a change in control of the Company or our management. Delaware law also contains provisions that could delay or make more difficult change in control transactions. As a result, the price of our common stock may be adversely affected. SHARES ISSUABLE UPON THE EXERCISE OF OPTIONS, WARRANTS, DEBENTURES AND CONVERTIBLE NOTES OR UNDER ANTI-DILUTION PROVISIONS IN CERTAIN AGREEMENTS COULD DILUTE YOUR STOCK HOLDINGS AND ADVERSELY AFFECT OUR STOCK PRICE. We have issued options and warrants to acquire common stock to our employees and certain other persons at various prices, some of which are or may in the future have exercise prices at below the market price of our stock. We currently have outstanding options and warrants for 14,254,228 shares. Of these options and warrants, as of January 8, 2004, 1,446,257 have exercise prices above the recent market price of $1.92 per share (as of January 8, 2004), and 12,807,971 have exercise prices at or below that recent market price. If exercised, these options and warrants will cause immediate and possibly substantial dilution to our stockholders. Our existing stock option plan currently has approximately 2,284,217 shares available for issuance as of January 8, 2004. Future options issued under the plan may have further dilutive effects. We issued to Union Bank of California, N.A. an unsecured note that is convertible into shares of common stock at a price per share of eighty percent (80%) of the average share closing price of our common stock for the ten trading day period immediately preceding the payoff date of the note, which is March 31, 2004. This note will have a dilutive effect on stockholders if converted. As of September 30, 2003, the bank assigned this note to Roth Capital Partners, LLC. Under a securities purchase agreement dated November 7, 2003 between the Company and various institutional investors, for a six-month period the Company is obligated to issue the investors additional shares of common stock, if the Company or any subsidiary or affiliate of the Company sells any of the Company's common stock for an aggregate purchase price of $1 million for a per share price that is less than 120% of the then current per share purchase price paid by such investors. The number of shares issued pursuant to the anti-dilution provision when aggregated with all prior issuances pursuant to the November 7, 2003 securities purchase agreement can not exceed 7,600,000 without stockholder approval. Sales of shares issued pursuant to exercisable options, warrants, convertible notes or anti-dilution provisions could lead to subsequent sales of the shares in the public market, and could depress the market price of our stock by creating an excess in supply of shares for sale. Issuance of these shares and sale of these shares in the public market could also impair our ability to raise capital by selling equity securities. WE MAY BE UNABLE TO SUCCESSFULLY INTEGRATE OUR OPERATIONS WITH PAGE DIGITAL INCORPORATED ("PAGE DIGITAL") OR RETAIL TECHNOLOGIES INTERNATIONAL, INC. ("RTI") OR REALIZE ALL OF THE ANTICIPATED BENEFITS OF THESE ACQUISITIONS. On January 30, 2004, we acquired Page Digital (see "Recent Transactions" below). On January 6, 2004, we executed a Letter of Intent/Term Sheet pursuant to which we intend to acquire RTI., subject to securing financing, due diligence, the execution of a definitive agreement, the approval of the board of directors of the Company and the approvals of the board of directors and shareholders of RTI. These acquisitions involve integrating two companies that previously operated independently into Island Pacific. These integrations will be complex, costly and time-consuming processes. The difficulties of combining these companies' operations include, among other things: o Coordinating geographically disparate organizations, systems and facilities; o Strain on management resources due to integration demands; o Integrating personnel with diverse business backgrounds; o Consolidating corporate and administrative functions; o Coordinating product development; o Coordinating sales and marketing functions; o Retaining key employees; and o Preserving relationships with key customers. SATISFYING CLOSING CONDITIONS MAY DELAY OR PREVENT THE COMPLETION OF THE RTI TRANSACTION. The closing of the RTI acquisition is conditioned, among other things, upon our securing financing, completion of due diligence, executing definitive agreements and securing the approval of the board of directors of Island Pacific and the approvals of the board of directors and the shareholders of RTI. Satisfying all these conditions is a complicated and time consuming process. We will have to dedicate significant financial and managerial resources to completing this transaction. It is possible that one of these conditions may become difficult or impossible to satisfy delaying or frustrating the consummation of the acquisition. There can be no assurance that the Company will be able to secure the necessary financing to complete the acquisition of RTI. BUSINESS RISKS FACED BY PAGE DIGITAL COULD DISADVANTAGE OUR BUSINESS. Page Digital is a developer of multi-channel commerce software and faces several business risks that could disadvantage our business if the proposed transaction is consummated. These risks include many of the risks that we face, described above, as well as: o LONG AND VARIABLE SALES CYCLES MAKE IT DIFFICULT TO PREDICT OPERATING RESULTS - Historically, the period between initial contact with a prospective customer and the licensing of Page Digital's products has ranged from one to twelve months. Page Digital's average sales cycle is currently three months. The licensing of Page Digital's products is often an enterprise wide decision by customers that involves a significant commitment of resources by Page Digital and its prospective customer. Customers generally consider a wide range of issues before committing to purchase Page Digital's products, including product benefits, cost and time of implementation, ability to operate with existing and future computer systems, ability to accommodate increased transaction volume and product reliability. As a part of the sales process, Page Digital spends a significant amount of resources informing prospective customers about the use and benefits of Page Digital products, which may not result in a sale, therefore increasing operating expenses. As a result of this sales cycle, Page Digital's revenues are unpredictable and could vary significantly from quarter to quarter causing our operating results to vary significantly from quarter to quarter. o DEFECTS IN PRODUCTS COULD DIMINISH DEMAND FOR PRODUCTS AND RESULT IN LOSS OF REVENUES - From time to time errors or defects may be found in Page Digital's existing, new or enhanced products, resulting in delays in shipping, loss of revenues or injury to Page Digital's reputation. Page Digital's customers use its products for business critical applications. Any defects, errors or other performance problems could result in damage to Page Digital's customers' businesses. These customers could seek significant compensation from Page Digital for any losses. Further, errors or defects in Page Digital's products may be caused by defects in third-party software incorporated into Page Digital products. If so, Page Digital may not be able to fix these defects without the assistance of the software providers. o FAILURE TO FORMALIZE AND MAINTAIN RELATIONSHIPS WITH SYSTEMS INTEGRATORS COULD REDUCE REVENUES AND HARM PAGE DIGITAL'S ABILITY TO IMPLEMENT PRODUCTS - A significant portion of Page Digital's sales are influenced by the recommendations of systems integrators, consulting firms and other third parties who assist with the implementation and maintenance of Page Digital's products. These third parties are under no obligation to recommend or support Page Digital's products. Failing to maintain strong relationships with these third parties could result in a shift by these third parties toward favoring competing products, which could negatively affect Page Digital's software license and service revenues. o PAGE DIGITAL'S PRODUCT MARKETS ARE SUBJECT TO RAPID TECHNOLOGICAL CHANGE, SO PAGE DIGITAL'S SUCCESS DEPENDS HEAVILY ON ITS ABILITY TO DEVELOP AND INTRODUCE NEW APPLICATIONS AND RELATED SERVICES - The retail software industry is characterized by rapid technological change, evolving standards and wide fluctuations in supply and demand. Page Digital must cost-effectively develop and introduce new applications and related services that keep pace with technological developments to compete. If Page Digital fails to gain market acceptance for its existing or new offerings or if Page Digital fails to introduce progressive new offerings in a timely or cost-effective manner, our financial performance may suffer. o FAILURE TO PROTECT PROPRIETARY RIGHTS OR INTELLECTUAL PROPERTY, OR INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS AGAINST PAGE DIGITAL COULD RESULT IN PAGE DIGITAL LOSING VALUABLE ASSETS OR BECOMING SUBJECT TO COSTLY AND TIME-CONSUMING LITIGATION - Page Digital's success and ability to compete depend on its proprietary rights and intellectual property. Page Digital relies on trademark, trade secret and copyright laws to protect its proprietary rights and intellectual property. Page Digital also has one issued patent. Despite Page Digital's efforts to protect intellectual property, a third party could obtain access to Page Digital's software source code or other proprietary information without authorization, or could independently duplicate Page Digital's software. Page Digital may need to litigate to enforce intellectual property rights. If Page Digital is unable to protect its intellectual property it may lose a valuable asset. Further, third parties could claim Page Digital has infringed their intellectual property rights. Any claims, regardless of merit, could be costly and time-consuming to defend. o COMPETITION IN THE SOFTWARE MARKET IS INTENSE AND COULD REDUCE PAGE DIGITAL'S SALES OR PREVENT THEM FROM ACHIEVING PROFITABILITY - The market for Page Digital's products is intensely competitive and subject to rapid technological change. Competition is likely to result in price reductions, reduced gross margins and loss of Page Digital's market share, any one of which could reduce future revenues or earnings. Further, most of Page Digital's competitors are large companies with greater resources, broader customer relationships, greater name recognition and an international presence. As a result, Page Digital's competitors may be able to better respond to new and emerging technologies and customer demands.

parsed_sections/risk_factors/2004/CIK0000906471_davco_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ RISK FACTORS An investment in the EISs, shares of our Class A common stock and/or our senior subordinated notes involves a number of risks. In addition to the other information contained in this prospectus, prospective investors should give careful consideration to the following factors. Risks Relating to the EISs, shares of Class A Common Stock and/or Senior Subordinated Notes You may not receive interest or dividends in the amounts contemplated in this prospectus. The terms of our new credit facility will restrict our ability to pay principal and interest on our senior subordinated notes and to pay dividends on shares of our Class A and Class B common stock. The terms of our senior subordinated notes and our franchise agreements with Wendy's International restrict our ability to pay dividends on shares of our Class A and Class B common stock. Our ability to make payments of principal and interest on our senior subordinated notes, pay dividends on our Class A and Class B common stock or make other distributions will be subject to applicable law and contractual restrictions contained in the instruments governing our indebtedness, including the terms of our new credit facility, the indenture governing our senior subordinated notes and our franchise agreements with Wendy's International. The terms of our new credit facility will prevent us from paying principal or interest on our senior subordinated notes during the existence of a payment default thereunder and for 179 days following a default thereunder, other than a payment default. Our new credit facility will also prevent us from paying dividends on our shares of Class A and Class B common stock if an event of default exists thereunder or if certain financial covenant ratios are not met. See "Description of Certain Indebtedness New Credit Facility." The indenture governing our senior subordinated notes contains significant restrictions on our ability to pay dividends on shares of our Class A and Class B common stock based upon meeting certain fixed charge coverage ratios and other conditions, as described under "Description of Senior Subordinated Notes" and prohibits the payment of dividends during the existence of an event of default (including the non-payment of interest on our senior subordinated notes, when due) thereunder. Under the terms of our franchise agreements with Wendy's, we are restricted from paying dividends on our Class A and Class B common stock if at the time of such payment we are not current in our capital expenditure obligations or our royalty fee, advertising contribution or other payment obligations to Wendy's, or if such payment would prevent us from making required payments to Wendy's under our agreements with Wendy's. See "Business Relationship with Wendy's International Ownership and Other Requirements of Wendy's International Dividend restrictions." Accordingly, you may not receive interest or dividends in the amounts contemplated by the senior subordinated notes or the dividend policy to be adopted by our board of directors upon the closing of this offering. You may not receive the level of dividends provided for in the dividend policy our board of directors will adopt upon the closing of this offering or any dividends at all. Dividend payments are not mandatory or guaranteed, and holders of our common stock do not have any legal right to receive, or require us to pay, dividends. Furthermore, our board of directors may, in its sole discretion, amend or repeal the dividend policy to be adopted upon the closing of this offering. Our board of directors may decrease the level of dividends provided for in this dividend policy or entirely discontinue the payment of dividends. Future dividends with respect to shares of our capital stock, if any, will depend on, among other things, our results of operations, cash requirements, financial condition, contractual restrictions, business opportunities, provisions of applicable law and other factors that our board of directors may deem relevant. Under state law, our board of directors may declare DavCo Restaurants Inc. [GRAPHIC OMITTED] dividends only to the extent of our "surplus" (which is defined as total assets at fair market value minus total liabilities, minus statutory capital), or, if there is no surplus, out of the current or immediately preceding fiscal year's earnings. Further, the new credit facility, the indenture governing our senior subordinated notes and our franchise agreements with Wendy's contain significant restrictions on our ability to make dividend payments on our shares of common stock. The reduction or elimination of dividends may negatively affect the market price of the EISs. If we have insufficient cash flow to cover the expected dividend payments under the dividend policy to be adopted by our board of directors we would need to reduce or eliminate dividends or, to the extent permitted under our debt agreements, fund a portion of our dividends with additional borrowings. If our cash flows from operations for future periods were to fall below our minimum expectations (or if our assumptions as to capital expenditures, interest expense or tax expense were too low or our assumptions as to the sufficiency of our new credit facility to finance our new restaurant capital expenditures and any of our seasonal working capital needs and other assumptions were to prove incorrect), we would need either to reduce or eliminate dividends or, to the extent we were permitted to do so under the terms of our new credit facility and the indenture governing our senior subordinated notes, fund a portion of our dividends with borrowings or from other sources. If we were to use our new credit facility or other borrowings to fund dividends, we would have less cash or borrowing capacity available for future dividends and other purposes, which could negatively impact our financial condition, our results of operations and our ability to maintain or expand our business. The degree to which we are leveraged on a consolidated basis may impact our financing options and liquidity position. Following the closing, we will have an aggregate $66.3 million of our senior subordinated notes outstanding (or $75.1 million if the underwriters' over-allotment option is exercised in full) and have entered into the new credit facility. Under certain circumstances, our new credit facility and the indenture governing our senior subordinated notes will permit us to incur additional indebtedness. The degree to which we are leveraged on a consolidated basis could have important consequences to the holders of the EISs or senior subordinated notes, including: it may be more difficult to satisfy our obligations under our new credit facility and the senior subordinated notes and pay dividends on our common stock; our ability in the future to obtain additional financing for working capital, capital expenditures or acquisitions may be limited; we may not be able to refinance our indebtedness on terms acceptable to us or at all; a significant portion of our cash flow from operations is likely to be dedicated to the payment of the principal of and interest on our indebtedness, thereby reducing funds available for future operations, capital expenditures and/or dividends on our common stock; and we may be more vulnerable to economic downturns and be limited in our ability to withstand competitive pressures. We are subject to restrictive debt covenants that limit our business flexibility by imposing operating and financial restrictions on our operations. The agreements governing our indebtedness, including the new credit facility and the indenture governing our senior subordinated notes, impose significant operating and financial restrictions on us. These restrictions prohibit or limit, among other things: the payment of principal and interest on our senior subordinated notes, dividends and distributions on, and purchase or redemption of, capital stock; TABLE OF CONTENTS Page the incurrence of additional indebtedness and the issuance of preferred stock and certain redeemable capital stock; a number of other restricted payments, including the making of certain investments; specified sales of assets; specified sale-leaseback transactions; the creation of a number of liens; specified transactions with affiliates; and consolidations, mergers and transfers of all or substantially all of our assets. These restrictions could limit our ability to obtain future financing, make acquisitions or needed capital expenditures, withstand downturns in our business or take advantage of business opportunities. The terms of the new credit facility include other restrictive covenants and prohibit us from prepaying our other indebtedness, including the senior subordinated notes, while indebtedness under the new credit facility is outstanding. The new credit facility also requires us to maintain certain financial ratios (as defined therein) including, without limitation, the following: a minimum Fixed Charge Coverage Ratio, a maximum Funded Indebtedness to EBITDA ratio, a maximum Adjusted Funded Indebtedness to EBITDAR ratio and a minimum of Adjusted EBITDA. Our ability to comply with the ratios or tests may be affected by events beyond our control, including prevailing economic, financial and industry conditions. A breach of any of these covenants, ratios or tests could result in a default under the new credit facility and/or the indenture. Certain events of default under the new credit facility would prohibit us from making payments on our senior subordinated notes, including payment of interest when due. In addition, upon the occurrence of an event of default under the new credit facility, the lender could elect to declare all amounts outstanding under the new credit facility, together with accrued interest, to be immediately due and payable. If we were unable to repay those amounts, the lender could proceed against the security granted to them to secure that indebtedness. If the lenders accelerate the payment of the indebtedness, our assets may not be sufficient to repay in full this indebtedness and our other indebtedness, including the senior subordinated notes. We are a holding company and rely on dividends, interest and other payments, advances and transfers of funds from our subsidiaries to meet our debt service and other obligations. We are a holding company and conduct all of our operations through our subsidiaries and currently have no significant assets other than the capital stock of DavCo Operations. As a result, we will rely on dividends and other payments or distributions from DavCo Operations and its subsidiaries to meet our debt service obligations and enable us to pay dividends. The ability of DavCo Operations and its subsidiaries to pay dividends or make other payments or distributions to us will depend on their respective operating results and will be restricted by, among other things, the laws of their jurisdiction of organization (which may limit the amount of funds available for the payment of dividends), agreements of those subsidiaries, the terms of the new credit facility and the covenants of any future outstanding indebtedness we or our subsidiaries incur. You may not be able to immediately accelerate the principal amount of the senior subordinated notes prior to their maturity which may delay your right, as a holder of senior subordinated notes, to enforce your remedies and receive payment. The maturity of the principal amount of the senior subordinated notes may not be immediately accelerated and the principal amount will not become due and payable, prior to the scheduled maturity date, for a period beginning on the date notice is provided to Wendy's with respect to the occurrence of certain events of default and ending 45 days after such date, as described in "Description of Senior Subordinated Notes Acceleration Forbearance Periods." This acceleration forbearance period may delay your right, as a holder of senior subordinated notes, to enforce your remedies and receive payments on the senior subordinated notes. Holders of Class B common stock may have conflicting interests from yours. Pursuant to a recapitalization to be effected concurrent with this offering, the management investors and Citicorp Venture Capital will own all of the shares of our Class B common stock. Pursuant to the stockholders agreement, so long as the existing equity investors hold at least 8% or more of the total economic value of the total outstanding equity interests in our company and 8% or more of the total outstanding voting interests in our company, they will be entitled to nominate two individuals for election to our board of directors. As a result, through their director designation right, the management investors and Citicorp Venture Capital will, collectively, exercise influence over matters requiring board approval, including decisions about our capital structure and the payment of dividends on our Class A and Class B common stock. As holders of our Class B common stock, which provide for dividends to be subordinated to the dividends payable to holders of our Class A common stock, their interests may conflict with your interests as a holder of EISs and Class A common stock. You will be immediately diluted by $12.45 per share of Class A common stock if you purchase EISs in this offering. If you purchase EISs in this offering, based on the book value of the assets and liabilities reflected on our balance sheet, you will experience an immediate dilution of $12.45 per share of Class A common stock represented by the EISs which exceeds the entire price allocated to each share of common stock represented by the EISs in this offering because there will be a net tangible book deficit for each share of Class A common stock outstanding immediately after this offering. Our net tangible book deficiency as of June 27, 2004, after giving effect to this offering, was approximately $60.1 million, or $4.80 per share of common stock. Our expansion is dependent on our continued ability to borrow under our new credit facility and our interest expense thereunder may significantly increase and could cause our net income and distributable cash to decline significantly. Our ability to continue to expand our business, including to make new restaurant expenditures, will be dependent upon our ability to borrow funds under our new credit facility and to obtain other third-party financing, including through the sale of EISs or any sale of securities. We cannot assure you that such financing will be available to us on favorable terms or at all. The new credit facility will be subject to periodic renewal or must otherwise be refinanced. We may not be able to renew or refinance the new credit facility, or if renewed or refinanced, the renewal or refinancing may occur on less favorable terms. Any future borrowings under our new credit facility will be made at a floating rate of interest. In the event of an increase in the base reference interest rates, our interest expense will increase and could have a material adverse effect on our ability to make cash dividend payments to our stockholders. We may not generate sufficient funds from operations to pay our indebtedness at maturity or upon the exercise by holders of our senior subordinated notes of their rights upon a change of control. A significant portion of our cash flow from operations will be dedicated to maintaining our restaurants and servicing our debt requirements. In addition, we currently expect to distribute a significant portion of any remaining available cash to our stockholders in the form of quarterly dividends. Moreover, prior to the maturity of our senior subordinated notes, we will not be required to make any payments of principal on our senior subordinated notes. We may not generate sufficient funds from operations to repay the principal amount of our indebtedness at maturity or in case you exercise your right to require us to purchase your senior subordinated notes upon a change of control. In making your investment decision, you should rely only on the information contained in this prospectus or to which we have referred you. We have not authorized anyone to provide you with information that is different. If anyone provided you with different or inconsistent information, you should not rely on it. This prospectus may only be used where it is legal to sell these securities. We may therefore need to refinance our debt or raise additional capital. These alternatives may not be available to us when needed or on satisfactory terms due to prevailing market conditions, a decline in our business or restrictions contained in our senior debt obligations. Your right to receive payments on the senior subordinated notes and the senior subordinated note guarantees is junior to all senior debt of our company and its subsidiaries. We are a holding company and conduct all of our operations through our subsidiaries. The senior subordinated notes and the senior subordinated note guarantees issued by our subsidiary guarantors will be unsecured senior subordinated obligations, junior in right of payment to our senior debt and that of each of our subsidiary guarantors, respectively. As a result of the subordinated nature of our senior subordinated notes and related guarantees, upon any distribution to our creditors or the creditors of the subsidiary guarantors in bankruptcy, liquidation or reorganization or similar proceeding relating to us or the subsidiary guarantors or our or their property, the holders of our senior indebtedness and senior indebtedness of the subsidiary guarantors will be entitled to be paid in full in cash before any payment may be made with respect to our senior subordinated notes or the subsidiary guarantees. In the event of a bankruptcy, liquidation or reorganization or similar proceeding relating to us or the subsidiary guarantors, holders of our senior subordinated notes will participate with all other holders of unsecured indebtedness of ours or the subsidiary guarantors similarly subordinated in the assets remaining after we and the subsidiary guarantors have paid all senior indebtedness. In any of these cases, we and the subsidiary guarantors may not have sufficient funds to pay all of our creditors, and holders of our senior subordinated notes may receive less, ratably, than the holders of senior indebtedness. In such event, we and our subsidiary guarantors would not be able to make all principal payments on our senior subordinated notes. The subordination provisions of the indenture governing the senior subordinated notes will also provide that payments to you under the subsidiary guarantees may be blocked for up to 179 days by holders of designated senior indebtedness (at the closing of this offering, the lenders under the new credit facility) if a default other than a payment default exists under such senior indebtedness. During any period in which payments to you are blocked in this manner, any amounts received by you with respect to the subsidiary guarantees, including as a result of any legal action to enforce such subsidiary guarantees, would be required to be turned over to the holders of senior indebtedness. See "Description of Senior Subordinated Notes Ranking." On a pro forma basis as of June 27, 2004, we would have had approximately $28.0 million of outstanding senior indebtedness, plus approximately $4.6 million of letters of credit and the subsidiary guarantors would have had approximately $28.0 million of outstanding senior indebtedness. In addition, as of June 27, 2004, on a pro forma basis, DavCo Operations would have had the ability to borrow up to an additional amount of $9.1 million under the new credit facility (less amounts reserved for letters of credit), which would have ranked senior in right of payment to our senior subordinated notes. The guarantees of the senior subordinated notes by our subsidiaries may not be enforceable. Under federal bankruptcy law and comparable provisions of state fraudulent transfer laws, a guarantee could be voided, or claims in respect of a guarantee could be subordinated to all other debt of the guarantor, if, among other things, the guarantor, at the time that it assumed the guarantee: issued the guarantee to delay, hinder or defraud present or future creditors; or INDUSTRY AND MARKET DATA Unless otherwise indicated, all United States restaurant industry data in this prospectus is from the Technomic Information Services ("Technomic") 2003 report entitled "Technomic Top 100: Update and Analysis of the Largest U.S. Chain Restaurant Companies" (the "Technomic Report"). received less than reasonably equivalent value or fair consideration for issuing the guarantee and, at the time it issued the guarantee: was insolvent or rendered insolvent by reason of issuing the guarantee and the application of the proceeds of the guarantee; was engaged or about to engage in a business or a transaction for which the guarantor's remaining assets available to carry on its business constituted unreasonably small capital; intended to incur, or believed that it would incur, debts beyond its ability to pay the debts as they mature; or was a defendant in an action for money damages, or had a judgment for money damages docketed against it if, in either case, after final judgment, the judgment is unsatisfied. In addition, any payment by the guarantor under its guarantee could be voided and required to be returned to the guarantor or to a fund for the benefit of the creditors of the guarantor or the guarantee could be subordinated to other debt of the guarantor. The measures of insolvency for the purposes of fraudulent transfer laws vary depending upon the law applied in any proceeding to determine whether a fraudulent transfer has occurred. Generally, however, a person would be considered insolvent if, at the time it incurred the debt: the sum of its debts, including contingent liabilities, was greater than the fair saleable value of its assets; the present fair saleable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts, including contingent liabilities, as they become absolute and mature; or it could not pay its debts as they become due. We believe that immediately after the issuance of the senior subordinated notes and the guarantees, we and each of the subsidiary guarantors will be solvent, will have sufficient capital to carry on our respective businesses and will be able to pay our respective debts as they mature. However, we cannot be sure what standard a court would apply to determine whether the subsidiary guarantors are solvent or that a court would reach the same conclusions with regard to these issues. Regardless of the standard that the court uses, we cannot be sure that the issuance by the subsidiary guarantors of the subsidiary guarantees would not be voided or the subsidiary guarantees would not be subordinated to their other debt. The guarantee of our senior subordinated notes by any subsidiary guarantor could be subject to the claim that, since the guarantee was incurred for the benefit of DavCo Restaurants, and only indirectly for the benefit of the subsidiary guarantor, the obligations of the subsidiary guarantor were incurred for less than fair consideration. If such a claim were successful and it was proven that the subsidiary guarantor was insolvent at the time the guarantee was issued, a court could void the obligations of the subsidiary guarantor under the guarantee or subordinate these obligations to the subsidiary guarantor's other debt or take action detrimental to holders of the senior subordinated notes. If the guarantee of any subsidiary guarantor were voided, our senior subordinated notes would be effectively subordinated to the indebtedness of that subsidiary guarantor. Seasonality and variability of our businesses may cause volatility in the market value of your investment and may hinder our ability to make timely distributions on the EISs. Our business is seasonal in nature, and our net sales and operating results vary significantly from quarter to quarter. This variability results from several factors, including consumer habits driven by changes in the seasons and weather. Consequently, results of operations for any particular quarter may not be indicative of the results of operations of future periods, which make it difficult to forecast our results for an entire year. This variability may cause volatility in the market price of the EISs. In addition, the seasonality and variability of our business means that at certain times of the year our cash receipts are significantly higher than at other times. Given that we are required to make equal quarterly interest payments and expect to pay equal quarterly dividends to EIS holders throughout the year, there is a risk that we will experience cash shortages, which could hinder our ability to make timely distributions to EIS holders. Interest on the senior subordinated notes may not be deductible by us for U.S. federal income tax purposes, which could significantly reduce our future cash flow and impact our ability to make interest and dividend payments. If all or a portion of the senior subordinated notes were treated as equity rather than debt (including if the EISs were treated as an indivisible equity security) for U.S. federal income tax purposes, then a corresponding portion of the interest on the senior subordinated notes would not be deductible by us for U.S. federal income tax purposes. In addition, we would be subject to liability for U.S. withholding taxes on interest payments to non-U.S. holders if such payments were determined to be dividends. Our inability to deduct interest on the senior subordinated notes could materially increase our taxable income and, thus, our U.S. federal and applicable state income tax liability. If the senior subordinated notes were determined to be equity for income tax purposes, our liability for income taxes (and withholding taxes) would materially reduce our after-tax cash flow and would materially and adversely impact our ability to make interest and/or dividend payments. In the case of foreign holders, treatment of the senior subordinated notes as equity for U.S. federal income tax purposes would subject such holders in respect of the senior subordinated notes to withholding or estate taxes in the same manner as with regard to common stock and could subject us to liability for withholding taxes that were not collected on payments of interest. Therefore, foreign holders would receive any such payments net of the tax withheld. Even if the IRS does not challenge the tax treatment of the senior subordinated notes, it is possible that as a result of changes in circumstances, IRS interpretations or the law or other facts that come to light after this offering (including facts indicating the inaccuracy of the representations given by the initial purchasers of the senior subordinated notes not in the form of EISs), we may need to establish an accrual for contingent tax liabilities associated with a potential disallowance of all or part of the interest deductions on the senior subordinated notes, although our present view is that no such accrual is necessary or appropriate. If we were required to maintain a material accrual, our income tax provision, and related income tax liability, could be materially impacted. As a result, our ability to make dividend payments on our common stock could be impaired, due to restrictions under the terms of our new credit facility, in the indenture governing our senior subordinated notes, in our franchise agreements with Wendy's or under applicable law, and the market price or liquidity for the EISs or Class A common stock could be adversely affected. If we subsequently issue senior subordinated notes with significant original issue discount, we may not be able to deduct all of the interest on those senior subordinated notes, which may adversely affect our cash flow available for interest payments and distributions to our equityholders. It is possible that the senior subordinated notes we issue in a subsequent issuance will be issued at a discount to their face value and, accordingly, may have "significant original issue discount" and thus be classified as "applicable high yield discount obligations," or AHYDOs. If any such senior subordinated notes were so treated, a portion of the original issue discount on such senior subordinated notes could be nondeductible by us and the remainder would be deductible only when paid. This treatment would have the effect of increasing our taxable income and may adversely affect our cash flow available for interest payments and distributions to our equityholders. The allocation of the purchase price of the EISs may not be respected, which may adversely affect your tax position. The purchase price of each EIS must be allocated between the share of Class A common stock and senior subordinated notes represented thereby in proportion to their respective fair market values at the time of purchase. We expect to report the initial fair market value of each share of Class A common stock as $7.65 and the initial fair market value of the principal amount of our senior subordinated notes as $7.35 and, by purchasing EISs, under the terms of the indenture, you will agree to and be bound by such allocation, assuming an initial public offering price of $15.00 per EIS, which represents the midpoint of the range set forth on the cover page of this prospectus. If this allocation is not respected, it is possible that the senior subordinated notes will be treated as having been issued with original issue discount (if the allocation to the senior subordinated notes were determined to be too high) or amortizable bond premium (if the allocation to the senior subordinated notes were determined to be too low). You generally would have to include original issue discount in income in advance of the receipt of cash attributable to that income. If the IRS successfully asserts that the senior subordinated notes have a fair market value greater than that which we allocate to such notes, it is possible that the senior subordinated notes will be treated as having amortizable bond premium. If the senior subordinated notes were treated as having amortizable bond premium, you would be able to elect to amortize bond premium over the term of the senior subordinated note. We intend to treat the acquisition of an EIS as an acquisition of the share of Class A common stock and the senior subordinated note represented by the EISs. However, there are no directly applicable legal authorities governing the issue of whether EISs will be treated for U.S. federal income tax purposes as the acquisition of a share of common stock and a separate debt instrument or whether EISs will instead be treated as an indivisible security that is solely an equity security. Consequently, our counsel is unable to opine definitely whether the EISs will be treated for U.S. federal income tax purposes as the acquisition of a share of common stock and a separate debt instrument, although counsel believes they should be so treated. For additional information on the U.S. federal income tax consequences if the EISs were treated as an indivisible equity security, see " Interest on the senior subordinated notes may not be deductible by us for U.S. federal income tax purposes, which could significantly reduce our future cash flow and impact our ability to make interest and dividend payments." Subsequent issuances of senior subordinated notes may cause you to recognize original issue discount and have other adverse consequences. The indenture governing our senior subordinated notes will provide that, in the event there is a subsequent issuance of senior subordinated notes with a new CUSIP number having terms that are substantially identical to the senior subordinated notes (or any issuance of senior subordinated notes thereafter), each holder of EISs or separately held senior subordinated notes (not in the form of EISs), as the case may be, agrees that a portion of such holder's senior subordinated notes will be automatically exchanged for a portion of the senior subordinated notes acquired by the holders of such subsequently issued senior subordinated notes. Consequently, immediately following each such subsequent issuance and exchange, each holder of senior subordinated notes, held either as part of EISs or separately, will own an inseparable unit composed of a proportionate percentage of senior subordinated notes of each separate issuance. Therefore, subsequent issuances of senior subordinated notes with original issue discount pursuant to an EIS offering by us or following exchange by our existing equity investors of Class B common stock for EISs may adversely affect your tax treatment by increasing the original issue discount, if any, that you were previously accruing with respect to your senior subordinated notes. Furthermore, due to the lack of applicable authority, it is unclear whether the exchange of senior subordinated notes for subsequently issued senior subordinated notes will result in a taxable exchange for U.S. federal income tax purposes and our counsel is not able to opine on this issue. It is possible that the IRS might successfully assert that such an exchange should be treated as a taxable exchange. Following any subsequent issuance of senior subordinated notes with original issue discount and exchange, we (and our agents) will report any original issue discount on the subsequently issued senior subordinated notes ratably among all holders of EISs and separately held senior subordinated notes, and each holder of EISs and separately held senior subordinated notes will, by purchasing EISs or senior subordinated notes, agree to report original issue discount in a manner consistent with this approach. However, the Internal Revenue Service may assert that any original issue discount should be reported only to the persons that initially acquired such subsequently issued senior subordinated notes (and their transferees) and thus may challenge the holders' reporting of OID on their tax returns. In such case, the Internal Revenue Service might further assert that, unless a holder can establish that it is not a person that initially acquired such subsequently issued senior subordinated notes (or a transferee thereof), all of the senior subordinated notes held by such holder have original issue discount. Any of these assertions by the Internal Revenue Service could create significant uncertainties in the pricing of EISs and senior subordinated notes and could adversely affect the market for EISs and senior subordinated notes. For a discussion of these and additional tax related risks, see "Material U.S. Federal Income Tax Consequences." Subsequent issuances of senior subordinated notes may adversely affect your treatment in a bankruptcy. The aggregate stated principal amount of the senior subordinated notes owned by each holder will not change as a result of such subsequent issuances of senior subordinated notes or exchanges into EISs. However, under New York and federal bankruptcy law, holders of subsequently issued senior subordinated notes having original issue discount may not be able to collect the portion of their principal face amount that represents unamortized original issue discount as at the acceleration or filing date in the event of an acceleration of the senior subordinated notes or a bankruptcy of DavCo Restaurants prior to the maturity date of the senior subordinated notes. As a result, an automatic exchange that results in a holder receiving a senior subordinated note with original issue discount could have the effect of ultimately reducing the amount such holder can recover from us in the event of an acceleration or bankruptcy. Before this offering, there has not been a public market for our EISs, Class A common stock or senior subordinated notes. The price of the EISs or separately held senior subordinated notes may fluctuate substantially, which could negatively affect EIS holders or holders of senior subordinated notes. None of our EISs, shares of common stock or senior subordinated notes has a relevant public market history. Our shares of common stock were publicly traded from August 13, 1993 to April 1, 1998 but have not publicly traded since that time. In addition, there has not been an active market in the United States for securities similar to the EISs. We cannot assure you that an active trading market for the EISs or our senior subordinated notes will develop in the future, and we currently do not expect that an active trading market for the shares of our Class A common stock will develop, if at all, which may cause the price of EISs to fluctuate substantially. If the senior subordinated notes represented by your EISs are redeemed or mature, the EISs will automatically separate and you will then hold the shares of our Class A common stock. We do not intend to list our senior subordinated notes on any securities exchange. Our Class A common stock initially will not be separately listed on the American Stock Exchange and, until a sufficient number of shares of our Class A common stock are held separately and not in the form of EISs as may be necessary to satisfy applicable listing requirements, we will not apply for such listing. If our senior subordinated notes and shares of our Class A common stock are not listed separately on any securities exchange, the trading market for these securities may be limited, which could adversely affect the trading price of these securities and your ability to transfer these securities. Even if the Class A common stock is listed for separate trading, an active trading market may not develop, or even if it develops, may not last, in which case the trading price of the Class A common stock could be adversely affected and your ability to transfer your shares will be limited. The initial public offering prices of the EISs and senior subordinated notes sold separately in this offering have been determined by negotiations among us, the existing equity investors and the representatives of the underwriters and may not be indicative of the market prices of the EISs and senior subordinated notes after this offering. Factors such as quarterly variations in our financial results, announcements by us or others, developments affecting us or the industry in which we operate, our customers and our suppliers, general interest rate levels and general market volatility could cause the market prices of the EISs and senior subordinated notes sold separately in this offering to fluctuate significantly. In addition, to the extent a market develops for shares of our Class A common stock or our senior subordinated notes, or both, separate from the EISs, the price of your EISs may be affected. The limited liquidity of the trading market for the senior subordinated notes sold separately (not represented by EISs) may adversely affect the trading price of the separate senior subordinated notes. We are separately selling $7.5 million aggregate principal amount of senior subordinated notes (not represented by EISs), representing approximately 10% of the total outstanding senior subordinated notes (including those senior subordinated notes represented by EISs and assuming the underwriters exercise their over-allotment option in full). While the senior subordinated notes sold separately (not represented by EISs) are part of the same series of notes as, and are identical to, the senior subordinated notes represented by the EISs, at the time of the issuance of the separate senior subordinated notes, the senior subordinated notes represented by the EISs will not be separable for at least 45 days and will not be separately tradeable until separated. As a result, the initial trading market for the senior subordinated notes sold separately (not represented by EISs) will be very limited. After the holders of the EISs are permitted to separate their EISs, a sufficient number of holders of EISs may not separate their EISs into shares of our Class A common stock and senior subordinated notes so that a sizable and more liquid trading market for the senior subordinated notes not represented by EISs may not develop or may not develop in a timely manner. Trading markets for debt securities have generally treated debt securities issued in larger aggregate principal amounts more favorably than similar securities issued in smaller aggregate principal amounts because of the increased liquidity created by potentially higher trading volumes associated with larger debt issuances. Given that approximately 90% of the senior subordinated notes will initially be represented by EISs, it is likely that the senior subordinated notes sold separately (not represented by EISs) will not trade at prices reflecting the aggregate principal amount of the combined issuance of senior subordinated notes included in the EIS offering and the separate senior subordinated notes offering. Therefore, a liquid market for the senior subordinated notes sold separately (not represented by EISs) may not develop or may not develop in a timely manner, which may adversely affect the ability of the holders of the separate senior subordinated notes to sell any of their separate senior subordinated notes and the price at which these holders would be able to sell any of the senior subordinated notes sold separately (not represented by EISs). Future sales or the possibility of future sales of a substantial amount of EISs, shares of our Class A common stock or our senior subordinated notes may depress the price of these securities. Future sales or the availability for sale of substantial amounts of EISs or shares of our Class A common stock or a significant principal amount of our senior subordinated notes in the public market could adversely affect the prevailing market price of the EISs, the shares of our Class A common stock and our senior subordinated notes, as applicable, and could impair our ability to raise capital through future sales of our securities. Beginning on the 366th day after the consummation of this offering, holders of shares of our Class B common stock will have certain rights to exchange their shares of our Class B common stock for EISs pursuant to the stockholders agreement. Until the second anniversary of the consummation of this offering, our franchise agreements with Wendy's will prohibit the management investors from exercising this exchange right with respect to all of their shares of our Class B common stock, and our stockholders agreement will restrict the holders of shares of our Class B common stock from exercising this exchange right if, following the exchange, the holders of shares of our Class B common stock would hold less than 1,250,860 shares of our Class B common stock, representing 10% of our common stock equity at the closing of this offering (or less than 1,135,578 shares assuming full exercise of the underwriters' over-allotment option). Any exchange is subject to the terms of our new credit facility, the indenture governing our senior subordinated notes and our franchise agreements with Wendy's. In addition, any issuance of EISs upon exchange must occur pursuant to an effective registration statement under the Securities Act. For a complete description of this exchange right and the terms of our Class A and Class B common stock, see "Related Party Transactions Amendment and Restatement of Stockholders Agreement" and "Description of Capital Stock." We may issue shares of our Class A common stock and senior subordinated notes, which may be in the form of EISs, or other securities from time to time as consideration for future acquisitions and investments. In the event any such acquisition or investment is significant, the number of shares of our Class A common stock and the aggregate principal amount of senior subordinated notes, which may be in the form of EISs, or the number or aggregate principal amount, as the case may be, of other securities that we may issue may in turn be significant. In addition, we may also grant registration rights covering those EISs, shares of our Class A common stock, senior subordinated notes or other securities in connection with any such acquisitions and investments. You may be required to sell your EISs or Class A common stock and may be deprived of an opportunity to obtain a takeover premium for your securities as a result of the 20% ownership limitations imposed on us by Wendy's. Our franchise agreements with Wendy's provide that, if at any time, any person or group acting together (other than the management investors) directly or indirectly owns, controls or exercises control or direction over or is the beneficial owner of more than 20% the total economic value of the total outstanding equity interests in our company or more than 20% of the total outstanding voting interests in our company and we do not within ten days of the date that we first have knowledge of such ownership or control, take steps as may be permitted under our amended and restated certificate of incorporation to reduce such interest to 20% or lower or if such ownership or control remains at more than a 20% of ownership level for more than 90 days after the date we first have knowledge of such ownership or control, such ownership or control shall constitute a default under the franchise agreements with Wendy's International. In such event, Wendy's International has, among other things, the right to terminate any and all of the franchise agreements or exercise its purchase option. Pursuant to our amended and restated certificate of incorporation, in the event that either of the foregoing limitations is or may be contravened, we may take such action with respect to such ownership level over the 20% ownership level as we deem advisable, including refusing to give effect thereto on the stock transfer books, instituting proceedings, redeeming such interest or requiring the sale of such interest in order to reduce the ownership level to or below a 20% ownership level. Upon taking any such action, the affected holders will cease to be holders of that portion of their interest over the 20% ownership level. For the purpose of the foregoing, the 20% ownership limitations will be applicable to holdings of outstanding shares of our Class A common stock, as components of EISs or held separately, as well as all other classes of our capital stock. Our amended and restated certificate of incorporation and amended and restated by-laws contain provisions that could result in adverse consequences to holders of our common stock. Our amended and restated certificate of incorporation authorizes the issuance of preferred stock and Class C common stock without stockholder approval and, in the case of the preferred stock, upon such terms applicable to the preferred stock as the board of directors may determine. The rights of the holders of shares of our common stock will be subject to, and may be adversely affected by, the rights of holders of any class or series of preferred stock that may be issued in the future. If interest rates rise, the trading value of our EISs and senior subordinated notes may decline. Should interest rates rise further or should the threat of rising interest rates continue to develop, debt markets may be adversely affected. As a result, the trading value of our EISs and senior subordinated notes may decline. Risks Related to our Business and Industry The competitive nature of the quick service restaurant market and the effect of fluctuating demographics and consumer trends may harm our business. The restaurant industry generally, and, the quick service restaurant market in particular, is intensely competitive with respect to price, service, location, type and quality of food and personnel. We compete with other well-established companies with extensive financial, technological, marketing and personnel resources and high brand name recognition and awareness. Some of those competitors have been in existence substantially longer than us, have substantially greater financial and other resources than us and have substantially more restaurants or may be better established in the markets where our restaurants are or may be located. McDonald's and Burger King restaurants are our principal competitors in the hamburger segment of the quick service restaurant market and both have substantially more restaurants in our exclusive franchise territory than we do. We also compete with other national and regional restaurant franchises and with non-franchise restaurants. Some of our quick service restaurant competitors have from time to time attempted to draw customer traffic through deep discounting. While we do not believe that this is a profitable long-term strategy, these changes in pricing and other marketing strategies have at times had, and in the future could have, a negative impact on our financial performance. The quick service restaurant market is also affected by changes in demographic trends, traffic patterns, and the type, number and proximity of competing quick service restaurants. In addition, factors such as inflation, increased food, labor and benefits costs, and the availability of experienced management and hourly-paid employees may also adversely affect the financial performance of the quick service restaurant industry in general and the financial performance of our restaurants in particular. Our success also depends on numerous factors affecting discretionary consumer spending, including economic conditions, disposable consumer income and consumer confidence. Adverse changes in these factors could reduce customer traffic or impose limits on pricing, either of which would negatively affect our financial performance. Public health concerns about the safety of beef products and our other menu items could adversely impact our financial performance. Certain events such as the recent report of bovine spongiform encephalopathy, also known as BSE or "mad cow disease," could reduce consumption of our beef products. For the fiscal year 2003, approximately 32% of our sales were derived from beef products. Until now, we have not experienced any decrease in sales that we can trace to public health concerns regarding "mad cow disease" or the safety of the nation's beef supply, however, there can be no assurances that we will not be adversely affected in the future. Changes in the regulation of the beef industry as a result of the discovery of "mad cow disease" in the U.S. may affect the supply of beef or significantly increase the price of beef, which may in turn have a material adverse impact on our financial performance. Other public health concerns about "foot/mouth disease," salmonella or avian flu in chicken also may reduce the consumption of our food products and adversely affect our financial performance. Changes in consumer preferences could adversely affect our financial performance. Our success depends, in part, upon the continued popularity of our hamburgers, chicken breast sandwiches, salads, chili, French fries and soft drinks. In recent years, numerous companies in the quick service restaurant industry have introduced food items positioned to capitalize on the growing consumer preference for food items that are, or are perceived to be, healthy, nutritious or low in calories, carbohydrates or fat content. Shifts in consumer preferences could be based on health concerns related to the cholesterol, carbohydrate or fat content of certain food items, including items featured on our menu. Negative publicity over the health aspects of such food items may adversely affect consumer demand for our menu items and could adversely affect our financial performance. We rely on the availability and quality of raw materials, which, if unavailable, may have a material adverse effect on our financial performance. Our financial performance is dependent on our continuing ability to offer fresh, premium quality food at competitive prices. Various factors beyond our control may affect the availability, quality and price of the raw materials such as fresh beef, chicken or bacon, used in our products. A significant reduction in the availability or quality of the raw materials purchased by us, or an increase in price that cannot be passed on to our customers could have a material adverse effect on our financial performance. We are highly dependent on Wendy's International and our success is tied to the success of Wendy's International. We are a franchisee of Wendy's International and are highly dependent on Wendy's International for our operations. Due to the nature of franchising and our agreements with Wendy's International, our success is, to a large extent, directly related to the success of the Wendy's International restaurant system, including the financial condition, management and marketing success of Wendy's International and the successful operation of Wendy's restaurants owned by other franchisees. In turn, the ability of the Wendy's system to compete effectively depends upon the success of the management of the Wendy's system by Wendy's International. There can be no assurance that Wendy's International will be able to compete effectively with other quick service restaurants. Under our franchise agreements with Wendy's International, we are required to comply with operational programs and standards established by Wendy's International. In particular, Wendy's (Unaudited) Operating activities Net (loss) income $ (18,152 ) $ 5,058 $ 2,735 $ 719 $ (3,291 ) Adjustments to reconcile net (loss) income to net cash provided by operating activities: Depreciation 4,020 3,646 3,676 2,832 2,741 Amortization of leased properties 2,729 2,616 2,866 2,044 2,274 Amortization of franchise rights 180 189 190 143 142 Amortization of goodwill 1,497 Net loss (gain) on disposal of assets held for sale and write-down of impaired long-lived assets 10,784 (757 ) (963 ) (181 ) (455 ) Amortization of deferred financing costs 731 1,497 1,536 1,152 1,152 Write-off of deferred offering and related costs 6,041 Net loss on disposition of fixed assets 2,035 54 55 94 Deferred income taxes 734 307 307 Other 122 Changes in operating assets and liabilities: Receivables 297 99 (420 ) 357 588 Inventories 138 259 34 (42 ) (18 ) Income tax receivable 77 (1,958 ) 1,958 1,958 Prepaid expenses and other assets (192 ) (329 ) 74 658 879 Accounts payable and other accrued expenses 4,119 (76 ) (376 ) (2,321 ) 149 Accrued advertising and royalty fees 2 472 777 800 172 Accrued salaries and wages 17 1,654 International maintains discretion over the menu items that we can offer in our restaurants. We may be under market pressure to adopt price discount promotions that may be unprofitable. We are also required to pay Wendy's International a technical assistance fee upon the opening of each new restaurant, a monthly royalty and a national advertising fee. If we fail to comply with any of the agreements that govern our relationship with Wendy's International for restaurants within our exclusive franchise territory, Wendy's International could terminate the exclusive nature of our franchise rights in such territory or the franchise rights for the restaurant governed by the new unit franchise agreement. The termination of the exclusive nature of our franchise rights in such territory or of franchise rights for the restaurant governed by the new unit franchise agreement could have a material and adverse impact on our operations and would have a material and adverse impact on our future development plans. Wendy's International must approve our opening of any new restaurant, including restaurants opened within our exclusive franchise territory, and the closing of any of our existing restaurants. Wendy's International has a right of first refusal to acquire existing Wendy's restaurants which we may seek to acquire. Although Wendy's International has historically granted its approval for most of our acquisition requests, we cannot be assured that they will continue to do so. Upon their expiration, we may renew the new unit franchise agreements for additional periods equal to the term in Wendy's International's standard form of franchise agreement being executed by other franchisees renewing their franchises on the renewal date, provided that, among other things, we are not in default under any of the franchise agreements, we are up to date on our payments to Wendy's International and we pay a renewal fee. The terms of the new unit franchise agreements are renegotiated upon renewal and we cannot be assured that we will successfully negotiate the terms of the renewal with Wendy's International or that the terms of the new unit franchise agreements we negotiate upon renewal will not differ materially from those in effect during the initial term. See "Business Relationship with Wendy's International." Wendy's International is not selling, offering for sale nor underwriting all or any part of this offering. Wendy's International is not receiving the proceeds of this offering. Wendy's International does not endorse or make any recommendations with respect to this offering or the EISs offered hereby. Wendy's International is not an obligor under the senior subordinated notes which are part of this offering and has no obligation with respect to the payment of principal or interest under the senior subordinated notes. If we fail to comply with the terms of our development agreement or other agreements with Wendy's International, Wendy's International has the right, among other things, to terminate our franchise agreements or exercise its remedies under leasehold mortgages we have granted to Wendy's to secure our obligations under the franchise agreements. Under our development letter with Wendy's International relating to our exclusive franchise territory, we commit to operate a total of 240 restaurants in our franchise territory by December 31, 2015. Should we fail to comply with the development letter or default under any franchise agreement or any other agreement with Wendy's International, its affiliates or its advertising co-operative, or the material provisions of its restaurant supply agreements, Wendy's International could, among other things, terminate the development letter and the exclusive nature of our franchises in our franchise territory. The termination of the exclusive nature of our franchise rights in our territory or the franchise rights for any of our restaurants governed by the new unit franchise agreements could have a material and adverse impact on our operations and our future development plans. See "Business Relationship with Wendy's International." In addition, we have agreed to secure our obligations under the franchise agreements by granting Wendy's International continuing first priority leasehold mortgages on a limited number of our Allocated to Class A common stock $ 4,959 $ (687 ) Allocated to Class B common stock 2,141 restaurants with a value in the aggregate of not less than $10 million. This value is based on a multiple of EBITDA for our most recently completed fiscal year attributable to the restaurants subject to such leasehold mortgages. In the event that we are in default under our franchise agreements and Wendy's or its designees determines to succeed to the leasehold interests pursuant to the leasehold mortgages, Wendy's or its designees will have the right to operate these restaurants. See "Business Relationship with Wendy's International Operating Requirements of Wendy's International Security for our obligations." Finally, Wendy's International is entitled to a right of first refusal, a purchase option and a right of consent in respect of certain transactions described in "Business Relationship with Wendy's International Ownership and Other Requirements of Wendy's International." These entitlements may restrict our ability to undertake certain transactions. We face substantial risks with regard to our plans for growth and development. We intend to grow our business by opening new Wendy's restaurants. Our development letter with Wendy's International requires us to open or commence construction of a prescribed minimum number of restaurants in each year through 2015, and to operate a total of 240 restaurants in our franchise territory by December 31, 2015. Although we currently have no plans to explore other restaurant concepts, subject to obtaining Wendy's prior consent, we may do so in the future. Our growth and development plans involve substantial risks, including the following: our inability to obtain the necessary approvals of Wendy's International; our inability to obtain or self-fund adequate development financing; that our development costs may exceed budgeted amounts; the unavailability of suitable sites; our inability to obtain suitable sites on acceptable lease or purchase terms; our inability to obtain all necessary zoning, construction and other permits; our inability to adequately supervise construction and delays in completion of construction; the incurrence of substantial unrecoverable costs in the event we abandon a development project prior to completion; our inability to recruit, train and retain managers and other employees necessary to staff each new restaurant; that new restaurants may not perform in accordance with targeted sales or cash flow levels or match the performance of our other restaurants; that new restaurants may result in reduced sales at our existing restaurants near newly opened restaurants; changes in governmental rules, regulations and interpretations; and changes in general economic and business conditions. We cannot assure that our growth and development plans can be achieved. If the management investors fail to hold a prescribed interest in us, Wendy's International has the right to, among other things, terminate our franchise agreements. The franchise agreements with Wendy's International require that as of, and at all times following, the closing of this offering, the management investors who, immediately after the recapitalization will be Ronald D. Kirstien, Harvey Rothstein, David J. Norman, Joseph F. Cunnane, III and Richard H. Borchers, own, in the aggregate and free and clear of liens, encumbrances or other restrictions, a prescribed interest in our company. Until the second anniversary of the closing of this offering, the management investors are required to own not less than 10% of the total economic value of the total outstanding equity interests and not less than 10% of the total outstanding voting interests in our company, determined at the closing of this offering. After the second anniversary of the closing of this offering, the management investors are required to own not less than 10% of the outstanding total economic value of the total outstanding equity interests and not less than 10% of the total outstanding voting interests determined at that time. If the management investors' interest level changes solely as a result of the exchange by one or more of the management investors of their shares of our Class B common stock for EISs after the second anniversary of the closing of this offering, the management investors may own less than such 10% interest provided that Citicorp Venture Capital, together with the management investors, own not less than such 10% interest and provided further that the management investors own not less than the greater of the initial 10% interest determined at the closing of this offering or 5% of the total outstanding economic value of the total outstanding equity interests and not less than 5% of the total outstanding voting interests determined at that time. The franchise agreements also impose restrictions on transfer of the interest in our company held by the management investors, and in certain circumstances, provide Wendy's International with a right to consent and a right of first refusal on proposed transfers of such interest. If the management investors fail to hold the prescribed interest, directly or indirectly, in our company, Wendy's International is entitled, among other things, to terminate the franchise agreements. See "Business Relationship with Wendy's International Ownership and Other Requirements of Wendy's International Ownership requirements for management investors." Wendy's International has certain rights of first refusal, purchase rights and consent rights in connection with a change in our ownership, transfers of assets, future offerings of EISs and other securities and certain other events affecting the EISs. Pursuant to the franchise agreements, Wendy's International also has, subject to certain exceptions, a right of first refusal to acquire the interests or assets proposed to be transferred or issued and a right to consent to any such transfer, including on: a proposed transfer by us of any ownership or equity interest in our operating subsidiary, DavCo Operations; a proposed transfer of any portion of the shares of our common stock owned by the management investors; a proposed issuance of securities in any public or private sale of any ownership or equity interest in DavCo Restaurants (other than this offering, as to which Wendy's has consented) or DavCo Operations; a proposed transfer of one or more Wendy's restaurants or any of the franchise agreements; or a proposed direct or indirect transfer of all or substantially all of the Wendy's business or the assets of the Wendy's business or of any part of the Wendy's business or assets such that the assets proposed to be transferred comprise all or substantially all of the assets of one or more Wendy's restaurants; except that, after this offering, this right of first refusal will not be applicable to, among other things, a transfer of outstanding EISs (and the shares of Class A common stock and senior subordinated notes outstanding upon any future separation of any EISs), shares of Class A common stock and/or senior subordinated notes. Failure to comply with the right of first refusal constitutes a default under the franchise agreements, permitting Wendy's International to, among other things, terminate such agreements, as well as to exercise its purchase option. The franchise agreements provide Wendy's International with an option to purchase: (i) all of the equity interests in DavCo Operations; and/or (ii) all of the assets of DavCo Restaurants and all of the assets of DavCo Operations relating to the business, ownership and operation of Wendy's restaurants, at fair market value in the event that, among other things: our company transfers, permits the transfer or suffers a transfer of any direct or indirect interest in DavCo Restaurants or DavCo Operations in violation of any terms and conditions of any right of first refusal held by Wendy's International; any transfer of any direct or indirect interest by or in our company or DavCo Operations in violation of the consent requirements of Wendy's International occurs; any transfer pursuant to, or demand for payment made under, any guarantee by DavCo Restaurants or DavCo Operations, including the guarantee of the senior subordinated notes occurs; any person or group acting together (other than the management investors and Citicorp Venture Capital) acquires more than 20% of the total economic value of the total outstanding equity interests or more than 20% of the total outstanding voting interests in our company in violation of the terms of Wendy's consent; or the terms of the indenture governing our senior subordinated notes are amended in a manner which would be in violation or inconsistent with the provisions of Wendy's consent without the prior written consent of Wendy's International. See "Business Relationship with Wendy's International Ownership and Other Requirements of Wendy's International." We are required to obtain Wendy's consent for certain future public or private offerings of our securities which may affect our ability to raise capital. If, solely as a result of the dilutive effects of the issuance of shares of our Class A common stock or EISs in a proposed follow-on offering, the management investors would own less than 10% of the total economic value of the total outstanding equity interests or total outstanding voting interests in our company, the franchise agreements provide that such reduction in ownership requires the prior consent of Wendy's. As a condition of such consent, Wendy's may require that the management investors own, after giving effect to the proposed follow-on offering, not less than a prescribed interest in our company and that at all times following the second anniversary of the closing of the follow-on offering, the management investors own, together with the holdings of Citicorp Venture Capital, no less than 10% of the total economic value of the total outstanding equity interests or total outstanding voting interests in our company. We are not required to obtain Wendy's consent for future public or private offerings of our senior subordinated notes. Except as described above, Wendy's International has agreed that its right of first refusal will not apply and, subject to the fulfillment of certain conditions (including the condition that subsequent offerings will not materially and adversely affect the rights of Wendy's International under the franchise agreements), its consent will not be required should we undertake offerings of shares of our Class A common stock or EISs to the public in the United States (which offerings may include private placements of shares of our Class A common stock or EISs in the United States in accordance with Rule 144A of the Securities Act) which are consummated not later than December 31, 2015 and all of the net proceeds of which are used in connection with the Wendy's business. The requirement to obtain Wendy's prior consent to certain follow-on offerings of our Class A common stock or EISs and the requirement that the management investors own not less than a prescribed interest in our company may affect our ability to effect follow-on offerings to raise capital. Changes in geographic concentration and regional conditions may negatively impact our operations. All of our restaurants are located in the same region. As a result, a severe or prolonged economic recession or changes in demographic mix, employment levels, population density, weather patterns, real estate market conditions or other factors unique to our geographic region may adversely affect us more than some of our competitors that are more geographically diverse. Increased costs beyond our control may negatively affect our operations and have a material adverse affect on our financial performance. Our labor costs are substantial and we may not be able to offset increased labor costs with increased sales. Our operations are subject to federal and/or state minimum wage laws governing matters such as working conditions and overtime. Significant numbers of our restaurant employees are paid at rates related to the minimum wage and, accordingly, further increases in the minimum wage or mandatory health insurance coverage requirements could increase our labor costs and adversely affect our financial performance. Our success depends on a number of key personnel, the loss of whom could have an adverse effect on our financial performance. Our success depends on the personal efforts of a small group of skilled employees and experienced senior management. Although we believe we will be able to replace key employees within a reasonable time should the need arise, the loss of key personnel could have a material short-term adverse effect on our financial performance. We believe that it would be difficult to replace members of the senior management team with individuals having comparable experience. Consequently, the loss of the services of any member of the senior management team could have a material adverse effect on our financial performance. In addition, under our franchise agreements with Wendy's International, Ronald D. Kirstien, our President and Chief Executive Officer, Harvey Rothstein, our Senior Executive Vice President, and Joseph F. Cunnane, III, our Executive Vice President of Operations, have each been designated by Wendy's International as the individuals responsible for the development and management of our restaurants. If Mr. Kirstien, Mr. Rothstein or Mr. Cunnane (or any other successor approved by Wendy's International) leaves us, any replacement operator must first be approved by Wendy's International. There can be no assurance that Wendy's International will approve the replacement operator we propose. See "Business Relationship with Wendy's International." We may experience labor shortages which may affect the quality level of customer service and lead to reduced customer traffic which could have an adverse effect on our financial performance. In times of high demand for employees, such as during the period of robust economic growth in the U.S. in 2000 and 2001, we experienced labor shortages. A labor shortage may affect the quality level of customer service and lead to reduced customer traffic and can adversely affect our financial performance. There can be no assurance we will not experience labor shortages in the future. We are subject to government regulation and changes to those regulations may affect our operations. We are subject to various federal, state and local laws affecting our business. See "Business Government Regulation." The laws that affect our business include those relating to the preparation and sale of food, employment and discrimination, zoning, building restrictions, and design and operation of our restaurants. Difficulties obtaining or failure to obtain the required licenses or approvals could delay or prevent our development of new restaurants in a particular area and have an adverse impact on our operations and future development plans. We may be subject to significant environmental liabilities. In certain cases, we have agreed to indemnify the purchasers of our former properties for liabilities arising thereon or have agreed to remain liable for certain potential liabilities that were not assumed by the purchaser. Environmental contamination of soil and groundwater by petroleum constituents have been identified at eight properties we currently or formerly operated, although we believe further remedial action will not be required at these properties. Several additional restaurant properties had previous petroleum distribution or industrial uses which may have resulted in contamination, and the prior uses and potential for contamination at a number of additional restaurant properties are unknown. We were one of several defendants in two related lawsuits filed in federal and state court in Missouri in 1995 seeking recovery of petroleum cleanup costs at a former gasoline service station property that we leased in St. Charles, Missouri. The lawsuit was dismissed without prejudice in May 2002 but can be re-filed. Although no specified amount of damages was sought, based on our understanding of the claims in the lawsuits, the total estimated damages would have been expected to be less than $100,000 and the damages sought would be proportionate to the number of the defendants in the chain of title prior to the plaintiffs for restitution of legal and remediation expenses. The parties recently entered into an extension of their standstill agreement to facilitate a potential resolution of the cleanup costs and a determination to what extent such costs would be reimbursed by the state Petroleum Storage Tank Insurance Fund, which the parties believe may pay all or a substantial portion of the cleanup costs. Potential litigation resulting in a significant judgment and/or adverse publicity could have a material adverse affect on our performance. We may be subject to complaints, regulatory proceedings or litigation from customers or other persons alleging food-related illness, injuries suffered on our premises or other food quality, health or operational concerns, including improper handling and preparation in food items and environmental claims. Adverse publicity resulting from such allegations or alleged discrimination or other operating issues stemming from one Wendy's location or a limited number of Wendy's locations could adversely affect our business, regardless of whether the allegations are true, or whether or not our company or another Wendy's restaurant franchisee is ultimately held liable. A significant judgment against us could have a material adverse effect on our financial performance.

parsed_sections/risk_factors/2004/CIK0000922237_enova_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ RISK FACTORS You should carefully consider the following risks and all other information contained in this prospectus before you decide to buy our common stock. We have included a discussion of each material risk that we have identified as of the date of this prospectus. If any of the following risks actually occur, our business, financial condition or operating results could suffer. If this occurs, the trading price of our common stock could decline, and you could lose all or part of the money you paid to buy our common stock. Risks Relating to this Offering Economic conditions beyond our control may keep the price of our stock low. Numerous factors, many of which are beyond our control, may cause the market price of our common stock to fluctuate significantly. These factors include, but are not limited to, the following: o continued losses; o announcements concerning us, our competitors or our customers; o market conditions in the electric vehicle and the hybrid electric vehicle industry and the general state of the securities markets. General economic, political and market conditions, including recession, international instability or military tension or conflicts may adversely affect the market price of our common stock. If we are named as a defendant in any securities-related litigation as a result of decreases in the market price of our shares, we may incur substantial costs, and our management's attention may be diverted, for lengthy periods of time. The market price of our common stock may not increase above the offering price or maintain its price at or above any particular level. Securities traded on the OTC Bulletin Board are generally thinly traded and an active market may never develop. Our common stock trades on the OTC Bulletin Board. Shares traded in the OTC market are generally bought and sold in small amounts, highly volatile and not usually followed by analysts. You may therefore have difficulty selling your shares in the resale market. "Penny stock" regulations may impose restrictions on marketability of our stock. The Securities and Exchange Commission has adopted regulations which generally define "penny stock" to be any equity security that is not traded on a national securities exchange or NASDAQ and that has a market price of less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exceptions. Since our securities that are currently included on the OTC Bulletin Board are trading at less than $5.00 per share at any time, our stock 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 accredited investors. Accredited investors generally include investors that have assets in excess of $1,000,000 or an individual annual income exceeding $200,000, or together with the investor's spouse, a joint income of $300,000. For transactions covered by these rules, the broker-dealer must make a special suitability determination for the purchase of the securities and must receive the purchaser's written consent to the transaction prior to the purchase. Additionally, for any transaction involving penny stock, unless exempt, the rules require, among other things, the delivery, prior to the transaction, of a risk disclosure document mandated by the SEC relating to the penny stock market and the risks associated therewith. The broker-dealer must also disclose the commission 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 our securities and may affect your ability to sell your shares in the secondary market. We do not expect to pay dividends in the foreseeable future. We have not declared or paid any cash dividends in the past and do not expect to pay cash dividends in the foreseeable future. We intend to retain our future earnings, if any, to finance the development of our business. We are required to pay dividends on our Series A Stock and our Series B Stock before we may pay dividends on our common stock. At March 31, 2004, we had an accumulated deficit of approximately $97,238,000 and, until this deficit is eliminated, we are prohibited from paying dividends on any class of our stock except out of net profits unless we can meet certain assets and other tests under Sections 500 through 511 of the California Corporations Code. Our board of directors will determine any future dividend policy in light of the all of the foregoing information and then existing conditions, including our earnings, financial condition and financial requirements. You may never receive dividend payments from us. The market price of our Common Stock could be adversely affected by sales of a substantial number of shares of our Common Stock As of the date of this prospectus, we have outstanding 401,853,232 shares of common stock, 2,790,136 shares of Series A Stock, each of which is convertible into one share of common stock, and 1,217,196 shares of Series B Stock, each of which is convertible into two shares of common stock. Sales of a substantial number of shares of our common stock in the public market following this offering could cause our stock price to decline. All the shares sold in this offering will be freely tradable. Currently 154,180,500 shares of common stock are freely tradable and an additional 5,224,500 shares of Series A Stock or Series B Stock would be freely tradable upon conversion to common stock. Approximately an additional 247,672,700 shares of common stock are eligible for sale in the public market subject to volume restrictions of Rule 144 and 15,594,288 shares of common stock issuable upon exercise of outstanding options will become freely tradable upon issuance. In addition, the sale of these shares could cause our stock price to decline and impair our ability to raise capital through the sale of additional stock. See "Shares Eligible for Future Sale." Our principal shareholders, executive officers and directors have substantial control over most matters submitted to a vote of the shareholders, thereby limiting your power to influence corporate action. Our officers, directors and principal shareholders beneficially own approximately 60% of our common stock (including in that percentage shares of our Series A Stock and Series B Stock). As a result, these shareholders have the power to control the outcome of most matters submitted to a vote of shareholders, including the election of members of our board, and the approval of significant corporate transactions. The shareholders purchasing shares in this offering will have little influence on these matters. This concentration of ownership may also have the effect of making it more difficult to obtain the needed approval for some types of transactions that these shareholders oppose, and may result in delaying, deferring or preventing a change in control of our company. The effects of anti-takeover provisions in our charter and bylaws could inhibit the acquisition of us by others. Several provisions of our articles of incorporation and bylaws could discourage potential acquisition proposals and could delay or prevent a change in control of our company. Risks Related to Our Business Our industry is new and is subject to technological changes. The mobile and stationary power markets including electric vehicle and hybrid electric vehicles continue to be subject to rapid technological change. Most of the major domestic and foreign automobile manufacturers: (1) have already produced electric and hybrid vehicles, and/or (2) have developed improved electric storage, propulsion and control systems, and/or (3) are now entering or have entered into production, while continuing to improve technology or incorporate newer technology. Various companies are also developing improved electric storage, propulsion and control systems. In addition, the stationary power market is still in its infancy. A number of established energy companies are developing new technologies. Cost-effective methods to reduce price per kilowatt have yet to be established and the stationary power market is not yet viable. Our current products are designed for use with, and are dependent upon, existing technology. As technologies change, and subject to our limited available resources, we plan to upgrade or adapt our products in order to continue to provide products with the latest technology. We cannot assure you, however, that we will be able to avoid technological obsolescence, that the market for our products will not ultimately be dominated by technologies other than ours, or that we will be able to adapt to changes in or create "leading-edge" technology. In addition, further proprietary technological development by others could prohibit us from using our own technology. There are substantial risks involved in the development of unproven products. In order to remain competitive, we must adapt existing products as well as develop new products and technologies. In fiscal years 2003 and 2002 we spent $799,000 and $1,152,000 respectively on research and development of new products and technology. Despite our best efforts, a new product or technology may prove to be unworkable, not cost effective, or otherwise unmarketable. We can give you no assurance that any new product or technology we may develop will be successful or that an adequate market for such product or technology will ever develop. We may be unable to effectively compete with other companies who have significantly greater resources than we have. Many of our competitors, in the automotive, electronic and other industries, are larger, more established companies that have substantially greater financial, personnel, and other resources than we do. These companies may be actively engaged in the research and development of power management and conversion systems. Because of their greater resources, some of our competitors may be able to adapt more quickly to new or emerging technologies and changes in customer requirements, or to devote greater resources to the promotion and sales of their products than we can. We believe that developing and maintaining a competitive advantage will require continued investment in product development, manufacturing capability and sales and marketing. We cannot assure you that we will have sufficient resources to make the necessary investments to do so. In addition, current and potential competitors may establish collaborative relationships among themselves or with third parties, including third parties with whom we have relationships. Accordingly, new competitors or alliances may emerge and rapidly acquire significant market share. We have continued losses. We have experienced recurring losses from operations and have been profitable in only one year, fiscal 1986. For the three months ended March 31, 2004, we had a net loss of $161,000 on sales of $1,108,000 and an accumulated deficit of $97,238,000. For the twelve months ended December 31, 2003, we had a net loss of $3,186,000 on sales of $4,310,000. For the twelve months ended December 31, 2002, we had a net loss of $3,598,000 on sales of $4,455,000. For the twelve months ended December 31, 2001, we had a net loss of $3,428,000 on sales of $3,780,000. There can be no assurance that we will achieve profitability in the near or foreseeable future or that any net operating losses will be available to us in the future as an offset against future profits for income tax purposes. If we do not raise significant additional capital, we will be unable to fund continuing operations and will likely be forced to reduce or even cease operations. We need substantial working capital to fund our operations. As of March 31, 2004, we had cash, cash equivalents and short-term investment balances of approximately $587,000. Our internal projections show that cash on hand as of March 31, 2004, together with anticipated revenues should be sufficient to fund operations at the current level for at least the next 12 months December 2004. We are currently negotiating to correct a payment default with respect to a $120,000 unsecured note to Jeann Schulz. Unless we are successful in our efforts to raise additional funds, our cash resources will be used to satisfy our existing liabilities, such as that of Ms. Schulz, and we will be unable to fund our current operations, which may result in the reduction of operations. Even if we are successful in these efforts to raise funds, such funds may not be adequate to fund our operations on a long-term basis. Future equity financings may dilute your holdings in our company. We need to obtain additional funding through public or private equity or debt financing, collaborative agreements or from other sources. If we raise additional funds by issuing equity securities, current shareholders may experience significant dilution of their holdings. We may be unable to obtain adequate financing on acceptable terms, if at all. If we are unable to obtain adequate funds, we may be required to reduce significantly our spending and delay, scale back or eliminate research, development or marketing programs, or cease operations altogether. Potential intellectual property, shareholder or other litigation could adversely impact our business. Because of the nature of our business, we may face litigation relating to intellectual property matters, labor matters, product liability or shareholder disputes. Any litigation could be costly, divert management attention or result in increased costs of doing business. Although we intend to vigorously defend any future lawsuits, we cannot assure you that we would ultimately prevail in these efforts. An adverse judgment could negatively impact the price of our common stock and our ability to obtain future financing on favorable terms or at all. We may be exposed to product liability or tort claims if our products fail, which could adversely impact our results of operations. A malfunction or the inadequate design of our products could result in product liability or other tort claims. Accidents involving our products could lead to personal injury or physical damage. Any liability for damages resulting from malfunctions could be substantial and could materially adversely affect our business and results of operations. In addition, a well-publicized actual or perceived problem could adversely affect the market's perception of our products. This could result in a decline in demand for our products, which would materially adversely affect our financial condition and results of operations. We are highly subject to general economic conditions. The financial success of our company is sensitive to adverse changes in general economic conditions, such as inflation, unemployment, and consumer demand for our products. These changes could cause the cost of supplies, labor, and other expenses to rise faster than we can raise prices. Such changing conditions also could significantly reduce demand in the marketplace for our products. We have no control over any of these changes. We are an early growth stage company. Although our company was originally founded in 1976, many aspects of our business are still in the early growth stage development, and our proposed operations are subject to all of the risks inherent in a start-up or growing business enterprise, including the likelihood of continued operating losses. We are relatively new in focusing our efforts on electric systems, hybrid systems and fuel cell managed systems. The likelihood of our success must be considered in light of the problems, expenses, difficulties, complications, and delays frequently encountered in connection with the growth of an existing business, the development of new products and channels of distribution, and current and future development in several key technical fields, as well as the competitive and regulatory environment in which we operate. We operate in a highly regulated business environment and changes in regulation could impose costs on us or make our products less economical. Our products are subject to federal, state, local and foreign laws and regulations, governing, among other things, emissions as well as laws covering occupational health and safety. Regulatory agencies may impose special requirements for implementation and operation of our products or may significantly impact or even eliminate some of our target markets. We may incur material costs or liabilities in complying with government regulations. In addition, potentially significant expenditures could be required in order to comply with evolving environmental and health and safety laws, regulations and requirements that may be adopted or imposed in the future. We are highly dependent on a few key personnel and will need to retain and attract such personnel in a labor competitive market. Our success is largely dependent on the performance of our key management and technical personnel, including Carl Perry, our Chief Executive Officer, Larry Lombard, our Acting Chief Financial Officer, Edward Moore, our Chief Operating Officer and Don Kang, our Vice President of Engineering, the loss of one or more of whom could adversely affect our business. Additionally, in order to successfully implement our anticipated growth, we will be dependent on our ability to hire additional qualified personnel. There can be no assurance that we will be able to retain or hire other necessary personnel. We do not maintain key man life insurance on any of our key personnel. We believe that our future success will depend in part upon our continued ability to attract, retain, and motivate additional highly skilled personnel in an increasingly competitive market. There are minimal barriers to entry in our market. We presently license or own a limited amount of proprietary technology and, therefore, have created little or no barrier to entry for competitors other than the time and significant expense required to assemble and develop similar production and design capabilities. Our competitors may enter into exclusive arrangements with our current or potential suppliers, thereby giving them a competitive edge which we may not be able to overcome, and which may exclude us from similar relationships. Our industry is affected by political and legislative changes. In recent years there has been significant public pressure to enact legislation in the United States and abroad to reduce or eliminate automobile pollution. Although states such as California have enacted such legislation, we cannot assure you that there will not be further legislation enacted changing current requirements or that current legislation or state mandates will not be repealed or amended, or that a different form of zero emission or low emission vehicle will not be invented, developed and produced, and achieve greater market acceptance than electric or hybrid electric vehicles. Extensions, modifications or reductions of current federal and state legislation, mandates and potential tax incentives could also adversely affect our business prospects if implemented. CAUTIONARY NOTE ON FORWARD-LOOKING STATEMENTS Some of the matters discussed under the captions "Prospectus Summary," "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business" and elsewhere in this prospectus include forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "could," "predicts," "potential," "continue," "expects," "anticipates," "future," "intends," "plans," "believes," "estimates" and similar expressions. These statements are based on our current beliefs, expectations and assumptions and are subject to a number of risks and uncertainties. Actual results, levels of activity, performance, achievements and events may vary significantly from those implied by the forward-looking statements. A description of risks that could cause our results to vary appears under the caption "Risk Factors" and elsewhere in this prospectus. These forward-looking statements are made as of the date of this prospectus, and, except as required under applicable securities law, we assume no obligation to update them or to explain the reasons why actual results may differ.

parsed_sections/risk_factors/2004/CIK0000927829_nitromed_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ Risk factors An investment in our common stock involves a high degree of risk. You should carefully consider the following risk factors, which we believe are the most significant risk factors we face, before you decide to buy our common stock. Risks relating to our business Because we have a history of losses and our future profitability is uncertain, our common stock is a highly speculative investment. We have experienced significant operating losses since our inception in 1992. For the nine-month period ended September 30, 2004, we had a net loss of $20.1 million. As of September 30, 2004, we had an accumulated deficit of approximately $126.9 million. We expect that we will continue to incur substantial losses and that our cumulative losses will increase as our commercialization, research and development efforts expand. We expect that the losses that we incur will fluctuate from quarter to quarter and that these fluctuations may be substantial. To date, we have not recorded any revenue from the sale of products, and we will not be able to do so unless and until one of our products completes clinical trials and receives regulatory approval. BiDil is our only product candidate that has advanced into late-stage clinical trials, and we do not anticipate receiving revenues from BiDil until at least 2005, if ever. All of our other product candidates are in research or pre-clinical development, will require significant additional testing prior to submission of any regulatory applications and, as such, are not expected to be commercially available for many years, if at all. A large portion of our expenses is fixed, including expenses related to facilities, equipment and personnel. In addition, we expect to spend significant amounts to fund commercialization, research and development of our product candidates and to enhance our core technologies. As a result, we expect that our operating expenses will continue to increase significantly in the near term and, consequently, we will need to generate significant revenue to achieve profitability. At the present time we are unable to estimate the level of revenues, if any, that we will realize from the commercialization of our product candidates, including BiDil. We are therefore unable to estimate when we will achieve profitability, if at all. Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis. Our failure to become and remain profitable could depress the market price of our common stock and could impair our ability to raise capital, expand our business, diversify our product offerings or continue our operations. We are heavily dependent on obtaining regulatory approval for and successfully commercializing BiDil, our most advanced drug candidate. Our financial, operational and management resources are primarily dedicated to our most advanced drug candidate, BiDil, which has not been approved by the FDA. In July 2004, we halted our phase III confirmatory clinical trial of BiDil on the recommendation of the independent Data and Safety Monitoring Board and the trial's steering committee due to a significant survival benefit seen in African American patients taking the drug. We submitted the clinical dataset from the trial to the FDA on November 1, 2004 and expect to file an amendment to our NDA with the FDA by the end of 2004. We will need to receive FDA Michael D. Loberg, Ph.D. Chief Executive Officer NitroMed, Inc. 125 Spring Street Lexington, Massachusetts 02421 (781) 266-4000 (Name, address, including zip code, and telephone number, including area code, of agent for service) approval of our amended NDA before we can market and sell BiDil in the United States. We cannot predict whether or when we may receive FDA approval of BiDil. In particular, while we expect to have available by the end of first quarter of 2005 the sales force and quantities of finished product required to support the launch of BiDil, we do not expect that the FDA will act on our application by that time. Even if we obtain FDA approval, we may not be able to launch BiDil prior to the end of 2005, if at all. Our BiDil clinical trial was performed exclusively on subjects who are self-identified as African American. To our knowledge, the FDA has never approved a drug product for use in a particular ethnic population. The FDA's receptiveness to drugs that are approved and marketed on the basis of different ethnicity-based therapeutic outcomes is untested and may be adversely affected by contrary scientific or public health evidence or political or legal factors. For example, scientific evidence could emerge that suggests that there is no physiological basis to support pharmaceutical development of drugs based upon ethnicity. Moreover, others may express the view that ethnicity is only a sociological concept and, accordingly, there is not a valid basis for the commercialization of medicines based on ethnicity. These factors or others may significantly delay FDA approval of our BiDil application beyond the time normally required for the FDA to act and could prevent us from obtaining FDA approval of BiDil. If we fail to achieve regulatory approval or market acceptance of BiDil, our near-term ability to generate product revenue, our reputation and our ability to raise additional capital will be materially impaired, and the value of an investment in our stock will decline. We will require substantial additional funds and, if additional capital is not available, we may need to limit, scale back or cease our operations. We have used and will continue to require substantial funds to conduct research and development, including pre-clinical testing and clinical trials of our product candidates, and to market and manufacture any products that are approved for commercial sale. For example, we estimate that we will incur significant expenses in the last quarter of 2004 and during 2005 as we develop sales and marketing capabilities and prepare for the anticipated 2005 launch of BiDil, assuming FDA approval. Moreover, we may incur significant additional expenditures to conduct pre-clinical testing of our nitric-oxide stents, nitric oxide-enhancing COX-2 inhibitors, and other early-stage development programs. Because the successful development of these programs is uncertain, we are unable to estimate the actual funds we will require to complete research and development of our product candidates and commercialization of our products. We believe that our existing cash and marketable securities, together with the proceeds of this offering and cash we expect to receive under our collaborations with Boston Scientific and Merck, will be sufficient to support our current operating plan for at least the next 15 months. However, our future capital requirements, and the period in which we expect our current cash to support our operations, may vary from what we expect due to a number of factors, including the following: the time and costs involved in obtaining regulatory approvals for BiDil and our other product candidates; the costs of manufacturing, distributing, marketing and selling BiDil, if and when approved by regulatory authorities; Copies to: Steven D. Singer, Esq. Cynthia T. Mazareas, Esq. Wilmer Cutler Pickering Hale and Dorr LLP 60 State Street Boston, Massachusetts 02109 Telephone: (617) 526-6000 Telecopy: (617) 526-5000 Geoffrey B. Davis, Esq. Ropes & Gray LLP One International Place Boston, Massachusetts 02110 Telephone: (617) 951-7000 Telecopy: (617) 951-7050 the timing, receipt and amount of milestone and other payments, if any, from collaborators; the timing, receipt and amount of sales and royalties, if any, from our potential candidates; the resources required to successfully complete our clinical trials; continued progress in our research and development programs, as well as the magnitude of these programs; the costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims; costs related to acquiring or in-licensing new technologies; and our ability to establish and maintain additional collaborative arrangements. We may be required to seek additional funding in the future and may do so through collaborative arrangements and public or private financings. Additional financing may not be available to us on acceptable terms, or at all. In addition, the terms of the financing may adversely affect the holdings or the rights of our stockholders. For example, if we raise additional funds by issuing equity securities, further dilution to our then-existing stockholders will result. If we are unable to obtain funding on a timely basis, we may be required to significantly curtail one or more of our research or development programs. We also could be required to seek funds through arrangements with collaborators or others that may require us to relinquish rights to some of our technologies, product candidates or products which we would otherwise pursue on our own. If we do not successfully market and sell BiDil or our other product candidates, either directly or through third parties, our future revenue will be limited. We currently have limited sales, marketing and distribution experience. If BiDil is approved, we intend to launch and market BiDil in North America ourselves, using a contract sales force, and, in the future, we may also seek to market other products ourselves which are not already subject to marketing agreements where we believe the target physician market can be effectively reached by the sales force we intend to establish directly or by contract. In order to develop or contract for sales and marketing capabilities, we will have to invest significant amounts of money and management resources. Because we minimized these expenditures prior to obtaining the results of our BiDil clinical trial, we may have insufficient time to build our sales and marketing capabilities in advance of BiDil's expected launch. Moreover, if the approval of BiDil is delayed substantially, or BiDil is not approved, we will have incurred significant unrecoverable expenses. For BiDil and any other product candidates for which we decide to perform for sales, marketing and distribution functions ourselves or through a third party, we could face a number of additional risks, including: we may not be able to attract, build and retain or contract for a significant and qualified marketing or sales force; the cost of establishing or contracting for a marketing or sales force may not be justifiable in light of the revenues generated by any particular product; and our direct sales and marketing efforts may not be successful. Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this registration statement. If the only securities being registered on this form are being offered pursuant to dividend or interest reinvestment plans, please check the following box. If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, other than securities offered only in connection with dividend or interest reinvestment plans check the following box. If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If this form is a post-effective amendment filed pursuant to rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. For products with larger target physician markets, we plan to rely significantly on sales, marketing and distribution arrangements with third parties. For example, we plan to rely on our existing collaboration for the commercialization of stents coated with nitric oxide-releasing compounds if development is successful and such products are approved by the FDA. We may have to enter into additional marketing arrangements in the future. We may not be able to successfully enter into sales, marketing and/or distribution agreements with any other third parties in the future, on terms which are favorable to us, if at all. In addition, we may have limited or no control over the sales, marketing and distribution activities of these third parties. Our future revenues for any products for which we rely on third-party sales, marketing and distribution support will depend heavily on the success of the efforts of these third parties. If our third-party contract sales organization does not devote sufficient resources to our BiDil project, our ability to achieve near-term revenue could be harmed. We recently executed a definitive agreement with Publicis Selling Solutions, Inc., or Publicis, a contract sales organization, pursuant to which, on our behalf, Publicis will recruit, hire, train and employ a specialty sales force of 175 to 200 sales representatives to sell BiDil to our target prescriber markets. If BiDil is approved, our near-term revenue for BiDil will depend heavily upon the success and efforts of Publicis. If Publicis does not devote the resources, time and training required to establish an effective and qualified sales force, our ability to achieve revenue from sales of BiDil will be harmed. Physicians, payors and patients may not be receptive to BiDil or our other product candidiates, if approved, which could prevent us from achieving and maintaining profitability. BiDil and the other product candidates that we are developing are based upon technologies or therapeutic approaches that are not currently in the marketplace. Assuming we receive FDA approval, we plan to market BiDil only in the United States. Key participants in the U.S. pharmaceutical marketplace, such as physicians, payors and patients, may not accept a product intended to improve therapeutic results based on ethnicity. As a result, it may be more difficult for us to convince the medical community and third-party payors and patients to accept and use our products. Our business is substantially dependent on market acceptance of BiDil. If we are unable to launch and commercialize BiDil, we will not generate revenue, and our stock price may decline. Other factors that we believe will materially affect market acceptance of BiDil and our other product candidates under development include: the timing of our receipt of any marketing approvals, the terms of any approval (including labeling requirements and/or limitations), and the countries in which approvals are obtained, if any; the safety, efficacy and ease of administration of BiDil; the success of our physician education programs; and the availability of government and third-party payor reimbursement. Total 97,063 31 (6) 97,088 Less amounts classified as cash and cash equivalents 67,605 THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. The application of our nitric oxide technology is unproven in humans and, as a result, we may not be able to successfully develop and commercialize any products based upon this technology. A component of our strategy is to seek to improve existing medicines with our proprietary nitric oxide technology. Our product candidates include nitric oxide enhancements of existing drugs. Thus, we are modifying compounds whose chemical and pharmacological profiles are well-documented and understood. However, many of our potential product candidates are new molecules with chemical and pharmacological profiles that differ from that of the existing drugs. These compounds may not demonstrate in patients the chemical and pharmacological properties ascribed to them in laboratory studies, and they may interact with human biological systems in unforeseen, ineffective or harmful ways. In addition, it is possible that existing drugs or newly-discovered drugs may not benefit from the application of our nitric oxide technology. If we are not able to successfully develop and commercialize drugs based upon our technological approaches, we will not generate revenue based on these drugs, and the value of our stock will decline. If our clinical trials for any product candidates we advance into clinical testing are not successful, we may not be able to successfully develop and commercialize our products. In order to obtain regulatory approvals for the commercial sale of our product candidates, we or our collaborators will be required to complete extensive clinical trials in humans to demonstrate the safety and efficacy of our product candidates. We may not be able to obtain authority from the FDA or other regulatory agencies to commence or complete these clinical trials. If permitted, such clinical testing may not prove that our drug candidates are safe and effective to the extent necessary to permit us to obtain marketing approvals from regulatory authorities. Moreover, positive results demonstrated in pre-clinical studies and clinical trials that we complete may not be indicative of results obtained in future clinical trials. Furthermore, we, one of our collaborators, institutional review boards or regulatory agencies may suspend clinical trials at any time if it is believed that the subjects or patients participating in such trials are being exposed to unacceptable health risks. Adverse or inconclusive clinical trial results concerning any of our drug candidates could require us to conduct additional clinical trials, result in increased costs and significantly delay the filing for marketing approval for those drug candidates with the FDA or result in a filing for a narrower indication than was originally sought or result in a decision to discontinue development of those drug candidates. The successful completion of our clinical trials will depend on, among other things, the rate of patient enrollment. Patient enrollment is a function of many factors, including the size of the patient population, the nature of the clinical protocol, the availability of alternative treatments, the proximity of patients to clinical sites and the eligibility criteria for the study. We may be unable to enroll the number of patients we need to complete a trial on a timely basis. Moreover, delays in planned patient enrollment for clinical trials may cause us to incur increased costs and delay commercialization. We have relied on academic institutions or clinical research organizations to supervise or monitor some or all aspects of our BiDil trial, and we expect to rely on academic institutions and clinical research organizations for other product candidates we advance into clinical testing. Accordingly, we have less control over the timing and other aspects of these clinical trials than if we conducted them entirely on our own. Balance at December 31, 2001 30,770 $ 80,187 963 $ Balance at December 31, 2002 30,770 $ 82,884 985 $ As a result of these factors, we or third parties on whom we rely may not successfully begin or complete our clinical trials in the time periods we have forecasted, if at all. Moreover, if we incur costs and delays in our programs or if we do not successfully develop and commercialize our products, our stock price could decline. If we and our partners do not obtain and maintain the regulatory approvals required to market and sell BiDil and our other product candidates, then our business will be unsuccessful, and the market price of our stock will substantially decline. We and our partners will not be able to market any of our products in the United States, Europe or in any other country without marketing approval from the FDA or equivalent foreign regulatory agency. The regulatory process to obtain market approval for a new drug or medical device takes many years and requires expenditures of substantial resources. We have had only limited experience in preparing applications and obtaining regulatory approvals. If we do not receive required regulatory approval or clearance to market BiDil or any of our other product candidates, we will not be able to develop and commercialize these products, which will affect our ability to achieve profitability and cause the value of our common stock to substantially decline. If we, our third-party manufacturers or our service providers fail to comply with applicable laws and regulations, we or they could be subject to enforcement actions, which could affect our ability to market and sell our products and harm our reputation. If we or our third-party manufacturers or service providers fail to comply with applicable federal, state or foreign laws or regulations, we could be subject to enforcement actions which could affect our ability to develop, market and sell our products successfully and could harm our reputation and lead to less acceptance of our products by the market. These enforcement actions include: product seizures; voluntary or mandatory recalls; voluntary or mandatory patient or physician notification; withdrawal of product approvals; restrictions on, or prohibitions against, marketing our products; fines; restrictions on importation of our products; injunctions; debarment; civil and criminal penalties; and suspension of review of, or refusal to approve, pending applications. Assuming BiDil is approved for commercial sale, if the third-party manufacturer of BiDil encounters delays or difficulties in production, we may not be able to meet demand for the product, and we may lose potential revenue. We do not manufacture BiDil and have no plans to do so. We engaged Schwarz Pharma Manufacturing, Inc., or Schwarz Pharma, for the manufacture of batches of BiDil for clinical trials and are negotiating a definitive agreement for the manufacture and supply of commercial quantities of BiDil, assuming it receives FDA approval. Although we are currently negotiating the terms of a definitive commercial manufacture and supply agreement for BiDil with Schwarz Pharma, to date we have not secured a long-term commercial supply arrangement for BiDil. We cannot assure you that we will be able to enter into a commercial manufacturing and supply agreement with Schwarz Pharma or any other contract manufacturer for BiDil on a timely basis or on terms that are favorable to us. If we are unable to establish or maintain a commercially reasonable manufacturing agreement for the production of BiDil, if approved, we may not be able to successfully develop and commercialize BiDil and our stock price will decline. Furthermore, Schwarz Pharma, if engaged, may encounter difficulties in production. These problems may include: difficulties with production costs and yields; quality control and assurance; shortages of qualified personnel; compliance with strictly enforced federal, state and foreign regulations; and lack of capital funding. Schwarz Pharma may not perform as agreed or may terminate its engagement with us, which would adversely impact our ability to produce and sell BiDil. The number of third-party manufacturers with the manufacturing and regulatory expertise and facilities necessary to manufacture finished drug products for us on a commercial scale is limited, and it would take a significant amount of time to arrange, qualify, and receive necessary regulatory approval for alternative arrangements. We may not be able to contract for manufacturing on acceptable terms, if at all. Any of these factors could increase our costs and result in our being unable to effectively commercialize BiDil. Furthermore, if Schwarz Pharma or any other third-party manufacturer of BiDil fails to deliver the required commercial quantities of finished product on a timely basis and at commercially reasonable prices, we may be unable to meet the demand for our product, and we may lose potential revenues. The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted. Subject to Completion, dated November 26, 2004 Prospectus 3,247,878 shares Common stock We are offering 3,247,878 shares of our common stock. Our common stock is traded on the NASDAQ National Market under the symbol "NTMD." The last reported sale of our common stock on November 23, 2004 was $20.08. The development and commercialization of our product candidates may be terminated or delayed, and the cost of development and commercialization may increase, if third parties on whom we rely to manufacture our products do not fulfill their obligations. We do not manufacture any of our other product candidates and have no current plan to develop any capacity to do so in the future. In order to continue to develop products, apply for regulatory approvals and commercialize our products, we plan to rely on third parties for the production of clinical and commercial quantities of our product candidates. We will depend upon these third parties to perform their obligations in a timely manner and in accordance with applicable laws and regulations. To the extent that third-party manufacturers with whom we contract fail to perform their obligations in accordance with applicable laws and regulations, we may be adversely affected in a number of ways, including: we may not be able to initiate or continue clinical trials of our product candidates; we may be delayed in submitting applications for regulatory approvals for our products; we may be required to cease distribution and/or recall some or all batches of our products; and we may not be able to meet commercial demands for our products or achieve profitability. We rely on a single source supplier for one of the two active ingredients in BiDil, and the loss of this supplier could prevent us from selling BiDil, which would materially harm our business. We rely on Sumitomo for our supply of hydralazine, one of the two active ingredients in BiDil. Sumitomo is currently the only supplier of hydralazine worldwide. We do not have any agreement with Sumitomo regarding the supply of hydralazine. If Sumitomo stops manufacturing or is unable to manufacture hydralazine, or if we are unable to procure hydralazine from Sumitomo on commercially favorable terms, we may be unable to continue to sell BiDil on commercially viable terms, if at all. Furthermore, because Sumitomo is currently the sole supplier of hydralazine, Sumitomo has unilateral control over the price of hydralazine. Any increase in the price for hydralazine may reduce our gross margins. The termination of our collaboration agreement with Merck, resulting from Merck's recent decision to withdraw its COX-2 inhibitor, Vioxx, from worldwide markets, will result in the loss of anticipated milestone and royalty based revenue from the collaboration and may indicate that the development of nitric oxide-enhancing COX-2 inhibitors is not viable. In December 2002, we entered into an exclusive, worldwide research, collaboration and licensing agreement with Merck pursuant to which we granted Merck marketing and sales rights to our technology for nitric oxide-enhancing COX-2 inhibitors. On September 30, 2004, Merck halted the phase II trial of our lead candidate in nitric oxide-enhancing COX-2 inhibitors. This lead nitric oxide candidate is composed of a derivative of rofecoxib. Rofecoxib is the active ingredient in Vioxx, a COX-2 inhibitor which Merck voluntarily withdrew from worldwide markets on September 30, 2004. We have agreed with Merck to terminate our collaboration agreement, which will result in the loss of any potential milestone or royalty revenue from the sale of products that may have resulted from the collaboration as well as any research and development funding that we may have received beyond the end of the initial research term in December 2005. If the FDA imposes additional regulatory burdens for the approval of new Per share Total COX-2 inhibitors, if COX-2 inhibitors continue to pose safety concerns, or if the market for COX-2 inhibitors contracts, then we may lose any investment made in the development of, and any potential revenue that may have resulted from, the development, sale or licensing of nitric oxide-enhancing COX-2 inhibitors. We currently depend on collaborative partners for a significant portion of our revenues and to develop, conduct clinical trials with, obtain regulatory approvals for, and manufacture, market and sell some of our product candidates, and these collaborations may not be successful. We are relying on Boston Scientific to fund the development of and to commercialize nitric oxide-enhancing stents using our technology to prevent the re-closure of arteries, or restenosis, following balloon angioplasty, a treatment to widen blocked arteries. In addition, Merck has funded the development of products based upon our nitric oxide-enhancing COX-2 inhibitor technologies. All of our $12.8 million of revenues for 2003 and our $7.0 million of revenues for the nine months ended September 30, 2004 were derived from licensing, research and development and milestone payments paid to us by Boston Scientific and Merck. We have agreed with Merck to terminate our collaboration on nitric oxide-enhancing COX-2 inhibitor technologies. Please see "Risk Factors The termination of our collaboration agreement with Merck, stemming from Merck's recent decision to withdraw its COX-2 inhibitor, Vioxx, from worldwide markets, will result in the loss of anticipated milestone and royalty based revenue from the collaboration and may indicate that the development of nitric oxide-enhancing COX-2 inhibitors is not viable." for additional risks relating to our agreement with Merck. Our agreement with Boston Scientific provides us research and development funding for our nitric oxide-enhancing stent program, and additional payments due to us under the collaboration agreement are generally based on the achievement of specific development and commercialization milestones that may not be met. The agreement with Boston Scientific can be terminated at any time upon 30 days' prior written notice. We are also entitled to royalty payments that are based on the sales of products developed and marketed through the collaboration. These future royalty payments may not materialize or may be less than expected if the related product candidates are not successfully developed or marketed, or if we or our collaborator is forced to license intellectual property from third parties. Accordingly, we cannot predict with certainty whether this collaboration will continue to generate revenues for us and if so, for how long. The loss of the Boston Scientific collaboration could decrease our revenues. We intend to enter into collaborative agreements with other parties in the future relating to other product candidates, and we are likely to have similar risks with regard to any such future collaborations. In addition, our existing collaboration and any future collaborative arrangements that we seek to enter into with third parties may not be scientifically or commercially successful. Factors that may affect the success of our collaborations include the following: our collaborators may be pursuing alternative technologies or developing alternative product candidates, either on their own or in collaboration with others, that may be competitive with the product on which they are collaborating with us and which could affect their commitment to our collaboration; Price to public $ $ Underwriting discounts and commissions $ $ Proceeds to NitroMed $ $ reductions in marketing or sales efforts or a discontinuation of marketing or sales of our products by our collaborators would reduce our revenues, which will be based on a percentage of net sales by the collaborator; our collaborators may terminate their collaborations with us, which could make it difficult for us to attract new collaborators or adversely affect how we are perceived in the business and financial communities; and our collaborators may pursue higher-priority programs or change the focus of their development programs, which could affect the collaborators' commitment to us. Our failure to successfully acquire, develop and market additional drug candidates or approved drugs would impair our ability to grow. As part of our strategy, we intend to acquire, develop and market additional drugs and drug candidates to treat African Americans with cardiovascular, metabolic and other diseases that affect this population. The success of this strategy depends upon our ability to identify, select and acquire appropriate pharmaceutical drug candidates and drugs. Any drug candidate we license or acquire may require additional development efforts prior to commercial sale, including extensive clinical testing and approval by the FDA and applicable foreign regulatory authorities. All drug candidates are prone to the risks of failure inherent in pharmaceutical product development, including the possibility that the drug candidate will not be shown to be sufficiently safe and effective for approval by regulatory authorities. In addition, we cannot assure you that any drugs that we develop or acquire that are approved will be manufactured or produced economically, successfully commercialized or widely accepted in the marketplace. Proposing, negotiating and implementing an economically viable acquisition of a drug or drug candidate is a lengthy and complex process. Other companies, including those with substantially greater financial, marketing and sales resources, may compete with us for the acquisition of product candidates and approved products. We may not be able to acquire the rights to additional drug candidates and approved drugs on terms that we find acceptable, if at all. Risks relating to our intellectual property rights Our patent protection for BiDil, which is a combination of two generic drugs, is limited, and we may be subject to generic substitution or competition and resulting pricing pressure. We have no composition of matter patent covering our lead product candidate, BiDil, which we intend to market for the treatment of heart failure in African Americans. BiDil is a fixed-dose combination of two generic drugs, isosorbide dinitrate and hydralazine, which are approved and separately marketed, in dosages similar to those we include in BiDil, for indications other than heart failure, at prices below the prices we expect to charge for BiDil. We have three issued method-of-use patents, one of which covers the use of the combination of isosorbide dinitrate and hydralazine to reduce the incidence of mortality associated with chronic congestive heart failure, expiring in 2007, and the others covering the treatment of heart failure in black patients, expiring in 2020. As a practical matter, we may not be able to enforce these method-of-use patents to prevent physicians from prescribing isosorbide dinitrate We have granted the underwriters the right to purchase up to 487,181 additional shares of common stock to cover over-allotments. Investing in our common stock involves a high degree of risk. See "Risk Factors" beginning on page 6. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy of accuracy of this prospectus. Any representation to the contrary is a criminal offense. JPMorgan Pacific Growth Equities, LLC Deutsche Bank Securities Bear, Stearns & Co. Inc. November , 2004 and hydralazine separately for the treatment of heart failure in African Americans, even though neither drug is approved for such use. Other factors may also adversely affect our patent protection for BiDil. The combination therapy of isosorbide dinitrate and hydralazine for use in heart failure was developed through lengthy, publicly-sponsored clinical trials conducted during the 1980s, prior to the filing of the patent application that resulted in the 2007 patent. The U.S. Patent and Trademark Office, or U.S. patent office, considered published reports on these clinical trials and concluded that they did not constitute prior art that would prevent the issuance of the 2007 patent. The U.S. patent office also considered the question of whether the 2007 patent constituted prior art with respect to the 2020 patents, but determined that the claims of the 2020 patents were non-obvious and patentable. A court considering the validity of the 2007 or 2020 patents with respect to questions of prior art might be presented with other alleged prior art or might reach conclusions different from those reached by the U.S. patent office. If the 2007 or 2020 patents were to be invalidated or if physicians were to prescribe isosorbide dinitrate and hydralazine separately for heart failure in African Americans, our BiDil revenue could be significantly reduced, we could fail to recover the cost of developing BiDil and BiDil might not be a viable product. If we are not able to obtain and enforce patent protection for our discoveries, our ability to develop and commercialize our product candidates will be harmed, and we may not be able to operate our business profitably. Our success depends, in part, on our ability to protect proprietary methods and technologies that we develop under the patent and other intellectual property laws of the United States and other countries, in order to prevent others from using our inventions and proprietary information. Because certain United States patent applications are confidential until patents issue, such as applications filed prior to November 29, 2000 or applications filed after such date which will not be filed in foreign countries, third parties may have filed patent applications for technology covered by our pending patent applications without our being aware of those applications, and our patent applications may not have priority over any patent applications of others. Our strategy depends on our ability to rapidly identify and seek patent protection for our discoveries. This process is expensive and time consuming, and we may not be able to file and prosecute all necessary or desirable patent applications at a reasonable cost or in a timely manner. Despite our efforts to protect our proprietary rights, unauthorized parties may be able to obtain and use information that we regard as proprietary. The mere issuance of a patent does not guarantee that it is valid or enforceable, so even if we obtain patents, they may not be valid or enforceable against third parties. The issued patents and patent applications for our product candidates and nitric oxide technology include claims with respect to both the composition of specific drugs or compounds and specific methods of using these drugs or compounds in therapeutic areas. In some cases, like BiDil, our only patent protection is with respect to the method of using a drug or compound, and we do not have patent claims covering the underlying composition of the drug or compound. Method-of-use patents may provide less protection for our product candidates because it may be more difficult to prove direct infringement against a pharmaceutical manufacturer or distributor once they have gained approval for an alternative indication. In addition, if any other company gains FDA approval for an indication separate from the one we are pursuing and markets a drug that we expect to market under the protection of a method-of-use patent, physicians will be able to prescribe that drug for use in the indication for which we have obtained approval, even though the drug is not approved for such indication. As a practical matter, we may not be able to enforce our method-of-use patents against physicians prescribing drugs for such off-label use. Off-label use and any resulting off-label sales could make it more difficult to obtain the price we would otherwise wish to achieve for, or to successfully commercialize, our product. In addition, in those situations where we have only method-of-use patent coverage for a product candidate, it may be more difficult to find a pharmaceutical company partner to license or support development of our product candidate. Our pending patent applications may not result in issued patents. The patent position of pharmaceutical or biotechnology companies, including ours, is generally uncertain and involves complex legal and factual considerations. The standards which the U.S. patent office and its foreign counterparts use to grant patents are not always applied predictably or uniformly and can change. There is also no uniform, worldwide policy regarding the subject matter and scope of claims granted or allowable in pharmaceutical or biotechnology patents. Accordingly, we do not know the degree of future protection for our proprietary rights or the breadth of claims allowed in any patents issued to us or to others. We also rely on trade secrets, know-how and technology, which are not protected by patents, to maintain our competitive position. If any trade secret, know-how or other technology not protected by a patent were to be disclosed to or independently developed by a competitor, our business and financial condition could be materially adversely affected. If we become involved in patent litigation or other proceedings to enforce our patent rights, we would incur substantial costs and expenses, substantial liability for damages or be required to stop our product development and commercialization efforts. A third party may sue us for infringing on its patent rights. Likewise, we may need to resort to litigation to enforce a patent issued to us or to determine the scope and validity of third-party proprietary rights. The cost to us of any litigation or other proceeding relating to intellectual property rights, even if resolved in our favor, could be substantial, and the litigation would divert our management's efforts. Some of our competitors may be able to sustain the costs of complex patent litigation more effectively than we can because they have substantially greater resources. In addition, our strategy of providing nitric oxide-enhancing versions of existing medicines could lead to more patent litigation as the markets for these existing medicines are very large and competitive. Uncertainties resulting from the initiation and continuation of any litigation could limit our ability to continue our operations. For example, we have filed an opposition in the European Patent Office, or EPO, to revoke NicOx S.A.'s European Patent No. 904 110, which we refer to as EP '110. This patent is directed to the use of organic compounds containing a nitrate group or inorganic compounds containing a nitric oxide group to reduce the toxicity caused by certain drugs, including non-steroidal anti-inflammatory drugs, or NSAIDs. The basis for our opposition, in part, is that the claims in EP '110 are anticipated and therefore invalid if they are construed to cover a single compound chemically linked to a nitrate. While we believe that the claims in EP '110 will be invalidated, or be narrowed, we cannot predict with certainty the outcome of the opposition. If the EPO finds that there are valid claims in EP '110 that cover compounds chemically linked to nitrates, we may be adversely affected in our ability to market our product candidates for reducing gastrointestinal toxicity without first obtaining a license from NicOx, which may not be available on favorable terms, if at all. We do not know whether NicOx has filed claims of similar scope to the EP '110 patent in the United States. If any parties are able to successfully claim that our creation or use of proprietary technologies infringes upon their intellectual property rights, we might be forced to pay damages, potentially including treble damages, if we are found to have willfully infringed on such parties' patent rights. In addition to any damages we might have to pay, a court could require us to stop the infringing activity or obtain a license on unfavorable terms. Moreover, any legal action against us or our partners claiming damages and seeking to enjoin commercial activities relating to the affected products and processes could, in addition to subjecting us to potential liability for damages, require us or our partners to obtain a license in order to continue to manufacture or market the affected products and processes. Any license required under any patent may not be made available on commercially-acceptable terms, if at all. In addition, some licenses may be non-exclusive, and therefore our competitors may have access to the same technology licensed to us. If we fail to obtain a required license or are unable to design around a patent, we may be unable to effectively market some of our technology and product candidates, which could limit our ability to generate revenues or achieve profitability and possibly prevent us from generating revenue sufficient to sustain our operations. In addition, a number of our collaborations provide that royalties payable to us for licenses to our intellectual property may be offset by amounts paid by our collaboration partners to third parties who have competing or superior intellectual property positions in the relevant fields, which could result in significant reductions in our revenues from products developed through collaborations. We in-license a significant portion of our principal proprietary technologies, and if we fail to comply with our obligations under any of the related agreements, we could lose license rights that are necessary to developing BiDil and our other product candidates. We are a party to a number of licenses that give us rights to third-party intellectual property that is necessary for our business. In particular, we have obtained the exclusive right to develop and commercialize BiDil pursuant to a license agreement with Dr. Jay N. Cohn, and some of our intellectual property rights relating to nitric oxide compounds have been obtained pursuant to license agreements with the Brigham and Women's Hospital and Boston University. We expect to enter into additional licenses in the future. These licenses impose various development, commercialization, funding, royalty, diligence, and other obligations on us. If we breach these obligations, the licensor may have the right to terminate the license or render the license non-exclusive, which would result in us being unable to develop, manufacture and sell products that are covered by the licensed technology. Risks relating to our industry We face significant competition, which may result in others discovering, developing or commercializing products before or more successfully than we do. The pharmaceutical and medical device industries are highly competitive and characterized by rapid and significant technological change. Our principal competitors in the markets we have targeted, such as cardiovascular disease and inflammation, are large, multinational pharmaceutical and medical device companies that have substantially greater financial and other resources than we do and are conducting extensive research and development activities on technologies and product candidates similar to or competitive with ours. There are a number of companies currently marketing and selling products to treat heart failure in the general population that will compete with BiDil, if it is approved. These include GlaxoSmithKline, plc, which currently markets Coreg, Merck & Co., Inc., which currently markets Vasotec, Pfizer Inc., which currently markets Inspra, and Astra Zeneca, plc, which currently markets Toprol XL. We also face competition from other pharmaceutical companies seeking to develop drugs using nitric oxide technology. For example, we are aware of at least four companies working in the area of nitric oxide based therapeutics. These companies are GB Therapeutics, NicOx S.A., OxoN Medica, and Vasopharm BIOTECH GmbH. Many of our competitors are more experienced than we are in drug development and commercialization, obtaining regulatory approvals and product marketing and manufacturing. As a result, our competitors may develop and commercialize pharmaceutical products before we do. In addition, our competitors may develop and commercialize products that render our products obsolete or non-competitive or that block or delay approval of our products as a result of patent or non-patent exclusivity. We may be exposed to product liability claims and may not be able to obtain or maintain adequate product liability insurance. Our business exposes us to the risk of product liability claims that is inherent in the manufacturing, testing, and marketing of human therapeutic products. Our clinical trial liability insurance is subject to deductibles and coverage limitations. We do not currently have any commercial product liability insurance. We may not be able to obtain or maintain insurance on acceptable terms, or at all. Moreover, any insurance that we do obtain may not provide adequate protection against potential liabilities. If third-party payors do not reimburse customers for BiDil or any of our product candidates that are approved for marketing, they might not be used or purchased, and our revenues and profits might be adversely affected. Our revenues and profits depend heavily upon the availability of coverage and reimbursement for the use of BiDil, and any of our product candidates that are approved for marketing, from third-party healthcare and state and federal government payors, both in the United States and in foreign markets. Reimbursement by a third-party payor may depend upon a number of factors, including the third-party payor's determination that use of a product is: safe, effective and medically necessary; appropriate for the specific patient; cost-effective; and neither experimental nor investigational. Since reimbursement approval for a product is required from third-party and government payors, seeking this approval, particularly when seeking approval for a preferred form of reimbursement over other competitive products, is a time-consuming and costly process. Third-party payors may require cost-benefit analysis data from us in order to demonstrate the cost-effectiveness of any product we might bring to market. For any individual third-party payor, we may not be able to provide data sufficient to gain reimbursement on a similar or preferred basis to competitive products or at all. Once reimbursement at an agreed level is approved by a third-party payor, we may lose that reimbursement entirely or we may lose the similar or better reimbursement we receive compared to competitive products. As reimbursement is often approved for a period of time, this risk is greater at the end of the time period, if any, for which the reimbursement was approved. Risks relating to our common stock Our stock price is subject to fluctuation, which may cause an investment in our stock to suffer a decline in value. The market price of our common stock may fluctuate significantly in response to factors that are beyond our control. The stock market in general has recently experienced extreme price and volume fluctuations. The market prices of securities of pharmaceutical, biotechnology and other life sciences companies have been extremely volatile, and have experienced fluctuations that often have been unrelated or disproportionate to the operating performance of these companies. For example, our stock price could be adversely affected if product candidates by others that utilize nitric oxide technology are not successful in clinical testing, fail to achieve regulatory approval or are not accepted in the marketplace, even though these failures may not be related to our product candidates or technology. These broad market fluctuations could result in extreme fluctuations in the price of our common stock, which could cause a decline in the value of our common stock. We may incur significant costs and suffer management distraction and reputational damage from class action litigation and regulatory or government investigations and actions due to trading in our common stock. Our stock price has been, and is likely to continue to be, volatile. Our stock price may fluctuate for many reasons, including as a result of public announcements regarding the progress of our development and marketing efforts, the addition or departure of key personnel, variations in our quarterly operating results and changes in market valuations of pharmaceutical, biotechnology or other life sciences companies. When the market price of a company's stock is volatile, holders of that company's stock may bring securities class action litigation against the company that issued the stock. If any of our stockholders were to bring a lawsuit of this type against us, even if the lawsuit was without merit, we could incur substantial costs defending the lawsuit. On July 20, 2004, the Market Regulation Department of the National Association of Securities Dealers, Inc. advised us that it is conducting a review of trading activity in our common stock surrounding our July 19, 2004 announcement that we had halted our phase III confirmatory clinical trial of BiDil due to the significant survival benefit seen with BiDil. The NASD is reviewing, among other things, information on relationships between our officers, directors Loss from operations (12,326 ) (17,914 ) (9,246 ) (10,039 ) (20,989 ) Non-operating income (expense): Interest expense (48 ) (10 ) (4 ) (3 ) (1 ) Interest income 557 387 399 212 913 Other income 188 195 82 82 and service providers and individuals and institutions who may have traded in our common stock prior to the July 19, 2004 announcement. We are cooperating with this review and have identified certain persons on the list provided to us by the NASD as having a relationship with our chief executive officer and others at NitroMed. We have established a special committee of our board of directors to oversee our response to this review. The NASD may refer this matter to the SEC once it completes its review. The SEC or other securities regulators may investigate trading activity of insiders and others around events that result in stock price volatility, such as our July 19 announcement, and we may incur substantial costs in connection with any such government investigation or related action. A stockholder lawsuit, SEC or other investigation or action could also damage our reputation or that of our officers or directors and divert their time and attention away from management of NitroMed. Substantially all of our outstanding common stock may be sold into the market at any time. This could cause the market price of our common stock to drop significantly. Sales of a substantial number of shares of our common stock in the public market could occur at any time. These sales, or the perception in the market that the holders of a large number of shares intend to sell shares, could reduce the market price of our common stock. As of September 30, 2004, we had outstanding 26,356,630 shares of common stock. Subject to lock up agreements which will restrict the sale of approximately 5,489,333 of these shares for a period of 45 days after this offering, 6,367,228 of these shares for a period of 60 days after this offering, and 1,920,176 of these shares for a period of 90 days after this offering, substantially all of these shares may also be resold in the public market at any time. In addition, we have a significant number of shares that are subject to outstanding options. The exercise of these options and the subsequent sale of the underlying common stock could cause a further decline in our stock price. These sales also might make it difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate. Insiders have substantial control over us and could delay or prevent a change in corporate control. As of September 30, 2004, our directors, executive officers and principal stockholders, together with their affiliates, own, in the aggregate, approximately 53% of our outstanding common stock. As a result, these stockholders, if acting together, will have the ability to determine the outcome of matters submitted to our stockholders for approval, including the election and removal of directors and any merger, consolidation or sale of all or substantially all of our assets. In addition, these persons, if acting together, will have the ability to control the management and affairs of our company. Accordingly, this concentration of ownership may harm the market price of our common stock by: delaying, deferring or preventing a change in control of our company; impeding a merger, consolidation, takeover or other business combination involving our company; or discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of our company. Summary financial data You should read the following summary financial data in conjunction with "Selected financial data," "Management's discussion and analysis of financial condition and results of operations" and our financial statements and related notes, all included elsewhere in this prospectus. The summary financial data for the three years ended December 31, 2003 are derived from our audited financial statements, which are included elsewhere in this prospectus. The summary financial data for the nine months ended September 30, 2003 and 2004 and as of September 30, 2004 are derived from our unaudited financial statements included elsewhere in this prospectus. The unaudited financial statements include, in the opinion of management, all adjustments, consisting only of normal recurring accruals, that management considers necessary for a fair presentation of our results of operations for these periods and financial position at that date. The historical results are not necessarily indicative of results to be expected in any future period, and the results for the nine months ended September 30, 2004 should not be considered indicative of results expected for the full fiscal year. Provisions in our charter documents and under Delaware law may prevent or frustrate attempts by stockholders to change current management and hinder efforts to acquire a controlling interest in us. Provisions of our restated certificate of incorporation and bylaws may discourage, delay or prevent a merger, acquisition or other change in control that stockholders may consider favorable, including transactions in which stockholders might otherwise receive a premium for their shares. These provisions may prevent or frustrate attempts by stockholders to replace or remove our current management. These provisions include: a prohibition on stockholder action through written consent; a requirement that special meetings of stockholders be called only by a majority of the board of directors, the chairman of the board or the chief executive officer; advance notice requirements for stockholder proposals and nominations; limitations on the ability of stockholders to amend, alter or repeal our certificate of incorporation or bylaws; and the authority of the board of directors to issue preferred stock with such terms as the board of directors may determine. In addition, Section 203 of the Delaware General Corporation Law prohibits a publicly-held Delaware corporation from engaging in a business combination with an interested stockholder, generally defined as a person or entity which together with its affiliates owns or within the last three years has owned 15% of our voting stock, for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. Accordingly, Section 203 may discourage, delay or prevent a change in control of our company. Total current liabilities 6,272 10,446 15,680 Deferred revenue, long term 6,667 6,925 1,731 Notes payable, less current portion Total marketable securities $ 29,458 $ Note payable in monthly payments of $4 through June 30, 2004, including interest at 8% per annum $ 64 $ Long term portion $ Year ended December 31,

parsed_sections/risk_factors/2004/CIK0001077552_gentek-inc_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ RISK FACTORS An investment in our common stock involves a high degree of risk. You should carefully consider the risks described below before deciding to invest in our common stock. In assessing these risks, you should also refer to the other information in this prospectus, including our financial statements and the related notes. Various statements in this prospectus, including some of the following risk factors, constitute forward-looking statements. Risks Related to Our Company We recently emerged from a Chapter 11 Bankruptcy Reorganization and have a history of losses. We sought protection under Chapter 11 of the Bankruptcy Code in October 2002. We incurred net losses of approximately $360 million and $170 million during the fiscal years ended December 31, 2002 and December 31, 2001, respectively. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." On November 10, 2003, we emerged from Chapter 11 protection pursuant to the Plan , under which our equity ownership and capital structure changed and our board of directors was replaced. Our return to profitability is not assured and we cannot assure you that we will grow or achieve profitability in the near future, or at all. Our business is capital intensive and we cannot assure you that we will have sufficient liquidity to fund our working capital and capital expenditures and to meet our obligations under our existing debt instruments. Our business is very capital intensive and has always required significant amounts of cash. We cannot be certain that we will achieve sufficient cash flow in the future. Failure to maintain profitability and generate sufficient cash flow could diminish our ability to sustain operations, meet financial covenants, obtain additional required funds and make required payments on any indebtedness we have incurred or may incur. If we do not comply with the covenants in our credit agreements or otherwise default under them, we may not have access to borrowings under our Revolving Credit Facility or the funds necessary to pay all amounts that could become due. Although we believe that our current levels of cash and cash equivalents, along with available borrowings on our Revolving Credit Facility, will be sufficient for our cash requirements during the next twelve months, it is possible that these sources of cash will be insufficient resulting in our having to raise additional funds for liquidity. There can be no assurance we will have the requisite access to new funding if the need arises. The industries in which we operate are highly competitive. This competition may prevent us from raising prices at the same pace as our costs increase, making it difficult for us to maintain existing business and win new business. We face significant competition from established and new competitors in each of our businesses. Certain of these competitors have very large market shares and may have substantially greater financial and technical resources than we do. Moreover, we may also be required to reduce prices if our competitors reduce prices, or as a result of any other downward pressure on prices for our products and services, which could have an adverse effect on us. In each of our business segments, we operate in competitive markets. Our manufacturing segment competes with numerous international and North American companies, including various captive operations of original equipment manufacturers (OEMs) and Tier 1 suppliers to automotive manufacturers. Competition in the manufacturing segment's markets is based on a number of factors, including design and engineering capabilities, price, quality and the ability to meet customer delivery requirements. Most of the markets in which our performance products segment does business are highly competitive. The major competitors of our performance products segment are typically segregated by end market and include international, regional and, in some cases, small independent producers. Competition in the performance products segment's markets is based on a number of factors, including price, freight economics, product quality and technical support. Due to the level of competition faced by our performance products segment, our customers have regularly requested price decreases and maintaining or raising prices has been difficult over the past several years and will likely continue to be so in the near future. Our communications segment also operates in highly competitive markets, with many of our competitors being large, international and technologically sophisticated companies. Competition in our communications segment is based on a number of factors, including technological advancements, price, product line breadth, technical support and service and product quality. The ability to achieve and maintain successful performance in this segment is also dependent on our ability to develop products cost effectively which meet the changing requirements of our customers that are driven by rapid advances in technology. If we are unable to compete successfully, our financial condition and results of operations could be adversely affected. We are a holding company that is dependent upon cash flow from our subsidiaries to meet our obligations; our ability to access that cash flow may be limited in some circumstances. We are a holding company with no independent operations or significant operating assets other than our investments in and advances to our subsidiaries. We depend upon the receipt of sufficient funds from our subsidiaries to meet our obligations. In addition, the terms of our existing and future indebtedness and that of our subsidiaries and the laws of the jurisdictions under which our subsidiaries are organized limit the payment of dividends, loan repayments and other distributions to us under many circumstances. Our current amount of leverage could adversely affect our financial health and diminish shareholder value. We may find that we are over-leveraged, which could have significant negative consequences, including: o it may become more difficult for us to satisfy our obligations with respect to all of our indebtedness; o we may be vulnerable to a downturn in the industries in which we operate or a downturn in the economy in general; o we may be required to dedicate a substantial portion of our cash flow from operations to fund working capital, capital expenditures and other general corporate requirements; o we may be limited in our flexibility to plan for, or react to, changes in our businesses and the industries in which we operate; o we may be placed at a competitive disadvantage compared to our competitors that have less debt; o we may determine it to be necessary to dispose of certain assets or one or more of our businesses to reduce our debt; and o our ability to borrow additional funds may be limited. Additionally, there may be factors beyond our control that could impact our ability to meet debt service requirements. Our ability to meet debt service requirements will depend on our future performance, which, in turn, will depend on a number of factors, including conditions in the global markets for our products, the global economy generally, the behavior of our competitors, the financial condition and sourcing decisions made by our customers, our future cash funding requirements for environmental and pension liabilities, the impact of current and future tax regulations on our cash flows and financial condition and other factors that are beyond our control. We can provide no assurance that our businesses will generate sufficient cash flow from operations or that future borrowings will be available in amounts sufficient to enable us to pay our indebtedness or to fund our other liquidity needs. Moreover, we may need to refinance all or a portion of our indebtedness on or before maturity. We cannot make assurances that we will be able to refinance any of our indebtedness on commercially reasonable terms or at all. If we are unable to make scheduled debt payments or comply with the other provisions of our debt instruments, our various lenders will be permitted under certain circumstances to accelerate the maturity of the indebtedness owing to them and exercise other remedies provided for in those instruments and under applicable law. We are subject to restrictive debt covenants pursuant to our indebtedness. These covenants may restrict our ability to finance our business and, if we do not comply with the covenants or otherwise default under them, we may not have the funds necessary to pay all amounts that could become due and the lenders could foreclose on substantially all of our assets. As part of our implementation of the Plan, we issued $250 million principal amount of senior term debt under the terms of a new credit agreement (referred to herein as the Senior Term Loan Credit Agreement). In addition, we entered into our $125 million Revolving Credit Facility which matures on November 10, 2008. Both facilities are secured by substantially all of our assets. The Revolving Credit Facility, among other things, significantly restricts and, in some cases, effectively eliminates our ability and the ability of most of our subsidiaries to: o incur additional debt; o create or incur liens; o pay dividends or make other equity distributions; o purchase or redeem share capital; o make investments; o sell assets; o issue or sell share capital of certain subsidiaries; o engage in transactions with affiliates; o issue or become liable on a guarantee; o voluntarily prepay, repurchase or redeem debt; o create or acquire new subsidiaries; and o effect a merger or consolidation of, or sell all or substantially all of our assets. Similar restrictive covenants are contained in the Senior Term Loan Credit Agreement which are applicable to us and most of our subsidiaries. In addition, under our Revolving Credit Facility, we and our subsidiaries must comply with certain financial covenants. In the event we were to fail to meet any of such covenants and were unable to cure such breach or otherwise renegotiate such covenants, the lenders under those facilities would have significant rights to seize control of substantially all of our assets. Such a default, or a breach of any of the other obligations in the Senior Term Loan Credit Agreement, could also trigger a default under our Revolving Credit Facility and vice versa. The covenants in our Revolving Credit Facility and the Senior Term Loan Credit Agreement and any credit agreement governing future debt may significantly restrict our future operations. Furthermore, upon the occurrence of any event of default under the Senior Term Loan Credit Agreement, our Revolving Credit Facility or the agreements governing any other debt of our subsidiaries, the lenders could elect to declare all amounts outstanding under such indentures, credit facilities or agreements, together with accrued interest, to be immediately due and payable. If those lenders were to accelerate the payment of those amounts, we cannot assure you that our assets and the assets of our subsidiaries would be sufficient to repay in full those amounts. We are also subject to interest rate risk due to our indebtedness at variable interest rates. Our Revolving Credit Facility and our senior term debt bear interest at variable rates based on a base rate or LIBOR plus an applicable margin. We cannot assure you that shifts in interest rates will not have a material adverse effect on us. We may be required to prepay our indebtedness prior to its stated maturity, which may limit our ability to pursue business opportunities. Pursuant to the terms of our Revolving Credit Facility and Senior Term Loan Credit Agreement, in certain instances we are required to prepay this indebtedness prior to their stated maturity dates, even if we are otherwise in compliance with the covenants contained in the agreements. Specifically, (i) certain asset sale proceeds must be used to pay down indebtedness and can therefore not be reborrowed; and (ii) the Senior Term Loan Credit Agreement provides that, beginning in 2005, we must apply the majority of any "excess cash flow" generated in the prior year to the prepayment of the senior term debt. These prepayment provisions may limit our ability to utilize this excess cash flow to pursue business opportunities. Our Chapter 11 reorganization and uncertainty over our financial condition may harm our businesses and our brand names. Any adverse publicity or news coverage regarding our recent Chapter 11 reorganization and financial condition could have an adverse effect on parts of our business. Due to the potential effect of that publicity, we may find it difficult to maintain relationships with existing customers or obtain new customers. Although we have successfully consummated the Plan, there is no assurance that any such negative publicity will not adversely impact our results of operations or have a long-term negative effect on our businesses and brand names in the future. In addition, uncertainty during our recapitalization process and losses experienced by certain of our unsecured creditors may have adversely affected our relationships with our suppliers. If suppliers become increasingly concerned about our financial condition, they may demand faster payments or refuse to extend normal trade credit, both of which could further adversely affect our cash flow and our results of operations. We may not be successful in obtaining alternative suppliers if the need arises and this would adversely affect our results of operations. In accordance with our Plan, potential preference rights of actions under Section 547 of the Bankruptcy Code against non-insider creditors who received payments within the ninety (90) days prior to our petition date have been assigned to a Preference Claim Litigation Trust (referred to herein as the "Trust"). This Trust, subject to certain limitations, is authorized to prosecute, settle or waive, in its sole discretion, these preference rights. Although this Trust is separate and distinct from the Company and the Company will not receive any significant recoveries from the Trust, its activities may aggravate certain of our suppliers, customers and employees, and could potentially disrupt the flow of necessary raw materials and services, negatively impact our sales and increase our costs, and thereby adversely affect our results of operations. Material changes in pension and other post-retirement benefit costs may occur in the future. In addition, investment returns on pension assets may be lower than assumed, which could result in larger cash funding requirements for our pension plans, which could have an adverse impact on us. We maintain several defined benefit pension plans covering certain employees in Canada, Germany, Ireland and the United States. We record pension and post retirement benefit costs in amounts developed from actuarial valuations. Inherent in these valuations are key assumptions including the discount rate and expected long-term rate of return on plan assets. We believe that material changes in pension and other post retirement benefit costs may occur in the future due to changes in these assumptions, differences between actual experience and the assumptions used, and changes in the benefit plans. Amounts we pay are also dependant upon interest rates. Due to current interest rates and investment returns, some of our plans are substantially underfunded and will require substantial cash contributions over the next several years. Moreover, if investment returns on pension assets are lower than assumed, we may have substantially larger cash funding requirements for our pension plans, which may have a material adverse impact on our liquidity. For a further discussion of our defined benefit pension plans, see "Management's Discussion and Analysis - Financial Condition, Liquidity and Capital Resources" and "Management and Executive Compensation - Pension Plans." We cannot predict the impact of any asset or business disposition or acquisition. From time to time we consider dispositions and acquisitions of assets or businesses. We cannot predict the types of dispositions or acquisitions we may undertake in the future or the financial impact of such actions. For example, any after-tax cash proceeds that we would receive in connection with any disposition would be dependent on levels of interest from potential purchasers, the structure of the transaction and the transaction's tax complexity. As a result, there can be no assurance as to the terms of any such disposition or acquisition, the level of any disruption to the operations of the Company caused by such transaction, or the long-term effect of such transaction on the Company or its financial condition. Our prospects will depend in part on our ability to control our costs while maintaining and improving our service levels. We have been engaged in a process of reducing expenditures in a variety of areas, including by way of a reduction in the number of our employees, the closure of certain facilities, negotiated price reductions on certain raw materials and purchased components, and the outsourcing of some functions. Our prospects will depend in part on our ability to continue to control costs and operate more efficiently, while maintaining and improving our existing service levels. There can be no assurance that the cost reduction efforts listed above will not negatively impact our service levels, quality and employee morale, which would, in turn, adversely affect our results of operations and financial condition. We are highly dependent upon skilled employees and a number of key personnel. We operate businesses that are highly dependent on skilled employees. A loss of a significant number of key professionals or skilled employees could have a material adverse effect on us. We believe that our future success will depend in large part on our continued ability to attract and retain highly skilled and qualified personnel. There can be no assurance that we will be able to retain and employ qualified management and technical personnel. While we maintained a severance and retention plan designed to retain certain of our key employees during the Chapter 11 process, the final retention bonus payment under the plan was made on December 31, 2003. Future compensation and other benefits provided to employees will be determined under the direction of our new board of directors. There can be no assurance that key employees will not seek other employment following the final retention bonus payment or in response to any future changes in employee compensation or benefit programs. Moreover, there is no guarantee that the post-bankruptcy environment will not introduce new risks to employee retention. In addition, certain administrative functions and corporate support services have historically been provided to us by the management company Latona Associates Inc. (Latona). After the Effective Date, we entered into a new one-year agreement with Latona which expires in the fourth quarter of 2004. By the expiration of this agreement, we intend to internally perform, or outsource to other third parties in certain circumstances, the services previously provided by Latona. As a result, unless otherwise agreed to, we will also no longer have access to the services of Latona. Successful operation of our businesses depends on our ability to assume or otherwise provide for these responsibilities and may result in increased costs to us. We may continue to pursue new acquisitions and joint ventures, and any such transaction could adversely affect our operating results or result in increased costs or other operating or management problems. We remain subject to the ongoing risks of successfully integrating and managing the acquisitions and joint ventures through which we have historically grown our business. We have historically grown our business through acquisitions and joint ventures. These transactions expose us to the risk of successfully integrating those acquisitions. Such integration impacts various areas of our business, including our workforce, management, decision making, production facilities, information systems, accounting and financial reporting, and customer service. Disruption to any of these areas of our business could materially harm our financial condition or results of operations. We may continue to pursue new acquisitions and joint ventures in the future, a pursuit which will consume substantial time and resources. Identifying appropriate acquisition candidates and negotiating and consummating acquisitions can be a lengthy and costly process. The successful implementation of our operating strategy at current and future acquisitions and joint ventures may require substantial attention from our management team, which could divert management attention from our existing businesses. The businesses we acquire, or the joint ventures we enter into, may not generate the cash flow and earnings, or yield the other benefits, we anticipated at the time of their acquisition or formation. Furthermore, we may also encounter substantial unanticipated costs or other problems associated with the acquired businesses. The risks inherent in our strategy could have an adverse impact on our results of operation or financial condition. Our principal businesses are subject to government regulation, including environmental regulation, and changes in current regulations may adversely affect us. Our principal business activities are regulated and supervised by various governmental bodies. Changes in laws, regulations or governmental policy or the interpretations of those laws or regulations affecting our activities and those of our competitors could have a material adverse effect on us. For example, our various manufacturing operations, which have been conducted at a number of facilities for many years, are subject to numerous laws and regulations relating to the protection of human health and the environment in the U.S., Canada, Australia, China, Germany, Great Britain, India, Mexico and other countries. We believe that we are in substantial compliance with such laws and regulations. However, as a result of our operations, from time to time we are involved in administrative and judicial proceedings and inquiries relating to environmental matters. Based on information available to us at this time with respect to potential liability involving these facilities, we believe that any such liability will not have a material adverse effect on our financial condition, cash flows or results of operations. However, modifications of existing laws and regulations or the adoption of new laws and regulations in the future, particularly with respect to environmental and safety standards, could require us to make expenditures which may be material or otherwise adversely impact our operations. In addition, the Comprehensive Environmental Response Compensation and Liability Act of 1980 (CERCLA) and similar statutes have been construed as imposing joint and several liability, under certain circumstances, on present and former owners and operators of contaminated sites, and transporters and generators of hazardous substances, regardless of fault. Our facilities have been operated for many years by us or prior owners and operators, and adverse environmental conditions of which we are not aware may exist. Modifications of existing laws and regulations, and the discovery of additional or unknown environmental contamination at any of our current or former facilities, could have a material adverse effect on our financial condition, cash flows and/or results of operations. We may experience increased costs and production delays if suppliers fail to deliver materials to us or if prices increase for raw materials and other goods and services that we purchase from third parties. We purchase raw materials from a number of domestic and foreign suppliers. Although we believe that the raw materials needed for our businesses will be available in sufficient supply on a competitive basis for the foreseeable future, increases in the cost of raw materials, including energy and other inputs used to make our products, could affect future sale volumes, prices and margins for our products. If a supplier should cease to deliver goods or services to us, we would probably find other sources, however, this disruption could result in added cost and manufacturing delays. In addition, political instability, war, terrorism and other unexpected disruptions to international transit routes that are beyond our control could adversely impact our ability to obtain key raw materials in a timely fashion, or at all. Our revenues are dependent on the continued operation of our manufacturing facilities, and breakdowns or other problems in their operation could adversely affect our results of operations. Our revenues are dependent on the continued operation of our various manufacturing facilities. In particular, the operation of chemical manufacturing plants involves many risks, including the breakdown, failure or substandard performance of equipment, natural disasters, power outages, the need to comply with directives of government agencies, and dependence on the ability of railroads and other shippers to transport raw materials and finished products in a timely manner. The occurrence of material operational problems, including but not limited to these events, at one or more of our facilities could have a material adverse effect on our results of operations or financial condition. Certain facilities within each of our business segments account for a significant share of our profits. Disruption to operations at one of these facilities could have a material adverse impact on segment financial performance and our overall financial condition. In addition, in certain circumstances we could also be affected by a disruption or closure of a customer's plant or facility to which we supply our products. The production of chemicals is associated with a variety of hazards which could create significant liabilities or cause our facilities to suspend their operations. Our operations are also subject to various hazards incident to the production of chemicals, including the use, handling, processing, storage and transportation of certain hazardous materials. These hazards, which include the risk of explosions, fires and chemical spills or releases, can cause personal injury and loss of life, severe damage to and destruction of property and equipment, environmental damage, suspension of operations and potentially subject us to lawsuits relating to personal injury and property damages. Any such event or circumstance could have a material adverse effect on our results of operations or financial condition. Due to the nature of our business, we are, from time to time, involved in administrative and judicial proceedings relating to environmental matters which could have a material adverse effect on our results of operations, cash flow and financial condition. As a result of our operations, we may be involved from time to time in proceedings with various regulatory authorities which could require us to pay various fines and penalties due to violations of environmental laws and regulations at our sites, remediate contamination at some of these sites, comply with applicable standards or other requirements or incur capital expenditures to modify certain pollution control equipment or processes at our sites. Although the amount of any liability that could arise with respect to these matters cannot be accurately predicted, we believe that the ultimate resolution of these matters will have no material adverse effect on our results of operations, cash flows or financial condition. On September 7, 2000, the U.S. Environmental Protection Agency issued to us an IAO pursuant to Section 3008(h) of the Resource Conservation and Recovery Act, which requires that we conduct an environmental investigation of certain portions of our Delaware Valley Facility and, if necessary, propose and implement corrective measures to address any historical environmental contamination at the facility. Depending on the scope of any investigation and any remedial activity required as a result, additional costs above those currently estimated could be incurred over a period of the next several years. We are currently unable to estimate the nature and extent of these potential additional costs. As such, it is possible that the final outcome could have a material adverse effect on our results of operations, cash flow and financial condition. We may not be able to obtain insurance at our historical rates and our insurance coverage may not cover all claims and losses. We maintain insurance coverage on our properties, machines, supplies and other elements integral to our business and against certain third party litigation, environmental matters and similar events . Due to recent changes in market conditions in the insurance industry and other factors, we may not be able to secure insurance at a similar cost to what we have previously paid, if at all. In addition, there are certain types of losses, generally of a catastrophic nature, such as earthquakes, floods, hurricanes, terrorism or acts of war, that may be uninsurable or not economically insurable. Inflation, changes in building codes and ordinances, environmental considerations, and other factors, including terrorism or acts of war, also might make the insurance proceeds insufficient to repair or replace a property if it is damaged or destroyed. Under such circumstances, the insurance proceeds received might not be adequate to restore our economic position with respect to the affected real property. In addition, as a result of the events of September 11, 2001, insurance companies are limiting and/or excluding coverage for acts of terrorism in insurance policies. As a result, we may suffer losses from acts of terrorism that are not covered by insurance. We are subject to risks relating to our foreign operations. We have significant manufacturing and sales activities outside of the U.S. and we also export products from the U.S. to various foreign countries. These international operations and exports to foreign markets make us subject to a number of risks such as: currency exchange rate fluctuations; foreign economic conditions; trade barriers; exchange controls; national and regional labor strikes; political instability; risks of increases in duties; taxes; governmental royalties; war; and changes in laws and policies governing operations of foreign-based companies. The occurrence of any one or a combination of these factors may increase our costs or have other negative effects on us. The seasonal nature of the environmental services business could increase our costs or have other negative effects. The businesses of the communications and manufacturing segments are generally not seasonal. However, within the performance products segment, the environmental services business has higher volumes in the second and third quarters of the year, owing to higher spring and summer demand for sulfuric acid regeneration services from gasoline refinery customers to meet peak summer driving season demand and higher spring and summer demand from water treatment chemical customers to manage seasonally high and low water conditions. The seasonal degree of peaks and declines in the volumes of our environmental services business could increase our costs, negatively impact our manufacturing efficiency, require further capital investments or have other negative effects on our operations, customer service or financial performance. We are dependent upon many critical systems and processes, many of which are dependent upon hardware that is concentrated in a limited number of locations. If a catastrophe were to occur at one or more of those locations, it could have a material adverse effect on our business. Our business is dependent on many sophisticated critical systems, which support various aspects of our operations, from our computer network to our billing and customer service systems. The hardware supporting a large number of critical systems is housed in a relatively small number of locations. If one or more of these locations were to be subject to fire, natural disaster, terrorism, power loss, or other catastrophe, it could have a material adverse effect on our business. While we believe that we maintain reasonable disaster recovery programs, there can be no assurance that, despite these efforts, any disaster recovery, security and service continuity protection measures we have or may take in the future will be sufficient. In addition, computer viruses, electronic break-ins or other similar disruptive problems could also adversely affect our operations. Our insurance policies may not adequately compensate us for any losses that may occur due to any failures or interruptions in our computer systems. Risks Related to Our Common Stock The market price of our common stock is subject to volatility as well as trends in our industries in general. We recently emerged from Chapter 11 and the current market price of our common stock may not be indicative of prices that will prevail in the trading markets in the future. The market price of our common stock could be subject to wide fluctuations in response to numerous factors, many of which are beyond our control. These factors include, among other things, actual or anticipated variations in our operating results and cash flow, the nature and content of our earnings releases and our competitors' earnings releases, announcements of technological innovations that impact our products, customers, competitors or markets, changes in financial estimates by securities analysts, business conditions in our markets and the general state of the securities markets and the market for similar stocks, changes in capital markets that affect the perceived availability of capital to companies in our industries, governmental legislation or regulation, currency and exchange rate fluctuations, as well as general economic and market conditions, such as recessions. In addition, in the short period since the issuance of our common stock on the Effective Date, the price of our common stock has been somewhat volatile and remains subject to volatility. Trends in the industries in which we compete are likely to have a corresponding impact on the price of our common stock. Specifically, in our manufacturing segment, the loss of any individual engine line or model contract would not be material to our overall financial condition. However, an economic downturn in the automotive industry as a whole or other events (e.g., labor disruptions) resulting in significantly reduced operations at any of DaimlerChrysler, Ford or General Motors, or at certain of our manufacturing plants, could have a material adverse impact on the results of our manufacturing segment. In addition, in the appliance and electronic and industrial markets, risks include softening of appliance demand, continued price pressure from major customers and continued competition from lower-cost Asian sources. For our performance products business, the continued weakness in the pulp and paper, electronics or chemical processing industries could have an adverse effect on our results of operations. In our communications segment, a loss of key contracts with current customers and vendors in addition to weakness in economic conditions in the communications market and competitive pricing driven by overcapacity could have a material adverse effect on the price of our stock. Sales of large amounts of our common stock or the perception that sales could occur may depress our stock price. On the Effective Date, we issued an aggregate of 10,000,000 shares of our common stock to former holders of our debt securities and other claimants. These shares represented all of our outstanding common stock as of the Effective Date and may be sold at any time, subject to compliance with applicable law, including the Securities Act, and certain provisions of our certificate of incorporation, bylaws and the Registration Rights Agreement (as defined herein). Sales in the public market of large blocks of shares of our common stock acquired pursuant to the Plan could lower our stock price and impair our ability to raise funds in future stock offerings. We may in the future seek to raise funds through equity offerings, or there may be other events which would have a dilutive effect on our common stock. In the future we may determine to raise capital through offerings of our common stock, securities convertible into our common stock, or rights to acquire such securities or our common stock. In any such case, the result would ultimately be dilutive to our common stock by increasing the number of shares outstanding. In addition, if options or warrants to purchase our common stock are exercised or other equity interests are granted under our management and directors incentive plan or under other plans adopted in the future, such equity interests will also have a dilutive effect on our common stock. Additional shares of our common stock and additional warrants may be issued pursuant to the Plan to certain claimants, subject to the resolution of certain claims. In the event that the holders of California Tort Claims (as defined in the Plan) prevail on their asserted claims against us and our insurance does not cover such claims, stock and warrants would be issued to holders of such claims and dilution of any outstanding shares of our common stock would occur. Although we believe we have meritorious defenses to the California Tort Claims and, if our insurance covers this liability, that we have sufficient insurance coverage to satisfy any liquidated amounts relating to such claims, there can be no assurance this will be the case. Under the Plan, holders of California Tort Claims, to the extent they are determined to hold allowable claims not covered by insurance, will receive additional shares of our common stock and warrants beyond those reserved for general unsecured creditors, in an amount that will provide the same percentage recovery as received by general unsecured creditors. We cannot predict the effect any such dilution may have on the price of our common stock. We may be unable to list our stock on a national securities exchange. We are currently traded on the Over the Counter Bulletin Board. Pursuant to the Plan, we are obligated to use our best efforts to list our common stock on a national securities exchange. Despite our efforts, we may not be able to meet the applicable listing requirements of any national securities exchange and, therefore, our common stock may not become listed on a national securities exchange. If our stock is not traded through a market system, it may not be liquid and we may be unable to obtain future equity financing, or use our common stock as consideration for mergers or other business combinations on favorable terms or at all. We do not expect to pay dividends on our common stock in the foreseeable future. We do not expect to pay dividends on our common stock in the foreseeable future. The payment of any dividends by us in the future will be at the discretion of our board of directors and will depend upon, among other things, future earnings, operations, capital requirements, our general financial condition and the general financial condition of our subsidiaries. In addition, under Delaware law, unless a corporation has available surplus or earnings it cannot declare or pay dividends on its capital stock. Furthermore, the terms of our Revolving Credit Facility and our Senior Term Loan Credit Agreement impose limitations on the payment of dividends to us by our subsidiaries and the distribution of earnings or making of other payments to us by our subsidiaries, which consequently limits amounts available for us to pay dividends on our common stock. Additionally, the Senior Term Loan Credit Agreement directly limits our ability to pay dividends on our common stock. The terms of any future indebtedness of our subsidiaries may generally restrict the ability of some of our subsidiaries to distribute earnings or make other payments to us. Certain transfer restrictions on our common stock imposed by our charter may inhibit market activity in our common stock. Our common stock is subject to certain transfer restrictions imposed by our charter. These restrictions generally prohibit the following transfers of our equity securities without the prior written consent of our board of directors, which consent can be withheld only if our board of directors, in its sole discretion, determines that the transfer creates a material risk of limiting certain tax benefits: (i) transfers to a person (including any group of persons making a coordinated acquisition) who beneficially owns, or would beneficially own after the transfer, more than 4.75% of the total value of our outstanding equity securities, to the extent that the transfer would increase such person's beneficial ownership above 4.75% of the total value of our outstanding equity securities and (ii) transfers by a person (or group of persons having made a coordinated acquisition) who beneficially owns more than 4.75% of the total value of our outstanding equity securities. The restrictions are not applicable to transfers pursuant to a tender offer to purchase 100% of our common stock for cash or marketable securities so long as such tender offer results in the tender of at least 50% of our common stock then outstanding. The restrictions begin only at such time that 25% of the our common stock has been transferred, for tax purposes (which generally takes into consideration only transfers to or from shareholders who beneficially own 5% of the value of our common stock), and will remain in effect until the earlier of: (i) the second anniversary of the Effective Date or (ii) such date as the board of directors determines, in its sole discretion, that such restrictions are no longer necessary to protect tax benefits. These transfer restrictions may inhibit market activity in our common stock. Some provisions of the agreements governing our indebtedness and certain provisions of our certificate of incorporation could delay or prevent transactions involving a change of control of GenTek. We may, under some circumstances involving a change of control, be obligated to offer to repay substantially all of our outstanding indebtedness, and repay other indebtedness (including our Revolving Credit Facility and senior term debt). We cannot assure you that we will have available financial resources necessary to repay this indebtedness in those circumstances. If we cannot repay this indebtedness in the event of a change of control, the failure to do so would constitute an event of default under the agreements under which that indebtedness was incurred and could result in a cross-default under other indebtedness. The threat of this default could have the effect of delaying or preventing transactions involving a change of control of GenTek, including transactions in which stockholders might otherwise receive a substantial premium for their shares over then current market prices, and may limit the ability of our stockholders to approve transactions that they may deem to be in their best interest. Certain provisions of our certificate of incorporation, including the provision restricting transfer of shares in order to assist in the preservation of certain tax benefits, may have the effect, alone or in combination with each other or with the existence of authorized but unissued common stock and preferred stock, of preventing or making more difficult transactions involving a change of control of GenTek.

parsed_sections/risk_factors/2004/CIK0001086319_gasco_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ RISK FACTORS Investing in our common stock will provide you with an equity ownership in Gasco. As one of our stockholders, you will be subject to risks inherent in our business. The trading price of your shares will be affected by the performance of our business relative to, among other things, competition, market conditions and general economic and industry conditions. The value of your investment may decrease, resulting in a loss. You should carefully consider the following factors as well as other information contained in this prospectus before deciding to invest in shares of our common stock. We have incurred losses since our inception and will continue to incur losses in the future. To date our operations have not generated sufficient operating cash flows to provide working capital for our ongoing overhead, the funding of our lease acquisitions and the exploration and development of our properties. Without adequate financing, we may not be able to successfully develop any prospects that we have or acquire and we may not achieve profitability from operations in the near future or at all. During the year ended December 31, 2002 and during the nine months ended September 30, 2003, we incurred losses of $5,649,682 and $1,890,166, respectively. We have an accumulated deficit of $24,655,402 from our inception through September 30, 2003, including the Series A Convertible Redeemable Preferred Stock deemed distribution of $11,400,000 as further described in Note 11 of our accompanying financial statements. Our oil and gas reserve information is estimated and may not reflect our actual reserves. Estimating accumulations of gas and oil is complex and is not exact because of the numerous uncertainties inherent in the process. The process relies on interpretations of available geological, geophysical, engineering and production data. The extent, quality and reliability of this technical data can vary. The process also requires certain economic assumptions, some of which are mandated by the SEC, such as gas and oil prices, drilling and operating expenses, capital expenditures, taxes and availability of funds. The accuracy of a reserve estimate is a function of: .the quality and quantity of available data; .the interpretation of that data; .the accuracy of various mandated economic assumptions; and .the judgment of the persons preparing the estimate. The proved reserve information included in this prospectus is based on estimates prepared by James R. Stell, independent petroleum engineer. Estimates prepared by others could differ materially from these estimates. The most accurate method of determining proved reserve estimates is based upon a decline analysis method, which consists of extrapolating future reservoir pressure and production from historical pressure decline and production data. The accuracy of the decline analysis method generally increases with the length of the production history. Since most of our wells had been producing less than two months, their production history was relatively short, so other (generally less accurate) methods such as volumetric analysis and analogy to the production history of wells of other operators in the same reservoir were used in conjunction with the decline analysis method to determine our estimates of proved reserves. As our wells are produced over time and more data is available, the estimated proved reserves will be redetermined on an annual basis and may be adjusted based on that data. Actual future production, gas and oil prices, revenues, taxes, development expenditures, operating expenses and quantities of recoverable gas and oil reserves most likely will vary from our estimates. Any significant variance could materially affect the quantities and present value of our reserves. In addition, we may adjust estimates of proved reserves to reflect production history, results of exploration and development and prevailing gas and oil prices. Our reserves may also be susceptible to drainage by operators on adjacent properties. It should not be assumed that the present value of future net cash flows included herein is the current market value of our estimated proved gas and oil reserves. In accordance with SEC requirements, we generally base the estimated discounted future net cash flows from proved reserves on prices and costs on the date of the estimate. Actual future prices and costs may be materially higher or lower than the prices and costs as of the date of the estimate. Future changes in commodity prices or our estimates and operational developments may result in impairment charges to our reserves. We may be required to writedown the carrying value of our gas and oil properties when gas and oil prices are low or if there is substantial downward adjustments to the estimated proved reserves, increases in the estimates of development costs or deterioration in the exploration results. We follow the full cost method of accounting, under which, capitalized gas and oil property costs less accumulated depletion and net of deferred income taxes may not exceed an amount equal to the present value, discounted at 10%, of estimated future net revenues from proved gas and oil reserves plus the cost, or estimated fair value, if lower of unproved properties. Should capitalized costs exceed this ceiling, an impairment is recognized. The present value of estimated future net revenues is computed by applying current prices of gas and oil to estimated future production of proved gas and oil reserves as of period-end, less estimated future expenditures to be incurred in developing and producing the proved reserves assuming the continuation of existing economic conditions. Once an impairment of gas and oil properties is recognized, is not reversible at a later date even if oil or gas prices increase. Our common stock does not trade in a mature market and therefore has limited liquidity. Our common stock is highly speculative and has only been trading in the public markets since January 2001. Our common stock trades on the over-the-counter market. Holders of our common stock may not be able to liquidate their investment in a short time period or at the market prices that currently exist at the time a holder decides to sell. Because of this limited liquidity, it is unlikely that shares of our common stock will be accepted by lenders as collateral for loans. The development of oil and gas properties involves substantial risks that may result in a total loss of investment. The business of exploring for and producing oil and gas involves a substantial risk of investment loss that even a combination of experience, knowledge and careful evaluation may not be able to overcome. Drilling oil and gas wells involves the risk that the wells will be unproductive or that, although productive, the wells do not produce oil and/or gas in economic quantities. Other hazards, such as unusual or unexpected geological formations, pressures, fires, blowouts, loss of circulation of drilling fluids or other conditions may substantially delay or prevent completion of any well. Adverse weather conditions can also hinder drilling operations. A productive well may become uneconomic in the event water or other deleterious substances are encountered, which impair or prevent the production of oil and/or gas from the well. In addition, production from any well may be unmarketable if it is contaminated with water or other deleterious substances. We may not be able to obtain adequate financing to continue our operations. We have relied in the past primarily on the sale of equity capital and farm-out and other similar types of transactions to fund working capital and the acquisition of its prospects and related leases. Failure to generate operating cash flow or to obtain additional financing could result in substantial dilution of our property interests, or delay or cause indefinite postponement of further exploration and development of our prospects with the possible loss of our properties. For example, we are party to an agreement with ConocoPhillips Petroleum to conduct drilling operations on approximately 30,000 acres within the Riverbend project. ConocoPhillips will fund its share of drilling and completion costs of wells that it drills within that area. In order to maximize our interests in any future Riverbend wells drilled by ConocoPhillips, we must fund our proportionate share of the drilling and completion costs of such wells. Generally, if we fund our proportionate share of drilling and completion costs in a well drilled by ConocoPhillips, we will retain a 14% working interest (which becomes a 10.5% working interest after payout) in the well drilled by ConocoPhillips and the spacing unit surrounding the well. If we do not fund our proportionate shares of drilling and completion costs in a well drilled by ConocoPhillips, our interests will be reduced to a 0.35% overriding interest in the well and spacing unit before payout, which will convert to a 2.10% working interest after such well reaches payout. This project and our other projects will require significant new funding. We have not yet secured specific sources of adequate funding for this and other projects, and we may be unable to timely secure financing on terms that are favorable to us or at all. Any future financing through the issuance of our common stock will likely result in a substantial dilution to our stockholders. We may suffer losses or incur liability for events that we or the operator of a property have chosen not to obtain insurance. Although management believes the operator of any property in which we may acquire interests will acquire and maintain appropriate insurance coverage in accordance with standard industry practice, we may suffer losses from uninsurable hazards or from hazards, which we or the operator have chosen not to insure against because of high premium costs or other reasons. We may become subject to liability for pollution, fire, explosion, blowouts, cratering and oil spills against which we cannot insure or against which we may elect not to insure. Such events could result in substantial damage to oil and gas wells, producing facilities and other property and personal injury. The payment of any such liabilities may have a material, adverse effect on our financial position. We may incur losses as a result of title deficiencies in the properties in which we invest. If an examination of the title history of a property that we have purchased reveals a petroleum and natural gas lease that has been purchased in error from a person who is not the owner of the mineral interest desired, our interest would be worthless. In such an instance, the amount paid for such petroleum and natural gas lease or leases would be lost. It is our practice, in acquiring petroleum and natural gas leases, or undivided interests in petroleum and natural gas leases, not to undergo the expense of retaining lawyers to examine the title to the mineral interest to be placed under lease or already placed under lease. Rather, we will rely upon the judgment of petroleum and natural gas lease brokers or landmen who perform the fieldwork in examining records in the appropriate governmental office before attempting to acquire a lease in a specific mineral interest. Prior to the drilling of a petroleum and natural gas well, however, it is the normal practice in the petroleum and natural gas industry for the person or company acting as the operator of the well to obtain a preliminary title review of the spacing unit within which the proposed petroleum and natural gas well is to be drilled to ensure there are no obvious deficiencies in title to the well. Frequently, as a result of such examinations, certain curative work must be done to correct deficiencies in the marketability of the title, and such curative work entails expense. The work might include obtaining affidavits of heirship or causing an estate to be administered. The volatility of natural gas and oil prices could have a material adverse effect on our business. A sharp decline in the price of natural gas and oil prices would result in a commensurate reduction in our income from the production of oil and gas. In the event prices fall substantially, we may not be able to realize a profit from our production and would continue to operate at a loss. In recent decades, there have been periods of both worldwide overproduction and underproduction of hydrocarbons and periods of both increased and relaxed energy conservation efforts. Such conditions have resulted in periods of excess supply of, and reduced demand for, crude oil on a worldwide basis and for natural gas on a domestic basis. These periods have been followed by periods of short supply of, and increased demand for, crude oil and natural gas. The excess or short supply of crude oil has placed pressures on process and has resulted in dramatic price fluctuations even during relatively short periods of seasonal market demand. Among the factors that can cause the price volatility are: - Worldwide or regional demand for energy, which is affected by economic conditions; - The domestic and foreign supply of natural gas and oil; - Weather conditions; - Domestic and foreign governmental regulations; - Political conditions in natural gas or oil producing regions; - The ability of members of the Organization of Petroleum Exporting Countries to agree upon and maintain oil prices and production levels; and - The price and availability of alternative fuels. All of our production is currently located in, and all of our future production is anticipated to be located in, the Rocky Mountain Region of the United States. The gas prices that the Company and other operators in the Rocky Mountain region have received and are currently receiving are at a steep discount to gas prices in other parts of the country. Factors that can cause price volatility for crude oil and natural gas within this region are: - The availability of gathering systems with sufficient capacity to handle local production; - Seasonal fluctuations in local demand for production; - Local and national gas storage capacity; - Interstate pipeline capacity; and - The availability and cost of gas transportation facilities from the Rocky Mountain region. In addition, because of our size we do not own or lease firm capacity on any interstate pipelines. As a result, our transportation costs are particularly subject to short-term fluctuations in the availability of transportation facilities. Our management believes that the steep discount in the prices it receives may be due to pipeline constraints out of the region, but there is no assurance that increased capacity will improve the prices to levels seen in other parts of the country in the future. Even if we acquire additional pipeline capacity, conditions may not improve due to other factors listed above. It is impossible to predict natural gas and oil price movements with certainty. Lower natural gas and oil prices may not only decrease our revenues on a per unit basis but also may reduce the amount of natural gas and oil that we can produce economically. A substantial or extended decline in natural gas and oil prices may materially and adversely affect our future business, financial condition, results of operations, liquidity and ability to finance planned capital expenditures. Further, oil prices and natural gas prices do not necessarily move together. Our ability to market the oil and gas that we produce is essential to our business. Several factors beyond our control may adversely affect our ability to market the oil and gas that we discover. These factors include the proximity, capacity and availability of oil and gas pipelines and processing equipment, market fluctuations of prices, taxes, royalties, land tenure, allowable production and environmental protection. The extent of these factors cannot be accurately predicted, but any one or a combination of these factors may result in our inability to sell our oil and gas at prices that would result in an adequate return on our invested capital. For example, we currently distribute the gas that we produce through a single pipeline. If this pipeline were to become unavailable, we would incur additional costs to secure a substitute facility in order to deliver the gas that we produce. We rely upon the services of third party gathering companies to transport our natural gas to market. A disruption in this service could materially limit our ability to move our natural gas to market until alternative transportation can be arranged which may take an extended period of time. We are subject to environmental regulation that can adversely affect the timing and cost of our operations. Our exploration and proposed production activities are subject to certain federal, state and local laws and regulations relating to environmental quality and pollution control. These laws and regulations increase the costs of these activities and may prevent or delay the commencement or continuance of a given operation. Specifically, we are subject to legislation regarding emissions into the environment, water discharges, and storage and disposition of hazardous wastes. In addition, legislation has been enacted which requires well and facility sites to be abandoned and reclaimed to the satisfaction of state authorities. However, such laws and regulations have been frequently changed in the past, and we are unable to predict the ultimate cost of compliance as a result of future changes. It is anticipated that before full field development can occur we will be required to conduct Environmental Assessments and/or Environmental Impact Statements which may result in material delays and/or limitations to developing all or part of our leasehold interests. We are subject to complex governmental regulations which may adversely affect the cost of our business. Petroleum and natural gas exploration, development and production are subject to various types of regulation by local, state and federal agencies. We may be required to make large expenditures to comply with these regulatory requirements. Legislation affecting the petroleum and natural gas industry is under constant review for amendment and expansion. Also, numerous departments and agencies, both federal and state, are authorized by statute to issue and have issued rules and regulations binding on the petroleum and natural gas industry and its individual members, some of which carry substantial penalties for failure to comply. Any increases in the regulatory burden on the petroleum and natural gas industry created by new legislation would increase our cost of doing business and, consequently, adversely affect our profitability. A major risk inherent in drilling is the need to obtain drilling permits from local authorities. Delays in obtaining drilling permits, the failure to obtain a drilling permit for a well or a permit with unreasonable conditions or costs could have a materially adverse effect on our ability to effectively develop our properties. Our competitors may have greater resources which could enable them to pay a higher price for properties and to better withstand periods of low market prices for hydrocarbons. The petroleum and natural gas industry is intensely competitive, and we compete with other companies, which have greater resources. Many of these companies not only explore for and produce crude petroleum and natural gas but also carry on refining operations and market petroleum and other products on a regional, national or worldwide basis. Such companies may be able to pay more for productive petroleum and natural gas properties and exploratory prospects or define, evaluate, bid for and purchase a greater number of properties and prospects than our financial or human resources permit. In addition, such companies may have a greater ability to continue exploration activities during periods of low hydrocarbon market prices. Our ability to acquire additional properties and to discover reserves in the future will be dependent upon our ability to evaluate and select suitable properties and to consummate transactions in a highly competitive environment. We may have difficulty managing growth in our business. Because of our small size, growth in accordance with our business plans, if achieved, will place a significant strain on our financial, technical, operational and management resources. As we expand our activities and increase the number of projects we are evaluating or in which we participate, there will be additional demands on our financial, technical and management resources. The failure to continue to upgrade our technical, administrative, operating and financial control systems or the occurrence of unexpected expansion difficulties, including the recruitment and retention of experienced managers, geoscientists and engineers, could have a material adverse effect on our business, financial condition and results of operations and our ability to timely execute our business plan. Our success depends on our key management personnel, the loss of any of whom could disrupt our business. The success of our operations and activities is dependent to a significant extent on the efforts and abilities of our management. The loss of services of any of our key managers could have a material adverse effect on our business. We have not obtained "key man" insurance for any of our management. Mr. Erickson is the Chief Executive Officer and Mr. Decker is an executive vice president and Chief Operating Officer of Gasco. The loss of their services may adversely affect our business and prospects. Our officers and directors are engaged in other businesses which may result in conflicts of interest Certain of our officers and directors also serve as directors of other companies or have significant shareholdings in other companies. To the extent that such other companies participate in ventures in which we may participate, or compete for prospects or financial resources with us, these officers and directors will have a conflict of interest in negotiating and concluding terms relating to the extent of such participation. In the event that such a conflict of interest arises at a meeting of the board of directors, a director who has such a conflict must disclose the nature and extent of his interest to the board of directors and abstain from voting for or against the approval of such participation or such terms. In accordance with the laws of the State of Nevada, our directors are required to act honestly and in good faith with a view to the best interests of Gasco. In determining whether or not we will participate in a particular program and the interest therein to be acquired by it, the directors will primarily consider the degree of risk to which we may be exposed and its financial position at that time. It may be difficult to enforce judgments predicated on the federal securities laws on some of our board members who are not U.S. residents. Two of our directors reside outside the United States and maintain a substantial portion of their assets outside the United States. As a result it may be difficult or impossible to effect service of process within the United States upon such persons, to bring suit in the United States or to enforce, in the U.S. courts, any judgment obtained there against such persons predicated upon any civil liability provisions of the U.S. federal securities laws. Foreign courts may not entertain original actions against our directors or officers predicated solely upon U.S. federal securities laws. Furthermore, judgments predicated upon any civil liability provisions of the U.S. federal securities laws may not be directly enforceable in foreign countries. CAUTIONARY STATEMENT ABOUT FORWARD-LOOKING STATEMENTS Some of the information in this prospectus, contains forward-looking statements within the meanings of Section 27A of the Securities Exchange Act of 1934. These statements express, or are based on, our expectations about future events. These include such matters as: - financial position; - business strategy; - budgets; - amount, nature and timing of capital expenditures; - estimated reserves of natural gas and oil; - drilling of wells; - acquisition and development of oil and gas properties; - timing and amount of future production of natural gas and oil; - operating costs and other expenses; and - cash flow and anticipated liquidity. There are many factors that could cause these forward-looking statements to be incorrect including, but not limited to, the risks described under "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." These factors include, among others: - our ability to generate sufficient cash flow to operate; - the lack of liquidity of our common stock; - the risks associated with exploration; - natural gas and oil price volatility; - uncertainties in the projection of future rates of production and timing of development expenditures; - operating hazards attendant to the natural gas and oil business; - downhole drilling and completion risks that are generally not recoverable from third parties or insurance; - potential mechanical failure or under-performance of significant wells; - climatic conditions; - availability and cost of material and equipment; - delays in anticipated start-up dates; - actions or inactions of third-party operators of our properties; - our ability to find and retain skilled personnel; - availability of capital; - the strength and financial resources of our competitors; - regulatory developments; - environmental risks; and - general economic conditions. Any of the factors listed above and other factors contained in this prospectus could cause our actual results to differ materially from the results implied by these or any other forward-looking statements made by us or on our behalf. We cannot assure you that our future results will meet our expectations. You should pay particular attention to the risk factors and cautionary statements described under "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." When you consider these forward-looking statements, you should keep in mind these risk factors and the other cautionary statements in this prospectus. Our forward-looking statements speak only as of the date made.

parsed_sections/risk_factors/2004/CIK0001089518_acs-long_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ RISK FACTORS An investment in the IDSs, our Class A common stock and the notes involves a high degree of risk. You should read and consider carefully each of the following factors, as well as the other information contained in this prospectus, before making a decision to invest in the IDSs, our Class A common stock and/or the notes. The risks described below are not the only risks facing us. Additional risks and uncertainties not currently known to us or those we currently deem to be immaterial may also materially and adversely affect our business operations. Any of the following risks could materially adversely affect our business, financial condition, liquidity or results of operations. In such case, you may lose all or part of your original investment. Risks Relating to the IDSs, Including the Class A Common Stock and Notes Represented by the IDSs, and the Separate Notes Our substantial indebtedness could adversely affect our financial health and restrict our ability to pay interest and principal on the notes and to pay dividends with respect to our Class A common stock, represented by the IDSs and adversely affect our financing options and liquidity position. We have now and, following the closing of this offering and the other Transactions, will continue to have a substantial amount of indebtedness. After giving effect to this offering, the other Transactions, and the redemption of our senior discount debentures, which we expect to complete on June 14, 2004, as of March 31, 2004 we would have had total long-term obligations of $ million and a deficiency of earnings to fixed charges for the three months ended March 31, 2004 of $ . Our substantial level of indebtedness could have important consequences for you as a holder of an IDS or the separate notes. For example, our substantial indebtedness could: make it more difficult for us to satisfy our obligations with respect to the notes and our other indebtedness and/or pay dividends on our Class A common stock and Class B common stock; limit our flexibility to plan, adjust or react to changing economic, market or industry conditions, reduce our ability to withstand competitive pressures, and increase our vulnerability to general adverse economic and industry conditions; place us at a competitive disadvantage to many of our competitors who are less leveraged than we are; limit our ability to issue new IDSs or other equity; limit our ability to borrow additional amounts for working capital, capital expenditures, future business opportunities, including strategic acquisitions and other general corporate requirements or hinder us from obtaining such financing on terms favorable to us or at all; require us to seek additional financing or sell certain of our assets if we cannot generate sufficient cash flow to meet our debt service obligations and fund our working capital requirements; require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, future business opportunities and other general corporate purposes; and limit our ability to refinance our indebtedness. Despite our substantial indebtedness, we and our subsidiaries may be able to incur substantial additional indebtedness in the future that would make it more difficult for us to satisfy obligations on the notes and our other indebtedness and pay dividends on our Class A common stock and Class B common stock and further reduce the cash we have available to invest in our operations. If we do not Primary Standard Industrial Classification Code Number generate sufficient cash flow to meet our debt service obligations and to fund our working capital requirements, we may need to seek additional financing or sell certain of our assets. The terms of the indenture governing the notes, the terms of our new revolving credit facility and the terms of our other indebtedness, including the indentures governing the ACSH notes, allow us and our subsidiaries to incur additional indebtedness upon the satisfaction of certain conditions. See "Description of Notes" and "Description of Other Indebtedness." As of March 31, 2004, after giving effect to this offering, the other Transactions and the redemption of our senior discount debentures, which we expect to complete on June 14, 2004, we would have had $50 million available for additional borrowings under the new revolving credit facility. If new indebtedness is added to current levels of indebtedness, the related risks described above could intensify. We will require a significant amount of cash to service our indebtedness. Our ability to generate cash depends on many factors beyond our control. Our ability to make payments on and to refinance our indebtedness, including the notes and amounts borrowed under the new revolving credit facility, and to fund planned capital expenditures and any strategic acquisitions we may make, if any, will depend on our ability to generate cash in the future. Based on our current level of operations, we believe our cash flow from operations, together with available cash and available borrowings under the revolving credit facility, will be adequate to meet our future liquidity needs for at least the next twelve months. However, we cannot assure you that our business will generate sufficient cash flow from operations in the future, that our currently anticipated growth in revenues and cash flow will be realized on schedule or that future borrowings will be available to us in an amount sufficient to enable the repayment of our indebtedness, or to fund our other liquidity needs. We may need to refinance all or a portion of our indebtedness, including the notes, on or before maturity. We cannot assure you that we will be able to refinance any of our debt, including the ACSH notes, the new revolving credit facility and the notes, on commercially reasonable terms or at all. Your right to receive payments on the notes is junior to our existing senior indebtedness and possibly all of our future borrowings. Further, the guarantees of these notes are junior to all of the guarantors' existing senior indebtedness and possibly to all their future borrowings. These notes and the guarantees are unsecured and rank junior to all of our and the guarantors' existing senior indebtedness, including our borrowings and the related guarantees by guarantors under the ACSH senior notes and the new revolving credit facility, and all of our and the guarantors' future senior indebtedness. As of March 31, 2004, after giving effect to this offering, the other Transactions and the redemption of our senior discount debentures, which we expect to complete on June 14, 2004, the notes would have been subordinated to approximately $189.7 million of our senior debt, of which $182 million would have consisted of indebtedness under ACSH's 97/8% senior notes due 2011. In addition, approximately $50.0 million would have been available to us for borrowing as additional senior debt on a secured basis under the new revolving credit facility. We would also be permitted to borrow substantial additional indebtedness, including senior debt, in the future. As a result of such subordination, upon any distribution to our creditors or the creditors of the guarantors in a bankruptcy, liquidation, reorganization or similar proceeding relating to us, the guarantors, our property or the guarantors' property, the holders our of senior debt and the senior debt of the guarantors will be entitled to be paid in full before any payment may be made with respect to the notes or the guarantees. In addition, all payments on the notes and the guarantees will be blocked in the event of a payment default on certain designated senior debt, which will include debt under the new revolving credit facility, and may be blocked for up to 179 consecutive days in the event of certain non-payment defaults on such designated senior debt. In the event of a bankruptcy, liquidation or reorganization or similar proceeding relating to us or the guarantors, the indenture relating to the I.R.S. Employer Identification Number notes will require that amounts otherwise payable to holders of the notes in a bankruptcy or similar proceeding instead be paid to holders of senior debt until the holders of the senior debt are paid in full. As a result, holders of the notes may not receive all amounts owed to them and may receive ratably less than holders of trade payables and other unsubordinated indebtedness in any such proceeding. Our secured creditors will be entitled to be paid in full from the proceeds from the sale of our pledged assets before such proceeds will be available for payments on the IDSs and the separate notes. In addition to being contractually subordinated to all its existing and future senior debt, our obligations under the notes will be unsecured while our obligations under the new revolving credit facility will be secured by substantially all of our assets and those of our subsidiaries. We also have other secured indebtedness. As of March 31, 2004, after giving effect to this offering and the other Transactions, we would have had $7.7 million of secured indebtedness. As of March 31, 2004, on the same pro forma basis, we would have had $50.0 million available for borrowing on a secured basis under the new revolving credit facility. The new revolving credit facility and the indentures governing the ACSH notes permit, and the indenture governing the notes will also permit, us to incur additional secured indebtedness provided certain conditions are met. If we become insolvent or are liquidated, or if payment under the new revolving credit facility is accelerated, the lenders under the new revolving credit facility will be entitled to exercise the remedies available to a secured lender under applicable law. These lenders will have a claim on all assets securing the new revolving credit facility before those proceeds would be available for distribution to our other creditors, including holders of the notes represented by IDSs and holders of the separate notes, or our equity holders, including holders of the Class A common stock represented by IDSs. We may not have sufficient assets remaining to pay amounts due on any or all of the notes then outstanding, including the notes represented by IDSs and the separate notes, or to make payments to our equity holders, including holders of the Class A common stock represented by IDSs. Our debt instruments include restrictive and financial covenants that limit our operating flexibility. Our new revolving credit facility will require us to maintain certain financial ratios and the new revolving credit facility, the indenture governing the notes and the indentures governing the ACSH notes contain covenants that, among other things, restrict our ability to take specific actions, even if we believe such actions are in our best interest. These include restrictions on our ability to: issue certain preferred or redeemable capital stock or IDSs; incur debt; create liens; pay dividends or distributions on, redeem or repurchase our capital stock; make certain types of investments, loans, advances or other forms of payments; issue, sell or allow distributions on capital stock of specified subsidiaries; prepay or defease specified indebtedness, including the notes; enter into transactions with affiliates; or merge, consolidate or sell our assets. If we do not comply with the covenants in our debt agreements, our debt obligations may be accelerated. Our ability to comply with the ratios in the new revolving credit facility may be affected by events beyond our control, including prevailing economic, financial and industry conditions. Any failure to comply with the restrictions of the new revolving credit facility, the indenture governing the notes, the indentures governing the ACSH notes, or certain other current or future financing agreements may result in an event of default. Such default may allow our creditors to accelerate the related debt and may result in the acceleration of any other debt to which a cross-acceleration or cross-default provision applies. Under such circumstances terms of the new revolving credit facility may prohibit us from making payments on the notes or paying dividends on our Class A common stock. These creditors may also be able to terminate any commitments they had made to provide us with additional funds. See "Description of Notes" and "Description of Other Indebtedness," for more information on our restrictive and financial covenants. You may not receive the level of dividends provided for in the dividend policy our board of directors is expected to adopt upon the closing of this offering or any dividends at all. Our board of directors may, in its discretion, amend or repeal the dividend policy it is expected to adopt upon the closing of this offering which may result in the decrease or discontinuation of dividends. Future dividends with respect to shares of our capital stock, if any, will depend on, among other things, our results of operations, cash requirements, financial condition, contractual restrictions, business opportunities, provisions of applicable law and other factors that our board of directors may deem relevant. Additionally, Delaware law and the terms of the indentures governing the notes and the ACSH notes may limit or completely restrict our ability to pay dividends. See "Dividend Policy and Restrictions." Dividends on the Class A common stock and Class B common stock will rank equally, based on their respective dividend rates. As the annual dividend rate on the Class B common stock is expected to be equal to the total annual payments on the IDS, the dividend rate on the Class B common stock will be higher than the dividend rate on the Class A common stock. If there is a limited amount of surplus or net profits available to make dividend distributions, because of the different dividend rates, the pro rata portion of the amount available to make dividend distributions distributed to the Class B common stockholders will be greater than that distributed to the Class A common stockholders. We may not declare dividends on our Class A common stock unless at such time the corresponding proportionate dividend is declared on our Class B common stock. A reduction, or a perceived reduction, in the funds available for dividends resulting from nondeductability of the interest on the notes may negatively affect the market price of the IDSs and the Class A common stock. Funds available for dividend and interest payments would be reduced if the notes were treated as equity rather than debt for U.S. federal income tax purposes. In that event, the stated interest on the notes could be treated as a dividend, and interest on the notes would not be deductible by us for U.S. federal income tax purposes. Our inability to deduct interest on the notes could materially increase our taxable income and, thus, our U.S. federal and applicable state income tax liability thereby reducing the funds available to pay interest on the notes and for dividends. The reduction or elimination of dividends may negatively affect the market price of the IDSs or the Class A common stock represented thereby. We may amend the terms of our new revolving credit facility, or we may enter into new financing agreements that govern our senior indebtedness, and the amended or new agreements may significantly affect our ability to pay dividends on our Class A common stock and interest on the notes. As a result of general economic conditions, conditions in the lending markets, the results of our business or for any other reason, we may elect or be required to amend or refinance our new revolving credit facility, at or prior to maturity, or enter into additional agreements relating to senior indebtedness. Regardless of any protection you have in the indenture governing the notes, any such amendment, refinancing or additional agreement may contain covenants which could limit in a *The address, including zip code and telephone number, including area code, of the principal executive offices of these additional registrants is 600 Telephone Avenue, Anchorage, Alaska 99503, (907) 297-3000. significant way our ability to make interest payments on the notes and make dividend payments on our Class A common stock. The indenture governing the notes, our new revolving credit facility and the terms of our other indebtedness permit us to pay a significant portion of our available funds to stockholders in the form of dividends. Although the indenture governing the notes, the indentures governing the ACSH notes and our new revolving credit facility contain limitations on the payment of dividends on our Class A common stock and our Class B common stock, these agreements permit us to pay a significant portion of our available funds to our stockholders in the form of dividends. For example, in the indenture governing the notes, the covenant that restricts our ability to pay dividends and make other "restricted payments" will contain an initial basket in the amount of $ million, which would enable us to pay substantial dividends after the closing of this offering. Following the closing of this offering, we intend to pay a quarterly dividend on our Class A common stock and our Class B common stock, as described in this prospectus, see "Dividend Policy and Restrictions" and "Summary Pro Forma Interest and Dividend Distributions to IDS Holders." Any amounts paid by us in the form of dividends will not be available in the future to satisfy our obligations under the notes. The realizable value of our assets upon liquidation may be insufficient to satisfy claims. As of March 31, 2004, our assets included intangible assets in the amount of $78.6 million, representing approximately 11.8% of our total consolidated assets and consisting primarily of goodwill, wireless spectrum licenses and debt issuance costs. The value of these intangible assets depends significantly upon the success of our business as a going concern and our ability to manage the operations of businesses we acquire. If we are unable to manage our business successfully and integrate future acquisitions, the realizable value of these intangible assets may be substantially lower and may be insufficient to satisfy the claims of our creditors. The U.S. federal income tax consequences of the purchase, ownership and disposition of IDSs are unclear. No statutory, judicial or administrative authority directly addresses the treatment of the IDSs or instruments similar to the IDSs for U.S. federal income tax purposes. As a result, the U.S. federal income tax consequences of the purchase, ownership and disposition of IDSs are unclear. We will receive an opinion from our counsel, Skadden, Arps, Slate, Meagher & Flom LLP, that an IDS should be treated as a unit representing a share of Class A common stock and $ principal amount of notes and that the notes should be treated as debt for U.S. federal income tax purposes. However, the Internal Revenue Service or the courts may take the position that the notes included in the IDSs are equity, which could adversely affect the amount, timing and character of income, gain or loss in respect of your investment in IDSs, and materially increase our taxable income and, thus, our U.S. federal and applicable state income tax liability. This would reduce our after-tax cash flow and materially and adversely affect our ability to make interest and dividend payments on the notes, including the separate notes, and the Class A common stock. In addition, non-U.S. holders could be subject to withholding or estate taxes with regard to the notes included in the IDSs in the same manner as they will be with regard to the Class A common stock and it could subject us to liability for withholding taxes that were not collected on payments of interest. Payments to non-U.S. holders would not be grossed-up for any such taxes. For discussion of these tax-related risks, see "Material U.S. Federal Income Tax Considerations." Subsequent issuances of notes may cause you to recognize original issue discount and may reduce your recovery in the event of bankruptcy. The indenture governing the notes and the related agreements with the trustee for the notes will provide that, in the event there is a subsequent issuance by us of notes of the same series having terms SUBJECT TO COMPLETION, DATED JUNE , 2004. The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted. PROSPECTUS Income Deposit Securities (IDSs) and $ % Senior Subordinated Notes due 2019 Alaska Communications Systems Group, Inc. identical (except for the issuance date) to the notes, and such subsequently issued notes are treated as issued with original issue discount for U.S. federal income tax purposes or are issued subsequent to an automatic exchange of notes or if we otherwise determine that such notes need to have a new CUSIP number, each holder of notes or IDSs, as the case may be, agrees that a portion of such holder's notes will be automatically exchanged for a portion of the notes acquired by the holders of such subsequently issued notes. Consequently, immediately following each such subsequent issuance and exchange, each holder of notes or IDSs, will own an inseparable unit composed of a proportionate percentage of both the old notes and the newly issued notes equal to the aggregate stated principal amount of notes owned by the holder. Therefore, subsequent issuances of notes with original issue discount, including as part of IDSs issued in exchange for Class B common stock, may adversely affect your tax treatment by increasing the original issue discount, if any, that you were previously accruing with respect to your notes. Due to the lack of applicable authority, it is unclear whether the exchange of notes for subsequently issued notes will result in a taxable exchange for U.S. federal income tax purposes, and our counsel is unable to opine on this issue. It is possible that the Internal Revenue Service might successfully assert that such an exchange should be treated as a taxable exchange, resulting in the recognition of gain or loss. It is also possible that the Internal Revenue Service might successfully assert that any such loss should be disallowed under the "wash sale" rules. Regardless of whether a subsequent issuance results in a taxable exchange, such exchange may result in holders having to include original issue discount in taxable income prior to the receipt of cash and may have other potentially adverse U.S. federal income tax consequences. Following any subsequent issuance and exchange of notes, we (and our agents) and each holder of notes will report any original issue discount on the subsequently issued notes ratably among all holders of notes and IDSs. However, there can be no assurance that the Internal Revenue Service will not assert that any original issue discount should be reported only to the persons that initially acquired such subsequently issued notes (and their transferees). In this case, the Internal Revenue Service might further assert that all of the notes held by such holder have original issue discount. Any of these assertions by the Internal Revenue Service could create significant uncertainties in the pricing of IDSs and the notes and could adversely affect the market and trading rate for the IDSs and notes. Holders of subsequently issued notes having any amount of discount may not be able under New York and federal bankruptcy law to collect the portion of their principal amount that represents unaccrued discount in the event of an acceleration of the notes or our bankruptcy prior to the maturity date of the notes. As a result, an automatic exchange that results in a holder receiving a note with discount could have the effect of ultimately reducing the amount such holder can recover from us in the event of an acceleration or bankruptcy. The indenture governing the notes will contain no limit on the pricing of any additional notes or IDSs or the discount at which such notes may be sold upon issue. Accordingly, additional notes issued in the future may be issued at a very deep discount, which could cause the tax and bankruptcy risks described above to be very material to you as an investor in notes or IDSs in the event that we issue such additional notes or IDSs. For a discussion of these and additional tax related risks, see "Material U.S. Federal Income Tax Considerations." If we subsequently issue notes with significant original issue discount, we may not be able to deduct all of the interest on those notes. It is possible that notes we issue in a subsequent issuance will be issued at a discount to their face value and, accordingly, may have "significant original issue discount" and thus be classified as "applicable high yield discount obligations" for U.S. federal income tax purposes. If any such notes were so treated, a portion of the original issue discount on such notes may be nondeductible by us and the remainder would be deductible only when paid. This treatment would have the effect of increasing We are offering IDSs. The IDSs being offered by this prospectus represent shares of our Class A common stock and $ million aggregate principal amount of our % senior subordinated notes due 2019. Each IDS initially represents: one share of our Class A common stock, and $ principal amount of our % senior subordinated notes due 2019. We have granted the underwriters an option to purchase up to additional IDSs to cover overallotments. We are also separately offering $ million aggregate principal amount of our % senior subordinated notes due 2019, not as part of the IDSs. These separate notes and the notes included in the IDSs are identical in all respects and will be issued under the same indenture as part of a single series. This is the first offering of our IDSs and the separate notes. We currently expect the offering price of the IDSs will be between $ and $ per IDS and the offering price of the separate notes will be % of the stated principal amount of $ per separate note. We will apply to have the IDSs listed on the under the symbol " ." The Class A common stock will not be listed for separate trading until the minimum listing criteria on the are satisfied by our outstanding shares of Class A common stock not held in the form of IDSs for a period of 30 consecutive trading days. We do not anticipate that the notes will be separately listed on any exchange. The notes mature on , 2019 (assuming that they do not mature earlier under their terms). The notes will bear interest at the rate of % per year. The notes will be our unsecured senior subordinated obligations, guaranteed on an unsecured senior subordinated basis by each of our direct and indirect domestic subsidiaries (other than unrestricted subsidiaries). Investing in the IDSs, Class A common stock and notes, including the separate notes, involves risks. See "Risk Factors" beginning on page 22. The Class A common stock offered as part of the IDSs is different from our existing common stock, which is quoted on the Nasdaq National Market under the symbol "ALSK." The last reported sale price of our existing common stock on May 28, 2004 was $6.47. Our existing common stock will be reclassified concurrently with the closing of this offering, as further described in "The Transactions." Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. our taxable income and may adversely affect our cash flow available for interest payments on the notes and distributions to holders of our IDSs and our Class A common stock. The allocation of the purchase price of the IDSs may not be respected. The purchase price of each IDS will be allocated between the Class A common stock and notes in proportion to their respective fair market values at the time of purchase. By purchasing the IDSs you will agree to and be bound by the allocations we make. If our allocation is not respected, it is possible that the notes will be treated as having been issued with original issue discount (if the allocation to the notes were determined to be too high) or amortizable bond premium (if the allocation to the notes were determined to be too low) for U.S. federal income tax purposes. You generally would have to include original issue discount in income in advance of the receipt of cash attributable to that income and would be able to elect to amortize bond premium over the term of the notes. Ownership change will limit our ability to use certain losses for U.S. federal income tax purposes and may increase our tax liability. The Transactions will result in an "ownership change" within the meaning of the U.S. federal income tax laws addressing net operating loss carryforwards, alternative minimum tax credits and other similar tax attributes. As a result of such ownership change, there will be specific limitations on our ability to use our net operating loss carryforwards and other tax attributes from periods prior to the Transactions. It is possible in the future that such limitations could limit our ability to utilize such tax attributes and, therefore, result in an increase in our U.S. federal income tax liability. Such an increase would reduce the funds available for the payment of dividends and might require us to reduce or eliminate the dividends on our IDSs and Class A common stock. You will be immediately diluted by $ per share of Class A common stock if you purchase IDSs in this offering. If you purchase IDSs in this offering, you will experience an immediate dilution of $ per share of Class A common stock represented by the IDSs, which exceeds the entire price allocated to each share of Class A common stock represented by the IDSs in this offering because there will be a net tangible book deficit for each share of Class A common stock outstanding immediately after this offering. Our net tangible book deficiency as of March 31, 2004, after giving effect to this offering and the Transactions, would have been approximately $ million, or $ per share of Class A common stock. Our capital structure after closing of this offering may limit our ability to market and issue equity-only securities. As a result of the restrictions in the indenture governing the notes and the restrictions in the other agreements governing our indebtedness, we may be prevented from issuing additional IDSs in the future. In particular, we may only issue additional IDSs if we satisfy certain financial tests under the new revolving credit facility and the indenture governing the notes. Therefore, we may be forced to rely on equity-only securities as an additional source of capital. However, as a result of this offering and the reclassification, most of our equity holders will hold their investment in us in the form of IDSs, and consequently equity-only securities may be a comparatively less attractive investment. Therefore, we cannot assure you that we will be able to issue equity-only securities on commercially reasonable terms, or at all. Per IDS(1) We may not have the ability to raise the funds necessary to fulfill our obligations under the notes following a change of control. This would place us in default under the indenture governing the notes. Upon the occurrence of certain specific kinds of change of control events, we will be required to offer to repurchase all of the outstanding notes. However, it is possible that we will not have sufficient funds at the time of the change of control to make the required repurchase or that restrictions in the new revolving credit facility will not allow such repurchases. Our ability to repurchase these notes upon certain specific kinds of change of control events may be limited by the terms of our senior indebtedness and the subordination provisions of the indenture governing the notes. For example, the new revolving credit facility will prohibit us from repurchasing these notes after certain specific kinds of change of control events until we first repay debt under the new revolving credit facility in full or obtain a waiver from the lenders under our new revolving credit facility. If we fail to repurchase these notes in that circumstance, we will be in default under the indenture related to the notes and under the new revolving credit facility. Any future debt that we incur may also contain restrictions on repayment which come into effect upon certain specific kinds of change of control events. If a change of control occurs, we cannot assure you that we will have sufficient funds to repay other debt obligations which we will be required to repay in addition to the notes. See "Description of Notes Change of Control" and "Description of Other Indebtedness." Federal and state statutes allow courts, under specific circumstances, to void the notes or the guarantees and require noteholders to return payments received from us or the guarantors. If unpaid creditors of us or any guarantor initiate a bankruptcy case or lawsuit, the debt represented by the notes or the guarantees may be reviewed under the federal bankruptcy law and comparable provisions of state fraudulent transfer laws. Under these laws, the notes or the guarantees could be voided, or claims in respect of the notes or the guarantees could be subordinated to our or the applicable guarantor's other debt. To the extent that the claims of the holders of these notes against us or any guarantor were subordinated in favor of other creditors of ours or such guarantor, such other creditors would be entitled to be paid in full before any payment could be made on these notes or the guarantees. If one or more of the guarantees is voided or subordinated, we cannot assure you that, after providing for all prior claims, there would be sufficient assets remaining to satisfy the claims of the holders of these notes. In addition, any payment by us or a guarantor pursuant to the notes or the guarantees, as the case may be, could be voided and required to be returned to us or such guarantor, or to a fund for the benefit of the creditors of us or such guarantor. If a guarantee were voided as a fraudulent conveyance or held unenforceable for any other reason, holders of these notes would be simply our creditors and creditors of our other subsidiaries that have validly guaranteed these notes. These notes then would be effectively subordinated to all obligations of the subsidiary whose guarantee was voided. For more information, see "Description of Notes Overview of the Notes and the Guarantees The Guarantees." Certain transactions related to the enforceability of the guarantees of the notes by certain of our subsidiaries may require the Federal Communications Commission, or FCC, or the Regulatory Commission of Alaska, or RCA, approval, which may not be granted or which may be subject to delays or conditions that could affect your ability to enforce the guarantees. The FCC and RCA may need to approve certain transactions related to the enforceability of the guarantees of the notes provided by certain of our subsidiaries, including the transfer of control of various radio licenses held by our operating subsidiaries or the transfer of control over or sale of the assets of our operating subsidiaries. Such approvals may not be obtained, in which case such guarantees may be unenforceable, or may be subject to delays or conditions that could affect your ability to enforce the guarantees. The total assets of these subsidiaries as of March 31, 2004 was $391.6 million. Total In the event of bankruptcy or insolvency, the notes and guarantees could be adversely affected by principles of equitable subordination or recharacterization. In the event of bankruptcy or insolvency affecting us or our subsidiaries, a party in interest may seek to subordinate the notes or the guarantees under principles of equitable subordination or to recharacterize the notes as equity. There can be no assurance as to the outcome of such proceedings. In the event a court subordinates the notes or the guarantees, or recharacterizes the notes as equity, we cannot assure you that you would recover any amounts owed on the notes or the guarantees and you may be required to return to us any payments we made to you within six years before the bankruptcy on account of the notes or the guarantees. In addition, should the court equitably subordinate the notes or the guarantees, or recharacterize the notes as equity, you may not be able to enforce the guarantees. Before this offering, there has not been a public market for our IDSs, the notes or shares of our Class A common stock and there has only been a limited market for our existing common stock. The IDSs have no public market history. In addition, as the IDS is a new security there has not been an active market in the United States for securities similar to the IDSs. Our existing common stock is currently publicly traded and listed on the Nasdaq National Market, however, as a result of the IDS offering our existing common stock will be delisted from Nasdaq. Furthermore, prior to this offering, there has been limited trading volume in our existing common stock, averaging 7,007 shares per day from January 1, 2004 to March 31, 2004 and, prior to this offering, only approximately 30% of our existing common stock was held by stockholders other than management and affiliates of Fox Paine. Therefore, we cannot predict whether an active public market will develop for our IDSs following this offering. We currently do not expect that an active trading market for our Class A common stock will develop after this offering or that an active trading market for the notes will develop. If a trading market for the IDSs or the Class A common stock represented thereby does develop, the market price will not be correlated to the market price of our current common stock. We do not expect to list our Class A common stock on any securities exchange until a sufficient number of our shares are no longer held in the form of IDSs to satisfy the minimum listing criteria of the , as described in "Description of Capital Stock Class A Common Stock Listing." We currently do not intend to list our notes on any securities exchange. The automatic separation of IDSs may negatively affect holders of IDSs. If the notes are redeemed or mature or certain payment defaults or bankruptcy events affecting us occur, the IDSs will automatically separate and you will then hold our Class A common stock and notes, separate from an IDS. Upon separation, an active trading market may not develop or be sustained for the Class A common stock or the notes. As a result, you may not be able to sell your Class A common stock or notes at a value derived from the market price of the IDS prior to separation. If, upon separation of the IDSs, a trading market for the IDSs or the Class A common stock does not develop, the trading value of the Class A common stock and the notes may not reflect the market price of the IDSs prior to the separation. See "Description of the IDSs Automatic Separation." The price of the IDSs may fluctuate substantially, which could negatively affect holders of IDSs. The initial public offering price of the IDSs and the offering price of the separate notes will be determined by negotiations among us and the representatives of the underwriters and may not be indicative of the market price of the IDSs or the separate notes after the offering. Factors such as quarterly variations in our financial results, announcements by us or others, developments affecting us, Per Separate Note our customers, general interest rate levels and general market volatility could cause the market price of the IDSs or the separate notes to fluctuate significantly. The limited liquidity of the trading market for the separate notes may affect the trading price of the separate notes. We are separately offering $ million principal amount of the notes that will not be represented by the IDSs, reflecting % of the total outstanding notes (assuming the underwriters do not exercise their overallotment option). While the separate notes are part of the same series of notes as, and identical to, the notes represented by the IDSs, the notes represented by the IDSs will not be separable from the IDSs for 45 days following the closing of this offering and will not be separately tradeable until separated and, as a result, the trading market for the separate notes initially will be very limited. There can be no assurance that, after holders of the IDSs are permitted to separate their IDSs, a sufficient number of holders of IDSs will separate their IDSs into Class A common stock and notes to create a liquid trading market for the notes. It is more likely for debt securities issued in larger aggregate principal amounts to trade more favorably than similar securities issued in smaller aggregate principal amounts because of the increased liquidity created by higher trading volumes resulting from larger issuances. Therefore, because approximately 90% of the notes will initially be represented by the IDSs, it is likely that the separate notes will not trade at prices reflecting the aggregate principal amount of the combined issuance of notes included in the IDS offering and the separate notes offering. There can be no assurance as to the liquidity of any market for the separate notes that may develop, the ability of the holders of the separate notes to sell any of their separate notes and the price at which the holders of separate notes would be able to sell any of their separate notes. If interest rates rise, the trading value of our IDSs may decline. We cannot predict the interest rate environment or guarantee that interest rates will not rise in the near future. Should interest rates rise or should the threat of rising interest rates develop, the trading value of the IDS may be adversely affected. As the IDSs are composed of both Class A common stock and notes, the trading price of the IDSs will be based, in part, on whether the interest rate on the notes is comparable to the then current interest rates on indebtedness of companies similar to us. To the extent prevailing interest rates for indebtedness with similar characteristics as the notes are higher than the interest rate on the notes, the trading price of the IDSs will be negatively affected. Future sales or the possibility of future sales of a substantial amount of IDSs, shares of our Class A common stock or notes, or sales or exchanges of our Class B common stock or Class C common stock, may depress the price of the IDSs and of our Class A common stock and the notes. Future sales or the availability for sale of substantial amounts of IDSs or shares of our Class A common stock or a significant principal amount of the notes in the public market could adversely affect the prevailing market price of the IDSs, our Class A common stock and the notes. We may issue shares of our Class A common stock and notes, which may be in the form of IDSs, or we may issue notes or Class B common stock or Class C common stock separately, or other securities from time to time as consideration for future acquisitions and investments. In addition, we may also grant registration rights covering those IDSs, shares of our Class A common stock, Class B common stock, Class C common stock, notes or other securities in connection with any such acquisitions and investments. See "Description of Capital Stock" for a summary of the material terms of our capital stock. If the underwriters exercise their overallotment option in full, there will be additional IDSs outstanding. In addition, 12 days after the completion of the reclassification, a substantial portion of the Class B common stock that we issue in the reclassification will be exchanged for IDSs. These additional outstanding IDSs and any additional IDSs or Class A Net cash provided by operating activities 50,249 64,827 75,263 Cash Flows from Investing Activities: Construction and capital expenditures, net of capitalized interest (48,404 ) (67,277 ) (87,582 ) Net proceeds from sale of business unit 155,269 Release of funds from escrow 3,539 3,706 Placement of funds in escrow (3,725 ) (6,932 ) Issuance of note receivable (15,000 ) Other investing activities Net cash provided (used) by operating activities $ 88,111 $ (11,474 ) $ (1,374 ) $ $ 75,263 Cash Flows from Investing Activities: Construction and capital expenditures (87,548 ) (34 ) (87,582 ) Placement of funds in escrow (6,932 ) (6,932 ) Other investing activities 31 Total common stock or any new Class B common stock or Class C common stock could further adversely affect prevailing market prices of the IDSs or the Class A common stock. Subject to certain limitations, on the second anniversary of the closing this offering all of our outstanding shares of our Class B common stock will be automatically exchanged into either IDSs or, if the IDSs have automatically separated or are otherwise not outstanding at such time, the applicable number of shares of Class A common stock and a note having a principal amount equal to each note which was represented by an IDS, which could adversely affect prevailing market prices and could impair our ability to raise capital through future sales of our securities. IDSs eligible for future sale may depress the trading price of the IDSs. We, all our executive officers and directors and Fox Paine and some of its affiliates have agreed that, for a period of 180 days from the date of this prospectus (other than in connection with the redemption or exchange of shares of Class B common stock described under "Description of Capital Stock Class B Common Stock Redemption; Exchange") we and they will not, without the prior written consent of each of the representatives of the underwriters, dispose of or hedge any IDSs, our Class A common stock, our Class B common stock or the notes, including the separate notes. The representatives of the underwriters, may release any of the securities subject to these lock-up agreements at any time without notice. We will at the time of this offering enter into a registration rights agreement with Fox Paine and some of their affiliates. The registration rights agreement provides, among other things, that Fox Paine may require us, subject to certain limitations, to register with the SEC all or a portion of their IDSs, Class A common stock, notes or Class B common stock that they hold. If Fox Paine exercises these or other similar rights under the registration rights agreement to sell substantial amounts of IDSs, Class A common stock, notes or Class B common stock in the public market, or if it is perceived that such exercise or sale could occur, the market price of our IDSs, Class A common stock, notes or Class B common stock, as the case may be, may fall. See "Certain Relationships and Related Party Transactions Registration Rights" for a summary of the terms of the registration rights agreement. Holders of our existing common stock will hold all of our Class B common stock after the offering and the interests of such holders may conflict with your interests as holders of our IDSs or Class A common stock. In connection with the reclassification, holders of our existing common stock will be receiving shares of Class B common stock. After giving effect to the Transactions, the Class B common stock will represent % of our total outstanding equity. Holders of our existing common stock, including Fox Paine, will beneficially own 100% of the outstanding shares of our Class B common stock and % of the outstanding shares of our voting capital stock ( % if the underwriters' overallotment option is exercised in full). Fox Paine will beneficially own % of the outstanding shares of Class B common stock and % of the outstanding shares of our voting capital stock ( % of our outstanding shares of Class B common stock and % of the outstanding shares of our voting capital stock if the underwriters' overallotment option is exercised in full). Shares of the Class A common stock represented by the IDSs and the Class B common stock issued in connection with the reclassification will vote as a class on all matters presented to the stockholders for a vote. However, the interest of the holders of the Class B common stock may be different than the interests of the holders of the Class A common stock and the holders of IDSs. As a result, the holders of our Class B common stock, including Fox Paine, will have the ability to exert significant influence over the outcome of matters requiring stockholder approval, including: the election of directors and the directors of our subsidiaries; the amendment of our charter or by-laws; and Public Offering Price $ $ % $ Underwriting Discount $ $ % $ Proceeds to Alaska Communications Systems Group, Inc. (before expenses) $ $ % $ the adoption or prevention of mergers, consolidations or the sale of all or substantially all of our assets or our subsidiaries' assets. Finally, Fox Paine may in the future make significant investments in other telecommunications companies. Some of these companies may compete with us. Fox Paine and its affiliates are not obligated to advise us of any investment or business opportunities of which they are aware, and they are not restricted or prohibited from competing with us. Our organizational documents could limit another party's ability to acquire us and deprive our investors of the opportunity to obtain a takeover premium for their securities. A number of provisions in our Amended and Restated Certificate of Incorporation and amended and restated by-laws will make it difficult for another company to acquire us and for you to receive any related takeover premium for your securities. For example, our organizational documents provide that stockholders generally may not act by written consent and require advance notice of stockholder proposals and nominations. In addition, our Amended and Restated Certificate of Incorporation provides that directors can be removed without cause only upon the affirmative vote of 80% of the then outstanding shares of our capital stock generally entitled to vote in the election of directors. Our organizational documents also authorize the issuance of common stock and preferred stock without stockholder approval and upon such terms as the board of directors may determine. The rights of the holders of shares of our common stock will be subject to, and may be adversely affected by, the rights of holders of shares of preferred stock that may be issued in the future. The settlement date for the offerings of the IDSs and the separate notes will extend beyond the standard settlement period. The IDSs and separate notes sold in this offering will be ready for delivery, subject to payment, on or about the closing date noted on the cover page of the prospectus, for the offering of the IDSs and the separate notes. The closing date for the offering of IDSs and the separate notes is expected to be the fifth business day following the date of pricing of this offering. Under SEC rules, trades in the secondary market are generally required to settle in three business days, unless the parties to any such trade expressly agree otherwise. Therefore, investors who purchase IDSs or separate notes in the offering who wish to immediately trade the IDSs or separate notes on the date of pricing or the next succeeding business day will be required to specify an alternate settlement cycle at the time of any such trade to ensure that when the subsequent resale of IDSs or separate notes is settled the investor has the IDSs or separate notes to deliver to the subsequent purchaser. The laws of some jurisdictions may restrict the ability of a holder of the IDSs to transfer beneficial ownership of IDSs. Ownership of the beneficial interests in the IDSs will be shown, and the transfer of that ownership will only be effected through, the facilities of The Depository Trust Company, or DTC. The laws of some jurisdictions may require that, in connection with transactions relating to the transfer of the IDSs, physical delivery of IDSs in definitive form be taken. These laws may impair the ability to transfer or pledge beneficial interests in the IDSs. As DTC can only act on behalf of its participant members which in turn act on behalf of owners of beneficial interests held through such participants, including financial institutions, the ability of a person having a beneficial interest in an IDS to pledge or transfer such interest to persons or entities that do not participate in the DTC system may be limited. (1)Comprised of $ allocated to each share of Class A common stock and $ allocated to each note, representing 100% of its stated principal amount. The underwriters expect to deliver the securities to purchasers on or about , 2004. Risks Related to Our Business Our business is subject to extensive governmental legislation and regulation. Applicable federal and state legislation and regulations and changes to them could adversely affect our business. We operate in a heavily regulated industry, and most of our revenues come from the provision of services regulated by the FCC and the RCA. Laws and regulations applicable to us and our competitors may be, and have been, challenged in the courts, and could be changed by legislation or regulatory orders at any time. We cannot predict the impact of future developments or changes to the regulatory environment or the impact such developments or changes would have on us. See "Regulation." There are a number of FCC and RCA rules under review that could have a significant impact on us. For example, many of the FCC's rules with regard to the provisioning of unbundled network elements, or UNEs, and other LEC interconnection rules were revised by the FCC in 2003 and are subject to further proceedings at the FCC and RCA. An appellate court recently vacated, remanded and upheld different portions of the FCC's order. This decision may be subject to further judicial review as well as regulatory proceedings. Rulings in this area could affect our obligation to provide UNEs and the prices we receive for the UNEs. Changes to intercarrier compensation that could affect our access revenues are also likely over the next few years. The FCC is also looking at universal service fund contribution and disbursement rules that are likely to affect the amount and timing of our contributions to and receipt of universal service funds; our obligations may increase and/or our revenue may decline, and our competitors may receive greater payments. Further, most FCC and RCA telecommunications decisions are subject to substantial delay and judicial review. These delays and related litigation create risk associated with uncertainty over the final direction of federal and state policies. As the ILEC in our service areas, we are subject to legislation and regulation that are not applicable to our competitors. Existing federal and state rules impose obligations and limitations on us, as the incumbent local telephone company, or ILEC, that are not imposed on our competitors. Federal obligations to share facilities, file and justify tariffs, maintain certain types of accounts, and file certain types of reports are all examples of disparate regulation. Similarly, state regulators impose limitations on bundling, require structural separations between affiliated entities, and impose accounting and reporting requirements and service obligations on us that do not exist for our competitors. In addition, state regulators have imposed greater tariffing standards and obligations on us than on our competitors, have required us to operate our business segments separately, and have prohibited our ILECs from promoting our long distance services more favorably than our competitors. The requirement to disclose proposed tariffs six to 12 months before they go into effect has enabled our competitors to plan competitive responses before we are able to implement new rates, diminishing our ability to compete in the marketplace. As our business becomes increasingly competitive, the continued regulatory disparity could impede our ability to compete in the marketplace, which could have a material adverse effect on our business. A reduction by the RCA or the FCC of the rates we charge our customers would reduce our revenues and earnings. The rates we charge our local telephone customers are based, in part, on a rate of return authorized by the RCA on capital invested in our LECs' networks. These authorized rates, as well as allowable investment and expenses, are subject to review and change by the RCA at any time. If the RCA orders us to reduce our rates, both our revenues and our earnings will be reduced. We presently have retail rate filings pending before or due to the RCA. There can be no assurance that new rates will be implemented at these times. Additionally, in this competitive market, we are not sure we would be able to implement higher rates even if approved by the RCA. Further, the rate increases, if any, may not be large enough to recover the revenue deficiencies. Citigroup CIBC World Markets JPMorgan State regulators may rebalance our planned rates or set new rates closer to costs, and refuse to keep sensitive business information confidential, continuing our competitive disadvantage in the marketplace. Our local exchange service competitors may also gain a competitive advantage as a result of the state regulators permitting our competitors to intervene in rate-setting proceedings. See "Regulation State Regulation." FCC regulations also affect rates that are charged to customers. The FCC regulates tariffs for interstate access and subscriber line charges, both of which are components of our network service revenue. The FCC currently is considering proposals to reduce interstate access charges for carriers like us. If the FCC lowers interstate access charges without adopting an adequate revenue replacement mechanism, we may be required to recover more revenue through subscriber line charges and universal service funds or forego this revenue altogether. This could reduce our revenue or impair our competitive position. The rates, terms and conditions for the leasing of facilities and resale of services in Anchorage are subject to regulatory review and may be adjusted in a manner adverse to us. The rates for the leasing of facilities in Anchorage by competitors, including General Communication, Inc., or GCI, has been at issue since January 2000. An RCA hearing was held in November 2003 and a decision is pending. There is risk that the rates will remain unresolved for a substantial period of time. There is also risk that the RCA may continue the practice of setting facility lease rates below what we believe to be compensatory levels. Conversely, if the RCA sets lease rates that are more favorable to us, there is a risk that doing so will encourage GCI to provide service over its own facilities, further reducing our revenues. There is also a risk that, aside from rates, the RCA could order us to enter into an agreement with unfavorable contract terms. Finally, there is the risk that the entire matter may be subject to judicial appeal, which would result in an extended period of uncertainty and additional cost associated with the proceedings. Loss of the exemption from certain forms of competition granted to our rural LECs under the Federal Telecommunications Act of 1996 exposes us to increased competition. Historically, our rural LECs (which do not include ACS of Anchorage, Inc. (or ACSA)) operated under a federal statutory exemption under which they were not required to offer UNEs and wholesale discounted resale services to competitors. On June 30, 1999, the APUC issued an order revoking these rural exemptions. In July 1999 we sought reconsideration of this order from the RCA, and on October 11, 1999, the RCA issued an order sustaining the APUC decision. In December 2003, the Alaska Supreme Court issued a decision reversing the RCA's order as to ACS of Northland, Inc. (or ACSN), and remanding the matter back to the RCA for further proceedings as to ACS of Fairbanks, Inc., or ACSF, and ACS of Alaska, Inc, or ACSAK. On April 18, 2004, ACSF and ACSAK entered into a settlement agreement with GCI in which ACSF and ACSAK waive their claim to the rural exemption with regards to GCI's requests to lease UNEs. Due to the loss of the regulatory exemptions, ACSF and ACSAK will continue to face local exchange service competition, which may reduce revenues and returns. Interconnection duties are governed by telecommunications rules and regulations related to the UNEs that must be provided. These rules and regulations remain subject to ongoing modifications. In addition, to the extent that rural exemptions are terminated, other carriers are entitled to obtain interconnection agreements with us on the basis of picking and choosing elements from the GCI agreements. Finally, to the extent the new rates are higher than the previous rates, that may encourage GCI or other competitors to provide service over their own facilities, further depriving us of revenue. ACSA, ACSF and ACSAK have responded to a formal complaint brought by GCI at the FCC involving order processing and provisioning performance metrics, and have proposed prospective and Banc of America Securities LLC RBC Capital Markets retrospective remedies. The parties have reached a settlement, and requests for approval of revised interconnection agreements are pending at the RCA. Our results of operations could be materially harmed if GCI develops its own network facilities and stops leasing capacity on our network elements. GCI has announced plans to deploy cable telephony by the end of 2004 and migrate its customers served using our UNEs off of our network and onto its own cable system. While we are unable to confirm GCI's plans, GCI has made similar claims in prior years without decreasing its reliance on our network. Nevertheless, we believe GCI has now migrated a small group of its customers onto its own network. Significant migration of customers could result in a significant reduction of revenue for us, as GCI would no longer be leasing our facilities to serve those customers, which could materially harm our results of operations. The telecommunications industry is extremely competitive, and we may have difficulty competing effectively. The telecommunications industry is extremely competitive and we face competition in local voice, local high-speed data, wireless, Internet and long distance services. Competition in the markets in which we operate could: reduce our customer base; require us to lower rates and other prices in order to compete; require us to invest in new facilities and capabilities; increase marketing expenditures and the use of discounting and promotional campaigns that would adversely affect our margins; or otherwise lead to reduced revenues, margins, and returns. New competitors in local services may be encouraged by FCC and RCA rules regarding interconnection agreements and universal service supports. We face competition from wireless service providers for local, long distance and wireless customers. Existing and emerging wireless technologies are increasingly competitive with local exchange services in some or all of our service areas. We and a competitor of ours are deploying a new generation of wireless technologies which will provide wireless data in addition to wireless voice services, and the FCC has ordered wireline-to-wireless and wireless-to-wireless number portability. As a consequence, we anticipate increased risk of wireless substitution for traditional local telephone services and increased competition among wireless carriers. In addition, new carriers offering voice over Internet Protocol, or VoIP, services may also lead to a reduction in traditional local and long distance telephone service customers and revenues as well as our network access revenues. Some of our competitors may have financial and technical resources greater than ours. See "Business Competition" for more information. Revenues from our retail local telephone access lines may be reduced or lost. As the ILEC, we face stiff competition mainly from resellers, local providers who lease UNEs from us, and, to a lesser degree, facilities-based providers of local telephone services. Seven years ago the two largest long distance carriers in Alaska began providing competitive local telephone services in Anchorage through UNE interconnection with our facilities and resale of our services. Interconnection agreements have since been executed with several other competitors. As a result, since 1996 when the industry was opened to competition through March 31, 2004, we have lost approximately 30% of our retail local telephone lines. In our largest market, Anchorage, which opened to competition in 1996, we have lost approximately 50% of our retail local telephone access lines. Similarly, in Fairbanks and Juneau, where competition began only a few years ago, we have lost more than 25% of our retail local telephone access lines. While we generally continue to enjoy revenues for these lines from our competitors, albeit at reduced rates compared to retail customers, our competitors may, in the future, bypass or remove these customers from our network completely, which would eliminate our revenue from those lines altogether. Additionally, although we plan to reacquire customers previously lost to competitors, there can be no assurance that we will be successful in this regard. Revenues from access charges may be reduced or lost. We received 26.5% of our 2003 pro forma operating revenues from access charges paid by interstate and intrastate interexchange carriers and subscriber line charges paid end users for the use of our network to connect the customer premises to the interexchange network. The amount of revenue that we receive from access charges and subscriber line charges is calculated in accordance with requirements set by the FCC and the RCA. Any change in these requirements may reduce our revenues and earnings. Generally, access charges have decreased since our inception in 1999. Under the regulatory rules that exist today, we receive access revenue related to the calls made by all of our retail customers as well as our competitors' customers who are served via wholesale resale service. Access revenue related to our competitors' retail customers that are served by UNEs or by the competitors' own facilities flows to our competitors. To the extent that competitors shift the form in which they provide service away from wholesale resale to UNEs or their own facilities, our access revenue will be reduced. The FCC is reviewing mechanisms for intercarrier compensation, and some parties have suggested terminating all interstate access charge payments by interexchange carriers. If such a proposal is adopted, it could have a material impact on our revenue and earnings. In any event, the FCC has stated its intent to adopt some form of access charge reform soon, which more likely than not will reduce this source of revenue. Similarly, the RCA has issued draft regulations phasing out intra-state access charges over five years. Adoption of this intrastate access charge proposal may reduce our revenue. In addition, both GCI and AT&T alleged that we collected excess interstate access revenue during the years 1997 through 2000. While those claims have been resolved, we cannot assure you that claims alleging excess charges in subsequent years will not be made, nor that we will be able to defeat all such claims. A reduction in the universal service support currently received by some of our subsidiaries would reduce our revenues and earnings. We received 4.9% of our 2003 pro forma operating revenues from the Universal Service Fund, or USF, which was established under the direction of the FCC to compensate carriers for the high cost of providing universal telecommunications services in rural, insular, and high-cost areas. If the support received from the USF is materially reduced or discontinued, some of our rural LECs might not be able to operate profitably. Also, because we provide interstate and international services, we are required to contribute to the USF a percentage of our revenue earned from such services. Although our rural LECs receive support from the USF, we cannot be certain of how, in the future, our contributions to the USF will compare to the support we receive from the USF. Various reform proceedings are under way at the FCC to change the method of calculating the amount of contributions paid into the USF by all carriers and the amount of contributions or support rural carriers like ACSF, ACSAK and ACSN receive from the USF, as well as the amount of support received by our competitors. Already the FCC has imposed caps or limits on the amount of USF distributed and has explored opportunities to obtain contributions from providers of services not currently contributing to USF. We cannot predict at this time whether or when any change in the method of calculating contributions and support may affect our business. You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with different information. We are not making an offer of these securities in any state where the offer is not permitted. You should not assume that the information contained in this prospectus is accurate as of any date other than the date on the front of this prospectus. The RCA has granted Eligible Telecommunications Carrier, or ETC, status to GCI in Fairbanks and Juneau. Under current FCC rules, this entitles GCI to the same amount of per-line USF support that we are entitled to receive regardless of GCI's costs, and may reduce the amount of USF payments we receive. To the extent that any competitive ETC, such as GCI, has lower costs than us, but receives the same amount of financial support, the competitor gains a competitive cost advantage over us. We cannot say when or how these rules may change. There has been a trend toward granting ETC status to wireless carriers. Alaska DigiTel LLC, or DigiTel, ACS Wireless, Inc., or ACSW, Dobson, and MTA Wireless have petitioned for ETC status. Further, Dobson has asked the RCA to redefine our rural service areas to permit Dobson to receive support on a wire-center basis, but without having to serve the entire area that we are currently required to serve. Redefining ACS's rural service areas requires the approval of both the RCA and the FCC. Creating additional service areas may impose a costly regulatory burden on us for which we may not be compensated. On August 28, 2003, the RCA granted DigiTel's request for ETC status. The ACSW, Dobson and Matanuska-Kenai, Inc. d/b/a MTA Wireless petitions are still pending. We cannot predict whether these pending petitions will be granted or when a decision will be rendered. Granting another carrier's petition would provide it with a competitive cost advantage. The granting of Dobson's request to redefine service areas could materially reduce our revenues from USF, in addition to increasing competition. Revenues from wireless services may be reduced. Market prices for wireless voice and data services have declined over the last several years and may continue to decline in the future due to increased competition. We cannot assure you that we will be able to maintain or improve our average revenue per user, or ARPU. We expect significant competition among wireless providers, which has been intensified by wireless number portability scheduled for May 2004, to continue to drive service and equipment prices lower, which may lead to increased turnover of customers. If market prices continue to decline it could adversely affect our ability to grow revenue, which would have an adverse effect on our financial condition and results of operation. We may not be able to offer long distance and Internet services on a profitable basis. Our long distance operations have historically been modest in relation to the long distance businesses of our competitors and have generated operating losses of $2.0 million in 2001, $1.6 million in 2002 and $21.2 million in 2003. Our Internet operations generated operating losses of $9.6 million in 2001, $21.6 million in 2002, and $60.5 million in 2003. We have, over the last several years, failed to achieve various plans to increase sales and revenue for these businesses. There is, therefore, no assurance that our operating losses from long distance and Internet services will not increase in the future, even after taking account of any additional revenue from complementary or advanced services. If we substantially underestimate or overestimate the demand for our long distance services, our cost of providing these services could increase. We expect to continue to enter into resale agreements for a portion of our long distance services. In connection with these agreements, we must estimate future demand for our long distance service. If we overestimate this demand, we may be forced to pay for services we do not need, and if we underestimate this demand, we may need to lease additional capacity on a short-term basis at unfavorable prices, assuming additional capacity is available. If additional capacity is not available, we will not be able to meet this demand. TABLE OF CONTENTS Page Our investment in an advanced network may prove unprofitable if the network becomes subject to regulation or if we cannot increase the customer base using the network. We have recently invested approximately $20 million in an advanced Multi Protocol Label Switching (MPLS) network. The service we provide over this network currently is not subject to regulation as a telecommunications service. If the FCC or the RCA subject this type of service to increased regulation, it could materially increase our costs and/or reduce our revenues. To date, we have not added sufficient customers for the services this network allows us to offer to generate enough revenues to operate it profitably and as a result, recorded an impairment charge reducing the carrying value of these assets in the third quarter of 2003. If we are unable to increase our customer base in this network, we may not recover our investment in the network. We may not be able to profitably take advantage of future fiber-optic capacity that we may purchase. In anticipation of our obligations under the Telecommunications Services Partnering Agreement, or TPA, we entered with the State of Alaska, we entered an agreement that enables us to purchase additional fiber-optic capacity in future years from Neptune Communications, L.L.C., or Neptune, the expenditures for which are expected to be significant and may exceed $25 million over the next four years. The subsequent termination of our contract with the State of Alaska has reduced our utilization of the additional fiber-optic capacity purchased from Neptune and may reduce the profitability of the agreement with Neptune. As part of the agreement, we made a $15 million loan to Neptune Communications. In connection with this loan, Neptune has granted us an option to purchase certain of its network assets no later than January 2, 2006 at a price equal to the then-outstanding loan balance. Certain material terms of the agreement with Neptune remain subject to continued negotiation, including with respect to the structure and terms of the loans, and it is impossible to determine the ultimate outcome of these negotiations at this time. We cannot assure you that we will successfully resolve any open issues nor can we assure you of the consequences of our inability to resolve any open issues. In addition, even if we are able to resolve the issues, we cannot assure you that we will generate sufficient revenue from these future acquisitions of fiber-optic capacity to provide satisfactory returns on our investment. If we do not adapt to technological changes in the telecommunications industry, we could lose customers or market share. Our success may depend on our ability to adapt to rapid technological changes in the telecommunications industry. Our failure to adopt a new technology, or our choice of one technological innovation over another, may have an adverse impact on our ability to compete or meet the demands of our customers. Technological change could, among other things, reduce the capital required by a competitor to provide local service in our service areas. As we cannot predict with precision the pace of technology change, our ability to deploy new technologies may be constrained by insufficient capital and/or the need to generate sufficient cash to make quarterly distributions on our IDSs or interest payments on the separate notes or our other indebtedness. New products and services may arise out of technological developments and our inability to keep pace with these developments may reduce the attractiveness of our services. If we fail to adapt successfully to technological changes or fail to obtain access to important new technologies, we could lose customers and be limited in our ability to attract new customers and/or sell new services to our existing customers. The successful delivery of new products and services is uncertain and dependent on many factors, and we may not generate anticipated revenues from such services. New governmental regulations may impose obligations on us to upgrade our existing technology or adopt new technology that may require additional capital and we may not be able to comply with these new regulations on a timely basis. We cannot predict the extent to which the government will impose new unfunded mandates such as those related to emergency location, law enforcement assistance and local number portability. Each of these government obligations has imposed new requirements for capital that could not have been predicted with any precision. Along with these obligations the FCC has imposed deadlines for compliance with these mandates. We may not be able to provide services that comply with these mandates in time to meet the imposed deadlines or our petitions for extensions of the deadlines may be denied. We cannot predict whether other mandates, from the FCC or other regulatory authorities, will occur in the future or the demands they will place on capital expenditures. Our network capacity and customer service system may not be adequate and may not expand quickly enough to support our anticipated customer growth. Our financial and operational success depends on ensuring that we have adequate network capacity, sufficient infrastructure equipment and a sufficient customer support system to accommodate anticipated new customers and the related increase in usage of our network. Our failure to expand and upgrade our networks, including through obtaining and constructing additional cell sites, obtaining wireless telephones of the appropriate model and type to meet the demands and preferences of our customers and obtaining additional spectrum, if required, to meet the increased usage could have a material adverse effect on our business. Our failure to complete the build-out of our new wireless network, or a delay in the build-out and launch could have an adverse effect on our wireless operations and we may not be able to recover the costs of deploying the new wireless network. ACS Wireless, Inc. is currently commencing the deployment of a new packet-switched digital network. Substantial costs are involved in the hardware and software necessary to implement this network. Customers may not immediately receive the full benefits of this network's enhanced capabilities, as we expect network deployment to occur in stages over time. If we are not able to successfully deploy the technology, we may lose customers to other carriers. In addition, there is no assurance that this network will work as we expect. The size of the Alaska customer base being served by this new network is also small, and we cannot assure you that we will fully recover all costs related to this network within a reasonable period of time, or at all. There is also no assurance that even if the new network is fully built out and performs as expected that it will be or will become the technology preferred by a substantial number of people. We will have to implement a new billing and customer service system in connection with the launch of our new wireless network, which may result in disruptions in our billing systems and other business processes which could have an adverse affect on our business. Additionally, new billing and customer service arrangements are being implemented by us to service customers on the new wireless network. The process of migrating existing customers from the existing wireless network to the new network involves risks related to the business process changes. During the process of switching billing systems, it is possible that we may experience a disruption in our billing cycle and that customers may be dropped from our database. Any prolonged disruption of our billing function or loss of customers from our database could have an adverse effect on our business, financial condition and results of operations. The changes to our businesses processes have not been proven to work consistently and efficiently, and the failure of these processes could delay or disrupt the deployment of the new network and have an adverse affect on our business and customer satisfaction. Indenture EBITDA $ 63,549 $ 116,710 $ 128,535 $ 119,782 $ 112,522 $ 30,097 $ 26,038 $ $ Adjustments to Indenture EBITDA: Directories Business operations(ii) (9,200 ) (15,822 ) (19,186 ) (19,434 ) (7,153 ) (4,829 ) State of Alaska contract operations(i) 5,783 5,726 529 Fox Paine management fees and expenses(iii) 542 975 1,106 1,117 1,019 257 220 Cash charges included in loss from discontinued operations 141 407 1,015 649 41 Wireless number portability may increase the competitiveness of the wireless industry and increase customer turnover. The wireless industry is extremely competitive and characterized by a high rate of customer turnover. Customer turnover results from different factors, including pricing, service offerings, network coverage and customer service. Efforts to reduce customer turnover and retain customers through various incentives may involve increased costs and reduced pricing. Local number portability allows a customer to retain his or her telephone number when changing telecommunications carriers within the same local market. The FCC requires local number portability for CMRS carriers under rules that distinguish between carriers operating in the largest 100 metropolitan statistical areas and those operating outside the top 100 markets. None of the cities in which we provide wireless service is among the top 100 markets. Under the FCC's rules, ACSW must be capable of allowing number portability by May 24, 2004 or within 6 months of a bona fide request, whichever is later. ACSW has already been successfully porting numbers on a daily basis. The FCC, however, is still clarifying its rules regarding wireline to wireless number portability. While most of our wireline customers have full portability, we may not be able to comply with the porting requirements in some of our small wireline exchanges. Our failure to comply with the local number portability requirements could result in fines, other penalties or enforcement actions against us. The successful operation and growth of our businesses are dependent on economic conditions in Alaska. Substantially all of our customers and operations are located in Alaska. Due to our geographical concentration, the successful operation and growth of our businesses is dependent on economic conditions in Alaska. The Alaskan economy, in turn, is dependent upon many factors, including: the strength of the natural resources industries, particularly oil production; the strength of the Alaskan tourism industry; the level of government and military spending; and the continued growth in services industries. The customer base for telecommunications services in Alaska is small and geographically concentrated. According to the U.S. Census Bureau estimates, the population of Alaska is approximately 649,000, over 60% of whom live in Anchorage, Fairbanks and Juneau. There can be no assurance that Alaska's economy will grow or even be stable. We have a new senior management team with no prior experience in the Alaskan telecommunications market. In connection with our disposition of a controlling interest in our Directories Business in May 2003, our then-president and chief operating officer, Wesley E. Carson, departed to run that business. On October 6, 2003, Charles E. Robinson retired as our chief executive officer. Liane Pelletier joined us, effective October 6, 2003, as our president and chief executive officer in a position that consolidates the day-to-day responsibilities of Mr. Robinson and Mr. Carson. We cannot assure you that the transition in leadership will be seamless and without disruption to our businesses. Although Ms. Pelletier has extensive telecommunications experience, she has limited history running our company. In addition, Mr. David C. Eisenberg joined us as Senior Vice President, Corporate Strategy and Development on November 3, 2003; Mr. Sheldon Fisher joined us as Senior Vice President, Sales and Product Marketing on February 23, 2004, and Mr. David Wilson joined us as Chief Financial Officer on March 1, 2004. Each of Ms. Pelletier, Mr. Wilson, Mr. Eisenberg and Mr. Fisher have experience in the telecommunications industry, but none have experience in the Alaskan telecommunications market and it may be a substantial amount of time before they are familiar with the Alaskan market. The lack of Alaskan telecommunications market experience may place us at a competitive disadvantage. We depend on key members of our senior management team. Our success depends largely on the skills, experience and performance of key members of our senior management team, as well as our ability to attract and retain other highly qualified management and technical personnel. There is intense competition for qualified personnel in our industry, and we cannot assure you that we will be able to attract and retain the personnel necessary for the development of our business. If we lose one or more of our key employees, or the transition in leadership is not successful, our ability to successfully implement our business plan could be materially adversely affected. We do not maintain any "key person" insurance on any of our personnel. We rely on a limited number of key suppliers and vendors for timely supply of equipment and services relating to our network infrastructure. If these suppliers or vendors experience problems or favor our competitors, we could fail to obtain sufficient quantities of the products and services we require to operate our business successfully. We depend on a limited number of suppliers and vendors for equipment and services relating to our network infrastructure. If these suppliers experience interruptions or other problems delivering these network components on a timely basis, subscriber growth and our operating results could suffer significantly. Our initial choice of a network infrastructure supplier can, where proprietary technology of the supplier is an integral component of the network, cause us to be effectively locked into one of a few suppliers for key network components. As a result we have become reliant upon a limited number of network equipment manufacturers, including Nortel Networks Corporation. In the event it becomes necessary to seek alternative suppliers and vendors, we may be unable to obtain satisfactory replacement suppliers or vendors on economically attractive terms, on a timely basis, or at all, which could increase costs and may cause disruption in service. Wireless devices may pose health and safety risk, and driving while using a wireless phone may be prohibited; as a result, we may be subject to new regulations, and demand for our services may decrease. Media reports have suggested that, and studies have been undertaken to determine whether, certain radio frequency emissions from wireless handsets and cell sites may be linked to various health concerns, including cancer, and may interfere with various electronic medical devices, including hearing aids and pacemakers. In addition, lawsuits have been filed against other participants in the wireless industry alleging various adverse health consequences as a result of wireless phone usage. If consumers' health concerns over radio frequency emission increase, they may be discouraged from using wireless handsets, regulators may impose or increase restrictions on the location and operation of cell sites or increase regulation on handsets and wireless providers may be exposed to litigation, which, even if not successful, can be costly to defend. The actual or perceived risk of radio frequency emissions could also adversely affect us through a reduced subscriber growth rate, a reduction in our subscribers, reduced network usage per subscriber or reduced financing available to the wireless communications industry. In addition, the use of a wireless device while driving may also adversely affect our results of operations. Studies have indicated that using wireless devices while driving may impair a driver's attention. The U.S. Congress has proposed legislation that would seek to withhold a portion of federal funds from any state that does not enact legislation prohibiting an individual from using a wireless telephone while driving motor vehicles. In addition, many state and local legislative bodies have passed and proposed legislation to restrict the use of wireless telephones while driving motor vehicles. Concerns over safety risks and the effect of future legislation, if adopted and enforced in the areas we serve, could limit our ability to market and sell our wireless services and may discourage use of our wireless devices and decrease our revenue from customers who now use their wireless telephones while driving. Further, litigation relating to accidents, deaths or serious bodily injuries allegedly injured as a result of wireless telephone use while driving could result in damage awards against telecommunications providers, adverse publicity and further governmental regulation. Any or all of these results, if they occur, could have a material adverse effect on our results of operations and financial condition. We are subject to environmental regulation and environmental compliance expenditures and liabilities. Our business is subject to many environmental laws and regulations, particularly with respect to owned or leased real property relating to our network equipment and underlying our tower sites. Compliance with these laws and regulations is a factor in our business. Some or all of the environmental laws and regulations to which we are subject could become more stringent or more stringently enforced in the future. Our failure to comply with applicable environmental laws and regulations and permit requirements could result in civil or criminal fines or penalties or enforcement actions, including regulatory or judicial orders enjoining or curtailing operations or requiring corrective measures, installation of pollution control equipment or remedial actions. In addition to operational standards, environmental laws also impose obligations to clean up contaminated properties or to pay for the cost of such remediation. We could become liable, either contractually or by operation of law, for such remediation costs even if the contaminated property is not presently owned or operated by us, or if the contamination was caused by third parties during or prior to our ownership or operation of the property. Moreover, future events, such as changes in existing laws or policies or their enforcement, or the discovery of currently unknown contamination, may give rise to material remediation costs. A system failure could cause delays or interruptions of service, which could cause us to lose customers. To be successful, we will need to continue to provide our customers reliable service over our network. Some of the risks to our network and infrastructure include: physical damage to access lines; power surges or outages; software defects; and disruptions beyond our control. We rely heavily on our networks, network equipment, data and software and the networks of other telecommunications providers to support all of our functions and for substantially all of our revenues. We are able to deliver services only to the extent that we can protect our network systems against damage from power or telecommunication failures, computer viruses, natural disasters, unauthorized access and other disruptions. While we endeavor to provide for failures in the network by providing back-up systems and procedures, we cannot guarantee that these back-up systems and procedures will operate satisfactorily in an emergency. Should we experience a prolonged system failure or a significant service interruption, our ongoing customers may choose a different provider and our reputation may be damaged. We cannot assure you that we will be able to successfully integrate any acquisitions we may make in the future. We continually explore acquisitions. However, any future acquisitions we make may involve some or all of the following risks: diversion of management attention from operating matters; financial flexibility. This recapitalization and refinancing will consist of the following transactions which will be completed concurrently: This Offering. This offering includes the offering of both the IDSs and the separate notes. Reclassification of Our Common Stock. We will reclassify each outstanding share of our existing common stock into the right to receive $ in cash and shares of our Class B common stock. We refer to this as the reclassification. New Revolving Credit Facility. ACSH will enter into a new $50.0 million revolving credit facility. Repayment of the Existing Credit Facility. We will terminate and repay all outstanding borrowings under our existing credit facility. Interest Rate Swap Arrangements. We will enter into certain interest rate swap arrangements relating to ACSH's outstanding notes. For more information, see "The Transactions". The closing of this offering, the reclassification, the entering into of the new revolving credit facility and the entering into the interest rate swap arrangements are each conditioned on the completion of the others. The completion of the reclassification and the closing of this offering will occur on the same day. A portion of the shares of Class B common stock issued in the reclassification to the holders of our existing common stock is subject to pro rata redemption with the net proceeds received by us from any sale of IDSs in connection with the exercise of the underwriters' overallotment option. On the 12th day after the completion of the reclassification and pro rata redemption, any remaining outstanding shares of Class B common stock in excess of 10% of the overall value of our equity capitalization will be exchanged for IDSs. We refer to this offering, the reclassification, including the subsequent redemption and exchange of Class B common stock in the 12 days after completion of the reclassification, entering into of the new revolving credit facility, the repayment of the existing credit facility and the entering into of the interest rate swap arrangements, collectively, as the Transactions. unanticipated liabilities or contingencies of acquired businesses; failure to achieve projected cost savings or cash flow from acquired businesses; inability to retain key personnel of the acquired business or maintain relationships with its customers; inability to successfully integrate acquired businesses with our existing businesses, including information-technology systems, personnel, products and financial, computer, payroll and other systems of the acquired businesses; difficulties in enhancing our customer support resources to adequately service our existing customers and the customers of the acquired businesses; and difficulty in maintaining uniform standards, controls, procedures, and policies. In addition, our ability to make acquisitions may be constrained by our inability to use equity as an acquisition currency and by our need to ensure cash for quarterly distributions on our IDSs. Acquisition targets that fail to generate a positive cash flow are probably excluded from consideration under our proposed capital structure. As to targets that do generate positive cash flows, we may not have sufficient available cash or access to sufficient capital resources necessary to complete a transaction for such targets. Estimated Timeline of the Offering and Reclassification

parsed_sections/risk_factors/2004/CIK0001094019_newtek_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ RISK FACTORS Investing in our common stock involves risks. Before you invest in our common stock, you should carefully consider the following risks as well as the other information included in this prospectus. These risks set out below are not the only risks we face. If any of the following risks occur, our business, financial condition and results of operations could be materially and adversely affected. In that case, the value of our common stock could decline and you may lose all or part of your investment. RISKS RELATING TO OUR BUSINESS GENERALLY Our business focuses on the investment in and acquisition of small businesses, which typically have a high rate of failure, may take some time to become profitable and may never become profitable. We place primary emphasis on the investment in and acquisition of small businesses with the objective of developing a network of profitable businesses, most of which will principally serve the small and medium-sized business market. Early stage businesses historically have a higher rate of failure than larger businesses, and many that do not fail will have only limited profitability. Moreover, profit generated by any of our majority-owned companies or other investments could be offset by losses generated by others. Our profitability resulting from the operations of our businesses may be delayed for the foreseeable future. For example, our consolidated subsidiaries experienced aggregate net losses of approximately $2,700,000 for the year ended December 31, 2003, aggregate net losses of approximately $3,591,000 for the year ended December 31, 2002, and aggregate net losses of approximately $215,000 for the first quarter ended March 31, 2004. We recorded no net losses from equity method investees in 2003 and approximately $729,000 in 2002. In addition, during 2003 we wrote off approximately $1,996,000 of investments in small businesses, compared to approximately $1,602,000 in 2002, representing management s best estimate as to the amount of the other than temporary decline in the value of the investments. During the first quarter of 2004 we had $0 in write offs. We have generated and carry goodwill as an asset resulting from some of our acquisition transactions and expect to do so as well in the CrystalTech transaction. In 2003, we determined to write down the value of our goodwill by approximately $1,435,000. We can make no assurance that our current or future additional goodwill will not be written down pursuant to applicable accounting standards. A significant write down of a major asset, such as goodwill, could have a material adverse effect on our business, a negative impact on earnings and the value of our common stock. Each of our major investments and affiliated companies may be impacted by a variety of adverse economic, governmental, industrial and internal company factors unique to that business and outside our control. If our investments and affiliated companies do not succeed in overcoming these adverse factors, the value of our assets and the price of our stock would fall. In the past few years we have increasingly concentrated our investments in companies participating in small business lending and electronic payment processing, and we plan to make significant investments in a new insurance agency, the Newtek Insurance Agency, and CrystalTech, following its acquisition by us, in the near future. Each of these businesses has numerous risks associated with them and you should read the specific risk factors set forth below with respect to each of these businesses. As we have concentrated our investments, typically made through the capco programs, in companies which are part of our nationwide marketing strategy of providing a variety of services to small and medium-sized businesses, our exposure and that of our affiliated companies to risks specific to these business lines has increased. We discuss below some of the risks of our significant operations in government-guaranteed small business lending and acting as an independent sales organization in the electronic card processing business. If we are not successful in implementing this business strategy and developing and marketing our new products and services, our results of operations will be negatively impacted. Approximate date of commencement of proposed sale of securities to the public: As soon as practicable after the effective date of this Registration Statement. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act, check the following box. If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If the delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. Table of Contents We rely on our capcos to fund our investments and our capcos are limited by regulations in the types of investments they can make. Our ability to invest in or acquire companies has in the past and is expected to be in the future significantly reliant on investments permissible under the capco programs in which we participate. In the programs under which the capcos operate, investments by a capco may only be made in the state in which the particular capco operates and the target company must meet certain requirements as to size, employment of state residents and possible restrictions on the ability to relocate. These limitations may require us to forego attractive or desirable investments, which could adversely affect or prevent implementation of our business strategy. If we do not manage our growth effectively, our financial performance could be harmed. Our rapid revenue growth has placed, and will continue to place, certain pressures on our management, administrative, operational and financial infrastructure. As we continue to grow our business, such growth could require capital, systems development and human resources beyond current capacities. As evidence of our internal growth, on December 31, 2001, we and all of our consolidated and majority-owned affiliates had approximately 20 employees, and on December 31, 2003 we had approximately 100 employees, without consideration of independent contractors. The increase in the size of our operations may make it more difficult for us to ensure that we execute our present businesses and future strategies. The failure to manage our growth effectively could have a material adverse effect on our financial condition and results of operations. Because expenses are expected to increase as we build an infrastructure and implement our business strategy, we may incur additional losses in the future. Because our expenses are expected to increase more quickly than our revenue as we build our infrastructure and implement our business strategy, we will likely incur additional losses in the near future. We expect the additional expenses to result primarily from our plans to: expand existing systems; broaden affiliated company support capabilities; continue to explore acquisition opportunities and alliances; and facilitate business arrangements among affiliated companies. If we are unable to obtain the resources required for the growth and development of our affiliated companies, they will be highly susceptible to failure, which would directly affect our profitability and value. Early-stage businesses often fail due to their limited capital and human resources. The effective implementation of our business model is dependent upon the ability of the affiliated companies, with assistance from us, to arrange for the managerial, capital and other resources which they usually require in order to become and remain profitable. We may not be able to integrate acquired companies into our company and, as we acquire more and larger interests in affiliated companies, our resources available to assist our affiliated companies may be insufficient. We have made strategic acquisitions and we intend to continue to make acquisitions in accordance with our business plan. Each acquisition involves a number of risks, including: the diversion of our management s attention to the assimilation and ongoing assistance with the operations and personnel of the acquired business, which could strain the management resources we have available; the potential for our affiliated companies to grow rapidly and adversely affect our ability to assist our affiliated companies as intended; CALCULATION OF REGISTRATION FEE Table of Contents possible adverse effects on our results of operations and cash flows; and possible inability by us to achieve the intended objective of the acquisition. Any strain on our ability to assist our affiliated companies as intended or to acquire and integrate businesses under our business plan could have a negative impact on our operations, financial results and cash flows. Our business may be adversely affected by the highly regulated industries in which we operate. Many of the industries in which we operate are highly regulated and we cannot assure you that we or our affiliated companies are, or that we will continue to be, in full compliance with current laws, rules and regulations. If we or our affiliated companies are unable to comply with applicable laws or regulations or if new laws limit or eliminate some of the benefits of our business lines, our financial condition, results of operations and our cash flows could be materially adversely affected. If we lose our key personnel, we may not be able to find and hire experienced replacements. Our business relies heavily on the expertise of our senior management, particularly Messrs. Barry Sloane, Brian A. Wasserman and Jeffrey G. Rubin, our CEO, CFO and President, respectively. These individuals currently serve pursuant to employment agreements which expire on June 30, 2005. The loss of the services of these individuals could have a material adverse effect on our financial condition, results of operations and cash flows and it is likely that it will be difficult to find adequate replacements. We and our affiliated companies depend on our ability to attract and retain key personnel and any loss of ability to attract these personnel could adversely affect us. Our success depends upon the ability of our affiliated companies and other investments to attract and retain qualified personnel and our ability to supplement those capabilities with our senior management personnel. Competition for qualified employees is intense. If our affiliated companies lose the services of key personnel, or are unable to attract additional qualified personnel, the business, financial condition, results of operations and cash flows of us or one or more of our affiliated companies could be materially adversely affected. It can take a significant period of time to identify and hire personnel with the combination of skills and attributes required in carrying out our strategy. Our success depends on our ability to compete effectively in the highly competitive industries in which we operate. We face intense competition in organizing capcos, originating SBA loans, processing electronic payments and offering insurance, as well as in the other industries in which we or our affiliated companies operate. Low barriers to entry often result in a steady stream of new competitors entering certain of these businesses. Current and potential competitors are or may be better established, substantially larger and have more capital and other resources than we do. If we expand into additional geographical markets, we will face competition from others in those markets as well. A major feature of our business strategy is the development of opportunities for our service and product provider businesses to market to the customers of our other business lines and to the customer bases of our alliance partners. Although the business strategy of management contemplates the referring of prospects between wholly-owned and partially owned companies in our network, there is no history of such cross-selling and there can be no assurances that any effort to make referrals across our network of affiliated companies will result in additional revenue opportunities. In order for our referral network to achieve the desired result, each of the constituent Title of each class of securities to be registered Amount to be registered(1) Proposed maximum offering price per share Proposed maximum aggregate offering price Amount of registration fee (2) Common stock, $.02 par value 7,026,477 shares $ 4.91 $ 34,500,000 $ 4,372 (1) Includes 916,497 shares of common stock that may be sold by the registrant and the selling shareholders upon exercise of the underwriters over-allotment option. (2) Calculated pursuant to Rule 457(o) under the Securities Act of 1933. Such amount was previously paid. Table of Contents companies must have proper incentives and feel comfortable making such introduction, and furthermore, the service provider receiving such referral must properly service such referred client. Instituting a corporate culture conducive to sending and receiving referrals is difficult and may not yield the results anticipated by us. In addition, our marketing alliances are terminable and, if we make serious errors or fail to produce sufficient revenues for our alliance partners, we are at risk of losing these relationships. The inability of any one of our business segments to service customers adequately referred to it from within our other companies could impair our overall relationship with such customers. A significant benefit of our structure and strategy is the ability to cross market between our SBA, electronic payment processing and other business customers, including potentially those of CrystalTech. However, should the business relationship between one of our business segments and customers deteriorate for any reason, such customers may opt to withdraw their business from our other businesses. Such a loss of business could negatively impact our results of operations and cash flows. We rely on information processing systems, and our strategy of cross marketing to customers among our majority-owned subsidiaries will increase this reliance; the interruption, loss or failure of which would materially and adversely affect our business. Our ability to provide business services depends, and will increasingly depend, on our capacity to store, retrieve, process and manage significant amounts of data and expand and upgrade our information processing capabilities. Interruption or loss of our information processing capabilities through loss of stored data, breakdown or malfunctioning of computer equipment and software systems, telecommunications failure or damage caused by acts of god or other disruption, could have a material adverse effect on our business, financial condition and results of operations. Although we have disaster recovery procedures in place and insurance to protect against such contingencies, we cannot be certain that our disaster recovery systems or insurance will continue to be available at reasonable prices, cover all our losses or compensate us for the possible loss of clients occurring during any period that we are unable to provide outsourced business services. We are attempting to build a national Newtek brand for services and products marketed to small and medium-sized businesses, but we are unable to obtain a significantly high level of protection for the brand name due to its previous usage in other contexts. The current and past usage by others of names similar to Newtek may make obtaining a significant level of protection for the use of such name very costly. We cannot assure you that we will be able to prevent competitors from using the name Newtek in other contexts or even in competition with us. In the event of such an infringement, we would attempt to vigorously defend our rights to the name, but we can give no assurance that we will be successful in doing so. We have not registered the mark Newtek with the United States Patent and Trademark Office. RISKS RELATED TO OUR CAPCO BUSINESS Because our capcos are subject to minimum investment and other requirements under state law, a failure of any of them to meet these requirements could subject the capco and our shareholders to the loss of one or more capcos and would preclude participation in future capco programs. Involuntary decertification of all or substantially all of our capcos would result in material loss to us and our shareholders. In general, capcos issue debt and equity instruments, such as warrants, to insurance company investors and the capcos then acquire interests in companies in accordance with applicable state statutes. In return, the states issue tax credits to the capcos, which are available to and used by the insurance company investors to reduce their state tax liabilities. In order to maintain its status as a capco and to avoid the recapture of the tax credits granted, each capco must meet a number of state requirements. A key requirement in order to maintain capco certification is The registrant hereby amends this registration statement on such date or dates as maybe necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall there after become effective in accordance with section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Commission, acting pursuant to said section 8(a), may determine. Table of Contents that a capco must comply with minimum investment schedules that benchmark both the timing and type of required investments. Although to date we have met all applicable benchmarks, we may not do so in the future. A final involuntary loss of capco status, referred to as a decertification as a capco, will result in a loss of the tax credits for us and our insurance company investors; it would also enable the capco insurer, which has the obligation to make compensatory payments to offset the lost tax credits, to take control of one or more capcos and manage or liquidate the capco investments to offset its losses. This would deprive us of the value of the investments and make participation in future capco programs highly unlikely. The ability of our capcos to meet minimum investment requirements is materially and adversely affected by the cost of capco insurance. Each of our capcos, following its organization and payment for capco insurance, begins operations with cash approximately equal to 50% of its initial funding (inclusive of any funds obtained from the capco insurer as premium financing), or certified capital, the amount on which the minimum investment requirement is based. In order to avoid decertification and remain in compliance with applicable rules, each capco must invest an amount equal to at least 50% of certified capital in qualified investments. The capcos receive full credit in the minimum investment calculation for the reinvestment of funds returned to the capco by the repayment, sale or liquidation of investments. However, each capco s ability to meet its minimum investment requirement could be adversely effected by: the cost of insurance at the beginning of the capco s investment cycle; the ability to obtain the premium financing from the capco insurer; the transfer of 2.5% of certified capital per year as management fees to us; the direct costs and expenses of operating the capco, including legal and accounting fees; the payment of taxes due by the capco; and losses by the capco, which are common on investments in riskier early-stage, start up and potentially high growth businesses. As of March 31, 2004 seven of our eleven operating capcos have met the minimum investment requirements (the capco managed by Exponential Business Development, Inc., or Exponential, is not included as we only manage but do not own it). The eleventh capco, in Alabama, was funded and began operations in January, 2004 and is at the beginning of its business cycle, with the entire amount of its certified capital yet to be invested. However, the remaining four capcos must invest an aggregate of approximately $14,000,000 within the varying time frames prescribed by the capcos respective states. Failure of one of these capcos to make the minimum investments within the prescribed time frames would lead to decertification of a capco. The capco programs and the tax credits they provide are created by state legislation, and such laws are subject to possible action to repeal or retroactively revise the programs for political, economic or other reasons. Such an attempted repeal would create substantial difficulty for the capco programs and could, if ultimately successful, cause us material financial harm. The tax credits associated with the capco programs and provided to our capcos investors are to be utilized by the investors over a period of time, typically ten years. Much can change during such a period and it is possible that one or more states may revise or eliminate the tax credits. Any such revision or repeal could have a material adverse economic impact on our capco, either directly or as a result of the capco s insurer s actions. During 2002 a single legislator in Louisiana did introduce such a proposed bill, on which no action was taken, and in Colorado in 2003 and 2004 bills to modify (not repeal) its capco program were introduced; the 2002 legislation was defeated in a legislative committee. The 2004 Colorado legislation could have a material and adverse impact on the potential profitability of our Colorado capco if some of the proposed provisions are adopted. Table of Contents In the event of a threat of decertification by a state, the capco insurer is authorized to assume partial or complete control of a capco which would likely result in financial loss to the capco and possibly us and our shareholders. Under the terms of insurance policies purchased by all but one of our capcos for the benefit of the investors, the capco insurer is authorized, in the event of a formal written threat of decertification by a state and absent appropriate corrective action by the capco, to assume partial or complete control of a capco in order to avoid final decertification and the requirement to pay compensatory interest to the certified investors under the policies. While avoiding final decertification, control by the insurer would result in significant disruption of the capco s business and likely result in financial loss to the capco and our business. In the absence of the adoption of new capco programs, we will be unable to derive any new income from tax credits, which to date represents substantially all of our income. Virtually all of our net income for each of the years since inception was derived from the recognition of income related to tax credits available under current capco programs. We will recognize additional income related to tax credits from the current capco programs over the next ten years. Thereafter, unless additional capco programs are adopted and we are able to participate in them, we will derive no income from additional capco programs. The adoption of new state capco programs could be materially and adversely affected by adverse economic conditions or a change in the political acceptability of economic development or capco programs. Our method of income recognition derived from the capco tax credits causes most of such income to be received in the first five years of the programs. In the absence of income from our investments or other sources, we would sustain material losses in later years. In our capco programs we recognize the majority of our income from the tax credits in the early years of the programs because income recognition is tied to the schedule by which the tax credits become irrevocable and beyond recapture (approximately five years). We recognize the majority of our income from ten year capco programs in the first five years. In the absence of income from other sources, such as our investments in small businesses and affiliated companies, our income would decrease materially and we would likely sustain material losses in later years. Although we will not be recognizing significant tax credit income in the latter part of the program, we will continue to incur costs for the administration of the capcos, insurance expenses for the capcos and interest expenses on the capco notes. In the absence of our participation in new capco programs, income from tax credits will remain stagnant or decrease as the capcos reach maturity beginning in 2004. If we are deemed to be an investment company under the Investment Company Act of 1940, we will not be able to execute our business strategy. Because capcos can operate in a manner similar to venture capital funds, there is a risk that the Securities and Exchange Commission, or the SEC, or a court might conclude that we fall within the definition of investment company, and unless an exemption is available, we would be required to register under the Investment Company Act of 1940. Compliance with the Investment Company Act as a registered investment company would cause us to alter significantly our business strategy of participating in the management and development of affiliated companies, impair our ability to operate as planned and seriously harm our business. In addition, our contracts would be voidable and a court could appoint a receiver to take control of and liquidate our business. The SEC has adopted Rule 3a-1 that provides an exemption from registration as an investment company if a company meets both an asset and an income test and is not otherwise primarily engaged in an investment company business by, among other things, holding itself out to the public as such or by taking controlling interests in companies with a view to realizing profits through subsequent sales of these interests. A company satisfies the asset test of Rule 3a-1 if it has no more than 45% of the value of its total assets (adjusted to exclude U.S. Government securities and cash) in the form of securities other than interests in majority-owned subsidiaries and companies which it primarily and actively controls. A company satisfies the income test of Rule 3a-1 if it has derived no more than 45% of its net income for its last four fiscal quarters combined from securities other than interests in majority owned subsidiaries and primarily and actively controlled companies. Table of Contents The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted. PRELIMINARY PROSPECTUS SUBJECT TO COMPLETION, DATED JUNE 25, 2004 6,000,000 Shares Common Stock Table of Contents RISKS RELATING TO OUR SBA LENDING BUSINESS We have specific risks associated with small business administration loans. We have generally sold the guaranteed portion of SBA loans in the secondary market. There can be no assurance that we will be able to continue originating these loans, or that a secondary market will exist for, or that we will continue to realize premiums upon the sale of, the guaranteed portions of the SBA loans. We believe that our SBA loan portfolio does not involve more than a normal risk of collection. However, since we have sold the guaranteed portion of substantially all of our SBA loan portfolio, we incur a pro rata credit risk on the non-guaranteed portion of the SBA loans since we share pro rata with the SBA in any recoveries. In the event of default on an SBA loan, our pursuit of remedies against a borrower is subject to SBA approval, and where the SBA establishes that its loss is attributable to deficiencies in the manner in which the loan application has been prepared and submitted, the SBA may decline to honor its guarantee with respect to our SBA loans or it may seek the recovery of damages from us. If we should experience significant problems with our underwriting of SBA loans, such failure to honor a guarantee or the cost to correct the problems could have a material adverse effect on us. Although the SBA has never declined to honor its guarantees with respect to SBA loans made by us since our acquisition of the lender, no assurance can be given that the SBA would not attempt to do so in the future. Curtailment of the government guaranteed loan programs could cut off an important segment of our business. There can be no assurance that the federal government will maintain the SBA program, or that it will continue to guarantee loans at current levels. If we cannot continue making and selling government guaranteed loans, we will generate fewer origination fees and our ability to generate gains on sale of loans will decrease. From time to time, the government agencies that guarantee these loans reach their internal budgeted limits and cease to guarantee loans for a stated time period. In addition, these agencies may change their rules for loans. Also, Congress may adopt legislation that would have the effect of discontinuing or changing the programs. Non-governmental programs could replace government programs for some borrowers, but the terms might not be equally acceptable. If these changes occur, the volume of loans to small business and industrial borrowers of the types that now qualify for government guaranteed loans could decline, as could the profitability of these loans. Changing interest rates may reduce our income from lending. Fluctuations in interest rates may affect customer demand for our loans and other products and services. Our lending business will likely increase during times of falling interest rates and, conversely, decrease during times of significantly higher interest rates. Significant fluctuations in interest rates and loan demand could have a potentially adverse effect on our results of operations and cash flows. Our ability to participate in the SBA government-guaranteed loan program depends on our ability to obtain sufficient warehouse or similar lending facilities, on sufficiently attractive terms, to enable us to make profitable loans. In conjunction with the acquisition of our SBA lending affiliate, we were able to assist in the renegotiation and extension of a major warehouse loan facility from an affiliate of Deutsche Bank. This warehouse line enables NSBF to fund loans and repay the line at the time all or a portion of the loan is sold, as is typically the case. On June 22, 2004, NSBF executed an amendment to such warehouse facility to provide for an extension of the warehouse credit line to June 30, 2005 and a possible increase of such line from the current $75 million up to $100 million under certain conditions. The credit facility had been scheduled to terminate on June 30, 2004. We are offering 6,000,000 shares of our common stock. Our common stock is traded on the Nasdaq National Market under the symbol NKBS. On June 24, 2004, the last reported sale price of our common stock was $4.14 per share. This prospectus contains important information that you should know before investing. Please read it before you invest and keep it for future reference. Investing in our common stock involves risks. See Risk Factors beginning on page 7. Per Share Table of Contents The amended warehouse line contains adjustments to the terms of the advances and required reserves, additional financial and non-financial covenants and a commitment from NSBF to obtain $10 million in additional funding by August 2, 2004. In addition, the amended agreement requires, among other terms and conditions, that: (1) Newtek continue its previous guaranty of all of NSBF s obligations under the credit line (including the possible expanded facility), (2) Newtek conform to maximum debt and minimum equity requirements, (3) Newtek not pay dividends for the one year term of the facility and (4) in the absence of funding from other sources, Newtek make a debt or equity infusion of at least $10 million to support the lending activities of NSBF. While there can be no assurance that the additional third party funding will be available, NSBF has had numerous discussions with additional lenders and has signed a non-binding letter of intent with one possible lender for $12 million. The failure to arrange the additional funding would be treated as a default under the credit line. However Newtek currently anticipates that NSBF will be able to enter into a third party loan agreement on or before August 2, 2004 or , alternatively, secure from Newtek the required debt or equity infusion by that date, the funds for which may come, in whole or in part, from the proceeds of this offering. In the absence of NSBF s warehouse line of credit, or some other comparable credit facility, NSBF would be unable to make any material number of loans without finding a replacement lending facility. Furthermore, our interest spread and net earnings from this segment of our business would be directly effected by the terms and conditions of the replacement lending facilities. An increase in non-performing assets would reduce our income and increase our expenses. If our level of non-performing assets in our SBA lending business rises in the future, it could adversely affect our revenue and earnings. Non-performing assets are primarily loans on which borrowers are not making their required payments. Non-performing assets also include loans that have been restructured to permit the borrower to have smaller payments and real estate that has been acquired through foreclosure of unpaid loans. To the extent that our loan assets are non-performing, we will have less cash available for lending and other activities. RISKS RELATING TO OUR ELECTRONIC PAYMENT PROCESSING BUSINESS We rely currently on a single bank sponsor, which has substantial discretion with respect to certain elements of our business practices, in order to process bankcard transactions. If this sponsorship is terminated and we are not able to secure or migrate merchant portfolios to new bank sponsors, we will not be able to conduct our electronic payment processing business. Because we are not a bank, we are unable to belong to and directly access the Visa and MasterCard bankcard associations. The Visa and MasterCard operating regulations require us to be sponsored by a bank in order to process bankcard transactions. We are currently registered with Visa and MasterCard through the sponsorship of one bank that is a member of the card associations. If this sponsorship is terminated and we are unable to secure a bank sponsor, we will not be able to process bankcard transactions. Furthermore, our agreement with our sponsoring bank gives the sponsoring bank substantial discretion in approving certain elements of our business practices, including our solicitation, application and qualification procedures for merchants, the terms of our agreements with merchants, the processing fees that we charge, our customer service levels and our use of independent sales organizations. We cannot guarantee that our sponsoring bank s actions under these agreements will not be detrimental to us. If we or our bank sponsor fail to adhere to the standards of the Visa and MasterCard credit card associations, our registrations with these associations could be terminated and we could be required to stop providing payment processing services for Visa and MasterCard. Substantially all of the transactions we process involve Visa or MasterCard. If we or our bank sponsor fail to comply with the applicable requirements of the Visa and MasterCard credit card associations, Visa or MasterCard could suspend or terminate our registration. The termination of our registration or any changes in the Total (1) Table of Contents Visa or MasterCard rules that would impair our registration could require us to stop providing payment processing services, which would have a material adverse effect on our business. We and our electronic payment processing subsidiaries rely on other card payment processors and service providers. If they no longer agree to, or are unable to, provide their services, our merchant relationships could be adversely affected and we could lose business. Our electronic payment processing business relies on agreements with several other large payment processing organizations to enable us to provide card authorization, data capture, settlement and merchant accounting services and access to various reporting tools for the merchants we serve. We also rely on third parties to whom we outsource specific services, such as reorganizing and accumulating daily transaction data on a merchant-by-merchant and card issuer-by-card issuer basis and forwarding the accumulated data to the relevant bankcard associations. Many of these organizations and service providers are our competitors. The termination by our service providers of these arrangements with us or their failure to perform these services efficiently and effectively may adversely affect our relationships with the merchants whose accounts we serve and may cause those merchants to terminate their processing agreements with us. On occasion, we experience increases in interchange and sponsorship fees. If we cannot pass these increases along to our merchants, our profit margins will be reduced. Our electronic payment processing subsidiaries pay interchange fees or assessments to card associations for each transaction we process using their credit, debit and gift cards. From time to time, the card associations increase the interchange fees that they charge processors and the sponsoring banks. At their sole discretion, our sponsoring banks have the right to pass any increases in interchange fees on to us. In addition, our sponsoring banks may increase their Visa and MasterCard sponsorship fees, all of which are based upon the dollar amount of the payment transactions we process. If we are not able to pass these fee increases along to merchants through corresponding increases in our processing fees, our profit margins in this line of business will be reduced. Unauthorized disclosure of merchant or cardholder data, whether through breach of our computer systems or otherwise, could expose us to liability and business losses. Through our electronic payment processing subsidiaries, we collect and store sensitive data about merchants and cardholders and we maintain a database of cardholder data relating to specific transactions, including payment, card numbers and cardholder addresses, in order to process the transactions and for fraud prevention and other internal processes. If anyone penetrates our network security or otherwise misappropriates sensitive merchant or cardholder data, we could be subject to liability or business interruption. We cannot guarantee that our systems will not be penetrated in the future. If a breach of our system occurs, we may be subject to liability, including claims for unauthorized purchases with misappropriated card information, impersonation or other similar fraud claims. We have potential liability if our merchants refuse or cannot reimburse charge-backs resolved in favor of their customers. If a billing dispute between a merchant and a cardholder is not ultimately resolved in favor of the merchant, the disputed transaction is charged back to the merchant s bank and credited to the account of the cardholder. If we or our processing banks are unable to collect the charge-back from the merchant s account, or if the merchant refuses or is financially unable due to bankruptcy or other reasons to reimburse the merchant s bank for the charge-back, we bear the loss for the amount of the refund paid to the cardholder s bank. We face potential liability for customer or merchant fraud. Credit card fraud occurs when a merchant s customer uses a stolen card (or a stolen card number in a card-not-present transaction) to purchase merchandise or services. In a traditional card-present transaction, if the Public offering price $ $ Underwriting discount $ $ Proceeds, before expenses, to us(2) $ $ (1) We and the selling shareholders named in this prospectus have granted the underwriters a 45-day option to purchase up to an additional 900,000 shares of our common stock at the public offering price, less the underwriting discount. If this over-allotment option is exercised in full, the total public offering price will be $ , the total underwriting discount will be $ and the total proceeds, before expenses, to us would be $ . For all shares sold pursuant to the over-allotment option, 50% will be sold by us on a first priority basis; and 50% will be sold by three of our principal shareholders, all of whom are executive officers, on the same terms and conditions as us, but on a second priority basis. (2) We estimate that we will incur approximately $ in offering expenses in connection with this offering. This is a firm commitment underwriting. The underwriters have the option to purchase up to 450,000 shares of common stock from us and thereafter an additional 450,000 shares from the three selling shareholders on the same basis as the shares sold by us within 45 days from the date of this prospectus to cover over-allotments, if any. The underwriters expect to deliver the shares on or about , 2004. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. Roth Capital Partners Maxim Group LLC The date of this prospectus is , 2004. Table of Contents merchant swipes the card, receives authorization for the transaction from the card issuing bank and verifies the signature on the back of the card against the paper receipt signed by the customer, the card issuing bank remains liable for any loss. In a fraudulent card-not-present transaction, even if the merchant receives authorization for the transaction, the merchant is liable for any loss arising from the transaction. Many of our business customers are small and transact a substantial percentage of their sales over the Internet or by telephone or mail orders. Because their sales are card-not-present transactions, these merchants are more vulnerable to customer fraud than larger merchants and we could experience charge-backs arising from cardholder fraud more frequently with these merchants. Merchant fraud occurs when a merchant, rather than a customer, knowingly uses a stolen or counterfeit card or card number to record a false sales transaction or intentionally fails to deliver the merchandise or services sold in an otherwise valid transaction. Anytime a merchant is unable to satisfy a charge-back, we are responsible for that charge-back. We have established systems and procedures to detect and reduce the impact of merchant fraud, but we cannot assure you that these measures are or will be effective. Failure to effectively manage risk and prevent fraud could increase our charge-back liability. RISKS RELATING TO OUR ACQUISITION AND OPERATION OF A WEBSITE HOSTING BUSINESS The closing of the CrystalTech acquisition is contingent on our receiving net proceeds from this offering or a similar financing. Even if this offering is completed, we may still not be able to consummate the acquisition. In such a case, we would not be able to acquire the website hosting business. Under the terms of our agreement with CrystalTech, our obligation to consummate this acquisition is conditioned upon our receiving sufficient financing to fund the cash portion of the purchase price of $10,000,000 plus an additional amount of $2,000,000. Moreover, some of the other closing conditions are not within our control, such as obtaining the consent of CrystalTech s landlord. Absent fulfillment of all material conditions, we may be unable to complete the transaction. In addition, we have agreed with the underwriters for this offering that we will use our commercially reasonable best efforts to consummate the transaction with CrystalTech within eight days of closing this offering. CrystalTech operates in a competitive industry where technological change can be rapid. The website hosting business and its related technology involve a broad range of rapidly changing technologies. CrystalTech s equipment and the technologies on which it is based may not remain competitive over time, and others may develop superior technologies that render CrystalTech s products non-competitive without significant additional capital expenditures. CrystalTech s website hosting business depends on the efficient and uninterrupted operation of its computer and communications hardware systems and infrastructure. Despite precautions taken by CrystalTech against possible failure of its systems, interruptions could result from natural disasters, power loss, the inability to acquire fuel for our backup generators, telecommunications failure, terrorist attacks and similar events. CrystalTech also leases telecommunications lines from local, regional and national carriers whose service may be interrupted. Our business, financial condition and results of operations could be harmed after our acquisition of CrystalTech by any damage or failure that interrupts or delays our operations. Of primary importance to CrystalTech s website hosting customers is the integrity of its infrastructure and the privacy of confidential information. CrystalTech s infrastructure is potentially vulnerable to physical or electronic break-ins, viruses or similar problems. If a person circumvents CrystalTech s security measures, he or she could jeopardize the security of confidential information stored on CrystalTech s systems, misappropriate proprietary information or cause interruptions in CrystalTech s operations. We may be required to make significant additional investments and Table of Contents You should rely only on the information contained in this prospectus or any supplement. We have not authorized anyone to provide you with any different information. You should not consider any statement modified or superceded, except as so modified or superceded by any supplement to this prospectus, to constitute a part of this prospectus. Unless otherwise indicated, all information in this prospectus assumes that the underwriters will not exercise their option to purchase shares to cover over-allotments. To understand this offering fully, you should read this entire document carefully, including, in particular, the Risk Factors section beginning on page 7 as well as the documents identified in the section entitled Where You Can Find More Information on page 85. [remainder of page intentionally left blank] Table of Contents efforts to protect against or remedy security breaches. Security breaches that result in access to confidential information could damage our reputation and expose us to a risk of loss or liability. The security services that CrystalTech offers in connection with customers networks cannot assure complete protection from computer viruses, break-ins and other disruptive problems. Although CrystalTech attempts to limit contractually its liability in such instances, the occurrence of these problems may result in claims against CrystalTech or us or liability on our part. These claims, regardless of their ultimate outcome, could result in costly litigation and could harm our business and reputation and impair CrystalTech s ability to attract and retain customers. CrystalTech s business depends on Microsoft Corporation for the license to use software as well as other intellectual property in its website hosting business. CrystalTech s website hosting business is built on a technological platform relying on the Microsoft Windows products that CrystalTech currently licenses. As a result, if we are unable to continue to have the benefit of that licensing arrangement or if the Microsoft Windows products upon which CrystalTech s platform is built become obsolete, our business could be materially and adversely affected. CrystalTech depends on the services of a few key personnel in managing its website hosting business, and the loss of one or more of them could materially impair its ability to maintain current levels of customer service and the proper technical operations of its business. After we acquire CrystalTech we will depend upon the continued management by Tim Uzzanti of the operations of CrystalTech s website hosting business, along with two or three other individuals to supervise CrystalTech s technical operations and the customer technical service response. If we were to lose the services of one or more of these persons, our website hosting business could be significantly diminished. RISKS RELATING TO OUR NEW BUSINESSES The new businesses we plan to develop or organize, namely insurance sales, tax preparation services and financial information services will be businesses which are new to us and we may incur significant losses prior to becoming profitable if ever. We do not have any experience in conducting our proposed new businesses in any meaningful manner in the past. Our investment in and operation of these businesses may result in losses due to our lack of knowledge and experience. We cannot assure that the insurance, tax preparation or financial information services we plan to offer will be price competitive or accepted by our customers. Despite our efforts to design, market and deliver integrated services to our customers, our proposed new services may not be widely accepted and we may not be able to compete with other larger and better capitalized providers of such services. We will depend on third parties, particularly property and casualty insurance companies, to supply the products marketed by our agents. Our future contracts with property and casualty insurance companies typically will provide that the contracts can be terminated by the supplier without cause. Our inability to enter into satisfactory arrangements with these suppliers or the loss of these relationships for any reason would adversely affect the results of our new insurance business. Termination of our professional liability insurance policy may adversely impact our financial prospects and our ability to continue our relationships with insurance companies. We will need to obtain professional liability insurance in connection with the operation of this business. If we are unable to obtain or if we lose such insurance after we obtain it, it is unlikely that our relationships with Table of Contents insurance companies would continue. We are currently in the process of obtaining professional liability insurance to cover the operations of the insurance agency and meet applicable state licensing requirements but no assurances can be given that we will be able to obtain such insurance. Once obtained, our failure to maintain this insurance would have a material adverse impact on the business. If we fail to comply with government regulations, our insurance agency business could be adversely affected. Our insurance agency business will be subject to comprehensive regulation in the various states in which we plan to conduct business. Our success will depend in part upon our ability to satisfy these regulations and to obtain and maintain all required licenses and permits. Our failure to comply with any statutes and regulations could have a material adverse effect on us. Furthermore, the adoption of additional statutes and regulations, changes in the interpretation and enforcement of current statutes and regulations or the expansion of our business into jurisdictions that have adopted more stringent regulatory requirements than those in which we currently conduct business could have a material adverse effect on us. We do not have any control over the commissions our insurance agency expects to earn on the sale of insurance products which are based on premiums and commission rates set by insurers and the conditions prevalent in the insurance market. Our insurance agency expects to earn commissions on the sale of insurance products. Commission rates and premiums can change based on the prevailing economic and competitive factors that affect insurance underwriters. In addition, the insurance industry has been characterized by periods of intense price competition due to excessive underwriting capacity and periods of favorable premium levels due to shortages of capacity. We cannot predict the timing or extent of future changes in commission rates or premiums or the effect any of these changes will have on the operations of our insurance agency. RISKS RELATING TO OUR COMMON STOCK AND THIS OFFERING Three of our shareholders, all of whom are executive officers and directors, will beneficially own approximately 42% of our common stock after completion of this offering (including the exercise of the over-allotment option) and the acquisition of Crystal Tech (assuming all contingent share payments are earned and issued), and will be able to control the outcome of most shareholder actions. Because of their ownership of our stock, Messrs. Sloane, Wasserman and Rubin will be able to control or have significant influence over all actions requiring shareholder approval, including the election of directors, the adoption of amendments to the certificate of incorporation, approval of stock incentive plans and approval of major transactions such as a merger or sale of assets. This could delay or prevent a change in control of our company, deprive our shareholders of an opportunity to receive a premium for their shares of common stock as part of a change in control and have a negative effect on the market price of our common stock. There is a limited trading market for our common stock, and you may not be able to resell your shares at or above the price you pay for them. The price of our common stock is subject to fluctuations based on, among other things, economic and market conditions for companies in similar industries to ours and the stock market in general, as well as changes in investor perceptions of us. While we are a publicly-traded company, the volume of trading activity in our stock is relatively small. The current public float of our common stock is approximately 11,600,000 shares, and the average daily trading volume of our common stock from January 1, 2004 through March 31, 2004 was approximately 63,000 shares. Even if a more active market develops, there can be no assurance that such a market will continue or that our shareholders will be able to sell their shares at or above the offering price. Table of Contents Our management will have broad discretion over the use of the net proceeds of this offering, and you may not agree with the way the proceeds are used. While we currently intend to use the net proceeds of this offering for the CrystalTech acquisition, capital or liquidity in connection with NSBF s warehouse credit facility, potential future acquisitions, working capital and other general purposes, we may subsequently choose to use the net offering proceeds for different purposes or not at all. In addition, the CrystalTech acquisition may fail to close for a reason or reasons which we cannot now contemplate. The effect of the offering will be to increase capital resources available to our management, and our management will allocate these capital resources as it determines is necessary. You will be relying on the judgment of our management with regard to the use of the net proceeds of this offering. See Use of Proceeds. Future issuances of our common stock or other securities, including preferred stock, may dilute the per share book value of our common stock or have other adverse consequences to our common shareholders. Following the completion of this offering, our board of directors has the authority, without the action or vote of our shareholders, to issue all or part of the approximately 5,800,000 authorized but unissued shares of our common stock. If issued, these common shares would represent approximately 17% of our outstanding common stock. Our business strategy relies upon investment in and acquisition of businesses using the resources available to us, including our common stock. We have made acquisitions during 2002 and 2003 involving the issuance of our common stock, and we expect to make additional acquisitions in the future using our common stock. Additionally, we anticipate granting additional options or restricted stock awards to our employees and directors in the future. We may also issue additional securities, through public or private offerings, in order to raise capital to support our growth, including in connection with possible acquisitions or in connection with purchases of minority interests in affiliated companies or capcos. Future issuances of our common stock will dilute the percentage of ownership interest of current shareholders and could decrease the per share book value of our common stock. In addition, option holders may exercise their options at a time when we would otherwise be able to obtain additional equity capital on more favorable terms. Pursuant to our certificate of incorporation, our board of directors is authorized to issue, without action or vote of our shareholders, up to 1,000,000 shares of blank check preferred stock, meaning that our board of directors may, in its discretion, cause the issuance of one or more series of preferred stock and fix the designations, preferences, powers and relative participating, optional and other rights, qualifications, limitations and restrictions thereof, including the dividend rate, conversion rights, voting rights, redemption rights and liquidation preference, and to fix the number of shares to be included in any such series. The preferred stock so issued may rank superior to the common stock with respect to the payment of dividends or amounts upon liquidation, dissolution or winding-up, or both. In addition, the shares of preferred stock may have class or series voting rights. The authorization and issuance of blank check preferred stock could have an anti-takeover effect detrimental to the interests of our shareholders. Our certificate of incorporation allows our board of directors to issue preferred stock with rights and preferences set by the board without further shareholder approval. The issuance of shares of this blank check preferred stock could have an anti-takeover effect detrimental to the interests of our shareholders. For example, in the event of a hostile takeover attempt, it may be possible for management and the board to impede the attempt by issuing the preferred shares, thereby diluting or impairing the voting power of the other outstanding shares of common stock and increasing the potential costs to acquire control of us. Our board has the right to issue any new shares, including preferred shares, without first offering them to the holders of common stock as they have no preemptive rights. Table of Contents We know of no other publicly-held company that sponsors and operates capcos as a material part of its business. As such, there are, to our knowledge, no other companies against which investors may compare our capco business, operations, results of operations and financial and accounting structures. In the absence of any meaningful peer group comparisons for our capco business, investors may have a difficult time understanding and judging the strength of our business. This, in turn, may have a depressing effect on the value of our stock. Substantial sales of shares may impact the market price of our common stock. If our shareholders sell substantial amounts of our common stock, the market price of our common stock may decline. These sales also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate. We are unable to predict the effect that sales may have on the then prevailing market price of our common stock. This risk is compounded by the fact that three of our executive officers and directors will own approximately 42% of our common stock after completion of this offering (including the exercise of the over-allotment option) and the acquisition of CrystalTech (assuming all contingent share payments are earned and issued), and sales by any one of them of substantial numbers of shares, or the perception that such sales could occur, could adversely affect the market price. Further, these three shareholders, as well as all of our other directors, have entered into lock-up agreements with the underwriters in which they have agreed to refrain from selling their shares for a period of 180 days after the date of this prospectus. Increased sales of our common stock in the market after the expiration of these lock up agreements could exert significant downward pressure on our stock price. Provisions of our certificate of incorporation and New York law place restrictions on our shareholders ability to recover from our directors. As permitted by New York law, our amended and restated certificate of incorporation limits the liability of our directors for monetary damages for breach of a director s fiduciary duty except for liability in certain instances. As a result of these provisions and New York law, shareholders have restrictions and limitations upon their rights to recover from directors for breaches of their duties. In addition, our certificate of incorporation provides that we must indemnify our directors and officers to the fullest extent permitted by law. We may not be able to comply in a timely manner with all of the recently enacted or proposed corporate governance requirements. Beginning with the enactment of the Sarbanes-Oxley Act of 2002, in July 2002, a significant number of new corporate governance requirements have been adopted or proposed by the SEC and the Nasdaq Stock Market. Although we currently expect to comply with all current and future requirements, we may not be successful in complying with these requirements in the future. In addition, certain of these requirements may require us to make changes to our corporate governance. There are risks associated with one of our underwriter s lack of recent experience in public offerings. Although certain principals of Maxim Group LLC have extensive experience in the securities industry, Maxim Group LLC itself is newly formed and has acted as an underwriter in only one prior public offering. This lack of operating history may have an adverse effect on this offering. Maxim Group LLC was formed in October 2002 and is a member of the National Association of Securities Dealers and the Securities Investor Protection Corporation. Table of Contents The Offering Common stock offered by us 6,000,000 shares Common stock to be outstanding after this offering 33,246,433 shares Over-Allotment Option We have granted to the underwriters an option for 45 days to purchase up to 450,000 additional shares of common stock to cover over-allotments, if any. In addition, three of our principal shareholders, who are all executive officers, have also granted a similar option to the underwriters to cover over-allotments and will sell up to an aggregate of 450,000 shares of their respective common stock subsequent to our shares being sold. Nasdaq National Market symbol NKBS Use of proceeds We intend to use the net proceeds of this offering to pay the cash portion of the purchase price of CrystalTech and, whether or not the CrystalTech transaction closes, for working capital and general corporate purposes, including potential future acquisitions of complementary businesses and technologies and providing additional capital or liquidity to our current or future operating subsidiaries. Risk Factors See Risk Factors beginning on page 7 for a discussion of factors you should carefully consider before deciding to invest in our common stock. Table of Contents

parsed_sections/risk_factors/2004/CIK0001108271_conor_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ RISK FACTORS Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors and all other information contained in this prospectus before purchasing our common stock. If any of the following risks occur, our business, financial condition or results of operations could be materially and adversely affected. In these circumstances, the market price of our common stock could decline, and you may lose some or all of your investment. Risks Related to Our Intellectual Property Intellectual property rights, including in particular patent rights, play a critical role in the drug eluting stent sector of the medical device industry, and therefore in our business. We face significant risks relating to patents, both as to our own patent position as well as to patents held by third parties. These risks are summarized below. We describe in greater detail our patent position, and patents held by third parties that could impact our business, under the caption Business Patents and Proprietary Rights. You should consider carefully the matters discussed under that caption and in the risk factors below in considering an investment in our common stock. We believe that it is highly likely that one or more third parties will assert a patent infringement claim against us. If any such claim is successful, we could be enjoined, or prevented, from commercializing our COSTAR stent or other product candidates, and you should assume that a lawsuit asserting such a claim has been or will be filed against us. There are numerous U.S. and foreign issued patents and pending patent applications owned by third parties with patent claims in areas that are the focus of our product development efforts. We are aware of patents owned by third parties, to which we do not have licenses, that relate to, among other things: use of paclitaxel (in general or on a stent) to treat restenosis; stent structure; catheters used to deliver stents; and stent manufacturing processes. Based on the prolific litigation that has occurred in the stent industry and the fact that we may pose a competitive threat to some large and well-capitalized companies who own or control patents relating to stents and their use, manufacture and delivery, we believe that it is highly likely that one or more third parties will assert a patent infringement claim against the manufacture, use or sale of our COSTAR stent based on one or more of these patents. It is not unlikely that a lawsuit asserting patent infringement and related claims will be filed against us prior to the completion of this offering, and it is possible that a lawsuit may have already been filed against us of which we are not aware. Any lawsuit could seek to enjoin, or prevent, us from commercializing our COSTAR stent and may seek damages from us, and would likely be expensive for us to defend against. In particular, it has been reported that Boston Scientific plans to initiate litigation asserting patent infringement claims against us prior to commercialization of our COSTAR stent in the United States. We cannot predict when this lawsuit will be filed, and investors should assume that a lawsuit alleging that we have infringed or are infringing one or more patents controlled by Boston Scientific has been filed by Boston Scientific at or prior to the time of this offering. Although we have not otherwise received any definitive communications from third parties indicating that they intend to pursue patent infringement claims against us, we have received letters from third parties who have intellectual property rights in, or who have been actively involved in litigation or oppositions relating to, coronary stents, asserting that they may have rights to patents that are relevant to our operations or our stent platform and requesting the initiation of discussions. A court may determine that these patents are valid and infringed by us. A number of these patents are owned by very large and well-capitalized companies that are active participants in the stent market, such as Boston Scientific Corporation and Guidant Corporation. Several of these third party patents have been or are being asserted in litigation against purported infringers, demonstrating The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment that specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine. Table of Contents a willingness by the patent owners to litigate their claims. For a description of patents that we consider to pose a material litigation risk to us, see the discussion under the caption Business Patents and Proprietary Rights Third-Party Patent Rights. There may be patents in addition to those described under that caption that relate to aspects of our technology and that may materially and adversely affect our business. Moreover, because patent applications can take many years to issue, there may be currently pending applications, unknown to us, which may later result in issued patents that pose a material risk to us. The stent and related markets have experienced rapid technological change and obsolescence in the past, and our competitors have strong incentives to stop or delay the introduction of new products and technologies. Some of the companies in these markets, such as Boston Scientific and Guidant Corporation, have been able to capture significant market share by introducing new technologies. These companies have maintained their position in the market by, among other things, establishing intellectual property rights relating to their products and enforcing these rights aggressively against their competitors and potential new entrants into the market. All of the major companies in the stent and related markets, including Boston Scientific Corporation, Johnson & Johnson, Guidant Corporation and Medtronic, have been repeatedly involved in patent litigation relating to stents since at least 1997. Recently filed patent litigation includes litigation between Boston Scientific and Johnson & Johnson relating to Boston Scientific s drug eluting and bare metal stents and Johnson & Johnson s drug eluting stent, as well as patent litigation by Advanced Cardiovascular Systems, a subsidiary of Guidant, against Boston Scientific relating to stent structure. Each company is claiming that the other company infringes its intellectual property. We may pose a competitive threat to many of the companies in the stent and related markets. Accordingly, many of these companies, especially Boston Scientific and others against which we would compete directly, will have a strong incentive to take steps, through patent litigation or otherwise, to prevent us from commercializing our COSTAR stent. For example, Boston Scientific owns a series of patents, known as the Kunz patents, which cover the use of paclitaxel to treat restenosis generally and also to treat restenosis via a stent. Boston Scientific is currently asserting two of the Kunz patents in a patent infringement lawsuit in the Federal District Court in Delaware against Johnson & Johnson and Cordis Corporation, a subsidiary of Johnson & Johnson. In addition, Angiotech Pharmaceuticals, Inc. is the owner of a number of patents, sometimes referred to as the Hunter patents, and has licensed from the U.S. government a number of other patents, sometimes referred to as the Kinsella patents, that also cover the use of paclitaxel coated stents to treat angiogenesis and restenosis. We understand that, in a 1997 license agreement, Angiotech granted co-exclusive sublicenses to Boston Scientific and Cook Inc. under these patents. On September 24, 2004, Angiotech announced that Cook elected to exit the coronary vascular field and focus on the development of paclitaxel-eluting peripheral vascular and gastrointestinal stents. Angiotech also announced that Cook returned all of its rights in the coronary vascular field under the 1997 license agreement to Angiotech. On November 23, 2004, Boston Scientific announced that they had become the only license holder of these rights in the coronary vascular field of use and had obtained the right to sublicense these rights. Angiotech announced that Cook will maintain its rights in the Angiotech patents in the field of paclitaxel-eluting peripheral vascular and gastrointestinal stents. Boston Scientific owns other patents that may have a material adverse affect on us. These include a stent structure patent with claims covering an expanded stent with a plurality of cavities which are micro-holes or micro-slits that extend from the outer surface through the inner surface and which act as reservoirs for a substance. In addition, Guidant owns a number of patents that could have a material adverse effect on us. These include the Yock family of patents that are directed to rapid exchange catheters, the Lau family of patents which claim rapid exchange catheters for stent delivery, another Lau family of patents directed to stent structures and the Castro patents, which are directed to a manufacturing process involving the application of a material to a stent. While our products are in clinical trials, and prior to commercialization, we believe our activities in the United States related to the submission of data to the FDA fall within the scope of the exemptions that cover Table of Contents activities related to developing information for submission to the FDA and fall under general investigational use or similar laws in other countries. However, the U.S. exemptions would not cover our stent manufacturing or other activities in the United States that support overseas clinical trials if those activities are not also reasonably related to developing information for submission to the FDA. In any event, the fact that no third party has asserted a patent infringement claim against us to date should not be taken as an indication, or a level of comfort, that a patent infringement claim will not be asserted against us prior to or upon commercialization. Whether we would, upon commercialization, infringe any patent claim will not be known with certainty unless and until a court interprets the patent claim in the context of litigation. If an infringement allegation is made against us, we may seek to invalidate the asserted patent claim and/or to allege non-infringement of the asserted patent claim. In order for us to invalidate a U.S. patent claim, we would need to rebut the presumption of validity afforded to issued patents in the United States with clear and convincing evidence of invalidity, which is a high burden of proof. In the event that we are found to infringe any valid claim in a patent held by a third party, we may, among other things, be required to: pay damages, including up to treble damages and the other party s attorneys fees, which may be substantial; cease the development, manufacture, use and sale of products that infringe the patent rights of others, including our COSTAR stent, through a court-imposed sanction called an injunction; expend significant resources to redesign our technology so that it does not infringe others patent rights, or to develop or acquire non-infringing intellectual property, which may not be possible; discontinue manufacturing or other processes incorporating infringing technology; and/or obtain licenses to the infringed intellectual property, which may not be available to us on acceptable terms, or at all. Any development or acquisition of non-infringing products or technology or licenses could require the expenditure of substantial time and other resources and could have a material adverse effect on our business and financial results. If we are required to, but cannot, obtain a license to valid patent rights held by a third party, we would likely be prevented from commercializing the relevant product. We believe that it is unlikely that we would be able to obtain a license to any necessary patent rights controlled by companies, like Boston Scientific, against which we would compete directly. This would include, for example, a license to the Kunz, Hunter or Kinsella patents. If we need to redesign products to avoid third-party patents, we may suffer significant regulatory delays associated with conducting additional studies or submitting technical, manufacturing or other information related to the redesigned product and, ultimately, in obtaining approval. In addition, some of our agreements, including our agreement with Phytogen International LLC for the supply of paclitaxel, our distribution agreements with Biotronik AG and the St. Jude Medical affiliates and our supply agreements for laser-cut stents and catheters, require us to indemnify the other party in certain circumstances where our products have been found to infringe a patent or other proprietary rights of others. An indemnification claim against us may require us to pay substantial sums to our supplier, including its attorneys fees. If we are unable to obtain and maintain intellectual property protection covering our products, others may be able to make, use or sell our products, which would adversely affect our market share, and, therefore, our revenues. Our ability to protect our drug eluting stent technology from unauthorized or infringing use by third parties depends substantially on our ability to obtain and maintain valid and enforceable patents. Due to evolving legal standards relating to the patentability, validity and enforceability of patents covering medical devices and pharmaceutical inventions and the scope of claims made under these patents, our ability to obtain and enforce patents is uncertain and involves complex legal and factual questions. Accordingly, rights under any of our issued patents may not provide us with commercially meaningful protection for our drug eluting stents or afford us a commercial advantage against our competitors or their competitive products or processes. In addition, Paclitaxel dose (mcg/17mm stent) 10 10 10 10 30 30 Estimated duration of elution (days) 5 10 10 30 30 Table of Contents The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted. SUBJECT TO COMPLETION, DATED DECEMBER 10, 2004 PROSPECTUS 5,000,000 Shares Common Stock $ per share Table of Contents patents may not issue from any pending or future patent applications owned by or licensed to us, and moreover, patents that have issued to us or may issue in the future may not be valid or enforceable. Further, even if valid and enforceable, our patents may not be sufficiently broad to prevent others from marketing stents like ours, despite our patent rights. The validity of our patent claims depends, in part, on whether prior art references described or rendered obvious our inventions as of the filing date of our patent applications. We may not have identified all prior art, such as U.S. and foreign patents or published applications or published scientific literature, that could adversely affect the validity of our issued patents or the patentability of our pending patent applications. For example, patent applications in the United States are maintained in confidence for up to 18 months after their filing. In some cases, however, patent applications remain confidential in the U.S. Patent and Trademark Office, which we refer to as the U.S. Patent Office, for the entire time prior to issuance as a U.S. patent. Patent applications filed in countries outside the United States are not typically published until at least 18 months from their first filing date. Similarly, publication of discoveries in the scientific or patent literature often lags behind actual discoveries. Therefore, we cannot be certain that we were the first to invent, or the first to file patent applications relating to, our stent technologies. In the event that a third party has also filed a U.S. patent application covering our stents or a similar invention, we may have to participate in an adversarial proceeding, known as an interference, declared by the U.S. Patent Office to determine priority of invention in the United States. It is possible that we may be unsuccessful in the interference, resulting in a loss of some portion or all of our U.S. position. The laws of some foreign jurisdictions do not protect intellectual property rights to the same extent as in the United States, and many companies have encountered significant difficulties in protecting and defending such rights in foreign jurisdictions. If we encounter such difficulties or we are otherwise precluded from effectively protecting our intellectual property rights in foreign jurisdictions, our business prospects could be substantially harmed. We may initiate litigation to enforce our patent rights, which may prompt our adversaries in such litigation to challenge the validity, scope or enforceability of our patents. If a court decides that our patents are not valid, not enforceable or of a limited scope, we will not have the right to stop others from using our inventions. We also rely on trade secret protection to protect our interests in proprietary know-how and for processes for which patents are difficult to obtain or enforce. We may not be able to protect our trade secrets adequately. In addition, we rely on non-disclosure and confidentiality agreements with employees, consultants and other parties to protect, in part, trade secrets and other proprietary technology. These agreements may be breached, and we may not have adequate remedies for any breach. Moreover, others may independently develop equivalent proprietary information, and third parties may otherwise gain access to our trade secrets and proprietary knowledge. Any disclosure of confidential data into the public domain or to third parties could allow our competitors to learn our trade secrets and use the information in competition against us. We may incur substantial costs as a result of litigation or other proceedings relating to patent and other intellectual property rights. There has been substantial litigation and other proceedings regarding patent and intellectual property rights in the medical device industry generally and the drug eluting stent industry in particular. We may be forced to defend claims of infringement brought by our competitors and others, and we may institute litigation against others who we believe are infringing our intellectual property rights. The outcome of patent litigation is subject to substantial uncertainties, especially in medical device-related patent cases that may, for example, turn on the interpretation of claim language by the court which may not be to our advantage, and also the testimony of experts as to technical facts upon which experts may reasonably disagree. Our involvement in intellectual property litigation could result in significant expense. Some of our competitors, such as Boston Scientific and Guidant, have considerable resources available to them and a strong economic incentive to undertake substantial efforts to stop or delay us from bringing our COSTAR stent to market and achieving market acceptance. We, on the other hand, are a development stage company with comparatively few resources available to us to engage in costly and protracted litigation. Moreover, regardless of the outcome, intellectual property litigation against or by We are selling 5,000,000 shares of our common stock. We and the selling stockholder named in this prospectus have granted the underwriters an option to purchase up to 750,000 additional shares of common stock to cover over-allotments. We will not receive any proceeds from the sale of shares by the selling stockholder. This is the initial public offering of our common stock. We currently expect the initial public offering price to be between $11.00 and $13.00 per share. We have applied to have our common stock approved for quotation on the Nasdaq National Market under the symbol CONR. Table of Contents us could significantly disrupt our development and commercialization efforts, divert our management s attention and quickly consume our financial resources. If third parties file patent applications or are issued patents claiming technology also claimed by us in pending applications, we may be required to participate in interference proceedings with the U.S. Patent Office or in other proceedings outside the United States, including oppositions, to determine priority of invention or patentability. Even if we are successful in these proceedings, we may incur substantial costs, and the time and attention of our management and scientific personnel will be diverted in pursuit of these proceedings. Risks Related to Our Business We will depend heavily on the success of our lead product candidate, our COSTAR stent, which is still in development. If we are unable to commercialize our COSTAR stent or experience significant delays in doing so, our ability to generate revenue will be significantly delayed and our business will be harmed. We have invested all of our product development time and resources in our drug eluting stent technology, which we intend to commercialize initially in the form of our COSTAR stent. We anticipate that in the near term our ability to generate revenues will depend solely on the successful development, regulatory approval and commercialization of our COSTAR stent. If we are not successful in the completion of clinical trials for the development, approval and commercialization of our COSTAR stent, we may never generate any revenues and may be forced to cease operations. Although we are investigating the potential applicability of our stent technology to the treatment of an acute myocardial infarction, or AMI, we do not expect to seek regulatory approval of this product candidate for many years, if at all. The commercial success of our COSTAR stent will depend upon successful completion of clinical trials, manufacturing commercial supplies, obtaining marketing approval, successfully launching the product and acceptance of the product by the medical community and third party payors as clinically useful, cost-effective and safe. If the data from our clinical trials is not satisfactory, we may not proceed with our planned filing of applications for regulatory approvals or we may be forced to delay the filings. Even if we file an application for approval with satisfactory clinical data, the FDA or foreign regulatory authorities may not accept our filing, or may request additional information, including data from additional clinical trials. The FDA or foreign regulatory authorities may also approve our COSTAR stent for very limited purposes with many restrictions on its use, may delay approval, or ultimately, may not grant marketing approval for our COSTAR stent. Even if we do receive FDA or foreign regulatory approval, we may be unable to gain market acceptance by the medical community and third party payors. We do not have the necessary regulatory approvals to market our COSTAR stent or other product candidates, and we may never obtain regulatory approval. We do not have the necessary regulatory approvals to market our COSTAR stent or any other product in the United States or in any foreign market. The regulatory approval process for our COSTAR stent involves, among other things, successfully completing clinical trials and obtaining FDA approval of a premarket approval application, or PMA, and obtaining equivalent foreign market approvals, including taking the steps necessary for our COSTAR stent to bear CE marking in the European Community. We cannot assure you that we will obtain the necessary regulatory approvals to market our COSTAR stent in the United States or abroad. Our COSTAR stent is a combination product that will be regulated primarily as a class III medical device in the United States, which cannot be commercially distributed until the FDA approves our PMA. The premarket approval process can be expensive and uncertain, requires detailed and comprehensive scientific and other data, generally takes several years and may never result in the FDA granting premarket approval. We will also have to obtain similar, or in some cases more stringent, foreign marketing approval in order to commercialize our product candidates outside of the United States. If we do not obtain the requisite regulatory or marketing Investing in our common stock involves risks. See Risk Factors beginning on page 8. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. Table of Contents approvals, we will be unable to market our COSTAR stent and may never recover any of the substantial costs we have invested in the development of our COSTAR stent. If our pre-clinical tests or clinical trials for our COSTAR stent or other product candidates do not meet safety or efficacy endpoints, or if we experience significant delays in these tests or trials, our ability to commercialize our COSTAR stent or other product candidates and our financial position will be impaired. Before marketing our COSTAR stent or any other product candidate, we must successfully complete pre-clinical studies and clinical trials that demonstrate that the product is safe and effective. Product development, including pre-clinical studies and clinical testing, is a long, expensive and uncertain process and is subject to delays. It may take us several years to complete our testing, if at all, and a trial may fail at any stage. For example, we discovered that the dosage formulations for our SCEPTER trial were not ideal, and we decided not to complete the data analysis from this trial. The results of pre-clinical or clinical studies do not necessarily predict future clinical trial results, and acceptable results in early studies might not be seen in later studies. For example, the four-month follow-up data from our PISCES study may not be sustained in later follow-up of patients in the trial, and we may discover unanticipated side effects. Any pre-clinical or clinical test may fail to produce results satisfactory to the FDA or foreign regulatory authorities. Pre-clinical and clinical data can be interpreted in different ways, which could delay, limit or prevent regulatory approval. We intend to design the protocol of our planned pivotal U.S. clinical trial for our COSTAR stent based in part on prior clinical trials that used different stents. The results of these prior clinical trials may not be indicative of the clinical results we would obtain for our U.S. pivotal clinical trial. We intend to commercialize our drug eluting stent technology in the form of our COSTAR stent, which is a cobalt chromium, paclitaxel eluting stent. We have only limited clinical data on our COSTAR stent, which we derived from the COSTAR I study. Our other prior clinical trials used either a bare metal stainless steel stent or a stainless steel, paclitaxel eluting stent. In addition to using a different metal than used in our COSTAR stent, the stainless steel stent had slightly different dimensions than our COSTAR stent. We intend to design the protocol, including the dosage formulations, for our planned U.S. pivotal clinical trial based on the results of these prior clinical trials. This trial is being designed in large part based on the results of our PISCES study, which used a stainless steel, paclitaxel eluting form of our stent technology, as well as on the results of our COSTAR I study. Currently, we have only four-month follow-up data from these studies. The results of these prior trials may not be indicative of the behavior of, and therefore the clinical results we will obtain with, our COSTAR stent. If results at least as favorable as the four-month results in our PISCES and COSTAR I studies are not observed in subsequent clinical trials, our development efforts will be delayed or halted and our business may be harmed. The clinical results we have reported to date are after four-month follow-up, and may not be indicative of future clinical results. The clinical results we have reported to date are limited to four-month follow-up data from our PISCES study and our COSTAR I study. The pivotal trial we are conducting for marketing approval in the European Community, EuroSTAR, will report six-month follow-up data, and our planned U.S. pivotal clinical trial, COSTAR II, will require at least eight-month follow-up data. The four-month results from our PISCES and COSTAR I studies may not be indicative of the clinical results obtained when we examine the patients at a later date. While the stainless steel, paclitaxel eluting stent has shown favorable results after four months in our PISCES study, it is possible that the results are not durable, and that the long-term results we obtain with our COSTAR stent may not show similar effectiveness. Per Share Table of Contents Our current and planned clinical trials may not begin on time, or at all, and may not be completed on schedule, or at all. The commencement or completion of any of our clinical trials may be delayed or halted for numerous reasons, including, but not limited to, the following: the FDA or other regulatory authorities do not approve a clinical trial protocol or a clinical trial, or place a clinical trial on hold; patients do not enroll in clinical trials at the rate we expect; patients are not followed-up at the rate we expect; patients experience adverse side effects; patients die during a clinical trial for a variety of reasons, including the advanced stage of their disease and medical problems, which may not be related to our product candidates; third party clinical investigators do not perform our clinical trials on our anticipated schedule or consistent with the clinical trial protocol and good clinical practices, or other third party organizations do not perform data collection and analysis in a timely or accurate manner; regulatory inspections of our clinical trials or manufacturing facilities, which may, among other things, require us to undertake corrective action or suspend or terminate our clinical trials if investigators find us not to be in compliance with regulatory requirements; changes in governmental regulations or administrative actions; the interim results of the clinical trial are inconclusive or negative; or our trial design, although approved, is inadequate to demonstrate safety and/or efficacy. Before we can commence our planned U.S. pivotal clinical trial for our COSTAR stent, an investigational device exemption, or IDE, application must be approved by the FDA. Although we currently anticipate submitting an IDE application to the FDA in 2005, the timing of our IDE submission or the FDA s approval may be delayed for a number of reasons. For example, in animal studies, we observed evidence of small cracks in the previous design of our COSTAR stent. Accordingly, we modified the design of our COSTAR stent in mid-2004, which we believe eliminated the potential for the small cracks we observed in the animal studies. We anticipate our IDE submission will be based, in part, on data from trials conducted with the previous stent design. The FDA may require us to conduct additional studies with the modified stent, which could delay the timing of our IDE submission and/or FDA approval to commence the trial. The FDA may also require us to conduct additional studies of our COSTAR stent since a significant percentage of the patients evaluated in our clinical trials to date were treated with our paclitaxel eluting stainless steel stent. Additionally, the FDA may require us to conduct additional studies of our COSTAR stent at the paclitaxel dose to be used in our planned U.S. pivotal clinical trial. Discussions with the FDA regarding other aspects of our planned clinical trial may also delay the submission of our IDE application or the FDA s approval of the application. Clinical trials may require the enrollment of large numbers of patients, and suitable patients may be difficult to identify and recruit. For example, the FDA may require that we enroll 2,000 or more patients for our U.S. pivotal clinical trial for our COSTAR stent. Patient enrollment in clinical trials and completion of patient follow-up in clinical trials depend on many factors, including the size of the patient population, the nature of the trial protocol, the proximity of patients to clinical sites and the eligibility criteria for the study and patient compliance. For example, patients may be discouraged from enrolling in our clinical trials if the trial protocol requires them to undergo extensive post-treatment procedures to assess the safety and effectiveness of our COSTAR stent, or they may be persuaded to participate in contemporaneous trials of competitive products. In addition, patients participating in our clinical trials may die before completion of the trial or suffer adverse medical effects unrelated to our COSTAR stent. Delays in patient enrollment or failure of patients to continue to participate in a study may cause an increase in costs and delays or result in the failure of the trial. Total Table of Contents Our development costs will increase if we have material delays in our clinical trials or if we need to perform more or larger clinical trials than planned. Adverse events during a clinical trial could cause us to repeat a trial, terminate a trial or cancel the entire program. Problems with the stent to be used in the control group could adversely affect our planned U.S. pivotal clinical trial for our COSTAR stent. Our planned U.S. pivotal clinical trial of our COSTAR stent could be significantly delayed or harmed if we experience problems with the stent to be used in the control group for this trial. We plan to use one of the two currently marketed drug eluting stents, Johnson & Johnson s CYPHER stent and Boston Scientific s TAXUS Express2 stent, as the control stent in our planned U.S. pivotal clinical trial. In July 2004, Boston Scientific announced the recall of approximately 85,000 TAXUS Express2 stent systems and approximately 11,000 Express2 stent systems due to characteristics in the delivery catheters that have the potential to impede balloon deflation during a coronary angioplasty procedure. In August 2004, Boston Scientific announced that it would recall an additional 3,000 TAXUS Express2 stents. If prior to or during the enrollment and treatment period for our planned U.S. pivotal clinical trial, there is a recall of the control stent or the control stent is removed from the market, our trial would likely be substantially delayed. The FDA could also require us to redesign the trial based on an alternative control stent. Any significant delay or redesign would significantly delay and potentially impair our ability to commercialize our COSTAR stent. We may not be successful in our efforts to expand our portfolio of products and develop additional drug delivery technologies. A key element of our strategy is to discover, develop and commercialize a portfolio of new products in addition to our COSTAR stent. We are seeking to do so through our internal research programs and intend to explore strategic collaborations for the development of new products utilizing our stent technology. Research programs to identify new disease targets, product candidates and delivery techniques require substantial technical, financial and human resources, whether or not any product candidates are ultimately identified. Our research programs may initially show promise in identifying potential product candidates, yet fail to yield product candidates for clinical development for many reasons, including the following: the research methodology used may not be successful in identifying potential product candidates; competitors may develop alternatives that render our product candidates obsolete; our delivery technologies may not safely or efficiently deliver the drugs; and product candidates may on further study be shown to have harmful side effects or other characteristics that indicate they are unlikely to be effective. Our strategy also includes exploring the use of compounds and drugs other than paclitaxel for the treatment of restenosis and other indications. We may not be able obtain any necessary licenses to promising compounds or drugs on reasonable terms, if at all. In addition, our strategy includes substantial reliance on strategic collaborations with others to develop new products. If these collaborators do not prioritize and commit substantial resources to these collaborations, or if we are unable to secure successful collaborations on acceptable business terms, we may be unable to discover suitable potential product candidates or develop additional delivery technologies and our business prospects will suffer. Pre-clinical development is a long, expensive and uncertain process, and we may terminate one or more of our pre-clinical development programs. We may determine that certain pre-clinical product candidates or programs do not have sufficient potential to warrant the allocation of resources, such as the potential development of our stent technology for the treatment of AMI. Accordingly, we may elect to terminate our programs for such product candidates. If we terminate a pre- Public Offering Price $ $ Underwriting Discounts $ $ Proceeds to Conor Medsystems, Inc. (before expenses) $ $ The underwriters expect to deliver the shares to purchasers on or about , 2004. Citigroup Table of Contents clinical program in which we have invested significant resources, our prospects will suffer, as we will have expended resources on a program that will not provide a return on our investment and will have missed the opportunity to have allocated those resources to potentially more productive uses. We depend on single source suppliers for our COSTAR stent components, manufacturing components, and the active drug used in our COSTAR stent. The loss of these suppliers could delay our clinical trials or prevent or delay commercialization of our COSTAR stent. We rely on third parties to supply us with the critical components and the active drug, paclitaxel, used in our COSTAR stent. Phytogen International LLC is our sole supplier of paclitaxel. Our agreement with Phytogen restricts our ability to commercialize products that incorporate paclitaxel we purchase from third parties, and there is a limited number of alternative suppliers that are capable of manufacturing paclitaxel and are willing, or legally able, to do so. In addition, the agreement permits Phytogen to manufacture and supply paclitaxel to others. If Phytogen is unable or refuses to meet our demand for paclitaxel, if Phytogen terminates its agreement with us or if Phytogen s supplies do not meet quality and other specifications, the development and commercialization of our COSTAR stent could be prevented or delayed. To date, our paclitaxel requirements have consisted of quantities that we need to conduct our pre-clinical and clinical trials. If we obtain market approval for our COSTAR stent, we anticipate that we will require substantially larger quantities of paclitaxel. Phytogen may not provide us with sufficient quantities of paclitaxel that meet quality and other specifications, and we may not be able to locate an alternative supplier of paclitaxel in a timely manner or on commercially reasonable terms, if at all. We do not have long-term contracts with our third party suppliers of stent delivery catheters or the cobalt chromium tubing and laser-precision cutting process required to produce our COSTAR stent. In addition, we do not have long-term contracts with our third party suppliers of some of the equipment and components that are used in our manufacturing process. Except for the suppliers of our laser-cut stents and stent delivery catheters, none of our suppliers have agreed to maintain a guaranteed level of production capacity. Furthermore, suppliers that have guaranteed a level of production capacity may still be unable to satisfy our supply needs. Establishing additional or replacement suppliers for these components may take a substantial amount of time. We may also have difficulty obtaining similar components from other suppliers that are acceptable to the FDA or foreign regulatory authorities. Furthermore, since some of these suppliers are located outside of the United States, we are subject to foreign export laws and U.S. import and customs regulations, which complicate and could delay shipments to us. Some of the manufacturers of stent components are also our competitors and may be reluctant to supply components to us on favorable terms, if at all. If we have to switch to replacement suppliers, we may face additional regulatory delays and the manufacture and delivery of our COSTAR stent could be interrupted for an extended period of time, which may delay completion of our clinical trials or commercialization of our COSTAR stent. In addition, we will be required to obtain regulatory clearance from the FDA or foreign regulatory authorities to use different suppliers or components that may not be as safe or as effective. As a result, regulatory approval of our COSTAR stent may not be received on a timely basis or at all. We have limited manufacturing capabilities and manufacturing personnel, and if our manufacturing facilities are unable to provide an adequate supply of products, our growth could be limited and our business could be harmed. We currently manufacture our COSTAR stent at our facilities in Menlo Park, California, and we are currently establishing manufacturing capacity in Ireland to manufacture our COSTAR stent for sale outside of the United States. If there were a disruption to our existing manufacturing facility, we would have no other means of manufacturing our COSTAR stent until we were able to restore the manufacturing capability at our facility or develop alternative manufacturing facilities. If we were unable to produce sufficient quantities of our COSTAR stent for use in our current and planned clinical trials, or if our manufacturing process yields substandard stents, our development and commercialization efforts would be delayed. CIBC World Markets SG Cowen & Co. A.G. Edwards , 2004 Table of Contents We currently have limited resources, facilities and experience to commercially manufacture our product candidates. In order to produce our COSTAR stent in the quantities that we anticipate will be required to meet anticipated market demand, we will need to increase, or scale up, the production process by a significant factor over the current level of production. There are technical challenges to scaling-up manufacturing capacity, and developing commercial-scale manufacturing facilities would require the investment of substantial additional funds and hiring and retaining additional management and technical personnel who have the necessary manufacturing experience. We may not successfully complete any required scale-up in a timely manner or at all. If we are unable to do so, we may not be able to produce our COSTAR stent in sufficient quantities to meet the requirements for the launch of the product or to meet future demand, if at all. If we develop and obtain regulatory approval for our COSTAR stent and are unable to manufacture a sufficient supply of our COSTAR stent, our revenues, business and financial prospects would be adversely affected. In addition, if the scaled-up production process is not efficient or produces stents that do not meet quality and other standards, our future gross margins may decline. In addition, while we have validated our manufacturing process for consistency, we have experienced drug release kinetic variability within and between manufacturing lots, and we may experience similar issues in the future. Manufacturing lot variability may result in unfavorable clinical trial results. Additionally, any damage to or destruction of our Menlo Park facilities or our equipment, prolonged power outage or contamination at our facility would significantly impair our ability to produce our COSTAR stents. For example, because our Menlo Park facilities are located in a seismic zone, we face the risk that an earthquake may damage our facilities and disrupt our operations. Our manufacturing facilities and the manufacturing facilities of our suppliers must comply with applicable regulatory requirements. If we fail to achieve regulatory approval for these manufacturing facilities, our business and our results of operations would be harmed. Completion of our clinical trials and commercialization of our product candidates require access to, or the development of, manufacturing facilities that meet applicable regulatory standards to manufacture a sufficient supply of our products. Although we are currently in the process of establishing a manufacturing facility in Ireland for products to be sold outside of the United States, our manufacturing facility may not meet applicable foreign regulatory requirements or standards at acceptable cost and on a timely basis. In addition, the FDA must approve facilities that manufacture our products for U.S. commercial purposes, as well as the manufacturing processes and specifications for the product. Suppliers of components of, and products used to manufacture, our products must also comply with FDA and foreign regulatory requirements, which often require significant time, money and record-keeping and quality assurance efforts and subject us and our suppliers to potential regulatory inspections and stoppages. Our suppliers may not satisfy these requirements. If we or our suppliers do not achieve required regulatory approval for our manufacturing operations, our commercialization efforts could be delayed, which would harm our business and our results of operations. Quality issues in our manufacturing processes could delay our clinical development and commercialization efforts. The production of our COSTAR stent must occur in a highly controlled, clean environment to minimize particles and other yield- and quality-limiting contaminants. In spite of stringent quality controls, weaknesses in process control or minute impurities in materials may cause a substantial percentage of defective products in a lot. If we are not able to maintain stringent quality controls, or if contamination problems arise, our clinical development and commercialization efforts could be delayed, which would harm our business and our results of operations. Table of Contents Table of Contents Our COSTAR stent may never achieve market acceptance even if we obtain regulatory approvals. Even if we obtain regulatory approval, our COSTAR stent, or any other drug delivery device that we may develop, may not gain market acceptance among physicians, patients, health care payors and the medical community. The degree of market acceptance of any of our drug delivery devices that we may develop will depend on a number of factors, including: the perceived effectiveness of the product; the prevalence and severity of any side effects; potential advantages over alternative treatments; the strength of marketing and distribution support; and sufficient third party coverage or reimbursement. If our COSTAR stent, or any other drug delivery device that we may develop, is approved but does not achieve an adequate level of acceptance by physicians, healthcare payors and patients, we may not generate product revenue and we may not become profitable. If we fail to obtain an adequate level of reimbursement for our products by third party payors, there may be no commercially viable markets for our product candidates or the markets may be much smaller than expected. The availability and levels of reimbursement by governmental and other third party payors affect the market for our product candidates. The efficacy, safety, performance and cost-effectiveness of our product candidates and of any competing products will determine the availability and level of reimbursement. Reimbursement and healthcare payment systems in international markets vary significantly by country, and include both government sponsored healthcare and private insurance. To obtain reimbursement or pricing approval in some countries, we may be required to produce clinical data, which may involve one or more clinical trials, that compares the cost-effectiveness of our products to other available therapies. We may not obtain international reimbursement or pricing approvals in a timely manner, if at all. Our failure to receive international reimbursement or pricing approvals would negatively impact market acceptance of our products in the international markets in which those approvals are sought. Although we intend to commercialize our COSTAR stent in India, India does not currently have a reimbursement infrastructure, and we do not anticipate that the commercialization of our COSTAR stent in India will provide us with any significant revenues. We believe that future reimbursement may be subject to increased restrictions both in the United States and in international markets. Future legislation, regulation or reimbursement policies of third party payors may adversely affect the demand for our products currently under development and limit our ability to sell our product candidates on a profitable basis. In addition, third party payors continually attempt to contain or reduce the costs of healthcare by challenging the prices charged for healthcare products and services. If reimbursement for our products is unavailable or limited in scope or amount or if pricing is set at unsatisfactory levels, market acceptance of our products would be impaired and our future revenues, if any, would be adversely affected. If we are unable to establish sales and marketing capabilities or enter into and maintain arrangements with third parties to sell and market our COSTAR stent, our business may be harmed. We do not have a sales organization and have no experience as a company in the sales, marketing and distribution of drug eluting stents or other medical devices. To market and sell our COSTAR stent internationally, we have entered into distribution agreements with third parties and anticipate that we will have to enter into additional distribution arrangements. Our existing distribution agreements are generally short-term in duration, and we will have to pursue alternative distributors if the other parties to these distribution agreements terminate or elect not to renew their agreements with us. If our relationships with our distributors do not progress Table of Contents TABLE OF CONTENTS Page Table of Contents as anticipated, or if their sales and marketing strategies fail to generate sales of our products in the future, our business, financial condition and results of operations would be harmed. If our COSTAR stent is approved for commercial sale in the United States, we currently plan to establish our own sales force to market it in the United States. If we develop our own marketing and sales capabilities, our sales force will be competing with the experienced and well-funded marketing and sales operations of our competitors. Developing a sales force is expensive and time consuming and could delay or limit the success of any product launch. We may not be able to develop this capacity on a timely basis or at all. If we are unable to establish sales and marketing capabilities, we will need to contract with third parties to market and sell our COSTAR stent in the United States. To the extent that we enter into arrangements with third parties to perform sales, marketing and distribution services in the United States, our product revenues could be lower than if we directly marketed and sold our COSTAR stent, or any other drug delivery device that we may develop. Furthermore, to the extent that we enter into co-promotion or other marketing and sales arrangements with other companies, any revenues received will depend on the skills and efforts of others, and we do not know whether these efforts will be successful. Some of our existing or future distributors may have products or product candidates that compete with ours, and they may have an incentive not to devote sufficient efforts to marketing our products. For example, Biotronik AG, with whom we have an agreement that primarily covers European distribution, is developing an absorbable magnesium alloy stent. If we are unable to establish and maintain adequate sales, marketing and distribution capabilities, independently or with others, we may not be able to generate product revenue and may not become profitable. The medical device industry is highly competitive and subject to rapid technological change. If our competitors are better able to develop and market products that are safer and more effective than any products that we may develop, our commercial opportunity will be reduced or eliminated. The medical device industry is highly competitive and subject to rapid and profound technological change. Our success depends, in part, upon our ability to maintain a competitive position in the development of technologies and products in the drug delivery field. We face competition from established pharmaceutical and biotechnology companies, as well as from academic institutions, government agencies and private and public research institutions in the United States and abroad. Our principal competitors have significantly greater financial resources and expertise in research and development, manufacturing, pre-clinical testing, conducting clinical trials, obtaining regulatory approvals and marketing approved products than we do. For example, Johnson & Johnson and Boston Scientific, two companies with far greater financial and marketing resources than we possess, have both developed, and are actively marketing, drug eluting stents which have been approved by the FDA. We may be unable to demonstrate that our COSTAR stent offers any advantages over Johnson & Johnson s CYPHER stent or Boston Scientific s TAXUS Express2 stent. In addition, in August 2004, Boston Scientific announced that it had begun enrolling patients in a pivotal study to support commercialization of its new TAXUS Liberte coronary stent as a platform for its paclitaxel eluting coronary stent system. Boston Scientific has stated that the trial is designed to assess the safety and efficacy of a slow-release dose formulation for the treatment of coronary disease and that the TAXUS Liberte stent system is designed to further enhance deliverability and conformability, particularly in challenging lesions. Many other large companies, including Guidant Corporation, Medtronic Inc. and Abbott Laboratories, among others, are reportedly developing drug eluting stents. Smaller or early-stage companies may also prove to be significant competitors, particularly through collaborative arrangements with, or mergers with or acquisitions by, large and established companies or through the development of novel products and technologies. Our competitors may: develop and patent processes or products earlier than us; obtain regulatory approvals for competing products more rapidly than us; and develop more effective or less expensive products or technologies that render our technology or product candidates obsolete or non-competitive. Summary 1 Risk Factors 8

parsed_sections/risk_factors/2004/CIK0001108482_shopping_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ RISK FACTORS Investing in our ordinary shares involves a high degree of risk. You should carefully consider the following risks, as well as the other information in this prospectus, before deciding whether to invest in our ordinary shares. If any of the following risks actually occur, our business, financial condition, results of operations and liquidity could suffer. In that event, the trading price of our ordinary shares could decline and you might lose all or part of your investment. Risks Related to Our Business The rapid evolution of our industry makes it difficult for investors to evaluate our business prospects, and may result in significant declines in our share price. Our service has been available since 1998. Since that time, Internet commerce has grown rapidly and consumer usage patterns have continually evolved. During this period, many businesses related to Internet commerce have failed, and many new comparison shopping services have been introduced and some have failed. Because Internet commerce is a young industry and comparison shopping is a new business sector, we have made frequent changes in our websites and other aspects of our business operations. Some of the special risks we face in our rapidly-evolving industry are: the new and unproven nature of our Shopping.com brand; delays and obstacles to enhancing our service to meet evolving demands; difficulties in forecasting trends that may affect our operations; challenges in attracting and retaining consumers and merchants; significant dependence on a small number of revenue sources; evolving industry demands that require us to adapt our pricing model from time to time; and adverse technological changes and regulatory developments. If we are unable to meet these risks and difficulties as we encounter them, our business, financial condition, results of operations and liquidity may suffer. Our financial results are likely to fluctuate significantly from quarter to quarter, which makes them difficult to predict and could result in significant variations in our share price. Our quarterly financial results have fluctuated significantly in the past and are likely to fluctuate significantly in the future. As a result, you should not rely upon our quarterly financial results as indicators of future performance. Our financial results depend on numerous factors, many of which are outside of our control, including: seasonal fluctuations in consumer shopping and merchant advertising; the number of consumer visits to our service and subsequent lead referrals; changes in the lead referral fees that merchants are willing to pay; the costs of attracting consumers and merchants to our service, including advertising costs; the timing and amount of international expansion costs; the introduction of new consumer and merchant offerings; the loss of one or more of our merchants or other listings providers; system failures, security breaches or Internet downtime; The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment that specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine. Table of Contents difficulty in upgrading our information technology systems and infrastructure; fluctuations in currency exchange rates; and the costs of acquisitions and risks of integration of acquired businesses. Many of our expenses are fixed in the short term and determined based on our investment plans and estimates of future revenues. We expect to incur significant new expenses in developing our technology and service offerings, as well as in advertising and promotion to attract and retain consumers and merchants, before generating associated revenues. We may be unable to adjust our expenditures quickly enough to compensate for any unexpected revenue shortfall. For these or other reasons, our financial results in future quarters may fall below the expectations of management or investors and the price of, and long-term demand for, our ordinary shares could decline. We typically generate a disproportionately high amount of our revenues in the fourth quarter of each year. If that seasonal pattern were to be disrupted for any reason, our revenues and financial results for that year could be harmed, resulting in a decline in our share price. We may incur losses in future periods, which could reduce investor confidence and cause our share price to decline. We had a history of losses prior to 2003, and we may incur losses again. We had net losses of $72.9 million in 2001 and $5.1 million in 2002. We expect to continue to increase our sales and marketing expenses, research and development expenses, and general and administrative expenses, and we cannot be certain that our revenues will continue to grow at the same pace, if at all. If our revenue growth does not continue, we may experience a loss in future periods, which could cause our share price to decline. We have incurred a deemed dividend, and expect to incur additional deemed dividend amounts in connection with this offering, which would reduce our earnings per share or increase our net loss per share, for the period in which this offering occurs and could reduce the trading price of our ordinary shares. In June 2004 we amended our articles of association to increase the conversion ratios of certain classes of our preferred shares. We have recorded a non-cash deemed dividend representing the estimated value of the modification of the conversion ratios as of the date of the shareholder approval, in the amount of $10.5 million. We expect to record an additional amount as a deemed dividend upon the closing of this offering, in an amount equal to the excess of the fair value of the ordinary shares that will be issued upon conversion of the preferred shares over the fair value of the ordinary shares that would have been issued pursuant to the original conversion terms and the $10.5 million that was recorded in June 2004. The fair value will be based upon our actual initial public offering price. The amount of this additional deemed dividend is estimated to be approximately $6.2 million if our initial offering price is $17.00 per share, $7.2 million if it is $18.00 per share and $5.2 million if it is $16.00 per share. We believe that as a result of this deemed dividend, we are likely to report a net loss attributable to ordinary shareholders, and a net loss per share, for 2004 even if we report net income in accordance with GAAP. If we otherwise report a net loss in the period in which we recognize this deemed dividend, the deemed dividend would increase our net loss attributable to ordinary shareholders, and our net loss per share. This could result in a decline in the trading price of our ordinary shares. Table of Contents If we fail to grow the number of consumers and merchants that use our service, our financial results will suffer. Our relationships with consumers and merchants are mutually dependent. We believe consumers will not use our service unless we offer extensive product listings from merchants and that merchants will not use our service unless consumers actively use it to purchase products from them. It is difficult to predict the degree to which consumers and merchants will use our service in the future. Consumers who dislike changes to our service may stop using it, and merchants who dislike the quality of lead referrals that we send to them may cease to use our service or reduce overall spending for our service. Additionally, merchant attrition or reductions in merchant spending could reduce the comprehensiveness of the listings presented on our service, which could lead to fewer consumers using our service. The top three relevant merchant listings that we display in our response to a consumer query in some product categories are selected based on the amount paid by these merchants to us. As a result, consumers may perceive our service to be less objective than those provided by other online shopping solutions. Failure to achieve and maintain a large and active base of consumers and merchants using our service could reduce our revenues and profitability. We face intense competition that could harm our financial performance. The business of providing comparison shopping services is highly competitive. Any service that helps consumers find, compare or buy products or services is a competitor to us. Our competitors may be categorized as focused comparison shopping websites, search engines and portals, online retailers, and other specialized shopping services and publications, such as the following: Focused comparison shopping websites. Several companies focus exclusively on providing comparison shopping services. In this group, our principal competitors are BizRate, mySimon, NexTag and PriceGrabber in the United States, and Kelkoo in Europe (which was recently acquired by Yahoo!). We believe that many of these companies have specific competitive advantages over us. For example, BizRate specializes in merchant reviews and PriceGrabber specializes in computers and consumer electronics categories. Search engines and portals. Search engines and portals serve as origination websites for consumers to find products. Many have large audiences of visitors, consumers and merchants, established brand recognition, loyal users, and significant financial resources and personnel at their disposal. We rely on search engines for a substantial portion of the consumers visiting our websites. Yahoo! provides a service similar to ours, and Google, Inc., or Google, has developed a search engine for finding products for sale online. If these search engines were to change their algorithms or otherwise restrict the flow of consumers visiting our websites, our financial results would suffer. Online retailers. Online retailers serve as destination websites from which consumers directly buy products. They are skilled at building customer loyalty and generating repeat business. Consumers may bypass our service in favor of going straight to retailer websites. This risk is compounded because several of these online retailers, such as Amazon.com and eBay, are also our customers. Competition may limit our growth and increase our costs of doing business. Many of our competitors have significantly longer operating histories, larger and broader customer bases, and greater technical expertise, brand recognition and online commerce experience. Many of our competitors have greater financial resources than we do to invest in marketing and promotional campaigns, attracting consumers and merchants, and hiring and retaining key employees. If we are to remain competitive, we must invest substantial resources in our business with no assurance of any additional revenues. If consumers and merchants forego the use of our service for those of our competitors, our revenues and financial results would suffer. (Loss) income from operations (7,332 ) (60 ) (767 ) 1,025 Interest income 324 118 31 43 (Loss) gain on disposal of fixed assets (322 ) 11 Table of Contents The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted. Subject to Completion. Dated October 25, 2004. 6,871,160 Shares Ordinary Shares Table of Contents Approximately 38% of our revenues in 2003 came from Google, which also competes with us, and a change in this relationship could harm our business. In August 2002, we entered into the first of three agreements with Google to participate in its sponsored links program. Under each of these agreements, we display merchant listings from Google s advertisers on the Featured Resources section of our service, and we generate revenues when consumers click through these listings to the Google advertisers websites. In 2003, we derived approximately 38% of our revenues under these agreements. In the first six months of 2004, we derived approximately 43% of our revenues under these agreements. The agreement under which most of our revenues from Google are derived accounted for 27% of our 2003 revenues and expires in April 2006. Under this agreement, we were guaranteed payments totaling $16.0 million during each of the 12-month periods ended April 30, 2003 and 2004. We have a second agreement with Google relating to our U.K. subsidiary, which expires in April 2005 but can be terminated by either party as of October 31, 2004, and which accounted for 2% of our 2003 revenues. We have a third agreement with Google, originally entered into by Epinions, Inc., that expires in February 2005 and accounted for 9% of our 2003 revenues. We are guaranteed payments of $500,000 per month under this agreement. If these contracts end unexpectedly, fail to be renewed or are renewed on less favorable economic terms, our results of operations will suffer. Google operates a search engine for finding products for sale online, called Froogle, that competes with Shopping.com. Google could decide in the future that it prefers not to do business with us due to the competitive nature of our services. In that event, Google could decide not to renew its current agreements with us when they expire, or it could decide to offer renewal terms that are less favorable to us than the terms of our current agreements with Google. In either case, we could experience a significant decline in our revenues and the value of your investment could decline. The recent resignation of our chief operating officer may make it more difficult for us to run our business and may make our prospects more difficult to predict. On June 30, 2004, Nirav Tolia, who had been our chief operating officer, resigned as a member of our board of directors, executive officer and employee, following an investigation by an independent committee of our board of directors into the accuracy of his representations about his educational background and work history that he made during the course of his employment by us. The investigation commenced after counsel to a group of former Epinions stockholders that has made claims associated with our acquisition of Epinions asserted that Mr. Tolia, the chief executive officer of Epinions at the time we acquired it, had made untrue statements about his background. The absence of Mr. Tolia may make it more difficult to run our business, because he was a key contributor to our strategic and marketing efforts after our April 2003 acquisition of Epinions. His departure may place additional burdens on our executive management resources, as existing personnel will assume his management responsibilities. We may also find it necessary to recruit additional personnel to perform some of his responsibilities. Because Mr. Tolia was highly regarded by many employees and by many contributors of our Epinions reviews, his departure could adversely affect employee morale and the level of activity and loyalty among our review contributors. All of these consequences have the potential to harm our business and financial results. The loss of a significant number of merchants could harm our business by reducing our revenues and by making our service less attractive to users. Although merchants enter into contracts with us when they enroll in our service, they are not required to pay us any minimum amounts, or to list a minimum number of products. Merchants are entitled to a refund of any unused prepaid amounts, which amounted to $1.2 million as of June 30, 2004, and they may terminate their agreements with us at any time. If a large number of our merchants Series F Shares 3,000,000 3,000,000 $ 3,060 $ 6 Series E Shares 4,750,000 3,943,098 40,371 8 Series D Shares 10,200,000 8,940,867 64,591 22 Series C Shares 12,500,000 9,817,935 28,131 25 Series B Shares 4,457,150 4,314,293 3,020 11 Series A Shares 4,738,080 4,738,080 1,490 This is an initial public offering of ordinary shares of Shopping.com Ltd. Shopping.com Ltd. is offering 5,060,084 ordinary shares, and the selling shareholders identified in this prospectus are offering an additional 1,811,076 ordinary shares, to be sold in this offering. These amounts are based on an assumed initial public offering price of $17.00 per share. It is currently estimated that the initial public offering price per share will be between $16.00 and $18.00. Shopping.com will not receive any proceeds from the sale of ordinary shares being sold by the selling shareholders. Prior to this offering, there has been no public market for the ordinary shares. Our ordinary shares have been approved for quotation on the Nasdaq National Market under the symbol SHOP. See Risk Factors beginning on page 9 to read about factors you should consider before buying the ordinary shares. (In thousands) Net (loss) income $ (72,854 ) $ (5,082 ) $ 6,922 $ 3,788 $ 3,852 Interest expense 242 386 32 19 3 Interest and other (income) expense, net (972 ) (38 ) (672 ) (141 ) (188 ) Provision for income taxes 158 25 18 Depreciation and amortization 2,361 2,396 2,310 1,135 1,141 Amortization of goodwill and other purchased intangibles 42,336 500 164 353 Restructuring and other charges 9,517 1,019 617 Stock-based compensation 114 Table of Contents were to cancel or significantly reduce the number of their product listings, the quality of the shopping experience we offer consumers would decline, leading to a reduction in the number of consumers using our service, harming our business and financial results. Spending to develop and maintain the Shopping.com brand is costly and does not assure future revenues. Many competing online shopping services have well-established brands. If we do not build brand recognition and loyalty with consumers and merchants quickly, we may lose the opportunity to build the large base of loyal consumers and merchants that we believe is essential to our success. In September 2003, we launched our new website, www.shopping.com, and we have had only a short time to develop recognition of the Shopping.com brand. During the fourth quarter of 2003, we spent approximately $3.8 million on a television advertising campaign to promote our new brand. We may make significant expenditures for similar promotions in the future, but we have not yet determined the timing or amount of these expenditures. There is no guarantee that this strategy will increase the recognition of our brand. In addition, even if our brand recognition increases, this may not result in increased use of our service or higher revenues. We depend on search engines to attract a substantial portion of the consumers who visit our service, and losing these consumers would adversely affect our revenues and financial results. Many consumers access our service by clicking through on search results displayed by search engines, such as Google and Yahoo! Search engines typically provide two types of search results, algorithmic listings and purchased listings. Algorithmic listings cannot be purchased, and instead are determined and displayed solely by a set of formulas designed by the search engine. Purchased listings can be purchased by advertisers in order to attract users to their websites. We rely on both algorithmic and purchased listings to attract and direct a substantial portion of consumers to our service. Search engines revise their algorithms from time to time in an attempt to optimize their search result listings. When search engines on which we rely for algorithmic listings modify their algorithms, this has, on occasion, resulted in fewer consumers clicking through to our website, requiring us to resort to other costly resources to replace this traffic, which, in turn, reduces our operating and net income or our revenues, which harms our business. If one or more search engines on which we rely for purchased listings modifies or terminates its relationship with us, our expenses could rise, or our revenues could decline and our business may suffer. Recent changes to our pricing model might not succeed in increasing our revenues or might cause our revenues to decrease, which would harm our results of operations. Because Internet commerce is a relatively new and rapidly evolving industry, we have occasionally adjusted, and may in the future adjust, our pricing model in an attempt to maximize our profitability. For example, in April 2004, for many of our product categories, we modified the pricing model for lead referral payments by merchants and the system for prioritizing the display of merchant listings on our service. Under this new model, the first three relevant merchant listings are selected for display solely based on the amount of lead referral fees paid to us. All remaining relevant merchant offers are ordered based on a combination of product price and trustworthiness of store, with the first of these merchant listings designated a Smart Buy. The lead referral fees the merchants are willing to pay us for these remaining merchant listings do not affect the order of presentation on our service. For the first four merchant listings displayed, we charge the lead referral fee that each merchant has indicated it is willing to pay us. For the remaining merchant listings displayed, we charge the minimum category listing fee, without regard to the listing fee the merchants may be willing to pay. Before this change, we prioritized relevant merchant listings in all product categories according to a variety of factors, principally the amount paid to us, and charged each merchant the amount that merchant had (In thousands) Net (loss) income $ (72,854 ) $ (5,082 ) $ 6,922 $ 3,788 $ 3,852 Interest expense 242 386 32 19 3 Interest and other (income) expense, net (972 ) (38 ) (672 ) (141 ) (188 ) Provision for income taxes 158 25 18 Depreciation and amortization 2,361 2,396 2,310 1,135 1,141 Amortization of goodwill and other purchased intangibles 42,336 500 164 353 Restructuring and other charges 9,517 1,019 617 Stock-based compensation 114 Total non-cash stock compensation $ 114 $ Phase I Preference Series F Shares 3,000,000 3,000,000 $ 3,060 $ 6 Series E Shares 3,943,098 3,943,098 40,283 8 Series D Shares 9,167,944 8,940,867 63,963 22 Series C Shares 9,817,935 9,817,935 27,795 25 Series B Shares 4,389,293 4,389,293 3,073 11 Series A Shares 4,738,080 4,738,080 2,331 12 Phase II Preference Series I Shares 10,803,587 10,803,587 11,811 24 Series G Shares 10,972,748 10,972,748 8,126 24 Series H Shares 6,171,510 6,171,510 25,000 Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense. Table of Contents indicated it was willing to pay us for its listing, regardless of the placement of the merchant s listing on our service. We still apply this method to those product categories not affected by the new pricing model. If these changes to our pricing model do not succeed in increasing our revenues or cause our revenues to decrease, and if we are not able to revise our pricing model in time to reverse this trend, our results of operations would be harmed and our stock price could suffer. If members of the Epinions community cease to provide us with reviews or remove their content from our service, the number of consumers using our service and our revenues could decline. Our service contains a significant amount of consumer-generated content, primarily reviews of products, services and merchants. This content is created for us by members of our Epinions community, many of whom receive nominal payments from us for our use of this content. Our user agreement with Epinions members provides that the member retains the intellectual property rights to this content. Epinions members may modify or remove their content from our service at any time, and some have done so in the past. A small number of reviewers have produced a substantial portion of the Epinions content. If a large amount of content were to be removed from our service, it could lower the value of our service to consumers and harm our business. In addition, though we provide tools to allow the community to rate the helpfulness of reviews, we do not approve, edit or modify any consumer-generated content on our service. Epinions members have, in the past, submitted profane or other undesirable content, which could offend our consumers or merchants. If Epinions members cease authoring reviews or if the quality of their reviews deteriorates, the number of consumers using our service could decline, which could result in a decrease in revenues, adversely impacting our results of operations. Our plans for international expansion could fail as a result of risks associated with international operations. Although our service can be accessed around the world, most of our consumers and merchants are located in the United States. International expansion is a key element of our strategy, but we have limited experience developing or customizing our service to conform to currencies, languages, cultures, standards and regulations outside the United States. We have operated a website in the United Kingdom since December 1999. We previously operated websites in Germany and Japan, but discontinued them in 2001 due to a lack of local market acceptance. Expanding our international operations will require management attention and resources, and will engage us in competition with local companies that are better established and more familiar with the preferences of consumers and merchants in those markets than we are. In addition, the risks we will face in expanding our business internationally include: online shopping might not be sufficiently popular with consumers and merchants in different countries; we might be unable to customize our website to conform to local market preferences; costs required to customize our product catalog for different countries might be high; regulatory requirements in different countries might restrict some product offerings; governments might impose taxes, tariffs or other limitations on Internet access or transactions; foreign operations could require significant management attention; foreign currency exchange rates will fluctuate; protection of intellectual property rights may be weaker in some countries; (Unaudited) Computers, software and peripheral equipment $ 5,962 $ 8,569 $ 12,107 Office furniture and equipment 905 895 913 Leasehold improvements 532 524 536 Motor vehicles Per Share Table of Contents technological infrastructures, such as access to broadband, might be less developed in some countries; we might experience longer payment cycles and greater collection problems; and political instability in some countries might disrupt our business. Any of these risks could have a material adverse effect on our international operations and could affect the profitability of those operations or even cause their total failure, resulting in the loss of our investment. In such events, our business, results of operations, financial condition and liquidity would suffer. Our transfer pricing procedures may be challenged, which may subject us to higher taxes or penalties and adversely affect our earnings. Transfer prices are prices that one company in a group of related companies charges to another member of the group for goods, services or use of property. If two or more affiliated companies are located in different countries, the tax laws or regulations of each country generally will require that transfer prices be the same as those between unrelated companies dealing at arms length. We have operated pursuant to oral and, as of May 2004 with respect to some arrangements with our U.S. subsidiary and as of September 2004 with respect to some arrangements with our U.K. subsidiary, written transfer-pricing agreements that establish the transfer prices for transactions between Shopping.com Ltd. and our U.S. and U.K. subsidiaries. However, our transfer pricing procedures are not binding on applicable tax authorities. No official authority in any country has made a determination as to whether or not we are operating in compliance with its transfer pricing laws. If tax authorities in any of these countries were to challenge our transfer prices successfully, they could require us to adjust our transfer prices and thereby reallocate our income to reflect these transfer prices. A reallocation of income from a lower tax jurisdiction to a higher tax jurisdiction would result in a higher tax liability for us. In addition, if the country from which the income is reallocated does not agree with the reallocation, both countries could tax the same income, resulting in double taxation. Changes in laws and regulations may require us to change our transfer prices or operating procedures. If tax authorities were to allocate income to a higher tax jurisdiction, subject our income to double taxation or assess penalties, it would result in a higher tax liability for us, which would adversely affect our earnings and liquidity. Non-Israeli tax authorities may tax some or all of Shopping.com Ltd. s income, which would adversely affect our earnings. Shopping.com Ltd. is incorporated in Israel and conducts business operations within Israel. Its income is subject to Israeli income tax. The majority of Shopping.com Ltd. s management is based in the United States. We have endeavored to structure our business so that all of our U.S. operations are carried out by our U.S. subsidiaries and all of our U.K. operations are carried out by our U.K. subsidiary. Our U.S. subsidiaries are subject to U.S. income tax and our U.K. subsidiary is subject to U.K. income tax. Under tax treaties between Israel and the United States and between Israel and the United Kingdom, Shopping.com Ltd. s business income is not subject to tax in either the United States or the United Kingdom to the extent that it is not attributable to a permanent establishment located in either of these countries. Shopping.com Ltd. has filed its tax returns on the basis that it does not have a permanent establishment for tax purposes in the United States or in the United Kingdom and that it is not engaged in a U.S. business. U.S. tax law does not clearly define activities that constitute being engaged in a U.S. business or a permanent establishment. The Internal Revenue Service could contend that some or all of Shopping.com Ltd. s income should be subject to U.S. income tax (at the regular corporate rates, plus additional branch profits taxes) or subject to U.S. withholding tax. Similarly, tax authorities in other jurisdictions could contend that some or all of Shopping.com Ltd. s Balance at December 31, 2001 31,754,273 78 4,038,715 84,764 10 172,977 (1,201 ) (163,167 ) 8,697 Net loss (5,082 ) (5,082 ) Comprehensive income (loss) Translation differences 15 Total Table of Contents income should be subject to income tax in those other jurisdictions. If Shopping.com Ltd. s income is subject to taxes in jurisdictions outside of Israel, it will adversely affect our net income. The Israeli Approved Enterprise tax benefits for which we qualify require us to meet specific conditions; if we fail to meet these conditions or if the programs are modified or terminated, these tax benefits could be terminated or reduced, which would increase our taxes and lower our net income. To maintain our qualification as an Approved Enterprise under Israeli tax law, we must continue to meet conditions set forth in Israeli law and regulations, including making specified investments in property and equipment and financing a percentage of our investments with share capital. If we fail to comply with these conditions in the future, the benefits we receive could be cancelled or reduced and we could be required to pay increased taxes or refund the amounts of the tax benefits we received, together with interest and penalties. The Israeli government may terminate these programs or modify the conditions for qualifications at any time. The Law for the Encouragement of Capital Investments, 1959, under which the Approved Enterprise program and its benefits are administered, will expire on October 31, 2004, unless it is extended. Accordingly, requests for new programs or expansions of existing programs that are not approved on or before October 31, 2004, will not confer any tax benefits, unless the term of the law is extended. In addition, from time to time, we may submit requests for expansion of our Approved Enterprise programs or for new programs to be designated as Approved Enterprises. These requests might not be approved. The termination or reduction of these tax benefits, or our inability to get approvals for expanded or new programs, could increase our taxes, thereby reducing our profits or increasing our losses. Additionally, as we increase our activities outside of Israel, our increased activities will not be eligible for inclusion in Israeli tax benefit programs. We recorded taxable income in Israel for the first time in 2003, but that income was offset by tax loss carryforwards. Accordingly, we have received no tax benefits to date under the Approved Enterprise tax program. Capacity constraints and system failures or security breaches could prevent access to our service, which could affect our revenues and harm our reputation. Our service goals of performance, reliability and availability require that we have adequate capacity in our computer systems to cope with the volume of visits to our websites. As our operations grow in size and scope, we will need to improve and upgrade our systems and infrastructure to offer consumers and merchants enhanced services, capacity, features and functionality. The expansion of our systems and infrastructure will require us to commit substantial financial, operational and technical resources before the volume of our business increases, with no assurance that our revenues will increase. If our systems cannot be expanded in a timely manner to cope with increased website traffic, we could experience disruptions in service, slower response times, lower consumer and merchant satisfaction, and delays in the introduction of new products and services. Any of these problems could impair our reputation and cause our revenues to decline. Our ability to provide high-quality service depends on the efficient and uninterrupted operation of our computer and communications systems. Our service has experienced system interruptions from time to time and could experience periodic system interruptions in the future. Our systems and operations also are vulnerable to damage or interruption from human error, natural disasters, power loss, telecommunication failures, break-ins, sabotage, computer viruses, design defects, vandalism, denial-of-service attacks and similar events. Some of our facilities are located in the San Francisco Bay area, a major earthquake zone. We do not have full second-site redundancy, a formal disaster recovery plan or alternative providers of hosting services, and outages at our data centers could mean Initial public offering price $ $ Underwriting discount $ $ Proceeds, before expenses, to Shopping.com $ $ Proceeds, before expenses, to the selling shareholders $ $ To the extent that the underwriters sell more than 6,871,160 ordinary shares, the underwriters have the option to purchase up to an additional 1,030,674 shares from us at the initial public offering price less the underwriting discount. Table of Contents the loss of some or all of our website functionality. Our business interruption insurance may not adequately compensate us for losses that may occur. Any system failure that causes an interruption in service or decreases the responsiveness of our service could impair our reputation and cause our revenues to decline. We may not be able to hire and retain the personnel we need to support and expand our business, which could cause our business to shrink, or slow any expansion. Our future success depends on our ability to identify, hire, train, retain and motivate highly-skilled executive, technical, sales, marketing and business development personnel. Our existing key personnel include all of our executive officers and management team. The loss of any member of this team could disrupt our operations until a suitable replacement is found. Competition for highly-skilled personnel is intense in the technology and Internet markets. The process of locating, training and successfully integrating highly-skilled personnel into our operations can be lengthy and expensive. If we fail to attract, integrate and retain highly-skilled personnel, our ability to support, expand and manage our business could suffer. We may be subject to costly litigation arising out of our acquisition of Epinions, Inc., and that litigation could have a material adverse effect on our business, and the trading price of our ordinary shares, if decided adversely. On May 28 and June 7, 2004, we received letters on behalf of a group of former holders of Epinions, Inc. common stock claiming that they were damaged by alleged misrepresentations and failures to disclose material information, as well as breaches of fiduciary duty, in connection with our April 2003 acquisition of Epinions. That acquisition, following a fairness hearing before the California Department of Corporations and approval by substantial majorities of the Epinions preferred and common stockholders, resulted in holders of Epinions preferred stock receiving shares of our preferred stock and the Epinions common stock being cancelled. In addition, some Epinions employees were hired and granted options to purchase our ordinary shares. The letters claim that the holders of Epinions common stock were not properly informed (or were misled) about financial results and projections of Epinions and about the terms and amounts of stock options to be granted to Epinions employees who were hired by Shopping.com. The letters also claim that a group of controlling stockholders and directors of Epinions improperly increased their ownership interest by agreeing to a merger in which the valuation of Epinions was too low. The alleged controlling group referred to in the letters appears to include Nirav Tolia, our former chief operating officer and director, who was the chief executive officer of Epinions at the time of the acquisition, J. William Gurley and John R. Johnston, who are current members of our board of directors, and some or all of the former holders of Epinions preferred stock, some of which are among our significant shareholders. The letters assert that the former common stockholders of Epinions have suffered damages of over $30 million and that such former stockholders are entitled to between approximately 1.8 million and 2.4 million Shopping.com ordinary shares. The letters further state that the former stockholders may seek punitive damages, or to impose a constructive trust on misappropriated property and possibly other remedies, such as rescission and restitution. The former stockholders may hold us responsible for some or all of these claims. These former Epinions stockholders may choose to commence litigation against us, our directors and officers, and some of our shareholders. If that were to happen, the plaintiffs could claim additional damages and seek additional remedies. In any such litigation, the credibility of Mr. Tolia would likely be an issue, and that credibility may be adversely affected by his recent resignation following an investigation by our board of directors into the accuracy of his representations about his educational background and work history. Dealing with any such claims or litigation could be costly and our insurance, if any, may not cover costs and losses we might suffer. In addition, our management could be required to spend a considerable amount of time attending to these claims, whether or not they result in litigation. Any damages for which we may be liable as a result of such litigation, or any (Loss) income from operations (3,182 ) (2,545 ) (518 ) 1,511 564 3,127 943 1,806 2,083 1,602 Income taxes (25 ) (25 ) (108 ) (6 ) (12 ) Interest (expense) income, net (241 ) (57 ) (56 ) 6 (72 ) 194 147 371 168 Assets and liabilities of the subsidiary at the disposal date: Working capital (excluding cash and cash equivalents) $ (416 ) Fixed assets 9 Other assets 204 Lease liabilities (72 ) Capital gain from the sale of the subsidiary 8,997 Minority interest The underwriters expect to deliver the shares against payment in New York, New York on October , 2004. Goldman, Sachs & Co. Credit Suisse First Boston Deutsche Bank Securities Piper Jaffray Table of Contents settlement, which we may enter into in order to resolve the claims, may require us to spend a material amount of funds or issue new securities. If we were to issue any new shares as compensation to the claimants, there would be an immediate dilution in the value of other outstanding ordinary shares, including any shares sold in this offering, and that dilution could be significant. As a result, these claims and any related litigation could have a material adverse effect on our business, results of operations, financial condition and liquidity and upon the value of your investment in us. We may be subject to costly litigation arising out of information presented on or collected in connection with our service, and the litigation could have a material adverse effect on our business if decided adversely. Claims could be made against us under U.S. and foreign law for defamation, libel, invasion of privacy, deceptive or unfair practices, fraud, negligence, copyright or trademark infringement, or other theories based on the nature and content of the materials disseminated through our service or based on our collection and use of information. The law relating to the liability of online companies for information carried on, disseminated through or collected by their services is currently unsettled. Our service includes consumer-generated reviews from our Epinions website, which includes information regarding the quality of goods, and the reliability of merchants that sell those goods. Similar claims could be made against us for that content. We may be required to reduce exposure to liability for information disseminated through our service, which could require substantial expenditures and discontinuation of some service offerings. Any such response could materially increase our expenses or reduce our revenues. Our liability insurance may not be adequate to indemnify us if we become liable for information disseminated through our service. Any costs incurred as a result of such liability that are not covered by insurance could reduce our profitability or cause us to sustain losses, which could have a material adverse effect on our business, results of operations, financial condition and liquidity. We may also be subject to claims or regulatory action arising out of the collection or dissemination of personal, non-public information of users of our service. We may be subject to costly intellectual property litigation that could have a material adverse effect on our business if decided adversely. We could face claims that we have infringed the patent, trademark, copyright or other intellectual property rights of others. From time to time we receive such claims and we are ordinarily involved in litigation over such claims. Intellectual property litigation is often extremely costly, unpredictable and disruptive to business operations. It may not be possible to obtain or maintain insurance covering these risks. Any adverse decision, including an injunction or damage award entered against us, could subject us to significant liabilities, require us to seek to obtain licenses from others, make changes to our brand, prevent us from operating our business, or cause severe disruptions to our operations or the markets in which we compete. Any of these developments could harm our reputation, our business and our results of operations. We may not be able to protect intellectual property rights upon which our business relies, and if we lose intellectual property protection, we may lose valuable assets. Our business depends on our intellectual property, including internally-developed technology and data resources and brand identification by the public, which we attempt to protect through a combination of copyright, trade secret, patent and trademark law and contractual restrictions, such as confidentiality and proprietary rights agreements. We also depend on our trade names and domain names. We have no patents. Applications we have filed for patent and other intellectual property registration may not result in the issuance of patents, registered trademarks, service marks or other intellectual property registrations. In particular, if we are not able to obtain a registered trademark for the name Shopping.com, and as a result are not able to protect our brand, our business could suffer from possible (Unaudited) Company A 19 % 11 % Company B 19 % 11 % 13 % Company C 14 % Company D 11 % Company E Prospectus dated , 2004. Table of Contents confusion among consumers and merchants, among other things. In addition, our use of unregistered trade names and service marks may not protect us from the use of similar marks by third parties. Intellectual property laws vary from country to country, and it may be more difficult to protect and enforce our intellectual property rights in some foreign jurisdictions. We have had experiences with other companies using or planning to use a name similar to ours as part of a company name, domain name, trademark or service mark. In the future, we may need to litigate in the United States or elsewhere to enforce our intellectual property rights or determine the validity and scope of the proprietary rights of others. This litigation would be expensive and would likely divert the attention of our management. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our service, technology and other intellectual property, and we cannot be certain that the steps we have taken will prevent any misappropriation or confusion among consumers and merchants, or unauthorized use of these rights. If we are unable to procure, protect and enforce our intellectual property rights, then we may not realize the full value of these assets, and our business may suffer. We may be unable to protect our Internet domain names, which could decrease the value of our brand. We have the right to use domain names for website destinations that we use in our business. If we are unable to protect our rights in these domain names, our competitors could capitalize on our brand recognition by using these domain names for their own benefit. Domain names similar to Shopping.com have been registered in the United States and elsewhere and in most countries the top- level domain name shopping is owned by other parties. We might not acquire or maintain country- specific versions of the shopping domain name, such as shopping.co.uk in the United Kingdom, shopping.de in Germany or shopping.fr in France. Furthermore, the relationship between regulations governing domain names and laws protecting trademarks and similar proprietary rights is unclear and varies from jurisdiction to jurisdiction. We may be unable to prevent third parties from acquiring domain names that infringe on, or otherwise decrease the value of, our brand, or our trademarks, service marks or other proprietary rights. Protecting and enforcing our intellectual property rights and determining the proprietary rights of others may require litigation, which could result in substantial costs and divert management attention. We may not prevail if litigation is initiated. Exchange rate fluctuations between the U.S. Dollar and the New Israeli Shekel or the British Pound may decrease our earnings. A portion of our revenues and a portion of our costs, including personnel and some marketing, facilities and other expenses, are incurred in New Israeli Shekels and British Pounds. Inflation in Israel or the United Kingdom may have the effect of increasing the U.S. Dollar cost of our operations in that country. If the U.S. Dollar declines in value in relation to one or more of these currencies, it will become more expensive for us to fund our operations in the countries that use those other currencies. From April 2003 to February 2004 the U.S. Dollar to the British Pound, and from February 2003 to July 2003 the U.S. Dollar to the New Israeli Shekel, declined significantly. We do not hedge any of our foreign currency risk. Our acquisitions have been and could be difficult to integrate, disrupt our business, dilute shareholder value and have a material adverse effect on our operating results. We have entered into business combinations with other companies in the past, including our April 2003 acquisition of Epinions, Inc., and we may make additional acquisitions in the future. Acquisitions involve significant risks, including difficulties in the integration of the operations, internal controls, business strategy, services, technologies and corporate culture of the acquired companies, diversion of Table of Contents Table of Contents management s attention from other business concerns, overvaluation of the acquired companies, the rejection of the acquired companies products and services by our customers and the potential impairment of acquired assets. We have experienced many of these risks in connection with the acquisitions that we completed in the past. For example, we realized an impairment of intangible assets of $6.4 million in 2001 relating to the acquisition of Digital Jones, Inc. In addition, future acquisitions would likely result in dilution to existing shareholders, if securities are issued. Additionally, the expenditure of cash or the assumption of debt or contingent liabilities in connection with these acquisitions could have a material adverse effect on our financial condition, results of operations and liquidity. Accordingly, any future acquisitions could result in a material adverse effect on our business. If we cannot adequately manage any future growth, our results of operations will suffer. We have experienced rapid growth in our operations, and our anticipated future growth, if such growth occurs at all, may place a significant strain on our managerial, operational and financial resources. We have made, and may continue to make, inadequate estimates for the costs and risks associated with our expansion, and our systems, procedures and managerial controls may not be adequate to support our operations. Any delay in implementing, or transitioning to, new or enhanced systems, procedures or controls may adversely affect our ability to manage our product listings and record and report financial and management information on a timely and accurate basis. If we are unable to manage any such expansion successfully, our revenues may not grow, our expenses may increase and our results of operations may be adversely affected. Risks Related to Our Industry If Internet usage and infrastructure do not continue to grow rapidly, our business prospects and share price could decline. Our revenues and profits depend on the continued acceptance and use of the Internet and online services as a medium for commerce. The failure of the Internet to continue to develop as a commercial medium could have a material adverse effect on our business and financial results. Consequently, the growth of the market for our service depends upon improvements being made to the entire Internet, as well as to the networking infrastructures of our merchant customers to alleviate overloading and response time delays. We believe that growth in the market for our service also depends upon growth in the utilization of broadband connections. If this growth fails to continue or slows, our financial results and the trading price of our ordinary shares could be adversely affected. Government regulation and legal uncertainties may damage our business. The laws and regulations applicable to the Internet and our service in the countries where we operate are evolving. Governments may adopt new laws and regulations governing the Internet or the conduct of business on the Internet that could increase our costs of doing business or limit the attractiveness of online shopping. In addition, we might be required to comply with existing laws regulating or requiring licenses for certain businesses of our merchants, such as the distribution of alcohol or firearms. These laws and regulations could expose us to substantial compliance costs and liability. In response to these laws and regulations, whether proposed or enacted, as well as public opinion, we may also elect to limit the types of merchants or products we display on our service, which could in turn decrease the desirability of our service and reduce our revenues. The Federal Trade Commission, or FTC, issued guidance in 2002 regarding what disclosures are desirable in order to avoid misleading users about the effect that purchased listings may have on the inclusion or ranking of listings in search results in Internet search engines. This guidance may differ from the existing practices of the industry, including our practices. If the FTC brings enforcement Table of Contents Table of Contents actions against firms not complying with the guidance, and our business practices are covered by and not complaint with the guidelines, we could be subject to litigation by the FTC, as well as State Attorneys General and private litigants, potentially resulting in the payment of significant sums of money for consumer restitution, penalties and fines. Imposition of sales and other taxes may damage our business. Current law does not require merchants to collect sales or other similar taxes with respect to goods sold by them over the Internet in many cases. As a result, consumers are able to buy goods on the Internet without paying sales taxes required by law. Some states may seek to impose sales tax collection obligations on online retailers, or may seek to collect sales tax directly from online consumers. The Internet Tax Freedom Act, which limited the ability of states to impose taxes on access to the Internet, expired on November 1, 2003. A proposal to extend this moratorium has been made, but there can be no assurance that it will be enacted. Failure to extend the moratorium could allow any state to impose taxes on Internet access or online commerce. The imposition of Internet usage taxes or enhanced enforcement of sales tax laws could make online shopping less attractive to consumers, which would have a material adverse effect on our business. Increased security risks to us in particular and online commerce in general may deter future use of our service. Concerns over the security of transactions conducted on the Internet and the privacy of Internet users may inhibit use of the Internet and other online services, including online commerce. Any misappropriation of third-party information collected by an Internet provider, security breach or a change in industry standards, regulations or laws or an adverse judicial determination could deter people from using the Internet to conduct transactions that involve transmitting confidential information such as online commerce, which would harm our business. Our market may undergo rapid technological change and any inability to meet the changing needs of our industry could harm our financial performance. The markets in which we compete are characterized by rapidly changing technology, evolving industry standards, frequent new service announcements, introductions and enhancements, and changing consumer demands. We may not be able to keep up with these rapid changes. As a result, our future success depends on our ability to adapt to rapidly changing technologies, to respond to evolving industry standards and to improve the performance, features and reliability of our service. In addition, the widespread adoption of new Internet, networking or telecommunications technologies or other technological changes may require us to incur substantial expenditures to modify or adapt our service and infrastructure, which could harm our financial performance and liquidity. Risks Related to Our Operations in Israel Because we maintain operations in Israel, political, economic or military instability there could disrupt our operations. We maintain a portion of our research and development facilities and personnel in Israel, and as a result, political, economic and military conditions in Israel affect our operations there. Over the past several decades, a number of armed conflicts have taken place between Israel and its Arab neighbors. Since 2000, hostilities between Israel and the Palestinians have increased in intensity. Continued or increased hostility with Palestinians, military hostilities with other states, or other terrorism could make it more difficult for us to continue our operations in Israel, which could increase our costs and adversely affect our financial results. Table of Contents Table of Contents Israeli courts might not enforce judgments rendered outside of Israel, which may make it difficult to collect on judgments rendered against us. We are incorporated in Israel, and some of our assets are located outside the United States; accordingly, enforcement of judgments obtained in the United States against us, including by our shareholders, may be difficult to obtain within the United States. In addition, some of our directors are not residents of the United States, and service of process and enforcement of judgments obtained in the United States against them also may be difficult to obtain within the United States. We have been informed by our legal counsel that there is doubt as to the enforceability of civil liabilities under U.S. securities laws in original actions instituted in Israel. Our personnel in Israel are required to perform military service, which could disrupt our operations or increase our costs. Many of our employees in Israel are obligated to perform up to 36 days of military reserve duty each year, and are subject to being called for active duty under emergency circumstances. If a military conflict or war arises, these individuals could be required to serve in the military for extended periods of time. Our Israeli operations could be disrupted by the absence of employees due to military service, which could adversely affect our business. Your rights and responsibilities as a shareholder will be governed by Israeli law and differ in some respects from the rights and responsibilities of shareholders under U.S. law. We are incorporated under Israeli law. The rights and responsibilities of holders of our ordinary shares are governed by our articles of association and by Israeli law. These rights and responsibilities differ in some respects from the rights and responsibilities of shareholders in typical U.S. corporations. In particular, a shareholder of an Israeli company has a duty to act in good faith toward the company and other shareholders and to refrain from abusing his power in the company, including, among other things, in voting at the general meeting of shareholders on certain matters. Israeli law provides that these duties are applicable in shareholder votes on, among other things, amendments to a company s articles of association, increases in a company s authorized share capital, mergers and interested party transactions requiring shareholder approval. In addition, a shareholder who knows that it possesses the power to determine the outcome of a shareholder vote or to appoint or prevent the appointment of a director or executive officer in the company has a duty of fairness toward the company. However, Israeli law does not define the substance of this duty of fairness. Because Israeli corporate law has undergone extensive revision in recent years, there is little case law available to assist in understanding the implications of these provisions that govern shareholder behavior. Risks Related to Our Ordinary Shares and This Offering There is no established trading market for our ordinary shares, and the market price of our ordinary shares may be highly volatile or may decline regardless of our operating performance. There has not been a public market for our ordinary shares prior to this offering. A trading market in our ordinary shares may not develop. If you purchase ordinary shares in this offering, you will pay a price that was not established in the public trading markets. The initial public offering price will be determined by negotiations between the underwriters and us. You may not be able to resell your shares at or above the initial public offering price and may suffer a loss of some or all of your investment. The market prices of the securities of Internet companies have been volatile, and have been known to decline rapidly. Broad market and industry conditions and trends may cause fluctuations in (Unaudited) Cash flows from operating activities: Net (loss) income $ (7,330 ) $ 69 $ (725 ) $ 1,068 Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities: Depreciation and amortization 2,036 1,830 469 342 Stock-based compensation 69 Loss (gain) on disposal of fixed assets 322 (11 ) (11 ) Changes in assets and liabilities: Accounts receivable (239 ) (1,331 ) 94 878 Prepaid expenses and other current assets 105 (43 ) (32 ) 4 Accounts payable (526 ) 334 (89 ) 13 Accrued liabilities (677 ) (295 ) (65 ) Table of Contents the market price of our ordinary shares, regardless of our actual operating performance. Additional factors that could cause fluctuation in the price of our ordinary shares include, among other things: actual or anticipated variations in quarterly operating results; changes in financial estimates by us or by any securities analysts who may cover our shares; conditions or trends affecting our merchants or other listings providers; changes in the market valuations of other online commerce companies; announcements by us or our competitors of significant acquisitions, strategic partnerships or divestitures; announcements concerning the commencement, progress or resolution of investigations or regulatory scrutiny of our operations or lawsuits filed or other claims alleged against us; capital commitments; introduction of new products and service offerings by us or our competitors; entry of new competitors into our market; and additions or departures of key personnel. In the past, securities class action litigation has often been brought against companies following periods of volatility in the market prices of their securities. Such litigation could result in significant costs and divert management attention and resources, which could seriously harm our business and operating results. If the ownership of our ordinary shares continues to be highly concentrated, it may prevent you and other shareholders from influencing significant corporate decisions. Our current executive officers, directors and their affiliates will own or control approximately 40% of our outstanding ordinary shares following the completion of this offering at an assumed public offering price of $17.00 per share, the mid-point of the estimated price range shown on the cover of this prospectus. Accordingly, these executive officers, directors and their affiliates, acting as a group, will have substantial influence over the outcome of corporate actions requiring shareholder approval, including the election of directors, any merger, consolidation or sale of all or substantially all of our assets and any other significant corporate transaction. These shareholders may also delay or prevent a change of control of us, even if such a change of control would benefit our other shareholders. Future sales of ordinary shares by our existing shareholders may cause our share price to fall. The market price of our ordinary shares could decline as a result of sales of ordinary shares by our existing shareholders, including by our directors, officers or their affiliates, or the perception that these sales could occur. These sales might also make it more difficult for us to sell equity securities at a time and price that we deem appropriate. The lock-up agreements delivered by shareholders, including our directors and executive officers, provide that Goldman, Sachs & Co., in its sole discretion, may release any of those parties, at any time or from time to time and without notice, from obligations under these agreements, including the obligation not to dispose of ordinary shares for a period of 180 days or 15 days, as applicable, after the date of this prospectus. We may be treated as a passive foreign investment company, which may subject U.S. shareholders to additional taxes. If our passive income, or our assets that produce passive income, exceed levels provided by law for any taxable year, we may be characterized as a passive foreign investment company for U.S. Table of Contents federal income tax purposes. If we are treated as a passive foreign investment company, U.S. holders of our ordinary shares may be subject to additional taxes based on our taxable income and may be taxed at ordinary U.S. federal income tax rates (rather than at capital gains rates) when our ordinary shares are sold. Whether we are treated as a passive foreign investment company depends on questions of fact as to our assets and revenues that can only be determined at the end of each fiscal year. Accordingly, we cannot be certain that we will not be treated as a passive foreign investment company for 2004 or for any subsequent year. We may need to raise additional capital, which we may not be able to obtain on favorable terms, or at all, which could adversely affect your investment in our company, harm our financial and operating results, and cause our share price to decline. We require substantial working capital to fund our business. We cannot be certain that additional financing will be available to us on favorable terms when required, or at all. We have in the past experienced negative cash flow from operations and may experience negative cash flow from operations in the future. We currently anticipate that the net proceeds of this offering, together with our available funds, will be sufficient to meet our anticipated needs for working capital and capital expenditures through at least the next 12 months. However, we may need to raise additional funds prior to the expiration of this period or at a later date. In addition, if we raise additional funds through the issuance of equity, equity-related or convertible debt securities, these securities may have rights, preferences or privileges senior to those of the rights of our ordinary shares and our shareholders may experience additional dilution. Any such developments can adversely affect your investment in our company, harm our financial and operating results, and cause our share price to decline. You will suffer an immediate and substantial dilution in the net tangible book value of the ordinary shares you purchase. On average, prior investors have paid substantially less per share than the price in this offering. The initial public offering price is substantially higher than the pro forma net tangible book value per share of the outstanding ordinary shares immediately after this offering. As a result, based on pro forma net tangible book value and pro forma ordinary shares issued and outstanding as of June 30, 2004, investors purchasing ordinary shares in this offering will incur immediate dilution of $12.93 per share at an assumed public offering price of $17.00 per share, the mid-point of the estimated price range shown on the cover of this prospectus. The exercise of outstanding stock options will result in further dilution to investors. If the initial public offering price of our ordinary shares in this offering is less than $16.00 per share, the conversion ratios of some of our preferred shares will be adjusted according to a formula, increasing the number of ordinary shares into which they convert. As a result, you would suffer additional dilution. The number of ordinary shares to be outstanding after this offering assumes the initial public offering price is $17.00 per share, the mid-point of the estimated price range shown on the cover of this prospectus. If the initial public offering price in this offering is less than $16.00 per share, the conversion ratios of our Series D, Series E, Series G, Series H and Series I preferred shares will be adjusted, each according to a formula. The number of ordinary shares into which each such series of preferred share would convert upon the closing of this offering would increase as the price per share at which we sell ordinary shares in this offering declines below $16.00. For instance, all 62,777,118 outstanding preferred shares would convert upon the closing of this offering into 17,237,967 ordinary shares if the initial public offering price is $15.00 per share, 17,672,697 ordinary shares if the initial public offering price is $14.00 per share and 16,857,911 ordinary shares if the initial public offering price is $16.00 per share or higher. Table of Contents The amendment of the conversion ratios of the Series D and Series E preferred shares after the filing of the registration statement for this offering may give holders of those shares rescission rights under federal or state securities laws, and could expose us to penalties or fines. After the initial filing of the registration statement for this offering, the conversion ratios of our Series D and Series E preferred shares were changed. The largest holder of Series D preferred shares and the principal holder of Series E preferred shares offered to release us from our agreement not to consummate an initial public offering at a price per share below $16.00 without the consent of those two holders, if we agreed to modify the conversion ratios of the Series D and Series E preferred shares to cause the issuance of more ordinary shares to all holders of those series of preferred shares upon their automatic conversion in this offering at prices below $16.00 per share. That amendment was implemented with the approval of our board of directors and shareholders. It is possible that this amendment was a new offer and sale of securities involving a new investment decision by the holders of Series D and Series E preferred shares. If the amendment was an offer and sale of securities and it was not exempt from the registration requirements of federal or state securities laws, then those holders have rights to bring claims against us for rescission or damages. For example, for a period of one year after the violation, a holder of any of the 8,940,867 Series D preferred shares currently outstanding, or any of the 3,943,098 Series E preferred shares currently outstanding, could bring a claim against us for rescission to recover the consideration the holder paid to us in the amendment, with interest, or for damages. Since the amendment did not involve any issuance of securities for cash, it is uncertain how rescission would be valued or damages would be determined. The value of the consideration surrendered by the shareholders in the amendment, and therefore the magnitude of any related claim for rescission or damages, is uncertain. One measure of rescission or damages may be the value of the consideration surrendered by the former holders of the Series D or Series E preferred shares; assuming that value is equivalent to the value of the additional ordinary shares ultimately issued as a result of the amendment, we estimate that value would be up to approximately $4.1 million (based on an assumed initial public offering price of $15.00 per share), or up to approximately $8.2 million (based on an assumed initial public offering price of $14.00 per share), plus interest. We cannot offer any assurance that the extent of our exposure to damages would be limited to these amounts, or calculated according to these assumptions. We would contest any such claim, but any such litigation would be costly to defend and could harm our results of operations, financial condition and liquidity. We may commence a rescission offer to the holders of these shares in connection with our initial public offering if the initial public offering price is below $16.00 per share, but we cannot offer any assurance that doing so will limit any future claims relating to these shares. In addition, we may be subject to penalties or fines relating to these issuances, and such penalties or fines could harm our results of operations, financial condition and liquidity. If we fail to implement changes in our system of internal controls to address reportable conditions, we may not be able to report our financial results accurately or detect fraud. As a result, we could be subject to costly litigation, and current and potential shareholders could lose confidence in our financial reporting, which could harm our business and the trading price of our ordinary shares. Effective internal controls are required for us to provide reliable financial reports and to detect and prevent fraud. We are currently assessing our system of internal controls and potential areas of improvement. We expect that enhancements, modifications and changes to our internal controls will be necessary. We have in the past discovered, and may in the future discover, areas of our internal controls that need improvement. For example, during our 2003 audit, our independent registered public accounting firm brought to our attention a need to limit employee access to our revenue tracking system, to retain certain electronic records, to automate more of our financial processes that are currently performed manually, and to prepare timely reconciliations between our general ledger and certain subledgers. The independent registered public accounting firm identified these items as reportable conditions, which means that they were matters that in the independent registered public Table of Contents accounting firm s judgment could adversely affect our ability to record, process, summarize and report financial data consistent with the assertions of management in the financial statements. We are in the process of implementing changes to address these reportable conditions, but have not yet completed implementing them. As a result, we have not yet fully remedied these reportable conditions. Completing our assessment of internal controls, implementing changes to address the identified reportable conditions and any other changes that are necessary, and maintaining an effective system of internal controls will be expensive and require considerable management attention. However, if we fail to implement and maintain an effective system of internal controls or prevent fraud, we could be subject to costly litigation, investors could lose confidence in our reported financial information and our brand and operating results could be harmed, which could have a negative effect on the trading price of our ordinary shares. We will have broad discretion over the use of the proceeds to us from this offering. We will have broad discretion to use the net proceeds to us from this offering, and you will be relying on the judgment of our board of directors and management regarding the application of these proceeds. Although we expect to use the net proceeds from this offering for general corporate purposes, including working capital, we may also use a portion of the net proceeds for investments or acquisitions. We have not allocated these net proceeds for specific purposes. We have never paid cash dividends on our share capital, and we do not anticipate paying any cash dividends in the foreseeable future. We have never paid cash dividends on any class of our share capital to date and we currently intend to retain any future earnings to fund the development and growth of our business. Furthermore, Israeli law limits the distribution of dividends to the greater of retained earnings or earnings generated over the two most recent fiscal years, provided that we reasonably believe that the dividend will not render us unable to meet our current or foreseeable obligations when due. As of June 30, 2004, our accumulated deficit amounted to $157.5 million. Accordingly, investors must rely on sales of their ordinary shares after price appreciation, which may never occur, as the only way to realize any future gains on their investment. Investors seeking cash dividends should not purchase our ordinary shares. Provisions of our articles of association and Israeli law may prevent or delay an acquisition of Shopping.com, which could depress the price of our shares. Upon the closing of this offering, our articles of association will be amended and restated. Our amended and restated articles of association will contain provisions that could make it more difficult for a third party to acquire control of us, even if that change in control would be beneficial to our shareholders. Specifically, our board of directors will be divided into three classes, each serving staggered three-year terms, there will be advance notice requirements for shareholder proposals and nominations of directors, and approval of mergers will require an absolute majority of the voting power in our company. In addition, provisions of Israeli law may have the effect of delaying, preventing or making more difficult a merger with, or other acquisition of, our company. As a result of these provisions of our articles of association and Israeli law, our ordinary shares may trade at prices below the price that third parties might be willing or able to pay to gain control of us. Table of Contents

parsed_sections/risk_factors/2004/CIK0001108727_ipcs-inc_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ RISK FACTORS You should carefully consider the following risk factors in addition to other information contained in this prospectus before investing in our common stock. Risks Related to Our Business, Strategy and Operations Our substantial leverage could adversely affect our ability to incur additional indebtedness if needed and could negatively affect our ability to service our debt. We are highly leveraged. As of June 30, 2004, after giving effect to the reorganization, our total outstanding debt, including capital lease obligations, would have been approximately $165.4 million. As of that date, such indebtedness represented approximately 63.5% of our total pro forma capitalization. The indenture that governs our 111/2% senior notes due 2012 permits us and our subsidiaries to incur additional indebtedness subject to certain limitations, which could further exacerbate the risks associated with our leverage. If we incur additional indebtedness that ranks equally with the senior notes, the holders of that debt will be entitled to share ratably with the holders of the senior notes, respectively, in any proceeds distributed in connection with any insolvency, liquidation, reorganization, dissolution or other winding-up of us. Our substantial indebtedness could adversely affect our financial health by, among other things: increasing our vulnerability to adverse economic conditions; limiting our ability to obtain any additional financing we may need to operate, develop and expand our business; limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; requiring us to dedicate a substantial portion of any cash flow from our operating activities to service our debt, which reduces the funds available for operations and future business opportunities; and potentially making us more highly leveraged than our competitors, which could decrease our ability to compete in our industry. The ability to make payments on our debt will depend upon our future operating performance, which is subject to general economic and competitive conditions and to financial, business and other factors, many of which we cannot control. If the cash flow from our operating activities is insufficient, we may take actions, such as delaying or reducing capital expenditures, attempting to restructure or refinance our debt, selling assets or operations or seeking additional equity capital. Any or all of these actions may not be sufficient to allow us to service our debt obligations. Further, we may be unable to take any of these actions on satisfactory terms in a timely manner or at all. The indenture that governs the senior notes limits our ability to take several of these actions. Our failure to generate sufficient funds to pay our debts or to successfully undertake any of these actions could, among other things, materially adversely affect the market value of the senior notes and our ability to repay our obligations under such notes. We recently emerged from bankruptcy and we have a history of net losses. We may incur additional losses in the future, and our operating results could fluctuate significantly on a quarterly and annual basis which could negatively affect our stock price. We emerged from bankruptcy on July 20, 2004. We sustained net losses of $21.1 million for the nine months ended June 30, 2004 and $72.9 million for the year ended September 30, 2003. Our earnings were insufficient to cover our fixed charges by $19.6 million for the nine months ended June 30, 2004 and $71.1 million for the year ended September 30, 2003. Our future operating profitability and cash flows from operating activities will depend upon many factors, including, among others, our ability to market Sprint PCS products and services, achieve projected market penetration and manage subscriber turnover rates. If we do not achieve and maintain operating profitability and positive cash flows from operating activities, we may be unable to make interest or principal payments on the senior notes. Our inability to satisfy our obligations may result in our restructuring or bankruptcy, in which case you could lose all or part of your investment. In addition, our future operating results and cash flows will be subject to quarterly and annual fluctuations due to many factors, some of which are outside our control. These factors include increased costs we may incur in connection with the further development, expansion and upgrade of our wireless network and fluctuations in the demands for our services. We may not achieve or sustain profitability. To the extent our quarterly or annual results of operations fluctuate significantly, we will be unable to pay amounts due under the senior notes. Our inability to satisfy our obligations may result in our restructuring or bankruptcy, in which case you could lose all or part of your investment. It is our strategy to accelerate our subscriber growth, which may negatively affect our near term profitability. During the year ended September 30, 2003 and the nine months ended June 30, 2004, we experienced overall declining net subscriber growth compared to periods prior to fiscal year 2003. We limited new subscriber activation volume to ensure adequate liquidity to meet our financial obligations. As a means to conserve cash in fiscal 2003, we closed 15 company-owned retail stores and cancelled 21 agreements with local third-party distributors, thereby reducing our retail presence in a number of our markets. Now that we have completed the reorganization, we intend to accelerate the growth of our subscriber base by expanding our sales distribution channels, particularly the number of local third-party distributors and our company-owned retail stores, and by increasing our sales and marketing activities in order to maximize revenues from our third generation network and advanced product offerings. As we seek to accelerate our subscriber growth, we will incur significant up-front subscriber acquisition expenses, which initially will result in reduced levels of cash flows from operating activities as compared to our most recent prior periods. In addition, to the extent our subscriber growth includes a higher percentage of sub-prime credit subscribers, our churn and bad debt expense may increase, which would impair our ability to maintain and increase our revenues and cause a deterioration in our operating margin. Potential mergers and acquisitions or territory expansions may require us to incur substantial additional debt and integrate new technologies, operations and services, which may be costly, time consuming and negatively affect our operating results. We may evaluate expansion opportunities and, subject to the availability of financing, may strategically expand our territory. In addition, a number of similarly situated PCS Affiliates of Sprint may benefit from combined operations. Accordingly, we expect to continually evaluate opportunities for mergers or the acquisition of businesses that are intended to complement or extend our existing operations. If we acquire additional businesses or territories the market value of our common stock may be adversely effected and we may encounter difficulties that may be costly and time-consuming and slow our growth. For example, we may have to: assume and/or incur substantial additional debt to finance the acquisitions and fund the ongoing operations of the acquired companies; integrate new operations with our existing operations; or divert the attention of our management from other business concerns. Our ability to obtain any additional financing that we may need in order to finance any such acquisitions or fund the ongoing operations of such acquired companies or integrate such new operations could be limited by our substantial existing indebtedness, as well as our recent emergence from bankruptcy which would negatively affect our liquidity. Our financial condition or results of operations will not be comparable to the financial condition or results of operations reflected in our historical financial statements which may negatively affect our share price. As a result of our emergence from bankruptcy, we are operating our business with a new capital structure, and are subject to the fresh-start accounting prescribed by generally accepted accounting principles. As required by fresh-start accounting, assets and liabilities will be recorded at fair value, with the enterprise value being determined in connection with the reorganization. Certain reported assets do not yet give effect to the adjustments that may result from the adoption of fresh-start accounting and, as a result, could change materially. Accordingly, our financial condition and results of operations from and after the effective date of the plan of reorganization will not be comparable to the financial condition or results of operations reflected in our historical consolidated financial statements included elsewhere in this prospectus. In addition, in preparing the unaudited pro forma condensed consolidated financial information included in this prospectus, we have made certain assumptions regarding the application of fresh-start accounting principles to our historical financial information. For example, we have made certain assumptions regarding the reorganization enterprise value and the fair values of identifiable assets and liabilities. When a detailed valuation of our business and all of our identifiable assets and liabilities is completed following the effective date of the plan of reorganization, it is possible that such valuation may result in our final reorganization enterprise value and the final fair value of our identifiable assets and liabilities being different from the amounts used in the preparation of the pro forma consolidated financial statements contained in this prospectus. Therefore, actual amounts of identifiable assets, liabilities and revalued intangibles will differ from the amounts reflected in our pro forma consolidated financial statements. The fair value adjustment to these assets and liabilities may also be amortized to income in different amounts than reflected in the pro forma condensed consolidated financial statements, although this amortization would have no impact on our cash flows. As a result, our consolidated financial statements prepared after we emerge from bankruptcy may be materially different in these respects from those set forth in this prospectus which may negatively affect our share price. The bankruptcy proceeding may adversely affect our ability to engage in transactions. Our past inability to meet our obligations that resulted in our bankruptcy filing, or the perception that we may not be able to meet our obligations following the reorganization, could adversely affect our relationships with third parties, as well as our ability to retain or attract high-quality employees. For example, we may have difficulty entering into leases and other agreements related to our operations because of our bankruptcy filing which may negatively affect our operating results. If we receive lower revenues or incur more fees than we anticipate for PCS roaming from Sprint PCS, our results of operations may be negatively affected. We are paid a fee from Sprint PCS or a PCS Affiliate of Sprint for every minute and kilobyte that Sprint PCS or that affiliate's subscribers use the Sprint PCS network in our territory. Similarly, we pay a fee to Sprint or another PCS Affiliate of Sprint for every minute and kilobyte that our subscribers use the Sprint PCS network outside our territory. The per-minute and per-kilobyte rates that we receive from Sprint PCS and that we pay to Sprint PCS or another PCS Affiliate of Sprint are the same and are fixed until the end of December 2006. Thereafter, the rate will change, based on an agreed-upon formula that may have an adverse effect on us. In addition, Sprint PCS subscribers based The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted. Subject to Completion, dated November 23, 2004 PROSPECTUS iPCS, INC. 5,007,237 Shares of Common Stock in our territory may spend more time outside our territory than we anticipate, and wireless subscribers from outside our territory may spend less time in our territory or may use our services less than we anticipate. Our ratio of inbound to outbound roaming with Sprint PCS was approximately 1.3 to 1 for the nine months ended June 30, 2004. We expect this ratio to decline over time as our subscriber base continues to grow, resulting in us receiving less Sprint PCS roaming revenue and/or having to pay more in Sprint PCS roaming fees than we collect in Sprint PCS roaming revenue which will negatively affect our operating results. Roaming revenue from subscribers of wireless communications providers other than Sprint PCS and PCS Affiliates of Sprint may decline in the future which may negatively affect our operating results. We derive a significant amount of roaming revenue from wireless communications providers other than Sprint PCS and PCS Affiliates of Sprint for permitting their subscribers to roam on our network when they are in our territory. For fiscal year 2003 and the nine months ended June 30, 2004, approximately 19% and 14%, respectively, of our roaming revenue was attributable to revenue derived from these other wireless communications providers. We do not have agreements directly with these providers. Instead, we rely on roaming arrangements that Sprint PCS has negotiated. Sprint PCS may negotiate roaming arrangements with other wireless communications providers at rates that are lower than current rates, resulting in a decrease in our roaming revenue. If the rates offered by Sprint PCS are not attractive, these other wireless communications providers may decide to build out their own networks in our territory and compete with us directly or enter into roaming arrangements with our competitors who also already have networks in our territory, resulting in a decrease in our roaming revenue. Roaming revenue from subscribers of wireless communications providers other than Sprint PCS and PCS Affiliates of Sprint may also decline as a result of decreased roaming traffic in our territory if our quality of service does not continue to meet designated technical and quality standards or if we are unable to control fraudulent use. Our roaming arrangements may not be competitive with other wireless communications providers, which may restrict our ability to attract and retain subscribers which may negatively affect our operating results. We do not have agreements directly with other wireless service providers for roaming coverage outside our territory. Instead, we rely on roaming arrangements that Sprint PCS has negotiated with other wireless communications providers for coverage in these areas. Some risks related to these arrangements are as follows: the arrangements may not benefit us in the same manner that they benefit Sprint PCS; the quality of the service provided by another provider during a roaming call may not approximate the quality of the service provided by Sprint PCS; the price of a roaming call may not be competitive with prices charged by other wireless companies for roaming calls; customers must end a call in progress and initiate a new call when leaving the Sprint PCS network and entering another wireless network; Sprint PCS subscribers may not be able to use advanced PCS features from Sprint PCS, such as PCS Vision, while roaming; Sprint PCS or the carriers providing the service may not be able to provide us with accurate billing information on a timely basis; and if Sprint PCS subscribers do not have a similar wireless experience as when they are on the PCS network of Sprint PCS, we may lose current subscribers and Sprint PCS products and services may be less attractive to potential new subscribers. This prospectus relates to the offer and sale from time to time by each of the selling stockholders identified in this prospectus of up to 5,007,237 shares of our common stock. These selling stockholders obtained their shares of common stock as part of our recent reorganization. We will not receive any of the proceeds from the sale of our shares being sold by the selling stockholders. Our common stock is quoted on the National Quotation Bureau's Pink Sheets under the ticker symbol "IPCX". On November 22, 2004, the last reported sale price of one share of our common stock was $25.75. If we are unable to attract and retain customers for any reason, our ability to maintain and increase revenues will be impaired and our operating margin will deteriorate. Unauthorized use of, or interference with, the Sprint PCS network in our territory could disrupt our service and increase our costs. We may incur costs associated with the unauthorized use of the Sprint PCS network in our territory, including administrative and capital costs associated with detecting, monitoring and reducing the incidence of fraud. Fraudulent use of the Sprint PCS network in our territory may impact interconnection costs, capacity costs, administrative costs, fraud prevention costs and payments to other carriers for fraudulent roaming. As these costs increase, our operating performance may decline which could adversely affect our ability to make payments on our debt and operate our business. If we lose the right to install our equipment on wireless towers or are unable to renew expiring leases for wireless towers on favorable terms or at all, our business and results of operations could be adversely impacted. Approximately 86% of our base stations are installed on leased tower facilities that may be shared with one or more other wireless communications providers. We expect this percentage to increase to nearly 100% if we are successful in selling our remaining currently owned towers for which we have entered into a sale agreement. In addition, a large portion of these leased tower sites are owned by a few tower companies. If a master agreement with one of these tower companies were to terminate, or if one of these tower companies were unable to support the use of its tower sites by us, we would have to find new sites or may be required to rebuild the affected portion of our network. In addition, the concentration of our tower leases with a limited number of tower companies could adversely affect our results of operations and financial condition if any of our operating subsidiaries is unable to renew its expiring leases with these tower companies either on favorable terms or at all. If any of the tower leasing companies that we do business with should experience severe financial difficulties, or file for bankruptcy protection, our ability to use our towers could be adversely affected. That, in turn, would adversely affect our revenues and financial condition if a material number of towers were involved. The technology that we use may become obsolete, which would limit our ability to compete effectively within the wireless telecommunications industry which would negatively affect our operating results and share price. The wireless telecommunications industry is experiencing significant technological change. We employ CDMA (a digital spread-spectrum wireless technology that allows a large number of users to access a single frequency band by assigning a code to all transmission bits, sending a scrambled transmission of the encoded information over the air and reassembling the speech and data into its original format), the digital wireless communications technology selected by Sprint PCS and certain other carriers for their nationwide networks. Other carriers employ other technologies, such as TDMA (time division multiple access, a technology used in digital cellular telephone communication that divides each cellular channel into three time slots in order to increase the amount of data that can be carried), GSM (global system for mobile communication, a technology that digitizes and compresses data, then sends it down a channel with two other streams of user data, each in its own time slot) and iDEN (integrated digital enhanced network, a technology containing the capabilities of a digital cellular telephone, two-way radio, alphanumeric pager, and data/fax modem in a single network), for their nationwide networks. If another technology becomes the preferred industry standard, we would be at a competitive disadvantage and competitive pressures may require Sprint PCS to change its digital technology, which in turn could require us to make changes to our network at substantial cost. We may be unable to respond to these pressures and implement new technology on a timely basis or at an acceptable cost. Additionally, our substantial indebtedness, coupled with our recent emergence from bankruptcy, could limit our ability to obtain any additional financing that we may need in order to Investing in our common stock involves a high degree of risk. See "Risk Factors" beginning on page 9 to read about factors you should consider before buying the shares of common stock. Neither the SEC nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful and complete. Any representation to the contrary is a criminal offense. The date of this prospectus is November , 2004. make changes to our network, which may require us to dedicate a substantial portion of any cash flow from our operating activities to make such changes, thereby reducing funds available for future marketing activities and debt repayment. We may also lose subscribers if we fail to implement significant technological changes evidenced by the development and commercial acceptance of advanced wireless data services, shorter development cycles for new products and enhancements and changes in end-user requirements and preferences. If we lose subscribers, our ability to maintain and increase revenues will be impaired and our operating margin will deteriorate. Additionally, we may be required to make additional capital expenditures to upgrade base stations on certain towers in our Michigan markets as a result of the expected obsolescence of the Lucent Technologies mini-cell technology we employ on the towers. The loss of the officers and skilled employees upon whom we depend to operate our business could adversely affect our operating results and share price. Our business is managed by a small number of executive officers on whom we depend to operate our business. We believe that our future success will depend in part on our continued ability to retain these executive officers and to attract and retain other highly qualified technical and management personnel. Notwithstanding our employment agreements with certain of our executives, we may not be successful in retaining key personnel or in attracting and retaining other highly qualified technical and management personnel. Moreover, our past inability to meet our obligations that resulted in our bankruptcy filing, or the perception that we may not be able to meet our obligations following the reorganization, could adversely affect our ability to retain or attract high-quality personnel. The loss of the officers and skilled employees upon whom we depend to operate our business could adversely affect operating results and share price. Risks Related to Our Relationship with Sprint PCS Our ability to conduct our business would be severely restricted if Sprint PCS terminates our affiliation agreements and our share price would be negatively affected. Our relationship with Sprint PCS is governed by our affiliation agreements with it. As we do not own any licenses to operate a wireless network, our business depends on the continued effectiveness of these affiliation agreements. Sprint PCS may be able to terminate our affiliation agreements with it if we materially breach the terms of the agreements. These terms include operational and network requirements that are extremely technical and detailed and apply to each retail store, cell site and switch site. Many of these operational and network requirements can be changed by Sprint PCS, in certain cases, with little notice. As a result, we may not always be in compliance with all requirements of our affiliation agreements with Sprint PCS. Sprint PCS conducts periodic audits of compliance with various aspects of its program guidelines and identifies issues it believes need to be addressed. We may need to incur substantial costs to remedy any noncompliance. The fact that we are not in compliance with our affiliation agreements could limit our ability to obtain any additional financing that we may need in order to remedy such noncompliance. Additionally, our substantial indebtedness and our recent emergence from bankruptcy could further limit our ability to obtain additional financing. If we cannot obtain additional financing, we may be unable to remedy such noncompliance, thereby resulting in a material breach of our affiliation agreements which could lead to their termination by Sprint. If Sprint PCS terminates or fails to renew our affiliation agreements or fails to perform its obligations under those agreements, our ability to conduct business would be severely restricted and our share price would be negatively affected. TABLE OF CONTENTS PAGE If we materially breach our affiliation agreements with Sprint PCS, Sprint PCS may have the right to purchase our operating assets at a discount to market value. Our affiliation agreements with Sprint PCS require that we provide network coverage to a minimum network coverage area within specified time frames and that we meet and maintain Sprint PCS' technical and customer service requirements. A failure by us to meet Sprint PCS' technical or customer service requirements contained in the affiliation agreements, among other things, would constitute a material breach of the agreements, which could lead to their termination by Sprint PCS. We may amend our affiliation agreements with Sprint PCS in the future to expand our network coverage. Our affiliation agreements with Sprint PCS provide that upon the occurrence of an event of termination caused by our breach of such agreements, Sprint PCS has the right to, among other things, purchase our operating assets without stockholder approval and for a price equal to 72% of our "entire business value," which is our appraised value determined using certain principles set forth in our affiliation agreements with Sprint PCS and based on the price a willing buyer would pay a willing seller for our entire business as a going concern. See "Business Our Affiliation Agreements with Sprint PCS" for a description of how we calculate our entire business value. Sprint PCS may make decisions that could increase our expenses and/or our capital expenditure requirements, reduce our revenues or make our affiliate relationships with Sprint PCS less advantageous than expected. Under our affiliation agreements with Sprint PCS, Sprint PCS has a substantial amount of control over factors that significantly affect the conduct of our business. Accordingly, subject to newly established limits set forth in the amendments to our affiliation agreements with Sprint PCS, Sprint PCS may make decisions that adversely affect our business, such as the following: Sprint PCS prices its national calling plans based on its own objectives and could set price levels or change other characteristics of its plans in a way that may not be economically advantageous for our business; and Sprint PCS may alter its network and technical requirements or request that we build out additional areas within our territory, which could result in increased equipment and build-out costs or in Sprint PCS building out that area itself or assigning it to another PCS Affiliate of Sprint. Certain provisions of our affiliation agreements with Sprint PCS may diminish our value and restrict the sale of our business which may negatively affect our share price. Under specific circumstances and without stockholder approval, Sprint PCS may purchase our operating assets or capital stock at a discount. In addition, Sprint PCS has the right to withhold its consent to any transaction in which the "ultimate parent" of iPCS Wireless, Inc., our operating subsidiary that is the party to the affiliation agreements with Sprint PCS, changes. We must obtain the consent of Sprint PCS prior to any assignment by us of our affiliation agreements with it. Sprint PCS also has a right of first refusal if we decide to sell our operating assets to a third party. We are also subject to a number of restrictions on the transfer of our business, including a prohibition on the sale of our operating assets to competitors of Sprint. These restrictions and the other restrictions contained in our affiliation agreements with Sprint PCS restrict our ability to sell our business, may reduce the value a buyer would be willing to pay for our business, and may reduce our "entire business value," which is our appraised value determined using principles set forth in our affiliation agreements with Sprint PCS and based on the price a willing buyer would pay a willing seller for our entire business as a going concern. Problems with Sprint PCS' internal support systems could lead to customer dissatisfaction or increase our costs. We rely on Sprint PCS' internal support systems, including customer care, billing and back office support. Sprint PCS has entered into business process outsourcing agreements with third parties to provide these services. Sprint PCS may not be able to successfully add system capacity, its internal support systems may not be adequate and the third parties that Sprint PCS has contracted with may not perform their obligations. Problems with Sprint PCS' internal support systems could cause: delays or problems in our operations or services; delays or difficulty in gaining access to subscriber and financial information; a loss of subscribers; and an increase in the costs of customer care, billing and back-office services. Should Sprint PCS fail to deliver timely and accurate information, this may lead to adverse short-term decisions and inaccurate assumptions in our business plan. It could also adversely affect our cash flows, because Sprint PCS collects our receivables and remits to us a net amount that is based on the financial information it produces for us. Our costs for internal support systems may increase if Sprint PCS terminates all or part of our service agreements with it. The costs for the services provided by Sprint PCS under our affiliation agreements with Sprint PCS relative to billing, customer care and other back-office functions for the nine months ended June 30, 2004 were approximately $12.9 million and for the year ended September 30, 2003 were approximately $18.9 million. Because we incur the majority of these costs on a per-subscriber basis, which is fixed until the end of December 2006 and after which will be adjusted by Sprint PCS based on a formula related to Sprint PCS' costs to provide the services, we expect the aggregate cost for such services to increase as the number of our subscribers increases after December 2006. Sprint PCS may terminate any service provided under such agreements upon nine months' prior written notice, but if we desire to continue receiving such service, Sprint PCS has agreed that it will assist us in developing that function internally or locating a third party vendor that will provide that service. Although Sprint PCS has agreed in such an event to reimburse us for expenses we incur in transitioning to any service internally or to a third party, if Sprint PCS terminates a service for which we have not developed or are unable to develop a cost-effective alternative, our operating costs may increase beyond our expectations and our operations may be interrupted or restricted. We do not currently have a contingency plan if Sprint PCS terminates a service we currently receive from it. If Sprint PCS does not maintain control over its licensed spectrum, our affiliation agreements with Sprint PCS may be terminated which will negatively affect our operating results. Sprint PCS, not us, owns the licenses necessary to provide wireless services in our territory. The FCC requires that licensees like Sprint PCS maintain control of their licensed systems and not delegate control to third party operators or managers without the FCC's consent. Our affiliation agreements with Sprint PCS reflect an arrangement that the parties believe meets the FCC requirements for licensee control of licensed spectrum. However, if the FCC were to determine that any of our affiliation agreements with Sprint PCS need to be modified to increase the level of licensee control, we have agreed with Sprint PCS to use our best efforts to modify the agreements to comply with applicable law. If we cannot agree with Sprint PCS to modify the agreements, those agreements may be terminated. If the agreements are terminated, we would no longer be a part of the PCS network of Sprint PCS and we would not be able to conduct our business. The FCC may fail to renew the Sprint PCS wireless licenses under certain circumstances, which would prevent us from providing wireless services. Sprint PCS' wireless licenses are subject to renewal and revocation by the FCC. The Sprint PCS wireless licenses in our territory will expire in 2005 and 2007, but may be renewed for additional ten-year terms. The FCC has adopted specific standards that apply to wireless personal communications services license renewals. Any failure by Sprint PCS or us to comply with these standards could result in the non-renewal of the Sprint PCS licenses for our territory. Additionally, if Sprint PCS does not demonstrate to the FCC that Sprint PCS has met the construction requirements for each of its wireless personal communications services licenses, it can lose those licenses. If Sprint PCS loses its licenses in our territory for any of these reasons, we and our subsidiaries would not be able to provide wireless services without obtaining rights to other licenses. If Sprint PCS loses its licenses in another territory, Sprint PCS or the applicable PCS Affiliate of Sprint would not be able to provide wireless services without obtaining rights to other licenses and our ability to offer nationwide calling plans would be diminished and potentially more costly. We rely on Sprint PCS for a substantial amount of our financial information. If that information is not accurate, our ability to accurately report our financial data could be adversely affected, and the investment community could lose confidence in us. Under our affiliation agreements, Sprint performs our billing, customer care and collections, PCS network systems support, inventory logistics, long distance transport and national third party sales support. The data provided by Sprint related to these functions they perform for us is the primary source for our service revenue and for a significant portion of our cost of service and roaming, and selling and marketing expenses included in our statement of operations. We use this data to record our financial results and prepare our financial statements. If Sprint fails to deliver timely and accurate information, this may lead us to make adverse decisions and inaccurate assumptions for future business plans and could also negatively affect our cash flows as Sprint collects our receivables and remits a net amount to us that is based on the financial information it provides. In addition, delays and inaccuracies which are material could adversely affect the effectiveness of our disclosure controls and procedures and if we later identify material errors in that data provided to us, we may be required to restate our financial statements. If that occurs as to us or any other PCS Affiliate of Sprint, investors and securities analysts may lose confidence in us. If Sprint PCS does not succeed, our business may not succeed. In the event of a business combination involving Sprint, we could be adversely affected as a PCS Affiliate of Sprint in various ways that would be beyond our control. In particular, if a business combination is completed involving Sprint, we may incur significant costs associated with minimizing any customer confusion in the event the Sprint and Sprint PCS brand names are not retained by the successor entity. Any diminution in brand recognition or loyalty could cause a decrease in our revenues. If Sprint has a significant disruption to its business plan or network, fails to operate its business in an efficient manner or suffers a weakening of its brand name, our operations and profitability would likely be negatively impacted. If Sprint should have significant financial problems, including bankruptcy, our business would suffer material adverse consequences, which could include termination or revision of our affiliation agreements with Sprint PCS. If other PCS Affiliates of Sprint have financial difficulties, the PCS network of Sprint PCS could be disrupted which may negatively affect our operating results. The PCS network of Sprint PCS is a combination of networks. The large metropolitan areas are operated by Sprint, and the areas in between them are operated by PCS Affiliates of Sprint, all of which are independent companies like us. We believe that most, if not all, of these companies have incurred substantial debt to pay the large cost of building out their networks. If other PCS Affiliates of Sprint experience financial difficulties, the PCS network of Sprint could be disrupted in the territories of those PCS Affiliates of Sprint. Material disruptions in the PCS network of Sprint PCS could have a material adverse effect on our ability to attract and retain subscribers. If the affiliation agreements of those PCS Affiliates of Sprint are like ours, Sprint PCS would have the right to step in and operate the affected territory. However, this right could be delayed or hindered by legal proceedings, including any bankruptcy proceeding related to the affected PCS Affiliate of Sprint. In addition to us, another PCS Affiliate of Sprint has declared bankruptcy, alleging that Sprint violated its agreements with the PCS Affiliate, and others have experienced financial difficulties which have led to the reorganization of their debt obligations. We may have difficulty in obtaining an adequate supply of certain handsets from Sprint PCS, which could adversely affect our results of operations. We depend on our relationship with Sprint PCS to obtain handsets and other wireless devices. Sprint PCS orders handsets and other wireless devices from various manufacturers. We could have difficulty obtaining specific types of handsets in a timely manner if: Sprint PCS does not adequately project the need for handsets for itself, its PCS Affiliates and its other third-party distribution channels, particularly in transition to new technologies, such as 3G technology; Sprint PCS gives preference to other distribution channels, which has occurred in the past, most recently in 2000; we do not adequately project our need for handsets or other wireless devices; Sprint PCS modifies its handset logistics and delivery plan in a manner that restricts or delays our access to handsets; or there is an adverse development in the relationship between Sprint PCS and its suppliers or vendors. The occurrence of any of the foregoing could disrupt our customer service and/or result in a decrease in our subscribers. If we lose subscribers, our ability to maintain and increase revenues will be impaired and our operating margin will deteriorate. Risks Related to the Wireless Telecommunications Industry We may experience a high rate of subscriber turnover, which would adversely affect our financial performance. Significant competition in our industry and general economic conditions may cause our future churn rate to be higher than our historical rate. Factors that may contribute to higher churn include: inability or unwillingness of subscribers to pay, resulting in involuntary deactivations, which accounted for over 36% of our subscriber deactivations in the nine months ended June 30, 2004; subscriber mix and credit class, particularly sub-prime credit subscribers, which accounted for over 37% of our gross subscriber additions for the nine months ended June 30, 2004 and for approximately 24% of our subscriber base as of June 30, 2004; attractiveness of our competitors' products, services and pricing; network performance and coverage relative to our competitors; customer service; any increased prices for services in the future; and kilobytes of use for limited time periods. We offer these promotional campaigns to potential subscribers in our territory. Sales force with local presence. We have established local sales forces to execute our marketing strategy through our company-owned retail stores, local distributors, direct business-to-business contacts and other channels. Sales and Distribution Our sales and distribution plan is designed to mirror Sprint's multiple channel sales and distribution plan and to enhance it through the development of local distribution channels. Key elements of our sales and distribution plan consist of the following: Sprint PCS retail stores. As of June 30, 2004, we operated twelve Sprint PCS stores at various locations within our territory. These stores provide us with a local presence and visibility in certain markets within our territory. Following the Sprint PCS model, these stores are designed to facilitate retail sales, subscriber activation, bill collection and customer service. In addition to retail stores that we operate, we began in 2003 to enter into agreements with exclusive agents which operate Sprint PCS stores in our territory to further expand our distribution channels. These "branded stores" function similarly to our company-owned stores but are operated by a third party. This third party purchases equipment from us, resells it to the consumer and receives compensation from us in the form of commission. As of June 30, 2004, we had six of these branded stores and kiosks operating in our territory. In calendar year 2004, we plan to add four company-owned Sprint PCS retail stores and to re-emphasize obtaining new subscribers from our retail stores and local third party distributors in our territory. National third party retail stores. Sprint PCS has national distribution agreements with various national retailers such as RadioShack and Best Buy for such retailers to sell Sprint PCS products. These national agreements cover retailers' stores in our territory, and as of June 30, 2004, these retailers had approximately 208 locations in our territory. Local third party distributors. We contract directly with local third party distributors in our territory. These retailers are typically local businesses that have a presence in our markets. Local third party distributors purchase handsets and other PCS retail equipment from us and market Sprint PCS services on our behalf. We are responsible for managing this distribution channel and as of June 30, 2004, these local third party distributors had approximately 125 locations within our licensed territory. We compensate local third party distributors through commissions for subscriber activations. Electronic commerce. Sprint PCS maintains an Internet site, www.sprintpcs.com, which contains information on Sprint PCS products and services. A visitor to the Sprint PCS Internet site can order and pay for a handset and select a rate plan. Sprint PCS wireless subscribers visiting the site can review the status of their account, including the number of minutes used in the current billing cycle. We recognize the revenues generated by wireless subscribers in our territory who purchase Sprint PCS products and services over the Sprint PCS Internet site. Distribution mix. During the nine months ended June 30, 2004, the approximate percentage of our new subscribers that originated from each of our distribution channels is as follows: Sprint retail stores 30 % National third party retail stores 32 Local third party distributors 20 Other any future changes by us in the products and services we offer or in the terms under which we offer our products or services, especially to sub-prime credit subscribers. An additional factor that may contribute to a higher churn rate is the FCC's wireless local number portability ("WLNP") requirement. The FCC regulations relating to WLNP enable wireless subscribers to keep their telephone numbers when switching to another carrier. As of May 24, 2004, all covered Commercial Mobile Radio Service ("CMRS") providers, including broadband PCS, cellular and certain specialized mobile radio ("SMR") licensees, must allow customers to retain, subject to certain geographic limitations, their existing telephone number when switching from one telecommunications carrier to another. We anticipate that the WLNP mandate will impose increased operating costs on all CMRS providers, including us, and may result in higher churn rates and subscriber acquisition and retention costs. To date, WLNP has had a slight negative impact on our operations but the ultimate impact is uncertain. A high rate of subscriber turnover could adversely affect our competitive position, liquidity, financial position, results of operations and our costs of, or losses incurred in, obtaining new subscribers, especially because we subsidize most of the costs of initial purchases of handsets by subscribers. Regulation by government agencies and taxing authorities may increase our costs of providing service or require us to change our services. Our operations and those of Sprint PCS are subject to varying degrees of regulation by the FCC, the Federal Trade Commission, the Federal Aviation Administration, the Environmental Protection Agency, the Occupational Safety and Health Administration, and state and local regulatory agencies and legislative bodies. Adverse decisions or regulations of these regulatory bodies could negatively impact our operations and those of Sprint PCS thereby increasing our costs of doing business. For example, changes in tax laws or the interpretation of existing tax laws by state and local authorities could subject us to increased income, sales, gross receipts or other tax costs or require us to alter the structure of our current relationship with Sprint PCS. Concerns over health risks and safety posed by the use of wireless handsets may reduce consumer demand for our services. Media reports have suggested that radio frequency emissions from wireless handsets may: be linked to various health problems resulting from continued or excessive use, including cancer; interfere with various electronic medical devices, including hearing aids and pacemakers; and cause explosions if used while fueling an automobile. Widespread concerns over radio frequency emissions may expose us to potential litigation, discourage the use of wireless handsets or result in additional regulation imposing restrictions or increasing requirements on the location and operation of cell sites or the use or design of wireless handsets. Any resulting decrease in demand for these services or increase in the cost of complying with additional regulations could impair our ability to profitably operate our business. Such concerns may result in the loss of subscribers, which may impair our ability to maintain and increase revenues and lower our operating margin. In addition, we may need to dedicate a larger portion of any cash flow from our operating activities to comply with such additional regulations. Due to safety concerns, some state and local legislatures have passed or are considering legislation restricting the use of wireless telephones while driving automobiles. Concerns over safety risks and the effect of future legislation, if adopted in the areas we serve, could limit our ability to market and sell our wireless services. In addition, it may discourage use of our wireless devices and decrease our revenues from subscribers who now use their wireless telephones while driving. Further, litigation relating to accidents, deaths or serious bodily injuries allegedly incurred as a result of wireless telephone use while driving could result in damage awards, adverse publicity and further governmental regulation. Significant competition in the wireless telecommunications industry may result in our competitors offering new services or lower prices, which could prevent us from operating profitably and may cause prices for our services to continue to decline in the future. Competition in the wireless telecommunications industry is intense. Competition has caused, and we anticipate that competition will continue to cause, the market prices for two-way wireless products and services to decline. Our ability to compete will depend, in part, on our ability to anticipate and respond to various competitive factors affecting the wireless telecommunications industry. While we try to maintain and increase our ARPU, we cannot assure you that we will be able to do so. If prices for our services continue to decline, it could adversely affect our ability to increase revenue, which would have a material adverse effect on our financial condition, our results of operations and our ability to repay the senior notes. In addition, the viability of our business depends upon, among other things, our ability to compete with other wireless providers on reliability, quality of service, availability of voice and data features and customer care. In addition, the pricing of our services may be affected by competition, including the entry of new service providers into our markets. Furthermore, there has been a recent trend in the wireless telecommunications industry toward consolidation of wireless service providers, which we expect to lead to larger competitors over time. Our dependence on Sprint PCS to develop competitive products and services and the requirement that we obtain Sprint PCS' consent to sell non-Sprint approved equipment may limit our ability to keep pace with our competitors on the introduction of new products, services and equipment. Some of our competitors are larger than us, possess greater resources and more extensive coverage areas, and may market other services, such as landline telephone service, cable television and Internet access, along with their wireless communications services. In addition, we may be at a competitive disadvantage because we may be more highly leveraged than some of our competitors. We also face competition from paging, dispatch and conventional mobile radio operations, enhanced specialized mobile radio ("ESMR") and mobile satellite services. In addition, future FCC regulation or Congressional legislation may create additional spectrum allocations that would have the effect of adding new entrants (and thus additional competitors) into the mobile telecommunications market. Market saturation could limit or decrease our rate of new subscriber additions and increase costs to keep our current subscribers. Intense competition in the wireless telecommunications industry could cause prices for wireless products and services to continue to decline. If prices drop, our rate of net subscriber additions will take on greater significance in improving our financial condition and results of operations. However, as our and our competitors' penetration rates in our markets increase over time, our rate of adding net subscribers could decrease further. In addition, we may incur additional costs through equipment upgrades and other retention costs to keep our current subscribers from switching to our competitors. If this decrease were to happen, it could materially adversely affect our liquidity, financial condition and results of operations. Alternative technologies and current uncertainties in the wireless market may reduce demand for PCS products and services. The wireless telecommunications industry is experiencing significant and rapid technological change, as evidenced by the increasing pace of digital upgrades in existing analog wireless systems, evolving industry standards, ongoing improvements in the capacity and quality of digital technology, shorter development cycles for new products and enhancements and changes in end-user requirements and preferences. Technological advances and industry changes could cause the technology used in our network to become obsolete. We rely on Sprint PCS for research and development efforts with respect to Sprint PCS products and services and with respect to the technology used on our network. Sprint PCS may not be able to respond to such changes and implement new technology on a timely basis, or at an acceptable cost. If Sprint PCS is unable to keep pace with these technological changes or other changes in the wireless communications market, the technology used on our network or our business strategy may become obsolete. In addition, other carriers are in the process of completing, or have completed, upgrades to 1xRTT or other 3G technologies. 1xRTT is the name for the first phase in CDMA's evolution to 3G technology. 3G technology provides high-speed, always-on Internet connectivity and high-quality video and audio. We have upgraded our network to CDMA 1xRTT, and as of June 30, 2004, are offering PCS Vision services, in markets representing approximately 97% of the covered population in our territory. We are a consumer business and an economic downturn in the United States involving significantly lowered consumer spending could negatively affect our results of operations. Our primary subscriber base is composed of individual consumers, and in the event that the economic downturn that the United States and other countries have recently experienced becomes more pronounced or lasts longer than currently expected and spending by individual consumers drops significantly, our business may be negatively affected. Risks Related to Our Common Stock Your ability to influence corporate matters will be limited because a small number of stockholders beneficially own a substantial amount of our common stock. Entities that are investment advised by AIG Global Investment Corp. (a subsidiary of American International Group) own approximately 2,623,500 shares or 30.1% of our common stock and funds managed by affiliates of Silver Point Capital, L.P. ("Silver Point") own approximately 2,208,700 shares or 25.3% of our common stock. As a result, AIG Global Investment Corp. and Silver Point can exert significant influence over our management and policies until such time as they sell a substantial portion of their shares and may have interests that are different from yours. Sales of our common stock in connection with this offering could adversely affect our stock price. Sales of a substantial number of shares of our common stock into the public market through this offering or subject to limitations under Rule 144 could adversely effect our stock price. On July 20, 2004, we issued 8,724,998 shares of common stock in connection with our emergence from bankruptcy. Subject to our compliance with our obligations to maintain the effectiveness of the registration statement of which this prospectus is part, all of our outstanding shares of common stock are or will be freely tradable without restriction or further registration under the federal securities laws. There is not, and there may never be, an established active trading market for our common stock. There is no established active trading market for our common stock and such a trading market may never develop. Our common stock is currently quoted on the National Quotation Bureau's Pink Sheets. If an established active trading market does develop, it may not be sustained and a high degree of price volatility may continue to exist in any such market. We intend to apply for listing of our common stock on The Nasdaq National Market, but we may not be able to satisfy the listing requirements to do so, in particular, the requirements for a minimum number of round lot holders. If for any reason our common stock is not eligible for initial or continued listing on The Nasdaq Stock Market, or if a public trading market does not develop, purchasers of our common stock may have difficulty selling their shares. The price of our common stock may be more volatile than the equity securities of established companies and such volatility may disproportionately reduce the market value of our common stock at certain times. The market price of our common stock could be subject to significant fluctuations in response to various factors, including: variations in our, or Sprint PCS', quarterly operating results; our or Sprint PCS' failure to achieve operating results consistent with securities analysts' projections; the operating and stock price performance of other companies that investors may deem comparable to us or Sprint PCS; announcements of technological innovations or new products and services by us, Sprint PCS or our competitors; announcements by us or Sprint PCS of joint development efforts or corporate partnerships in the wireless telecommunications market; market conditions in the technology, telecommunications and other growth sectors; and rumors relating to us, Sprint PCS or our competitors. The stock market has experienced extreme price volatility. Under these market conditions, stock prices of many growth stage companies have often fluctuated in a manner unrelated or disproportionate to the operating performance of such companies. As we are a growth stage company, our common stock may be subject to greater price volatility than the stock market as a whole. You may not receive a return on investment through dividend payments nor upon the sale of your shares. We do not anticipate paying any cash dividends on our common stock in the foreseeable future. Instead, we intend to retain future earnings to fund our growth. Therefore, you will not receive a return on your investment in our common stock through the payment of dividends. You also may not realize a return on your investment upon selling your shares.

parsed_sections/risk_factors/2004/CIK0001115285_eyetech_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ RISK FACTORS This offering involves a high degree of risk. You should consider carefully the risks and uncertainties described below and the other information in this prospectus, including the consolidated financial statements and the related notes appearing at the end of this prospectus, before deciding to invest in shares of our common stock. If any of the following risks or uncertainties actually occurs, our business, prospects, financial condition and operating results would likely suffer, possibly materially. In that event, the market price of our common stock could decline and you could lose all or part of your investment. Risks Relating to Our Business We depend heavily on the success of our lead product candidate, Macugen, which is still under development and with respect to which pivotal clinical trial data became available only recently. If we are unable to commercialize Macugen, or experience significant delays in doing so, our business will be materially harmed. We have invested a significant portion of our time and financial resources since our inception in the development of Macugen. We anticipate that in the near term our ability to generate revenues will depend solely on the successful development and commercialization of Macugen. The commercial success of Macugen will depend on several factors, including the following: successful completion of clinical trials; producing batches of the active pharmaceutical ingredient used in Macugen as well as finished drug product in sufficient commercial quantities through a validated process; receipt of marketing approvals from the FDA and similar foreign regulatory authorities; launching commercial sales of the product in collaboration with Pfizer; successfully building and sustaining manufacturing capacity to meet anticipated future market demand; and acceptance of the product in the medical community and with third party payors. Based on the results from the first year of our ongoing Phase 2/3 pivotal clinical trials for the use of Macugen in the treatment of wet AMD, we and Pfizer are filing a new drug application with the FDA as a rolling submission to seek marketing approval for the 0.3 mg dose of Macugen for the treatment of all subtypes of wet AMD. The FDA has accepted for review the preclinical and clinical study report sections of our NDA. However, new information may arise from our continuing analysis of the data that may be less favorable than currently anticipated. Clinical data often is susceptible to varying interpretations and many companies that have believed that their products performed satisfactorily in clinical trials have nonetheless failed to obtain FDA approval for their products. We may not complete the filing of our NDA for the use of Macugen in the treatment of wet AMD in the third quarter of 2004, our anticipated time frame. Furthermore, even after we complete the filing, the FDA may not accept our submission as complete, may request additional information from us, including data from additional clinical trials, and, ultimately, may not grant marketing approval for Macugen. If we are not successful in commercializing Macugen, or are significantly delayed in doing so, our business will be materially harmed and we may need to curtail or cease operations. The success of Macugen depends heavily on our collaboration with Pfizer, which was established in December 2002 and involves a complex sharing of control over decisions, responsibilities and costs and benefits. Any loss of Pfizer as a collaborator, or adverse development in the collaboration, would materially harm our business. In December 2002, we entered into our collaboration with Pfizer to develop and commercialize Macugen for the prevention and treatment of diseases of the eye. The collaboration involves a complex sharing of control over decisions, responsibilities and costs and benefits. For example, with respect to the Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement is declared effective. If any of the securities being registered on this Form are offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, as amended (the Securities Act ) please check the following box. If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. Table of Contents sharing of costs and benefits, Pfizer will co-promote Macugen with us in the United States and will share with us in profits and losses. Outside the United States, Pfizer will commercialize Macugen pursuant to an exclusive license and pay us a royalty on net sales. In addition, Pfizer generally is required to fund a majority of ongoing development costs incurred pursuant to an agreed upon development plan. With respect to control over decisions and responsibilities, the collaboration is governed by a joint operating committee, consisting of an equal number of representatives of Pfizer and us. There are also subcommittees with equal representation from both parties that have responsibility over development, regulatory, manufacturing and commercialization matters. Ultimate decision-making authority is vested in us as to some matters and in Pfizer as to other matters. A third category of decisions requires the approval of both Pfizer and us. Outside the United States, ultimate decision-making authority as to most matters is vested in Pfizer. Pfizer may terminate the collaboration relationship without cause upon six to twelve months prior notice, depending on when such notice is given. Any loss of Pfizer as a collaborator in the development or commercialization of Macugen, dispute over the terms of, or decisions regarding, the collaboration or other adverse development in our relationship with Pfizer would materially harm our business and might accelerate our need for additional capital. If our clinical trials are unsuccessful, or if we experience significant delays in these trials, our ability to commercialize Macugen and our future product candidates will be impaired. We must provide the FDA and similar foreign regulatory authorities with preclinical and clinical data that demonstrate that our product candidates are safe and effective for each target indication before they can be approved for commercial distribution. The preclinical testing and clinical trials of any product candidates that we develop must comply with regulations by numerous federal, state and local government authorities in the United States, principally the FDA, and by similar agencies in other countries. Clinical development is a long, expensive and uncertain process and is subject to delays. We may encounter delays or rejections based on our inability to enroll enough patients to complete our clinical trials. Patient enrollment depends on many factors, including the size of the patient population, the nature of the trial protocol, the proximity of patients to clinical sites and the eligibility criteria for the study. Our ongoing Phase 2/3 pivotal clinical trial for the use of Macugen in the treatment of wet AMD and Phase 2 clinical trial for use of Macugen in the treatment of DME are currently fully enrolled. We expect to commence a Phase 2 clinical trial for the use of Macugen in the treatment of retinal vein occlusion in the second quarter of 2004. We also may commence additional clinical trials in the future. Although we have not to date experienced any significant delays in enrolling clinical trial patients for our ongoing clinical trials, delays in patient enrollment for future trials may result in increased costs and delays, which could have a harmful effect on our ability to develop products. It may take several years to complete the testing of a product, and failure can occur at any stage of testing. For example: interim results of preclinical or clinical studies do not necessarily predict their final results, and acceptable results in early studies might not be seen in later studies, in large part because earlier phases of studies are often conducted on smaller groups of patients than later studies, and without the same trial design features, such as randomized controls and long-term patient follow-up and analysis; potential products that appear promising at early stages of development may ultimately fail for a number of reasons, including the possibility that the products may be ineffective, less effective than products of our competitors or cause harmful side effects; any preclinical or clinical test may fail to produce results satisfactory to the FDA or foreign regulatory authorities; preclinical and clinical data can be interpreted in different ways, which could delay, limit or prevent regulatory approval; CALCULATION OF REGISTRATION FEE Table of Contents negative or inconclusive results from a preclinical study or clinical trial or adverse medical events during a clinical trial could cause a preclinical study or clinical trial to be repeated or a program to be terminated, even if other studies or trials relating to the program are successful; the FDA can place a hold on a clinical trial if, among other reasons, it finds that patients enrolled in the trial are or would be exposed to an unreasonable and significant risk of illness or injury; we may encounter delays or rejections based on changes in regulatory agency policies during the period in which we develop a drug or the period required for review of any application for regulatory agency approval; and our clinical trials may not demonstrate the safety and efficacy needed for our products to receive regulatory approval. We have completed the first year of our Phase 2/3 pivotal clinical trials for the use of Macugen in the treatment of wet AMD. Based on results from the first year of these trials, we and Pfizer are filing sections of our NDA with the FDA for the use of Macugen in the treatment of all subtypes of wet AMD as a rolling submission. The FDA has accepted for review the preclinical and clinical study report sections of our NDA filing. We plan to complete our NDA filing in the third quarter of 2004. We are currently conducting a second year of these trials. We have also fully enrolled a Phase 2 clinical trial for the use of Macugen in the treatment of DME. To obtain marketing approval, we may decide to, or the FDA or other regulatory authorities may require us to, pursue additional clinical trials or other studies of Macugen. For example, in addition to our Phase 2 clinical trial for the use of Macugen in the treatment of DME, we anticipate that we need to conduct Phase 3 clinical trials for DME before filing a new drug application or supplemental new drug application, as the case may be, for this second indication. In addition, as part of the drug approval process, we must conduct a comprehensive assessment of the carcinogenic, or cancer causing, potential of our product candidates. Our testing of Macugen to date indicates that the product s carcinogenic potential is low. In one test for carcinogenicity risk, two potential Macugen metabolites showed, in one out of five bacterial strains tested, a small increase in the number of altered bacteria, a potential indicator of carcinogenicity risk. However, because this elevated proportion of altered bacteria did not increase further as we increased the dose of the metabolites, we do not believe the results from these tests indicate carcinogenicity potential. Furthermore, no other test, including animal studies, of Macugen and its metabolites showed carcinogenic potential. We have requested that the FDA grant us a waiver from the requirement to perform full animal carcinogenicity studies for the treatment of wet AMD based primarily on the unmet medical need presented by wet AMD, low overall systemic exposure to Macugen and the fact that this disease generally affects older populations. However, the FDA may require us to conduct additional carcinogenicity testing of Macugen. Based on our discussions with the FDA to date, if we are required to conduct further carcinogenicity testing of Macugen in connection with its use in the treatment of wet AMD, we believe that the FDA will allow us to conduct any such testing as a post-NDA approval study. However, we will not be certain of this until the NDA review process of Macugen for this indication is completed. We expect that the FDA may require us to complete satisfactory carcinogenicity testing of Macugen prior to any approval of the use of Macugen in the treatment of DME. If we are required to conduct additional clinical trials or other studies of Macugen beyond those that we currently contemplate, if we are unable to successfully complete our clinical trials or other studies or if the results of these trials or studies are not positive or are only modestly positive, we may be delayed in obtaining marketing approval for Macugen, we may not be able to obtain marketing approval or we may obtain approval for indications that are not as broad as intended. Our product development costs will also increase if we experience delays in testing or approvals. Significant clinical trial delays could allow our competitors to bring products to market before we do and impair our ability to commercialize our products or potential products. If any of this occurs, our business will be materially harmed. Table of Contents We face substantial competition, which may result in others discovering, developing or commercializing products before or more successfully than we do. The development and commercialization of new drugs is highly competitive. We will face competition with respect to Macugen and any products we may develop or commercialize in the future from major pharmaceutical companies, specialty pharmaceutical companies and biotechnology companies worldwide. Our competitors may develop products or other novel technologies that are more effective, safer or less costly than any that we are developing. Our competitors may also obtain FDA or other regulatory approval for their products more rapidly than we may obtain approval for ours. The two therapies currently available for the treatment of wet AMD are photodynamic therapy, which was developed by QLT, Inc. and is marketed by Novartis AG, and thermal laser treatment. In the United States, photodynamic therapy is FDA-approved only for the predominantly classic subtype of wet AMD. In the European Union, there is an approved therapy only for the predominantly classic and occult subtypes. In the United States, however, the Centers for Medicare Medicaid Services implemented a decision in April 2004 to provide coverage for photodynamic therapy to patients with wet AMD who have occult and minimally classic lesions that are four disc areas or less in size and show evidence of recent disease progression even though the FDA has not approved photodynamic therapy for such treatment. The current therapies for the treatment of DME are thermal laser treatment and steroid treatment administered by physicians on an off-label basis. Unless additional therapies are approved, these existing therapies will represent the principal competition for Macugen if Macugen is approved for marketing. Additional treatments for AMD and DME are in various stages of preclinical or clinical testing. If approved, these treatments would also compete with Macugen. Potential treatments in late stage clinical trials include drugs sponsored by a collaboration of Genentech, Inc. and Novartis, Alcon, Inc., Allergan, Inc. through its recent acquisition of Oculex Pharmaceuticals, Inc., Eli Lilly and Co., Bausch Lomb Incorporated, a collaboration of Regeneron Pharmaceuticals, Inc. and Aventis S.A., Miravant Medical Technologies, and Genaera Corporation. Some of the sponsors of these potential products have recently announced favorable results from Phase 1 or Phase 2 clinical trials. The Genentech/Novartis collaboration is developing an anti-VEGF humanized antibody fragment for intravitreal injection. This product candidate may be viewed as particularly competitive with Macugen because of the similarity of its mechanism of action. In addition, Alcon expects to announce results of its Phase 3 clinical trial of anecortave acetate, an angiostatic steroid, for the treatment of wet AMD patients, that features a less invasive injectable delivery that requires less frequent administration (every six months), in the fourth quarter of 2004 and to file an NDA thereafter for the predominantly classic subtype of wet AMD. Further, Alcon is enrolling patients in two Phase 3 clinical trials, one in South America and one in Europe, comparing the safety and efficacy of Alcon s steroid against placebo in patients with all subtypes of wet AMD. Other laser, surgical or pharmaceutical treatments for AMD and DME may also compete against Macugen. These competitive therapies may result in pricing pressure if we receive marketing approval for Macugen even if Macugen is otherwise viewed as a preferable therapy. Many of our competitors have substantially greater financial, technical and human resources than we have. Additional mergers and acquisitions in the pharmaceutical and biotechnology industries may result in even more resources being concentrated by our competitors. Competition may increase further as a result of advances made in the commercial applicability of technologies and greater availability of capital for investment in these fields. We may not be successful in our efforts to expand our portfolio of products. A key element of our strategy is to commercialize a portfolio of new ophthalmic drugs in addition to Macugen. We are seeking to do so through our internal research programs and through licensing or otherwise acquiring the rights to potential new drugs and drug targets for the treatment of ophthalmic disease. 1 .1 Form of Underwriting Agreement 3 .1(6) Amended and Restated Certificate of Incorporation of the Registrant 3 .3(6) Amended and Restated Bylaws of the Registrant 4 .1(1) Specimen Certificate evidencing shares of common stock 4 .2(2) Warrant Agreement, dated as of March 31, 2000, by and between the Registrant and Gilead Sciences, Inc. 4 .3(2) Warrant Agreement Amendment, dated as of September 4, 2003, by and among the Registrant, Gilead Sciences, Inc. and University License Equity Holdings, Inc. 4 .4 (3) Series D Preferred Stock Purchase Agreement, dated as of December 17, 2002, by and between the Registrant, Pfizer Ireland Pharmaceuticals and Pfizer Inc. 4 .5(2) Amended and Restated Investors Rights Agreement, dated as of February 7, 2003, by and among the Registrant and the parties listed therein 5 .1 Opinion of Morrison Foerster LLP 10 .1(2) 2001 Stock Plan, as amended 10 .2(6) 2003 Stock Incentive Plan 10 .3(6) 2003 Employee Stock Purchase Plan 10 .4 (3) License Agreement, dated as of December 17, 2002, by and between Pfizer Inc. and the Registrant 10 .5 (3) Collaboration Agreement, dated as of December 17, 2002, by and between Pfizer Inc. and the Registrant 10 .6 (3) License, Manufacturing and Supply Agreement, dated February 5, 2002, by and between Shearwater Corporation and the Registrant 1 .1 Form of Underwriting Agreement 3 .1(6) Amended and Restated Certificate of Incorporation of the Registrant 3 .3(6) Amended and Restated Bylaws of the Registrant 4 .1(1) Specimen Certificate evidencing shares of common stock 4 .2(2) Warrant Agreement, dated as of March 31, 2000, by and between the Registrant and Gilead Sciences, Inc. 4 .3(2) Warrant Agreement Amendment, dated as of September 4, 2003, by and among the Registrant, Gilead Sciences, Inc. and University License Equity Holdings, Inc. 4 .4 (3) Series D Preferred Stock Purchase Agreement, dated as of December 17, 2002, by and between the Registrant, Pfizer Ireland Pharmaceuticals and Pfizer Inc. 4 .5(2) Amended and Restated Investors Rights Agreement, dated as of February 7, 2003, by and among the Registrant and the parties listed therein 5 .1 Opinion of Morrison Foerster LLP 10 .1(2) 2001 Stock Plan, as amended 10 .2(6) 2003 Stock Incentive Plan 10 .3(6) 2003 Employee Stock Purchase Plan 10 .4 (3) License Agreement, dated as of December 17, 2002, by and between Pfizer Inc. and the Registrant 10 .5 (3) Collaboration Agreement, dated as of December 17, 2002, by and between Pfizer Inc. and the Registrant 10 .6 (3) License, Manufacturing and Supply Agreement, dated February 5, 2002, by and between Shearwater Corporation and the Registrant 10 .7 (3) Licensing Agreement, dated as of March 30, 2000 and amended on May 9, 2000, December 4, 2001 and April 12, 2002, by and between Gilead Sciences, Inc. and the Registrant 10 .8 (3) License Agreement, dated as of December 31, 2001, by and between Isis Pharmaceuticals, Inc. and the Registrant 10 .9(2) Consulting Agreement, dated as of November 1, 2001, by and between the Registrant and Samir Patel 10 .10(2) Executive Employment Agreement, dated as of April 12, 2000, by and between the Registrant and David R. Guyer 10 .11(2) Amendment to Executive Employment Agreement, dated as of August 25, 2003, by and between the Registrant and David R. Guyer 10 .12(2) Employment Agreement, dated as of August 25, 2003, by and between Paul Chaney and the Registrant 10 .13(2) Employment Agreement, dated as of February 1, 2002, by and between the Registrant and Glenn Sblendorio 10 .14(1) Amendment to Employment Agreement, dated as of October 17, 2003, by and between the Registrant and Glenn Sblendorio 10 .15(2) Employment Agreement, dated as of April 12, 2002, by and between the Registrant and Anthony P. Adamis 10 .16(1) Amendment to Employment Agreement, dated as of October 20, 2003, by and between the Registrant and Anthony P. Adamis 10 .17(2) Employment Agreement, dated as of August 25, 2003, by and between Douglas H. Altschuler and the Registrant Proposed Maximum Proposed Maximum Amount of Title of Each Class of Amount to Offering Price Aggregate Offering Registration Securities to be Registered be Registered Per Share(2) Price(2) Fee Table of Contents A significant portion of the research that we are conducting involves new and unproven technologies. Research programs to identify new disease targets and product candidates require substantial technical, financial and human resources whether or not we ultimately identify any candidates. Our research programs may initially show promise in identifying potential product candidates, yet fail to yield product candidates for clinical development for a number of reasons, including: the research methodology used may not be successful in identifying potential product candidates; or potential product candidates may on further study be shown to have harmful side effects or other characteristics that indicate they are unlikely to be effective drugs. We may be unable to license or acquire suitable product candidates or products from third parties for a number of reasons. In particular, the licensing and acquisition of pharmaceutical products is a competitive area. A number of more established companies are also pursuing strategies to license or acquire products in the ophthalmic field. These established companies may have a competitive advantage over us due to their size, cash resources and greater clinical development and commercialization capabilities. Other factors that may prevent us from licensing or otherwise acquiring suitable product candidates include the following: we may be unable to license or acquire the relevant technology on terms that would allow us to make an appropriate return from the product; companies that perceive us to be their competitors may be unwilling to assign or license their product rights to us; or we may be unable to identify suitable products or product candidates within our areas of expertise. If we are unable to develop suitable potential product candidates through internal research programs or by obtaining rights to novel therapeutics from third parties, our business will suffer. Market acceptance of Macugen and other products we develop in the future that are based on new technologies may be limited. The commercial success of the products for which we may obtain marketing approval from the FDA or other regulatory authorities will depend upon the acceptance of these products by the medical community and third party payors as clinically useful, cost-effective and safe. Even if a potential product displays a favorable efficacy and safety profile in clinical trials, market acceptance of the product will not be known until after it is commercially launched. We expect that many of the products that we develop will be based upon new technologies. For example, Macugen is an aptamer, which is a type of nucleic acid. To date, no aptamer has been approved as a pharmaceutical by the FDA. As a result, it may be more difficult for us to achieve market acceptance of our products, particularly the first products that we introduce to the market based on new technologies. Our efforts to educate the medical community about these potentially unique approaches may require greater resources than would be typically required for products based on conventional technologies. The safety, efficacy, convenience and cost-effectiveness of our products as compared to competitive products will also affect market acceptance. We are in the process of establishing our sales and marketing capabilities. We will need to successfully recruit sales personnel and build a sales infrastructure to successfully commercialize Macugen and other products that we develop, acquire or license. We have limited experience in selling products and are in the process of establishing our sales capabilities. While we have personnel with significant marketing experience and have been collaborating with our partner, Pfizer, we have limited experience as a company marketing products. To achieve commercial success for any approved product, we must develop an effective sales and marketing organization. We are beginning to recruit a specialty sales force to participate in detailing Xalatan and, assuming regulatory approval, to market and sell Macugen in the United States in collaboration with Pfizer. If we are not successful in recruiting sales personnel or in building a sales and marketing Common Stock, $0.01 par value per share(1) 4,600,000 $36.01 $165,646,000 $20,987.35(3) Table of Contents infrastructure, our business will materially suffer. Moreover, if the commercial launch of Macugen is delayed as a result of FDA requirements or other reasons, we may establish sales and marketing capabilities too early relative to the launch of Macugen. This may be expensive, and our investment would be lost if we cannot retain our sales and marketing personnel. We expect to depend on collaborations with third parties to develop and commercialize our products. Our business strategy includes entering into collaborations with corporate and academic collaborators for the research, development and commercialization of additional product candidates, such as our collaboration with Pfizer. These arrangements may not be scientifically or commercially successful. The termination of any of these arrangements might adversely affect our ability to develop, commercialize and market our products. The success of our collaboration arrangements will depend heavily on the efforts and activities of our collaborators. Our collaborators will have significant discretion in determining the efforts and resources that they will apply to these collaborations. The risks that we face in connection with these collaborations, including our collaboration with Pfizer, include the following: our collaboration agreements are, or are expected to be, for fixed terms and subject to termination under various circumstances, including, in many cases, on short notice without cause; we expect to be required in our collaboration agreements not to conduct specified types of research and development in the field that is the subject of the collaboration. These agreements may have the effect of limiting the areas of research and development that we may pursue, either alone or in cooperation with third parties; our collaborators may develop and commercialize, either alone or with others, products and services that are similar to or competitive with our products that are the subject of the collaboration with us; and our collaborators may change the focus of their development and commercialization efforts. Pharmaceutical and biotechnology companies historically have re-evaluated their priorities following mergers and consolidations, which have been common in recent years in these industries. The ability of our products to reach their potential could be limited if our collaborators decrease or fail to increase spending relating to such products. Collaborations with pharmaceutical companies and other third parties often are terminated or allowed to expire by the other party. Such terminations or expirations can adversely affect us financially as well as harm our business reputation. We may not be successful in establishing additional collaborations, which could adversely affect our ability to develop and commercialize products and services. An important element of our business strategy is entering into collaborations for the development and commercialization of products when we believe that doing so will maximize product value. If we are unable to reach agreements with suitable collaborators, we may fail to meet our business objectives for the affected product or program. We face significant competition in seeking appropriate collaborators. Moreover, these collaboration arrangements are complex to negotiate and time consuming to document. We may not be successful in our efforts to establish additional collaborations or other alternative arrangements. The terms of any additional collaborations or other arrangements that we establish may not be favorable to us. Moreover, these collaborations or other arrangements may not be successful. Table of Contents We have no manufacturing facilities and limited manufacturing personnel. We will depend on third parties to manufacture Macugen and future products. If these manufacturers fail to meet our requirements, our product development and commercialization efforts may be materially harmed. We have limited personnel with experience in, and we do not own facilities for, manufacturing any products. We will depend on third parties to manufacture Macugen and any future products that we may develop. For our clinical trials of Macugen, we engaged a third party manufacturer to produce the active pharmaceutical ingredient used in Macugen. We have entered into an agreement with an affiliate of this third party for commercial supply of the active pharmaceutical ingredient. For our clinical trials of Macugen, we also engaged a separate fill and finish manufacturer for the finished drug product to formulate the active pharmaceutical ingredient from a solid into a solution and to fill the solution into syringes. We have entered into an agreement with this manufacturer to provide these finished product services for commercial supply. These manufacturers of Macugen will be single source suppliers to us for a significant period of time. We also expect to continue to rely on a single source of supply for the PEGylation reagent used in the manufacture of Macugen. We believe we currently have sufficient capacity to supply the active pharmaceutical ingredient of Macugen to meet anticipated demand for Macugen if the product is approved based on a 0.3 mg dose for approximately 24 months after approval. However, in order to sustain Macugen supply at the quantities we believe will be necessary to meet anticipated future market demand, we and our contract manufacturer will need to increase the manufacturing capacity for the active pharmaceutical ingredient. We initially intend to increase manufacturing capacity for the active pharmaceutical ingredient by duplicating a portion of our manufacturing lines at the contract manufacturer s facility. We are also exploring other alternatives for increasing manufacturing capacity. If we are unable to increase our manufacturing capacity, or if the cost of this increased capacity is uneconomic to us, we may not be able to produce Macugen in a sufficient quantity to meet future requirements to sustain supply of the product to meet anticipated future demand. In addition, our revenues and gross margins could be adversely affected. Reliance on third party manufacturers entails risks to which we would not be subject if we manufactured products ourselves, including: reliance on the third party for regulatory compliance and quality assurance; the possible breach of the manufacturing agreement by the third party because of factors beyond our control; and the possibility of termination or non-renewal of the agreement by the third party, based on its own business priorities, at a time that is costly or inconvenient for us. We may in the future elect to establish our own manufacturing facilities to manufacture some of our products. We would need to invest substantial additional funds and recruit qualified personnel in order to build or lease and operate any manufacturing facilities. The manufacture and packaging of pharmaceutical products such as Macugen are subject to the requirements of the FDA and similar foreign regulatory bodies. If we or our third party manufacturers fail to satisfy these requirements, our product development and commercialization efforts may be materially harmed. The manufacture and packaging of pharmaceutical products, such as Macugen and our future product candidates, are regulated by the FDA and similar foreign regulatory bodies and must be conducted in accordance with the FDA s current good manufacturing practices and comparable requirements of foreign regulatory bodies. There are a limited number of manufacturers that operate under these current good manufacturing practices regulations who are both capable of manufacturing Macugen and willing to do so. Failure by us or our third party manufacturers to comply with applicable regulations, requirements, or guidelines could result in sanctions being imposed on us, including fines, injunctions, civil penalties, failure David R. Guyer, M.D. Paul G. Chaney 275,000 18 % $ 3.50 8/11/2013 $ 8,444,366 $ 14,016,363 Glenn P. Sblendorio Anthony P. Adamis, M.D Douglas H. Altschuler 200,000 (1) All the shares of common stock will be sold by selling stockholders. (2) Estimated solely for the purpose of computing the registration fee, based on the average of the high and low sales prices of the common stock as reported by the Nasdaq National Market on May 11, 2004 in accordance with Rule 457 under the Securities Act of 1933. (3) Previously paid. Table of Contents of regulatory authorities to grant marketing approval of our products, delays, suspension or withdrawal of approvals, license revocation, seizures or recalls of product, operating restrictions and criminal prosecutions, any of which could significantly and adversely affect our business. Changes in the manufacturing process or procedure, including a change in the location where the product is manufactured or a change of a third party manufacturer, may require prior FDA review and/or approval of the manufacturing process and procedures in accordance with the FDA s current good manufacturing practices. There are comparable foreign requirements. This review may be costly and time consuming and could delay or prevent the launch of a product. For example, our third party contract manufacturer changed the site used to manufacture the active pharmaceutical ingredient of Macugen. We have completed the transfer of the relevant manufacturing technology to the new site, have used the new site to supply the active pharmaceutical ingredient of Macugen for use in our clinical trials and plan to continue to use this site to produce commercial quantities of the active pharmaceutical ingredient of Macugen. We are performing analytical tests to demonstrate comparability of our active pharmaceutical ingredient following the site change. If we cannot establish that the products manufactured at the new site are comparable to the satisfaction of the FDA, we may not obtain or may be delayed in obtaining approval to launch Macugen. In addition, if we elect to manufacture products in our own facility or at the facility of another third party, we would need to ensure that the new facility and the manufacturing process are in substantial compliance with current good manufacturing practices. Any such new facility would be subject to a pre-approval inspection by FDA. Furthermore, in order to obtain approval of our products, including Macugen, by the FDA and foreign regulatory agencies, we need to complete testing on both the active pharmaceutical ingredient and on the finished product in the packaging we propose for commercial sales. This includes testing of stability, identification of impurities and testing of other product specifications by validated test methods. In addition, we will be required to consistently produce the active pharmaceutical ingredient in commercial quantities and of specified quality on a repeated basis and document our ability to do so. This requirement is referred to as process validation. With respect to Macugen, although we have manufactured Macugen at commercial scale, we have started, but not yet completed, this process validation requirement. If the required testing or process validation is delayed or produces unfavorable results, we may not obtain approval to launch the product or approval may be delayed. The FDA and similar foreign regulatory bodies may also implement new standards, or change their interpretation and enforcement of existing standards and requirements, for manufacture, packaging, or testing of products at any time. If we are unable to comply, we may be subject to regulatory, civil actions or penalties which could significantly and adversely affect our business. Macugen and our other potential products may not be commercially viable if we fail to obtain an adequate level of reimbursement for these products by Medicare and other third party payors. The markets for our products may also be limited by the indications for which their use may be reimbursed or the frequency in which they may be administered. The availability and levels of reimbursement by governmental and other third party payors affect the market for products such as Macugen and others that we may develop. These third party payors continually attempt to contain or reduce the costs of healthcare by challenging the prices charged for medical products and services. In some foreign countries, particularly Canada and the countries of the European Union, the pricing of prescription pharmaceuticals is subject to governmental control. In these countries, pricing negotiations with governmental authorities can take six to twelve months or longer after the receipt of regulatory marketing approval for a product. To obtain reimbursement or pricing approval in some countries, we may be required to conduct a clinical trial that compares the cost-effectiveness of our products, including Macugen, to other available therapies. If reimbursement for our products is unavailable or limited in scope or amount or if pricing is set at unsatisfactory levels, our business could be materially harmed. The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to Section 8(a), may determine. Table of Contents Because most persons suffering from wet AMD are elderly, we expect that coverage for Macugen in the United States will be primarily through the Medicare program. Although drugs that are not usually self-administered are ordinarily covered by Medicare, the Medicare program has taken the position that it can decide not to cover particular drugs if it determines that they are not reasonable and necessary for Medicare beneficiaries. Limitations on coverage could also be imposed at the local Medicare carrier level or by fiscal intermediaries. Our business could be materially adversely affected if the Medicare program, local Medicare carriers or fiscal intermediaries were to make such a determination and deny or limit the reimbursement of Macugen. Our business also could be adversely affected if physicians are not reimbursed by Medicare for the cost of the procedure in which they administer Macugen on a basis satisfactory to the administering physicians. If the local contractors that administer the Medicare program are slow to reimburse physicians for Macugen, the physicians may pay us more slowly, which would adversely affect our working capital requirements. We also will need to obtain approvals for payment for Macugen from private insurers, including managed care organizations. We expect that private insurers will consider the efficacy, cost-effectiveness and safety of Macugen in determining whether to approve reimbursement for Macugen therapy and at what level. Obtaining these approvals can be a time consuming and expensive process. Our business would be materially adversely affected if we do not receive approval for reimbursement of Macugen from private insurers on a satisfactory basis. Our business could also be adversely affected if the Medicare program or other reimbursing bodies or payors limit the indications for which Macugen will be reimbursed to a smaller set than we believe it is effective in treating or establish a limitation on the frequency with which Macugen may be administered that is less often than we believe would be effective. We expect to experience pricing pressures in connection with the sale of Macugen and our future products due to the trend toward programs aimed at reducing healthcare costs, the increasing influence of health maintenance organizations and additional legislative proposals. The recent Medicare prescription drug coverage legislation and future legislative or regulatory reform of the healthcare system may affect our ability to sell our products profitably. In both the United States and some non-U.S. jurisdictions, there have been a number of legislative and regulatory proposals to change the healthcare system in ways that could affect our ability to sell our products profitably. In the United States, new legislation has been proposed at the federal and state levels that would result in significant changes to the healthcare system, either nationally or at the state level. In particular, in December 2003, President Bush signed into law new Medicare prescription drug coverage legislation. Effective January 2004, the legislation changed the methodology used to calculate reimbursement for drugs such as Macugen that are administered in physicians offices in a manner intended to reduce the amount that is subject to reimbursement. In addition, beginning in January 2006, the legislation directs the Secretary of Health and Human Services to contract with procurement organizations to purchase physician-administered drugs from the manufacturers and provides physicians with the option to obtain drugs through these organizations as an alternative to purchasing from the manufacturers, which some physicians may find advantageous. These changes may also cause private insurers to reduce the amounts that they will pay for physician-administered drugs. In addition, the Centers for Medicare Medicaid Services, or CMS, the agency within the Department of Health and Human Services that administers Medicare and will be responsible for reimbursement of the cost of Macugen, has asserted the authority of Medicare not to cover particular drugs if it determines that they are not reasonable and necessary for Medicare beneficiaries or to cover them at a lesser rate, comparable to that for drugs already reimbursed that CMS considers to be therapeutically comparable. Further federal and state proposals and healthcare reforms are likely. Our results of operations could be materially adversely affected by the Medicare prescription drug coverage legislation, by the possible effect of this legislation on amounts that private insurers will pay and by other healthcare reforms that may be enacted or adopted in the future. Table of Contents We face the risk of product liability claims and may not be able to obtain insurance. Our business exposes us to the risk of product liability claims that is inherent in the manufacturing, testing and marketing of drugs and related products. If the use of one or more of our products harms people, we may be subject to costly and damaging product liability claims. We have product liability insurance that covers our clinical trials up to a $10 million annual aggregate limit. We intend to expand our insurance coverage to include the sale of commercial products if we obtain marketing approval for any of the products that we may develop. Insurance coverage is increasingly expensive. We may not be able to obtain or maintain adequate protection against potential liabilities. If we are unable to obtain insurance at acceptable cost or otherwise protect against potential product liability claims, we will be exposed to significant liabilities, which may materially and adversely affect our business and financial position. These liabilities could prevent or interfere with our product development and commercialization efforts. We depend on our key personnel. If we are not able to retain them or recruit additional technical personnel, our business will suffer. We are highly dependent on the principal members of our management and scientific staff, particularly Dr. David R. Guyer, our co-founder and Chief Executive Officer, and Dr. Anthony P. Adamis, our scientific pioneer, Chief Scientific Officer and Senior Vice President, Research. Our employment agreements with these and our other executive officers are terminable on short or no notice. We do not carry key man life insurance on any of our key personnel. The loss of service of any of our key employees could harm our business. In addition, our growth will require us to hire a significant number of qualified technical, commercial and administrative personnel. There is intense competition from other companies and research and academic institutions for qualified personnel in the areas of our activities. If we cannot continue to attract and retain, on acceptable terms, the qualified personnel necessary for the continued development of our business, we may not be able to sustain our operations or grow. We depend on third parties in the conduct of our clinical trials for Macugen and any failure of those parties to fulfill their obligations could adversely affect our development and commercialization plans. We depend on independent clinical investigators, contract research organizations and other third party service providers in the conduct of our clinical trials for Macugen and expect to do so with respect to other product candidates. We rely heavily on these parties for successful execution of our clinical trials, but do not control many aspects of their activities. For example, the investigators are not our employees. However, we are responsible for ensuring that each of our clinical trials is conducted in accordance with the general investigational plan and protocols for the trial. Third parties may not complete activities on schedule, or may not conduct our clinical trials in accordance with regulatory requirements or our stated protocols. The failure of these third parties to carry out their obligations could delay or prevent the development, approval and commercialization of Macugen and future product candidates. Regulatory Risks We may not be able to obtain marketing approval for any of the products resulting from our development efforts, including Macugen. Failure to obtain these approvals could materially harm our business. Although we may not require additional research and development for the approval of Macugen for the treatment of wet AMD, the use of Macugen for the treatment of other indications and other products that we are developing or may develop in the future will require additional research and development. The research and development work that we must perform will include extensive preclinical studies and clinical trials. We will be required to obtain an investigational new drug application, or IND, prior to initiating human clinical trials in the United States and must obtain regulatory approval prior to any commercial distribution. This process is expensive, uncertain and lengthy, often taking a number of years until a product is approved for commercial distribution. We have only one product, Macugen, that has advanced Table of Contents to clinical trials. We have not received regulatory approval to market Macugen in any jurisdiction. Failure to obtain required regulatory approvals could materially harm our business. We may need to successfully address a number of technological challenges in order to complete the development of Macugen or any of our future products. For example, to obtain marketing approval for Macugen, we will be required to consistently produce the active pharmaceutical ingredient in commercial quantities and of specified quality on a repeated basis and document our ability to do so. We have not yet completed this process validation requirement and, if we are unable to do so, our business will be materially adversely affected. In addition, administration of a drug via intravitreal injection is a new method for the potentially long-term treatment of chronic eye disease. As a result, the FDA and other regulatory agencies may apply new standards for safety, manufacturing, packaging and distribution of drugs using this mode of administration, including Macugen. We are working with the FDA in connection with its development of appropriate standards for drugs using this mode of administration. As part of this process, we also support efforts by the United States Pharmacopoeia, which works with the FDA to establish standards, to devise a particulate limit and a standard to measure particulate matter appropriate for ophthalmologic treatments administered as ultra low-volume injectables. It may be time consuming or expensive for us to comply with these standards. This could result in delays in our obtaining marketing approval for Macugen, or possibly preclude us from obtaining such approval. This could also increase our commercialization costs, possibly materially. Furthermore, Macugen and any of our future products may not be effective, may be only moderately effective or may prove to have undesirable or unintended side effects, toxicities or other characteristics that may preclude our obtaining regulatory approval or prevent or limit commercial use, which could have a material adverse effect on our business. The FDA and other regulatory authorities may not approve any product that we develop. The fast track designation for development of Macugen may not actually lead to a faster development or regulatory review or approval process. If a drug is intended for the treatment of a serious or life-threatening condition and the drug demonstrates the potential to address unmet medical needs for this condition, the drug sponsor may apply for FDA fast track designation. The fast track classification does not apply to the product alone, but applies to the combination of the product and the specific indication or indications for which it is being studied. The FDA s fast track programs are designed to facilitate the clinical development and evaluation of the drug s safety and efficacy for the fast track indication or indications. Marketing applications filed by sponsors of products in fast track development may qualify for expedited review under policies or procedures offered by the FDA, but the fast track designation does not assure such qualification. Although we have obtained a fast track designation from the FDA for Macugen for the treatment of both wet AMD and DME, we may not experience a faster development process, review or approval compared to conventional FDA procedures. Our fast track designation may be withdrawn by the FDA if it believes that the designation is no longer supported by data from our clinical development program. Our fast track designation does not guarantee that we will qualify for or be able to take advantage of the expedited review procedures. Our products could be subject to restrictions or withdrawal from the market and we may be subject to penalties if we fail to comply with regulatory requirements, or if we experience unanticipated problems with our products, when and if any of them are approved. Any product for which we obtain marketing approval, along with the manufacturing processes, post-approval clinical data, advertising and promotional activities for such product, will be subject to continual requirements, review and periodic inspections by the FDA and other regulatory bodies. Even if regulatory approval of a product is granted, the approval may be subject to limitations on the indicated uses for which the product may be marketed or to the conditions of approval, or contain requirements for costly Table of Contents post-marketing testing and surveillance to monitor the safety or efficacy of the product. Later discovery of previously unknown problems with our products, manufacturer or manufacturing processes, or failure to comply with regulatory requirements, may result in: restrictions on such products or manufacturing processes; withdrawal of the products from the market; voluntary or mandatory recall; fines; suspension of regulatory approvals; product seizure; and injunctions or the imposition of civil or criminal penalties. We may be slow to adapt, or we may never adapt, to changes in existing regulatory requirements or adoption of new regulatory requirements or policies. Failure to obtain regulatory approval in foreign jurisdictions would prevent us from marketing our products abroad. We intend to have our products marketed outside the United States. In order to market our products in the European Union and many other non-U.S. jurisdictions, we must obtain separate regulatory approvals and comply with numerous and varying regulatory requirements. In the case of Macugen, Pfizer has responsibility to obtain regulatory approvals outside the United States, and we will depend on Pfizer to obtain these approvals. The approval procedure varies among countries and can involve additional testing. The time required to obtain approval may differ from that required to obtain FDA approval. The foreign regulatory approval process may include all of the risks associated with obtaining FDA approval. We may not obtain foreign regulatory approvals on a timely basis, if at all. Approval by the FDA does not ensure approval by regulatory authorities in other countries, and approval by one foreign regulatory authority does not ensure approval by regulatory authorities in other foreign countries or by the FDA. We and our collaborators may not be able to file for regulatory approvals and may not receive necessary approvals to commercialize our products in any market. The failure to obtain these approvals could materially adversely affect our business, financial condition and results of operations. We have only limited experience in regulatory affairs, and some of our products may be based on new technologies. These factors may affect our ability or the time we require to obtain necessary regulatory approvals. We have only limited experience as a company in filing and prosecuting the applications necessary to gain regulatory approvals. Moreover, some of the products that are likely to result from our product development, licensing and acquisition programs may be based on new technologies that have not been extensively tested in humans. The regulatory requirements governing these types of products may be less well defined or more rigorous than for conventional products. As a result, we may experience a longer regulatory review in connection with obtaining regulatory approvals of any products that we develop, license or acquire. Risks Relating to Intellectual Property If we are unable to obtain and maintain protection for the intellectual property incorporated into our products, the value of our technology and products will be adversely affected. Our success will depend in large part on our ability or the ability of our licensors to obtain and maintain protection in the United States and other countries for the intellectual property incorporated into our products. The patent situation in the field of biotechnology and pharmaceuticals generally is highly uncertain and involves complex legal and scientific questions. Neither we nor our licensors may be able to The selling stockholders named in this prospectus are offering 3,860,000 shares of Eyetech Pharmaceuticals, Inc. common stock. We will not receive any of the proceeds from the sale of common stock in this offering. Shares of our common stock are quoted on the Nasdaq National Market under the symbol EYET. On May 25, 2004, the last sale price of the common stock as reported on the Nasdaq National Market was $32.89 per share. Investing in the common stock involves risks. See Risk Factors beginning on page 7. Table of Contents obtain additional issued patents relating to our technology. Even if issued, patents may be challenged, narrowed, invalidated, or circumvented, which could limit our ability to stop competitors from marketing similar products or limit the length of term of patent protection we may have for our products. In addition, our patents and our licensors patents also may not afford us protection against competitors with similar technology. Because patent applications in the United States and many foreign jurisdictions are typically not published until 18 months after filing, or in some cases not at all, and because publications of discoveries in the scientific literature often lag behind actual discoveries, neither we nor our licensors can be certain that we or they were the first to make the inventions claimed in issued patents or pending patent applications, or that we or they were the first to file for protection of the inventions set forth in these patent applications. If we fail to comply with our obligations in the agreements under which we license development or commercialization rights to products or technology from third parties, we could lose license rights that are important to our business. We are a party to a number of technology licenses that are important to our business and expect to enter into additional licenses in the future. For example, we hold licenses from Gilead, Nektar Therapeutics and Isis Pharmaceuticals under patents relating to Macugen. These licenses impose various commercialization, milestone payment, royalty, insurance, and other obligations on us. If we fail to comply with these obligations, the licensor may have the right to terminate the license, in which event we would not be able to market products, such as Macugen, that may be covered by the license. If we are unable to protect the confidentiality of our proprietary information and know-how, the value of our technology and products could be adversely affected. In addition to patented technology, we rely upon unpatented proprietary technology, processes, and know-how. We seek to protect this information in part by confidentiality agreements with our employees, consultants and third parties. These agreements may be breached, and we may not have adequate remedies for any such breach. In addition, our trade secrets may otherwise become known or be independently developed by competitors. Third parties may own or control patents or patent applications that would be infringed by our technologies, drug targets or potential products. This could cause us to become involved in expensive patent litigation or other proceedings, which could result in our incurring substantial costs and expenses and liability for damages. This could also require us to seek licenses, which could increase our development and commercialization costs. In either case, this could require us to stop some of our development and commercialization efforts. We may not have rights under some patents or patent applications that would be infringed by technologies that we use in our research, drug targets that we select or product candidates that we seek to develop and commercialize. Third parties may own or control these patents and patent applications in the United States and abroad. These third parties could bring claims against us or our collaborators that would cause us to incur substantial expenses and, if successful against us, could cause us to pay substantial damages. Further, if a patent infringement suit were brought against us or our collaborators, we or they could be forced to stop or delay research, development, manufacturing or sales of the product or product candidate that is the subject of the suit. As a result of patent infringement claims, or in order to avoid potential claims, we or our collaborators may choose to seek, or be required to seek, a license from the third party and would most likely be required to pay license fees or royalties or both. These licenses may not be available on acceptable terms, or at all. Even if we or our collaborators were able to obtain a license, the rights may be nonexclusive, which would give our competitors access to the same intellectual property. Ultimately, we could be prevented from commercializing a product, or be forced to cease some aspect of our business operations if, as a result of actual or threatened patent infringement claims, we or our collaborators are unable to enter into licenses on acceptable terms. This could harm our business significantly. PRICE $ A SHARE Table of Contents There has been substantial litigation and other proceedings regarding the patent and other intellectual property rights in the pharmaceutical and biotechnology industries. In addition to infringement claims against us, we may become a party to other patent litigation and other proceedings, including interference proceedings declared by the United States Patent and Trademark Office and opposition proceedings in the European Patent Office, regarding intellectual property rights with respect to our products and technology. The cost to us of any patent litigation or other proceeding, even if resolved in our favor, could be substantial. Some of our competitors may be able to sustain the costs of such litigation or proceedings more effectively than we can because of their substantially greater financial resources. Uncertainties resulting from the initiation and continuation of patent litigation or other proceedings could have a material adverse effect on our ability to compete in the marketplace. Patent litigation and other proceedings may also absorb significant management time. Risks Relating to Our Financial Results and Need for Financing We have a limited operating history and have incurred losses since inception. If we do not generate significant revenues, we will not be able to achieve profitability. We have no current source of product revenue. We have a limited operating history and have not yet commercialized any products. To date, we have focused primarily on the development of Macugen. We began operations in 2000, and we have not been profitable in any quarter since inception. As of March 31, 2004, we had an accumulated deficit of approximately $153.3 million. We expect to increase our spending significantly as we continue to expand our infrastructure, development programs and commercialization activities. As a result, we will need to generate significant revenues to pay these costs and achieve profitability. We do not know whether or when we will become profitable because of the significant uncertainties with respect to our ability to generate revenues from the sale of our products and from our existing and potential future collaborations. We may need additional financing, which may be difficult to obtain. Our failure to obtain necessary financing or doing so on unattractive terms could adversely affect our development programs and other operations. We will require substantial funds to conduct development, including preclinical testing and clinical trials, of our potential products. We will also require substantial funds to meet our obligations to our licensors and maximize the prospective benefits to us from our licensors, and manufacture and market products that are approved for commercial sale in the future, including Macugen. We currently believe that our available cash, cash equivalents and marketable securities, expected milestone payments and reimbursements from Pfizer under our collaboration and interest income will be sufficient to fund our anticipated levels of operations through at least the end of 2005. However, our future capital requirements will depend on many factors, including: the success of our collaboration with Pfizer to develop and commercialize Macugen; the scope and results of our clinical trials; advancement of other product candidates into development; potential acquisition or in-licensing of other products or technologies; the timing of, and the costs involved in, obtaining regulatory approvals; the cost of manufacturing activities; the cost of commercialization activities, including product marketing, sales and distribution; the costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims and other patent-related costs, including litigation costs and the results of such litigation; Underwriting Proceeds Discounts and to Selling Price to Public Commissions Stockholders Table of Contents our ability to establish and maintain additional collaborative arrangements; and the success of our detailing agreement with Pfizer relating to Xalatan. Additional financing may not be available to us when we need it or it may not be available on favorable terms. If we are unable to obtain adequate financing on a timely basis, we may be required to significantly curtail one or more of our development, licensing or acquisition programs. We could be required to seek funds through arrangements with collaborators or others that may require us to relinquish rights to some of our technologies, product candidates or products that we would otherwise pursue on our own. If we raise additional funds by issuing equity securities, our then-existing stockholders will experience dilution and the terms of any new equity securities may have preferences over our common stock. After this offering, our executive officers, directors and major stockholders will maintain the ability to control all matters submitted to stockholders for approval. When this offering is completed, our executive officers, directors and stockholders who own more than 5% of our outstanding common stock, will, in the aggregate, beneficially own shares representing approximately 59% of our capital stock (assuming no exercise of the underwriters overallotment option). As a result, if these stockholders were to choose to act together, they would be able to control all matters submitted to our stockholders for approval, as well as our management and affairs. For example, these persons, if they choose to act together, will control the election of directors and approval of any merger, consolidation or sale of all or substantially all of our assets. This concentration of voting power could delay or prevent an acquisition of our company on terms that other stockholders may desire. Provisions in our charter documents and under Delaware law may prevent or frustrate attempts by our stockholders to change our management and hinder efforts to acquire a controlling interest in us. Provisions of our corporate charter and bylaws may discourage, delay or prevent a merger, acquisition or other change in control that stockholders may consider favorable, including transactions in which you might otherwise receive a premium for your shares. These provisions may also prevent or frustrate attempts by our stockholders to replace or remove our management. These provisions include: a classified board of directors; limitations on the removal of directors; advance notice requirements for stockholder proposals and nominations; the inability of stockholders to act by written consent or to call special meetings; and the ability of our board of directors to designate the terms of and issue new series of preferred stock without stockholder approval. The affirmative vote of the holders of at least 75% of our shares of capital stock entitled to vote is necessary to amend or repeal the above provisions of our certificate of incorporation. In addition, absent approval of our board of directors, our bylaws may only be amended or repealed by the affirmative vote of the holders of at least 75% of our shares of capital stock entitled to vote. In addition, Section 203 of the Delaware General Corporation Law prohibits a publicly held Delaware corporation from engaging in a business combination with an interested stockholder, generally a person which together with its affiliates owns or within the last three years has owned 15% of our voting stock, for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. Accordingly, Section 203 may discourage, delay or prevent a change in control of our company. If our stock price is volatile, purchasers of our common stock could incur substantial losses. Our stock price has been, and is likely to continue to be, volatile. The stock market in general and the market for biotechnology companies in particular have experienced extreme volatility that has often been Table of Contents unrelated to the operating performance of particular companies. As a result of this volatility, investors may not be able to sell their common stock at or above the public offering price. The market price for our common stock may be influenced by many factors, including: results of our clinical trials or those of our competitors; the regulatory status of Macugen and our other potential products; failure of any of our product candidates, if approved, to achieve commercial success; developments concerning our collaborators, including Pfizer; regulatory developments in, and outside of, the United States; developments or disputes concerning patents or other proprietary rights; our ability to manufacture products to commercial standards; public concern over our drugs; litigation; the departure of key personnel; future sales of our common stock; variations in our financial results or those of companies that are perceived to be similar to us; changes in the structure of healthcare payment systems; investors perceptions of us; and general economic, industry and market conditions. If there are substantial sales of our common stock, our stock price could decline. If our existing stockholders sell a large number of shares of our common stock or the public market perceives that existing stockholders might sell shares of common stock, the market price of our common stock could decline significantly. All of the shares sold in our initial public offering were, and the shares sold in this offering will be, freely tradable without restriction or further registration under the federal securities laws, unless purchased by our affiliates as that term is defined in Rule 144 under the Securities Act. Approximately 15.6 million shares will be eligible for sale upon the expiration of 180-day lock-up agreements on July 28, 2004, including the shares of some of our significant stockholders. Approximately 13.3 million additional shares will be eligible for sale upon the expiration of lock-up agreements expiring 90 days after the date of this prospectus. These amounts assume no exercise of the underwriters overallotment option. See the description of these agreements under Underwriters below. Upon completion of this offering, holders of an aggregate of approximately 24.9 million shares (or approximately 24.3 million shares, if the underwriters exercise their overallotment option in full) of common stock will have rights with respect to the registration of their shares of common stock with the Securities and Exchange Commission. If we register their shares of common stock following the expiration of the applicable lock-up agreements, they can sell those shares in the public market. We have registered approximately 9,543,000 shares of common stock that are authorized for issuance under our stock plans. As of March 31, 2004, 5,729,664 shares were subject to outstanding options, 4,701,004 of which were immediately exercisable, but with respect to which we had the right to repurchase at the initial exercise price all but 2,014,929 of the shares issuable upon exercise of these options. Because they are registered, the shares authorized for issuance under our stock plans can be freely sold in the public market upon issuance, subject to our repurchase rights, the lock-up agreements referred to above and the restrictions imposed on our affiliates under Rule 144. Table of Contents

parsed_sections/risk_factors/2004/CIK0001117119_kintera_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business." These statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward looking statements. Forward looking statements include, but are not limited to, statements about: marketing and commercialization of our products and services; our estimates for future revenues, expenses and profitability; our ability to attract customers and enter into customer contracts; our estimates regarding our capital requirements and our needs for additional financing; plans for future products and services and for enhancements of existing products and services; our patent applications and licensed technology; our plans to pursue strategic alliances and acquisitions; and sources of revenues and anticipated revenues and the continued viability and duration of those agreements. In some cases, you can identify forward looking statements by terms such as "may," "might," "will," "should," "could," "would," "expect," "believe," "intend," "estimate," "predict," "potential," or the negative of these terms, and similar expressions intended to identify forward looking statements. These statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward looking statements. We discuss many of these risks in this prospectus in greater detail under the heading "Risk Factors." Also, these forward looking statements represent our estimates and assumptions only as of the date of this prospectus. This prospectus contains statistical data that we obtained from industry publications and other industry sources, including reports generated by Giving USA and other third parties. These industry publications generally indicate that they have obtained their information from sources believed to be reliable, but do not guarantee the accuracy and completeness of their information. Although we believe that the publications are reliable, we have not independently verified their data. You should read this prospectus and the documents that we reference in this prospectus and have filed as exhibits to the registration statement, of which this prospectus is a part, completely and with the understanding that our actual future results may be materially different from what we expect. We qualify all of our forward looking statements by these cautionary statements. Information contained herein is subject to completion or amendment. A registration statement relating to these securities has been filed with the Securities and Exchange Commission. These securities may not be sold nor may offers to buy be accepted prior to the time the registration statement becomes effective. This prospectus shall not constitute an offer to sell or the solicitation of an offer to buy nor shall there be any sale of these securities in any state in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such state. (Subject to Completion, dated November 3, 2004) PRELIMINARY PROSPECTUS 2,694,998 Shares Common Stock Year ended December 31, 2004 First quarter $ 18.00 $ 9.70 Second quarter $ 17.73 $ 7.00 Third quarter $ 10.85 $ 5.25 Fourth quarter (through October 6, 2004) $ 10.13 $ 9.37 Year ended December 31, 2003 Fourth quarter (since December 19, 2003) $ 12.90 $ 7.91 DIVIDEND POLICY We have never declared or paid any cash dividends on our common stock and do not anticipate paying such cash dividends in the foreseeable future. We currently anticipate that we will retain all of our future earnings for use in the development and expansion of our business and for general corporate purposes. Any determination to pay dividends in the future will be at the discretion of our board of directors and will depend upon our results of operation, financial condition and other factors as the board of directors, in its discretion, deems relevant. This prospectus relates to the resale of 2,694,998 shares of our common stock held by certain of our stockholders. We are registering our common stock for resale by these selling stockholders who may offer such shares for sale from time to time at market prices prevailing at the time of sale or at privately negotiated prices. The selling stockholders may sell the shares directly to purchasers or through underwriters, broker-dealers or agents, that may receive compensation in the form of discounts, concessions or commissions. We will not receive any proceeds from this offering. See "Plan of Distribution." We will bear costs relating to the registration of these shares. Our common stock is traded on the Nasdaq National Market under the symbol "KNTA." On October 1, 2004, the last reported sales price for our common stock as quoted on the Nasdaq National Market was $9.80 per share.

parsed_sections/risk_factors/2004/CIK0001125011_kanbay_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement becomes effective. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933 check the following box: If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering: If this Form is to be a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement of the earlier effective registration statement for the same offering: If this Form is a post-effective amendment pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering: If the delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box: Profit on ordinary activities before taxation 3,867,747 4,645,095 4,009,478 Taxation on profit on ordinary activities The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine. Profit for the financial year(1) 2,679,246 3,215,445 2,471,364 Dividends The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities, and it is not soliciting an offer to buy these securities, in any jurisdiction where the offer or sale is not permitted. PRELIMINARY PROSPECTUS Subject to Completion December 7, 2004 Fixed assets Intangible assets 9 1,574,328 Tangible assets 10 3,078,729 3,750,072 Investments 4,800,000 Shares Common Stock 3,308,729 5,397,400 Current assets Debtors The selling stockholders named in this prospectus are offering 4,800,000 shares of our common stock. We will not receive any proceeds from the sale of any shares of our common stock sold by the selling stockholders. Our common stock is listed on the Nasdaq National Market under the symbol "KBAY." On December 6, 2004, the last sale price of our common stock as reported on the Nasdaq National Market was $27.59 per share. Investing in our common stock involves a high degree of risk. Before buying any shares, you should carefully read the discussion of material risks of investing in our common stock under "Risk factors" beginning on page 7 of this prospectus. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. Per Share Total 5,586,617 7,858,462 Creditors: amounts falling due within one year Public offering price $ $ Underwriting discounts and commissions $ $ Total assets less current liabilities 5,538,373 7,728,721 Creditors: amounts falling due after more than one year 14 587,206 Provisions for liabilities and charges Deferred taxation Proceeds, before expenses, to the selling stockholders $ $ The underwriters may also purchase up to an additional 720,000 shares of our common stock from the selling stockholders to cover over-allotments, if any. The underwriters are offering the common stock as set forth under "Underwriting." Delivery of the shares of common stock will be made on or about , 2004. UBS Investment Bank Robert W. Baird & Co. Janney Montgomery Scott LLC The date of this prospectus is , 2004. Capital and reserves Called up share capital 16 914 918 Share premium account 17 29,480 57,701 Capital reserve 17 9,962 9,962 Profit and loss account You should rely only on the information contained in this prospectus. We have not, and the selling stockholders and the underwriters have not, authorized anyone to provide you with additional information or information different from that contained in this prospectus. The selling stockholders are offering to sell, and seeking offers to buy, shares of our common stock only in jurisdictions where those offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of our common stock. TABLE OF CONTENTS Retained profit for the year Equity shareholders' funds(1) i Prospectus summary This summary highlights selected information contained elsewhere in this prospectus. This summary may not contain all the information that you should consider before investing in our common stock. You should carefully read the entire prospectus, including "Risk factors" and the financial statements, before making an investment decision. OUR BUSINESS We are a global provider of information technology, or IT, services and solutions focused on the financial services industry. We combine technical expertise with deep industry knowledge to offer a broad suite of services, including business process and technology advice, software package selection and integration, application development, maintenance and support, network and system security and specialized services, through our global delivery model. Our three-tier global delivery model combines onsite client relationship teams, senior technical and industry experts at our offsite regional service centers and cost-effective global delivery centers in India. The three tiers of our global delivery model help us to provide our clients with value-enhancing solutions using a seamless, consistent and cost-effective client service approach. We focus on the financial services industry and provide our services primarily to credit services companies, banking institutions, capital markets firms and insurance companies. In providing our services, we utilize a wide array of technologies to develop customized solutions that address our clients' specific needs. As of September 30, 2004, Household International (and its affiliates within the HSBC Group), Morgan Stanley, CitiFinancial (an affiliate of Citigroup), Development Bank of Singapore and ABN-AMRO were among our top clients. Our engagements with our top clients typically involve numerous projects and multiple business units within each client and vary in complexity, scope and duration. We seek to expand our client relationships and migrate each client over time from discrete initial engagements to longer-term, recurring projects. For example, over the past several years we have successfully deepened our relationship with our largest client, Household International. For the year ended December 31, 2003 and for the nine months ended September 30, 2004, Household International, which is also our largest stockholder with approximately 14.2% of our common stock after completion of this offering, and its affiliates within the HSBC Group, accounted for 53.2% and 56.0% of our total revenues. Similarly, we have successfully developed our relationship with our second largest client, Morgan Stanley, which will own approximately 4.7% of our common stock after completion of this offering, and accounted for 13.0% and 10.3% of our total revenues in the year ended December 31, 2003 and in the nine months ended September 30, 2004. Our five largest clients together accounted for 80.7% of our total revenues in the year ended December 31, 2003 and in the nine months ended September 30, 2004. We have operated our business since 1989 and are headquartered in suburban Chicago. We have operations and clients around the world, with regional offices located in eight countries and delivery centers in Pune and Hyderabad, India. We also own a 49.0% interest in SSS Holdings Corporation Limited (SSS), which is based in Liverpool, England and focuses on providing IT services to the securities industry. From 1999 through 2003, our revenues grew from $44.2 million to $107.2 million, representing a compound annual growth rate of 24.8%. Our net income was $11.4 million for the year ended December 31, 2003 and $19.3 million for the nine months ended September 30, 2004. Our share of the earnings of SSS provided us with $2.0 million of equity in earnings of affiliate for the year ended December 31, 2003 and for the nine months ended September 30, 2004. Net cash (used in) provided by financing activities 1,367 (1,412 ) (2,273 ) Effect of exchange rates on cash 50 (32 ) 1 OUR INDUSTRY The role of IT has evolved from simply supporting business enterprises to enabling their expansion and transformation. As a result of the recent global economic downturn, companies are placing a greater emphasis on improving their return on IT investments and closely managing IT spending. To attain high-quality IT services at a lower cost, companies are turning to providers with offshore delivery capabilities. India has become the preferred destination for the provision of offshore IT services, offering high-quality and accelerated delivery, significant cost benefits and an abundance of skilled professionals. The global financial services industry is currently faced with a number of challenges, including increased regulatory scrutiny, growing competition and ongoing domestic and international consolidation. As a result, providing rapid access to, and delivery of, real-time information and implementing solutions and processes that minimize system downtime are vital to the success of financial institutions. However, providing these solutions and processes internally is often more costly and time-consuming than outsourcing these services. Consequently, financial institutions are looking externally for solutions that allow them to reduce costs and improve performance. Total global IT services spending within the financial services industry is expected to increase from $123.1 billion in 2003 to $154.3 billion in 2007, representing a compound annual growth rate of 5.8%. The financial services industry is expected to account for 21.2% of total global IT services spending from 2003 to 2007, the highest percentage of any single industry sector. OUR COMPETITIVE STRENGTHS We believe our competitive strengths include: >Deep industry expertise. We have developed expertise in the financial services industry, with a specific focus on credit services companies, banking institutions, capital markets firms and insurance companies. Our industry focus has enabled us to acquire a thorough understanding of our clients' business issues and applicable technologies, which allows us to deliver services and solutions tailored to each client's needs. Because of our specific industry focus, a significant economic downturn in the financial services industry could negatively affect our business. >Three-tier global delivery model. Our global delivery model allows us to provide each of our clients with a responsive and accessible relationship management team at the client's location, a readily available offsite team of technology and industry experts at one of our regional delivery centers and a cost-effective application development, maintenance and support team at one of our global delivery centers in India. Although our global delivery model allows us to provide these benefits to our clients, demand for our services could decline as a result of negative public perception regarding or new legislation restricting the use of offshore IT service providers. >Commitment to attracting, developing and retaining the highest quality employees. We believe we have established a business culture throughout Kanbay that enables us to attract and retain the best available industry talent. From 2001 to 2003, we retained an average of 90% of our employees even though the number of our employees grew significantly. We believe that our high employee retention rate provides tangible benefits to our clients, such as low turnover on long-term engagements, retention of knowledge which can be applied to new projects, consistent quality and competent and responsive personnel. We expect that we will continue to grow and our anticipated growth could place a significant strain on our ability to maintain our culture and provide these tangible benefits to our clients. >Long-term client relationships. We have long-standing relationships with many large, international companies within the financial services industry. Our ability to successfully deliver consistent, seamless solutions on a global basis combined with our deep knowledge of the financial services industry helps us expand the breadth and scope of our engagements with existing clients. We Income (loss) from operations (3,691 ) 3,136 8,288 Other income (expense): Interest expense (335 ) (424 ) (287 ) Interest income 62 17 39 Foreign exchange gain (loss) (31 ) 69 (120 ) Equity in earnings of affiliate 861 2,241 2,046 Loss on investment (644 ) Other, net 8 6 Balance at December 31, 2003 3,333,333 $ 3 20,725,776 $ 2 manage client relationships with our relationship development methodology, which helps us to migrate our clients over time from discrete initial engagements to longer-term, recurring projects. Because of our long-standing relationships, we have historically earned, and believe that in the future we will continue to earn, a significant portion of our revenues from a limited number of clients. >Scalable global business model. We believe that our three-tier global delivery model allows us to quickly engage new projects in order to rapidly meet client needs. Because of our financial services industry focus, we can rapidly deploy our project teams on new engagements located anywhere in the world. Our ability to rapidly deploy our project teams on new engagements and to provide our services to our clients is dependent on many factors, including continued compliance with various immigration restrictions and the maintenance of our global communications infrastructure. OUR STRATEGY In order to enhance our position as a global IT services provider focused on the financial services industry, we intend to: >Diversify and develop our client base; >Expand our service offerings and solutions; >Deepen our financial services expertise; >Continue to attract and retain highly skilled IT professionals; and >Enhance our brand visibility. Our principal executive office is located at 6400 Shafer Court, Suite 100, Rosemont, Illinois 60018, and our telephone number at that office is (847) 384-6100. Our website is located at www.kanbay.com. Information contained on our website is not part of this prospectus. You should carefully consider the information contained in the "Risk factors" section of this prospectus before you decide to purchase our common stock. Strategic Investments Solutions Limited England 50 % Pension investment adviser The Monocle Holdings Corporation Limited England 23 % Computer software development The Monocle Corporation Limited England 3 The offering Common stock offered by the selling stockholders 4,800,000 shares Common stock to be outstanding after this offering 32,913,097 shares Use of proceeds after expenses We will not receive any proceeds from this offering. Nasdaq National Market symbol KBAY Unless otherwise indicated, the number of shares of common stock to be outstanding after this offering includes 512,264 shares of common stock offered hereby and to be issued upon the exercise of options by some of the selling stockholders and excludes: >8,287,680 shares of common stock issuable after the completion of this offering upon the exercise of outstanding stock options under our stock option plan and stock incentive plan at a weighted average exercise price of $7.58 per share; >596,064 shares of common stock issuable after the completion of this offering upon the exercise of outstanding warrants at a weighted average exercise price of $6.03 per share; and >1,640,520 shares of common stock available for future grants under our stock incentive plan. Unless otherwise indicated, all share amounts assume the underwriters' over-allotment option is not exercised. Certain of the selling stockholders have agreed to pay for a portion of the expenses we incur in connection with this offering. See "Underwriting Commissions and discounts." 4 Summary historical consolidated financial data The following table presents summary historical consolidated financial data as of, and for the years ended, December 31, 1999, 2000, 2001, 2002 and 2003, which has been derived from our audited consolidated financial statements, and as of, and for the nine months ended, September 30, 2003 and 2004, which has been derived from our unaudited consolidated financial statements and which, in our opinion, have been prepared on the same basis as the audited consolidated financial statements and reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of our results of operations and financial position. These historical results are not necessarily indicative of results to be expected for any future period. You should read this information together with "Selected historical consolidated financial data," "Management's discussion and analysis of financial condition and results of operations," and our consolidated financial statements and related notes for the years ended December 31, 2001, 2002 and 2003 and the nine months ended September 30, 2003 and 2004, which are included elsewhere in this prospectus. Nine months ended September 30, Years ended December 31, Income (loss) from operations (4,363 ) (10,986 ) (3,691 ) 3,136 8,288 5,512 22,034 Interest expense (379 ) (1,478 ) (335 ) (424 ) (287 ) (206 ) (17 ) Interest income 103 129 62 17 39 16 261 Foreign exchange gain (loss) 209 (17 ) (31 ) 69 (120 ) (48 ) (168 ) Equity in earnings of affiliate(2) 29 861 2,241 2,046 1,569 2,009 Loss on investment (644 ) Other, net 2 8 6 21 12 Income from operations 5,512 22,034 Other income (expense): Interest expense (206 ) (17 ) Interest income 16 261 Foreign exchange gain (loss) (48 ) (168 ) Equity in earnings of affiliate 1,569 2,009 Other, net 12 (in thousands, except per share amounts) Net revenues related parties $ 11,292 $ 14,377 $ 38,001 $ 50,253 $ 70,942 $ 48,909 $ 87,308 Net revenues third parties 32,914 43,144 31,653 32,336 36,211 26,515 44,420 Total selling, general and administrative expenses 21,985 31,819 31,065 29,756 36,846 26,159 36,474 Depreciation and amortization 1,362 2,171 2,437 2,682 3,308 2,305 3,860 (Gain) loss on sale of fixed assets 2 (9 ) 57 38 36 31 Total selling, general and administrative expenses 21,985 31,819 31,065 29,756 36,846 26,159 36,474 Depreciation and amortization 1,362 2,171 2,437 2,682 3,308 2,305 3,860 (Gain) loss on sale of fixed assets 2 (9 ) 57 38 36 31 Total selling, general and administrative expenses 26,159 36,474 Depreciation and amortization 2,305 3,860 Loss on sale of fixed assets 31 Total revenues 44,206 57,521 69,654 82,589 107,153 75,424 131,728 Cost of revenues 25,220 34,526 39,786 46,977 58,675 41,417 69,326 Total selling, general and administrative expenses 31,065 29,756 36,846 Depreciation and amortization 2,437 2,682 3,308 Loss on sale of fixed assets 57 38 8,557 11,315 Investment in affiliate 18,858 22,185 Deferred income taxes 1,350 Other assets 161 Raymond J. Spencer(1) 54 Chairman and Chief Executive Officer William F. Weissman 46 Vice President and Chief Financial Officer Jean A. Cholka 46 Vice President Global Client Management Cyprian D'Souza 49 Chief People Officer and Director Shrihari Gokhale 41 Vice President Global Services Delivery Mark L. Gordon(1)(2) 53 Director Donald R. Caldwell(1)(3)(4) 58 Director Kenneth M. Harvey(2)(4) 44 Director B. Douglas Morriss(2)(3) 41 Director Michael E. Mikolajczyk(3)(4) Income (loss) from operations (4,363 ) (10,986 ) (3,691 ) 3,136 8,288 5,512 22,034 Other income (expense): Interest expense and other, net (67 ) (1,364 ) (296 ) (332 ) (347 ) (226 ) 103 Equity in earnings of affiliate(2) 29 861 2,241 2,046 1,569 2,009 Loss on investment (644 ) Income (loss) before cumulative effect of accounting change (4,368 ) (12,310 ) (3,788 ) 4,819 11,439 Cumulative effect of accounting change(3) (2,043 ) Payments to acquire subsidiary undertakings and goodwill (note 21) (75 ) (587,130 ) Net cash and bank balances acquired Net income (loss) (4,368 ) (12,310 ) (3,788 ) 2,776 11,439 6,755 19,317 Dividends on preferred stock (608 ) (610 ) (608 ) (608 ) (608 ) (455 ) (277 ) (Increase) decrease in carrying value of stock subject to repurchase (6,558 ) (864 ) (676 ) 4,077 3,063 (2,362 ) Foreign debt $ 1,680 $ Capital leases Income (loss) available to common stockholders $ (11,534 ) $ (13,784 ) $ (5,072 ) $ 6,245 $ 13,894 $ 3,938 $ 19,040 Carrying value in SSS at beginning of year $ 15,961 $ 18,858 Equity in earnings of SSS 2,241 2,046 Cash dividend received from SSS (1,215 ) (763 ) Foreign currency translation adjustments 1,779 2,134 Change in ownership percentage and other Note payable to stockholder, interest at 7.4%, due in monthly payments of $3 $ 25 $ Note payable to stockholder, interest at 6%, due on demand 200 Notes payable to stockholder, non interest bearing, due on demand 331 Other related party loans Income (loss) before income taxes (4,430 ) (12,321 ) (3,770 ) 5,045 9,987 6,855 24,146 Income tax expense (benefit) (62 ) (11 ) 18 226 (1,452 ) Income (loss) before income taxes (4,430 ) (12,321 ) (3,770 ) 5,045 9,987 6,855 24,146 Income tax expense (benefit) (62 ) (11 ) 18 226 (1,452 ) Income before income taxes 6,855 24,146 Income tax expense Strategic System Solutions Ltd England 100 % Computer software development Strategic System Solutions Inc. USA 100 % Computer software development Strategic Training Solutions Ltd England 100 % Computer training provider Strategic Back-Office Solutions Ltd England 75 % Back office services SSS Hangzhou Co. Limited(*) China 5 The following table presents a summary of our balance sheet as of September 30, 2004: >on an actual basis; and >on an as adjusted basis to give effect to the issuance of 512,264 shares of common stock in connection with the exercise of options by some of the selling stockholders in conjunction with this offering, resulting in proceeds of $401,000, after deducting the estimated offering expenses that we will pay. As of September 30, 2004 Consolidated balance sheet data: Actual As adjusted (in thousands) Cash and cash equivalents $ 16,650 $ 17,051 Working capital 76,268 76,669 Total assets 164,809 165,210 Long-term debt Total stockholders' equity 128,508 128,909 (1) Reflects the results of Kanbay Australia Pty Ltd. from the date of its acquisition on October 29, 1999 for approximately $3 million in cash and stock. (2) On November 30, 2000, we acquired a 49.4% interest in SSS Holdings Corporation Limited (SSS) in exchange for 2,086,697 shares of our common stock valued at approximately $15.9 million. As of September 30, 2004, we owned approximately 49.0% of SSS. We account for SSS under the equity method of accounting. (3) Effective January 1, 2002, we adopted Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142 does not permit goodwill and indefinite-lived intangible assets to be amortized. Upon adoption of SFAS No. 142, we recorded a non-cash charge of $2.0 million to reduce the carrying value of goodwill. This non-cash charge was recorded as a cumulative effect of an accounting change. If we had applied SFAS No. 142 retroactively as of January 1, 1999, our net income (loss) would have been $(4.3 million) in 1999, $(12.0 million) in 2000 and $(2.4 million) in 2001. (4) For the period from January 1, 1999 through August 23, 2000, we operated as a Delaware limited liability company (LLC). On August 24, 2000, we converted from a LLC into a Delaware C corporation when all members exchanged their common and preferred units in the LLC for an equivalent number of shares of our common and preferred stock. Income (loss) per share of common stock and average shares outstanding is presented for the years during which we operated as a C corporation. Provision at U.S. federal statutory rate $ (1,282 ) $ 1,715 $ 3,396 State taxes, net of federal effect (94 ) 135 242 Foreign tax holiday (302 ) (655 ) (1,637 ) Undistributed earnings of SSS (402 ) (510 ) Foreign tax credit (259 ) Non-deductible items 501 326 470 Change in valuation allowance 1,204 (1,002 ) (2,772 ) Other (9 ) Risk factors You should carefully consider the following risks and other information in this prospectus before you decide to buy our common stock. An investment in our common stock involves a high degree of risk. Our business, financial condition or operating results may suffer if any of the following risks is realized. Additional risks and uncertainties not currently known to us may also adversely affect our business, financial condition or operating results. If any of these risks or uncertainties occurs, the trading price of our common stock could decline. RISKS RELATED TO OUR BUSINESS Our revenues are highly dependent on a small number of clients, including a single client from whom we receive more than 50% of our revenues and which is also our largest stockholder, and the loss of any one of our major clients could significantly impact our business. We have historically earned, and believe that in the future we will continue to earn, a significant portion of our revenues from a limited number of clients. Household International, which is our largest client, will own approximately 14.2% of our common stock after the completion of this offering and will continue to be our largest stockholder, accounted for 45.0%, 47.4%, 53.2% and 56.0% of our total revenues in the years ended December 31, 2001, 2002 and 2003 and in the nine months ended September 30, 2004, which, in 2003 and 2004, included revenues from its affiliates within the HSBC Group. Morgan Stanley, which is our second largest client and will own approximately 4.7% of our common stock after the completion of this offering, accounted for 9.6%, 13.5%, 13.0% and 10.3% of our total revenues in the years ended December 31, 2001, 2002 and 2003 and in the nine months ended September 30, 2004. Our five largest clients together accounted for 70.7%, 74.7%, 80.7% and 80.7% of our total revenues in the years ended December 31, 2001, 2002 and 2003 and in the nine months ended September 30, 2004. If we were to lose Household International, Morgan Stanley or one of our other major clients or have a major client cancel substantial projects or otherwise significantly reduce its volume of business with us, our revenues and profitability would be materially reduced. A significant or prolonged economic downturn in, increased regulation of and restrictions imposed on the financial services industry may result in our clients reducing or postponing spending on the services we offer. A significant portion of our revenues is derived from U.S. clients in the financial services industry, which is cyclical and recently experienced a significant downturn. In the nine months ended September 30, 2004, approximately 78% of our revenues were derived from the United States. If economic conditions weaken, particularly in the U.S. financial services industry, our clients may reduce or postpone their IT spending significantly, which may in turn lower the demand for our services and negatively affect our revenues and profitability. In addition to this economic downturn, there has been recent increased regulation of, and restrictions imposed on, financial services companies, which may negatively affect our clients and cause them to reduce their spending on the IT services we offer. Our failure to anticipate rapid changes in technology may negatively impact demand for our services in the marketplace. Our success will depend, in part, on our ability to develop and implement business and technology solutions that anticipate rapid and continuing changes in technology, industry standards and client preferences. We may not be successful in anticipating or responding to these developments on a timely basis, which may negatively impact demand for our solutions in the marketplace. Also, products and 7 technologies developed by our competitors may make our solutions noncompetitive or obsolete. Any one or a combination of these circumstances could have a material adverse effect on our ability to obtain and successfully complete client engagements. The IT services market is highly competitive, and our competitors have advantages that may allow them to better use economic incentives to secure contracts with our existing and prospective clients and attract skilled IT professionals. The IT services market in which we operate includes a large number of participants and is highly competitive. Our primary competitors include: >large consulting and other professional service firms, including Accenture, BearingPoint, Cap Gemini and Deloitte & Touche; >offshore IT service providers, including Cognizant Technology Solutions, Infosys Technologies and Wipro; and >in-house IT departments. The market in which we compete is experiencing rapid changes in its competitive landscape. Some of our competitors are large consulting firms or offshore IT service providers which have significant resources and financial capabilities combined with much larger numbers of IT professionals. Some of these competitors have gained access to public and private capital or have merged or consolidated with better capitalized partners, which has created and may in the future create larger and better capitalized competitors with superior abilities to compete for market share generally and for our existing and prospective clients. Our competitors may be better positioned to use significant economic incentives to secure contracts with our existing and prospective clients. These competitors may also be better able to compete for skilled professionals by offering them more attractive compensation or other incentives. In addition, one or more of our competitors may develop and implement methodologies that yield price reductions, superior productivity or enhanced quality that we are not able to match. Any of these circumstances would have an adverse effect on our revenues and profit margin. We also expect additional competition from offshore IT service providers with current operations in other countries, such as China and the Philippines, where we do not have operations other than our regional service center in Hong Kong. These competitors may be able to offer services using business models that are more effective than ours. Our executive officers and directors and their respective affiliates, including Household International, which will continue to own a large percentage of our common stock after the completion of this offering, have substantial voting control over Kanbay and their interests may differ from other stockholders. Upon completion of this offering, our executive officers and directors and their affiliates will beneficially own, in the aggregate, approximately 39.6% of our outstanding common stock. In particular, Household International will beneficially own approximately 14.2% of our common stock after the completion of this offering. As a result, these stockholders will be able to exercise significant control over all matters requiring stockholder approval, including the election of directors, any amendments to our certificate of incorporation and approval of significant corporate transactions. These stockholders may exercise this control even if they are opposed by our other stockholders. Without the consent of these stockholders, we could be delayed or prevented from entering into transactions (including the acquisition of our company by third parties) that may be viewed as beneficial to us or our other stockholders. In addition, this significant concentration of share ownership may adversely affect the trading price of our common stock if investors perceive disadvantages in owning stock in a company with controlling stockholders. 8 Negative public perception in the United States regarding offshore IT service providers and recently proposed federal legislation may adversely affect demand for our services. Recently, many organizations and public figures have publicly expressed concerns about a perceived association between offshore IT service providers and the loss of jobs in the United States. Our clients may stop using our services to avoid any negative perception that may be associated with utilizing an offshore IT service provider. In addition, federal legislation has been proposed that, if enacted, may restrict U.S. companies from outsourcing their IT work to companies outside the United States. Certain U.S. states have enacted legislation that restricts governmental agencies from outsourcing their IT work to companies outside the United States. Although we currently do not have significant contracts with governmental entities in the United States, it is possible that U.S. private sector companies may in the future be restricted from outsourcing their IT work related to government contracts to offshore service providers. Any expansion of existing laws or the enactment of new legislation restricting offshore IT outsourcing may adversely impact our ability to do business in the United States, particularly if these changes are widespread. If we do not effectively manage our anticipated rapid growth, we may not be able to develop or implement new systems, procedures and controls that are required to support our operations, market our services and manage our relationships with our clients. Between January 1, 2001 and September 30, 2004, the number of our employees has grown from 912 to 3,638. We expect that we will continue to grow and our anticipated growth could place a significant strain on our ability to: >recruit, train, motivate and retain highly skilled IT, marketing and management personnel; >adhere to our high quality process execution standards; >preserve our culture, values and entrepreneurial environment; >develop and improve our internal administrative infrastructure and our financial, operational, communications and other internal systems; and >maintain high levels of client satisfaction. To manage this anticipated growth, we must implement and maintain proper operational and financial controls and systems in order to expand our services and employee base. Further, we will need to manage our relationships with various clients, vendors and other third parties. We cannot give any assurance that we will be able to develop and implement, on a timely basis, the systems, procedures and controls required to support our operations. Our future operating results will also depend on our ability to develop and maintain a successful marketing and sales organization despite our rapid growth. If we are unable to manage our growth, our business, operating results and financial condition would be adversely affected. Our services may infringe on the intellectual property rights of others, which may subject us to legal liability, harm our reputation, prevent us from offering some services to our clients or distract management. We cannot be sure that our services or the products of others that we offer to our clients do not infringe on the intellectual property rights of third parties, and we may have infringement claims asserted against us or our clients. These claims may harm our reputation, distract management, cost us money and/or prevent us from offering some services to our clients. Historically, we have generally agreed to indemnify our clients for all expenses and liabilities resulting from claimed infringements of the intellectual property rights of third parties based on the services that we have performed. In some 9 instances, the amount of these indemnities may be greater than the revenues we receive from the client. In addition, as a result of intellectual property litigation, we may be required to stop selling, incorporating or using products that use the infringed intellectual property. We may be required to obtain a license or pay a royalty to make, sell or use the relevant technology from the owner of the infringed intellectual property, such licenses or royalties may not be available on commercially reasonable terms, or at all. We may also be required to redesign our products or change our methodologies so as not to use the infringed intellectual property, which may not be technically or commercially feasible and may cause us to expend significant resources. Any claims or litigation in this area, whether we ultimately win or lose, could be time-consuming and costly and/or injure our reputation. As the number of patents, copyrights and other intellectual property rights in our industry increases, we believe that companies in our industry will face more frequent infringement claims. Defending against these claims, even if the claims have no merit, could be expensive and divert management's attention and resources from operating our company. We have a limited ability to protect our intellectual property rights, and unauthorized use of our intellectual property could result in the loss of clients. Our success depends, in part, upon our ability to protect our proprietary methodologies and other intellectual property. We rely upon a combination of trade secrets, confidentiality policies, nondisclosure and other contractual arrangements and copyright and trademark laws to protect our intellectual property rights. However, existing laws of some countries in which we provide services, such as India, provide protection of intellectual property rights which may be more limited than those provided in the United States. The steps we take to protect our intellectual property may not be adequate to prevent or deter infringement or other unauthorized use of our intellectual property, and we may not be able to detect unauthorized use or take appropriate and timely steps to enforce our intellectual property rights. Our competitors may be able to imitate or duplicate our services or methodologies. The unauthorized use or duplication of our intellectual property could disrupt our ongoing business, distract our management and employees, reduce our revenues and increase our expenses. We may need to litigate to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Any such litigation could be time-consuming and costly. Our engagements with clients may not be profitable. Unexpected costs or delays could make our contracts unprofitable. When making proposals for engagements, we estimate the costs and timing for completing the projects. These estimates reflect our best judgment regarding the efficiencies of our methodologies and costs. The profitability of our engagements, and in particular our fixed-price contracts, is affected by increased or unexpected costs or unanticipated delays in connection with the performance of these engagements, including delays caused by factors outside our control, which could make these contracts less profitable or unprofitable. The occurrence of any of these costs or delays could result in an unprofitable engagement or litigation. Our clients may terminate our contracts on short notice. Our clients typically retain us on a non-exclusive, engagement-by-engagement basis, rather than under exclusive long-term contracts. Many of our consulting engagements are less than 12 months in duration, and our clients may terminate most of our engagements on short notice. Large client projects typically involve multiple engagements or stages, and there is always a risk that a client may choose not to retain us for additional stages of a project or that a client will cancel or delay additional planned engagements. When contracts are terminated, we lose the associated revenues, and we may not be able to eliminate associated costs in a timely manner or transition employees to new engagements in an efficient manner. 10 Our profitability is dependent on our billing and utilization rates, and our ability to control these factors is only partially within our control. Our profit margin is largely a function of the rates we are able to charge for our services and the utilization rate, or chargeability, of our professionals. Accordingly, if we are not able to maintain the rates we charge for our services or maintain an appropriate utilization rate for our professionals, we will not be able to sustain our profit margin, and our profitability will suffer. The rates we are able to charge for our services are affected by a number of factors, including: >our clients' perception of our ability to add value through our services; >our ability to control our costs and improve our efficiency; >introduction of new services or products by us or our competitors; >pricing policies of our competitors; and >general economic conditions. Our utilization rates are affected by a number of factors, including: >seasonal trends, primarily our hiring cycle and holiday and summer vacations; >our ability to transition employees from completed and/or terminated projects to new engagements; >the amount of time spent by our employees on non-billable training activities; >our ability to forecast demand for our services and thereby maintain an appropriate headcount; and >our ability to manage employee attrition. If we are unsuccessful in developing our new outsourcing business, we may not recoup our start-up costs and other expenses incurred in connection with this business. In February 2003, we formed Kanbay Managed Solutions, Inc. to pursue application management outsourcing opportunities. We must fund certain start-up costs and other expenses in connection with this business. We anticipate that outsourcing engagements may have a different engagement length and may require different skills than the services we have traditionally offered. The success of these service offerings is dependent, in part, upon continued demand for these services by our existing and new clients and our ability to meet this demand in a cost-competitive and timely manner. In addition, our ability to effectively offer a wide breadth of outsourcing services depends on our ability to attract existing or new clients to these service offerings. To obtain engagements to provide outsourcing services, we are also more likely to compete with large, well established firms, resulting in increased competition and marketing costs. Accordingly, we cannot be certain that our new service offerings will effectively meet client needs or that we will be able to attract existing or new clients to these service offerings. Failure to maintain full utilization of employees at our U.S.-based development center could adversely affect our financial results. From time to time, we undertake new initiatives to enhance our ability to deliver services to our clients around the world. In early 2004, we established a regional off-site development center in the United States, using approximately 90 former employees of one of our clients as the initial staff. In connection with this initiative, we entered into a service agreement with the client. The agreement expires in February 2005. If we are unable to promptly redeploy the staff of the development center on new or existing projects after the agreement expires, our financial results could suffer from either the employee 11 termination costs resulting from a reduction in our workforce or the costs of carrying the staff at the development center until full utilization is achieved again, or both. It would be difficult to replace our chairman and chief executive officer. We are highly dependent upon our chairman and chief executive officer, Raymond J. Spencer, who is one of our founders and our first employee. Mr. Spencer's efforts, talent and leadership have been, and will continue to be, critical to our success. The diminution or loss of the services of Mr. Spencer could have a material adverse effect on our business, operating results and financial condition. Our management has limited experience managing a public company and regulatory compliance may divert its attention from the day-to-day management of our business. Prior to our initial public offering in July 2004, our management team operated our business as a private company. The individuals who now constitute our management team have limited experience managing a publicly-traded company and limited experience complying with the increasingly complex laws pertaining to public companies. Our management team may not successfully or efficiently manage our transition into a public company that will be subject to significant regulatory oversight and reporting obligations under the federal securities laws. In particular, these new obligations will require substantial attention from our senior management and divert its attention away from the day-to-day management of our business, which could materially and adversely impact our business operations. We are investing substantial cash assets in new facilities, and our profitability could be reduced if our business does not grow proportionately. We currently plan to spend approximately $45 million for the construction of a new delivery center in Hyderabad, India and the expansion of our delivery center in Pune, India. We may face cost overruns or project delays in connection with these facilities or other facilities we may construct in the future. Such expansion may significantly increase our fixed costs. If we are unable to grow our business and revenues proportionately, our profitability will be reduced. Our ability to raise capital in the future may be limited and our failure to raise capital when needed could prevent us from growing. We expect that our cash flow from operations, together with our net proceeds from the initial public offering of shares of our common stock and the amounts we are able to borrow under our credit facility, will be adequate to meet our anticipated needs for at least the next two years. However, we may in the future be required to raise additional funds through public or private financing, strategic relationships or other arrangements. Such financing may not be available on acceptable terms, or at all, and our failure to raise capital when needed could seriously harm our business. Additional equity financing may be dilutive to the holders of our common stock, and debt financing, if available, may involve restrictive covenants and could reduce our profitability. Moreover, strategic relationships, if necessary to raise additional funds, may require us to relinquish some important rights or modify our allocation of resources. We do not control the business, operations or dividend policy of SSS, which contributes a significant portion of our net income. We own a 49.0% interest in SSS Holdings Corporation Limited (SSS), which is a Liverpool, England based IT services firm that focuses primarily on the securities industry with revenues earned predominantly in the United Kingdom. We do not have control of the board of directors of SSS or voting control of SSS. Consequently, we do not control the business, operations or dividend policy of SSS. For the years ended December 31, 2002 and 2003 and for the nine months ended September 30, 2004, our share of the earnings of SSS provided us with $2.2 million, $2.0 million and $2.0 million of equity in earnings of affiliate. 12 RISKS RELATED TO OUR INDIAN AND INTERNATIONAL OPERATIONS Wage pressures in India may reduce our profit margins. Wage costs in India have historically been significantly lower than wage costs in the United States and Europe for comparably skilled professionals. However, wages in India are increasing at a faster rate than in the United States, which will result in increased costs for IT professionals, particularly project managers and other mid-level professionals. We may need to increase the levels of our employee compensation more rapidly than in the past to remain competitive. Compensation increases may reduce our profit margins and otherwise harm our business, operating results and financial condition. Changes in the policies of the Government of India or political instability could delay the further liberalization of the Indian economy and adversely affect economic conditions in India, which could adversely impact our business. The role of the Indian central and state governments in the Indian economy is significant. Although the current Government of India supported the economic liberalization of the Indian economy, this economic liberalization may not continue in the future and specific laws and policies affecting technology companies, foreign investment, currency exchange and other matters affecting our business could change as well. Changes in the policies of the Government of India or political instability could delay the further liberalization of the Indian economy and could adversely affect business and economic conditions in India in general and our business in particular. Terrorist attacks or a war or regional conflicts could adversely affect the Indian economy, disrupt our operations and cause our business to suffer. Terrorist attacks, such as the attacks of September 11, 2001 in the United States, and other acts of violence or war, such as a conflict between India and Pakistan, have the potential to directly impact our clients and the Indian economy by making travel more difficult, interrupting lines of communication and effectively curtailing our ability to deliver our services to our clients. These obstacles may increase our expenses and negatively affect our operating results. In addition, military activity, terrorist attacks and political tensions between India and Pakistan could create a greater perception that the acquisition of services from companies with significant Indian operations involves a higher degree of risk, which could adversely affect our business. Disruptions in telecommunications could harm our global delivery model, which could result in client dissatisfaction and a reduction of our revenues. A significant element of our business strategy is to continue to leverage and expand our delivery centers in Hyderabad and Pune, India. In particular, our delivery centers in Pune and Hyderabad, India accounted for approximately 49.2% and 52.0% of our revenues for the year ended December 31, 2003 and for the nine months ended September 30, 2004. We depend upon third party service providers and various satellite and optical links to link our global delivery centers to our clients. We may not be able to maintain active voice and data communications between our global delivery centers and our clients' sites at all times. Any significant loss in our ability to communicate could result in a disruption in business, which could hinder our performance or our ability to complete client projects on time. This, in turn, could lead to client dissatisfaction and a material adverse effect on our business, our operating results and financial condition. Our net income would decrease if the Government of India reduces or withdraws tax benefits and other incentives it provides to us or adjusts the amount of our income taxable in India or if we repatriate our earnings from India. Currently, we benefit from the tax holidays the Government of India gives to the export of IT services from specially designated software technology parks in India. When our tax holidays and taxable income deduction expire or terminate beginning in 2005, our tax expense will materially increase, 13 reducing our profitability. Recently, the Government of India has disallowed these tax exemptions for certain software companies and required the companies to pay additional taxes. As a result, we cannot be certain that the Government of India will not attempt to disallow our tax holidays or taxable income deduction or require us to pay additional taxes. If we were required to pay additional taxes, our net income and profitability would decrease. For more information regarding our Indian tax exemptions, see "Management's discussion and analysis of financial condition and results of operations Critical accounting policies, estimates and risks Income taxes." The Government of India recently enacted new transfer pricing rules and began audits of companies, including us, that may be subject to these new rules. We believe that our transfer pricing policies reflect best practices in our industry, but we cannot be certain that the audits will not result in adjustments to our Indian taxable income given the lack of precedent in applying the new requirements. To the extent our income is taxable in India, any such adjustments would be expected to increase our Indian tax liability and to thereby decrease our net income. Although we intend to use substantially all of our Indian earnings to expand our international operations instead of repatriating these funds to the United States, under Indian law if we repatriated our Indian earnings in the future or such earnings were no longer deemed to be indefinitely reinvested, we would accrue the applicable amount of taxes associated with such earnings. We cannot currently determine the applicable amount of taxes, however, such amount could be material. Restrictions on immigration may affect our ability to compete for and provide services to clients in the United States, which could adversely affect our ability to meet growth and revenue projections. The majority of our IT professionals are Indian nationals. The ability of our IT professionals to work in the United States, Europe and in other countries depends on our ability to obtain the necessary work visas and work permits. Existing and proposed limitations on and eligibility restrictions for these visas could have a significant impact on our ability to transfer IT professionals to the United States, Europe and other countries. Further, in response to recent global political events, the level of scrutiny in granting visas has increased. New security procedures may delay the issuance of visas and affect our ability to staff projects in a timely way. Our reliance on work visas for a significant number of our IT professionals makes us particularly vulnerable to legislative changes and strict enforcement of new security procedures, as it affects our ability to staff projects with IT professionals who are not citizens of the country where the on-site work is to be performed. If we are not able to obtain a sufficient number of visas for our IT professionals or encounter delays or additional costs in obtaining or maintaining such visas, our ability to meet our growth and revenue projections could be adversely affected. Currency exchange rate fluctuations will affect our operating results. As indicated in the translation table below, the exchange rate between the Indian rupee and the U.S. dollar has changed substantially in recent years and may fluctuate substantially in the future. We expect that a majority of our revenues will continue to be generated in U.S. dollars for the foreseeable future and that a significant portion of our expenses, including personnel costs, as well as capital and operating expenditures, will continue to be denominated in Indian rupees. Accordingly, an appreciation of the Indian rupee against the U.S. dollar may have a material adverse effect on our cost of revenues, gross profit margin and net income, which may in turn have a negative impact on our business, operating results and financial condition. Specifically, based on our current cost structure, a 1% appreciation of the Indian rupee against the U.S. dollar would cause our gross profit margin to decrease by 12 basis points and our operating profit margin to decline by 18 basis points. We expect to adopt by December 31, 2004 a foreign currency exchange management policy to hedge our Exchange rate at January 1 43.505 46.690 48.344 48.120 Exchange rate at December 31 46.690 48.343 48.044 45.600 Change 3.185 1.653 (0.300 ) (2.520 ) % Change 7.3 % 3.5 % (0.6 )% (5.2 )% Our international operations subject us to risks inherent in doing business in international markets. Currently, we have facilities in eight countries around the world, and we earned 22% of our revenues for the nine months ended September 30, 2004 from clients outside the United States. Accordingly, we must comply with a wide variety of national and local laws, and we are subject to restrictions on the import and export of certain technologies and multiple and overlapping tax structures. In addition, we face competition in other countries from companies that may have more experience with operations in those countries or with international operations generally. Consequently, we may not be able to compete effectively in other countries. RISKS RELATED TO THIS OFFERING AND OUR STOCK Our quarterly revenues, operating results and profitability may vary from quarter to quarter, which may result in increased volatility of our share price. Our gross profit margin has fluctuated by as much as 4.3% from quarter to quarter during the past two years. In addition, our quarterly revenues, operating results and profitability have varied in the past and are likely to vary significantly from quarter to quarter in the future, making them difficult to predict. This may lead to volatility in our share price. The factors that are likely to cause these variations include: >seasonal trends, primarily our hiring cycle and holiday and summer vacations; >the business decisions of our clients regarding the use of our services; >the timing and profitability of projects, unanticipated contract terminations or project postponements; >the amount and timing of income or loss from SSS; >our ability to manage utilization and transition employees quickly from completed projects to new engagements; >the introduction of new services by us or our competitors; >changes in our pricing policies or those of our competitors; >our ability to manage costs, including personnel costs and support services costs; >costs related to possible acquisitions of other businesses; 15 >exchange rate fluctuations; and >global economic conditions. Due to the foregoing factors, it is possible that in some future periods our revenues and operating results may be significantly below the expectations of public market analysts and investors. In such an event, the price of our common stock would likely be materially and adversely affected. The future sale of our common stock could negatively affect our stock price after this offering. After this offering, we will have 32,913,097 shares of common stock outstanding. Sales of a substantial number of our shares of common stock in the public market following this offering or the expectation of such sales could cause the market price of our common stock to decline. All the shares sold in this offering will be freely tradeable except that any shares purchased by our affiliates will remain subject to certain restrictions. After this offering, the holders of approximately 6,269,105 of our shares of common stock and 596,064 shares issuable upon exercise of outstanding warrants will be entitled to registration rights with respect to these shares. Such holders may require us to register the resale of substantially all of these shares upon demand. These holders include Household International, which will own approximately 14.2% of our common stock after this offering and will be selling shares of our common stock in this offering. Any sales of our common stock by Household International could be negatively perceived in the trading markets and negatively affect the price of our common stock. We have registered all shares of common stock that we may issue to our employees under our stock option plan and stock incentive plan. Certain of these shares are eligible for resale in the public market without restriction. For more information, see "Shares eligible for future sale." We are subject to anti-takeover provisions which could affect the price of our common stock. Certain provisions of Delaware law and of our certificate of incorporation and by-laws could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire, control of us. For example, our certificate of incorporation and by-laws provide for a classified board of directors, limit the persons who may call special meetings of stockholders and allow us to issue preferred stock with rights senior to those of the common stock without any further vote or action by our stockholders. In addition, we will be subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which could have the effect of delaying, deterring or preventing another party from acquiring control of Kanbay. These provisions could deprive our stockholders of an opportunity to receive a premium for their common stock as part of a sale of our company or may otherwise discourage a potential acquirer from attempting to obtain control of our company, which in turn could have a material adverse effect on the market price of our common stock. We do not intend to pay dividends, which may limit the return on your investment in us. We have never declared or paid cash dividends on our common stock. We currently intend to retain all available funds and any future earnings for use in the operation and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future.

parsed_sections/risk_factors/2004/CIK0001142512_ziprealty_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ risks associated with operating a business or in a market in which we have little or no prior experience; potential write offs of acquired assets; loss of key employees of acquired businesses; and our inability to recover the costs of acquisitions or investments. If we are required to expense options, it could significantly reduce our net income in future periods. The Financial Accounting Standards Board, or FASB, issued an Exposure Draft, Share-Based Payment: an amendment of Statement of Financial Accounting Standards No. 123 and No. 95 in March 2004 that would require a company to recognize compensation cost for all share based payments, including employee stock options, at fair value beginning in 2005 and subsequent reporting periods. Recently the FASB concluded that the amendment referred to in the Exposure Draft would be effective for public companies for interim or annual periods beginning after June 15, 2005. If the amendment is enacted as described in the Exposure Draft, we will be required to record an expense for our stock-based compensation plans using the fair value method beginning on July 1, 2005. This expense could exceed the expense we currently record for our stock-based compensation plans and correspondingly reduce our net income in future periods. RISKS RELATED TO THIS OFFERING Our common stock could trade at prices below the initial public offering price. Before this offering, there has not been a public trading market for shares of our common stock. An active trading market may not develop or be sustained after this offering. The initial public offering price for the shares of common stock sold in this offering will be determined by negotiations between us and representatives of the underwriters. This price may bear no relationship to the price at which our common stock will trade after this offering. Our stock price may be volatile, and you may not be able to resell your shares at or above the initial public offering price. The trading price of our common stock after this offering may fluctuate widely, depending upon many factors, some of which are beyond our control. These factors include, among others, the risks identified above and the following: variations in our quarterly results of operations; announcements by us or our competitors or lead source providers; changes in estimates of our performance or recommendations, or termination of coverage by securities analysts; inability to meet quarterly or yearly estimates or targets of our performance; the hiring or departure of key personnel, including agents or groups of agents or key executives; changes in our reputation; acquisitions or strategic alliances involving us or our competitors; changes in the legal and regulatory environment affecting our business; and market conditions in our industry and the economy as a whole. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box. CALCULATION OF REGISTRATION FEE Title of Each Class of Proposed Maximum Aggregate Amount of Securities to be Registered Offering Price(1) Registration Fee(2) Common Stock $0.001 par value $69,000,000 $8,743 (1) Estimated solely for the purpose of computing the amount of the registration fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended. (2) Previously paid. The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission acting pursuant to said Section 8(a) may determine. Income (loss) before income taxes (2,977 ) (2,225 ) 446 173 (115 ) 1,187 1,271 Provision for income taxes 30 Table of Contents The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and we are not soliciting offers to buy these securities in any jurisdiction where the offer or sale is not permitted. PRELIMINARY PROSPECTUS Subject to completion November 8, 2004 4,550,000 Shares Common Stock This is our initial public offering of shares of our common stock. No public market currently exists for our common stock. The initial public offering price of our common stock is expected to be between $10.00 and $12.00 per share. The Nasdaq National Market has approved our common stock for quotation under the symbol ZIPR subject to notice of issuance. Before buying any shares, you should read the discussion of material risks of investing in our common stock in Risk factors beginning on page 9. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. Per share Total Other income (expense): Interest expense (226 ) (2,118 ) (2,273 ) (2,271 ) Interest income 193 126 60 44 95 Other income (expense), net 3 (14 ) Other income (expense): Interest expense (226 ) (2,118 ) (2,273 ) (2,271 ) Interest income 9 304 193 126 60 44 95 Other income (expense), net 3 (14 ) Other income (expense): Interest expense (226 ) (2,118 ) (2,273 ) (2,271 ) Interest income 193 126 60 44 95 Other income (expense), net 3 (14 ) Initial public offering price $ $ Underwriting discounts and commissions $ $ Proceeds, before expenses, to us $ $ The underwriters may also purchase up to 682,500 shares of common stock from us at the initial public offering price, less underwriting discounts and commissions, within 30 days from the date of this prospectus. The underwriters may exercise this option only to cover over-allotments, if any. The underwriters are offering the common stock as set forth under Underwriting. Delivery of the shares of common stock will be made on or about , 2004. UBS Investment Bank Deutsche Bank Securities Table of Contents Ziprealty is a full-service residential brokerage that uses the internet to empower consumers and deliver outstanding service and value to clients. Zip Realty Your home is where our heart is. ________________________________________________________________________________ You should only rely on the information contained in this prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus. We are offering to sell, and seeking offers to buy, shares of common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of common stock. ZipRealty is our registered trademark in the United States. Our pending trademarks appearing in this prospectus include: Your home is where our heart is, ZipAgent, ZipNotify and ZipAgent Platform. REALTOR and REALTORS are registered trademarks of the National Association of REALTORS . All other trademarks, trade names and service marks appearing in this prospectus are the property of their respective owners. TABLE OF CONTENTS Table of Contents Summary financial data The following table summarizes financial data regarding our business and should be read together with Management s discussion and analysis of financial condition and results of operations and our financial statements and related notes included elsewhere in this prospectus. Nine months ended Year ended December 31, September 30, Net revenues 5,593 8,633 10,301 9,280 10,899 16,270 17,572 Operating expenses: Cost of revenues 3,653 5,163 5,894 5,219 6,093 8,710 9,587 Product development 518 461 384 354 447 549 643 Marketing and business development 1,045 1,362 1,375 1,221 1,660 2,203 2,462 General and administrative 2,457 2,496 2,188 2,323 2,788 3,594 (1) 3,632 (1) Stock-based compensation 19 19 19 28 38 47 Net revenues 3,963 17,163 33,807 24,527 44,741 Income (loss) before income taxes (13,792 ) (14,765 ) (4,583 ) (4,756 ) 2,343 Provision for income taxes Income (loss) before income taxes (2,209 ) (19,965 ) (13,792 ) (14,765 ) (4,583 ) (4,756 ) 2,343 Provision for income taxes Total other income (expense), net (30 ) (2,006 ) (2,192 ) (2,230 ) 95 Income (loss) before income taxes (13,792 ) (14,765 ) (4,583 ) (4,756 ) 2,343 Provision for income taxes (in thousands) Provision for income taxes $ $ 47 $ Eric A. Danziger 50 President, Chief Executive Officer and Director Gary M. Beasley 39 Executive Vice President and Chief Financial Officer William Scott Kucirek 38 Executive Vice President of New Market Development and Director William C. Sinclair 55 Senior Vice President of Sales and Operations Alain J. An 47 Vice President of Human Resources Joseph Patrick Lashinsky 37 Vice President of Marketing and Business Development David A. Rector 58 Vice President, Controller and Chief Accounting Officer Karen B. Seto 39 Vice President, General Counsel and Secretary Joseph P. Trifoglio 51 Vice President of Technology Ronald C. Brown(1)(3) 50 Director Marc L. Cellier(2) 41 Director Matthew E. Crisp(2) 33 Director Robert C. Kagle(2)(3) 48 Director Stanley M. Koonce, Jr.(1) 56 Director Juan F. Mini 36 Director Donald F. Wood(1)(3) Total operating expenses 17,725 29,922 36,198 27,053 42,493 Income (loss) from operations (13,762 ) (12,759 ) (2,391 ) (2,526 ) 2,248 Total other income (expense), net (878 ) (1,357 ) 5 38 12 (20 ) (in thousands) Stock-based compensation $ 57 $ 126 $ Stock-based compensation can be allocated to the following: Cost of revenues $ 5 $ 1 $ 8 $ 1 $ 37 Product development 44 25 23 17 10 Marketing and business development 68 19 18 14 5 General and administrative 68 39 36 25 Net income (loss) $ (13,792 ) $ (14,765 ) $ (4,583 ) $ (4,756 ) $ 2,296 Other operating data Number of ZipAgents at period end 162 279 440 425 782 Total value of real estate transactions closed during period (in billions) $ 0.2 $ 0.9 $ 1.6 $ 1.2 $ 2.1 Number of transactions closed during period(1) 844 3,379 5,394 3,992 6,163 Average net revenue per transaction during period(2) $ 4,629 $ 4,970 $ 6,058 $ 5,915 $ 7,086 Table of Contents The following table presents a summary of our balance sheet data at September 30, 2004: on an actual basis; and on a pro forma as adjusted basis to give effect to the conversion of all outstanding shares of preferred stock into shares of common stock immediately prior to the completion of this offering, the sale of 4,550,000 shares of common stock offered by us at an assumed initial public offering price of $11.00 per share, the mid-point of the range on the cover of this prospectus, and the application of the net proceeds from this offering, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. September 30, 2004 Pro forma Balance sheet data Actual as adjusted Table of Contents Risk factors You should carefully consider the risk factors described below, together with all of the other information included in this prospectus, before you decide whether to invest in shares of our common stock. The occurrence of any of the following risks could harm our business, financial condition or results of operations. In that case, the market price of our common stock could decline, and you may lose all or part of your investment. RISKS RELATED TO OUR BUSINESS AND INDUSTRY Our business model is new and unproven, and we cannot guarantee our future success. Our Internet-enabled residential real estate brokerage service is a relatively new and unproven business model. Our business model differs significantly from that of a traditional real estate brokerage firm in several ways, including our heavy reliance on the Internet and technology and our employee agent model. The success of our business model depends on our ability to achieve higher transaction volumes at an overall lower cost per transaction in order to offset the costs associated with our technology, employee benefits, marketing and advertising expenses and discounts and rebates. If we are unable to efficiently acquire clients and maintain agent productivity, our ZipAgents may close fewer transactions and our net revenues could suffer as a result. In addition, our agents generally earn a lower per transaction commission than a traditional independent contractor agent. If we are unsuccessful in providing our agents with more opportunities to close transactions than under the traditional model, our ability to hire and retain qualified real estate agents would be harmed, which would in turn significantly harm our business. We have been profitable in only four quarters and may incur losses in the future, and our limited operating history makes our future financial performance difficult to assess. We were formed in January 1999 and therefore have a limited operating history upon which to evaluate our operations and future prospects. We have had a history of losses from inception through the first half of 2003 and at September 30, 2004 had an accumulated deficit of $53.0 million. While we were profitable in the third and fourth quarters of 2003 and the second and third quarters of 2004, we sustained a loss for the first quarter of 2004 and we may not be profitable in future quarters or on an annual basis. Our business model has evolved, and we have only recently achieved significant revenues. We may incur additional expenses with the expectation that our revenues will grow in the future, which may not occur. As a result, we could experience budgeting and cash flow management problems, unexpected fluctuations in our results of operations and other difficulties, any of which could harm our ability to achieve or maintain profitability, increase the volatility of the market price of our common stock or harm our ability to raise additional capital. We expect that we will continue to increase our expenses, including marketing and business development expenses and expenses incurred as a result of increasing the number of agents we employ. As we grow our business in existing markets and expand to new markets, we cannot guarantee our business strategies will be successful or that our revenues will ever increase sufficiently to achieve and maintain profitability on a quarterly or annual basis. Table of Contents Risk factors Our business model requires access to real estate listing services provided by third parties that we do not control, and the demand for our services may be reduced if our ability to display listings on our web site is restricted. A key component of our business model is that through our web site we offer clients access to, and the ability to search, real estate listings posted on the MLSs in the markets we serve. Most large metropolitan areas in the United States have at least one MLS, though there is no national MLS. The homes in each MLS are listed voluntarily by its members, who are licensed real estate brokers. The information distributed in an MLS allows brokers to cooperate in the identification of buyers for listed properties. If our access to one or more MLS databases were restricted or terminated, our service could be adversely affected and our business may be harmed. Because participation in an MLS is voluntary, a broker or group of brokers may decline to post their listings to the existing MLS and instead create a new proprietary real estate listing service. If a broker or group of brokers created a separate real estate listing database, we may be unable to obtain access to that private listing service on commercially reasonable terms, if at all. As a result, the percentage of available real estate listings that our clients would be able to search using our web site would be reduced, perhaps significantly, thereby making our services less attractive to potential clients. Additionally, the National Association of Realtors, or NAR, the dominant trade organization in the residential real estate industry, has recently adopted a mandatory policy for NAR-affiliated MLSs regarding the use and display of MLS listings data on virtual office web sites, or VOWs. We operate a VOW, which is a password protected website which allows us to show comprehensive MLS data directly to consumers without their having to visit an agent. Individual MLSs affiliated with NAR, which includes the vast majority of MLSs in the United States, will be required to implement their own individual VOW policies consistent with the NAR policy by July 1, 2005. NAR has extended the deadline for the implementation of its rules at least three times during an investigation by the antitrust division of the U.S. Department of Justice into NAR s policy that dictates how brokers can display other brokers property listings on their web sites. We presently do not know whether or when the NAR rules will be implemented in their current form or in a revised form, if at all. Once these individual MLS VOW policies are implemented, the NAR policy currently provides that member brokerages will have up to six months to comply with the policy. The NAR policy is designed to provide structure to the individual MLS VOW policies, subject to a number of areas in which the individual MLSs may tailor the policy to meet their local needs. One NAR policy provision with which the individual MLSs must adhere, once required to be implemented, is known as an opt-out. This provision creates a mechanism for individual brokers to prevent their listings data from being displayed on certain competitors VOWs. MLS members and participants, including individual brokers, could exercise a blanket opt-out, which would not allow their listings to be displayed on any competing VOW, or a selective opt-out, in which they could selectively prevent certain competing VOWs from displaying their listings, while allowing other VOWs to do so. A few of the MLSs of which we are a member, as well as at least one of the state Association of REALTORS of which we are a member, have adopted VOW policies with opt-out provisions, apparently in anticipation of their required implementation of the NAR policy. To our knowledge, to date no members or participants of any of those MLSs have exercised such an opt-out right. Should any such right be exercised, it could restrict our ability to display comprehensive MLS home listings data to our consumers, which is a key part of our business model. Should our ability to display MLS listings information on our web site be significantly restricted, it may reduce demand for our services and lead to a decrease in the number of residential real estate transactions completed by our ZipAgents, as well as increase our costs of ensuring compliance with such restrictions. Table of Contents Risk factors Total other income (expense), net (30 ) (2,006 ) (2,192 ) (2,230 ) If we fail to recruit, hire and retain qualified agents, we may be unable to service our clients and our growth could be impaired. Our business requires us to hire employees who are licensed real estate agents, and our strategy is based on consistently and rapidly growing our team of ZipAgents. Competition for qualified agents is intense, particularly in the markets in which we compete. While there are many licensed real estate agents in our markets and throughout the country, historically we have had difficulties in recruiting and retaining properly qualified licensed agents due particularly to agent discomfort with using technology and being actively managed by an employer. In addition, our lower per transaction agent commission model may be unattractive to certain higher performing agents. If we are unable to recruit, train and retain a sufficient number of qualified licensed real estate agents, we may be unable to service our clients properly and grow our business. Historically we have experienced a high degree of agent turnover, most of which occurs in the first few months after commencing employment. This turnover has required us to expend a substantial amount of time and money to replace agents who have left as we have been growing our business. If this situation worsens, our rate of expansion into new markets could be slowed and we will continue to employ a significantly higher number of new agents with less experience operating in our business model, which could cause us to be less effective at expanding our market share in our existing markets and entering new markets. Furthermore, we rely on federal and state exemptions from minimum wage and fair labor standards laws for our ZipAgents, who are compensated solely through commissions. Such exemptions may not continue to be available, or we may not qualify for such exemptions, which could subject us to penalties and damages for non-compliance. If similar exemptions are not available in states where we desire to expand our operations or if they cease to be available in the states where we currently operate, we may need to modify our agent compensation structure in such states. Our failure to effectively manage the growth of our ZipAgents and our information and control systems could adversely affect our ability to service our clients. As our operations have expanded, we have experienced rapid growth in our headcount from 233 total employees, including 162 ZipAgents, at December 31, 2001 to 919 total employees, including 782 ZipAgents, at September 30, 2004. We expect to continue to increase headcount in the future, particularly the number of ZipAgents. Our rapid growth has demanded, and will continue to demand, substantial resources and attention from our management. We will need to continue to hire additional qualified agents and improve and maintain our technology to properly manage our growth. If we do not effectively manage our growth, our client service and responsiveness could suffer and our costs could increase, which could negatively affect our brand and operating results. As we grow, our success will depend on our ability to continue to implement and improve our operational, financial and management information and control systems on a timely basis, together with maintaining effective cost controls. This ability will be particularly critical as we implement new systems and controls to help us comply with the more stringent requirements of being a public company, including the requirements of the Sarbanes-Oxley Act of 2002, which require management to evaluate and assess the effectiveness of our internal controls and our disclosure controls and procedures. Effective internal controls are required by law and are necessary for us to provide reliable financial reports and effectively prevent fraud. Effective disclosure controls and procedures will be required by law and are necessary for us to file complete, accurate and timely reports under the Securities Exchange Act of 1934. Any inability to provide reliable financial reports or prevent fraud or to file complete, accurate and timely reports under the Securities Exchange Act could harm our business, harm our reputation or result in a decline in or stock price. We are continuing to evaluate Total other income (expense), net 9 304 (30 ) (2,006 ) (2,192 ) (2,230 ) Table of Contents Risk factors and, where appropriate, enhance our systems, procedures and internal controls. We are in the process of establishing our disclosure controls and procedures. If our systems, procedures or controls are not adequate to support our operations and reliable, accurate and timely financial and other reporting, we may not be able to successfully satisfy regulatory and investor scrutiny, offer our services and implement our business plan. Our operating results are subject to seasonality and vary significantly among quarters during each calendar year, making meaningful comparisons of successive quarters difficult. The residential real estate market traditionally has experienced seasonality, with a peak in the spring and summer seasons and a decrease in activity during the fall and winter seasons. Revenues in each quarter are significantly affected by activity during the prior quarter, given the typical 30- to 45-day time lag between contract execution and closing. Historically, this seasonality has caused our revenues, operating income, net income and cash flow from operating activities to be lower in the first and fourth quarters and higher in the second and third quarters of each year. Factors affecting the timing of real estate transactions that can cause our quarterly results to fluctuate include: timing of widely observed holidays and vacation periods and availability of real estate agents and related service providers during these periods; a desire to relocate prior to the start of the school year; timing of employment compensation changes, such as raises and bonuses; and the time between entry into a purchase contract for real estate and closing of the transaction. We expect our revenues to continue to be subject to these seasonal fluctuations, which, combined with our recent growth, make it difficult to compare successive quarters. Interest rates have been at historic lows for the past several years, and increases in interest rates have the potential to negatively impact the housing market. When interest rates rise, all other things being equal, housing becomes less affordable, since at a given income level people cannot qualify to borrow as much principal, or given a fixed principal amount they will be faced with higher monthly payments. This result may mean that fewer people will be able to afford homes at prevailing prices, potentially leading to fewer transactions or reductions in home prices in certain regions, depending also on the relevant supply-demand dynamics of those markets. Since we operate in only 12 markets around the country, it is possible that we could experience a more pronounced impact than we would experience if our operations were more diversified. Should we experience softening in our markets and not be able to offset the potential negative market influences on price and volume by increasing our transaction volume through market share growth, our financial results could be negatively impacted. If consumers do not continue to use the Internet as a tool in their residential real estate buying or selling process, we may be unable to attract new clients and our growth and financial results may suffer. We rely substantially on our web site and web-based marketing for our client lead generation. As the residential real estate business has traditionally been characterized by personal, face-to-face relationships between buyers and sellers and their agents, our success will depend to a certain extent on the willingness of consumers to increase their use of online services in the real estate sales and purchasing process. In addition, our success will depend on consumers visiting our web site early in Table of Contents Risk factors their selling or buying process so that we can interface with potential clients before they have engaged a real estate agent to represent them in their transactions. If we are unable to convince visitors to our web site to transact business with us, our ZipAgents will have fewer opportunities to represent clients in residential real estate transactions and our net revenues could suffer. Our success depends in part on our ability to successfully expand into additional real estate markets. We currently operate in 12 markets, including 11 of the 25 most populous U.S. metropolitan statistical areas. A part of our business strategy is to grow our business by entering into additional real estate markets. Key elements of this expansion include our ability to identify strategically attractive real estate markets and to successfully establish our brand in those markets. We consider many factors when selecting a new market to enter, including: the economic conditions and demographics of a market; the general prices of real estate in a market; Internet use in a market; competition within a market from local and national brokerage firms; rules and regulations governing a market; the ability and capacity of our organization to manage expansion into additional geographic areas, additional headcount and increased organizational complexity; the existence of local MLSs; and state laws governing cash rebates and other regulatory restrictions. We have not entered a new geographic market since July 2000 and have limited experience expanding into and operating in multiple markets, managing multiple sales regions or addressing the factors described above. In addition, this expansion could involve significant initial start-up costs. We expect that significant revenues from new markets will be achieved, if ever, only after we have been operating in that market for some time and begun to build market awareness of our services. As a result, geographic expansion is likely to significantly increase our expenses and cause fluctuations in our operating results. In addition, if we are unable to successfully penetrate these new markets, we may continue to incur costs without achieving the expected revenues, which would harm our financial condition and results of operations. Unless we develop, maintain and protect a strong brand identity, our business may not grow and our financial results may suffer. We believe a strong brand is a competitive advantage in the residential real estate industry because of the fragmentation of the market and the large number of agents and brokers available to the consumer. Because our brand is relatively new, we currently do not have strong brand identity. In addition, we recently redesigned our logo and marketing slogan, which could result in loss of the brand recognition we currently have and confusion among consumers. We believe that establishing and maintaining brand identity and brand loyalty is critical to attracting new clients. In order to attract and retain clients, and respond to competitive pressures, we expect to increase our marketing and business development expenditures to maintain and enhance our brand in the future. We plan to expand our current online, radio, outdoor and newspaper advertising and conduct future television advertising campaigns. We plan to increase our advertising expenditures substantially in the future. While we intend to enhance our marketing and advertising activities in order to promote our Table of Contents Risk factors brand, these activities may not have a material positive impact on our brand identity. In addition, maintaining our brand will depend on our ability to provide a high-quality consumer experience and high quality service, which we may not do successfully. If we are unable to maintain and enhance our brand, our ability to attract new clients or successfully expand our operations will be harmed. We have numerous competitors, many of which have valuable industry relationships and access to greater resources than we do. The residential real estate market is highly fragmented, and we have numerous competitors, many of which have greater name recognition, longer operating histories, larger client bases, and significantly greater financial, technical and marketing resources than we do. Some of those competitors are large national brokerage firms or franchisors, such as Prudential Financial, Inc., RE/ MAX International Inc. and Cendant Corporation, which owns the Century 21, Coldwell Banker and ERA franchise brands, a large corporate relocation business and NRT Incorporated, the largest brokerage in the United States. NRT owns and operates brokerages that are typically affiliated with one of the franchise brands owned by Cendant. We are also subject to competition from local or regional firms, as well as individual real estate agents. We also compete or may in the future compete with various online services, such as InterActiveCorp and its LendingTree unit, HouseValues, Inc., HomeGain, Inc., Homestore, Inc. and its Realtor.com affiliate and Yahoo! Inc. that also look to attract and monetize home buyers and sellers using the Internet. Homestore is affiliated with NAR, the National Association of Home Builders, or NAHB, a number of major MLSs and Cendant, which may provide Homestore with preferred access to listing information and other competitive advantages. In addition, our technology-focused business model is a relatively new approach to the residential real estate market and many consumers may be hesitant to choose us over more established brokerage firms employing traditional techniques. Some of our competitors are able to undertake more extensive marketing campaigns, make more attractive offers to potential agents and clients and respond more quickly to new or emerging technologies. Over the past several years there has been a slow but steady decline in average commissions charged in the real estate brokerage industry, with the average commission percentage decreasing from 5.44% in 2000 to 5.14% in 2003 according to REAL Trends. Some of our competitors with greater resources may be able to better withstand the short- or long-term financial effects of this trend. In addition, the barriers to entry to providing an Internet-enabled real estate service are low, making it possible for current or new competitors to adopt certain aspects of our business model, including offering comprehensive MLS data to clients via the Internet, thereby reducing our competitive advantage. We may not be able to compete successfully for clients and agents, and increased competition could result in price reductions, reduced margins or loss of market share, any of which would harm our business, operating results and financial condition. Changes in federal and state real estate laws and regulations, and rules of industry organizations such as the National Association of REALTORS , could adversely affect our business. The real estate industry is heavily regulated in the United States, including regulation under the Fair Housing Act, the Real Estate Settlement Procedures Act, state and local licensing laws and regulations and federal and state advertising laws. In addition to existing laws and regulations, states and industry participants and regulatory organizations could enact legislation, regulatory or other policies in the future, which could restrict our activities or significantly increase our compliance costs. Moreover, the provision of real estate services over the Internet is a new and evolving business, and legislators, regulators and industry participants may advocate additional legislative or regulatory initiatives governing the conduct of our business. If existing laws or regulations are amended or new laws or Table of Contents Risk factors regulations are adopted, we may need to comply with additional legal requirements and incur significant compliance costs, or we could be precluded from certain activities. Because we operate through our web site, state and local governments other than where the subject property is located may attempt to regulate our activities, which could significantly increase our compliance costs and limit certain of our activities. In addition, industry organizations, such as NAR and other state and local organizations, can impose standards or other rules affecting the manner in which we conduct our business. As mentioned above, NAR has adopted rules that, if implemented, could result in a reduction in the number of home listings that could be viewed on our web site. NAR has extended the deadline for the implementation of its rules at least twice during an investigation by the antitrust division of the U.S. Department of Justice into NAR s policy that dictates how brokers can display other brokers property listings on their web sites. We presently do not know whether or when the NAR rules will be implemented in their current form or in a revised form, if at all. The implementation of the rules will not limit our access to listing information, but could limit the display of listing information to our clients through our web site in the manner we currently utilize, as well as increase our costs of ensuring compliance with such rules. Any significant lobbying or related activities, either of governmental bodies or industry organizations, required to respond to current or new initiatives in connection with our business could substantially increase our operating costs and harm our business. We derive a significant portion of our leads through third parties, and if any of our significant lead generation relationships are terminated or become more expensive, our ability to attract new clients and grow our business may be adversely affected. We generate leads for our ZipAgents through many sources, including leads from third parties with which we have only non-exclusive, short-term agreements that are generally terminable on little or no notice and with no penalties. Our largest third-party lead source in the first nine months of 2004, HomeGain, Inc., which competes with us for online customer acquisition, generated approximately 22% of our leads during that period. In addition, during the second quarter of 2004 our exclusive co-branded relationship which we had in four markets with one third-party lead source, Yahoo! Inc., was terminated, effective July 31, 2004. Leads from this source accounted for approximately 14% of our leads and 8% of our net revenues during the first nine months of 2004. These leads were inexpensive relative to those generated from competing sources, although they also were characterized by a lower conversion rate than is typical from our other sources. As a result, our lead replacement strategy includes delivering fewer leads to the agents in the areas impacted by the termination of the Yahoo! co-branded relationship with those leads characterized by what we believe to be higher conversion potential based upon historical experience. Should this replacement strategy not be successful, or any of our other lead generation relationships become materially more expensive such that we could not obtain substitute sources on acceptable terms, our ability to attract new clients and grow our business may be impaired. Our business could be harmed by economic events that are out of our control and may be difficult to predict. The success of our business depends in part on the health of the residential real estate market, which traditionally has been subject to cyclical economic swings. The purchase of residential real estate is a significant transaction for most consumers, and one which can be delayed or terminated based on the availability of discretionary income. Economic slowdown or recession, rising interest rates, adverse tax policies, lower availability of credit, increased unemployment, lower consumer confidence, lower wage and salary levels, war or terrorist attacks, or the public perception that any of these events may occur, could adversely affect the demand for residential real estate and would harm our business. Also, if interest rates increase significantly, homeowners ability to purchase a new home or a higher priced home may be reduced as higher monthly payments would make housing less affordable. In addition, Table of Contents Risk factors these conditions could lead to a decline in new listings, transaction volume and sales prices, any of which would harm our operating results. Our ability to expand our business may be limited by state laws governing cash rebates to home buyers. A significant component of our value proposition to our home buyer clients is a cash rebate provided to the buyer at closing. Currently, our clients who are home buyers represent a substantial majority of our business and revenues. Certain states, such as Alaska, Kansas, Kentucky, Louisiana, Mississippi, New Jersey, Oklahoma, Oregon and Tennessee, may presently prohibit sharing any commissions with, or providing rebates to, clients who are not licensed real estate agents. In addition, other states may limit or restrict our cash rebate program as currently structured, including Missouri and New York. Should we decide to expand into any of these states, we may have to adjust our pricing structure or refrain from offering rebates to buyers in these states. Moreover, we cannot predict whether alternative approaches will be cost effective or easily marketable to prospective clients. The failure to enter into these markets, or others that adopt similar restrictions, or to successfully attract clients in these markets, could harm our business. We may be unable to integrate our technology with each MLS on a cost-effective basis, which may harm our operating results and adversely affect our ability to service clients. Each MLS is operated independently and is run on its own technology platform. As a result, we must constantly modify our technology to successfully interact with each independent MLS in order to maintain access to that MLS s home listings information. In addition, when a new MLS is created, we must customize our technology to work with that new system. These activities require constant attention and significant resources. We may be unable to successfully interoperate with the MLSs without significantly increasing our engineering costs, which would increase our operating expenses without a related increase in net revenues and cause our operating results to suffer. We may also be unable to interoperate with the MLSs at all, which may adversely affect the demand for our services. If we fail to comply with real estate brokerage laws and regulations, we may incur significant financial penalties or lose our license to operate. Due to the geographic scope of our operations and the nature of the real estate services we perform, we are subject to numerous federal, state and local laws and regulations. For example, we are required to maintain real estate brokerage licenses in each state in which we operate and to designate individual licensed brokers of record. If we fail to maintain our licenses, lose the services of our designated broker of record or conduct brokerage activities without a license, we may be required to pay fines or return commissions received, our licenses may be suspended or we may be subject to other civil and/or criminal penalties. As we expand into new markets, we will need to obtain and maintain the required brokerage licenses and comply with the applicable laws and regulations of these markets, which may be different from those to which we are accustomed, may be difficult to obtain and will increase our compliance costs. In addition, because the size and scope of real estate sales transactions have increased significantly during the past several years, both the difficulty and cost of compliance with the numerous state licensing regimes and possible losses resulting from non-compliance have increased. Our failure to comply with applicable laws and regulations, the possible loss of real estate brokerage licenses or litigation by government agencies or affected clients may have a material adverse effect on our business, financial condition and operating results, and may limit our ability to expand into new markets. Table of Contents Risk factors We may have liabilities in connection with real estate brokerage activities. As a licensed real estate broker, we and our licensed employees are subject to statutory due diligence, disclosure and standard-of-care obligations. In the ordinary course of business we and our employees are subject to litigation from parties involved in transactions for alleged violations of these obligations. In addition, we may be required to indemnify our employees who become subject to litigation arising out of our business activities, including for claims related to the negligence of those employees. An adverse outcome in any such litigation could negatively impact our reputation and harm our business. We may be subject to liability for the Internet content that we publish. As a publisher of online content, we face potential liability for negligence, copyright, patent or trademark infringement, or other claims based on the nature and content of the material that we publish or distribute. Such claims may include the posting of confidential data, erroneous listings or listing information and the erroneous removal of listings. These types of claims have been brought successfully against the providers of online services in the past and could be brought against us or others in our industry. In addition, we may face liability if a MLS member or participant utilizes an opt-out provision, as previously discussed, and we fail to comply with that requirement. These claims, whether or not successful, could harm our reputation, business and financial condition. Although we carry general liability insurance, our insurance may not cover claims of these types or may be inadequate to protect us for all liability that we may incur. We monitor and evaluate the use of our web site by our registered users, which could raise privacy concerns. Visitors to our web site that register with us receive access to home listing and related information that we do not make available to unregistered users. As part of the registration process, our registered users consent to our use of information we gather from their use of our web site, such as the geographic areas in which they search for homes, the price range of homes they view, their activities while on our web site and other similar information. They also provide us with personal information such as telephone numbers and email addresses. While our registered users consent to our internal use of this information, if we were to use this information outside the scope of their consent or otherwise fail to keep this information confidential from third parties, including our former agents, we may be subject to legal claims or government action and our reputation and business could be harmed. While we do not share web site use and other personal information with any third parties, except with our clients consent to third parties involved in the transaction process, concern among consumers regarding our use of personal information gathered from visitors to our web site could cause them not to register with us. This would reduce the number of leads we derive from our web site. Because our web site is our primary client acquisition tool, any resistance by consumers to register on our web site would harm our business and results of operations, and could cause us to alter our business practices or incur significant expenses to educate consumers regarding the use we make of information. We may need to change the manner in which we conduct our business if government regulation of the Internet increases. The adoption or modification of laws or regulations relating to the Internet could adversely affect the manner in which we currently conduct our business. In addition, the growth and development of the market for online commerce may lead to more stringent consumer protection laws that may impose additional burdens on us. Laws and regulations directly applicable to communications or commerce over the Internet are becoming more prevalent. For example, both the U.S. government as well as the State of California have enacted Internet laws regarding privacy and sharing of customer information with third parties. Laws applicable to the Internet remain largely unsettled, even in areas where there Table of Contents Risk factors has been some legislative action. It may take years to determine whether and how existing laws such as those governing intellectual property, privacy, libel and taxation apply to the Internet. In addition, because each state in which we do business requires us to be a licensed real estate broker, and residents of states in which we do not do business could potentially access our web site, changes in Internet regulation could lead to situations in which we are considered to operate or do business in such states. This could result in potential claims or regulatory action. If we are required to comply with new regulations or new interpretations of existing regulations, we may not be able to differentiate our services from traditional competitors and may not attract a sufficient number of clients for our business to be successful. Our reputation and client and agent service offerings may be harmed by system failures and computer viruses. The performance and reliability of our technology infrastructure is critical to our reputation and ability to attract and retain clients and agents. Our network infrastructure is currently co-located at a single facility in Sunnyvale, California and we do not currently operate a back-up facility. As a result, any system failure or service outage at this primary facility would result in a loss of service for the duration of the failure or outage. Any system error or failure, or a sudden and significant increase in traffic, may significantly delay response times or even cause our system to fail resulting in the unavailability of our Internet platform. For example, earlier this year we experienced an unscheduled outage that lasted approximately 12 hours. During this period our clients and prospective clients were unable to access our web site or receive notifications of new listings. While we have taken measures to prevent unscheduled outages, outages may occur in the future. In addition, our systems and operations are vulnerable to interruption or malfunction due to certain events beyond our control, including natural disasters, such as earthquakes, fire and flood, power loss, telecommunication failures, break-ins, sabotage, computer viruses, intentional acts of vandalism and similar events. Our network infrastructure is located in the San Francisco Bay area, which is susceptible to earthquakes and has, in the past, experienced power shortages and outages, any of which could result in system failures and service outages. We may not be able to expand our network infrastructure, either on our own or through use of third party hosting systems or service providers, on a timely basis sufficient to meet demand. Any interruption, delay or system failure could result in client and financial losses, litigation or other consumer claims and damage to our reputation. Our intellectual property rights are valuable and our failure to protect those rights could adversely affect our business. Our intellectual property rights, including existing and future patents, trademarks, trade secrets, and copyrights, are and will continue to be valuable and important assets of our business. We believe that our proprietary ZAP technology and ZipNotify, as well as our ability to interoperate with multiple MLSs and our other technologies and business practices, are competitive advantages and that any duplication by competitors would harm our business. We have taken measures to protect our intellectual property, but these measures may not be sufficient or effective. For example, we seek to avoid disclosure of our intellectual property by requiring employees and consultants with access to our proprietary information to execute confidentiality agreements. We also seek to maintain certain intellectual property as trade secrets. Intellectual property laws and contractual restrictions may not prevent misappropriation of our intellectual property or deter others from developing similar technologies. In addition, others may develop technologies that are similar or superior to our technology, including our patented technology. Any significant impairment of our intellectual property rights could harm our business. Table of Contents Risk factors We may in the future be subject to intellectual property rights disputes, which could divert management attention, be costly to defend and require us to limit our service offerings. Our business depends on the protection and utilization of our intellectual property. Other companies may develop or acquire intellectual property rights that could prevent, limit or interfere with our ability to provide our products and services. One or more of these companies, which could include our competitors, could make claims alleging infringement of their intellectual property rights. Any intellectual property claims, with or without merit, could be time-consuming and expensive to litigate or settle and could significantly divert management resources and attention. Our technologies may not be able to withstand any third-party claims or rights against their use. If we were unable to successfully defend against such claims, we may have to: pay damages; stop using the technology found to be in violation of a third party s rights; seek a license for the infringing technology; or develop alternative non-infringing technology. If we have to obtain a license for the infringing technology, it may not be available on reasonable terms, if at all. Developing alternative non-infringing technology could require significant effort and expense. If we cannot license or develop alternative technology for the infringing aspects of our business, we may be forced to limit our product and service offerings. Any of these results could reduce our ability to compete effectively, and harm our business and results of operations. If we fail to attract and retain our key personnel, our ability to meet our business goals will be impaired and our financial condition and results of operations will suffer. The loss of the services of one or more of our key personnel could seriously harm our business. In particular, our success depends on the continued contributions of Eric A. Danziger, our President and Chief Executive Officer, and other senior level sales, operations, marketing, technology and financial officers. Our business plan was developed in large part by our senior level officers and its implementation requires their skills and knowledge. None of our officers or key employees has an employment agreement, and their employment is at will. We do not have key person life insurance policies covering any of our executives. We intend to evaluate acquisitions or investments in complementary technologies and businesses and we may not realize the anticipated benefits from, and may have to pay substantial costs related to, any acquisitions or investments that we undertake. As part of our business strategy, we plan to evaluate acquisitions of, or investments in, complementary technologies and businesses. We may be unable to identify suitable acquisition candidates in the future or be able to make these acquisitions on a commercially reasonable basis, or at all. If we complete an acquisition or investment, we may not realize the benefits we expect to derive from the transaction. Any future acquisitions and investments would have several risks, including: our inability to successfully integrate acquired technologies or operations; diversion of management s attention; problems maintaining uniform standards, procedures, controls and policies; potentially dilutive issuances of equity securities or the incurrence of debt or contingent liabilities; expenses related to amortization of intangible assets; Table of Contents Risk factors risks associated with operating a business or in a market in which we have little or no prior experience; potential write offs of acquired assets; loss of key employees of acquired businesses; and our inability to recover the costs of acquisitions or investments. If we are required to expense options, it could significantly reduce our net income in future periods. The Financial Accounting Standards Board, or FASB, issued an Exposure Draft, Share-Based Payment: an amendment of Statement of Financial Accounting Standards No. 123 and No. 95 in March 2004 that would require a company to recognize compensation cost for all share based payments, including employee stock options, at fair value beginning in 2005 and subsequent reporting periods. Recently the FASB concluded that the amendment referred to in the Exposure Draft would be effective for public companies for interim or annual periods beginning after June 15, 2005. If the amendment is enacted as described in the Exposure Draft, we will be required to record an expense for our stock-based compensation plans using the fair value method beginning on July 1, 2005. This expense could exceed the expense we currently record for our stock-based compensation plans and correspondingly reduce our net income in future periods. RISKS RELATED TO THIS OFFERING Our common stock could trade at prices below the initial public offering price. Before this offering, there has not been a public trading market for shares of our common stock. An active trading market may not develop or be sustained after this offering. The initial public offering price for the shares of common stock sold in this offering will be determined by negotiations between us and representatives of the underwriters. This price may bear no relationship to the price at which our common stock will trade after this offering. Our stock price may be volatile, and you may not be able to resell your shares at or above the initial public offering price. The trading price of our common stock after this offering may fluctuate widely, depending upon many factors, some of which are beyond our control. These factors include, among others, the risks identified above and the following: variations in our quarterly results of operations; announcements by us or our competitors or lead source providers; changes in estimates of our performance or recommendations, or termination of coverage by securities analysts; inability to meet quarterly or yearly estimates or targets of our performance; the hiring or departure of key personnel, including agents or groups of agents or key executives; changes in our reputation; acquisitions or strategic alliances involving us or our competitors; changes in the legal and regulatory environment affecting our business; and market conditions in our industry and the economy as a whole. Table of Contents Risk factors In addition, the stock market in general, and the market for technology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. These broad market and industry factors may seriously harm the market price of our common stock, regardless of our actual operating performance. Also, in the past, following periods of volatility in the overall market and the market price of a company s securities, securities class action litigation has often been instituted against these companies. This litigation, if instituted against us, could result in substantial costs and a diversion of our management s attention and resources and could harm the price of our common stock. Although we carry general liability and errors and omissions insurance, our insurance may not cover claims of these types or may be inadequate to protect us from all liability that we may incur. Our share price could decline due to the large number of outstanding shares of our common stock eligible for future sale. The market price of our common stock could decline as a result of sales of substantial amounts of our common stock in the public market after this offering, or from the perception that these sales could occur. These sales could also make it more difficult for us to sell our equity or equity-related securities in the future at a time and price that we deem appropriate. Immediately after this offering is completed, we will have 19,054,856 shares of common stock outstanding, or 19,737,356 shares if the representatives of the underwriters exercise their over-allotment option in full. The 4,550,000 shares sold pursuant to this offering will be immediately tradable without restriction. Of the remaining shares: no shares will be eligible for sale immediately upon completion of this offering; 12,399,323 shares will be eligible for sale upon the expiration of lock-up agreements, subject in some cases to the volume and other restrictions of Rule 144 and Rule 701 under the Securities Act of 1933, as amended; and 1,860,504 shares will be eligible for sale upon the exercise of vested options after the expiration of the lock-up agreements. The lock-up agreements expire 180 days after the date of this prospectus, provided that the 180-day lock-up period may be extended in most cases for up to 37 additional days under certain circumstances where we announce or pre-announce earnings or a material event within approximately 18 days prior to, or approximately 16 days after, the termination of the 180-day period. The representatives of the underwriters may, in their sole discretion and at any time without notice, release all or any portion of the securities subject to lock-up agreements. After the closing of this offering, we intend to register approximately 4,149,920 shares of common stock that have been issued or reserved for future issuance under our stock incentive plans. Our principal stockholders, executive officers and directors own a significant percentage of our stock, and as a result, the trading price for our shares may be depressed and these stockholders can take actions that may be adverse to your interests. Our executive officers and directors and entities affiliated with them will, in the aggregate, beneficially own more than two-thirds of our common stock following this offering. This significant concentration of share ownership may adversely affect the trading price for our common stock because investors often perceive disadvantages in owning stock in companies with controlling stockholders. These stockholders, acting together, will have the ability to exert control over all matters requiring approval by our stockholders, including the election and removal of directors and any proposed merger, consolidation or sale of all or substantially all of our assets. In addition, these stockholders who are Operating expenses: Cost of revenues 6,969 13,450 19,929 14,710 24,389 Product development 1,899 1,559 1,717 1,363 1,639 Marketing and business development 3,225 4,451 5,003 3,782 6,325 General and administrative 5,447 10,378 9,464 7,141 10,014 Stock-based compensation 185 84 85 57 Operating expenses: Cost of revenues 250 3,798 6,969 13,450 19,929 14,710 24,389 Product development 700 2,623 1,899 1,559 1,717 1,363 1,639 Marketing and business development 638 10,497 3,225 4,451 5,003 3,782 6,325 General and administrative 673 4,613 5,447 10,378 9,464 7,141 10,014 Stock-based compensation 124 185 84 85 57 Operating expenses: Cost of revenues 6,969 13,450 19,929 14,710 24,389 Product development 1,899 1,559 1,717 1,363 1,639 Marketing and business development 3,225 4,451 5,003 3,782 6,325 General and administrative 5,447 10,378 9,464 7,141 10,014 Stock-based compensation 185 84 85 57 Total stock-based compensation $ 185 $ 84 $ 85 $ 57 $ Table of Contents Risk factors executive officers or directors, or who have representatives on our board of directors, could dictate the management of our business and affairs. This concentration of ownership could have the effect of delaying, deferring or preventing a change in control, or impeding a merger or consolidation, takeover or other business combination that could be favorable to you. You will experience immediate and substantial dilution in the book value of your common stock. Investors purchasing shares of our common stock in this offering will pay more for their shares than the amount paid by existing stockholders who acquired shares prior to this offering. If you purchase common stock in this offering, you will incur immediate and substantial dilution in net tangible book value of approximately $7.63 per share. If the holders of outstanding options or warrants exercise those securities, you will most likely incur further dilution. See Dilution for additional information. Our charter documents and Delaware law could prevent a takeover that stockholders consider favorable and could also reduce the market price of our stock. Our amended and restated certificate of incorporation and our bylaws contain provisions that could delay or prevent a change in control of our company. These provisions could also make it more difficult for stockholders to elect directors and take other corporate actions. These provisions include: providing for a classified board of directors with staggered, three-year terms; not providing for cumulative voting in the election of directors; authorizing the board to issue, without stockholder approval, preferred stock with rights senior to those of common stock; prohibiting stockholder action by written consent; limiting the persons who may call special meetings of stockholders; and requiring advance notification of stockholder nominations and proposals. In addition, the provisions of Section 203 of Delaware General Corporate Law govern us. These provisions may prohibit large stockholders, in particular those owning 15% or more of our outstanding voting stock, from merging or combining with us for a certain period of time. These and other provisions in our amended and restated certificate of incorporation, our bylaws and under Delaware law could discourage potential takeover attempts, reduce the price that investors might be willing to pay for shares of our common stock in the future and result in the market price being lower than it would be without these provisions. See Description of capital stock Preferred Stock and Description of capital stock Anti-takeover Effects of Provisions of Our Amended and Restated Certificate of Incorporation, Our Bylaws and Delaware Law. Table of Contents

parsed_sections/risk_factors/2004/CIK0001175359_american_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ Risk Factors An investment in our IDSs and our notes involves a number of risks. In addition to the other information contained in this prospectus, prospective investors should give careful consideration to the following factors. Risks Relating to the IDSs, our Notes, the New Credit Facilities and the Shares of our Class A and Class B Common Stock You may not receive any dividends. We are not obligated to pay dividends. Dividend payments are not guaranteed and are within the absolute discretion of our board of directors. Future dividends with respect to shares of our capital stock, if any, will depend on, among other things, our results of operations, working capital requirements, financial condition, contractual restrictions, business opportunities, anticipated cash needs, provisions of applicable law and other factors that our board of directors may deem relevant. Our board of directors may decide not to pay dividends at any time and for any reason. Our general policy to distribute rather than retain excess cash is based upon our current assessment of our business and the environment in which it operates, and that assessment could change based on competitive or technological developments (which could, for example, increase our need for capital expenditures), new growth opportunities or other factors. Our board is free to depart from or change our dividend policy at any time and could do so, for example, if it were to determine that we had insufficient cash to take advantage of growth opportunities. The indenture governing the notes and our new credit facilities will contain limitations on our ability to pay dividends. See Dividend Policy and Restrictions. The reduction or elimination of dividends may negatively affect the market price of the IDSs. Our dividend policy may negatively impact our ability to finance capital expenditures or operations. Upon completion of this offering, our board of directors will adopt a dividend policy under which substantially all of the cash generated by our business in excess of operating needs and reserves will be distributed to our stockholders. As a result, we may not retain a sufficient amount of cash to finance growth opportunities or unanticipated capital expenditure needs or to fund our operations in the event of a significant business downturn. We may have to forego growth opportunities or capital expenditures that would otherwise be necessary or desirable in the event we do not find alternative sources of financing. In the event we do not have sufficient cash for these purposes, our financial condition and our business will suffer. Our substantial indebtedness could restrict our ability to pay interest and principal on the notes, pay dividends with respect to shares of our Class A common stock and Class B common stock, and impact our financing options and liquidity position. We have a significant amount of debt. For the last twelve months ended March 31, 2004, on a pro forma basis after giving the effect to this offering and related transactions as if they had occurred on April 1, 2003, our interest coverage ratio would have been 2.49 times and our ratio of total debt to Adjusted EBITDA would have been 4.21 times. The degree to which we are leveraged on a consolidated basis could have important consequences to the holders of the IDSs, including: it may be more difficult for us to satisfy our obligations under the notes and to the lenders under the new credit facilities, and to pay dividends on our Class A common stock and Class B common stock; our ability in the future to obtain additional financing for working capital, capital expenditures or acquisitions may be limited; we may not be able to refinance our indebtedness on terms acceptable to us or at all; a significant portion of our cash flow from operations is likely to be dedicated to the payment of the principal of and interest on our indebtedness, thereby reducing funds available for future operations, capital expenditures and/or dividends on our Class A common stock and Class B common stock; Primary Standard Industrial Classification Code Number Table of Contents we may be more vulnerable to economic downturns and be limited in our ability to withstand competitive pressures; and it may limit our flexibility to plan for and react to changes in our business or strategy. We may be able to incur substantially more debt, which would increase the risks described above associated with our substantial leverage. We may be able to incur substantial additional indebtedness in the future, including issuances of additional notes under the indenture. Any additional debt incurred by us could increase the risks associated with our substantial leverage. We are subject to restrictive debt covenants that limit our business flexibility by imposing operating and financial restrictions on our operations. Although credit facilities of similarly situated borrowers customarily prohibit payments of dividends on the shares of Class A common stock and Class B common stock, our new credit facilities will permit us to pay dividends on the shares of Class A common stock represented by IDSs and Class B common stock, so long as Holdings interest coverage ratio remains above certain established levels and no default or event of default exists under the new credit facilities. Because the payment of dividends will decrease the amount of cash available to service our senior debt, the new credit facilities will impose restrictions on our operations that are more restrictive than customary for credit facilities of similarly situated borrowers that prohibit or substantially limit payments of dividends. These restrictions prohibit or limit, among other things: the incurrence of additional indebtedness and the issuance of preferred stock and certain redeemable capital stock; the payment of dividends or distributions (including distributions by ASG to us to permit us to pay interest on the notes) on, and purchase or redemption of, capital stock; a number of other restricted payments, including investments and acquisitions; specified sales of assets; specified transactions with affiliates; the creation of liens on our assets; consolidations, mergers and transfers of all or substantially all of our assets; our ability to change the nature of our business; and our ability to make capital expenditures (other than maintenance capital expenditures). These restrictions could limit our ability to obtain future financing, make acquisitions or needed capital expenditures, withstand downturns in our business or take advantage of business opportunities. Furthermore, the new credit facilities will also require us to maintain specified financial ratios and satisfy financial condition tests, including a minimum fixed charge coverage ratio, a maximum leverage ratio and a maximum senior leverage ratio. Our ability to comply with the ratios or tests may be affected by events beyond our control, including prevailing economic, financial and industry conditions. A breach of any of these covenants, ratios or tests could result in a default under the new credit facilities and/or the indenture. Upon the occurrence of an event of default under the new credit facilities, the lenders could elect to declare all amounts outstanding under the new credit facilities to be immediately due and payable. If the lenders accelerate the payment of the indebtedness under the new credit facilities, our assets may not be sufficient to repay in full this indebtedness and our other indebtedness, including the notes. I.R.S. Employer Identification No. Table of Contents We may not be able to refinance our new credit facilities at maturity on favorable terms or at all. The new credit facilities will mature in full in 2008. We may not be able to renew or refinance the new credit facilities, or if renewed or refinanced, the renewal or refinancing may occur on less favorable terms. In particular, some of the terms of the notes that may be viewed as favorable to the senior lenders, such as our ability to defer interest and acceleration forbearance periods, become less favorable in 2009, which may materially adversely affect our ability to refinance or renew our new credit facilities beyond such dates. If we are unable to refinance or renew our new credit facilities, our failure to repay all amounts due on the maturity date would cause a default under the new credit facilities. In addition, our interest expense may increase significantly if we refinance our new credit facilities on terms that are less favorable to us than the terms of our new credit facilities. We will require a significant amount of cash, which may not be available to us, to service our debt, including the notes, and to fund our liquidity needs. Our ability to make payments on, or to refinance or repay, our debt, including the notes, to fund planned capital expenditures and expand our business, will depend largely upon our future operating performance. Our future operating performance is subject to general economic, financial, competitive, legislative and regulatory factors, as well as other factors that are beyond our control. If we are unable to generate sufficient cash to service our debt requirements, we will be required to refinance our new credit facilities. If we are unable to refinance our debt or obtain new financing, we would have to consider other options, including: sales of assets to meet our debt service requirements; sales of equity; and negotiations with our lenders to restructure the applicable debt. If we are forced to pursue any of the above options under distressed conditions, our business or the value of your investment in our IDSs and notes could be adversely affected. Compliance with rules regulating non-U.S. citizen ownership and control of fishing vessels may adversely affect the marketability or the price of our IDSs, shares of our Class A common stock or notes. The governance provisions we have adopted and the related steps we will take to comply with the foreign ownership restrictions imposed by federal law on companies that participate in U.S. fisheries are complex and burdensome. They may require beneficial owners of our Class A common stock to execute complex affidavits and provide detailed ownership information and they could require trades of IDSs or shares of our Class A common stock to be reversed or persons who hold IDSs or shares to dispose of them on unfavorable terms. These administrative burdens and requirements and the potential that trades could be unwound or sales required could have an adverse effect on the market for and trading price of IDSs, shares of our Class A common stock or notes. See Business Government Regulation. Our governance arrangements provide our present owners with the ability to exercise substantial control over us, which may create conflicts of interest. As the holders of our Series A, Series B and Series C preferred stock, Coastal Villages Pollock LLC, Bernt O. Bodal (who is our chairman and chief executive officer), and Centre Partners Management LLC will be entitled directly to designate a total of four members of our nine member board. In addition, through their ownership of Class B common stock, IDSs and preferred shares (which will vote together with the Class A common stock and Class B common stock based on the holders interests in ASLP and Holdings), Coastal, Mr. Bodal and Centre would, if they acted collectively, effectively have the ability to elect two additional independent members of our board through the operation of cumulative voting, which applies to the election of our directors and has the effect Code, and Telephone Number, Including Area Code, of Principal Executive Office Table of Contents of concentrating the voting power of significant holders. Accordingly, although they will hold only approximately 31.8% of the equity interests in Holdings, these three holders and their affiliates will have approximately 33.5% of the aggregate voting power in the Issuer and, effectively, the right to designate six of our nine directors. Our organizational documents require that all directors other than the four designated by the holders of preferred stock must satisfy all applicable independence requirements including those of the American Stock Exchange. In addition, for so long as Coastal does not sell equity that would reduce its holdings to below 5.0% of our business or is not otherwise diluted below 2.5% of our business, without the consent of Coastal and either of Mr. Bodal or Centre, or their permitted transferees, we may not create or modify any equity compensation plan, create or make certain modifications to any bonus or performance based compensation plan for executive officers or pay bonuses to executive officers other than pursuant to and in conformity with an existing bonus or performance based compensation plan. Coastal, Mr. Bodal and Centre will have the power to substantially dilute your voting power. Further, they may have views or interests that differ from those of the majority of IDS holders. Coastal Villages Pollock LLC will have board representation, voting and veto rights substantially in excess of its economic ownership, which may create conflicts of interest. Coastal Villages Pollock LLC, as the holder of the Series A preferred share, will have the right to elect two members of our board so long as Coastal does not sell equity that would reduce its holdings to below 5.0% of our business or is not otherwise diluted below 2.5% of our business (in which case it would be reduced to one director). In addition, for so long as it is entitled to two directors, Coastal has veto rights over changes to our governance arrangements and over certain compensation decisions made by the compensation committee of our board. Finally, by virtue of its ownership of IDSs, Class B common stock and the Series A preferred share, Coastal will have a total of 14.5% of our combined voting power. In addition, our nomination process will allow two or more directors who oppose any nominee for director proposed by our nominating and governance committee to propose an alternate nominee. So long as the alternative satisfies applicable independence and other requirements, we will be required to include disclosure about the alternate nominee in our annual proxy statement and processes. This mechanism, coupled with cumulative voting, would make it possible for Coastal to propose a candidate and use its cumulative voting rights to cast a significant number of votes in favor of such candidate. In our annual election of five directors, holders of approximately 16.7% of our voting power will have the ability to ensure the election of one director. After completion of this offering, Coastal will own approximately 14.5% of the voting power of our company or approximately 11.0% if the over-allotment option to purchase additional IDSs is exercised in full. Coastal will also have the right (for so long as it is entitled to elect two directors) to designate one member of our audit committee, provided the member satisfies applicable independence and other requirements. As a result of these various provisions, Coastal will have the ability to exert significant influence over our activities and decisions. Coastal is our largest supplier of community development quota and our current agreement with Coastal terminates on December 31, 2005. In addition, Coastal may, as an Alaska native organization, have goals or views that may differ from those of our other shareholders or our management and, accordingly, Coastal s substantial influence over our affairs may create conflicts of interest. Retained ownership by our existing owners and the special rights of our preferred stockholders may prevent you from receiving a premium in the event of a change of control. Upon the completion of the transactions contemplated by this offering, the existing owners, through their ownership of ASLP, IDSs and Class B common stock, will own approximately 39.2% of the equity interests of Table of Contents our business, or approximately 30.1% of the equity interests of our business, if the over-allotment option to purchase additional IDSs is exercised in full. If such existing owners, or their permitted transferees, exercise their rights to exchange all of their ownership in ASLP for IDSs, they will own approximately 39.2% of the voting power of our company. This concentration of ownership could have the effect of delaying, deferring or preventing a change in control, merger or tender offer, which would deprive you of an opportunity to receive a premium for your IDSs and may negatively affect the market price of the IDSs. Moreover, our existing owners could effectively receive a premium for transferring ownership to third parties that would not inure to your benefit. In addition, the special rights of preferred stockholders do not automatically cease upon a change of control and, therefore, the existence of these special rights may effectively deter a potential acquirer from acquiring us. We are a holding company and rely on dividends, interest and other payments, advances and transfers of funds from our subsidiaries to meet our debt service and other obligations. We are a holding company and conduct all of our operations through our subsidiaries and currently have no significant assets other than our equity interest in Holdings and our interest in the notes issued by Holdings. As a result, we will rely on interest and principal on the Holdings notes and on dividends, loans and other payments or distributions from our subsidiaries to meet our debt service obligations and enable us to pay interest and dividends. The ability of our subsidiaries to pay interest and dividends or make other payments or distributions to us will depend substantially on their respective operating results and will be subject to restrictions under, among other things, the laws of their jurisdiction of organization (which may limit the amount of funds available for the payment of dividends), agreements of those subsidiaries, the terms of the new credit facilities and the covenants of any future outstanding indebtedness we or our subsidiaries incur. Our new credit facilities will contain significant limitations on distributions and other payments. The new credit facilities will prohibit distributions from ASG and its subsidiaries to Holdings if, among other things, the interest coverage ratio of Holdings is less than the dividend suspension thresholds described under Description of Certain Indebtedness New Credit Facilities (or if we fail to timely deliver financial statements calculating such ratio), or if Holdings has any deferred and unpaid interest outstanding on the Holdings notes, other than distributions to pay interest on the Holdings notes and other permitted payments, such as to pay taxes. In addition, if the interest coverage ratio of Holdings is less than the interest deferral thresholds described under Description of Certain Indebtedness New Credit Facilities (or if we fail to timely deliver financial statements calculating such ratio), or if a default or event of default under the new credit facilities exists, the new credit facilities will prohibit distributions by ASG and its subsidiaries to Holdings to enable it to pay interest on the Holdings notes, as well as all other distributions from ASG to Holdings (other than distributions to pay taxes and certain administrative expenses). During any dividend suspension period or interest deferral period, ASG will be required to prepay the loans under the new credit facilities with a portion of its cash available after payments of taxes, scheduled principal and interest payments on its indebtedness, maintenance capital expenditures and other expenses, and such prepayments would reduce the amount of cash available for payments in respect of the notes. If the interest coverage ratio of Holdings is less than the interest deferral thresholds described under Description of Certain Indebtedness New Credit Facilities, the Issuer will be permitted to defer interest on the notes pursuant to the indenture governing the notes. However, the indenture provides that interest on the notes may not be deferred for more than eight quarters in the aggregate prior to 2009. If the Issuer may no longer defer interest on the notes but the interest coverage ratio of Holdings remains below the specified threshold and the new credit facilities prohibit ASG and its subsidiaries from making distributions to the Issuer, we will not have sufficient funds to pay interest on the notes, which would cause a default under the indenture governing the notes, entitling the holders of the notes to demand payment in full of all amounts outstanding under the notes, subject to an acceleration forbearance period of up to 90 days. The default and the acceleration of the notes under such circumstances would cause a default under our new credit facilities, and ASG and its subsidiaries might not have Table of Contents The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is declared effective. This prospectus is not an offer to sell these securities and is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted. Subject to Completion, Dated August 11, 2004 30,740,741 Income Deposit Securities (IDSs) Representing 30,740,741 Shares of Class A Common Stock and $158.3 million % Notes due 2019 and $27.9 million % Notes due 2019 Table of Contents sufficient funds to repay all amounts outstanding under the new credit facilities and make distributions to us to repay all amounts outstanding under the notes. Interest on the notes may not be deductible by us for U.S. federal income tax purposes, which could significantly reduce our future cash flow and impact our ability to make interest and dividend payments. While we believe that the notes should be treated as debt for U.S. federal income tax purposes, this position may not be sustained if challenged by the IRS. If the notes were treated as equity rather than debt for U.S. federal income tax purposes, then the stated interest on the notes would be treated as a dividend (to the extent paid out of our tax earnings and profits ), and interest on the notes would not be deductible by us for U.S. federal income tax purposes. Our inability to deduct interest on the notes could materially increase our taxable income and, thus, our U.S. federal and applicable state income tax liability. This would reduce our after-tax cash flow, which may result in a default under the new credit facilities, and would materially and adversely impact our ability to make interest and dividend payments and may also affect our ability to continue as a going concern. In the case of foreign holders, treatment of the notes as equity for U.S. federal income tax purposes would subject payments to such holders in respect of the notes to withholding or estate taxes in the same manner as payments made with regard to Class A common stock and could subject us to liability for withholding taxes that were not collected on payments of interest. You will be immediately diluted by $14.50 per share of Class A common stock if you purchase IDSs in this offering. Because there will be a net tangible book deficit for each share of Class A common stock outstanding immediately after this offering, if you purchase IDSs in this offering, based on the book value of our assets and liabilities, you will experience an immediate dilution of $14.50 per share of Class A common stock represented by the IDSs ($12.87 assuming all ASLP units have been exchanged for IDSs), which exceeds the price allocated to each share of Class A common stock represented by the IDSs in this offering. Our net tangible book deficit as of March 31, 2004, after giving effect to this offering, was approximately $228.7 million, or $6.15 per share of Class A and Class B common stock ($4.52 assuming all ASLP units have been exchanged for IDSs). As a result of this deficit, the face amount of notes will exceed the net book value of tangible assets by approximately $869 per $1,000 face amount of notes. The allocation of the purchase price of the IDSs may not be respected. The purchase price of each IDS must be allocated for tax purposes between the share of Class A common stock and the note comprising the IDS in proportion to their respective fair market values at the time of purchase. If our allocation is not respected, the notes may be treated as having been issued with original issue discount, or OID (if the allocation to the notes were determined to be too high), or amortizable bond premium (if the allocation to the notes were determined to be too low). You generally would be required to include OID in income in advance of the receipt of cash attributable to that income and would be able to elect to amortize bond premium over the term of the notes. Deferral of interest payments would have adverse tax consequences for you and may adversely affect the trading price of the IDSs or the notes. If interest payments on the notes are deferred, you will be required to recognize interest income for U.S. federal income tax purposes on an economic accrual basis in respect of the notes held by you before you receive any cash payment of this interest. See Material U.S. Federal Income Tax Considerations Consequences to U.S. Holders Notes Stated Interest; Deferral of Interest. In addition, you will not receive any cash payment with respect to accrued interest if you sell the IDSs or the notes before the end of any deferral period or before the record date relating to interest payments that are to be paid. We are selling 30,740,741 IDSs in respect of 30,740,741 shares of our Class A common stock and $158.3 million aggregate principal amount of our % notes due September 15, 2019. Each IDS represents: one share of our Class A common stock; and a % note with $5.15 principal amount. We are also selling separately (not represented by IDSs) $27.9 million aggregate principal amount of our % notes due September 15, 2019. The completion of the offering of separate notes is a condition to our sale of IDSs. This is the initial public offering of our IDSs and notes. We anticipate that the public offering price of the IDSs will be between $13.50 and $14.00 per IDS and the public offering price of the notes sold separately (not represented by IDSs) will be % of their stated principal amount. Holders of IDSs will have the right to separate IDSs into the shares of Class A common stock and notes represented thereby at any time after the earlier of 45 days from the closing of this offering or the occurrence of a change of control. Similarly, holders of our Class A common stock and notes may, at any time, unless the IDSs have automatically separated, combine the applicable number of shares of Class A common stock and notes to form IDSs. Separation of IDSs will occur automatically upon the continuance of a payment default on the notes for 90 days, or a repurchase, redemption or maturity of the notes. Upon a subsequent issuance by us of notes of the same series, a portion of your notes may be automatically exchanged for an identical principal amount of the notes issued in such subsequent issuance and, in such event, your IDSs or notes will be replaced with new IDSs or a unit consisting of your notes and new notes, as the case may be. In addition to the notes offered hereby, the registration statement of which this prospectus is a part also registers the notes and new IDSs to be issued to you upon any such subsequent issuance. For more information regarding these automatic exchanges and the effect they may have on your investment, see Risk Factors Subsequent issuances of notes may cause you to recognize original issue discount or cause a taxable exchange and Description of Notes Additional Notes and Material U.S. Federal Income Tax Considerations Consequences to U.S. Holders Notes Exchange Rights and Additional Issuances. We have applied to list our IDSs on the American Stock Exchange under the trading symbol SEA . We are subject to foreign ownership provisions of the American Fisheries Act as a result of which each owner of 5% or more of our capital stock (including purchasers in this offering) must certify to us that such person is a U.S. citizen, and at least 95% of all of our beneficial owners will be required to have U.S. addresses. These requirements, and the remedies we may need to invoke to satisfy them, may have an adverse effect on the market for and trading price of IDSs or shares of our Class A common stock. Investing in our IDSs and our notes involves risks. See Risk Factors beginning on page 25. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. Per IDS(1) Table of Contents If interest is deferred, the IDSs may trade at a price that does not fully reflect the value of accrued but unpaid interest on the notes. In addition, the existence of the right to defer payments of interest on the notes under certain circumstances may mean that the market price for the IDSs or the notes may be more volatile than other securities that do not have this feature. Your right to receive payments on the notes and the note guarantees is junior to all senior debt of Holdings and its subsidiaries. The Issuer and Holdings are holding companies and conduct all of their operations through ASG and its subsidiaries. The note guarantees issued by Holdings, ASG and the other subsidiary guarantors will be unsecured senior subordinated obligations, junior in right of payment to the senior debt of each subsidiary guarantor, respectively. As a result of the subordinated nature of these guarantees, upon any distribution to creditors of Holdings, ASG or the other subsidiary guarantors in bankruptcy, liquidation or reorganization or similar proceedings relating to Holdings, ASG or the other subsidiary guarantors or their property or assets, the holders of such entities senior indebtedness will be entitled to be paid in full in cash before any payment may be made with respect to the notes or the Holdings notes under the guarantees (and before any distribution may be made by ASG to Holdings or by Holdings to the Issuer). In the event of a bankruptcy, liquidation or reorganization or similar proceeding relating to ASG or the subsidiary guarantors, the Issuer, ASLP and the noteholders would participate under the guarantees with other holders of unsecured unsubordinated indebtedness after the payment in full of all senior indebtedness. In addition, as a result of contractual subordination of the guarantees to the guarantors obligations under the new credit facilities and other senior indebtedness, the Holders of the notes may receive less, ratably, than other creditors of the Guarantors that are not subject to contractual subordination. In any of these cases, there may not be sufficient funds to pay all of our creditors and the holders of the notes may receive less, ratably, than the holders of senior indebtedness. In such event the Issuer and the guarantors would not be able to make all principal payments on the notes. The subordination provisions of the indenture will also provide that payments to you under the subordinated note guarantees of Holdings, ASG and its domestic subsidiaries will be prohibited while a payment default exists under the senior indebtedness of these entities or if such senior indebtedness has been accelerated. In addition, these payments to you may be blocked for up to 179 days by holders of designated senior indebtedness if a default other than a payment default exists under such senior indebtedness. During any period in which payments to you are prohibited or blocked in this manner, any amounts received by you with respect to the subordinated note guarantees, including as a result of any legal action to enforce such guarantees, would be required to be turned over to the holders of senior indebtedness. In addition, so long as the notes are guaranteed by at least one guarantor, upon the occurrence of an event of default under the indenture governing the notes, the principal of and premium, if any, on the notes may not be accelerated for a period of up to 90 days until , 2009. See Description of Notes Acceleration Forbearance Periods, and Description of Notes Subordination of the Guarantees. On a pro forma basis, as of March 31, 2004, the subordinated guarantees would have ranked junior to $240.0 million of our outstanding senior indebtedness of subsidiary guarantors on a consolidated basis, all of which would have been secured. In addition, as of March 31, 2004, on a pro forma basis, ASG would have had the ability to borrow up to an additional amount of $60.0 million under the new revolver, which would have been senior in right of payment to the subordinated guarantees. In the event of bankruptcy or insolvency, the notes and guarantees could be adversely affected by principles of equitable subordination or recharacterization. In the event of bankruptcy or insolvency, a party in interest may seek to subordinate our debt, including the notes or the guarantees, under principles of equitable subordination or to recharacterize the notes as equity. In the event a court exercised its equitable powers to subordinate the notes or the guarantees, or recharacterizes the notes as equity, you may not recover any amounts owed on the notes or the guarantees and you may be required to return Total Table of Contents any payments made to you within six years before the bankruptcy on account of the notes or the guarantees. In addition, should the court treat the notes or the guarantees as equity either under principles of equitable subordination or recharacterization, you may not be able to enforce your rights under the notes or the guarantees. The notes and the guarantees may not be enforceable because of fraudulent conveyance laws. Under federal bankruptcy law and comparable provisions of state fraudulent transfer laws, a court could void the obligations under the notes or the guarantees, further subordinate the notes or the guarantees or take other action detrimental to you, if, among other things, at the time the indebtedness under the notes or the guarantees, as applicable, was incurred, the Issuer or a guarantor: issued the notes or the guarantee to delay, hinder or defraud present or future creditors; or received less than reasonably equivalent value or fair consideration for issuing the notes or the guarantee and, at the time it issued the notes or the guarantee: was insolvent or rendered insolvent by reason of issuing the notes or the guarantee and the application of the proceeds of the notes or the guarantee; was engaged or about to engage in a business or a transaction for which the guarantor s remaining unencumbered assets constituted unreasonably small capital to carry on its business; intended to incur, or believed that it would incur, debts beyond its ability to pay the debts as they mature; or was a defendant in an action for money damages, or had a judgment for money damages docketed against it if, in either case, after final judgment, the judgment is unsatisfied. The measures of insolvency for the purposes of fraudulent transfer laws vary depending upon the law applied in any proceeding to determine whether a fraudulent transfer has occurred. Generally, however, a person would be considered insolvent if, at the time it incurred the debt: the present fair saleable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts, including contingent liabilities, as they become absolute and mature; or it could not pay its debts as they become due. Regardless of the standard that a court uses to determine whether we or a guarantor were solvent at the relevant time, the issuance of the notes or the guarantees may be voided or further subordinated to the claims of creditors if it concludes the Issuer or a guarantor was insolvent. The guarantee of the notes by Holdings, ASG or any other subsidiary guarantor could be subject to the claim that, since the guarantee was incurred for the benefit of the Issuer, and only indirectly for the benefit of the guarantor, the guarantee was incurred for less than fair consideration. A court could therefore void the obligations of Holdings, ASG or the subsidiary guarantor under the guarantees or subordinate these obligations to Holdings , ASG s or the subsidiary guarantor s other debt or take action detrimental to holders of the notes. If the guarantee of Holdings, ASG or any subsidiary guarantor were voided, the holders of the notes would not have a debt claim against Holdings, ASG or that subsidiary guarantor. In addition, in the event that we meet any of the financial condition fraudulent transfer tests described above at the time of or as a result of this offering, a court could view the issuance of the notes, the guarantees and the other transactions occurring on the issue date, such as repayment of our existing debt and various distributions described under Detailed Transaction Steps as a single transaction and, as a result, conclude that the Issuer did not get fair value for the offering. In such a case, a court could hold the debt (including the guarantees) owed to the noteholders void or unenforceable or may further subordinate it to the claims of other creditors. Per Separate Note Table of Contents Seasonality and variability of our businesses may cause volatility in the market value of your investment and may hinder our ability to make timely distributions on the IDSs and the notes. Our business is seasonal in nature, and our net sales and operating results vary significantly from quarter to quarter. For example, our revenue per pound of fish harvested tends to be higher in the January-to-April season due to the harvesting of roe. Consequently, results of operations for any particular quarter may not be indicative of results of operations for future quarterly periods, which makes it difficult to forecast our results for an entire year. This variability may cause volatility in the market price of the IDSs and the notes. In addition, the seasonality and variability of our business means that at certain times of the year our cash receipts are significantly higher than at other times. Our fishing seasons, including the important January-to-April season, straddle more than one quarter. As a result, the timing of the recognition of sometimes significant amounts of revenue from one quarter to another can be a function of unpredictable factors, such as the timing of roe auctions, weather, the timing of shipments to pollock roe customers, fishing pace and product delivery schedules, all of which are likely to vary from year to year. Given that we are required to make equal quarterly interest payments to note holders and intend to pay equal quarterly dividends as well, there is a risk that we will experience cash shortages, which could hinder our ability to make timely distributions or interest payments. Subsequent issuances of notes may cause you to recognize original issue discount or cause a taxable exchange. The indenture governing the notes and the agreements with DTC will provide that, in the event there is a subsequent issuance of notes by the Issuer having identical terms as the notes but with OID, each holder of notes or IDSs (as the case may be) agrees that upon the issuance of any such notes issued with OID, and upon any issuance of notes thereafter, a portion of such holder s notes will be automatically exchanged for a portion of the notes acquired by the holders of such subsequently issued notes, and the records of any record holders of notes will be revised to reflect such exchanges. Consequently, following each such subsequent issuance and exchange, without any further action by such holder, each holder of notes or IDSs (as the case may be) will own an inseparable unit composed of notes of each separate issuance in the same proportion as each other holder. However, the aggregate stated principal amount of notes owned by each holder will not change as a result of such subsequent issuance and exchange. It is unclear whether the exchange of notes for subsequently issued notes results in a taxable exchange for U.S. federal income tax purposes, and it is possible that the IRS might successfully assert that such an exchange should be treated as a taxable exchange. In such case, a holder would recognize any gain realized on such exchange, but a loss recognized might be disallowed. Regardless of whether the exchange is treated as a taxable event, such exchange would result in holders having to include OID in taxable income prior to the receipt of cash as described below, and may result in other potentially adverse tax consequences to holders. See Material U.S. Federal Income Tax Considerations Consequences to U.S. Holders Notes Exchange Rights and Additional Issuances. In addition, the potential amount of OID that would be required to be included in taxable income by holders as a result of an automatic exchange (as described below) is indefinite and may be a significant amount, in part due to our ability to engage in numerous subsequent issuances. Following the subsequent issuance and exchange, we (and our agents) will report any OID on the subsequently issued notes ratably among all holders of notes and IDSs, and each holder of notes or IDSs will, by purchasing notes or IDSs, agree to report OID in a manner consistent with this approach. However, the IRS may assert that any OID should be reported only to the persons that initially acquired such subsequently issued notes (and their transferees) and thus may challenge the holders reporting of OID on their tax returns. In addition, the IRS might further assert that, unless a holder can establish that it is not such a person, all of the notes held by such holder have OID. Any of these assertions by the IRS could create significant uncertainties in the pricing of IDSs and notes and could adversely affect the market for IDSs and notes. For these and additional tax-related risks, see Material U.S. Federal Income Tax Considerations. Total(2) Table of Contents We may have to establish a reserve for contingent tax liabilities in the future, which could adversely affect our ability to make dividend payments on the IDSs. Even if the IRS does not challenge the tax treatment of the notes, it is possible that as a result of an alteration of facts relied upon at the time of issuance of the notes, we will in the future need to change our anticipated accounting treatment and establish a reserve for contingent tax liabilities associated with a disallowance of all or part of the interest deductions on the notes. If we were required to maintain such a reserve, our ability to make dividend payments could be materially impaired and the market for the IDSs, Class A common stock and notes could be adversely affected. In addition, any resulting impact to our financial statements could lead to defaults under our new credit facilities. Holders of subsequently issued notes may not be able to collect their full stated principal amount prior to maturity. Holders of subsequently issued notes having OID (including the recipients of such notes in the involuntary exchanges pursuant to the indenture) may not be able under New York and federal bankruptcy law to collect the portion of their principal amount that represents unaccrued OID in the event of an acceleration of the notes or a bankruptcy of the Issuer prior to the notes maturity date. As a result, an automatic exchange that results in a holder receiving an OID note could have the effect of ultimately reducing the amount such holder can recover from us in the event of an acceleration or bankruptcy. Prior to the consummation of this offering, there was no public market for our IDSs, shares of our Class A common stock or notes, which may cause the price of the IDSs, shares of our Class A common stock or the notes to fluctuate substantially and negatively affect the value of your investment. Our IDSs, the shares of our Class A common stock and the notes have no public market history. In addition, there has not been an active market for securities similar to the IDSs. An active trading market for the IDSs, shares of our Class A common stock or the notes might not develop in the future, which may cause the price of the IDSs, shares of our Class A common stock or the notes to fluctuate substantially, and we currently do not expect that an active trading market for the shares of our Class A common stock will develop until the notes mature. If the notes represented by your IDSs mature or are redeemed or repurchased, the IDSs will be automatically separated and you will then hold the shares of our Class A common stock. We will not apply to list our shares of Class A common stock for separate trading on the American Stock Exchange or any other exchange until the number of shares held separately and not represented by IDSs is sufficient to satisfy applicable requirements for separate trading on such exchange. The Class A common stock may not be approved for listing at such time. We do not intend to list our notes on any securities exchange. The limited liquidity of the trading market for the notes sold separately (not represented by IDSs) may adversely affect the trading price of the separate notes. We are separately selling (not represented by IDSs) $27.9 million aggregate principal amount of notes, representing approximately 11% of the total outstanding notes assuming the exchange of all ASLP interests for IDSs. While the notes sold separately (not represented by IDSs) are part of the same series of notes as, and identical to, the notes represented by the IDSs at the time of the issuance of the separate notes, the notes represented by the IDSs will not be separable for at least 45 days and will not be separately tradeable until separated. As a result, the initial trading market for the notes sold separately (not represented by IDSs) will be very limited. Even after holders of the IDSs are permitted to separate their IDSs, a sufficient number of holders of IDSs may not separate their IDSs into shares of our Class A common stock and notes to create a sizable and more liquid trading market for the notes not represented by IDSs. Therefore, a liquid market for the notes may not develop, which may adversely affect the ability of the holders of the separate notes to sell any of their separate notes and the price at which these holders would be able to sell any of the notes sold separately. Public offering price $ $ % $ Underwriting discount $ $ % $ Proceeds to American Seafoods Corporation (before expenses)(3) $ $ % $ Table of Contents Future sales or the possibility of future sales of a substantial amount of IDSs, shares of our Class A common stock or our notes may depress the price of the IDSs, the shares of our Class A common stock and our notes. Future sales or the availability for sale of substantial amounts of IDSs or shares of our Class A common stock or a significant principal amount of our notes in the public market could adversely affect the prevailing market price of the IDSs, the shares of our Class A common stock and our notes and could impair our ability to raise capital through future sales of our securities. We may issue shares of our Class A common stock and notes, which may be in the form of IDSs, or other securities from time to time as consideration for future acquisitions and investments. In the event any such acquisition or investment is significant, the number of shares of our Class A common stock and the aggregate principal amount of notes, which may be in the form of IDSs, or the number or aggregate principal amount, as the case may be, of other securities that we may issue may in turn be significant. In addition, we may also grant registration rights covering those IDSs, shares of our Class A common stock, notes or other securities in connection with any such acquisitions and investments. In addition, the holders of 1,551,866 IDSs which will be issued in a private placement in connection with this offering will have certain registration rights. In addition, following the second anniversary of the closing of this offering, holders of Class B common stock may demand registration of their Class B common stock two times a year, during two window periods, which will match the window periods in the exchange warrant issued to all ASLP partners permitting such holders after one year to exchange their ASLP limited partnership units for IDSs. Our organizational documents could limit another party s ability to acquire us and deprive our investors of the opportunity to obtain a takeover premium for their securities. A number of provisions in our amended and restated certificate of incorporation and amended and restated by-laws will make it difficult for another company to acquire us and for you to receive any related takeover premium for your securities. For example, our organizational documents provide that stockholders generally may not act by written consent and only stockholders representing at least 50% in voting power may request that our board of directors call a special meeting. Our organizational documents also authorize the issuance of preferred stock without stockholder approval and upon such terms as the board of directors may determine. The rights of the holders of shares of our Class A common stock will be subject to, and may be adversely affected by, the rights of holders of preferred stock and any other class or series of preferred stock that may be issued in the future. Risks Relating to Our Industry and Its Regulation The repeal of, or adverse amendments to, the American Fisheries Act and other industry regulations would likely impair our profitability. The American Fisheries Act restricts the number of vessels operating in the catcher-processor sector of the U.S. Bering Sea pollock fishery to 19 named catcher-processor vessels, of which we own and operate seven, and by allocating 40% of the directed pollock catch to this sector (with 36.6% being allocated to these 19 catcher-processor vessels and 3.4% being allocated to catcher-vessels). In the event that the American Fisheries Act and other related industry regulations were repealed or modified to permit additional large vessels to operate in the catcher-processor sector of the U.S. Bering Sea pollock fishery, we could be subject to new competition that could adversely affect our profitability. In addition, our pollock harvesting rights and profitability would be adversely affected if the American Fisheries Act and other industry regulations were repealed or modified in a manner that decreases the percentage of the total pollock harvest allocated to the 19 catcher-processor vessels named in the Act. A repeal or modification of the American Fisheries Act or other industry regulations could result from changes in the political environment, a significant increase or decrease in the pollock biomass or other factors, all of which are difficult to predict and are beyond our control. The relatively stable and predictable nature of our harvesting operations and our efficiencies would deteriorate if the Pollock Conservation Cooperative agreement were terminated or adversely changed. The members of the Pollock Conservation Cooperative, which is comprised of all participants in the catcher-processor sector of the U.S. Bering Sea pollock fishery, have agreed that each member will catch only an agreed- CASH FLOWS USED IN FINANCING ACTIVITIES: Principal payments on long-term debt (37,265 ) (11,568 ) Net borrowings (payments) on revolving debt 44,000 (7,500 ) Payments on obligations to related party (5,312 ) Financing fees and costs (82 ) (380 ) Costs related to recapitalization transaction (1,296 ) Contributions from members (1) Comprised of $5.15 allocated to each note which represents 100% of its stated principal amount and $ allocated to each share of Class A common stock. (2) Represents the $27.9 million aggregate principal amount of notes sold separately (not represented by IDSs). (3) Approximately $ million of those proceeds will be paid to the current owners of our business before this offering and approximately $35.6 million will be paid to a related party to repay indebtedness and redeem preferred stock. Table of Contents upon share of the total allowable catch allocated to the catcher-processor sector in that fishery. By establishing allocations among all catcher-processors, the Pollock Conservation Cooperative, which we refer to as the Cooperative, ensures that members will have the opportunity to harvest a fixed percentage of the total pollock harvest and removes the incentives to harvest and process pollock as fast as possible, thereby giving each member a greater opportunity to optimize operational efficiencies. The Cooperative could be terminated as a result of an adverse change in the American Fisheries Act allocations, the bankruptcy of a Cooperative member or the decision of two or more Cooperative members. The termination of the Cooperative or any adverse change to the allocation system currently in place under the agreement could increase the volatility of our operations, cause us to lose operational efficiencies and have an adverse effect on our existing harvesting rights. Growth in our core pollock harvesting operations and our profitability are limited by the American Fisheries Act. The American Fisheries Act imposes a statutory limit on the maximum amount of pollock that we may independently harvest equal to 17.5% of the directed pollock catch. We are allocated 16.8% of the directed pollock catch under our Cooperative agreements, and we lease the right to harvest another 0.7% of the directed pollock catch from other vessels in our fishery, bringing us to the 17.5% limit. Our business could be materially affected if the community development quota we purchase is significantly reduced or eliminated or offered to us at prices we consider unreasonable. We supplement our pollock harvest through the purchase of community development quota, which plays an important part in our strategy of maximizing access to pollock. The primary agreements governing our current arrangements for purchasing community development quota expire at the end of 2005. The Alaska Community Development Groups from which we purchase community development quota could decline to continue to sell their quota to us or could offer their quota at prices we consider unreasonable, which could materially adversely affect our business. In addition, every three years the state of Alaska may re-allocate the community development quota allocation among the six Alaska Community Development Groups. The next reallocation is for the period beginning 2006. The Alaska Community Development Groups from which we purchase community development quota could have their quota allocation reduced below current levels. If any significant reduction were to occur, we could experience a significant decline in our revenues, earnings and profitability. Our ocean harvested whitefish operations are subject to regulatory control and political pressure from interest groups that may seek to materially limit our ability to harvest fish. Under the American Fisheries Act, the Magnuson-Stevens Fishery Conservation and Management Act and other relevant statutes and regulations, various regulatory agencies, including the National Marine Fisheries Service and the North Pacific Fishery Management Council, are endowed with the power to control our harvest of pollock and other groundfish in the fisheries of the North Pacific. These regulatory agencies have the authority to materially reduce the Alaska pollock total allowable catch allocated to the catcher-processor sector as well as our allocation of pollock and other groundfish without any compensation to us. These regulators may decrease or eliminate our allocation of the fish supply from a broad spectrum of lobbying interests including: native Alaskan groups seeking a greater allocation of the pollock harvest to be devoted to community development quotas; other sectors of the pollock fishery, such as inshore processors who periodically seek an increased allocation of the pollock harvest devoted to the on-shore sector; and environmental protection groups. Table of Contents The laws and rules that govern the highly-regulated fishing industry could change in a manner that would have a negative impact on our operations. In addition, protests and other similar acts of politically-motivated third party groups could cause substantial disruptions to the ability of our vessels to engage in harvesting activities. These factors may affect a substantial portion of our harvesting and processing operations in any year, which could have a material adverse effect on our business, results of operations or financial condition. Regulations related to our by-catch could impose substantial costs on our operations and reduce our operational flexibility. The National Marine Fisheries Service imposes various operational requirements aimed at limiting our ability to discard unwanted species, or by-catch, in the North Pacific. Regulation regarding by-catch is from time to time debated in various forums, including the United Nations, and is the subject of public campaigns by environmental groups. Any significant change in the by-catch rules resulting from these debates or campaigns could materially increase our costs or decrease the flexibility of our fishing operations. Efforts to protect endangered species, such as Steller sea lions, may significantly restrict our ability to access our primary fisheries and revenues. There is a risk that access to certain areas of the primary fisheries in which we operate could be restricted due to constraints imposed by governmental authorities in response to the listing of endangered species, such as Steller sea lions, for purposes of the Endangered Species Act. Since 1990, the National Marine Fisheries Service has issued various biological opinions as to the impact on Steller sea lions of the pollock and other groundfish fisheries of the U.S. Bering Sea. These opinions have analyzed the effects of the various groundfish fisheries in the waters off Alaska and have recommended actions to avoid jeopardy for the western population of Steller sea lions and the adverse modification of its habitat. Based upon these opinions, the National Marine Fisheries Service has adopted several regulations relating to the protection of Steller sea lions which have caused us to harvest our allocation of pollock and other groundfish from less than the full territory of the fisheries in which we have historically operated. The regulations to protect endangered species, such as Steller sea lions, may significantly restrict our fishing operations and revenues. Further, whatever measures that are adopted may be found to be inadequate or not in compliance with the Endangered Species Act. Therefore, as has occurred in the past, a court may in the future force us to modify our fishing operations by restricting our access to certain areas of the primary fisheries in which we operate in order to ensure the protection of the Steller sea lions in compliance with the Endangered Species Act. These restrictions could have an impact on our fishing operations, profitability and revenues which may be material to our business. In addition, the U.S. Fish and Wildlife Service is currently preparing a biological opinion on the effects of the Bering Sea/Aleutian Islands/Gulf of Alaska groundfish fisheries on bird species listed under the Endangered Species Act, in particular the short-tailed albatross. The National Marine Fisheries Service is also conducting an assessment of the potential interactions between short-tailed albatross and equipment used by trawl vessels in these fisheries. The measures that could be imposed as a result of these investigations could have an impact on our fishing operations, profitability and revenues which may be material to our business. The National Marine Fisheries Service has determined that under certain circumstances, the short-tailed albatross do interact with longliners gear. There is a risk that additional measures to prevent short-tailed albatross mortality may be required. Such measures may include temporary time and area closures within the U.S. Bering Sea Pacific cod fishery. If we and members of our crew fail to comply with applicable regulations, our vessels may become subject to liens, foreclosure risks and various penalties and our fishing rights could be revoked. Our industry is subject to highly complex statutes, rules and regulations. For example, we are subject to statutory and contractual limitations on the type and amount of fish we may harvest, as well as restrictions as to where we Table of Contents Table of Contents may fish within our fisheries. If we or members of our crew violate maritime law or otherwise become subject to civil and criminal fines, penalties and sanctions, our vessels could be subject to forfeiture and our fishing rights could be revoked. The violations that could give rise to these consequences include operating a vessel with expired or invalid vessel documentation or in violation of trading restrictions, violating international fishing treaties or fisheries laws or regulations, submitting false reports to a governmental agency, interfering with a fisheries observer or improperly handling or discarding pollock roe. Because our vessels harvesting and processing activities take place at sea, outside the day-to-day supervision of senior management, members of the crews of our vessels may have been guilty of infractions or violations that could subject them or us to significant penalties, which could have a material and adverse effect on our results of operations and financial condition. In 2001, we became aware of allegations that certain crew members may have tampered or attempted to tamper with measurement equipment on board one or more of our vessels, principally related to the 2001 fishing season. In 2002, we received additional tampering allegations relating to one of our vessels. The National Marine Fisheries Service conducted an investigation regarding these allegations, and in consultation with the National Marine Fisheries Service, we also conducted an internal investigation regarding these allegations. In 2004, we received additional tampering allegations relating to one of our vessels. We and the National Marine Fisheries Service are currently conducting an investigation regarding these allegations. It is possible that violations may have occurred or may occur in the future. In addition, our vessels may become subject to liens imposed by operation of maritime law in the ordinary course of business. These include liens for unpaid crew wages, liens for damages arising from maritime torts, liens for various services provided to the vessel and liens arising out of the operation, maintenance and repair of the vessel. The holders of these liens may have the right to foreclose on the vessel if the circumstances giving rise to the liens are not adequately addressed. If we do not comply with rules regulating non-U.S. citizen ownership and control of fishing vessels, we could lose our eligibility to participate in U.S. fisheries. The American Fisheries Act requires that vessels engaged in U.S. fisheries be owned by entities that are at least 75% U.S. citizen owned and controlled. This requirement applies at each tier of ownership and must also be examined in the aggregate. If the provisions and procedures we adopt prove to be inadequate, we could lose our eligibility to harvest pollock, which would have a material adverse effect on our business, financial condition or results of operations. See Business Government Regulation. In addition, the Maritime Administration has the right to review the terms of our loan covenants and financing arrangements to determine if they constitute an impermissible shifting of control to a non-U.S. citizen lender. Based on discussions with counsel and with pertinent government officials, we believe the intention of the Maritime Administration is to prevent provisions couched as loan covenants from serving as a device to shift control to non-U.S. citizens, and not to impede conventional market based loans and credit facilities. The American Fisheries Act is relatively new legislation. As a result, no reported judicial cases clearly interpret its meaning. For this reason, the full future impact of the American Fisheries Act on our ownership and debt capital structure remains uncertain. Risks Relating to Our Business Our products are subject to pricing volatility, and the prices of our pollock roe and pollock surimi products, which declined significantly in 2003, may remain at their current low levels or decline even further, which would significantly reduce our profitability. The sale of pollock roe is our highest margin business. Pollock roe prices have experienced significant volatility in recent years and may continue to do so in the future. The average price of pollock roe that we sell is heavily Table of Contents Table Of Contents Page Table of Contents influenced by the size and condition of roe skeins, its color and freshness, the maturity of the fish caught, the grade mix of the pollock roe and market perceptions of supply. In addition, pollock roe prices are influenced by anticipated Russian and U.S. production and Japanese inventory carry-over, as pollock roe is consumed almost exclusively in Japan. In addition, a decline in the quality of the pollock roe that we harvest or fluctuations in supply could cause a significant decline in the market price of pollock roe, which would reduce our margins and revenues. In addition, during the second half of 2003, our financial results and liquidity were adversely affected by lower pollock surimi prices and lower sales volume. The quantity of pollock surimi inventories we held at December 31, 2003 was approximately 1.5 times higher than the average pollock surimi inventories we held over the last three years. Over the last five years, our seasonal average pollock surimi prices have fluctuated within a range of approximately 200 to 300 yen per kilogram. In the second half of 2003, our average pollock surimi price was at the low end of that range. Our overall average surimi price for the six-month period ended June 30, 2004 has been below the low end of our historical average surimi price range and will reflect a decline of approximately 25% as compared to the same period in 2003, which reflects both the overall decline in surimi market prices as well as our sales of a greater percentage of lower quality surimi. Partly as a result of these pricing factors, together with high inventories, our overall performance in 2003 was at a level that would have caused us to be in violation of certain of our financial bank covenants. To prevent this potential violation, during the third quarter of 2003, we cancelled 2003 management bonuses and reversed accruals of those bonuses through June 30, 2003, in accordance with the terms of some of our employment agreements and our general bonus policy, which does not require the payment of bonuses based on financial performance for any year in which there is or would be a violation of a covenant under our credit agreement. Despite the cancellation and reversal of these bonuses, we would have been in violation of those financial covenants under our existing credit agreement at the end of 2003 if we had not obtained a covenant modification from our bank lenders. See Management s Discussion and Analysis of Financial Condition and Results of Operations Debt Covenants. Prices and sales volume may remain at these low levels or decline even further, which would materially and adversely affect our results of operations and could impair our ability to meet our anticipated distributions to you. High catfish prices charged by farmers would adversely impact our operations if market prices for our catfish products do not increase proportionally. If prices at which we purchase catfish remain at high levels or increase, in either case without a proportionate increase in the prices at which we sell our catfish products, our ability to maintain profitability in our catfish processing operations will be adversely affected. In the second half of 2003, many of the farmers from whom we purchase catfish increased their prices to levels that jeopardized our ability to maintain satisfactory profit margins in the catfish processing operations. Partially as a result of these farm price increases, in September 2003, we temporarily closed our catfish processing plant in Demopolis, Alabama. Our Demopolis plant resumed full operations in October 2003. However, the prices charged by catfish farmers have remained at relatively high levels, which have adversely affected our catfish processing results. Prices at which farmers are willing or able to sell their catfish to us could remain at levels that do not enable us to maintain satisfactory margins and do not allow us to continue these operations without further shutdowns or interruptions. Southern Pride s recent operating results have not met our expectations, primarily as a result of increased fish costs paid to catfish farmers combined with lower processing yields. Should these conditions continue, and should operating results continue to fall below management s current expectations or decline further from present levels, we may conclude that it is more likely than not that the carrying value of the Southern Pride assets exceeds their fair value. Under such circumstances, we would be obligated to undertake an interim impairment test of the $7.2 million of goodwill recorded in connection with the acquisition of the assets of Southern Pride in 2002. To the extent a goodwill impairment test indicates that the carrying value exceeds the fair value, we would be required to record an impairment charge to our operations for the write-down of all or a portion of the recorded goodwill. Table of Contents A material decline in the population and biomass of pollock, other groundfish and catfish stocks in the fisheries in which we operate would materially and adversely affect our business. The population and biomass of pollock and other groundfish stocks are subject to natural fluctuations which are beyond our control and which may be exacerbated by disease, reproductive problems or other biological issues. Pollock stocks are also largely dependent on proper resource management and enforcement. The overall health of a fish stock is difficult to measure and fisheries management is still a relatively inexact science. Since we are unable to predict the timing and extent of fluctuations in the population and biomass of the pollock stocks, we are unable to engage in any measures that might alleviate the adverse effects of these fluctuations. Any such fluctuation which results in a material decline in the population and biomass of the pollock stocks in the fisheries in which we operate would materially and adversely affect our business. Conversely, a significant increase in Russian pollock stocks could dramatically reduce the market price of our products. Our catfish operations are also subject to the risk of variations in supply. For example, disease in catfish ponds could reduce catfish stocks and adversely affect our business. Our business is subject to Japanese currency fluctuations that could materially adversely affect our financial condition and liquidity. Our profitability depends in part on revenues received in Japanese yen as a result of sales in Japan. During 2003, our Japanese sales represented 24.9% of our total revenues. A decline in the value of the yen against the U.S. dollar would adversely affect our earnings from sales in Japan. Fluctuations in currency are beyond our control and are unpredictable. During the year ended December 31, 2002, the value of the dollar declined by 9.6% against the yen, from 131.3 per $1.00 to 118.6 per $1.00. During the year ended December 31, 2003, the value of the dollar declined by 9.9% against the yen, from 118.6 per $1.00 as of December 31, 2002 to 106.9 per $1.00, as of December 31, 2003. In addition, during the three months ended March 31, 2004 the value of the dollar declined by 2.7% against the yen, from 106.9 per $1.00 as of December 31, 2003 to 104.0 per $1.00, as of March 31, 2004. To hedge our exposure to Japanese currency fluctuations, we purchase derivative instruments primarily in the form of foreign exchange contracts. In addition to our revenues being exposed to Japanese currency fluctuations, our liquidity can also be impacted by unrealized losses sustained to our portfolio of foreign exchange contracts. A majority of these contracts have been entered into with a financial institution that requires collateralization of unrealized losses sustained by the portfolio above a certain threshold. To mitigate our short-term liquidity risk with respect to these collateralization requirements, we have executed contracts to forward purchase yen and have placed additional standing orders to forward purchase yen should the yen strengthen to certain spot rates. With the yen strengthening, several of these standing orders have been executed and currently one remains outstanding. The orders are significant and of a shorter duration than the portfolio of our foreign contracts and, as a result, could have a significant adverse impact on our short-term liquidity should the yen strengthen in relation to the U.S. dollar. In addition, we expect to manage our exposure to interest rates related to our new credit facilities through a cross-currency swap to yen. We believe this cross-currency swap arrangement will provide additional risk management against Japanese currency fluctuations related to our sales to Japan. The mark to market value of this cross-currency swap may also adversely impact our ability to comply with certain covenants under our new credit facilities, specifically, our senior leverage covenant and our total leverage debt incurrence test. These instruments may not be sufficient to provide adequate protection against losses related to currency fluctuations and, accordingly, any such fluctuations could adversely affect our revenues. There also exists the risk, should our forecasted yen denominated sales decline, that we could become overhedged through these instruments and thereby exposed to further foreign currency fluctuations. Table of Contents The segments of the seafood industry in which we operate are competitive, and our inability to compete successfully could adversely affect our business, results of operations and financial condition. We compete with major integrated seafood companies such as Trident Seafoods, Nippon Suisan and Maruha, as well as with inshore processors that operate inshore on fixed location processing facilities, relying on catcher-vessels to harvest and deliver fish for processing. We also compete with motherships that are solely at-sea processors, relying on catcher-vessels to harvest and deliver fish for processing. Additionally, we compete with other pollock fisheries, particularly the Russian pollock fishery in the Sea of Okhotsk. Some of our competitors have the benefit of marketing their products under brand names that have better market recognition than ours, or have stronger marketing and distribution channels than we do. In addition, other competitors may produce better quality products or have more advantageous pricing margins than we do. We may not be able to compete successfully with any of these companies. In addition, production and distribution of substitute products for pollock could have a significant adverse impact on our profitability. Increased competition as to any of our products could result in price reduction, reduced margins and loss of market share, which could negatively affect our profitability. An increase in imported products in the U.S. at low prices could also negatively affect our profitability. All of our business activities are subject to a variety of natural risks, which could have a material adverse effect on our business, financial condition or results of operations. The U.S. Bering Sea pollock fishery, which is the primary fishery in which we operate, is characterized by extreme sea conditions. Unusual weather conditions could materially and adversely affect the quality and quantity of the fish products we produce and distribute. Our vessels are expensive assets that are subject to substantial risks of serious damage or destruction. The sinking or destruction of, or substantial damage to, any of our vessels would entail significant costs to us, including the loss of production while the vessel was being replaced or repaired. Our insurance coverage may prove to be inadequate or may not continue to be available to us. In the event that such coverage proves to be inadequate, the sinking or destruction of, or substantial damage to, any of our vessels could have a material adverse effect on our business, financial condition or results of operations. Should any of our vessels be destroyed or otherwise become inoperable, the American Fisheries Act would limit our ability to replace that vessel. The statute permits the replacement of lost vessels only if the loss is due to an Act of God, an act of war, the result of a collision, or otherwise not an intentional act of the vessel s owner. These rules would restrict our ability to replace our vessels on account of obsolescence and, accordingly, could cause us to incur increased costs of maintaining our vessels, including the substantial loss of capacity during times of such maintenance and rebuilding. We may be required to pay significant damages in connection with litigation that is pending against us. A pending lawsuit against us could require us to pay significant damages, which could have a material adverse effect on our business, results of operations or financial condition. See Business Litigation. We may be adversely affected by an IRS audit. The IRS has opened an audit of ASG with respect to tax year 2001. We do not know what issues will be raised in the course of this audit and such audit could result in adjustments that could have a material adverse effect on our financial condition. We may incur material costs associated with compliance with environmental regulations. We are subject to foreign, federal, state, and local environmental regulations, including those governing discharges to water, the management, treatment, storage and disposal of hazardous substances, and the Table of Contents remediation of contamination. If we do not fully comply with environmental regulations, or if a release of hazardous substances occurs at or from one of our facilities or vessels, we may be subject to penalties and could be held liable for the cost of remediation. For example, an accident involving one of our vessels could result in significant environmental liability, including fines and penalties and remediation costs. If we are subject to these penalties or costs, we may not be covered by insurance, or any insurance coverage that we do have may not cover the entire cost. Compliance with environmental regulations could require us to make material capital expenditures and could have a material adverse effect on our results of operations and financial condition. We produce and distribute food products that are susceptible to contamination and, as a result, we face the risk of exposure to product liability claims and damage to our reputation. As part of the fish processing, small pieces of metal or other similar foreign objects may enter into some of our products. Additionally, our fish products are vulnerable to contamination by disease-producing organisms or pathogens. Shipments of products that contained foreign objects or were so contaminated could lead to an increased risk of exposure to product liability claims, product recalls, adverse public relations and increased scrutiny by federal and state regulatory agencies. If a product liability claim were successful, our insurance might not be adequate to cover all the liabilities we would incur, and we might not be able to continue to maintain such insurance, or obtain comparable insurance at a reasonable cost, if at all. If we did not have adequate insurance or contractual indemnification available, product liability claims relating to defective products could significantly increase our operating costs. In addition, even if a product liability claim was not successful or was not fully pursued, the negative publicity surrounding any such assertion could harm our reputation with our customers. Our operations are labor intensive, and our failure to attract and retain qualified employees may adversely affect us. The segments of the harvesting and processing industry in which we compete are labor intensive and require an adequate supply of qualified production workers willing to work in rough weather and potentially dangerous operating conditions at sea. Some of our operations have from time to time experienced a high rate of employee turnover and could continue to experience high turnover in the future. Labor shortages, the inability to hire or retain qualified employees or increased labor costs could have a material adverse effect on our ability to control expenses and efficiently conduct our operations. We may not be able to continue to hire and retain the sufficiently skilled labor force necessary to operate efficiently and to support our operating strategies, or we may not continue to experience favorable labor relations. In addition, our labor expenses could increase as a result of a continuing shortage in the supply of personnel. Changes in applicable state and federal laws and regulations could increase labor costs, which could have a material adverse effect on our business, results of operations and financial condition. Table of Contents

parsed_sections/risk_factors/2004/CIK0001175362_american_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

parsed_sections/risk_factors/2004/CIK0001175829_h-s_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ RISK FACTORS You should carefully consider the risk factors set forth below as well as the other information contained in this prospectus before deciding whether to participate in the exchange offer. The risks described below are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially and adversely affect our business operations. Any of the following risks could materially and adversely affect our business, financial condition or results of operations. In such case, you may lose all or part of your original investment. Risks Relating to the Exchange Offer If you fail to exchange your old securities, they may continue to be restricted securities and may become less liquid. Old securities that you do not tender or we do not accept may, following the exchange offer, continue to be restricted securities. You may not offer or sell untendered old securities except pursuant to in exemption from, or in a transaction not subject to, the Securities Act and applicable state securities laws. We will issue new securities in exchange for the old securities pursuant to the exchange offer only following the satisfaction of the procedures and conditions described elsewhere in this prospectus. These procedures and conditions include timely receipt by the exchange agent of the old securities and of a properly completed and duly executed letter of transmittal for your securities. Because we anticipate that most holders of old securities will elect to exchange their old securities, we expect that the liquidity of the market for any old securities remaining after the completion of the exchange offer may be substantially limited. Any old security tendered and exchanged in an exchange offer will reduce the aggregate principal amount of the old securities of that class outstanding. Risks Relating to the Securities Your ability to transfer the registered securities may be limited by the absence of a trading market. There is no established trading market for the securities, and the securities will not be listed on any securities exchange or quoted on any automated dealer quotation system. CSFB intends to make a market in the securities, but it is not obligated to do so. Accordingly, we cannot ensure that a liquid market will develop for any of the securities, that you will be able to sell your securities at a particular time or that the prices that you receive when you sell will be favorable. In addition, CSFB is not obligated to make a market and any such market-making may be interrupted or discontinued at any time without notice. In addition, such market-making activity will be subject to the limits imposed by the Securities Act and the Exchange Act. Future trading prices of the securities or the registered securities will depend upon many factors, including, our operating performance and financial condition, prevailing interest rates and the market for similar securities. Historically, the market for noninvestment grade debt has been subject to disruptions that have caused substantial volatility in the prices of securities similar to the securities. Any such disruptions may adversely affect the ability of holders of securities to dispose of them for a profit or at all. Our substantial indebtedness could adversely affect our financial health and prevent us from fulfilling our obligations under the securities. We have a significant amount of indebtedness. As of November 30, 2003, we had total indebtedness of $433.2 million and had $62.8 million of additional borrowings available under our senior credit facility, based on our borrowing base availability and after excluding $2.3 million of letters of credit outstanding under that facility. In addition, subject to the restrictions in our senior credit facility and the indentures governing the securities and our senior subordinated notes, we may incur significant additional indebtedness from time to time. ADDITIONAL REGISTRANTS Exact name of registrant as specified in its charter Our substantial indebtedness could have important consequences to you. For example, it could: make it more difficult for us to satisfy our obligations with respect to the securities; increase our vulnerability to general adverse economic and industry conditions; require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate needs; limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; result in higher interest expense in the event of increases in interest rates as some of our debt is, and will continue to be, at variable rates of interest; place us at a competitive disadvantage compared to our competitors that have less debt; and limit our ability to borrow additional funds. In addition, the indentures governing the securities and our senior subordinated notes and our senior credit facility contain restrictive covenants that limit our ability to engage in activities that may be in our long-term best interests. These covenants limit or restrict our ability to: incur additional indebtedness; create liens; pay dividends or make other equity distributions; purchase or redeem capital stock; make investments; sell assets; incur restrictions on the ability of subsidiaries to make dividends or distributions; engage in transactions with affiliates; and effect a consolidation or merger. These limitations and restrictions may adversely affect our ability to finance our future operations or capital needs or engage in other business activities that may be in our best interests. In addition, our senior credit facility requires us to comply with certain financial ratios and our ability to borrow under it is subject to borrowing base requirements. Our ability to comply with these ratios may be affected by events beyond our control. If we breach any of the covenants in our senior credit facility or our indentures, or if we are unable to comply with the required financial ratios, we may be in default under our senior credit facility or our indentures. If we default, the holders of the securities or lenders under our senior credit facility could declare all borrowings owed to them, including accrued interest and other fees, to be due and payable. If we were unable to repay the borrowings under our senior credit facility when due, the lenders under the senior credit facility could also proceed against the collateral granted to them, which could result in the holders of the securities receiving less, ratably, than those lenders. See "Risk Factors Your right to receive payments on the securities is effectively subordinated to the rights of our existing and future secured creditors," "Description of Certain Indebtedness" and "Description of Registered Securities." State or other jurisdiction of incorporation or organization We may not be able to service our debt without the need for additional financing, which we may not be able to obtain on satisfactory terms, if at all. Our ability to pay or to refinance our indebtedness, including the securities, will depend upon our future operating performance, which will be affected by general economic, financial, competitive, legislative, regulatory, business and other factors beyond our control. We cannot assure you that our business will generate sufficient cash flow from operations, that currently anticipated revenue growth and operating improvements will be realized or that future borrowings will be available to us in amounts sufficient to enable us to pay our indebtedness, including the securities, or to fund our other liquidity needs. If we are unable to meet our debt service obligations or fund our other liquidity needs, we could attempt to restructure or refinance our indebtedness or seek additional equity capital. We cannot assure you that we will be able to accomplish those actions on satisfactory terms, if at all. We will require a significant amount of cash to service our indebtedness. Our ability to generate cash depends on factors beyond our control. Our ability to make payments on our indebtedness, including our senior credit facility and the securities, and to fund our business initiatives will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available to us under our senior credit facility in an amount sufficient to enable us to service our indebtedness, including our senior credit facility and the securities, or to fund our other liquidity needs. We may need to refinance all or a portion of our indebtedness, including our senior credit facility and the securities, on or before maturity. We cannot assure you that we will be able to refinance any of our indebtedness, including our senior credit facility or the securities, on commercially reasonable terms or at all. Your right to receive payments on the notes is effectively subordinated to the rights of our existing and future secured creditors. Furthermore, the guarantees of the notes are effectively subordinated to all our guarantors' existing and future secured indebtedness. Holders of our secured indebtedness and the guarantor's secured indebtedness will have claims that are prior to your claims as holders of the securities to the extent of the value of the assets securing that other indebtedness. Holdings, our company and the guarantors of the securities are parties to our senior credit facility, which is secured by liens on our outstanding capital stock and substantially all of our and our subsidiaries' property and assets. The securities will be effectively subordinated to all that indebtedness to the extent of the related security. In the event of any distribution or payment of our assets in any foreclosure, dissolution, winding-up, liquidation, reorganization or other bankruptcy proceeding, holders of secured indebtedness will have a prior claim to those of our assets that constitute their collateral. Holders of the securities will participate ratably with all holders of our unsecured indebtedness that is deemed to be of the same class as the securities or which is not expressly subordinated to the securities, and potentially with all of our other general creditors, based upon the respective amounts owed to each holder or creditor, in our remaining assets. In any of the foregoing events, we cannot assure you that there will be sufficient assets to pay amounts due on the securities. As a result, holders of the securities may receive less, ratably, than holders of secured indebtedness. As of November 30, 2003, the aggregate amount of our secured indebtedness and the secured indebtedness of our subsidiaries was approximately $17.5 million, and approximately $62.8 million would have been available for additional borrowing under our senior credit facility, after excluding Primary Standard Industrial Classification Code Number $2.3 million of letters of credit outstanding under that facility. See "Description of Certain Indebtedness Senior Credit Facility." We may not have the ability to raise the funds necessary to finance the change of control offer required by the indenture. Upon the occurrence of certain specific kinds of change of control events, the indenture governing the securities requires us to offer to repurchase all outstanding securities at 101% of the principal amount thereof plus accrued and unpaid interest and liquidated damages, if any, to the date of repurchase. However, it is possible that we will not have sufficient funds at the time of the change of control to make the required repurchase of the securities. Moreover, our senior credit facility prohibits our repurchase of the securities upon a change of control and our senior notes limit our ability to repurchase the securities upon a change of control. Additionally, the occurrence of a change of control may require us to repay our senior credit facility and the senior subordinated notes. See "Description of Registered Securities Repurchase at the Option of Holders." Your right to require us to redeem the securities is limited. The holders of securities have limited rights to require us to purchase or redeem the securities in the event of a takeover, recapitalization or similar restructuring, including an issuer recapitalization or similar transaction with management. Consequently, the change of control provisions of the indenture for the securities will not afford any protection in a highly leveraged transaction, including such a transaction initiated by us, if such transaction does not result in a change of control or otherwise result in an event of default under the securities indenture. Accordingly, the change of control provision is likely to be of limited usefulness in such situations. Federal and state statutes allow courts, under specific circumstances, to void guarantees and require note holders to return payments received from guarantors. Under the federal bankruptcy law and comparable provisions of state fraudulent transfer laws, a guarantee could be voided, or claims in respect of a guarantee could be subordinated to all other debts of the guarantor if, among other things, the guarantor, at the time it incurred the indebtedness evidenced by its guarantee: received less than reasonably equivalent value or fair consideration for the incurrence of such guarantee; and was insolvent or rendered insolvent by reason of such incurrence; or was engaged in a business or transaction for which the guarantor's remaining assets constituted unreasonably small capital; or intended to incur, or believed that it would incur, debts beyond its ability to pay such debts as they mature. In addition, any payment by that guarantor pursuant to its guarantee could be voided and required to be returned to the guarantor, or to a fund for the benefit of the creditors of the guarantor. The measures of insolvency for purposes of these fraudulent transfer laws will vary depending upon the law applied in any proceeding to determine whether a fraudulent transfer has occurred. Generally, however, a guarantor would be considered insolvent if: the sum of its debts, including contingent liabilities, was greater than the fair saleable value of all of its assets; I.R.S. Employer Identification Number the present fair saleable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts, including contingent liabilities, as they become absolute and mature; or it could not pay its debts as they become due. On the basis of historical financial information, recent operating history and other factors, we believe that each guarantor, after giving effect to its guarantee of the securities, will not be insolvent, will not have unreasonably small capital for the business in which it is engaged and will not have incurred debts beyond its ability to pay such debts as they mature. We cannot assure you, however, as to what standard a court would apply in making these determinations or that a court would agree with our conclusions in this regard. Risks Relating to Our Business We have a narrow product range and our business would suffer if our products become obsolete or consumption of them decreased. We derive a significant portion of our net sales from customers in the business of publishing textbooks intended for the ELHI and college markets. Therefore, we are dependent upon the sale of books to these markets. Our business would suffer if consumption of these products decreased or if these products became obsolete. Our business could be adversely affected by factors such as changes in the funding of large institutional users of books such as elementary and high schools and colleges and universities. Our results of operations are dependent on our principal production facility for four-color educational textbooks. Approximately 50% of our net sales and 53% of our earnings before interest, taxes, depreciation and amortization for 2002 were generated from our Jefferson City, Missouri production facility where we manufacture, among other products, our four-color educational textbooks. Any disruption of our production capabilities at this facility for a significant term could adversely effect our operating results. While we maintain levels of insurance we believe to be adequate to protect against significant interruption in operations at our Jefferson City facility, there is no assurance that any proceeds from insurance would be sufficient to return such facility to operational status or that we could relocate our operations from such facility without incurring significant costs, including the possible loss of customers during any period during which production is interrupted. Our business is subject to seasonal and cyclical fluctuations in sales. We experience seasonal fluctuations in our sales. The seasonality of the ELHI market is significantly influenced by state and local school book purchasing schedules, which commence in the spring and peak in the summer months preceding the start of the school year. The college textbook market is also seasonal with the majority of textbook sales occurring during June through August and November through January. Significant amounts of inventory are acquired by publishers prior to those periods in order to meet customer delivery requirements. This places significant pressure on publishers and textbook manufacturers to monitor production and distribution accurately to satisfy these delivery requirements. We also experience cyclical fluctuations in our sales. The cyclicality of the ELHI market is primarily attributable to the textbook adoption cycle. Industry sales volume gains or losses in any year are principally due to shifts in adoption schedules and the availability of state and local government funding. Numerous states and localities are under budgetary constraints and are currently addressing deficit positions, which could result in short term funding reductions for these materials and may delay Address, including zip code, and telephone number, including area code, of registrant's principal executive office* future adoptions. To a lesser extent, the cyclicality of our business is also attributable to fluctuations in paper prices. Actual or perceived changes in paper prices will result in fluctuations in purchases by our customers and, accordingly, impact our sales in a given year. Lower than expected sales by us during the adoption period or a general economic downturn in our market or industry could have a material adverse effect on the timing of our cash flows and, therefore, on our ability to service our obligations with respect to the securities and our other indebtedness. See "Business The Instructional Materials Industry." Any problem or interruption in our supply of paper or other raw materials could delay production and adversely affect our sales. We rely on independent suppliers for key raw materials, principally paper, ink, bindery materials and adhesives, which may be available only from limited sources. Although supplies of our raw materials currently are adequate, shortages could occur in the future due to interruption of supply or increased industry demand. In addition, we do not have long-term contracts with any of our suppliers. We cannot assure you that these suppliers will continue to provide raw materials to us at attractive prices, or at all, or that we will be able to obtain such raw materials in the future from these or other providers on the scale and within the time frames we require. Although we believe we can obtain paper and other raw materials from alternate suppliers, any failure to obtain such raw materials on a timely basis at an affordable cost, or any significant delays or interruptions of supply could have a material adverse effect on our business, financial condition and results of operations. A significant amount of our business comes from a limited number of customers and our revenue and profits could decrease significantly if we lose one or more of them as customers. Our business depends on a limited number of customers. Our customers include, among others, approximately 50 autonomous divisions of the four major educational textbook publishers. Each of these divisions maintains its own manufacturing relationships and generally makes textbook manufacturing decisions independently of other divisions. Combining division sales, these four publishers accounted for approximately 42% of our net sales during 2002. We do not have long-term contracts with any of these customers. Accordingly, our ability to retain or increase our business often depends upon our relationships with each customer's divisional managers and senior executives. One or more of these customers may stop buying textbook manufacturing from us or may substantially reduce the amount of textbooks we manufacture for it. Any cancellation, deferral or significant reduction in manufacturing sold to these principal customers or a significant number of smaller customers could seriously harm our business, financial condition and results of operations. We operate in a very competitive business environment. Competition in our industry is intense. In particular, the educational textbook manufacturing market is concentrated and is served by large national printers and smaller regional printers. Because of greater resources, some of our competitors may be able to adapt more quickly to new or emerging technologies and changes in customer requirements or to devote greater resources to the promotion and sale of their products than we can. Since the textbook manufacturing process represents a small percentage of the total cost to publish a textbook, providers of textbook manufacturing have traditionally competed on the bases of quality of product, customer service, availability of printing time on appropriate equipment, timeliness of delivery and, to a lesser extent, price. We believe that maintaining a competitive advantage will require continued investment by us in product development, manufacturing capabilities and sales and marketing. We cannot assure you that we will have sufficient resources to make the necessary investments to do so, and we cannot assure you that we will be able to Registration No. compete successfully in our market or against our competitors. Accordingly, new competitors may emerge and rapidly acquire market share. See "Business Competition." If we do not retain our key personnel and attract and retain other highly skilled employees, our business could suffer. If we fail to retain and recruit the necessary personnel, our business and our ability to obtain new customers, maintain the quality of our products and provide acceptable levels of customer service could suffer. The success of our business depends heavily on the leadership of our senior management personnel and certain other key employees. If any of these persons were to leave our company, it could be difficult to replace them and our business could be harmed. See "Management." Our success also depends on our ability to recruit, retain and motivate highly skilled personnel. We believe that our success is attributable largely to the experience and stability of our labor force and our experienced and relatively stable workforce is one of our most significant assets, As our workforce ages and retirements occur, we may need to replace a significant portion of our skilled labor. Competition for these persons is intense, and we may not be successful in recruiting, training or retaining qualified personnel. Our productivity and growth depends on our ability to attract and retain additional qualified employees, and our failure to replace or expand our existing employee base could have a material adverse effect on our ability to grow. Our ultimate principal shareholder's interests may conflict with yours. DLJ Merchant Banking beneficially owns approximately 98.8% of Holdings' outstanding common stock. Holdings owns 100% of Von Hoffmann's common stock. As a result, DLJ Merchant Banking is in a position to control all matters affecting us, and may authorize actions or have interests that could conflict with your interests. DLJ Merchant Banking is an affiliate of CSFB. We could face considerable business and financial risk in implementing our acquisition strategy. As part of our growth strategy, we intend to consider acquiring complementary businesses. We cannot assure you that future acquisition opportunities will exist or, if they do, that we will be able to finance those opportunities. The indenture governing the securities and the senior subordinated notes and our senior credit facility contain covenants that limit our ability to incur additional indebtedness which could limit our ability to finance such acquisitions. Future acquisitions could result in us incurring debt and contingent liabilities or incurring impairment charges with respect to goodwill. Risks we could face with respect to acquisitions also include: difficulties in the integration of the operations, technologies, products and personnel of the acquired company; risks of entering markets in which we have no or limited prior experience; risks relating to potential unknown liabilities associated with acquired business; potential loss of employees; diversion of management's attention away from other business concerns; and expenses of any undisclosed or potential legal liabilities of the acquired company. The risks associated with acquisitions could have a material adverse effect upon our business, financial condition and results of operations. We cannot assure you that we will be successful in consummating future acquisitions on favorable terms or at all. H & S Graphics, Inc Delaware 27962 36-4228578 3640 Edison Place Rolling Meadows, IL 60008 (847) 506-9800 333-112031-03 The Lehigh Press, Inc. Pennsylvania 2752 23-1417330 701 North Park Drive Pennsauken, New Jersey 08109 (856) 665-5200 333-112031-01 Precision Offset Printing Company Delaware 27323 23-1354890 133 Main Street Leesport, PA 19533 (610) 926-3900 333-112031-02 If we are unable to successfully integrate the Lehigh Press business into our business, or if upon integration we fail to realize the expected cost savings of the combination, our operations could be disrupted and may suffer. Our acquisition of the Lehigh Press business has significantly increased the size and geographic scope of our operations. Our management's attention will be focused, in part, on the integration process for the foreseeable future. Our ability to integrate the Lehigh Press business with our existing business will be critical to the future success of our business. Our integration strategies are subject to numerous conditions beyond our control, including the possibility of negative reactions by existing customers or employees or adverse general and regional economic conditions, general negative industry trends and competition. We also may be unable to achieve the anticipated synergies and benefits from the Lehigh Press acquisition. If we are unable to realize these anticipated benefits due to our inability to address the challenges of integrating the Lehigh Press business or for any other reason, it could have a material adverse effect on our business and financial and operating results. We may be required to make significant capital expenditures in order to remain technologically and economically competitive. Production technology in the printing industry has evolved and continues to evolve. Although we have invested approximately $90.0 million in equipment and plant expansions (excluding equipment obtained in acquisitions) over the past five years and do not currently forecast any further major expenditure, the emergence of any significant technological advances utilized by competitors could require us to invest significant capital in additional production technology in order to remain competitive. We cannot assure you that we would be able to fund any such investments. Our failure to invest in new technologies could have a material adverse effect on our business, financial condition or results of operations. We are subject to significant environmental regulation and environmental compliance expenditures and liabilities. Our businesses are subject to many environmental and health and safety laws and regulations, particularly with respect to the generation, storage, transportation, disposal, release and emission into the environment of various substances. We believe we are in substantial compliance with these laws. Compliance with these laws and regulations is a significant factor in our business. Some or all of the environmental laws and regulations to which we are subject could become more stringent or more stringently enforced in the future and more stringent laws or regulations could be enacted. Our failure to comply with applicable environmental laws and regulations and permit requirements could result in civil or criminal fines or penalties or enforcement actions, including regulatory or judicial orders enjoining or curtailing operations or requiring corrective measures, installation of pollution control equipment or remedial actions. Some environmental laws and regulations impose liability and responsibility on present and former owners, operators or users of facilities and sites for contamination at such facilities and sites without regard to causation or knowledge of contamination. In addition, we occasionally evaluate various alternatives with respect to our facilities, including possible dispositions or closures. Investigations undertaken in connection with these activities may lead to discoveries of contamination that must be remediated, and closures of facilities may trigger compliance requirements that are not applicable to operating facilities. Consequently, we cannot assure you that existing or future circumstances or developments with respect to contamination will not require significant expenditures by us. Balances, December 31, 2002 $ *Name, address, including zip code, and telephone number, including area code, for agent of service of process for each of the Additional Registrants is Gary C. Wetzel at 1000 Camera Avenue, St. Louis, MO 63126, (314) 966-0909. EXPLANATORY NOTE This Registration Statement covers the registration of an aggregate principal amount of $60,000,000 of new 101/4% Senior Notes due 2009 of Von Hoffmann Corporation and related guarantees (collectively, the "New Securities") that may be exchanged for an equal principal amount of outstanding 101/4% Senior Notes due 2009 of Von Hoffmann Corporation and related guarantees. The registered notes will be, and the outstanding notes are, guaranteed by Von Hoffmann Holding Inc. and each of the additional registrants listed above under "Additional Registrants." This Registration Statement also covers the registration of the New Securities for resale by Credit Suisse First Boston Corporation and its affiliates that are affiliates of the registrants in market-making transactions. In addition, this Registration Statement is being filed as a post-effective amendment to Registration No. 333-90992. That Registration Statement (the "Earlier Registration Statement") covers the registration of $275,000,000 of 101/4% Senior Notes due 2009 and $100,000,000 of 103/8% Senior Subordinated Notes due 2007 of Von Hoffmann Corporation and $41,901,020 131/2% Subordinated Exchange Debentures due 2009 of Von Hoffmann Holdings Inc. for resale by Credit Suisse First Boston Corporation and its affiliates that are affiliates of the registrants in market-making transactions. The post effective amendment is being filed in accordance with Rule 429 of the Securities Act of 1933 to reflect the filing of a combined prospectus in this Registration Statement covering the resale of the New Securities and the resale of the securities registered under the Earlier Registration Statement. This Registration Statement accordingly contains two prospectuses, one relating to the exchange offer for the New Securities and the other relating to market-making transactions by Credit Suisse First Boston and its affiliates that are affiliates of the registrants covering both the resale of the New Securities and the securities registered under the Earlier Registration Statement. The complete prospectus to be used in the exchange offer follows immediately after this Explanatory Note. Following that are certain pages of the prospectus relating solely to market-making transactions, including alternate front and back cover pages, an alternate "Summary of the Terms of the Registered Securities" section, a section entitled "Risk Factors Risks Relating to the Senior Notes, the Senior Subordinated Notes and the Subordinated Exchange Debentures" to be used in lieu of the section entitled "Risk Factors Risks Relating to the Securities," and alternate "Plan of Distribution" and "Material United States Federal Income Tax Consequences" sections. In addition, the market making prospectus will include the following captions "Description of Registered Securities 103/8% Senior Subordinated Notes due 2007 and 131/2% Subordinated Exchange Debentures due 2009." In addition, the market-making prospectus will not include the following captions (or the information set forth under the captions) in the exchange offer prospectus: "Summary of the Terms of the Exchange Offer," "The Exchange Offer" "Description of Certain Indebtedness Senior Subordinated Notes and Subordinated Exchange Debentures." All other sections of the exchange offer prospectus will be included in the market-making prospectus.

parsed_sections/risk_factors/2004/CIK0001178518_restaurant_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ RISK FACTORS In addition to the other information contained in this prospectus, the following factors should be considered carefully before investing in the IDSs (including the Class A common stock and senior subordinated notes represented thereby) or our senior subordinated notes. If any of the following risks actually occur, our business, results of operations or financial condition would likely suffer. Risks Relating to the IDSs, the Shares of Class A Common Stock and the Senior Subordinated Notes Represented by the IDSs, and the Senior Subordinated Notes Offered Separately Buffets Holdings is a holding company and relies on dividends, interest and other payments, advances and transfer of funds from its subsidiaries to meet its debt service and other obligations. Buffets Holdings has no direct operations and no significant assets other than ownership of 100% of the stock of Buffets, all of which will be pledged to the creditors under the Amended Credit Facility which Buffets Holdings guarantees. Because Buffets Holdings conducts its operations through its direct and indirect subsidiaries, Buffets Holdings depends on those entities for dividends and other payments to generate the funds necessary to meet its financial obligations, including payments of principal and interest on the senior subordinated notes, and to pay dividends with respect to the common stock. Legal and contractual restrictions in the Amended Credit Facility, the indenture governing Buffets Senior Notes and other agreements governing current and future indebtedness of Buffets Holdings subsidiaries, as well as the financial condition and operating requirements of Buffets Holdings subsidiaries, may limit Buffets Holdings ability to obtain cash from its subsidiaries. The earnings from, or other available assets of, Buffets Holdings subsidiaries may not be sufficient to pay dividends or make distributions or loans to enable Buffets Holdings to make payments in respect of the senior subordinated notes when such payments are due and to pay dividends on the common stock. Your rights as holders of the senior subordinated notes and guarantees thereof to receive payments will be contractually subordinated to those of holders of our senior indebtedness and may be otherwise adversely affected in the event of our bankruptcy. As a result of the subordinated nature of the senior subordinated notes and related guarantees, upon any distribution to our creditors or the creditors of the subsidiary guarantors in bankruptcy, liquidation or reorganization or similar proceeding relating to Buffets Holdings or the subsidiary guarantors or Buffets Holdings or their property, the holders of Buffets Holdings senior indebtedness and senior indebtedness of the subsidiary guarantors will be entitled to be paid in full in cash before any payment may be made with respect to the senior subordinated notes or the subsidiary guarantees. Holders of the senior subordinated notes would then participate with all other holders of unsecured senior subordinated indebtedness of Buffets Holdings or the subsidiary guarantors similarly subordinated in the assets remaining after Buffets Holdings and the subsidiary guarantors have paid all senior indebtedness. Buffets Holdings and the subsidiary guarantors may not have sufficient funds to pay all of our creditors, and holders of our senior subordinated notes may receive less, ratably, than the holders of senior indebtedness, and because of the obligation to turn over distributions to holders of senior indebtedness, the holders of the notes may receive less, ratably, than trade payables and other general unsecured indebtedness. Further, in the event of such bankruptcy proceedings, a party in interest may seek to subordinate the senior subordinated notes to all creditors under principles of equitable subordination or to recharacterize the senior subordinated notes as equity. If such a subordination or recharacterization did occur, you may not recover any amounts owing on the senior subordinated notes or the guarantees and you might be required to return any payments made to you on account of the senior subordinated notes up to six years prior to our bankruptcy. As of June 30, 2004, on a pro forma basis, the senior subordinated notes and the subsidiary guarantees would have ranked junior, on a consolidated basis, to approximately $ million of indebtedness, including borrowings under the Amended Credit Facility and Buffets Senior Notes. In addition, as of June 30, 2004, on a pro forma basis, we would have had the ability to borrow up to an 23 .3* Consent of Faegre Benson LLP (included in Exhibit 5.2 to this Registration Statement). 10 .13** Severance Protection Agreement, dated September 29, 2000, between Buffets, Inc. and Jean C. Rostollan (incorporated by reference to Exhibit 10.9.1 to Buffets, Inc. s Annual Report on Form 10-K filed with the Commission on September 30, 2003 (SEC file No. 033-00171)). 12 .1 Statement of Computation of Ratios of Earnings to Fixed Charges. 21 List of Subsidiaries of Buffets Holdings, Inc. 23 .1 Consent of Deloitte Touche LLP. 23 .2* Consent of Paul, Weiss, Rifkind, Wharton Garrison LLP (included in Exhibits 5.1 and 8.1 to this Registration Statement). 23 .3* Consent of Faegre Benson LLP (included in Exhibit 5.2 to this Registration Statement). Table of Contents BUFFETS HOLDINGS, INC. TABLE OF ADDITIONAL REGISTRANTS Primary Standard IRS Jurisdiction of Industrial Employer Incorporation or Classification Identification Name Organization Number Number Table of Contents additional amount of $ million under the Amended Credit Facility (less amounts reserved for letters of credit), which would have ranked senior in right of payment to the senior subordinated notes. Payments on the senior subordinated notes may be blocked if we default under senior indebtedness, including the Amended Credit Facility. If we default in the payment of any of our senior indebtedness, including the Amended Credit Facility and Buffets Senior Notes, we will not make any payments on the senior subordinated notes until the payment default has been cured or waived. In addition, even if we are making payments on our senior indebtedness on a timely basis, payments on the senior subordinated notes may be blocked for up to 180 days if we default on our senior indebtedness in some other manner. During any period in which payments on the senior subordinated notes are prohibited or blocked in this manner, we and the guarantors will be prohibited from making any payments in respect of the senior subordinated notes and the guarantees. Claims of noteholders will be structurally subordinated to claims of creditors of all of our existing and future unrestricted subsidiaries, all of which will not guarantee the senior subordinated notes. The senior subordinated notes will not be guaranteed by any of our current or future unrestricted subsidiaries. Our unrestricted subsidiaries are separate and distinct legal entities and have no obligation, contingent or otherwise, to pay any amounts due pursuant to the senior subordinated notes, or to make any funds available therefor, whether by dividends, loans, distributions or other payments. Any right that we or the guarantors have to receive any assets of any of the unrestricted subsidiaries upon the liquidation or reorganization of those subsidiaries, and the consequent rights of holders of senior subordinated notes to realize proceeds from the sale of any of those subsidiaries assets, will be structurally subordinated to the claims of that subsidiaries creditors, including trade creditors and holders of debt of those subsidiaries. Our substantial level of indebtedness could adversely affect our financial condition and prevent us from fulfilling our obligations under the senior subordinated notes. We have substantial indebtedness. As of June 30, 2004, on a pro forma basis, we would have had $ million of total indebtedness. Our ability to make distributions, pay dividends or make other payments will be subject to applicable law and contractual restrictions contained in the instruments governing any indebtedness of ours and our subsidiaries, including the Amended Credit Facility and Buffets Senior Notes. Our level of debt could have negative consequences to you and to us. For example, it could: make it more difficult for us to satisfy our obligations with respect to the senior subordinated notes; increase our vulnerability to general adverse economic and industry conditions, as well as increases in interest rates; limit our ability to fund future working capital, capital expenditures, debt service and general corporate requirements; require us to dedicate a substantial portion of our cash flow from operations to the payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate purposes; place us at a competitive disadvantage compared to our competitors that have less debt; limit our ability to borrow additional funds; limit our ability to refinance our debt on terms acceptable to us or at all; make it more difficult to comply with the covenants in the indentures relating to our senior subordinated notes and Buffets Senior Notes and the amended credit agreement relating to the Table of Contents Amended Credit Facility, which could in turn result in an event of default under our indebtedness, which, if not cured or waived, could have a material adverse effect on us; and limit our flexibility in planning for, or reacting to, changes in our business and future business opportunities. Servicing our debt will require a significant amount of cash. Our subsidiaries ability to generate sufficient cash depends on numerous factors which are beyond our control and we may be unable to generate sufficient cash flow to service our debt obligations, including making payments on the senior subordinated notes, and to pay dividends on the common stock. Our ability to pay our expenses, principal and interest on the senior subordinated notes and other debt, and dividends on the common stock depends on our ability to generate positive cash flow in the future, which is subject to general economic, financial, competitive, legislative and regulatory factors and other factors that are beyond our control. Our subsidiaries operations may not generate sufficient cash flow from operations and future borrowings may not be available under the Amended Credit Facility in amounts sufficient to enable us or our subsidiaries to make payments in respect of the senior subordinated notes, to pay our other debt, to pay dividends on the common stock or to fund other liquidity needs. If our subsidiaries do not have sufficient cash flow from operations, Buffets Holdings or our subsidiaries may be required to incur additional indebtedness, refinance all or part of our existing debt or sell assets. If Buffets Holdings or our subsidiaries are required to refinance existing debt, or if Buffets Holdings or our subsidiaries are required to sell some of our assets, we may not be able to do so on terms that are acceptable to us or at all. In addition, the terms of existing or future debt agreements, including the indenture governing Buffets Senior Notes and the Amended Credit Facility, may restrict Buffets Holdings or our subsidiaries from effecting any of these alternatives or we may fail for other reasons. If we are required to pursue other alternatives, the value of the senior subordinated notes and the common stock, and our financial condition, could be significantly adversely affected. Despite our current leverage, we may still be able to incur substantially more debt. This could further exacerbate the risks that we and our subsidiaries face. We, including our subsidiaries, may be able to incur substantial additional indebtedness in the future. For example, the Amended Credit Facility will provide commitments of up to $ million, $ million of which would have been available for future borrowings as of June 30, 2004, on a pro forma basis, subject to the aggregate borrowing base availability and net of $ million in outstanding letters of credit. All of such indebtedness would have been secured and effectively senior to the senior subordinated notes. If we incur any additional indebtedness that ranks equally with the senior subordinated notes, the holders of that debt will be entitled to share ratably with the holders of the senior subordinated notes in any proceeds distributed in connection with any insolvency, liquidation, reorganization, dissolution or other winding-up of us. This may have the effect of reducing the amount of proceeds paid to you. If additional indebtedness is added to our or our subsidiaries current levels of indebtedness, the substantial risks described above would intensify. If we or our subsidiaries default on our or their obligations to pay our or their indebtedness, or fail to comply with other covenants thereunder, we may not be able to make payments on the senior subordinated notes and the common stock. If we or our subsidiaries are unable to generate sufficient cash flow and are otherwise unable to obtain funds necessary to meet required payments on our or their indebtedness, or if we or our subsidiaries otherwise fail to comply with the various covenants, including financial and operating covenants, in the instruments governing our or their indebtedness (including the Amended Credit Facility and our guarantee Table of Contents thereof and the indenture governing Buffets Senior Notes), we or they could be in default under the terms of the agreements governing such indebtedness. In the event of such default: the holders of such indebtedness could elect to declare all the funds borrowed thereunder to be due and payable, together with accrued and unpaid interest and liquidated damages, if any. The lenders under the Amended Credit Facility could elect to terminate their commitments, cease making further loans and institute foreclosure proceedings against our or our subsidiaries assets. We could directly or indirectly be prohibited from paying principal, premium, if any, and interest on the senior subordinated notes, and dividends with respect to the common stock, and we or our subsidiaries could be forced into bankruptcy or liquidation. We will be subject to restrictive covenants in our debt agreements that may limit our ability to pursue strategies that may otherwise improve our business. The indenture governing the senior subordinated notes, the indenture governing Buffets Senior Notes and the Amended Credit Facility will impose significant operating and financial restrictions on us. These restrictions will limit our ability, among other things, to: incur additional indebtedness; acquire the assets of, or merge or consolidate with, other companies; pay dividends or make other distributions on our capital stock or repurchase, repay or redeem the senior subordinated notes, subordinated debt and our capital stock; make certain investments; incur liens; make capital expenditures; enter into certain types of transactions with our stockholders and affiliates; limit dividends or other payments by our restricted subsidiaries to us; and transfer or sell certain or all or substantially all of our assets. These covenants in the indenture governing the senior subordinated notes, the indenture governing Buffets Senior Notes and the Amended Credit Facility may impair our ability to finance future operations or capital needs or to enter into acquisitions or joint ventures or engage in other favorable business activities. If we default under the indenture governing the senior subordinated notes, the indenture governing Buffets Senior Notes or the Amended Credit Facility or we fail to satisfy the financial covenants under the Amended Credit Facility, we could directly or indirectly be prohibited from making any payments with respect to the IDSs or our senior subordinated notes. In addition, the lenders under the Amended Credit Facility and the holders of Buffets Senior Notes could require immediate repayment of the entire principal that is outstanding under those facilities or those notes. If those lenders or holders require immediate repayment, our assets may not be sufficient to repay them and also repay the senior subordinated notes in full. Our dividend policy may negatively impact our ability to finance capital expenditure or operation. Upon completion of this offering, our board of directors will adopt a dividend policy under which cash generated by our business in excess of operating needs, interest and principal payments on indebtedness, and capital expenditures sufficient to maintain our properties would in general be distributed as regular quarterly dividends to the holders of our Class A common stock and Class B common stock rather than retained by us and used to finance growth opportunities. As a result, we may not retain a sufficient amount of cash to finance growth opportunities or unanticipated capital expenditure needs or to fund our Table of Contents operations in the event of a significant business downturn. We may have to forgo growth opportunities or capital expenditures that would otherwise be necessary or desirable if we do not find alternative sources or financing. If we do not have sufficient cash for these purposes or if the $ million in cash on hand available for capital expenditures is insufficient, our financial condition and our business will suffer. Federal and state laws permit a court to void the senior subordinated notes or the subsidiary guarantees under certain circumstances. The issuance of the senior subordinated notes and the guarantees may be subject to review under United States federal bankruptcy law and comparable provisions of state fraudulent conveyance laws if a bankruptcy or reorganization case or lawsuit is commenced by or on behalf of our or the guarantor s unpaid creditors. A court could void the obligations under the senior subordinated notes or the guarantees, further subordinate the senior subordinated notes or the guarantees or take other action detrimental to holders of the senior subordinated notes, if, among other things, at the time the indebtedness was incurred, Buffets Holdings or the guarantors: issued the senior subordinated notes or the guarantees to delay, hinder or defraud present or future creditors; or received less than reasonably equivalent value or fair consideration for issuing the senior subordinated notes or the guarantees at the time of issuance of the senior subordinated notes or the guarantees and: were insolvent or rendered insolvent by reason of issuing the senior subordinated notes or the guarantees; were engaged, or about to engage, in a business or transaction for which the remaining unencumbered assets constituted unreasonably small capital to carry on our or the guarantor s business; or intended to incur, or believed that we or the guarantor would incur, debts beyond our or the guarantor s ability to pay as they mature. The measures of insolvency for purposes of fraudulent transfer laws vary depending upon the law of the jurisdiction that is being applied in any proceeding to determine whether a fraudulent transfer had occurred. It is not clear what standard a court would use to determine whether or not we or a guarantor were solvent at the relevant time. Generally, however, a person would be considered insolvent if, at the time it incurred the debt: the sum of its debts, including contingent liabilities, was greater than the fair saleable value of all of its assets; the present fair saleable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts, including contingent liabilities, as they become absolute and mature; or it could not pay its debts as they become due. The proceeds of the offering will be used to repurchase a portion of Buffets Holdings common stock from our existing stockholders and to repurchase all of our outstanding 13 7/8% Notes and Buffets 11 1/4% Notes, which may subject the holders of our senior subordinated notes in this offering to the claim that we did not receive fair consideration for the senior subordinated notes issued in this offering. In the event that we meet any of the financial condition fraudulent transfer tests described above at the time of or as a result of this offering, a court could integrate the issuance of our senior subordinated notes with the distribution to our shareholders and the repurchase of Buffets 11 1/4% Notes, and, therefore, conclude that we did not get fair value for the offering viewed as an integrated transaction. In such a case, a court could hold the debt owed to the holders of our senior subordinated notes void or unenforceable or may subordinate it to the claims of other creditors. BALANCE, July 2, 2003 69 (44 ) 34 (21 ) 317 (25 ) 420 (90 ) FY 2004 Activity: Amortization (12 ) (8 ) (20 ) Additions 28 Table of Contents The guarantee of our senior subordinated notes by any subsidiary guarantor could be subject to the claim that, since the guarantee was incurred for the benefit of Buffets Holdings, and only indirectly for the benefit of the subsidiary guarantor, the obligations of the subsidiary guarantor were incurred for less than fair consideration. If such a claim were successful and it was proven that the subsidiary guarantor was insolvent at the time the guarantee was issued, a court could void the obligations of the subsidiary guarantor under the guarantee or subordinate these obligations to the subsidiary guarantor s other debt or take action detrimental to the holders of the senior subordinated notes. If the guarantee of any subsidiary guarantor were voided, our notes would be effectively subordinated to the indebtedness of that subsidiary guarantor. If we defease the senior subordinated notes, such defeasance may be subject to preferential transfer laws. The indenture relating to the senior subordinated notes will provide that we may, after complying with certain conditions, defease the senior subordinated notes and be released from our obligations under many of the covenants contained in the indenture, or discharge all our obligations under the indenture within a year of the maturity date or a redemption date. One of the conditions to such defeasance or discharge is that we deposit sufficient funds with the trustee to pay the principal, interest and premium on the outstanding senior subordinated notes through maturity or an applicable redemption date. If a bankruptcy or reorganization proceeding is initiated within the applicable preference period, which generally varies from 90 days to one year, the deposit would likely be subject to review under federal bankruptcy law and comparable provisions of state law. In such an event, a court may void the deposit of funds with the trustee as a preferential transfer and recover such funds for the benefit of the bankruptcy estate and/or otherwise order that the funds be made available to satisfy claims of other creditors. In addition, under the fraudulent conveyance laws described above, a court could also void the deposit of funds or take other actions detrimental to you. The indenture will permit us to finance the defeasance deposit by issuing secured debt that we would not otherwise be permitted to incur under the indenture. In the event that the payments used to defease the senior subordinated notes are found to be a preferential transfer or a fraudulent conveyance, any claims arising out of or relating to the senior subordinated notes would be effectively subordinated in right of payment to any of our secured debt, including the secured debt incurred to finance the defeasance, to the extent of the value of the assets securing that debt. Your ability to recover on the senior subordinated notes after a defeasance or discharge may be reduced or eliminated as a result of these risks. You may not receive the level of dividends provided for in our dividend policy, which our board of directors is expected to adopt upon the closing of this offering, or any dividends at all. Our board of directors may, in its discretion, amend or repeal the dividend policy it is expected to adopt upon the closing of this offering. Our board of directors may decrease the level of dividends provided for in this dividend policy or entirely discontinue the payment of dividends. Future dividends with respect to shares of our capital stock, if any, will depend on, among other things, our results of operations, cash requirements, financial condition, contractual restrictions, business opportunities, provisions of applicable law and other factors that our board of directors may deem relevant. The Amended Credit Facility, the indenture governing Buffets Senior Notes and the indenture governing the senior subordinated notes will contain significant restrictions on our ability to make dividend payments. In addition, certain provisions of the Delaware General Corporation Law may limit our ability to pay dividends. The indenture governing the senior subordinated notes will permit us to pay a significant portion of our free cash flow to stockholders in the form of dividends. The indenture governing the senior subordinated notes, the indenture governing Buffets Senior Notes and the Amended Credit Facility will permit us to pay a significant portion of our free cash flow to holders of our common stock, including Class A common stock held as part of IDSs, and Class B common stock in the form of dividends. Holders of senior subordinated notes held separately from the IDSs may be Table of Contents The information in this prospectus is not complete and may be changed without notice. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and we are not soliciting offers to buy these securities in any jurisdiction where the offer or sale is not permitted. SUBJECT TO COMPLETION, DATED AUGUST 27, 2004 Prospectus Income Deposit Securities (IDSs) $ million % Senior Subordinated Notes due 2019 Buffets Holdings, Inc. Table of Contents adversely affected by such provisions because any amounts paid by us in the form of dividends will not be available in the future to satisfy our obligations under the senior subordinated notes. The realizable value of our assets upon liquidation may be insufficient to satisfy claims. As of June 30, 2004, on a pro forma basis, our total assets included intangible assets in the amount of $ million, representing approximately % of our total consolidated assets. The value of these intangible assets will continue to depend significantly upon the continued profitability of the respective brands. As a result, in the event of a default on our senior subordinated notes or any bankruptcy or dissolution of our company, the realizable value of these assets may be substantially lower and may be insufficient to satisfy the claims of our creditors. Subject to restrictions set forth in the indenture, we may defer the payment of interest to you for a significant period of time. Prior to , 2009, we may, subject to restrictions set forth in the indenture, defer interest payments on our senior subordinated notes on one or more occasions for up to an aggregate period of eight quarters. In addition, after , 2009, we may, subject to certain restrictions, defer interest payments on our senior subordinated notes on four occasions for up to two consecutive quarters per each occasion. At the end of any interest deferral period following , 2009, we may not further defer interest unless and until all deferred interest, including interest accrued on deferred interest, is paid in full. Deferred interest will bear interest at the same rate as the senior subordinated notes. For any interest deferred during the first five years, we are not obligated to pay any deferred interest until , 2009; so you may be owed a substantial amount of deferred interest that will not be due and payable until such time. For any interest deferred after , 2009, we are not obligated to pay all of the deferred interest until , 2019, so you may be owed a substantial amount of deferred interest that will not be due and payable until such time. During any interest deferral period and so long as any deferred interest or interest on deferred interest remains outstanding, we will not be permitted to make any payment of dividends on our capital stock. Deferral of interest payments would have adverse tax consequences for you and may adversely affect the trading price of the IDSs or the separately held senior subordinated notes. If interest payments on the senior subordinated notes are deferred, you will be required to recognize interest income for U.S. federal income tax purposes on an economic accrual basis in respect of interest payments on the senior subordinated notes represented by the IDSs or the separately held senior subordinated notes, as the case may be, held by you before you receive any cash payment of this interest. In addition, you will not receive the cash with respect to accrued interest if you sell the IDSs or the separately held senior subordinated notes, as the case may be, before the end of any deferral period or before the record date relating to interest payments that are to be paid. If interest is deferred, the IDSs or the separately held senior subordinated notes may trade at a price that does not fully reflect the value of accrued but unpaid interest on the senior subordinated notes. In addition, the fact that we may defer payments of interest on the senior subordinated notes under certain circumstances may mean that the market price for the IDSs or the separately held senior subordinated notes may be more volatile than other securities that do not have this term. See Material U.S. Federal Income Tax Consequences Consequences to U.S. Holders Senior Subordinated Notes Deferral of Interest. Interest on the notes may not be deductible by us for U.S. federal income tax purposes, which could significantly reduce our future cash flow and impact our ability to make interest and dividend payments. While we believe that the senior subordinated notes should be treated as debt for U.S. federal income tax purposes, this position may not be sustained if challenged by the Internal Revenue Service. If the senior subordinated notes were treated as equity rather than debt for U.S. federal income tax purposes, then the stated interest on the senior subordinated notes would be treated as a dividend (to the extent of our tax earnings and profits ), and interest on the senior subordinated notes would not be deductible by We are selling IDSs representing shares of our Class A common stock and $ million aggregate principal amount of our % senior subordinated notes due 2019. Each IDS initially represents: one share of our Class A common stock; and a % senior subordinated note with a $ principal amount. We are also selling $ million aggregate principal amount of our % senior subordinated notes separately (not represented by IDSs). The offering of IDSs and the offering of the separate senior subordinated notes are conditioned upon each other. This is the initial public offering of our IDSs, and the shares of our Class A common stock and senior subordinated notes represented thereby, and our separate senior subordinated notes. We anticipate that the public offering price of the IDSs will be between $ and $ per IDS and the public offering price of the senior subordinated notes sold separately will be % of their stated principal amount. We will apply to list our IDSs on the under the trading symbol . Holders of IDSs will have the right to separate the IDSs into the shares of our Class A common stock and senior subordinated notes represented thereby at any time after the earlier of 45 days from the closing of this offering or the occurrence of a change of control. Similarly, any holder of shares of our Class A common stock and senior subordinated notes may, at any time, unless the IDSs have automatically separated, combine the applicable number of shares of Class A common stock and principal amount of senior subordinated notes to form IDSs. Separation of all of the IDSs will occur automatically upon the continuance of a payment default on the senior subordinated notes for 90 days or upon the redemption, maturity or acceleration of the senior subordinated notes. Our senior subordinated notes mature on , 2019. We will be permitted to defer interest payments on our senior subordinated notes under certain circumstances and subject to the limitations described in Description of Senior Subordinated Notes Terms of the Notes Interest Deferral. Deferred interest on our senior subordinated notes will bear interest quarterly at a rate equal to the stated annual rate of interest on the senior subordinated notes divided by four. Upon a subsequent issuance by us of IDSs or senior subordinated notes of the same series, a portion of your senior subordinated notes may be automatically exchanged for an identical principal amount of the senior subordinated notes issued in such subsequent issuance, and in that event your IDSs will be replaced with new IDSs. In addition to the senior subordinated notes offered hereby, the registration statement of which this prospectus is a part also registers the senior subordinated notes and new IDSs to be issued upon any such subsequent issuance. We have granted the underwriters an option to purchase up to additional IDSs to cover over-allotments, if any. We will use all the proceeds from the sale of additional IDSs upon exercise of the underwriters over-allotment option to repurchase shares of our Class B common stock or other securities from certain of our existing stockholders. Investing in our IDSs, shares of our Class A common stock and senior subordinated notes involves risks. See Risk Factors beginning on page 24. Per IDS(1) Total Per Note(2) Total Table of Contents us for U.S. federal income tax purposes. Our inability to deduct interest on the senior subordinated notes could materially increase our taxable income and, thus, our U.S. federal and applicable state income tax liability. This would reduce our after-tax cash flow, which may result in a default under the Amended Credit Facility, and would materially and adversely impact our ability to make interest and dividend payments and may also affect our ability to continue as a going concern. In the case of foreign holders, treatment of the notes as equity for U.S. federal income tax purposes would subject payments to such holders in respect of the notes to withholding or estate taxes in the same manner as payments made with regard to Class A common stock and could subject us to liability for withholding taxes that were not collected on payments of interest. The allocation of the purchase price of the IDSs may not be respected. The purchase price of each IDS must be allocated for tax purposes between the share of Class A common stock and senior subordinated note represented thereby in proportion to their respective fair market values at the time of purchase. We expect to report the initial fair market value of each share of Class A common stock as $ and the initial fair market value of each of our senior subordinated notes represented by an IDS as $ and, by purchasing IDSs, you will agree to and be bound by such allocation, assuming an initial public offering price of $ per IDS, which represents the mid-point of the range set forth on the cover page of this prospectus. If this allocation is not respected, it is possible that the senior subordinated notes will be treated as having been issued with OID (if the allocation to the senior subordinated notes were determined to be too high) or amortizable bond premium (if the allocation to the senior subordinated notes were determined to be too low). You generally would have to include OID in income in advance of the receipt of cash attributable to that income and would be able to elect to amortize bond premium over the term of the senior subordinated notes. Subsequent issuances of senior subordinated notes may cause you to recognize OID and may be treated as a taxable exchange by you. The indenture governing the senior subordinated notes will provide that, in the event there is a subsequent issuance of senior subordinated notes but having terms that are otherwise identical (other than issuance date) to the senior subordinated notes, including any issuance of IDSs in exchange for shares of Class B common stock, but that are issued with OID, each holder of IDSs or separately held senior subordinated notes, as the case may be, agrees that, upon such issuance and any issuance of senior subordinated notes thereafter, a portion of such holder s senior subordinated notes will be automatically exchanged for a portion of the senior subordinated notes acquired by the holders of such subsequently issued senior subordinated notes. Consequently, immediately following such subsequent issuance and exchange, without any action by such holder, each holder of senior subordinated notes, held either as part of IDSs or separately, will own senior subordinated notes of each separate issuance in the same proportion as each other holder. Regardless of whether the exchange is treated as a taxable event, such exchange would result in holders having to include OID in taxable income prior to the receipt of cash as described below, and may result in other potentially adverse tax consequences to holders. See Material U.S. Federal Income Tax Consequences Consequences to U.S. Holders Senior Subordinated Notes Additional Issuances. In addition, the potential amount of OID that would be required to be included in taxable income by holders as a result of an automatic exchange (as described below) is indefinite and may be a significant amount, in part due to our ability to engage in numerous subsequent issuances. Following any subsequent issuance and exchange of senior subordinated notes with OID, we (and our agents) will report any OID on the subsequently issued senior subordinated notes ratably among all holders of IDSs and separately held senior subordinated notes, and each holder of IDSs and separately held senior subordinated notes will, by purchasing IDSs or separately held senior subordinated notes, agree to report OID in a manner consistent with this approach. However, the Internal Revenue Service may assert that any OID should be reported only to the persons that initially acquired such subsequently issued senior subordinated notes (and their transferees) and thus may challenge the holders reporting of OID on Table of Contents their tax returns. In such case, the Internal Revenue Service might further assert that, unless a holder can establish that it is not a person that initially acquired such subsequently issued senior subordinated notes (or a transferee thereof), all of the senior subordinated notes held by such holder would have OID. Any of these assertions by the Internal Revenue Service could create significant uncertainties in the pricing of IDSs and senior subordinated notes and could adversely affect the market for IDSs and senior subordinated notes. For a discussion of these tax related risks, see Material U.S. Federal Income Tax Consequences. The aggregate stated principal amount of the senior subordinated notes owned by each holder will not change as a result of such subsequent issuance and automatic exchange. However, under New York and federal bankruptcy law, holders of subsequently issued senior subordinated notes having OID may not be able to collect the portion of their principal face amount that represents unamortized OID at the acceleration or filing date in the event of an acceleration of the senior subordinated notes or our bankruptcy prior to the maturity date of the senior subordinated notes. As a result, an automatic exchange that results in a holder receiving a senior subordinated note with OID could have the effect of ultimately reducing the amount such holder can recover from us in the event of an acceleration or bankruptcy. We may have to establish a reserve for contingent tax liabilities in the future, which could adversely affect our ability to make dividend payments on the IDSs. Even if the IRS does not challenge the tax treatment of the senior subordinated notes, it is possible that as a result of an alteration of facts relied upon at the time of issuance of the notes, we will in the future need to change our anticipated accounting treatment and establish a reserve for contingent tax liabilities associated with the disallowance of all or part of the interest deductions on the notes. If we were required to maintain such a reserve, our ability to make dividend payments could be materially impaired and the market for the IDSs, Class A common stock and senior subordinated notes could be adversely affected. In addition, any resulting impact to our financial statements could lead to a default under the Amended Credit Facility. Before this offering, there has not been a public market for our IDSs, shares of our common stock or the senior subordinated notes, which may cause the price of the IDSs, shares of our common stock and separate senior subordinated notes to fluctuate substantially and negatively affect the value of your investment. None of the IDSs, the shares of our common stock or senior subordinated notes has a public market history. In addition, there has not been an active market in the United States for securities similar to the IDSs. An active trading market for the IDSs, shares of our common stock or the senior subordinated notes sold separately in this offering might not develop in the future, which may cause the price of the IDSs, shares of our common stock or the senior subordinated notes sold separately in this offering to fluctuate substantially, and we currently do not expect that an active trading market for the shares of our common stock will develop until the senior subordinated notes mature, if at all. If the senior subordinated notes represented by your IDSs are redeemed or mature, the IDSs will automatically separate and you will then hold the shares of our common stock. We do not intend to list our senior subordinated notes on any securities exchange. The initial public offering price of the IDSs and the senior subordinated notes sold separately in this offering will be determined by negotiations among us, our principal equity sponsor and the representatives of the underwriters and may not be indicative of the market price of the IDSs and the senior subordinated notes sold separately in this offering after the offering. Factors such as quarterly variations in our financial results and dividend payments, announcements by us or others, developments affecting us, our clients and our suppliers, general interest rate levels and general market volatility could cause the market price of the IDSs and the senior subordinated notes sold separately in this offering to fluctuate significantly. In addition, to the extent a market develops for our common stock or senior subordinated notes, or both, separate from the IDSs, the price of your IDSs may be affected. BALANCE, June 30, 2004 $ 3,185,672 $ Table of Contents The limited liquidity of the trading market for the senior subordinated notes sold separately may adversely affect the trading price of the separate senior subordinated notes. We are separately selling $ million aggregate principal amount of senior subordinated notes, representing approximately 10% of the total outstanding senior subordinated notes (including those senior subordinated notes represented by IDSs). While the senior subordinated notes sold separately are part of the same series of notes as, and are identical to, the senior subordinated notes represented by the IDSs, at the time of the issuance of the separate senior subordinated notes, the senior subordinated notes represented by the IDSs will not be separable for at least 45 days and will not be separately tradeable until separated. As a result, the initial trading market for the senior subordinated notes sold separately will be very limited. After the holders of the IDSs are permitted to separate their IDSs, a sufficient number of holders of IDSs may not separate their IDSs into shares of our common stock and senior subordinated notes so that a sizable and more liquid trading market for the senior subordinated notes not represented by IDSs may not develop or may not develop in a timely manner. Trading markets for debt securities have generally treated debt securities issued in larger aggregate principal amounts more favorably than similar securities issued in smaller aggregate principal amounts because of the increased liquidity created by potentially higher trading volumes associated with larger debt issuances. Because approximately 10% of the senior subordinated notes will initially be represented by the IDSs, it is likely that the senior subordinated notes sold separately will not trade at prices reflecting the aggregate principal amount of the combined issuance of senior subordinated notes included in the IDS offering and the separate senior subordinated notes offering. Therefore, a liquid market for the senior subordinated notes sold separately may not develop or may not develop in a timely manner, which may adversely affect the ability of the holders of the separate senior subordinated notes to sell any of their separate senior subordinated notes and the price at which these holders would be able to sell any of the senior subordinated notes sold separately. If interest rates rise, the trading value of our IDSs and the senior subordinated notes sold separately in this offering may decline. If interest rates rise or should the threat of rising interest rates develop, debt markets may be adversely affected. As a result, the trading value of our IDSs and senior subordinated notes may decline. Future sales or the possibility of future sales of a substantial amount of IDSs, shares of our common stock or the senior subordinated notes, together with the future conversion of our Class B common stock into IDSs, may depress the price of the IDSs, shares of our common stock and the senior subordinated notes. Future sales or the availability for sale of substantial amounts of IDSs or shares of our common stock or a significant principal amount of the senior subordinated notes in the public market could adversely affect the prevailing market price of the IDSs, shares of our common stock and the senior subordinated notes and could impair our ability to raise capital through future sales of our securities. After consummation of the Transactions, we anticipate that our existing stockholders will own IDSs and shares of our Class B common stock (or IDSs, if the underwriters over-allotment option is exercised in full). Subject to satisfaction of the Conversion Conditions, such shares of our Class B common stock will initially be convertible into IDSs. We may issue shares of our common stock and senior subordinated notes, which will be in the form of IDSs, or other securities from time to time as consideration for future acquisitions and investments. In the event any such acquisition or investment is significant, the number of shares of our common stock and the aggregate principal amount of senior subordinated notes, which may be in the form of IDSs, or the number or aggregate principal amount, as the case may be, of other securities that we may issue may in turn be significant. In addition, we may also grant registration rights covering those IDSs, shares of our common stock, senior subordinated notes or other securities in connection with any such acquisitions and investments. Table of Contents Our amended certificate of incorporation and by-laws and several other factors could limit another party s ability to acquire us and deprive our investors of the opportunity to obtain a takeover premium for their securities. Provisions contained in our amended and restated certificate of incorporation and by-laws could make it more difficult for a third party to acquire us, even if doing so might be beneficial to our stockholders. Provisions of our amended and restated certificate of incorporation and by-laws impose various procedural and other requirements that make it more difficult for stockholders to effect some corporate actions. For example, our amended and restated certificate of incorporation authorizes our board to determine the rights, preferences, privileges and restrictions of unissued series of preferred stock, without any vote or action by our stockholders. Thus, our board can authorize and issue shares of preferred stock with voting or conversion rights that could adversely affect the voting or other rights of holders of our common stock. These rights may have the effect of delaying or deterring a change of control of our company, and could limit the price that investors might be willing to pay in the future for shares of our common stock. In addition, a change of control of our company may be delayed or deferred as a result of our having three classes of directors. We are also subject to Section 203 of the Delaware General Corporation Law, which prohibits us from engaging in a business combination with an interested stockholder for a three-year period following the time that this stockholder becomes an interested stockholder, unless the business combination is approved in a prescribed manner. In addition, our amended and restated certificate of incorporation provides that for such time as Caxton-Iseman Capital together with its affiliates and related parties beneficially own at least 10% or 5% of our equity, it will be entitled to nominate two of our directors or one director, respectively. These provisions might make an unsolicited takeover more difficult or less likely to occur or might prevent such a takeover, even though such a takeover might offer our stockholders the opportunity to sell their stock at a price above the prevailing market price and might be favored by a majority of our stockholders. You will be immediately diluted by $ per share of common stock if you purchase IDSs in this offering. If you purchase IDSs in this offering, based on the book value of the assets and liabilities reflected on our balance sheet, you will experience an immediate dilution of $ per share of common stock represented by the IDSs, which exceeds the entire price allocated to each share of common stock represented by the IDSs in this offering, because there will be a net tangible book deficit for each share of common stock outstanding immediately after this offering. Our pro forma net tangible book deficiency as of June 30, 2004, after giving effect to this offering, was approximately $ million, or $ per share of Class A common stock. We may not be able to repurchase the senior subordinated notes upon a change of control. Upon the occurrence of specific kinds of change of control events, we will be required to offer to repurchase the outstanding senior subordinated notes at 101% of their principal amount at the date of repurchase unless such senior subordinated notes have been previously called for redemption. We may not have sufficient financial resources to purchase all of the senior subordinated notes that are tendered upon a change of control offer. Furthermore, the Amended Credit Facility, with certain limited exceptions, will prohibit the repurchase or redemption of the senior subordinated notes before their stated maturity. Consequently, lenders thereunder may have the right to prohibit any such purchase or redemption, in which event we will seek to obtain waivers from the required lenders. We may not be able to obtain such waivers or refinance our indebtedness on terms acceptable to us, or at all. Buffets Senior Notes will have similar terms restricting the repurchase of the senior subordinated notes while Buffets Senior Notes remain outstanding. Finally, the occurrence of a change of control could also constitute an event of default under the Amended Credit Facility, which could result in the acceleration of all amounts due thereunder. See Description of Senior Subordinated Notes Change of Control. Public offering price $ $ % $ Underwriting discount $ $ % $ Proceeds to Buffets Holdings, Inc. (before expenses)(3)(4) $ $ % $ (1) The price per IDS comprises $ allocated to each share of Class A common stock and $ allocated to each senior subordinated note. (2) Relates to the $ million aggregate principal amount of senior subordinated notes sold separately (not represented by IDSs). (3) Approximately $ million of these proceeds will be paid to our existing stockholders. (4) Assumes no exercise of the underwriters over-allotment option. The underwriters expect to deliver the IDSs and the senior subordinated notes in book-entry form only through the facilities of The Depository Trust Company to purchasers on or about , 2004. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. Table of Contents We may not be able to refinance the Amended Credit Facility or Buffets Senior Notes at maturity on favorable terms or at all. The amended and restated revolving credit facility and the senior secured term loan facility included in the Amended Credit Facility will mature in full in 2009 and 2011, respectively and Buffets Senior Notes will mature in 2014. We may not be able to renew or refinance the Amended Credit Facility or Buffets Senior Notes, or if renewed or refinanced, the renewal or refinancing may occur on less favorable terms. In particular, some of the terms of the senior subordinated notes that may be viewed as favorable to the senior lenders, such as our ability to defer interest and acceleration forbearance periods, become less favorable in 2009, which may materially adversely affect our ability to refinance or renew the Amended Credit Facility or Buffets Senior Notes beyond such date. If we are unable to refinance or renew the Amended Credit Facility or Buffets Senior Notes, our failure to repay all amounts due on the maturity date would cause a default under the Amended Credit Facility and Buffets Senior Notes. In addition, our interest expense may increase significantly if we refinance the Amended Credit Facility or Buffets Senior Notes on terms that are less favorable to us than the terms of the Amended Credit Facility or Buffets Senior Notes, respectively. Risks Relating to Our Business Our core buffet restaurants are a maturing restaurant concept and face intense competition. Our restaurants operate in a highly competitive industry comprising a large number of restaurants, including national and regional restaurant chains and franchised restaurant operations, as well as locally-owned, independent restaurants. Price, restaurant location, food quality, service and attractiveness of facilities are important aspects of competition, and the competitive environment is often affected by factors beyond a particular restaurant management s control, including changes in the public s taste and eating habits, population and traffic patterns and economic conditions. Many of our competitors have greater financial resources than we have and there are few non-economic barriers to entry. Therefore, new competitors may emerge at any time. We cannot assure you that we will be able to compete successfully against our competitors in the future or that competition will not have a material adverse effect on our operations or earnings. We have been operating our core buffet restaurant concept for 20 years, and our restaurant locations have a median age of approximately 10 years. As a result, we are exposed to vulnerabilities associated with being a mature concept. These include vulnerability to innovations by competitors and out-positioning in markets where the demographics or customer preferences have changed. Mature units require greater expenditures for repair, maintenance, refurbishments and re-concepting, and we will be required to continue making such expenditures in the future in order to preserve traffic at many of our restaurants. We cannot assure you, however, that these expenditures, particularly for remodeling and refurbishing, will be successful in preserving or building guest counts, as proved to be the case with a number of units recently upgraded as part of a two year re-imaging program. We are required to respond to changing consumer preferences and dining frequency. Our profits are dependent upon discretionary spending by consumers, which is markedly influenced by variations in the economy. Our average weekly sales declined 2.0% during fiscal 2003 due in large part to weak economic conditions. Furthermore, if our competitors in the casual dining, mid-scale and quick-service segments respond to economic changes through menu engineering or by adopting discount pricing strategies, it could have the effect of drawing customers away from companies such as ours that do not routinely engage in discount pricing, thereby reducing sales and pressuring margins. Because certain elements of our cost structure are fixed in nature, particularly over shorter time horizons, changes in marginal sales volume can have a more significant impact on our profitability than for a business possessing a more variable cost structure. We are dependent on attracting and retaining qualified employees while controlling labor costs. We operate in the service sector and are therefore extremely dependent upon the availability of qualified restaurant personnel. Availability of staff varies widely from location to location. If restaurant Joint Book-Running Managers Credit Suisse First Boston Banc of America Securities LLC CIBC World Markets Table of Contents management and staff turnover trends increase, we would suffer higher direct costs associated with recruiting and retaining replacement personnel. Moreover, we could suffer from significant indirect costs, including restaurant disruptions due to management changeover, increased above-store management staffing and potential delays in new store openings due to staff shortages. Competition for qualified employees exerts pressure on wages paid to attract qualified personnel, resulting in higher labor costs, together with greater expense to recruit and train them. Many of our employees are hourly workers whose wages may be impacted by an increase in the federal or state minimum wage. Proposals have been made at federal and state levels to increase minimum wage levels. An increase in the minimum wage may create pressure to increase the pay scale for our employees. A shortage in the labor pool or other general inflationary pressures or changes could also increase our labor costs. Furthermore, the operation of buffet-style restaurants is materially different from other restaurant concepts. Consequently, the retention of executive management familiar with our core buffet business is important to our continuing success. The departure of one or more key operations executives or the departure of multiple executives in a short time period could have an adverse impact on our business. Our former Executive Vice President of Purchasing separated from the company in 2004. We are currently considering the addition of one additional position to our executive management group. Our workers compensation and employee benefit expenses are disproportionately concentrated in states with adverse legislative climates. Our highest per-employee workers compensation insurance costs are in the State of California, where we retain a large employment presence. California also enacted legislation in October 2003 that would require large employers to provide health insurance or equivalent funding for workers who have traditionally not been covered by employer health plans. While this law is currently being challenged, other states have proposed similar legislation. Other state and federal mandates, such as compulsory paid absences, increases in overtime wages and unemployment tax rates, stricter citizenship requirements and revisions in the tax treatment of employee gratuities, could also adversely affect our business. Any increases in labor costs could have a material adverse effect on our results of operations and could decrease our profitability and cash available to service our debt obligations, if we were unable to compensate for such increased labor costs by raising the prices we charge our customers or realizing additional operational efficiencies. We are dependent on timely delivery of fresh ingredients by our suppliers. Our restaurant operations are dependent on timely deliveries of fresh ingredients, including fresh produce, dairy products and meat. The cost, availability and quality of the ingredients we use to prepare our food are subject to a range of factors, many of which are beyond our control. Fluctuations in weather, supply and demand and economic and political conditions could adversely affect the cost, availability and quality of our ingredients. Historically, when operating expenses increased due to inflation or increases in food costs, we recovered increased costs by increasing our menu prices. However, we may not be able to recover increased costs in the future because competition may limit or prohibit such future increases. If our food quality declines due to the lack of, or lower quality of, our ingredients or due to interruptions in the flow of fresh ingredients and similar factors, customer traffic may decline and negatively affect our restaurants results. We rely exclusively on third-party distributors and suppliers for such deliveries. The number of companies capable of servicing our distribution needs on a national basis has declined over time, reducing our bargaining leverage and increasing vulnerability to distributor interruptions. Our restaurant sales are subject to seasonality and major world events. Our restaurant sales volume fluctuates seasonally. Overall, restaurant sales are generally higher in the summer months and lower in the winter months. Positive or negative trends in weather conditions can have a strong influence on our business. This effect is heightened because many of our restaurants are in geographic areas that experience extremes in weather, including severe winter conditions and tropical storm patterns. Additionally, major world events may adversely affect our business. UBS Investment Bank Table of Contents We face risks associated with government regulations. In addition to wage and benefit regulatory risks, we are subject to other extensive government regulation at a federal, state and local level. These include, but are not limited to, regulations relating to the sale of food in all of our restaurants and of alcoholic beverages in our Tahoe Joe s Famous Steakhouse restaurants. We are required to obtain and maintain governmental licenses, permits and approvals. Difficulty or failure in obtaining or maintaining them in the future could result in delaying or canceling the opening of new restaurants or the closing of current ones. Local authorities may suspend or deny renewal of our governmental licenses if they determine that our operations do not meet the standards for initial grant or renewal. This risk would be even higher if there were a major change in the licensing requirements affecting our types of restaurants. The Federal Americans with Disabilities Act prohibits discrimination on the basis of disability in public accommodations and employment. Mandated modifications to our facilities in the future to make different accommodations for disabled persons could result in material, unanticipated expense. Application of state Dram Shop statutes, which generally provide a person injured by an intoxicated patron the right to recover damages from an establishment that wrongfully served alcoholic beverages to the intoxicated person, to our operations, or liabilities otherwise associated with liquor service in our Tahoe Joe s Famous Steakhouse restaurants, could negatively affect our financial condition if not otherwise insured under our general liability insurance policy. Negative publicity relating to one of our restaurants, including our franchised restaurants, could reduce sales at some or all of our other restaurants. We are, from time to time, faced with negative publicity relating to food quality, restaurant facilities, health inspection scores, employee relationships or other matters at one of our restaurants or those of our franchisees. Adverse publicity may negatively affect us, regardless of whether the allegations are valid or whether we are liable. In addition, the negative impact of adverse publicity relating to one restaurant may extend beyond the restaurant involved to affect some or all of our other restaurants. If a franchised restaurant fails to meet our franchise operating standards, our own restaurants could be adversely affected due to customer confusion or negative publicity. A similar risk exists with respect to totally unrelated food service businesses, if customers mistakenly associate such unrelated businesses with our own operations. Food-borne illness incidents could result in liability to us and could reduce our restaurant sales. We cannot guarantee that our internal controls and training will be fully effective in preventing all food-borne illnesses. Furthermore, our reliance on third-party food processors makes it difficult to monitor food safety compliance and increases the risk that food-borne illness would affect multiple locations rather than single restaurants. Some food-borne illness incidents could be caused by third-party food suppliers and transporters outside of our control. New illnesses resistant to our current precautions may develop in the future, or diseases with long incubation periods could arise, such as bovine spongiform encephalopathy ( BSE ), sometimes referred to as mad cow disease, that could give rise to claims or allegations on a retroactive basis. In addition, the levels of chemicals or other contaminants that are currently considered safe in certain foods may be regulated more restrictively in the future or become the subject of public concern. The reach of food-related public health concerns can be considerable given the attention given these matters by the media. Local public health developments could have a national adverse impact on our sales, whether or not specifically attributable to our restaurants or those of our franchisees or competitors. Any negative development relating to our self-service food service approach would have a material adverse impact on our primary business. Our buffet restaurants utilize a service format that is heavily dependent upon self-service by our customers. Food tampering by customers or other events affecting the self-service format could cause Co-Managers JPMorgan Piper Jaffray The date of this prospectus is , 2004. Table of Contents regulatory changes or changes in our business pattern or customer perception. Any development that would materially impede or prohibit our continued use of a self-service food service approach, or reduce the appeal of self-service to our guests, would have a material adverse impact on our primary business. We face risks associated with environmental laws. We are subject to federal, state and local laws, regulations and ordinances that govern activities or operations that may have adverse environmental effects, such as discharges to air and water, as well as handling and disposal practices for solid and hazardous wastes. These may impose liability for the costs of cleaning up, and damage resulting from, sites of past spills, disposals or other releases of hazardous materials, both from governmental and private claimants. We could incur such liabilities regardless of whether we lease or own the restaurants or land in question and regardless of whether such environmental conditions were created by us or by a prior owner or tenant. We cannot assure you that environmental conditions relating to our prior, existing or future restaurants or restaurant sites will not have a material adverse affect on us. We face risks because of the number of restaurants that we lease. Our success depends in part on our ability to secure leases in desired locations at rental rates we believe to be reasonable. We currently lease all of our restaurants located in shopping centers and malls, and we lease the land for all but one of our freestanding restaurants. By December 2007, approximately 85 of our current leases will have expiring base lease terms and be subject to renewal consideration. Each lease agreement provides that the lessor may terminate the lease for a number of reasons, including our default in any payment of rent or taxes or our breach of any covenant or agreement in the lease. Termination of any of our leases could harm our results of operations and, as with a default under any of our indebtedness, could have a material adverse impact on our liquidity. Although we believe that we will be able to renew the existing leases that we wish to extend, we cannot assure you that we will succeed in obtaining extensions in the future at rental rates that we believe to be reasonable or at all. Moreover, if some locations should prove to be unprofitable, we could remain obligated for lease payments even if we decided to withdraw from those locations. See Business Property. We will incur special charges relating to the closing of such restaurants, including lease termination costs. Impairment charges and other special charges will reduce our profits. We may not be able to protect our trademarks and other proprietary rights. We believe that our trademarks and other proprietary rights are important to our success and our competitive position. Accordingly, we devote substantial resources to the establishment and protection of our trademarks and proprietary rights. However, the actions taken by us may be inadequate to prevent imitation of our brands, proprietary rights and concepts by others, which may thereby dilute our brands in the marketplace or diminish the value of such proprietary rights, or to prevent others from claiming violations of their trademarks and proprietary rights by us. In addition, others may assert rights in our trademarks and other proprietary rights. Our exclusive rights to our trademarks are subject to the common law rights of any other person who began using the trademark (or a confusingly similar mark) prior to both the date of our registration and our first use of such trademarks in the relevant territory. For example, because of the common law rights of such a preexisting restaurant in portions of Colorado and Wyoming, our restaurants in those states use the name Country Buffet. We cannot assure you that third parties will not assert claims against our intellectual property or that we will be able to successfully resolve such claims. Future actions by third parties may diminish the strength of our restaurant concepts trademarks or other proprietary rights and decrease our competitive strength and performance. We could also incur substantial costs to defend or pursue legal actions relating to the use of our intellectual property, which could have a material adverse affect on our business, results of operation or financial condition. TABLE OF CONTENTS Page Table of Contents

parsed_sections/risk_factors/2004/CIK0001178519_distinctiv_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

parsed_sections/risk_factors/2004/CIK0001179755_endurance_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ RISK FACTORS Before investing in our ordinary shares you should carefully consider the following risk factors and all other information set forth in this prospectus. These risks could materially affect our business, results of operations or financial condition and cause the trading price of our ordinary shares to decline. You could lose all or part of your investment. Risks Relating to Our Business Since we have a limited operating history, it is difficult to predict our future performance. Our Bermuda insurance subsidiary, Endurance Bermuda, was formed on November 30, 2001 and began operations on December 17, 2001. Endurance Holdings was formed on June 27, 2002. Endurance U.S. was formed on September 5, 2002 and received a license to write certain lines of reinsurance business in the State of New York from the New York State Department of Insurance (the New York Department ) on December 18, 2002. Endurance U.K. was formed on April 10, 2002 and on December 4, 2002 was authorized by the United Kingdom s Financial Services Authority ( FSA ) to begin writing certain lines of insurance and reinsurance in the United Kingdom and European Union. As a result, there is limited historical financial and operating information available to help you evaluate our past performance or to make a decision about an investment in our ordinary shares. Companies in their initial stages of development present substantial business and financial risks and may suffer significant losses. These new companies must successfully develop business relationships, establish operating procedures, hire staff, install management information and other systems, establish facilities and obtain licenses, as well as take other steps necessary to conduct their intended business activities. As a result of these risks, it is possible that we may not be successful in implementing our business strategy or in completing the development of the infrastructure necessary to run our business. In addition, because of our limited operating history, our historical financial results may not accurately predict our future performance. As a result of industry factors or factors specific to us, we may have to alter our anticipated methods of conducting our business, such as the nature, amount and types of risks we assume. If actual claims exceed our reserve for losses and loss expenses, our financial condition and results of operations could be adversely affected. Our success depends upon our ability to accurately assess the risks associated with the businesses that we insure or reinsure. We establish loss reserves to cover our estimated liability for the payment of all losses and loss expenses incurred with respect to premiums earned on the policies that we write. Loss reserves do not represent an exact calculation of liability. Rather, loss reserves are estimates of what we expect the ultimate settlement and administration of claims will cost. These estimates are based upon actuarial and statistical projections and on our assessment of currently available data, as well as estimates of future trends in claims severity and frequency, judicial theories of liability and other factors. Loss reserve estimates are refined continually in an ongoing process as experience develops and claims are reported and settled. Establishing an appropriate level of loss reserves is an inherently uncertain process. Moreover, these uncertainties are greater for insurers like us than for insurers with a longer operating history because we do not yet have an established loss history. Because of this uncertainty, it is possible that our reserves at any given time will prove inadequate. To the extent we determine that actual losses and loss expenses exceed our expectations and reserves recorded in our financial statements, we will be required to immediately increase reserves. This could cause a material reduction in our profitability and capital. The number and size of reported claims that we have received to date have been moderate, resulting in $162.5 million in case reserves on our balance sheet at December 31, 2003. In the future, the number of claims could increase, and their cumulative size could exceed our loss reserves. The selling shareholders identified in this prospectus are offering up to 8,000,000 ordinary shares of Endurance Specialty Holdings Ltd. We will not receive any proceeds from the sale of ordinary shares by the selling shareholders. Our ordinary shares are listed on the New York Stock Exchange ( NYSE ) under the trading symbol ENH. The last reported sale price of our ordinary shares on the NYSE on March 1, 2004 was $33.86 per share. Investing in our ordinary shares involves risk. See Risk Factors beginning on page 8 to read about factors you should consider before buying ordinary shares. Back to Contents As a property and property catastrophe insurer and reinsurer, we are particularly vulnerable to losses from catastrophes. Our property and property catastrophe insurance and reinsurance operations expose us to claims arising out of catastrophes. Catastrophes can be caused by various unpredictable events, including earthquakes, hurricanes, hailstorms, severe winter weather, floods, fires, tornadoes, explosions and other natural or man-made disasters. We also face substantial exposure to losses resulting from acts of war, acts of terrorism and political instability. The global geographic distribution of our business subjects us to catastrophe exposure for natural events occurring in a number of areas throughout the world, including, but not limited to, windstorms in Europe, hurricanes in Florida, the Gulf Coast and the Atlantic coast regions of the United States, typhoons and earthquakes in Japan and earthquakes in California and the New Madrid region of the United States. The loss experience of property catastrophe insurers and reinsurers has generally been characterized as low frequency but high severity in nature. We expect that increases in the values and concentrations of insured property will increase the severity of such occurrences in the future. In the event that we experience catastrophe losses, there is a possibility that our unearned premium and loss reserves will be inadequate to cover these risks. In addition, because accounting regulations do not permit insurers and reinsurers to reserve for such catastrophic events until they occur, claims from catastrophic events could cause substantial volatility in our financial results for any fiscal quarter or year and could have a material adverse effect on our financial condition and results of operations. Our ability to write new business also could be adversely impacted. See Business Underwriting and Risk Management. As a property and casualty insurer and reinsurer, we could face losses from war, terrorism and political unrest. We may have substantial exposure to losses resulting from acts of war, acts of terrorism and political instability. These risks are inherently unpredictable, although recent events may lead to increased frequency and severity. It is difficult to predict their occurrence with statistical certainty or to estimate the amount of loss an occurrence will generate. Accordingly, it is possible that our loss reserves will be inadequate to cover these risks. Although we generally exclude acts of terrorism from insurance policies and reinsurance treaties where practicable, we also provide coverage in circumstances where we believe we are adequately compensated for assuming such risk. Even in cases where we have deliberately sought to exclude coverage, we may not be able to eliminate completely our exposure to terrorist acts and thus it is possible that these acts will have a material adverse effect on us. The risks associated with property and casualty reinsurance underwriting could adversely affect us. Because we participate in property and casualty reinsurance markets, the success of our underwriting efforts depends, in part, upon the policies, procedures and expertise of the ceding companies making the original underwriting decisions. We face the risk that these ceding companies may fail to accurately assess the risks that they assume initially, which, in turn, may lead us to inaccurately assess the risks we assume. If we fail to establish and receive appropriate premium rates, we could face significant losses on these contracts. If actual renewals of our existing contracts do not meet expectations, our premiums written in future years and our future results of operations could be materially adversely affected. Our contracts are generally for a one-year term. In our financial forecasting process, we make assumptions about the renewal of our prior year s contracts. If actual renewals do not meet expectations, our premiums written in future years and our future results of operations could be materially adversely affected. This risk is especially prevalent in the first quarter of each year when a large number of reinsurance contracts are subject to renewal. The failure of any of the loss limitation methods we employ could have a material adverse effect on our financial condition or on our results of operations. We seek to limit our loss exposure by writing many of our insurance and reinsurance contracts on an excess of loss basis, adhering to maximum limitations on policies written in defined geographical zones, Per Share Total limiting program size for each client, establishing per risk and per occurrence limitations for each event and prudent underwriting guidelines for each program written. In the case of proportional treaties, we seek per occurrence limitations or loss ratio caps to limit the impact of losses from any one event. Most of our direct liability insurance policies include maximum aggregate limitations. We also seek to limit our loss exposure through geographic diversification. Geographic zone limitations involve significant underwriting judgments, including the determination of the area of the zones and whether a policy falls within particular zone limits. Disputes relating to coverage and choice of legal forum may also arise. As a result, various provisions of our policies, such as limitations or exclusions from coverage or choice of forum, may not be enforceable in the manner we intend and some or all of our other loss limitation methods may prove to be ineffective. Underwriting is a matter of judgment, involving important assumptions about matters that are inherently unpredictable and beyond our control, and for which historical experience and probability analysis may not provide sufficient guidance. One or more catastrophic or other events could result in claims that substantially exceed our expectations, which could have a material adverse effect on our financial condition and our results of operations, possibly to the extent of eliminating our shareholders equity. Since we are dependent on key executives, the loss of any of these executives or our inability to retain other key personnel could adversely affect our business. Our success substantially depends upon our ability to attract and retain qualified employees and upon the ability of our senior management and other key employees to implement our business strategy. We believe there are only a limited number of available qualified executives in the business lines in which we compete. Although we are not aware of any planned departures, we rely substantially upon the services of Kenneth J. LeStrange, our Chief Executive Officer, President and Chairman of the board of directors, Steven W. Carlsen, Chairman of Endurance U.S. and President of Endurance Services, and James R. Kroner, our Chief Financial Officer. Each of Messrs. LeStrange, Carlsen and Kroner have employment agreements with the Company. We believe we have been successful in attracting and retaining key personnel since our inception. The loss of any of their services or the services of other members of our management team or the inability to attract and retain other talented personnel could impede the further implementation of our business strategy, which could have a material adverse effect on our business. We do not currently maintain key man life insurance policies with respect to any of our employees. Our business could be adversely affected by Bermuda employment restrictions. We will need to continue to hire employees to work in Bermuda. Under Bermuda law, non-Bermudians (other than spouses of Bermudians) may not engage in any gainful occupation in Bermuda without an appropriate governmental work permit. Work permits may be granted or extended by the Bermuda government upon showing that, after proper public advertisement in most cases, no Bermudian (or spouse of a Bermudian) is available who meets the minimum standard requirements for the advertised position. The Bermuda government recently announced a new policy limiting the duration of work permits to six years, with certain exemptions for key employees. All of our 48 Bermuda-based professional employees who require work permits, including Messrs. LeStrange and Kroner, have been granted permits by the Bermuda government. The terms of these permits range from three to five years depending on the individual. None of our current Bermuda employees for whom we have applied for a work permit have been denied. It is possible that we could lose the services of one or more of our key employees if we are unable to obtain or renew their work permits, which could have a material adverse effect on our business. A decline in the financial strength ratings of Endurance Bermuda, Endurance U.K. or Endurance U.S. could affect our standing among brokers and customers and cause our premiums and earnings to decrease. Ratings have become an increasingly important factor in establishing the competitive position of insurance and reinsurance companies. A.M. Best assigned to Endurance Bermuda, Endurance U.K. and Endurance U.S. a financial strength rating of A (Excellent) and Standard & Poor s assigned a financial strength rating to Endurance Bermuda, Endurance U.K. and Endurance U.S. of A- (Strong). The objective of A.M. Best s and Standard & Poor s rating systems is to provide an opinion of an insurer s or reinsurer s financial strength and ability to meet ongoing obligations to its policyholders. These ratings reflect A.M. Back to Contents Best s and Standard & Poor s opinions of Endurance Bermuda s, Endurance U.K. s and Endurance U.S. s initial capitalization, performance, management and sponsorship, and are not applicable to the ordinary shares offered by this prospectus and are not a recommendation to buy, sell or hold such shares. A.M. Best maintains a letter scale rating system ranging from A++ (Superior) to F (In Liquidation), and includes 16 separate ratings categories. Within these categories, A++ (Superior) and A+ (Superior) are the highest, followed by A (Excellent) and A- (Excellent). Publications of A.M. Best indicate that the A and A- ratings are assigned to those companies that, in A.M. Best s opinion, have demonstrated an excellent ability to meet their ongoing obligations to policyholders. These ratings are subject to periodic review by, and may be revised downward or revoked at the sole discretion of, A.M. Best. The rating A (Excellent) by A.M. Best is the third highest of 15 rating levels (the rating of S (Suspended) is considered a rating category but not a rating level). Standard & Poor s maintains a letter rating system ranging from AAA (Extremely Strong) to R (Under Regulatory Supervision). Within these categories, AAA (Extremely Strong) is the highest, followed by AA+, AA and AA- (Very Strong) and A+, A and A- (Strong). Publications of Standard & Poor s indicate that the A+, A and A- ratings are assigned to those companies that, in Standard & Poor s opinion, have demonstrated strong financial security characteristics, but are somewhat more likely to be affected by adverse business conditions than are insurers with higher ratings. These ratings may be changed, suspended, or withdrawn at the discretion of Standard & Poor s. The rating A- (Strong) by Standard & Poor s is the seventh highest of twenty-one rating levels. If Endurance Bermuda s, Endurance U.K. s or Endurance U.S. s rating is reduced from its current level by A.M. Best or Standard & Poor s, our competitive position in the insurance and reinsurance industry would suffer, and it would be more difficult for us to market our products. A downgrade could result in a significant reduction in the number of insurance and reinsurance contracts we write and in a substantial loss of business as client companies, and brokers that place such business, move to other competitors with higher ratings. Our holding company structure and certain regulatory and other constraints affect our ability to pay dividends and make other payments. Endurance Holdings is a holding company and, as such, has no substantial operations of its own. Dividends and other permitted distributions from insurance subsidiaries are expected to be Endurance Holdings primary source of funds to meet ongoing cash requirements, including debt service payments and other expenses, and to pay dividends, if any, to shareholders. Bermuda law and regulations, including, but not limited to, Bermuda insurance regulations, restrict the declaration and payment of dividends and the making of distributions by Endurance Bermuda unless certain regulatory requirements are met. The inability of Endurance Bermuda to pay dividends in an amount sufficient to enable Endurance Holdings to meet its cash requirements at the holding company level could have a material adverse effect on its operations. In addition, Endurance U.K. and Endurance U.S. are subject to significant regulatory restrictions limiting their ability to declare and pay dividends. We therefore do not expect to receive dividends from either of those subsidiaries for the foreseeable future. Endurance Holdings is subject to Bermuda regulatory constraints that will affect its ability to pay dividends on its ordinary shares and make other payments. Under the Bermuda Companies Act 1981, as amended (the Companies Act ), Endurance Holdings may declare or pay a dividend or make a distribution out of retained earnings or contributed surplus only if it has reasonable grounds for believing that it is, or would after the payment be, able to pay its liabilities as they become due and if the realizable value of its assets would thereby not be less than the aggregate of its liabilities and issued share capital and share premium accounts. In addition, our credit facilities prohibit Endurance Holdings from declaring or paying any dividends if a default or event of default has occurred and is continuing at the time of such declaration or payment or would result from such declaration or payment. For a discussion of the legal limitations on our subsidiaries ability to pay dividends to Endurance Holdings and of Endurance Holdings to pay dividends to its shareholders, see Dividend Policy, Management s Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources, Certain Indebtedness and Regulatory Matters. Back to Contents The cost of reinsurance security arrangements may materially impact our margins. As a Bermuda reinsurer, Endurance Bermuda is required to post collateral security with respect to reinsurance liabilities it assumes from ceding insurers domiciled in the U.S. The posting of collateral security is generally required in order for U.S. ceding companies to obtain credit on their U.S. statutory financial statements with respect to reinsurance liabilities ceded to unlicensed or unaccredited reinsurers. Under applicable statutory provisions, the security arrangements may be in the form of letters of credit, reinsurance trusts maintained by third-party trustees or funds-withheld arrangements whereby the trusted assets are held by the ceding company. Endurance Bermuda has the ability to issue up to $470 million in letters of credit under the Company s letter of credit and revolving credit facility that expires on August 6, 2004. If this facility is not sufficient or if the Company is unable to renew this facility or is unable to arrange for other types of security on commercially acceptable terms, the ability of Endurance Bermuda to provide reinsurance to U.S.-based clients may be severely limited. Security arrangements may subject our assets to security interests and/or require that a portion of our assets be pledged to, or otherwise held by, third parties. Although the investment income derived from our assets while held in trust typically accrues to our benefit, the investment of these assets is governed by the investment regulations of the state of domicile of the ceding insurer, which may be more restrictive than the investment regulations applicable to us under Bermuda law. The restrictions may result in lower investment yields on these assets, which could have a material adverse effect on our profitability. The right of certain significant investors to designate a majority of our directors may prevent or frustrate attempts by shareholders to replace or remove the current management of the Company. As of the date of this prospectus, our founding shareholders beneficially own ordinary shares aggregating approximately 82% of the equity interest in our ordinary shares on a fully diluted basis assuming the full exercise of all vested share options, restricted share units and warrants exercisable for ordinary shares or class A shares. Certain of our significant investors have contractual rights to nominate designees as candidates for election to our board of directors and select from our directors members of committees of our board of directors, and have so designated seven of our existing eleven directors. See Description of Share Capital Amended and Restated Shareholders Agreement Composition of Board and Board Committees. As a result of their ownership position and contractual rights, our significant investors and their board representatives, independently and voting together with our other existing shareholders, will have the ability to significantly influence matters requiring shareholder approval, including, without limitation, the election of directors and amalgamations, consolidations and sales of all or substantially all of our assets. The commercial and investment activities of our significant investors may lead to conflicts of interest. Certain of our significant investors engage in commercial activities and enter into transactions or agreements with us or in competition with us, which may give rise to conflicts of interest. We derive a significant portion of our business through reinsurance relationships and other arrangements in which Aon, one of the selling shareholders, has acted as a broker or insurance or reinsurance intermediary. Due to Aon s investment in us and their involvement in our formation, it is possible that certain brokers and intermediaries that compete with Aon will perceive a conflict of interest in our relationships with Aon and may, therefore, be hesitant to present insurance and reinsurance proposals and opportunities to us. As of the date of this prospectus, Aon held approximately 21.9% of our outstanding ordinary shares on a fully diluted basis. After giving effect to this offering, assuming no exercise of the over-allotment option, Aon would have held approximately 19.4% of our outstanding ordinary shares on a fully diluted basis as of that date. See Principal and Selling Shareholders. Some of our significant investors or their affiliates have sponsored, and may in the future sponsor, other entities engaged in or intending to engage in insurance and reinsurance underwriting, some of which, together with our significant investors, may compete with us. Certain of our significant investors and their affiliates have also entered into agreements with and made investments in numerous companies that may compete with us. Back to Contents Profitability may be adversely impacted by inflation. The effects of inflation could cause the cost of claims from catastrophes or other events to rise in the future. Our reserve for losses and loss expenses includes assumptions about future payments for settlement of claims and claims handling expenses, such as medical treatments and litigation costs. To the extent inflation causes these costs to increase above reserves established for these claims, we will be required to increase our loss reserves with a corresponding reduction in our net income in the period in which the deficiency is identified. Our investment performance may affect our financial assets and ability to conduct business. We derive a significant portion of our income from our invested assets. As a result, our operating results depend in part on the performance of our investment portfolio, which currently consists of fixed maturity securities. Our income derived from our invested assets was $76.7 million or 29.1% of our net income for the year ended December 31, 2003. Our operating results are subject to a variety of investment risks, including risks relating to general economic conditions, market volatility, interest rate fluctuations, liquidity risk and credit and default risk. Additionally, with respect to certain investments, we are subject to pre-payment or reinvestment risk. With respect to our longer-term liabilities, we strive to structure our investments in a manner that recognizes our liquidity needs for our future liabilities. In that regard, we attempt to correlate the maturity and duration of our investment portfolio to our general and specific liability profile. However, if our liquidity needs or general and specific liability profile unexpectedly change, we may not be successful in continuing to structure our investment portfolio in that manner. The market value of our fixed maturity investments will be subject to fluctuation depending on changes in various factors, including prevailing interest rates. To the extent that we are unsuccessful in correlating our investment portfolio with our liabilities, we may be forced to liquidate our investments at times and prices that are not optimal, which could have a material adverse effect on the performance of our investment portfolio. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. Although we attempt to take measures to manage the risks of investing in a changing interest rate environment, we may not be able to mitigate interest rate sensitivity effectively. Our mitigation efforts include maintaining a high quality portfolio with a relatively short duration to reduce the effect of interest rate changes on book value. A significant portion of the investment portfolio matures each year, allowing for reinvestment at current market rates. The portfolio is actively managed and trades are made to balance our exposure to interest rates. However, a significant increase in interest rates could have a material adverse effect on our book value. We may be adversely affected by foreign currency fluctuations. We have made a significant investment in the capitalization of Endurance U.K., which is denominated in British Sterling. In addition, we enter into reinsurance and insurance contracts where we are obligated to pay losses in currencies other than U.S. dollars. For the year ended December 31, 2003, approximately 9% of our gross premiums were written in currencies other than the U.S. dollar. A portion of our cash and cash equivalents, investments and loss reserves are also denominated in non-U.S. currencies. The majority of our operating foreign currency assets and liabilities are denominated in Euros, British Sterling, Canadian Dollars, Japanese Yen and Australian Dollars ( Major Currencies ). We may, from time to time, experience losses from fluctuations in the values of these and other non-U.S. currencies, which could have a material adverse affect on our results of operations. We periodically buy and sell Major Currencies or investment securities denominated in Major Currencies in an attempt to match our non-U.S. dollar assets to our related non-U.S. dollar liabilities. We have no currency hedges in place; however, as part of our matching strategy, we consider the use of hedges when we become aware of probable significant losses that will be paid in non-U.S. currencies. However, it is possible that we will not successfully match our exposures or structure the hedges so as to effectively manage these risks. Public offering price $ $ Underwriting discount $ $ Proceeds, before expenses, to selling shareholders $ $ To the extent that the underwriters sell more than 8,000,000 ordinary shares, the underwriters have the option to purchase up to an additional 1,200,000 ordinary shares from the selling shareholders at the initial offering price less the underwriting discount. Neither the Securities and Exchange Commission, any state securities commission, the Registrar of Companies in Bermuda, the Bermuda Monetary Authority nor any other regulatory body has approved or disapproved of these securities or passed upon the adequacy of this prospectus. Any representation to the contrary is a criminal offense. The shares will be ready for delivery on or about , 2004. Back to Contents We may require additional capital in the future which may not be available or only available on unfavorable terms. Our future capital requirements depend on many factors, including our ability to write new business successfully and to establish premium rates and reserves at levels sufficient to cover losses. We may need to raise additional funds through financings or curtail our growth and reduce our assets. Any equity or debt financing, if available at all, may be on terms that are not favorable to us. In the case of equity financings, dilution to our shareholders could result, and in any case such securities may have rights, preferences and privileges that are senior to those of the ordinary shares offered hereby. If we cannot obtain adequate capital, our business, results of operations and financial condition could be adversely affected. Since we depend on a few brokers for a large portion of our revenues, loss of business provided by any one of them could adversely affect us. We market our insurance and reinsurance worldwide primarily through insurance and reinsurance brokers. In the year ended December 31, 2003, our top five brokers represented approximately 86% of our gross premiums written, excluding gross premiums acquired in the HartRe transaction. See Business Distribution. One of those brokers, Aon, is currently one of our investors and is a selling shareholder in the offering being made pursuant to this prospectus. Affiliates of two of these brokers, Marsh and Benfield, have also co- sponsored the formation of other Bermuda reinsurers that may compete with us, and these brokers may decide to favor the reinsurers they sponsored over other companies. Loss of all or a substantial portion of the business provided by one or more of these brokers could have a material adverse effect on our business. Our reliance on brokers subjects us to their credit risk. In accordance with industry practice, we frequently pay amounts owed on claims under our insurance or reinsurance contracts to brokers, and these brokers, in turn, pay these amounts over to the clients that have purchased insurance or reinsurance from us. If a broker fails to make such a payment, in a significant majority of business that the Company writes, it is highly likely that the Company will be liable to the client for the deficiency because of local laws or contractual obligations. Likewise, when the client pays premiums for these policies to brokers for payment over to us, these premiums are considered to have been paid and, in most cases, the client will no longer be liable to us for those amounts, whether or not we have actually received the premiums. Consequently, we assume a degree of credit risk associated with brokers around the world with respect to most of our insurance and reinsurance business. To date we have not experienced any losses related to such credit risks. The effects of emerging claim and coverage issues on our business are uncertain. As industry practices and legal, judicial, social and other environmental conditions change, unexpected and unintended issues related to claims and coverage may emerge. These issues may adversely affect our business by either extending coverage beyond our underwriting intent or by increasing the number or size of claims. In some instances, these changes may not become apparent until some time after we have issued insurance or reinsurance contracts that are affected by the changes. As a result, the full extent of liability under our insurance or reinsurance contracts may not be known for many years after a contract is issued. Recent examples of emerging claims and coverage issues include: larger settlements and jury awards for professionals and corporate directors and officers covered by professional liability and directors and officers liability insurance; and a growing trend of plaintiffs targeting property and casualty insurers in purported class action litigations relating to claims-handling, insurance sales practices and other practices related to the conduct of our business. The effects of these and other unforeseen emerging claim and coverage issues are extremely hard to predict and could harm our business. Goldman, Sachs & Co. Merrill Lynch & Co. Credit Suisse First Boston Deutsche Bank Securities JPMorgan Wachovia Securities Back to Contents We operate in a highly competitive environment which could adversely impact our operating margins. The insurance and reinsurance industries are highly competitive. We compete with major U.S. and non-U.S. insurers and reinsurers, including other Bermuda-based insurers and reinsurers. For information regarding competition in each of our business segments, see Business Business Segments. Many of our competitors have greater financial, marketing and management resources. A number of newly-organized, Bermuda-based insurance and reinsurance entities compete in the same market segments in which we operate. In addition, we may not be aware of other companies that may be planning to enter the segments of the insurance and reinsurance market in which we operate or of existing companies that may be planning to raise additional capital. Increasing competition could result in fewer submissions, lower premium rates and less favorable policy terms and conditions, which could have a material adverse impact on our growth and profitability. Further, insurance/risk-linked securities and derivative and other non-traditional risk transfer mechanisms and vehicles are being developed and offered by other parties, including non-insurance company entities, which could impact the demand for traditional insurance or reinsurance. A number of new, proposed or potential industry or legislative developments could further increase competition in our industry. These developments include: several new insurance and reinsurance companies have been formed and capitalized in excess of $500 million since September 2001 and a number of these companies compete with us in the same markets; legislative mandates for insurers to provide certain types of coverage in areas where we or our ceding clients do business, such as the mandated terrorism coverage in the Terrorism Risk Insurance Act of 2002, could eliminate the opportunities for us to write those coverages; and programs in which state-sponsored entities provide property insurance in catastrophe prone areas or other alternative markets types of coverage could eliminate the opportunities for us to write those coverages. In addition, insurance companies that merge may be able to enhance their negotiating position when buying reinsurance and may be able to spread their risks across a consolidated, larger capital base so that they require less reinsurance. New competition from these developments could cause the demand for insurance or reinsurance to fall or the expense of customer acquisition and retention to increase, either of which could have a material adverse affect on our growth and profitability. Efforts to comply with the Sarbanes-Oxley Act will entail significant expenditure; non-compliance with the Sarbanes-Oxley Act may adversely affect us. The Sarbanes-Oxley Act of 2002 that became law in July 2002, as well as new rules subsequently implemented by the Securities and Exchange Commission ( Commission ) and the NYSE, have required, and will require, changes to some of our accounting and corporate governance practices, including the requirement that we issue a report on our internal controls as required by Section 404 of the Sarbanes-Oxley Act. We expect these new rules and regulations to continue to increase our accounting, legal and other costs, and to make some activities more difficult, time consuming and/or costly. Compliance with Section 404 of the Sarbanes-Oxley Act is required by December 31, 2004. In the event that we are unable to achieve compliance with the Sarbanes-Oxley Act and related rules, it may have a material adverse effect on us. The historical cyclicality of the property and casualty reinsurance industry may cause fluctuations in our results. Historically, property and casualty reinsurers have experienced significant fluctuations in operating results due to competition, frequency of occurrence or severity of catastrophic events, levels of capacity, general economic conditions and other factors. Demand for reinsurance is influenced significantly by underwriting results of primary property and casualty insurers and prevailing general economic conditions. The date of this prospectus is , 2004. The information in this prospectus is not complete and may be changed. The selling shareholders may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted. The supply of reinsurance is related to prevailing prices, the levels of insured losses and the levels of industry surplus which, in turn, may fluctuate in response to changes in rates of return on investments being earned in the reinsurance industry. As a result, the reinsurance business historically has been a cyclical industry characterized by periods of intense price competition due to excessive underwriting capacity as well as periods when shortages of capacity permitted favorable premium levels. Although rates for many products have generally increased since our formation, and remain above our benchmark rates, the supply of reinsurance may increase, either by capital provided by new entrants or by the commitment of additional capital by existing reinsurers, which may cause prices to decrease. We are beginning to see more competition across many of the lines of business in which we participate. Any of these factors could lead to a significant reduction in premium rates, less favorable policy terms and conditions and fewer submissions for our underwriting services. In addition to these considerations, changes in the frequency and severity of losses suffered by insurers may affect the cycles of the reinsurance business significantly, and we expect to experience the effects of such cyclicality. For a description of recent trends in the property and casualty insurance and reinsurance industries, see Industry Background. Acquisitions or strategic investments that we made or may make could turn out to be unsuccessful. As part of our strategy, we have pursued and may continue to pursue growth through acquisitions and/or strategic investments in new businesses. The negotiation of potential acquisitions or strategic investments as well as the integration of an acquired business or new personnel could result in a substantial diversion of management resources. Acquisitions could involve numerous additional risks such as potential losses from unanticipated litigation or levels of claims and inability to generate sufficient revenue to offset acquisition costs. Our ability to manage our growth through acquisitions or strategic investments will depend, in part, on our success in addressing these risks. Any failure by us to effectively implement our acquisitions or strategic investment strategies could have a material adverse effect on our business, financial condition or results of operations. The regulatory system under which we operate, and potential changes thereto, could have a material adverse effect on our business. General. Our insurance subsidiaries may not be able to obtain or maintain necessary licenses, permits, authorizations or accreditations, or may be able to do so only at great cost. In addition, we may not be able to comply fully with, or obtain appropriate exemptions from, the wide variety of laws and regulations applicable to insurance or reinsurance companies or holding companies. Failure to comply with or to obtain appropriate exemptions under any applicable laws could result in restrictions on our ability to do business in one or more of the jurisdictions in which we operate and fines and other sanctions, which could have a material adverse effect on our business. See Regulatory Matters. Endurance Bermuda. Endurance Bermuda is a registered Class 4 Bermuda insurance and reinsurance company. Among other matters, Bermuda statutes, regulations and policies of the BMA require Endurance Bermuda to maintain minimum levels of statutory capital, statutory capital and surplus, and liquidity, to meet solvency standards, to obtain prior approval of ownership and transfer of shares and to submit to certain periodic examinations of its financial condition. These statutes and regulations may, in effect, restrict Endurance Bermuda s ability to write insurance and reinsurance policies, to make certain investments and to distribute funds. Endurance Bermuda does not maintain a principal office, and its personnel do not solicit, advertise, settle claims or conduct other activities that may constitute the transaction of the business of insurance or reinsurance, in any jurisdiction in which it is not licensed or otherwise not authorized to engage in such activities. Although Endurance Bermuda does not believe it is or will be in violation of insurance laws or regulations of any jurisdiction outside Bermuda, inquiries or challenges to Endurance Bermuda s insurance or reinsurance activities may still be raised in the future. The offshore insurance and reinsurance regulatory environment has become subject to increased scrutiny in many jurisdictions, including the United States and various states within the United States. Back to Contents Compliance with any new laws regulating offshore insurers or reinsurers could have a material adverse effect on our business. Endurance U.K. On December 4, 2002, Endurance U.K. received authorization from the FSA to begin writing certain lines of insurance and reinsurance in the United Kingdom. As an authorized insurer in the United Kingdom, Endurance U.K. is able to operate throughout the European Union, subject to compliance with certain notification requirements of the FSA and in some cases, certain local regulatory requirements. As an FSA authorized insurer, the insurance and reinsurance businesses of Endurance U.K. are subject to close supervision by the FSA. During 2004, the FSA will strengthen its requirements for senior management arrangements, systems and controls of insurance and reinsurance companies under its jurisdiction and will place an increased emphasis on risk identification and management in relation to the prudential regulation of insurance and reinsurance business in the United Kingdom. Though, in many respects, the 2004 changes in the FSA s requirements amplify existing FSA principles and rules and codify good business practice, certain of these changes, and any new guidance given by the FSA, may have an adverse impact on the business of Endurance U.K. In addition, given that the framework for supervision of insurance and reinsurance companies in the United Kingdom is largely formed by E.U. directives (which are implemented by member states through national legislation), changes at the E.U. level may affect the regulatory scheme under which Endurance U.K. operates. A general review of E.U. insurance solvency directives is currently in progress and may lead to changes, such as increased minimum capital requirements. Before this, however, the FSA has proposed to introduce new enhanced capital requirements ( ECR ) for insurers and reinsurers which will include capital charges based on assets, claims and premiums. The level of ECR seems likely to be at least twice the existing required minimum solvency margin for most companies, although the FSA has already adopted an informal approach of encouraging companies to hold at least twice the current EU minimum. In addition, the FSA is proposing to give guidance regularly to insurers under individual capital assessments, which may result in guidance that a company should hold in excess of the ECR. These changes may increase the required regulatory capital of Endurance U.K. Endurance U.S. Endurance U.S. is organized in and licensed to write certain lines of reinsurance business in the State of New York and, as a result, is subject to New York law and regulation under the supervision of the Superintendent of Insurance of the State of New York. The New York Superintendent also has regulatory authority over a number of affiliate transactions between Endurance U.S. and other members of our holding company system. The purpose of the state insurance regulatory statutes is to protect U.S. insureds and U.S. ceding insurance companies, not our shareholders. Among other matters, state insurance regulations require Endurance U.S. to maintain minimum levels of capital, surplus and liquidity, require Endurance U.S. to comply with applicable risk-based capital requirements and impose restrictions on the payment of dividends and distributions. These statutes and regulations may, in effect, restrict the ability of Endurance U.S. to write new business or distribute assets to Endurance Holdings. In recent years, the U.S. insurance regulatory framework has come under increased federal scrutiny, and some state legislators have considered or enacted laws that may alter or increase state regulation of insurance and reinsurance companies and holding companies. Moreover, the National Association of Insurance Commissioners ( NAIC ), which is an association of the insurance commissioners of all 50 states and the District of Columbia, and state insurance regulators regularly reexamine existing laws and regulations. Changes in these laws and regulations or the interpretation of these laws and regulations could have a material adverse effect on our business. For example, in response to the tightening of supply in certain insurance and reinsurance markets resulting from, among other things, the World Trade Center tragedy, the Terrorism Risk Insurance Act of 2002 was enacted to ensure the availability of insurance coverage for terrorist acts in the United States. This law establishes a federal assistance program through the end of 2005 to help the commercial property and casualty insurance industry cover claims related to future terrorism related losses and regulates the terms of insurance relating to terrorism coverage. This has increased underwriting capacity for certain of our competitors as a result of the Act s requirement that coverage for terrorist acts be offered by insurers. To date, this law has resulted in an increase of certain terrorism coverages which we are required to offer. We Back to Contents have taken steps to provide that our insurance operations are able to receive the benefit of this law. We are currently unable to predict the extent to which the foregoing new initiative may affect the demand for our products or the risks which may be available for us to consider underwriting. Risks Related to Ownership of Our Ordinary Shares Future sales of ordinary shares may affect their market price. We cannot predict what effect, if any, future sales of our ordinary shares, or the availability of ordinary shares for future sale, will have on the market price of our ordinary shares. Sales of substantial amounts of our ordinary shares in the public market following this offering, or the perception that such sales could occur, could adversely affect the market price of our ordinary shares and may make it more difficult for you to sell your ordinary shares at a time and price which you deem appropriate. See Description of Share Capital Registration Rights Agreement and Shares Eligible for Future Sale for further information regarding circumstances under which additional ordinary shares may be sold. As of March 1, 2004, 63,915,000 ordinary shares were outstanding and an additional 9,418,077 common shares were issuable upon the full exercise or conversion of outstanding vested options, warrants and restricted share units. We, our directors and officers, all of our warrant holders and the selling shareholders have agreed, with limited exceptions, for a period of 90 days after the date of this prospectus, that we and they will not, without the prior written consent of Goldman, Sachs & Co. and Merrill Lynch, Pierce, Fenner & Smith Incorporated on behalf of the underwriters, directly or indirectly, offer to sell, sell or otherwise dispose of or hedge any of our ordinary shares. One of our founding shareholders has agreed to the foregoing for a period of 30 days. In connection with an exchange offer in July of 2002 with all of our existing shareholders at the time, we granted rights to such shareholders to require us to register their ordinary shares under the Securities Act of 1933, as amended ( Securities Act ) for sale into the public markets pursuant to a registration rights agreement, dated as of July 22, 2002. A copy of the registration rights agreement has been filed as an exhibit to the registration statement of which this prospectus forms a part. We have filed this registration statement pursuant to the exercise of demand registration rights under such agreement by Aon, Capital Z Financial Services, Perry Corp., Texas Pacific Group and various Thomas H. Lee related entities. See Principal and Selling Shareholders. Pursuant to the registration rights agreement, we gave notice to our other founding shareholders that we have received notice of the exercise of demand registration rights under the registration rights agreement and gave such other shareholders the opportunity to include their shares in the registration statement and this prospectus. The other founding shareholders had up to 21 days after receipt of the notice, or February 23, 2004, to elect to include their shares in the offering to be made pursuant to this prospectus. It is possible that shareholders may decide to withdraw their shares from registration, as they have no obligation to sell any shares even though they may have exercised demand or other registration rights under our registration rights agreement. The actual number of shares to be sold by the selling shareholders pursuant to this offering (including pursuant to the over-allotment option) will be reflected in the final prospectus. Upon effectiveness of the registration statement, all shares included in such registration statement will be freely transferable. Upon consummation of this offering, the shareholders under the registration rights agreement and their transferees will continue to have the right to require us to register their ordinary shares for sale under the Securities Act, subject to the 90-day lock-up agreements described above and certain other exceptions. See Description of Share Capital Registration Rights Agreement. There are provisions in our charter documents that may reduce or increase the voting rights of our ordinary shares. As used in this prospectus, all references to bye-laws refer to the amended and restated bye-laws of Endurance Holdings. The bye-laws generally provide that any shareholder owning, directly, indirectly or, in the case of any U.S. Person, by attribution, more than 9.5% of our ordinary shares will have the voting rights attached to such ordinary shares reduced so that it may not exercise more than 9.5% of the total voting rights. The reduction in votes is generally to be applied proportionately among all shareholders who are members of the first shareholder s control group. A control group means, with respect to any person, all shares directly owned by such person and all shares directly owned by each other shareholder any of whose shares are included in the controlled shares of such person. Controlled shares means all ordinary shares that a person is deemed to own directly, indirectly (within the meaning of Section 958(a) of the Internal Revenue Code of 1986, as amended (the Code )) or, in the case of a U.S. Person, constructively (within the meaning of Section 958(b) of the Code). A similar limitation is to be applied to shares held directly by members of a related group. A related group means a group of shareholders that are investment vehicles and are under common control and management. Any reduction in votes will generally be allocated proportionately among members of the shareholder s control group or related group, as the case may be. The amount of any reduction of votes that occurs by operation of the above limitations will generally be reallocated proportionately among all other shareholders of Endurance Holdings who were not members of these groups so long as such reallocation does not cause any person to become a 9.5% shareholder. Under these provisions, certain shareholders may have their voting rights limited to less than one vote per share, while other shareholders may have voting rights in excess of one vote per share. Moreover, these provisions could have the effect of reducing the votes of certain shareholders who would not otherwise be subject to the 9.5% limitation by virtue of their direct share ownership. The bye-laws of Endurance Holdings provide that shareholders will be notified of their voting interests prior to any vote to be taken by the shareholders. See Description of Share Capital Voting Adjustments. As a result of any reallocation of votes, your voting rights might increase above 5% of the aggregate voting power of the outstanding ordinary shares, thereby possibly resulting in your becoming a reporting person subject to Schedule 13D or 13G filing requirements under the Securities Exchange Act of 1934, as amended (the Exchange Act ). In addition, the reallocation of your votes could result in your becoming subject to filing requirements under Section 16 of the Exchange Act. The Company also has the authority to request information from any shareholder for the purpose of determining whether a shareholder s voting rights are to be reallocated pursuant to the bye-laws. If a shareholder fails to respond to a request for information from the Company or submits incomplete or inaccurate information (after a reasonable cure period) in response to a request, the Company, in its reasonable discretion, may reduce or eliminate the shareholder s voting rights. Provisions of Endurance Holdings bye-laws may restrict the ability to transfer shares of Endurance Holdings. Pursuant to its bye-laws, Endurance Holdings board of directors may decline to register a transfer of any ordinary shares if the relevant instrument of transfer (if any) is in favor of five persons or more jointly or is not properly executed, the transferred shares are not fully paid shares or if the transferor fails to comply with all applicable laws and regulations governing the transfer. A shareholder may be required to sell its shares of Endurance Holdings. Endurance Holdings bye-laws provide that we have the option, but not the obligation, to require a shareholder to sell its ordinary shares for their fair market value to us, to other shareholders or to third parties if we determine, based on the written advice of legal counsel, that failure to exercise our option would result in adverse tax consequences to us or certain U.S. Persons as to which the shares held by such shareholder constitute controlled shares. In the latter case, our right to require a shareholder to sell its ordinary shares to us will be limited to the purchase of a number of ordinary shares that will permit avoidance of those adverse tax consequences. See Description of Share Capital Bye-laws Acquisition of Ordinary Shares by Endurance Holdings. Back to Contents A shareholder may be required to indemnify us for any tax liability that results from the acts of that shareholder. Our bye-laws provide certain protections against adverse tax consequences to us resulting from laws that apply to our shareholders. If a shareholder s death or non-payment of any tax or duty payable by the shareholder, or any other act or thing involving the shareholder, causes any adverse tax consequences to us, (i) the shareholder (or his executor or administrator) is required to indemnify us against any tax liability that we incur as a result, (ii) we will have a lien on any dividends or any other distributions payable to the shareholder by us to the extent of the tax liability, and (iii) if any amounts not covered by our lien on dividends and distributions are owed to us by the shareholder as a result of our tax liability, we have the right to refuse to register any transfer of the shareholder s shares. There are regulatory limitations on the ownership and transfer of our ordinary shares. Ordinary shares may be offered or sold in Bermuda only in compliance with the provisions of the Investment Business Act of 2003 of Bermuda which regulates the sale of securities in Bermuda. In addition, the BMA must approve all issuances and transfers of shares of a Bermuda exempted company. We have received from the BMA their permission for the issue and free transferability of the ordinary shares in the Company being offered pursuant to this prospectus, as long as the shares are listed on the NYSE, to and among persons who are non-residents of Bermuda for exchange control purposes. In addition, we will deliver to and file a copy of this prospectus with the Registrar of Companies in Bermuda in accordance with Bermuda law. The BMA and the Registrar of Companies accept no responsibility for the financial soundness of any proposal or for the correctness of any of the statements made or opinions expressed in this prospectus. The Financial Services and Markets Act 2000 ( FSMA ) regulates the acquisition of control of any U.K. insurance company authorized under FSMA. Any company or individual that (together with its or his associates) directly or indirectly acquires 10% or more of the shares of a U.K. authorized insurance company or its parent company, or is entitled to exercise or control the exercise of 10% or more of the voting power in such authorized insurance company or its parent company, would be considered to have acquired control for the purposes of FSMA, as would a person who had significant influence over the management of such authorized insurance company or its parent company by virtue of his shareholding or voting power in either. A purchaser of more than 10% of our ordinary shares would therefore be considered to have acquired control of Endurance U.K. Under the FSMA, any person proposing to acquire control over a U.K. authorized insurance company must notify the FSA of his intention to do so and obtain the FSA s prior approval. The FSA would then have three months to consider that person s application to acquire control. In considering whether to approve such application, the FSA must be satisfied both that the acquirer is a fit and proper person to have such control and that the interests of consumers would not be threatened by such acquisition of control. Failure to make the relevant prior application would constitute a criminal offense. State laws in the United States also require prior notices or regulatory agency approval of changes in control of an insurer or its holding company. The insurance laws of the State of New York, where Endurance U.S. is domiciled, provide that no corporation or other person except an authorized insurer may acquire control of a domestic insurance or reinsurance company unless it has given notice to such company and obtained prior written approval of the New York Superintendent. Any purchaser of 10% or more of our ordinary shares could become subject to such regulations and could be required to file certain notices and reports with the New York Superintendent prior to such acquisition. Back to Contents U.S. persons who own our ordinary shares may have more difficulty in protecting their interests than U.S. persons who are shareholders of a U.S. corporation. The Companies Act, which applies to Endurance Holdings and Endurance Bermuda, differs in certain material respects from laws generally applicable to U.S. corporations and their shareholders. In order to highlight those differences, set forth below is a summary of certain significant provisions of the Companies Act, including, where relevant, information on Endurance Holdings bye-laws, which differ in certain respects from provisions of Delaware corporate law. Because the following statements are summaries, they do not discuss all aspects of Bermuda law that may be relevant to Endurance Holdings and our shareholders. Interested Directors. Under Bermuda law and Endurance Holdings bye-laws, we cannot void any transaction we enter into in which a director has an interest, nor can such director be accountable to us for any benefit realized pursuant to such transaction, provided the nature of the interest is disclosed at the first opportunity at a meeting of directors, or in writing, to the directors. In addition, Endurance Holdings bye-laws allow a director to be taken into account in determining whether a quorum is present and to vote on a transaction in which he has an interest, but the resolution with respect to such transactions will fail unless it is approved by a majority of the disinterested directors voting on such a transaction. Under Delaware law such transaction would not be voidable if: the material facts as to such interested director s relationship or interests were disclosed or were known to the board of directors and the board had in good faith authorized the transaction by the affirmative vote of a majority of the disinterested directors; such material facts were disclosed or were known to the shareholders entitled to vote on such transaction and the transaction were specifically approved in good faith by vote of the majority of shares entitled to vote thereon; or the transaction was fair as to the corporation as of the time it was authorized, approved or ratified. Under Delaware law, the interested director could be held liable for a transaction in which the director derived an improper personal benefit. Business Combinations with Large Shareholders or Affiliates. As a Bermuda company, Endurance Holdings may enter into business combinations with its large shareholders or one or more wholly-owned subsidiaries, including asset sales and other transactions in which a large shareholder or a wholly-owned subsidiary receives, or could receive, a financial benefit that is greater than that received, or to be received, by other shareholders or other wholly-owned subsidiaries, without obtaining prior approval from our shareholders and without special approval from our board of directors. Under Bermuda law, amalgamations require the approval of the board of directors, and in some instances, shareholder approval. However, when the affairs of a Bermuda company are being conducted in a manner which is oppressive or prejudicial to the interests of some shareholders, one or more shareholders may apply to a Bermuda court, which may make such order as it sees fit, including an order regulating the conduct of the company s affairs in the future or ordering the purchase of the shares of any shareholders by other shareholders or the company. If we were a Delaware company, we would need prior approval from our board of directors or a supermajority of our shareholders to enter into a business combination with an interested shareholder for a period of three years from the time the person became an interested shareholder, unless we opted out of the relevant Delaware statute. Bermuda law or Endurance Holdings bye-laws would require board approval and in some instances, shareholder approval, of such transactions. Shareholders Suits. The rights of shareholders under Bermuda law are not as extensive as the rights of shareholders in many United States jurisdictions. Class actions and derivative actions are generally not available to shareholders under Bermuda law. However, the Bermuda courts ordinarily would be expected to follow English case law precedent, which would permit a shareholder to commence a derivative action in the name of a company where the act complained of is alleged to be beyond the corporate power of the company, is illegal or would result in the violation of Endurance Holdings memorandum of association or bye-laws. Furthermore, consideration would be given by the court to acts that are alleged to constitute a fraud against the minority shareholders or where an act requires the approval of a greater percentage of our Back to Contents Risks Relating to Our Company As part of your evaluation of the Company, you should take into account the risks we face in our business. These risks include: Limited Operating History. We have a limited operating and financial history. As a result, there is limited historical financial and operating information to help you evaluate our past performance or to make a decision about an investment in our ordinary shares. Uncertainty of Establishing Loss Reserves. Establishing and maintaining an appropriate level of loss reserves is an inherently uncertain process, especially for recently formed insurers like us without an established loss history. Because of this uncertainty, it is possible that our loss reserves at any given time will prove inadequate. This could cause a material reduction in our profitability and capital. Vulnerability to Losses from Catastrophes. Our property and property catastrophe insurance and reinsurance operations expose us to claims arising from catastrophes. In the event that we experience catastrophe losses, there is a possibility that our unearned premium and loss reserves will be inadequate to cover these risks, which could have a material adverse effect on our financial condition and our results of operations. Failure of Our Loss Limitation Methods. Limitations or exclusions from coverage or choice of forum, or other loss limitation methods we employ may not be effective or may not be enforceable in the manner we intend, which could have a material adverse effect on our financial condition and our results of operations, possibly to the extent of eliminating our shareholders equity. Non-renewal of Existing Contracts. Our contracts are generally for a one-year term. In our financial forecasting process, we make assumptions about the renewal of our prior year s contracts. If actual renewals do not meet expectations, our premiums written in future years and our future results of operations could be materially adversely affected. This risk is especially prevalent in the first quarter of each year when a large number of reinsurance contracts are subject to renewal. Constraints Related to Our Holding Company Structure. As a holding company, Endurance Holdings has no substantial operations of its own. Dividends and other permitted distributions from insurance subsidiaries are expected to be Endurance Holdings sole source of funds to meet ongoing cash requirements. These payments are limited by the regulations in the jurisdictions in which our subsidiaries operate. The inability of these subsidiaries to pay dividends in sufficient amounts for Endurance Holdings to meet its cash requirements could have a material adverse effect on its operations. Cyclical Nature of the Insurance and Reinsurance Business. Historically, the property and casualty reinsurance business has been a cyclical industry characterized by periods of intense price competition. Although premium levels for many products have generally increased during the past two years, the supply of insurance and reinsurance capacity may increase, either by capital provided by new entrants or by the commitment of additional capital by existing insurers and reinsurers, which may cause prices to decrease. For more information about these and other risks, see Risk Factors beginning on page 8. You should carefully consider these risk factors together with all the other information included in this prospectus before making an investment decision. Back to Contents shareholders than actually approved it. The successful party in such an action generally would be able to recover a portion of attorneys fees incurred in connection with such action. Endurance Holdings bye-laws provide that shareholders waive all claims or rights of action that they might have, individually or in the right of Endurance Holdings, against any director or officer for any action or failure to act in the performance of such director s or officer s duties, except such waiver shall not extend to any claims or rights of action that would render the waiver void pursuant to the Companies Act, that arise out of fraud or dishonesty on the part of such director or officer or with respect to the recovery of any gain, personal profit or advantage to which the officer or director is not legally entitled. Class actions and derivative actions generally are available to shareholders under Delaware law for, among other things, breach of fiduciary duty, corporate waste and actions not taken in accordance with applicable law. In such actions, the court has discretion to permit the winning party to recover attorneys fees incurred in connection with such action. Indemnification of Directors and Officers. Under Bermuda law and Endurance Holdings bye-laws, Endurance Holdings will indemnify its directors or officers or any person appointed to any committee by the board of directors and any resident representative (and their respective heirs, executors or administrators) against all actions, costs, charges, liabilities, loss, damage or expense, to the full extent permitted by law, incurred or suffered by such officer, director or other person by reason of any act done, conceived in or omitted in the conduct of the company s business or in the discharge of his/her duties; provided that such indemnification shall not extend to any matter involving any fraud or dishonesty on the part of such director, officer or other person. Under Delaware law, a corporation may indemnify a director or officer of the corporation against expenses (including attorneys fees), judgments, fines and amounts paid in settlement actually and reasonably incurred in defense of an action, suit or proceeding by reason of such position if such director or officer acted in good faith and in a manner he or she reasonably believed to be in or not be opposed to the best interests of the corporation and, with respect to any criminal action or proceeding, such director or officer had no reasonable cause to believe his or her conduct was unlawful. For more information on the differences between Bermuda and Delaware corporate laws, see Description of Share Capital Differences in Corporate Law. Anti-takeover provisions in our bye-laws could impede an attempt to replace or remove our directors, which could diminish the value of our ordinary shares. Endurance Holdings bye-laws contain provisions that may entrench directors and make it more difficult for shareholders to replace directors even if the shareholders consider it beneficial to do so. In addition, these provisions could delay or prevent a change of control that a shareholder might consider favorable. For example, these provisions may prevent a shareholder from receiving the benefit from any premium over the market price of our ordinary shares offered by a bidder in a potential takeover. Even in the absence of an attempt to effect a change in management or a takeover attempt, these provisions may adversely affect the prevailing market price of our ordinary shares if they are viewed as discouraging changes in management and takeover attempts in the future. Examples of provisions in our bye-laws that could have such an effect include: election of our directors is staggered, meaning that the members of only one of three classes of our directors are elected each year; the total voting power of any shareholder owning more than 9.5% of our ordinary shares will be reduced to 9.5% of the total voting power of our ordinary shares; our directors may, in their discretion, decline to record the transfer of any ordinary shares on our share register, unless the instrument of transfer is in favor of less than five persons jointly or if they are not satisfied that all required regulatory approvals for such transfer have been obtained; and we have the option, but not the obligation, to require a shareholder to sell its ordinary shares to us, to our other shareholders or to third parties at fair market value if we determine, based on Back to Contents the advice of legal counsel, that failure to exercise our option would result in adverse tax consequences to us or certain U.S. Persons as to which the shares held by such shareholder constitute controlled shares. It may be difficult to enforce service of process and enforcement of judgments against us and our officers and directors. Endurance Holdings is a Bermuda company and certain of its officers and directors are residents of various jurisdictions outside the United States. A substantial portion of its assets and its officers and directors, at any one time, are or may be located in jurisdictions outside the United States. Although Endurance Holdings has irrevocably appointed CT Corporation System as an agent in New York, New York to receive service of process with respect to actions against Endurance Holdings arising out of violations of the U.S. federal securities laws in any federal or state court in the United States relating to the transactions covered by this prospectus, it may be difficult for investors to effect service of process within the United States on our directors and officers who reside outside the United States or to enforce against us or our directors and officers judgments of U.S. courts predicated upon civil liability provisions of the U.S. federal securities laws. We have been advised by Appleby Spurling & Kempe, our Bermuda counsel, that there is no treaty in force between the United States and Bermuda providing for the reciprocal recognition and enforcement of judgments in civil and commercial matters. As a result, whether a United States judgment would be enforceable in Bermuda against us or our directors and officers depends on whether the U.S. court that entered the judgment is recognized by the Bermuda court as having jurisdiction over us or our directors and officers, as determined by reference to Bermuda conflict of law rules. A judgment debt from a U.S. court that is final and for a sum certain based on U.S. federal securities laws will not be enforceable in Bermuda unless the judgment debtor had submitted to the jurisdiction of the U.S. court, and the issue of submission and jurisdiction is a matter of Bermuda (not United States) law. In addition to and irrespective of jurisdictional issues, the Bermuda courts will not enforce a United States federal securities law that is either penal or contrary to public policy. It is the advice of Appleby Spurling & Kempe that an action brought pursuant to a public or penal law, the purpose of which is the enforcement of a sanction, power or right at the instance of the state in its sovereign capacity, will not be entertained by a Bermuda Court. Certain remedies available under the laws of U.S. jurisdictions, including certain remedies under U.S. federal securities laws, would not be available under Bermuda law or enforceable in a Bermuda court, as they would be contrary to Bermuda public policy. Further, no claim may be brought in Bermuda against us or our directors and officers in the first instance for violation of U.S. federal securities laws because these laws have no extraterritorial jurisdiction under Bermuda law and do not have force of law in Bermuda. A Bermuda court may, however, impose civil liability on us or our directors and officers if the facts alleged in a complaint constitute or give rise to a cause of action under Bermuda law. Risks Related to Taxation We may become subject to taxes in Bermuda after March 28, 2016, which may have a material adverse effect on our financial condition. The Bermuda Minister of Finance, under the Exempted Undertakings Tax Protection Act 1966, as amended, of Bermuda, has given Endurance Holdings and Endurance Bermuda an assurance that if any legislation is enacted in Bermuda that would impose tax computed on profits or income or computed on any capital asset, gain or appreciation, or any tax in the nature of estate duty or inheritance tax, then the imposition of any such tax will not be applicable to Endurance Holdings, Endurance Bermuda or any of their respective operations, shares, debentures or other obligations until March 28, 2016. See Material Tax Considerations Certain Bermuda Tax Considerations. Given the limited duration of the Minister of Finance s assurance, however, it is possible that after March 28, 2016 we may be subject to Bermuda taxes. Back to Contents We and our subsidiaries may be subject to U.S. tax which may have a material adverse effect on our financial condition and results of operations. Endurance Holdings and Endurance Bermuda are Bermuda companies and Endurance U.K. is an English company. Endurance Holdings, Endurance Bermuda and Endurance U.K. each intends to operate in such a manner that none of these companies will be deemed to be engaged in the conduct of a trade or business within the United States. Nevertheless, because definitive identification of activities which constitute being engaged in a trade or business in the United States is not provided by the Code, or regulations or court decisions, the Internal Revenue Service ( IRS ), might contend that any of Endurance Holdings, Endurance Bermuda and/or Endurance U.K. are/is engaged in a trade or business in the United States. If Endurance Holdings, Endurance Bermuda and/or Endurance U.K. were engaged in a trade or business in the United States, and if Endurance U.K. or Endurance Bermuda were to qualify for benefits under the applicable income tax treaty with the United States, but such trade or business were attributable to a permanent establishment in the United States (or in the case of Endurance Bermuda, with respect to investment income, arguably even if such income were not attributable to a permanent establishment ), Endurance Holdings, Endurance U.K. and/or Endurance Bermuda would be subject to U.S. federal income tax at regular corporate rates on the income that is effectively connected with the U.S. trade or business, plus an additional 30% branch profits tax in certain circumstances, in which case our financial condition and results of operations and your investment could be materially adversely affected. See Material Tax Considerations Certain United States Federal Income Tax Considerations United States Taxation of Endurance Holdings, Endurance Bermuda, Endurance U.K. and Endurance U.S. Endurance Holdings and/or any of its subsidiaries could be subject to U.S. tax on a portion of its income that is earned from U.S. sources (and certain types of foreign source income which are effectively connected with the conduct of a U.S. trade or business) if any of them are considered to be a personal holding company, or a PHC, for U.S. federal income tax purposes. This status will depend on whether more than 50% of our shares could be deemed to be owned by five or fewer individuals and the percentage of our income, or that of our subsidiaries, that consists of personal holding company income, as determined for U.S. federal income tax purposes. We believe, based upon information made available to us regarding our existing shareholder base, that neither we nor any of our subsidiaries will be considered a PHC, but due to the lack of complete information regarding our ultimate share ownership, we cannot be certain that this will be the case, or that the amount of U.S. tax that would be imposed if it were not the case would be immaterial. See Material Tax Considerations Certain United States Federal Income Tax Considerations United States Taxation of Endurance Holdings, Endurance Bermuda, Endurance U.K. and Endurance U.S. Personal Holding Companies. We and our subsidiaries may be subject to U.K. tax which may have a material adverse effect on our financial condition and results of operations. Endurance Holdings and Endurance Bermuda are organized in Bermuda and Endurance U.S. is a company incorporated in the United States. Accordingly, because they are not incorporated in the United Kingdom, none of Endurance Holdings, Endurance Bermuda or Endurance U.S. will be treated as being resident in the United Kingdom unless their central management and control is exercised in the United Kingdom. The concept of central management and control is indicative of the highest level of control of a company, which is wholly a question of fact. The directors of Endurance Holdings, Endurance Bermuda and Endurance U.S. intend to manage their affairs so that none of them are resident in the United Kingdom for tax purposes. A company not resident in the United Kingdom for corporation tax purposes can nevertheless be subject to U.K. corporation tax if it carries on a trade through a branch or agency in the United Kingdom but the charge to U.K. corporation tax is limited to profits (including revenue profits and capital gains) connected with such branch or agency. The directors of Endurance Holdings, Endurance Bermuda and Endurance U.S. intend that each will operate in such a manner that none of these companies carry on a trade through a branch or agency in the United Kingdom. Nevertheless, because neither case law nor U.K. statute definitively defines the activities that constitute trading in the United Kingdom through a branch or agency, the U.K. Inland Revenue might contend that any of Endurance Holdings, Endurance Bermuda and/or Endurance U.S. Back to Contents Summary Consolidated Financial Information The following table sets forth our summary consolidated financial information for the periods ended and as of the dates indicated. As described in Note 1 to our consolidated financial statements included elsewhere in this prospectus, our consolidated financial statements include the accounts of Endurance Holdings, Endurance Bermuda, Endurance U.K. and Endurance U.S. Endurance Bermuda was incorporated on November 30, 2001 and commenced operations on December 17, 2001. Endurance Holdings was incorporated on June 27, 2002 and effected an exchange offer in July 2002 with the shareholders of Endurance Bermuda. The exchange offer was accounted for as a business combination of companies under common control. On December 17, 2002, we effected a share premium issuance to our existing shareholders. Except as otherwise indicated, all share data in this prospectus assumes the share premium issuance to our existing shareholders of four additional shares for each common share outstanding had occurred as of the date such data is presented. The summary consolidated financial information presented below is derived from our consolidated financial statements included elsewhere in this prospectus. These historical results are not necessarily indicative of results to be expected from any future period. You should read this summary consolidated financial information together with our consolidated financial statements and related notes and the section of this prospectus entitled Management s Discussion and Analysis of Financial Condition and Results of Operations. Year Ended December 31, 2003 Year Ended December 31, 2002 Period Ended December 31, 2001 Back to Contents are/is trading in the United Kingdom through a branch or agency in the United Kingdom. If Endurance U.S. were trading in the U.K. through a branch or agency and Endurance U.S. were to qualify for benefits under the applicable income tax treaty between the United Kingdom and the United States, only those profits which were attributable to a permanent establishment in the United Kingdom would be subject to U.K. corporation tax. The United Kingdom has no income tax treaty with Bermuda. If Endurance Holdings, Endurance Bermuda or Endurance U.S. were treated as being resident in the United Kingdom for U.K. corporation tax purposes, or as carrying on a trade in the United Kingdom through a branch or agency, our financial condition and results of operations and your investment could be materially adversely affected. If you acquire 10% or more of Endurance Holdings ordinary shares, you may be subject to taxation under the controlled foreign corporation ( CFC ) rules. Each 10% U.S. Shareholder of a foreign corporation that is a CFC for an uninterrupted period of 30 days or more during a taxable year, and who owns shares in the CFC directly or indirectly through foreign entities on the last day of the CFC s taxable year, must include in its gross income for U.S. federal income tax purposes its pro rata share of the CFC s subpart F income, even if the subpart F income is not distributed. A foreign corporation is considered a CFC if 10% U.S. Shareholders own more than 50% of the total combined voting power of all classes of voting stock of such foreign corporation, or the total value of all stock of such corporation. A 10% U.S. Shareholder is a U.S. Person who owns at least 10% of the total combined voting power of all classes of stock entitled to vote of the foreign corporation. For purposes of taking into account insurance income, a CFC also includes a foreign corporation in which more than 25% of the total combined voting power of all classes of stock (or more than 25% of the total value of the stock) is owned by 10% U.S. Shareholders, on any day during the taxable year of such corporation, if the gross amount of premiums or other consideration for the reinsurance or the issuing of insurance or annuity contracts exceeds 75% of the gross amount of all premiums or other consideration in respect of all risks. For purposes of determining whether a corporation is a CFC, and therefore whether the 50% (or 25%, in the case of insurance income) and 10% ownership tests have been satisfied, own means owned directly, indirectly through foreign entities or is considered as owned by application of certain constructive ownership rules. Due to the anticipated dispersion of Endurance Holdings share ownership among holders, its bye-law provisions that impose limitations on the concentration of voting power of its ordinary shares and authorize the board of directors to purchase such shares under certain circumstances, and other factors, no U.S. Person that owns shares in Endurance Holdings directly or indirectly through foreign entities should be subject to treatment as a 10% U.S. Shareholder of a CFC. It is possible, however, that the IRS could challenge the effectiveness of these provisions and that a court could sustain such a challenge. See Material Tax Considerations Certain United States Federal Income Tax Considerations United States Taxation of Holders of Ordinary Shares Shareholders Who Are U.S. Persons. U.S. Persons who hold ordinary shares may be subject to U.S. income taxation on their pro rata share of our related party insurance income ( RPII ). If Endurance U.K. s or Endurance Bermuda s RPII were to equal or exceed 20% of Endurance U.K. s or Endurance Bermuda s gross insurance income in any taxable year and direct or indirect insureds (and persons related to such insureds) own (or are treated as owning directly or indirectly) 20% or more of the voting power or value of the shares of Endurance U.K. or Endurance Bermuda, a U.S. Person who owns ordinary shares of Endurance Holdings directly or indirectly through foreign entities on the last day of the taxable year would be required to include in its income for U.S. federal income tax purposes the shareholder s pro rata share of Endurance U.K. s or Endurance Bermuda s RPII for the entire taxable year, determined as if such RPII were distributed proportionately to such U.S. shareholders at that date regardless of whether such income is distributed. In addition, any RPII that is includible in the income of a U.S. tax-exempt organization would be treated as unrelated business taxable income. The amount of RPII earned by Endurance U.K. or Endurance Bermuda (generally, premium and related investment income from the direct or indirect insurance or reinsurance of any direct or indirect U.S. shareholder of Endurance U.K. or Endurance Bermuda or any person related to such shareholder) depends on a number of factors, including the Back to Contents geographic distribution of Endurance U.K. s or Endurance Bermuda s business and the identity of persons directly or indirectly insured or reinsured by Endurance U.K. or Endurance Bermuda. Although we believe that our RPII has not in the recent past equaled or exceeded 20% of our gross insurance income, and do not expect it to do so in the foreseeable future, some of the factors, which determine the extent of RPII in any period, may be beyond Endurance U.K. s or Endurance Bermuda s control. Consequently, Endurance U.K. s or Endurance Bermuda s RPII could equal or exceed 20% of its gross insurance income in any taxable year and ownership of its shares by direct or indirect insureds and related persons could equal or exceed the 20% threshold described above. The RPII rules provide that if a shareholder who is a U.S. Person disposes of shares in a foreign insurance corporation that has RPII (even if the amount of RPII is less than 20% of the corporation s gross insurance income or the ownership of its shares by direct or indirect insureds and related persons is less than the 20% threshold) and in which U.S. Persons own 25% or more of the shares, any gain from the disposition will generally be treated as ordinary income to the extent of the shareholder s share of the corporation s undistributed earnings and profits that were accumulated during the period that the shareholder owned the shares (whether or not such earnings and profits are attributable to RPII). In addition, such a shareholder will be required to comply with certain reporting requirements, regardless of the amount of shares owned by the shareholder. These rules should not apply to dispositions of ordinary shares because Endurance Holdings will not itself be directly engaged in the insurance business. The RPII provisions, however, have not been interpreted by the courts or the U.S. Treasury Department, and regulations interpreting the RPII provisions of the Code exist only in proposed form. Accordingly, the IRS might interpret the proposed regulations in a different manner and the applicable proposed regulations may be promulgated in final form in a manner that would cause these rules to apply to dispositions of our ordinary shares. See Material Tax Considerations Certain United States Federal Income Tax Considerations United States Taxation of Holders of Ordinary Shares Shareholders Who Are U.S. Persons. U.S. Persons who hold ordinary shares will be subject to adverse tax consequences if we are considered a passive foreign investment company (a PFIC ) for U.S. federal income tax purposes. We believe that we should not be considered a PFIC for U.S. federal income purposes for the year ended December 31, 2003. Moreover, we do not expect to conduct our activities in a manner that would cause us to become a PFIC in the future. However, it is possible that we could be deemed a PFIC by the IRS for 2003 or any future year. If we were considered a PFIC it could have material adverse tax consequences for an investor that is subject to U.S. federal income taxation, including subjecting the investor to a greater tax liability than might otherwise apply or subjecting the investor to tax on amounts in advance of when tax would otherwise be imposed. There are currently no regulations regarding the application of the PFIC provisions to an insurance company. New regulations or pronouncements interpreting or clarifying these rules may be forthcoming. We cannot predict what impact, if any, such guidance would have on a shareholder that is subject to U.S. federal income taxation. See Material Tax Considerations Certain United States Federal Income Tax Considerations United States Taxation of Holders of Ordinary Shares Shareholders Who Are U.S. Persons Passive Foreign Investment Companies. U.S. Persons who hold ordinary shares will be subject to adverse tax consequences if we or any of our subsidiaries are considered a foreign personal holding company ( FPHC ) for U.S. federal income tax purposes. Endurance Holdings and/or any of its non-U.S. subsidiaries could be considered to be a FPHC for U.S. federal income tax purposes. This status will depend on whether more than 50% of our shares could be deemed to be owned by five or fewer individuals who are citizens or residents of the United States, and the percentage of our income, or that of our subsidiaries, that consists of foreign personal holding company income, as determined for U.S. federal income tax purposes. We believe, based upon information made available to us regarding our existing shareholder base, that neither we nor any of our subsidiaries are, and we currently do not expect any of them or us to become, a FPHC for U.S. federal income tax purposes. Due to the lack of complete information regarding our ultimate share ownership, however, we cannot be certain that we will not be considered a FPHC. If we were considered a FPHC it could have material adverse tax Back to Contents consequences for an investor that is subject to U.S. federal income taxation including subjecting the investor to a greater tax liability than might otherwise apply and subjecting the investor to tax on amounts in advance of when tax would otherwise be imposed. See Material Tax Considerations Certain United States Federal Income Tax Considerations United States Taxation of Holders of Ordinary Shares Shareholders Who Are U.S. Persons Foreign Personal Holding Companies. Changes in U.S. federal income tax law could materially adversely affect shareholders investment. Legislation has been introduced in the U.S. Congress intended to eliminate certain perceived tax advantages of companies (including insurance companies) that have legal domiciles outside the United States but have certain U.S. connections. While there is no currently pending legislative proposal which, if enacted, would have a material adverse effect on us, our subsidiaries or our shareholders, it is possible that broader-based legislative proposals could emerge in the future that could have an adverse impact on us, our subsidiaries or our shareholders. Back to Contents

parsed_sections/risk_factors/2004/CIK0001232229_syntax_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ RISK FACTORS Before you invest in our common stock, you should be aware that there are risks, including those set forth below. You should carefully consider these risk factors, together with all the other information included in this prospectus, before you decide to purchase shares of our common stock. Risks Related to Our Business We have never achieved profitability on a quarterly or annual basis. We have never achieved profitability on a quarterly or annual basis. We incurred net losses of $18.7 million in 2003, $23.2 million in 2002, and $22.3 million in 2001. We cannot assure you that we will ever achieve or maintain profitability. We have secured only one retailer to sell our HDTVs, and we do not have long-term purchase commitments from OEM customers for our home theater or near-to-eye microdisplay products. We have secured only one retailer to sell our HDTVs. The inability to secure additional retailers to sell our HDTVs would substantially impede our revenue growth and could require us to write off substantial investments that we have made in this aspect of our business. We anticipate that our initial HDTV sales will be to a limited number of customers. As a result, we will face the risks inherent in relying on a concentration of customers. Additionally, the agreement with our first retailer customer provides that customer with certain termination rights. Any material delay, cancellation, or reduction of orders by one of these customers would adversely affect our operating results. Our OEM customers generally do not provide us with firm, long-term volume purchase commitments. In addition, the worldwide adverse economic slowdown commencing in 2001 has led to radically shortened lead times on purchase orders. Although we sometimes enter into manufacturing contracts with our OEM customers, these contracts typically clarify order lead times, inventory risk allocation, and similar matters rather than provide firm, long-term volume purchase commitments. As a result, OEM customers generally can cancel purchase commitments or reduce or delay orders at any time. The cancellation, delay, or reduction of OEM customer commitments could result in reduced revenue and in our holding excess and obsolete inventory and having unabsorbed manufacturing capacity. The large percentage of our OEM sales to customers in the electronics industry, which is subject to severe competitive pressures, rapid technological change, and product obsolescence, increases our inventory and overhead risks. In addition, we make significant decisions, including production schedules, component procurement commitments, facility requirements, personnel needs, and other resource requirements, based on our estimates of OEM customer requirements. The short-term nature of our OEM customers commitments and the possibility of rapid changes in demand for their products reduce our ability to estimate accurately the future requirements of those customers. Our operating results may be materially and adversely affected as a result of the failure to obtain anticipated orders and deferrals or cancellations of purchase commitments because of changes in OEM customer requirements. Because many of our costs and operating expenses are relatively fixed, a reduction in OEM customer demand can harm our gross margins and operating results. On occasion, OEM customers may require rapid increases in production, which can stress our resources and reduce operating margins. Although we have had a net increase in our manufacturing capacity over the past few years, we may not have sufficient capacity at any given time to meet all of our customers demands or to meet the requirements of a specific project. We face intense competition. Our HDTVs will encounter competition from a number of the world s most recognized consumer electronics companies, such as JVC, Panasonic, Philips, Samsung, Sharp, Sony, Thompson, and Toshiba. All of these companies have greater market recognition, larger customer bases, and substantially greater Table of Contents financial, technical, marketing, distribution, and other resources than we possess, which afford them competitive advantages over us. Intel has also announced its intention to begin manufacturing liquid crystal on silicon microdisplays. Other companies, such as Dell, Hewlett-Packard, Gateway, and ViewSonic, could directly or indirectly compete with our HDTVs. In addition to the high-definition television market, we serve intensely competitive industries that are characterized by price erosion, rapid technological change, and competition from major domestic and international companies. Our competitive position in these markets could suffer if one or more of our OEM customers decide to design and manufacture their own microdisplays, to use microdisplay products that we do not offer, to utilize competitive products, or to use alternative technologies that we may not offer. In addition, our OEM customers sometimes develop a second source, even for microdisplays we supply to them. These second source suppliers may win an increasing share of a program, particularly as it grows and matures, by competing primarily on price rather than on performance. Our ability to compete successfully depends on a number of factors, both within and outside our control. These factors include the following: our success in developing and producing new products; our ability to address the needs of our retailer and OEM customers; the pricing, quality, performance, reliability, features, ease of use, and diversity of our products; the quality of our customer service; our efficiency of production; the rate at which customers incorporate our products into their own products; product or technology introductions by our competitors; and foreign currency devaluations, especially in Asian currencies, such as the Japanese yen, the Korean won, and the Taiwanese dollar, which may cause a foreign competitor s products to be priced significantly lower than our products. Competing technologies could reduce the demand for our products. We are also subject to competition from competing technologies, such as CRT, high-temperature polysilicon, plasma, thin film transistor liquid crystal displays, or TFT LCDs, and digital micromirror technologies, as well as other emerging technologies or technologies that may be introduced in the future. For example, Motorola recently announced carbon nanotube technology that is intended to enable manufacturers to design large flat panel displays that exceed the image quality characteristics of plasma and LCD screens at a lower cost. The success of competing technologies could substantially reduce the demand for our products. We rely on contract manufacturers and assemblers for a portion of our HDTV production requirements, and any interruptions of these arrangements could disrupt our ability to fill customer orders. We outsource to various contract manufacturers and assemblers the production requirements for our HDTVs. The loss of our relationships with our contract manufacturers or assemblers or their inability to conduct their manufacturing and assembly services for us as anticipated in terms of cost, quality, and timeliness could adversely affect our ability to fill retailer customer orders in accordance with required delivery, quality, and performance requirements. If this were to occur, the resulting decline in revenue and revenue potential would harm our business. Securing new contract manufacturers and assemblers is time-consuming and might result in unforeseen manufacturing and operations problems. (State or Other Jurisdiction of Incorporation or Organization) (Primary Standard Industrial Classification Code Number) (I.R.S. Employer Identification Number) 1600 North Desert Drive Tempe, Arizona 85281-1230 (602) 389-8888 Table of Contents Our contract manufacturers and assemblers must maintain satisfactory delivery schedules and their inability to do so could increase our costs, disrupt our supply chain, and result in our inability to deliver our HDTV products, which would adversely affect our results of operations. Our contract manufacturers and assemblers must maintain high levels of productivity and satisfactory delivery schedules. We do not have long-term arrangements with any of our contract manufacturers or assemblers that guarantee production capacity, prices, lead times, or delivery schedules. Our contract manufacturers and assemblers serve many other customers, a number of which have greater production requirements than we do. As a result, our contract manufacturers and assemblers could determine to prioritize production capacity for other customers or reduce or eliminate services for us on short notice. Longer delivery schedules may be encountered in commencing volume production of our HDTVs. Any such problems could result in our inability to deliver our HDTV products in a timely manner and adversely affect our operating results. Shortages of components and materials may delay or reduce our sales and increase our costs. Our inability or the inability of our contract manufacturers and assemblers to obtain sufficient quantities of components and other materials necessary for the production of our products could result in delayed sales or lost orders, increased inventory, and underutilized manufacturing capacity. Many of the materials used in the production of our HDTV and microdisplay products are available only from a limited number of foreign suppliers, including our light engines from OCLI (a subsidiary of JDS Uniphase), our video processing integrated circuits from Pixelworks, and our screens from Toppan. As a result, we are subject to increased costs, supply interruptions, and difficulties in obtaining materials. Our OEM customers also may encounter difficulties or increased costs in obtaining from others the materials necessary to produce their products into which our products are incorporated. We depend on Shanghai-based Semiconductor Manufacturing International Corporation, or SMIC, for the fabrication of silicon wafers and ASICs for our HDTV microdisplay products. We depend on Taiwan-based United Microelectronics Corporation, or UMC, for the fabrication of silicon wafers and ASICs for our near-to-eye microdisplay products. We do not have a long-term contract with SMIC or UMC. As a result, neither is obligated to supply us with silicon wafers or ASICs for any specific period, in any specific quantity, or at any specific price, except as provided in purchase orders from time to time. The termination of our arrangements with SMIC or UMC or their inability or unwillingness to provide us with the necessary amount or quality of silicon wafers or ASICs on a timely basis would adversely affect our ability to manufacture and ship our microdisplay products until alternative sources of supply could be arranged. We cannot assure you that we would be able to secure alternative arrangements. We also depend on TFS for printed circuit board assembly and on Suntron Corporation for assembly, production, and project management services. The failure or unwillingness of TFS or Suntron to continue to provide such services to us would adversely affect our operations. Materials and components for some of our major programs may not be available in sufficient quantities to satisfy our needs because of shortages of these materials and components. Any supply interruption or shortages may result in lost sales opportunities. We do not sell any products to end users and depend on the market acceptance of the products of our customers. We do not sell any products to end users. Instead, we design and develop HDTVs for sale by retailers under their own brand names, and we sell microdisplay products that our OEM customers incorporate into their products. As a result, our success depends on the ability of our retailer customers to sell our HDTVs and the widespread market acceptance of our OEM customers products. Any significant slowdown in the demand for our customers products would adversely affect our business. Because our success depends on the widespread market acceptance of our customers products, we must secure successful retailers for our HDTV products and establish relationships for our microdisplay (Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant s Principal Executive Offices) VINCENT F. SOLLITTO, JR. PRESIDENT AND CHIEF EXECUTIVE OFFICER BRILLIAN CORPORATION 1600 North Desert Drive Tempe, Arizona 85281-1230 (602) 389-8888 Table of Contents products with OEMs in industries that have significant growth potential. Our failure to secure retailers to sell our HDTVs or to establish relationships with OEMs in those high-growth markets would reduce our revenue potential. Our dependence on the success of the products of our retailer and OEM customers exposes us to a variety of risks, including the following: our ability to supply products for customers on a timely and cost-effective basis; our success in maintaining customer satisfaction with our products; our ability to match our manufacturing capacity with customer demand and to maintain satisfactory delivery schedules; customer order patterns, changes in order mix, and the level and timing of orders placed by customers that we can complete in a quarter; and the cyclical nature of the industries and markets we serve. Our failure to address these risks may adversely affect our results of operations. We are subject to lengthy development periods and product acceptance cycles. We sell our microdisplay products to OEMs, which then incorporate them into the products they sell. OEMs make the determination during their product development programs whether to incorporate our microdisplay products or pursue other alternatives. This may require us to make significant investments of time and capital well before our OEM customers introduce their products incorporating our products and before we can be sure that we will generate any significant sales to our OEM customers or even recover our investment. During an OEM customer s entire product development process, we face the risk that our products will fail to meet our OEM customer s technical, performance, or cost requirements or will be replaced by a competing product or alternative technology. Even if we offer products that are satisfactory to an OEM customer, the customer may delay or terminate its product development efforts. The occurrence of any of these events would adversely affect our revenue. The lengthy development period also means that it is difficult to immediately replace an unexpected loss of existing business. Our Arizona facility and its high-volume LCoS microdisplay manufacturing line are critical to our success. Our Arizona facility and its high-volume LCoS microdisplay manufacturing line are critical to our success. We currently produce all of our LCoS microdisplays on this dedicated line. This facility also houses our principal research, development, engineering, design, and managerial operations. Any event that causes a disruption of the operation of this facility for even a relatively short period of time would adversely affect our ability to produce our LCoS microdisplays and to provide technical and manufacturing support for our customers. We experienced lower than expected manufacturing yields in commencing volume production of LCoS microdisplays, and we must achieve satisfactory manufacturing yields. The design and manufacture of microdisplays are new and highly complex processes that are sensitive to a wide variety of factors, including the level of contaminants in the manufacturing environment, impurities in the materials used, and the performance of personnel and equipment. As a result of these factors, we have experienced lower than expected manufacturing yields in producing LCoS microdisplays. These issues could continue, and we may continue to encounter lower than desired manufacturing yields as we manufacture LCoS microdisplays in higher volumes, which could result in the delay of the ramp-up to high-volume LCoS manufacturing production. Continued lower than expected manufacturing yields could significantly and adversely affect our operating margins. (Name, Address Including Zip Code, and Telephone Number, Including Area Code, of Agent for Service) Copies to: ROBERT S. KANT, ESQ. BRIAN H. BLANEY, ESQ. GREENBERG TRAURIG, LLP 2375 East Camelback Road Phoenix, Arizona 85016 (602) 445-8000 JOHN T. SHERIDAN, ESQ. ADAM R. DOLINKO, ESQ. JOILENE W. GROVE, ESQ. WILSON SONSINI GOODRICH ROSATI, P.C. 650 Page Mill Road Palo Alto, California 94304 (650) 493-9300 Table of Contents Although we added additional equipment to our Arizona manufacturing facility in the last two years for manufacturing LCoS microdisplays, the high-volume manufacture of LCoS microdisplays will require us to overcome numerous challenges, including the following: the availability of a sufficient quantity of quality materials, the implementation of new manufacturing techniques, the incorporation of new handling procedures, the maintenance of clean manufacturing environments, and the ability to master precise tolerances in the manufacturing process. In addition, the complexity of manufacturing processes will increase along with increases in the sophistication of microdisplays. Any problems with our manufacturing operations could result in the lengthening of our delivery schedules, reductions in the quality or performance of our design and manufacturing services, and reduced customer satisfaction. Various target markets for our LCoS microdisplays are uncertain, may be slow to develop, or could use competing technologies. Various target markets for our LCoS microdisplays, including HDTVs, home theaters, and near-to-eye microdisplays, are uncertain, may be slow to develop, or could utilize competing technologies, especially high-temperature polysilicon and digital micromirror devices. Many manufacturers have well-established positions in these markets. HDTV has only recently become available to consumers, and widespread market acceptance is uncertain. Penetrating this market will require us to offer an improved value, higher performance proposition to existing technology. In addition, the commercial success of the near-to-eye microdisplay market is uncertain. Gaining acceptance in these markets may prove difficult because of the radically different approach of microdisplays to the presentation of information. We must provide customers with lower cost, higher performance microdisplays for their products in these markets. The failure of any of our target markets to develop, or our failure to penetrate these markets, would impede our sales growth. Even if our products successfully meet our price and performance goals, our retailer customers may not achieve success in selling our HDTVs and our OEM customers may not achieve commercial success in selling their products that incorporate our microdisplay products. Our business depends on new products and technologies. We operate in rapidly changing industries. Technological advances, the introduction of new products, and new design and manufacturing techniques could adversely affect our business unless we are able to adapt to the changing conditions. As a result, we will be required to expend substantial funds for and commit significant resources to the following: continuing research and development activities on existing and potential products; engaging additional engineering and other technical personnel; purchasing advanced design, production, and test equipment; maintaining and enhancing our technological capabilities; and expanding our manufacturing capacity. We may be unable to recover any expenditures we make relating to one or more new technologies that ultimately prove to be unsuccessful for any reason. In addition, any investments or acquisitions made to enhance our technologies may prove to be unsuccessful. Our future operating results will depend to a significant extent on our ability to provide new products that compare favorably on the basis of time to introduction, cost, and performance with the products of Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement. If any of the securities being registered in this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box. CALCULATION OF REGISTRATION FEE Table of Contents competitive third-party suppliers and technologies. Our success in attracting new customers and developing new business depends on various factors, including the following: the acceptance of our technology; utilization of advances in technology; innovative development of new microdisplay products for customer products; and efficient, timely, and cost-effective manufacture of microdisplay products. Our products may not achieve commercial success or widespread market acceptance. A key element of our current business involves the ongoing commercialization of our LCoS microdisplay technology. Our products may not achieve customer or widespread market acceptance. Some or all of our products may not achieve commercial success as a result of technological problems, competitive cost issues, yield problems, and other factors. Even when we successfully introduce a new product designed for OEM customers, our OEM customers may determine not to introduce or may terminate products utilizing our products for a variety of reasons, including the following: difficulties with other suppliers of components for the products, superior technologies developed by our competitors, price considerations, lack of anticipated or actual market demand for the products, and unfavorable comparisons with products introduced by others. Our products are complex and may require modifications to resolve undetected errors or unforeseen failures, which could lead to an increase in our costs, a loss of customers, or a delay in market acceptance of our products. Our products are complex and may contain undetected errors or experience unforeseen failures when first introduced or as new versions are released. These errors could cause us to incur significant re-engineering costs, divert the attention of our engineering personnel from product development efforts, and cause significant customer relations and business reputation problems. If we deliver products with defects, our credibility and the market acceptance and sales of our products could be harmed. Defects could also lead to liability for defective products as a result of lawsuits against us or against our customers. We also may agree to indemnify our customers in some circumstances against liability from defects in our products. A successful product liability claim could require us to make significant damage payments. We must protect our intellectual property and could be subject to infringement claims by others. We believe that our success depends in part on protecting our proprietary technology. We rely on a combination of patent, trade secret, and trademark laws, confidentiality procedures, and contractual provisions to protect our intellectual property. We seek to protect certain aspects of our technology under trade secret laws, which afford only limited protection. We face risks associated with our intellectual property, including the following: intellectual property laws may not protect our intellectual property rights; third parties may challenge, invalidate, or circumvent any patents issued to us; rights granted under patents issued to us may not provide competitive advantages to us; pending patent applications may not be issued; unauthorized parties may attempt to obtain and use information that we regard as proprietary despite our efforts to protect our proprietary rights; Table of Contents others may independently develop similar technology or design around any patents issued to us; and effective protection of intellectual property rights may be limited or unavailable in some foreign countries in which we operate. We may not be able to obtain effective patent, trademark, service mark, copyright, and trade secret protection in every country in which we sell our products. We may find it necessary to take legal action in the future to enforce or protect our intellectual property rights or to defend against claims of infringement and such action may be unsuccessful. Third parties could claim that we are infringing their patents or other intellectual property rights. In the event that a third party alleges that we are infringing its rights, we may not be able to obtain licenses on commercially reasonable terms from the third party, if at all, or the third party may commence litigation against us. Litigation can be very expensive and can distract our management s time and attention, which could adversely affect our business. In addition, we may not be able to obtain a favorable outcome in any intellectual property litigation. The nature of our business requires us to make significant capital expenditures and investments. The nature of our business requires us to make significant capital expenditures and investments. For example, the capital acquisition cost of our assets, including intangibles such as tooling, licenses, and patents, was $27.1 million through December 31, 2003. To facilitate the development of our LCoS microdisplay products, we also made an equity investment of $3.8 million in Inviso, Inc., which we had to write off in 2001 as a result of the closing of those operations. In 2002, we purchased all of the technology of Inviso for $780,000 after Inviso ceased operations. In addition, we purchased assets and technology of the former Light Valve business unit of National Semiconductor Corporation for approximately $3.6 million during 1999. In early 2002, we purchased certain fixed assets of Zight Corporation at a liquidator s auction for approximately $600,000. Following that auction, we then negotiated with the representatives of the defunct Zight Corporation to purchase its intellectual property for approximately $2.0 million. We also invested $1.3 million in an advanced packaging company, Silicon Bandwidth, Inc., during 2001 and $5.1 million in ColorLink, Inc., a private company providing color management systems for LCoS microdisplay light engines, during 2002. We may be required to make similar investments and capital expenditures in the future to maintain or enhance our ability to offer technologically advanced products. We must finance the growth of our business and the development of new products. To remain competitive, we must continue to make significant investments in research and development, equipment, and facilities. As a result of the increase in fixed costs and operating expenses related to these capital expenditures, our failure to increase sufficiently our net sales to offset these increased costs would adversely affect our operating results. Rapid sales increases would also require substantial increases in working capital. From time to time, in addition to this offering, we may seek additional equity or debt financing to provide for the capital expenditures required to maintain or expand our design and production facilities and equipment or to finance working capital requirements. We cannot predict the timing or amount of any such capital requirements at this time. If such financing is not available on satisfactory terms, we may be unable to expand our business or to develop new business at the rate desired and our operating results may suffer. Debt financing increases expenses and must be repaid regardless of operating results. Equity financing could result in additional dilution to existing stockholders. We have agreed with TFS not to issue common stock if such issuance could result in the imposition of a tax under Section 355(e) of the Internal Revenue Code unless we receive an opinion of counsel that Section 355(e) would not apply to such issuance because it was not part of a plan at the time of the spin-off. Amount Proposed Maximum Proposed Maximum Title of Each Class of Securities to be to be Aggregate Offering Aggregate Amount of Registered Registered(1) Price Per Share(2) Offering Price(2) Registration Fee(3) Table of Contents If we choose to manufacture or sell in the European and Asian markets, we may encounter challenges. Any efforts to manufacture or sell in the European and Asian markets may create a number of challenges. We and our contract manufacturers and assemblers purchase certain materials from international sources, and in the future we may decide to move certain manufacturing functions to, or establish additional manufacturing functions in, international locations. Purchasing, manufacturing, and selling products internationally exposes us to various economic, political, and other risks, including the following: management of a multinational organization; the burdens and costs of compliance with local laws and regulatory requirements as well as changes in those laws and requirements; imposition of restrictions on currency conversion or the transfer of funds; transportation delays or interruptions and other effects of less developed infrastructures; foreign exchange rate fluctuations; employment and severance issues, including possible employee turnover or labor unrest; overlap of tax issues; tariffs and duties; lack of developed infrastructure; and political or economic instability in certain parts of the world. Political and economic conditions abroad may adversely affect our foreign relationships. Protectionist trade legislation in either the United States or foreign countries, such as a change in the current tariff structures, export or import compliance laws, or other trade policies, could adversely affect our ability to manufacture or sell microdisplays in foreign markets and to purchase materials or equipment from foreign suppliers. Changes in policies by the United States or foreign governments resulting in, among other things, increased duties, higher taxation, currency conversion limitations, restrictions on the transfer or repatriation of funds, limitations on imports or exports, or the expropriation of private enterprises also could have a material adverse effect on us. In addition, U.S. trade policies, such as most favored nation status and trade preferences for certain Asian nations, could affect the attractiveness of our products to our U.S. customers. While we transact business predominantly in U.S. dollars and bill and collect most of our sales in U.S. dollars, we occasionally collect a portion of our revenue in non-U.S. currencies. In the future, customers may make payments in non-U.S. currencies. Fluctuations in foreign currency exchange rates could affect our cost of goods and operating margins and could result in exchange losses. In addition, currency devaluation can result in a loss to us if we hold deposits of that currency. Hedging foreign currencies can be difficult, especially if the currency is not freely traded. We cannot predict the impact of future exchange rate fluctuations on our operating results. The cyclical nature of the consumer electronics industry may cause substantial period-to-period fluctuations in our operating results. The consumer electronics industry has experienced significant economic downturns at various times, characterized by diminished product demand, accelerated erosion of average selling prices, intense competition, and production over-capacity. In addition, the consumer electronics industry is cyclical in nature. We may experience substantial period-to-period fluctuations in operating results, at least in part because of general industry conditions or events occurring in the general economy. Common Stock, $.001 par value per share 1,725,000 $8.48 $14,628,000.00 $1,853.37 Table of Contents Our operating results may have significant periodic and seasonal fluctuations. In addition to the variability resulting from the short-term nature of our customers commitments, other factors may contribute to significant periodic and seasonal quarterly fluctuations in our results of operations. These factors include the following: the timing and volume of orders relative to our capacity; product introductions or enhancements and market acceptance of product introductions and enhancements by us, our OEM customers, and competitors; evolution in the life cycles of customers products; timing of expenditures in anticipation of future orders; effectiveness in managing manufacturing processes; changes in cost and availability of labor and components; product mix; pricing and availability of competitive products; and changes or anticipated changes in economic conditions. Accordingly, you should not rely on the results of any past periods as an indication of our future performance. It is likely that in some future period, our operating results may be below expectations of public market analysts or investors. If this occurs, our stock price may decline. We must effectively manage our growth. The failure to manage our growth effectively could adversely affect our operations. Our ability to manage our planned growth effectively will require us to enhance our operational, financial, and management systems; expand our facilities and equipment; and successfully hire, train, and motivate additional employees, including the technical personnel necessary to operate our production facility in Tempe, Arizona. We incur increased costs as a result of being a public company. As a public company, we incur significant legal, accounting, and other expenses that we did not incur as a division of TFS. In addition, the Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented by the Securities and Exchange Commission and Nasdaq, have required changes in corporate governance practices of public companies. We expect these new rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly. In addition, we incur additional costs associated with our public company reporting requirements. We also expect these new rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified persons to serve on our board of directors or as executive officers. We are currently evaluating and monitoring developments with respect to these new rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs. We depend on key personnel. Our development and operations depend substantially on the efforts and abilities of our senior management and technical personnel. The competition for qualified management and technical personnel is intense. Although we have not experienced problems of recruiting and maintaining qualified personnel to Table of Contents date, we have limited experience in personnel recruitment or retention as an independent company. The loss of services of one or more of our key employees or the inability to add key personnel could have a material adverse effect on us. Although we maintain non-competition and nondisclosure covenants with certain key personnel, we do not have any fixed-term agreements with, or key person life insurance covering, any officer or employee. Potential strategic alliances may not achieve their objectives. We have entered into various strategic alliances, and we plan to enter into other similar types of alliances in the future. Among other matters, we will explore strategic alliances designed to do the following: enhance or complement our technology or work in conjunction with our technology; increase our manufacturing capacity; provide necessary know-how, components, or supplies; and develop, introduce, or distribute products utilizing our technology. Any strategic alliances may not achieve their strategic objectives, and parties to our strategic alliances may not perform as contemplated. Any acquisitions that we undertake could be difficult to integrate, disrupt our business, dilute stockholder value, and harm our operating results. We plan to review opportunities to buy other businesses or technologies that would complement our current products, expand the breadth of our markets, enhance our technical capabilities, or otherwise offer growth opportunities. While we have no current agreements or active negotiations underway, we may buy businesses, products, or technologies in the future. If we make any future acquisitions, we could issue stock that would dilute existing stockholders percentage ownership, incur substantial debt, or assume contingent liabilities. We have agreed with TFS not to issue common stock in an acquisition transaction if such issuance could result in the imposition of a tax under Section 355(e) of the Internal Revenue Code unless we receive an opinion of counsel that Section 355(e) would not apply to such issuance because it was not part of a plan at the time of the spin-off. Our experience in acquiring other businesses and technologies is limited. Potential acquisitions also involve numerous risks, including the following: problems integrating the purchased operations, technologies, products, or services with our own; unanticipated costs associated with the acquisition; diversion of management s attention from our core businesses; adverse effects on existing business relationships with suppliers and customers; risks associated with entering markets in which we have no or limited prior experience; and potential loss of key employees and customers of purchased organizations. Our acquisition strategy entails reviewing and potentially reorganizing acquired business operations, corporate infrastructure and systems, and financial controls. Unforeseen expenses, difficulties, and delays frequently encountered in connection with rapid expansion through acquisitions could inhibit our growth and negatively impact our profitability. We may be unable to identify suitable acquisition candidates or to complete the acquisitions of candidates that we identify. Increased competition for acquisition candidates may increase purchase prices for acquisitions to levels beyond our financial capability or to levels that would not result in the returns required by our acquisition criteria. In addition, we may encounter difficulties in integrating the operations of acquired businesses with our own operations or managing acquired businesses profitably without substantial costs, delays, or other operational or financial problems. (1) Includes 225,000 shares of common stock that the underwriters have the option to purchase to cover over-allotments, if any. (2) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(c) under the Securities Act of 1933. (3) A filing fee in the amount of $5,068.00 was previously paid in connection with the filing of the Registration Statement. Table of Contents We are subject to governmental regulations. Like all businesses, our operations are subject to certain federal, state, and local regulatory requirements relating to environmental, waste management, health, and safety matters. We could become subject to liabilities as a result of a failure to comply with applicable laws and incur substantial costs from complying with existing, new, modified, or more stringent requirements. In addition, our past, current, or future operations may give rise to claims of exposure by employees or the public or to other claims or liabilities relating to environmental, waste management, or health and safety concerns. Risks Related to Our Recent Spin-Off We have a limited operating history as a public company, and our business has relied on TFS for various financial, managerial, and administrative services. We have a limited operating history as an independent company. Our business historically relied on TFS for various financial, managerial, and administrative services and was able to benefit from the earnings, assets, and cash flows of TFS other businesses. TFS is no longer obligated to provide assistance or services to us, except as described in the Master Separation and Distribution Agreement, the Transition Services Agreement, and the other agreements entered into between the companies, which are described under Relationship With TFS. Our historical financial information may not be representative of our results as a separate company, as we previously operated as a division of TFS. The historical financial information included in this prospectus may not be representative of our results of operations, financial position, and cash flows had we operated as a separate, stand-alone entity rather than as a division of TFS during the periods prior to September 15, 2003 or of our results of operations, financial position, and cash flows in the future. This results from the following: in preparing this information, we have made adjustments and allocations because TFS did not account for us as, and we were not operated as, a stand-alone business for all periods prior to the spin-off; and the information prior to the spin-off does not reflect many changes in our funding and operations as a result of our spin-off from TFS. We cannot assure you that the adjustments and allocations we have made in preparing our historical financial statements appropriately reflect our operations during those periods as if we had in fact operated as a stand-alone entity. We could incur significant tax liability if the contribution or the spin-off from TFS does not qualify for tax-free treatment. TFS received a private letter ruling from the IRS to the effect that, among other things, the spin-off was tax free to TFS and the TFS stockholders under Section 355 of the Internal Revenue Code, except to the extent that cash was received in lieu of fractional shares. The private letter ruling, while generally binding upon the IRS, was based upon factual representations and assumptions and commitments on our behalf with respect to future operations made in the ruling request. The IRS could modify or revoke the private letter ruling retroactively if the factual representations and assumptions in the request were materially incomplete or untrue, the facts upon which the private letter ruling was based were materially different from the facts at the time of the spin-off, or if we do not meet certain commitments made. If the spin-off failed to qualify under Section 355 of the Internal Revenue Code, corporate tax would be payable by the consolidated group of which TFS is the common parent based upon the difference between the aggregate fair market value of the assets of our business and the adjusted tax bases of such business to TFS prior to the spin-off. The corporate level tax would be payable by TFS. We have agreed, The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to Section 8(a), may determine. Table of Contents however, to indemnify TFS for this and certain other tax liabilities if they result from actions taken by us or from the spin-off. In addition, under the Internal Revenue Code s consolidated return regulations, each member of the TFS consolidated group, including our company, will be severally liable for these tax liabilities. If we are required to indemnify TFS for these liabilities or otherwise are found liable to the IRS for these liabilities, the resulting obligation could materially and adversely affect our financial condition. The agreements governing our relationship with TFS following the spin-off were negotiated while we were a subsidiary of TFS and, as a result, we cannot assure you that the agreements are on terms favorable to us. The agreements governing our relationship with TFS following the spin-off were negotiated in a parent-subsidiary context and were negotiated in the overall context of our separation from TFS. At the time of these negotiations, certain of our officers were employees of TFS. We cannot assure you that these agreements were the result of arm s-length negotiations. Especially as it relates to the Transition Services Agreement and the Real Property Sublease Agreement, we cannot assure you that these agreements are on terms comparable to those which might have been obtained from unaffiliated third parties. Additionally, upon the expiration of these agreements, we may not be able to replace the services and support that TFS provides under these agreements in a timely manner or on terms and conditions, including costs, as favorable as those we receive from TFS. While TFS is contractually obligated to provide us with certain transitional services, we cannot assure you that these services will be sustained at the same level as when we were part of TFS or that we will obtain the same benefits. In addition, as we build our own infrastructure during the term of those agreements, we will incur additional costs for duplicated administrative services. We will not be able to rely on TFS to fund future capital requirements and, therefore, we may not be able to provide for our capital needs. In the past, our capital needs were satisfied by TFS. However, TFS no longer provides any funds to finance our working capital or other cash requirements and does not guarantee our financial or other obligations. The $20.9 million cash funding that TFS provided us in connection with the spin-off may not be adequate for us to fund our planned operations and expenditures beyond 2004. It will be necessary for us to reduce substantially our operating losses (through either increased sales, reduced expenses, or both) or to raise additional funds, such as those to be provided by this offering. We cannot assure you that we will be able to increase our sales or raise necessary funds on terms satisfactory to us. We believe that our capital requirements will vary greatly from quarter to quarter, depending on, among other things, capital expenditures, fluctuations in our operating results, and financing activities. To increase our financial resources, we may be required to raise additional capital through a public offering or private placement of equity with strategic or other investors or through debt financing in the future. Future equity financings would dilute the relative percentage ownership of the then existing holders of our common stock and may be limited by our agreements with TFS, particularly the Tax Sharing Agreement. Future debt financings could involve restrictive covenants that limit our ability to take certain actions, such as pay dividends, incur additional indebtedness, or create liens. We may not be able to obtain financing on terms as favorable as those historically enjoyed by TFS. For a more complete discussion of our capital resources, see Management s Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources. Table of Contents Risks Related to this Offering The market price for our common stock may be volatile, and you may not be able to sell our stock at a favorable price or at all. Many factors could cause the market price of our common stock to rise and fall, including the following: variations in our quarterly results; announcements of technological innovations by us or by our competitors; introductions of new products or new pricing policies by us or by our competitors; acquisitions or strategic alliances by us or by our competitors; recruitment or departure of key personnel; the gain or loss of significant orders; the gain or loss of significant customers; changes in the estimates of our operating performance or changes in recommendations by any securities analysts that follow our stock; and market conditions in our industry, the industries of our customers, and the economy as a whole. In addition, stocks of technology companies have experienced extreme price and volume fluctuations that often have been unrelated or disproportionate to these companies operating performance. Public announcements by technology companies concerning, among other things, their performance, accounting practices, or legal problems could cause the market price of our common stock to decline regardless of our actual operating performance. Management will have discretion over the use of proceeds from this offering and could spend or invest those proceeds in ways with which you might not agree. Our management will have broad discretion with respect to the use of the net proceeds of this offering, and you will be relying on the judgment of our management regarding the application of these proceeds. We currently expect to use these proceeds to expand our HDTV business, to expand our sales and marketing efforts, to finance working capital needs associated with anticipated revenue increases, and for general corporate purposes. In addition, we may use a portion of the net proceeds to acquire or invest in complementary businesses, products, or technologies. These investments may not yield a favorable return. Substantial sales of our common stock, or the perception that such sales might occur, could depress the market price of our common stock. Substantially all of the shares of our common stock are eligible for immediate resale in the public market. Any sales of substantial amounts of our common stock in the public market, or the perception that such sales might occur, could depress the market price of our common stock. We have agreed to restrictions and adopted policies in connection with the spin-off that could have possible anti-takeover effects. We have agreed to certain restrictions on our future actions to assure that the spin-off is tax-free, including restrictions with respect to an acquisition of shares of our common stock by an unrelated party. If we fail to abide by these restrictions, and, as a result, the spin-off fails to qualify as a tax-free reorganization, we will be obligated to indemnify TFS for any resulting tax liability. These restrictions and the potential tax liability that could arise from an acquisition of shares of our common stock, together with Cash Flows from Financing Activities: Net transfers from Three-Five Systems, Inc. 10,226 33,898 24,411 Cash received in spin-off 20,853 Stock options exercised Table of Contents our related indemnification obligations, could have the effect of delaying, deferring, or preventing a change in control of our company. See Relationship With TFS Tax Sharing Agreement. Provisions in our certificate of incorporation, our bylaws, and Delaware law could make it more difficult for a third party to acquire us, discourage a takeover, and adversely affect existing stockholders. Our certificate of incorporation and the Delaware General Corporation Law contain provisions that may have the effect of making more difficult or delaying attempts by others to obtain control of our company, even when these attempts may be in the best interests of stockholders. These include provisions limiting the stockholders powers to remove directors or take action by written consent instead of at a stockholders meeting. Our certificate of incorporation also authorizes our board of directors, without stockholder approval, to issue one or more series of preferred stock, which could have voting and conversion rights that adversely affect or dilute the voting power of the holders of common stock. Delaware law also imposes conditions on certain business combination transactions with interested stockholders. We have also adopted a stockholder rights plan intended to encourage anyone seeking to acquire our company to negotiate with our board of directors prior to attempting a takeover. While the plan was designed to guard against coercive or unfair tactics to gain control of our company, the plan may have the effect of making more difficult or delaying any attempts by others to obtain control of our company. These provisions and others that could be adopted in the future could deter unsolicited takeovers or delay or prevent changes in our control or management, including transactions in which stockholders might otherwise receive a premium for their shares over then current market prices. These provisions may also limit the ability of stockholders to approve transactions that they may deem to be in their best interests. We do not pay cash dividends. We have never paid any cash dividends on our common stock and do not anticipate that we will pay cash dividends in the foreseeable future. Instead, we intend to apply any earnings to the expansion and development of our business.

parsed_sections/risk_factors/2004/CIK0001246715_madison_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ RISK FACTORS If you are interested in us you should consider carefully the risks described below, together with the other information contained in this Prospectus. GENERAL RISK FACTORS 1. THE POSSIBLE NEED FOR ADDITIONAL FINANCING MAY IMPAIR OUR ABILITY TO LOCATE ANY AVAILABLE BUSINESS OPPORTUNITY. We have extremely limited funds, and such funds may not be adequate to take advantage of any available business opportunities that would require a cash investment. Even if our funds prove to be sufficient to acquire an interest in, or complete a transaction with, a business opportunity, we may not have enough capital to exploit the opportunity. Our ultimate success may depend upon our ability to raise additional capital. We have not investigated the availability, source, or terms that might govern the acquisition of additional capital and will not do so until it determines a need for additional financing. If additional capital is needed, there is no assurance that funds will be available from any source or, if available, that they can be obtained on terms acceptable to us. If additional capital is not available, once a business opportunity is concluded, our operations will be limited to those that can be financed with our extremely limited capital and the capital, if any, of the acquired business or entity. 2. OUR LACK OF ANY OPERATING HISTORY MAY SEVERELY IMPACT OUR ABILITY TO LOCATE A VIABLE BUSINESS OPPORTUNITY. We were formed in April of 2003 for the purpose of registering our shares of common stock under the Securities Act of 1933 for the purpose of acquiring a business opportunity. We have no operating history, revenues from operations, or any significant assets. This lack of an operating history and our insignificant assets may impair our ability to attract a viable business opportunity. In fact, we may only be able to attract newly formed or development stage companies with a limited operating history. 3. REPORTING REQUIREMENTS MAY DELAY OR PRECLUDE OUR BUSINESS COMBINATION OBJECTIVES. Section 13 of the 1934 Act requires companies subject thereto to provide certain information about significant acquisitions, including certified financial statements for the company acquired, covering one or two years, depending on the relative size of the acquisition. The time and additional costs that may be incurred by some target entities to prepare such statements may significantly delay or essentially preclude consummation of an otherwise desirable acquisition by us. Acquisition prospects that do not have or are unable to obtain the required audited statements may not be appropriate for acquisition so long as the reporting requirements of the 1934 Act are applicable. 4. OUR POTENTIAL BUSINESS OPPORTUNITY HAS NOT BEEN IDENTIFIED AND WILL BE HIGHLY RISKY. We have not identified and have no commitments to enter into or acquire a specific business opportunity and therefore can only disclose the risks and hazards of a business or opportunity that we may enter into in a general manner, and cannot disclose the risks and hazards of any specific business or opportunity that we may enter into. A Shareholder should expect a potential business opportunity to be quite risky. Our acquisition of, or participation in, a business opportunity will likely be highly illiquid and could result in a total loss to us and our shareholders if the business or opportunity proves to be unsuccessful. 5. OUR FINANCIAL STATEMENTS CONTAIN A STATEMENT INDICATING THAT OUR ABILITY TO CONTINUE AS A GOING CONCERN IS DEPENDENT ON OUR ABILITY TO RAISE CAPITAL. We may not be able to operate as a going concern. Our independent auditor's report accompanying our financial statements contains an explanation that our financial statements have been prepared assuming that we will continue as a going concern. Since our inception on April 25, 2003,we have had no business operations and have incurred a net loss of $3,154 through March 31, 2004. On March 31, 2004, we had cash on hand totaling $105. We intend to use our shares of common stock to provide the consideration for any business combination in which we may participate. We do not expect that there will be any cash requirement for us to participate in any such business combination. However, it is possible that we will be required to issue more than the 8,250,000 shares of common stock being registered hereunder in connection with any business combination. In such event, it is possible that our existing shareholders may sell a portion of their shares or that we will issue additional, unregistered shares of common stock as part of any required consideration. 6. WE WILL HAVE SUBSTANTIAL COMPETITION FOR BUSINESS OPPORTUNITIES WHICH MAY AFFECT OUR ABILITY TO MERGE WITH OR ACQUIRE A BUSINESS. We are and will continue to be an insignificant participant in the business of seeking business opportunities. A substantial number of established and well financed entities, including investment banking and venture capital firms, have substantially greater financial resources, technical expertise and managerial capabilities than we have and, consequently, we will be at a competitive disadvantage in identifying suitable merger or acquisition candidates and successfully concluding a proposed merger or acquisition. 7. WE MAY NOT BE ABLE TO CONDUCT AN EXHAUSTIVE INVESTIGATION AND ANALYSIS OF POTENTIAL BUSINESS OPPORTUNITIES AND CONSEQUENTLY MAY NEVER FIND A BUSINESS OPPORTUNITY. Our limited funds and the lack of full-time management will likely make it impracticable to conduct a complete and exhaustive investigation and analysis of potential business opportunities. Management decisions, therefore, will likely be made without detailed feasibility studies, independent analysis, market surveys and the like which, if we had more funds available to us, would be desirable. We will be particularly dependent in making decisions upon information provided by the promoter, owner, sponsor, or others associated with the business opportunity seeking our participation. 8. THERE WILL BE A LIMITED PARTICIPATION BY MANAGEMENT IN OUR DAILY OPERATIONS, WHICH COULD DELAY OUR SEARCH FOR A BUSINESS OPPORTUNITY. We currently have five (5) individuals who are serving as our sole officers and directors. We will be heavily dependent upon their skills, talents, and abilities to implement our business plan, and may, from time to time, find that the inability of the officers and directors to devote their full time attention to our business results in a delay in progress toward implementing our business plan. Furthermore, since only five individuals are serving as our officers and directors, it will be entirely dependent upon their experience in seeking, investigating, and acquiring a business and in making decisions regarding our operations. At present our officers and directors have indicated that they will only be available on a limited basis for our affairs. They have indicated that they expect to commit not more than 3 - 4 hours per week to our business. 9. THERE IS A LACK OF CONTINUITY IN OUR MANAGEMENT AND WE WILL HAVE LIMITED ABILITY TO EVALUATE THE MANAGEMENT OF AN ACQUISITION CANDIDATE. We do not have an employment agreement with our officers and directors, and as a result, there is no assurance that they will continue to manage us in the future. In connection with acquisition of a business opportunity, it is highly likely that our current officers and directors will resign and that the management of the acquired business will then become our management. A decision to resign will be based upon the identity of the business opportunity and the nature of the transaction, and is likely to occur without the vote or consent of our shareholders. 10. THE CONTROL OF MADISON GROUP BY PRINCIPAL SHAREHOLDERS, OFFICERS AND DIRECTORS COULD IMPEDE OUR SHAREHOLDERS FROM HAVING ANY ABILITY TO DIRECT AFFAIRS AND BUSINESS. If all 8,250,000 shares are issued in a future business combination, our existing shareholders, officers and directors will beneficially own approximately 17.5% of our shares of common stock, assuming no additional shares are issued. As a result, the shareholders of the business entity acquired will have the ability to control us and direct our affairs and business. 11. OUR INDEMNIFICATION OF OFFICERS AND DIRECTORS MAY RESULT IN SUBSTANTIAL EXPENDITURES. Our Articles of Incorporation provide for the indemnification of directors, officers, employees, and agents, under certain circumstances, against attorney's fees and other expenses incurred by them in any litigation to which they become a party arising from their association with or activities on our behalf. We will also bear the expenses of such litigation for any directors, officers, employees, or agents, upon such person's promise to repay us therefore if it is ultimately determined that any such person shall not have been entitled to indemnification. This indemnification policy could result in substantial expenditures by us that it will be unable to recoup. 12. LACK OF MARKET FOR OUR SHARES WHICH WILL LIMIT LIQUIDITY AND PRICE OF OUR SHARES. Since there is no market for our shares we cannot predict the extent, if any, to which such a market may develop following completion of a business combination. In significant part, any market that may develop will be based upon the operating history, revenues and profitability, or lack thereof, of any company we may acquire. 13. A MARKET FOR OUR SHARES MAY NOT DEVELOP. An active trading market for our shares may never develop or, if developed, it may not be maintained. Shareholders may be unable to sell their shares in any market involving our shares unless that market can be established or maintained, and therefore your investment would be a complete loss. 14. REQUIRED REGULATORY DISCLOSURE RELATING TO LOW-PRICED STOCKS MAY NEGATIVELY IMPACT LIQUIDITY IN OUR COMMON STOCK. If our common stock does become publicly traded following completion of a business combination, it is likely that it will be considered a "penny stock," which generally is a stock trading under $5.00 and not registered on national securities exchanges or quoted on the national NASDAQ market. The SEC has adopted rules that impose special sales practice requirements upon broker- dealers who sell such securities to persons other than established customers or accredited investors. For purposes of the rule, the phrase "accredited investors" means, in general terms, institutions with assets in excess of $5,000,000, or individuals having a net worth in excess of $1,000,000 or having an annual income that exceeds $200,000 (or that, when combined with a spouse's income, exceeds $300,000). For transactions covered by the rule, the broker- dealer must make a special suitability determination for the purchaser and receive the purchaser's written agreement to the transaction prior to the sale. Consequently, the rule may affect the ability of broker-dealers to sell our shares and also may affect the ability of shareholders in this offering to sell their shares in any market that might develop therefore. In addition, the SEC has adopted a number of rules to regulate "penny stocks." Such rules include Rules 3a51-1, 15g-1, 15g-2, 15g-3, 15g-4, 15g-5, 15g-6, and 15g-7 under the 1934 Act, as amended. The rules may further affect the ability of shareholders to sell their shares in any market that might develop therefore. Shareholders should be aware that, according to SEC Release No. 34-29093, the market for penny stocks has suffered in recent years from patterns of fraud and abuse. Such patterns include (i) control of the market for the security by one or a few broker-dealers that are often related to the promoter or issuer; (ii) manipulation of prices through prearranged matching of purchases and sales and false and misleading press releases; (iii) "boiler room" practices involving high-pressure sales tactics and unrealistic price projections by inexperienced sales persons; (iv) excessive and undisclosed bid-ask differentials and markups by selling broker-dealers; and (v) the wholesale dumping of the same securities by promoters and broker-dealers after prices have been manipulated to a desired level, along with the resulting inevitable collapse of those prices and with consequent investor losses. The additional burdens imposed upon broker-dealers by such requirements may discourage broker-dealers from effecting transactions in our shares, which could severely limit the market liquidity and the ability of shareholders to sell the shares in the secondary market. RISKS FOR OWNERS OF POTENTIAL TARGET COMPANIES 1. INCREASED SCRUTINY FROM THE REGULATORY COMMUNITY AND SKEPTICISM FROM THE FINANCIAL COMMUNITY. Congress has found that blank check companies have been common vehicles for fraud and manipulation in the penny stock market in the past. Moreover, the financial community views shell transactions with a high degree of skepticism until the combined companies have been active for a sufficient period of time to demonstrate credible operating performance. Increased regulatory scrutiny and heightened market skepticism may increase your future costs of regulatory compliance and make it more difficult for the combined companies to establish an active trading market. 2. INEFFECTIVE MEANS FOR RAISING ADDITIONAL CAPITAL. A business combination with us will not provide an effective means of accessing the capital markets. Therefore, you should not consider a business combination with us if you currently need additional capital, or will require additional capital within twelve (12) to eighteen (18) months. Until the combined companies have been active for a sufficient period of time to demonstrate credible operating performance, it will be very difficult, if not impossible, for you to raise additional capital to finance the combined companies' operations. You cannot assume that the combined companies will ever be able to raise additional capital.

parsed_sections/risk_factors/2004/CIK0001260627_worldspan_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ RISK FACTORS You should carefully consider the risk factors set forth below as well as the other information contained in this prospectus before deciding whether to invest in our notes. If any of the following risks actually occur, our business, financial condition or results of operations could suffer. In such case, you may lose all or part of your original investment. Risks Relating to the Notes Substantial Leverage Our substantial indebtedness could adversely affect our financial health and prevent us from fulfilling our obligations under the notes. We have a significant amount of indebtedness. On March 31, 2004, we had total indebtedness of $453.2 million (of which $280.0 million consisted of the notes and the balance consisted of senior debt under our senior credit facility and obligations under capital leases and long-term software arrangements). Our ratio of earnings to fixed charges was 0.4x and 2.4x for the six months ended December 31, 2003 and the three months ended March 31, 2004, respectively. Our substantial indebtedness could have important consequences to you. For example, it could: make it more difficult for us to satisfy our obligations with respect to the notes; increase our vulnerability to general adverse economic and industry conditions; require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, research and development efforts and other general corporate purposes; limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; place us at a competitive disadvantage compared to our competitors that have less debt; and limit our ability to borrow additional funds. In addition, the indenture and our senior credit facility contain financial and other restrictive covenants that limit our ability to engage in activities that may be in our long-term best interests. Our failure to comply with those covenants could result in an event of default which, if not cured or waived, could result in the acceleration of all of our debts. Additional Borrowings Available Despite current indebtedness levels, we and our subsidiaries may still be able to incur substantially more debt. This could further exacerbate the risks associated with our substantial leverage. We and our subsidiaries may be able to incur substantial additional indebtedness in the future. The terms of the indenture do not fully prohibit us or our subsidiaries from doing so. Our senior credit facility permits additional borrowings of up to $50.0 million. If new debt is added to our and our subsidiaries' current debt levels, the related risks that we and they now face could intensify. See "Description of Other Indebtedness Senior Credit Facility." Restrictions on Existing Indebtedness Restrictions on our outstanding debt instruments may limit our ability to make payments on the notes or operate our business. Our senior credit facility and the indenture governing the notes contain covenants that limit the discretion of our management with respect to certain business matters. These covenants will significantly restrict our ability to (among other things): incur additional indebtedness; State of Incorporation or Organization create liens or other encumbrances; pay dividends or make certain other payments, investments, loans and guarantees; and sell or otherwise dispose of assets and merge or consolidate with another entity. In addition, our senior credit facility requires us to meet certain financial ratios and financial condition tests. You should read the discussions under the headings "Description of Other Indebtedness Senior Credit Facility" and "Description of the Notes Certain Covenants" for further information about these covenants. Events beyond our control can affect our ability to meet these financial ratios and financial condition tests. Our failure to comply with these obligations could cause an event of default under our senior credit facility. If an event of default occurs, our lenders could elect to declare all amounts outstanding and accrued and unpaid interest in our senior credit facility to be immediately due, and the lenders thereafter could foreclose upon the assets securing the senior credit facility. In that event, we cannot assure you that we would have sufficient assets to repay all of our obligations, including the notes and the related guarantees. We may incur other indebtedness in the future that may contain financial or other covenants more restrictive than those applicable to our senior credit facility or the indenture governing the notes. Ability to Service Debt To service our indebtedness, we will require a significant amount of cash. Our ability to generate cash depends on many factors beyond our control. Our ability to make payments on and to refinance our indebtedness, including the notes, and to fund planned capital expenditures and research and development efforts will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. Based on our current level of operations and anticipated cost savings and operating improvements, we believe our cash flow from operations, available cash and available borrowings under our senior credit facility, will be adequate to meet our future liquidity needs for the foreseeable future. We cannot assure you, however, that our business will generate sufficient cash flow from operations, that currently anticipated cost savings and operating improvements will be realized on schedule or that future borrowings will be available to us under our senior credit facility in an amount sufficient to enable us to pay our indebtedness, including the notes, or to fund our other liquidity needs. We may need to refinance all or a portion of our indebtedness, including the notes on or before maturity. We cannot assure you that we will be able to refinance any of our indebtedness, including our senior credit facility and the notes, on commercially reasonable terms or at all. Subordination to Secured Creditors Your right to receive payments on the notes is effectively subordinated to the rights of our existing and future secured creditors. Further, the guarantees of the notes are effectively subordinated to all our guarantors' existing and future secured indebtedness. Holders of our secured indebtedness and the secured indebtedness of the guarantors will have claims that are prior to your claims as holders of the notes to the extent of the value of the assets securing that other indebtedness. Notably, we and certain of our subsidiaries, including the guarantors, are parties to a senior credit facility, which is secured by liens on substantially all of our assets and the assets of the guarantors. In addition, our capital leases and long-term software arrangements are secured by the assets under such leases and arrangements. The notes are effectively subordinated to all that secured indebtedness. In the event of any distribution or payment of our assets in any foreclosure, dissolution, winding-up, liquidation, reorganization, or other bankruptcy proceeding, holders of secured indebtedness will have prior claim to those of our assets that constitute their collateral. Holders of the notes will participate ratably with all holders of our unsecured indebtedness that is deemed to be of the same class as the notes, and potentially with all of our other general creditors, based upon the respective amounts owed to each holder or creditor, in our remaining assets. In any of the foregoing Primary Standard Industrial Classification Code Number events, we cannot assure you that there will be sufficient assets to pay amounts due on the notes. As a result, holders of notes may receive less, ratably, than holders of secured indebtedness. As of March 31, 2004, the aggregate amount of our secured indebtedness and the secured indebtedness of our subsidiaries was approximately $86.0 million, and approximately $50.0 million was available for additional borrowing under the revolving credit facility portion of our senior credit facility. We are permitted to borrow substantial additional indebtedness, including senior debt, in the future under the terms of the indenture. See "Description of Other Indebtedness Senior Credit Facility." Not all Subsidiaries are Guarantors Your right to receive payments on the notes could be adversely affected if any of our non-guarantor subsidiaries declare bankruptcy, liquidate or reorganize. None of our foreign subsidiaries will guarantee the notes. In the event of a bankruptcy, liquidation or reorganization of any of our non-guarantor subsidiaries, holders of their indebtedness and their trade creditors will generally be entitled to payment of their claims from the assets of those subsidiaries before any assets are made available for distribution to us. As of March 31, 2004, our non-guarantor subsidiaries had approximately $28.3 million of trade accounts payable and other accrued expenses. Our non-guarantor subsidiaries generated approximately 14.2% of our consolidated revenues in the three month period ended March 31, 2004 and held approximately 3.5% of our consolidated assets as of March 31, 2004. See footnote 16 to our consolidated financial statements included at the back of this prospectus. Financing Change of Control Offer We may not have the ability to raise the funds necessary to finance the change of control offer required by the indenture. Upon the occurrence of certain specific kinds of change of control events, we will be required to offer to repurchase all outstanding notes at 101% of the principal amount thereof plus accrued and unpaid interest and liquidated damages, if any, to the date of repurchase. However, it is possible that we will not have sufficient funds at the time of the change of control to make the required repurchase of the notes or that restrictions in our senior credit facility will not allow such repurchases. In addition, certain important corporate events, such as leveraged recapitalizations that would increase the level of our indebtedness, would not constitute a "Change of Control" under the indenture. See "Description of the Notes Repurchase at the Option of Holders." Fraudulent Conveyance Matters Federal and state statutes allow courts, under specific circumstances, to void debts, including guarantees, and require note holders to return payments received from us or the guarantors. Under the federal bankruptcy law and comparable provisions of state fraudulent transfer laws, obligations under a note or a guarantee could be voided, or claims in respect of a note or a guarantee could be subordinated to all other debts of the debtor or guarantor if, among other things, the debtor or the guarantor, at the time it incurred the indebtedness evidenced by its note or guarantee: received less than reasonably equivalent value or fair consideration for the incurrence of such debt or guarantee; and one of the following applies: it was insolvent or rendered insolvent by reason of such incurrence; it was engaged in a business or transaction for which the guarantor's remaining assets constituted unreasonably small capital; or it intended to incur, or believed that it would incur, debts beyond its ability to pay such debts as they mature. IRS Employer Identification No. In addition, any payment by that debtor or guarantor pursuant to its note or guarantee could be voided and required to be returned to the debtor or guarantor, as the case may be, or to a fund for the benefit of the creditors of the debtor or guarantor. The measures of insolvency for purposes of these fraudulent transfer laws will vary depending upon the law applied in any proceeding to determine whether a fraudulent transfer has occurred. Generally, however, a debtor or guarantor would be considered insolvent if: the sum of its debts, including contingent liabilities, was greater than the fair saleable value of all of its assets; if the present fair saleable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts, including contingent liabilities, as they become absolute and mature; or it could not pay its debts as they become due. On the basis of historical financial information, recent operating history and other factors, we believe that the debtor and each guarantor, after giving effect to its note or guarantee of the notes, as the case may be, will not be insolvent, will not have unreasonably small capital for the business in which it is engaged and will not have incurred debts beyond its ability to pay such debts as they mature. We cannot assure you, however, as to what standard a court would apply in making these determinations or that a court would agree with our conclusions in this regard. Trading Market for Resale Notes If an active trading market is not sustained for these notes, you may not be able to sell them. We cannot assure you that an active trading market will exist for your notes. We do not intend to apply for listing of the notes on any securities exchange or for quotation through the National Association of Securities Dealers Automated Quotation system. The liquidity of any market for the notes will depend on various factors, including: the number of holders of the notes; the interest of securities dealers in making a market for the notes; the overall market for high yield securities; our financial performance or prospects; and the prospects for companies in our industry generally. Risks Relating To Our Business Dependence on Travel Industry in General and Airline Industry in Particular Our revenues are highly dependent on the travel industry, and particularly on the airlines, and a substantial decrease in travel bookings could adversely affect our business and operating results. Substantially all of our revenues are derived from airlines, hotel operators, car rental companies and other suppliers in the travel industry. Our revenues increase and decrease with the level of travel activity and are therefore highly subject to declines in or disruptions to travel. In particular, because a significant portion of our revenues are derived from transaction fees generated by airline bookings and airline outsourcing services, our revenues and earnings are especially sensitive to events that affect airline travel, the airlines that participate in our GDS and the airlines that obtain travel information technology services from us. Our business could also be adversely affected by a reduction in bookings on the airlines that participate in our GDS as a result of those airlines losing business for other reasons, including losing market share to other airlines, such as low-cost carriers, that do not participate in our GDS. In addition, travel expenditures are seasonal and are sensitive to business and personal discretionary spending levels and tend to decline during general economic downturns, which could also reduce our revenues and profits. The downturn in the commercial airline market, together with the terrorist attacks of September 11, 2001, the global economic downturn, SARS and the war and continuing conflict in Iraq, have adversely affected the financial condition of many commercial airlines and other travel suppliers. Several major airlines are experiencing liquidity problems, some have sought bankruptcy protection and still others may consider bankruptcy relief. A substantial portion of our revenues are derived from transaction fees received directly from airlines and from the sale of products and services directly to airlines. If an airline declared bankruptcy, we may be unable to collect our outstanding accounts receivable from the airline. In addition, the bankruptcy of the airline might result in reduced transaction fees and other revenues from the airline or a rejection by the airline of some or all of our agreements with it, all of which could have a material adverse effect on our business, financial condition and results of operations. Susceptibility to Terrorism and War Acts of terrorism and war could have an adverse effect on the travel industry, which in turn could adversely affect our business and operating results. Travel is sensitive to safety and security concerns, and thus declines after occurrences of, and fears of future incidents of, terrorism and hostilities that affect the safety, security and confidence of travelers. For example, the start of the war in Iraq in March 2003 and the continuing conflict and the terrorist attacks of September 11, 2001, which included attacks on the World Trade Center and the Pentagon using hijacked commercial aircraft, resulted in the cancellation of a significant number of flights and travel bookings and a decrease in new travel bookings. Future revenues may be reduced by similar and/or other acts of terrorism or war. The effects of these events could include, among other things, a protracted decrease in demand for air travel due to fears regarding additional acts of terrorism, military and governmental responses to acts of terrorism and a perceived inconvenience in traveling by air and increased costs and reduced operations by airlines due, in part, to new safety and security directives adopted by the Federal Aviation Administration or other governmental agencies. As an example, escalation of the U.S. Government's terrorist security alert level to code orange or higher may adversely impact demand for air travel. These effects, depending on their scope and duration, which we cannot predict, could significantly impact our business, financial condition and results of operations. Competition We operate in highly competitive markets, and we may not be able to compete effectively. In our electronic travel distribution segment, we compete primarily against other large and well-established GDSs, including those operated by Amadeus, Galileo and Sabre, each of which may have greater financial, technical and other resources than we have. These greater resources may allow our competitors to better finance more strategic transactions and more research and development than us and it could allow them to offer more or better products and services for less than we can. Competition among GDSs to attract and retain travel agencies is intense. In competitive markets, we and other GDSs offer discounts, incentive payments and other inducements to travel agencies if productivity or transaction volume growth targets are achieved. In order to compete effectively, we may need to increase inducements, increase spending on marketing or product development, make significant investments to purchase strategic assets or take other costly actions. Although expansion of the use of these inducements could adversely affect our profitability, our failure to continue to provide inducements could result in the loss of some travel agency customers. If we were to lose a significant portion of our current base of travel agencies to a competing GDS or if we were forced to increase the amounts of these inducements significantly, our business, financial condition and results of operations could be materially adversely affected. In addition, we face competition in the travel agency market from travel suppliers and new types of travel distribution companies that seek to bypass GDSs and distribute directly to travel agencies or consumers. In our information technology services segment, there are several organizations offering internal reservation system and related technology services to the airlines, with our main competitors being The information in this prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted. SUBJECT TO COMPLETION, DATED MAY 21, 2004 PROSPECTUS $30,000,000 Worldspan, L.P. WS Financing Corp. 95/8% Senior Notes Due 2011 Amadeus, EDS, Navitaire, Sabre and Unisys/SITA. This segment is highly competitive and the competitors are highly aggressive. If we cannot compete effectively to keep and grow this segment of business, we risk losing customers and economies of scale which could have a negative impact on our operating results. Factors affecting the competitive success of GDSs include the timeliness, reliability and scope of the information offered, the reliability and ease of use of the GDS, the fees charged and inducements paid to travel agencies, the transaction fees charged to travel suppliers and the range of products and services available to travel suppliers and travel agencies. We believe that we compete effectively with respect to each of these factors. In addition, deregulation of the GDS industry in the U.S. will likely increase competition between the GDSs. Increased competition could require us to increase spending on marketing or product development, decrease our transaction fees and other revenues, increase inducement payments or take other actions that could have a material adverse effect on our business, financial condition and results of operations. Travel Supplier Cost Savings Travel supplier cost savings efforts may shift business away from us or cause us to reduce the fees we charge to suppliers or increase the inducements we offer to travel agencies, thereby adversely affecting our results of operations. Travel suppliers, particularly airlines, are aggressively seeking ways to reduce distribution costs and, through the use of the Internet and otherwise, are seeking to decrease their reliance on global distribution systems including us. Travel suppliers have increasingly been providing direct access to their inventory through their own websites through travel agencies and through travel supplier joint ventures, which potentially bypass GDSs. See "Business Competition." Some of these travel suppliers offer lower prices when their products and services are purchased directly from these supplier-related distribution channels. These lower prices are not always available to us. Some of these travel suppliers are also not providing their lowest fares to GDSs unless the GDS provides them with lower transaction fees. These practices may have the effect of diverting customers away from us to other distribution channels, including websites, or of forcing us to reduce our transaction fees, which could have a material adverse effect on our business, financial condition and results of operations. Moreover, consolidation among travel suppliers, including airline mergers and alliances, may increase competition from these supplier-related distribution channels. In addition, some travel suppliers have reduced or eliminated commissions paid to both traditional and online travel agencies. The reduction or loss of commissions may cause travel agencies to become more dependent on other sources of revenues, such as traveler-paid service fees and GDS-paid inducements. We may have to increase inducement payments or incur other expenses in order to compete for travel agency business. Fare Content Agreements Our efforts to obtain more comprehensive content through airline fare content agreements may cause downward pressure on pricing and adversely affect our revenues and operating results. In recent months, some airlines have differentiated the fare content that they provide to us and to our GDS competitors. Some fare content has been provided to GDSs at no additional charge under standard participation agreements, and other content, such as web fares, has been withheld unless the GDS agrees to provide discounts, payments or other benefits to the airline. We have recently entered into fare content agreements with Continental Airlines, Delta, Northwest and United Air Lines. Generally, in these agreements, the airlines commit (subject to the exceptions contained in the agreements) to provide travel agencies covered by the agreements in the territories covered by the agreements with substantially the same fare content (including web fares) it provides to the travel agencies of other GDSs in exchange for payments from us to each airline and subject to us keeping steady the average transaction fees paid by each airline for travel agency bookings in the territories covered by the agreements. Further, in February 2004, we executed a three-year fare content agreement with British Airways to provide access to virtually all of their published fares (including web fares) to This prospectus relates to the offer and sale from time to time by the selling noteholder identified in this prospectus of up to $30,000,000 aggregate principal amount of 95/8% Senior Notes due 2011 issued by Worldspan, L.P. and WS Financing Corp. The notes being offered by the selling noteholder were initially issued on June 30, 2003 in a transaction exempt from the registration requirements of the Securities Act of 1933, as amended. We will not receive any of the proceeds from the sale of our senior subordinated notes being sold by the selling noteholders. The notes being offered by the selling noteholder are sometimes referred to in this prospectus as the "resale notes." Our senior notes are being registered to permit the selling noteholder to sell the securities from time to time to the public. The selling noteholder may sell the senior notes through ordinary brokerage transactions or through any other means described in the section entitled "Plan of Distribution." We do no know when or in what amounts a selling noteholder may offer securities for sale. The selling noteholders may sell any, all or none of the senior notes offered by this prospectus. We currently have outstanding an aggregate principal amount of $280,000,000 of 95/8% Senior Notes due 2011, of which the resale notes are a part. The remaining $250,000,000 of the outstanding notes are Series B 95/8% Senior Notes which have been registered with the Securities and Exchange Commission and were exchanged for a like amount of 95/8% Senior Notes due 2011 on January 30, 2004. The selling noteholder was not permitted to participate in the exchange offer because it is our affiliate. As a result, the resale notes are currently restricted securities and will remain so until transferred pursuant to this prospectus or pursuant to an available exemption from registration in which the restrictions on transfer lapse. Interest is payable on June 15 and December 15 of each year. The notes will mature on June 15, 2011. We may redeem all or part of the notes on or after June 15, 2007. Before June 15, 2006, we may redeem up to 35% of the notes from the proceeds of certain equity offerings. Redemption prices are set forth under "Description of the Notes Optional Redemption." The notes are guaranteed on a senior basis by all of our existing and future domestic subsidiaries. The notes and the guarantees will be our and the guarantors' general, unsecured obligations, are equal in right of payment to all of our and the guarantors' senior debt and are senior in right of payment to our and the guarantors' future subordinated indebtedness. Our foreign subsidiaries do not guarantee the notes. As a result, the notes are effectively junior to the creditors, including trade creditors, of those foreign subsidiaries. We do not intend to list the senior notes on any exchange. We cannot assure you that an active trading market for the senior notes will develop. some of our U.K. travel agencies. We believe that obtaining similar fare content from other major airline travel suppliers is important to our ability to compete, since other GDSs have also entered into fare content agreements with various airlines. Consequently, we plan to pursue agreements similar to these fare content agreements with some other major airlines. We expect that our fare content agreements will require us to make, in the aggregate, significant payments or other concessions to the participating airlines which could have a material adverse effect on our business, financial condition and results of operations in the future, including during the next three-year period. In addition, our fare content agreements are subject to several conditions, exceptions, term limitations and termination rights. There is no guarantee that the participating airlines will continue to provide their fare content to us to the same extent as they do at the current time. The loss or substantial reduction in the amount of fare content received from the participating airlines could negatively affect our business, financial condition and results of operations. Dependence on Small Number of Airlines We depend on a relatively small number of airlines for a significant portion of our revenues and the loss of any of our major airline relationships would harm our revenues and operating results. We depend on a relatively small number of airlines for a significant portion of our revenues. Our five largest airline relationships represented an aggregate of approximately 54% of our total 2003 revenues, down from 56% in 2002, while our ten largest airline relationships represented an aggregate of approximately 66% of our total 2003 revenues, down from 68% in 2002. Our five largest airline relationships by total revenue in 2003 were with Delta, Northwest, United Air Lines, American and US Airways, representing 19%, 12%, 9%, 8% and 5% of our total 2003 revenues, respectively. In 2002, these carriers accounted for 20%, 14%, 7%, 9% and 6%, respectively. We expect to continue to depend upon a relatively small number of airlines for a significant portion of our revenues. In addition, although we expect to continue our relationships with these airlines, our airline contracts can be terminated on short notice. Because our major airline relationships represent such a large part of our business, the loss of any of our major airline relationships, including due to the bankruptcy of an airline, could have a material negative impact on our business, financial condition and results of operations. Dependence on Small Number of Online Travel Agencies We are highly dependent on a small number of large online travel agencies, and the success of our business depends on continuing these relationships and the continued growth of online travel commerce. In 2003, Expedia, Hotwire, Orbitz and Priceline represented approximately 43% of our total transactions, with Expedia representing over 20% of our total transactions. If we were to lose and not replace the transactions generated by any of these online travel agencies, our business, financial condition and results of operations would be materially adversely impacted. In addition, if other online travel agencies become more successful or new online travel agencies emerge and we lose online transaction volumes as a result, our business, financial condition (including the carrying value of certain intangibles) and results of operations could be materially adversely impacted. While we have long-term contracts with Expedia, Orbitz and Priceline, these agencies have a variety of termination rights and other rights to reduce their business with Worldspan. Hotwire has the right to terminate its contract with us for any reason on 90 days advance notice. Expedia has the right to renegotiate the inducements payable to it by us every three years (with the next renegotiation right scheduled for July 2004), and it can terminate its contract with us if we cannot reach an agreement on inducements. In addition, Expedia informed us in May 2004 that it intends to exercise its right to move a portion of its transactions to another GDS provider. Although we currently continue to operate under these agreements, we cannot assure you that any travel agency will not attempt to terminate its agreement with us or otherwise move business to another GDS in the future. Any such termination or See "Risk Factors" beginning on page 12 for a discussion of risks that you should consider before buying the notes. a significant reduction in transaction volumes would have a material adverse effect on our business, financial condition (including the carrying value of certain intangibles) and results of operations. In addition, our growth strategy relies on the continuing growth in the travel industry of the Internet as a distribution channel. If consumers do not book significantly more travel online than they currently do today and if the use of the Internet as a medium of commerce for travel bookings does not continue to grow or grows more slowly than expected, our revenues and profit may be adversely affected. Consumers have historically relied on traditional travel agencies and travel suppliers and are accustomed to a high degree of human interaction in purchasing travel products and services. The success of our business is dependent on the number of consumers who use the Internet to make travel bookings increasing significantly. Relationships with Our Founding Airlines A significant portion of our current revenues are attributable to our founding airlines, and there is no guarantee that these airlines will continue to use our services to the same extent that they did when they owned us or that they will not indirectly compete with us. Each of American, Delta and Northwest has important commercial relations with us, and, in 2003, revenues received from our founding airlines represented, in the aggregate, approximately 39% of our revenues. Approximately 79% of this revenue was from transaction fees and the balance was derived from information technology services provided to Delta and Northwest. Delta is the largest single travel supplier utilizing our GDS, as measured by transaction fee revenues, generating transaction fees that accounted for approximately 14% of our 2003 revenue, while Northwest and American represent approximately 9% and 8%, respectively. In addition, approximately 86% of our information technology services revenues, which represented approximately 10% of our total revenues in 2003, are derived from providing processing, software development and other services to Delta and Northwest. Although we believe that each founding airline will continue to distribute its travel services through our GDS and that Delta and Northwest will continue to use our information technology services, there is no guarantee that our founding airlines will continue to use these services to the same extent as they did prior to the Acquisition or at all. In addition, although we have entered into noncompetition agreements with our founding airlines and each has agreed not to operate a GDS for three years after the Acquisition, there is no guarantee that our founding airlines will not indirectly compete with us in some or all of our markets, such as through supplier direct connections which could bypass our GDS. The loss or substantial reduction of fees from any of our founding airlines, or direct or indirect competition from any of our founding airlines, could negatively affect our business, financial condition and results of operations. For instance, the information technology services that we perform for Delta include computer functionality known as "PNR Sync." In 2003, Delta notified us that it intended to terminate PNR Sync. Following discussions with Delta relating to the mutual benefits of PNR Sync to Delta and us, we reached an agreement with Delta in December 2003 to continue to provide PNR Sync to Delta for a minimum three-year period at a fixed price and subject to several conditions, term limitations and termination rights. A termination of the PNR Sync functionality by Delta would represent a material adverse effect on our business, financial condition and results of operations. Additionally, in March 2004, Delta notified us that our GDS transaction fee pricing did not satisfy the conditions of our marketing support agreement with Delta. Delta indicated that, until we modify our GDS transaction fee pricing, it would suspend marketing support of us and the discount that Delta has provided to us for business travel. Pursuant to the agreement, we are working with Delta to review the relevant data and to resolve these issues. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense. FASA Credits The FASA credits and FASA credit payments owed under the FASAs may continue despite a significant reduction in or termination of FASA revenues. Pursuant to our founder airline services agreements, or FASAs, with each of Delta and Northwest, we are obligated to provide monthly FASA credits to Delta and Northwest to be applied against FASA service fee payments due from those airlines to us. The FASA credits are structured and will be applied through June 2012 in an amount up to an aggregate of approximately $116.7 million to each of Delta and Northwest as of December 31, 2003. Our obligations to provide these FASA credits to Delta and Northwest may continue despite a significant reduction in service fee payments from Delta or Northwest under the FASAs, as applicable. For instance, if Delta or Northwest reduces or ceases operations in a way that reduces or eliminates the amount of airline services the airline obtains from us under its FASA, our FASA credit obligations will remain, although its failure to comply with its software development minimum and exclusivity obligations will constitute a breach of its agreement. In the event that the monthly FASA credits deliverable by us to Delta or Northwest are more than the FASA service fee payments due from the applicable airline, then we will be obligated to pay such excess to such airline in cash. In addition, if we terminate the FASA other than as expressly permitted by the agreement, then we will be obligated to provide the scheduled FASA credits to the applicable airline by way of a monthly cash payment rather than applying the FASA credits against FASA service fee payments due from the airline. As a result, there could be a significant reduction in the revenues we receive from Delta and/or Northwest under the FASAs while our obligations to provide FASA credits and make FASA credit payments to Delta and/or Northwest, as applicable, would continue without interruption. In addition, Delta or Northwest may terminate its FASA due to our failure to satisfy the mainframe processing time, system availability or critical production data performance standards under that agreement. Furthermore, such a termination by Delta or Northwest of its FASA will constitute an event of default under our senior credit facility and may constitute a default under any other of our future senior credit facilities. If an event of default occurs, our lenders could elect to declare all amounts outstanding under our senior credit facility and any of our future credit facilities to be immediately due, and the lenders thereafter could foreclose upon the assets securing our senior credit facilities. In that event, we cannot assure you that we would have sufficient assets to repay all of our obligations, including our senior notes and the related guarantees. If the event of default is waived by the applicable lenders under our senior credit facilities or our senior credit facilities are no longer outstanding, the remaining portion of the FASA credits deliverable by us to the terminating airline will not be provided according to the nine year schedule and will instead be payable in cash to the terminating airline as and when, and only to the extent that, we are permitted to make such payments as "Restricted Payments" under the restricted payment covenant test contained in the indenture governing our senior notes. In such a circumstance, we will be required to make FASA credit payments to a terminating airline at a time when such airline is no longer paying FASA service fees to us. Although we have historically satisfied the relevant FASA performance standards under our predecessor services agreements with Delta and Northwest, we cannot assure you that we will continue to satisfy those standards and that the FASAs will not be terminated by Delta or Northwest. A termination of one or both of the FASAs under any of these circumstances could have a material adverse effect on our business, financial condition and results of operations. For further discussion of the terms of the FASAs, see "Management's Discussion and Analysis of Financial Condition and Results of Operations Liquidity." Critical Systems Our systems may suffer failures, capacity constraints and business interruptions, which could increase our operating costs, decrease our revenues and cause us to lose customers. The reliability of our GDS is critical to the success of our business. Much of our computer and communications hardware is located in a single data center located near Atlanta, Georgia. Our systems might be damaged or interrupted by fire, flood, power loss, telecommunications failure, break-ins, Net cash provided by (used in) operating activities $ 25,256 $ (1,582 ) $ $ 23,674 Cash flows from investing activities: Purchase of property and equipment (2,228 ) (634 ) (2,862 ) Proceeds from sale of property and equipment 20 The date of this prospectus is , 2004. earthquakes, terrorist attacks, war or similar events. Computer malfunctions, computer viruses, physical or electronic break-ins and similar disruptions might cause system interruptions and delays and loss of critical data and could significantly diminish our reputation and brand name and prevent us from providing services. Although we believe we have taken adequate steps to address these risks, we could be harmed by outages in, or unreliability of, the data center or computer systems. In addition, we rely on several communications services companies in the United States and internationally to provide network connections between our data center and our travel agencies' access terminals and also our travel suppliers. In particular, we rely upon AT&T and SITA, which is owned by a consortium of airlines and other travel-related businesses, to maintain our data communications and to provide network services in the United States and in many countries served by us. We occasionally experience network interruptions and malfunctions that make our global distribution system or other data processing services unavailable or less usable. Any significant failure or inability of AT&T, SITA or other communications companies to provide and maintain network access could have a material adverse effect on our business, financial condition and results of operations. Protection of Technology We may not protect our technology effectively, which would allow competitors to duplicate our products and services. This could make it more difficult for us to compete with them. Our success and ability to compete depend, in part, upon our technology. Among our significant assets are our software and other proprietary information and intellectual property rights. We rely on a combination of copyright, trademark and patent laws, trade secrets, confidentiality procedures and contractual provisions to protect these assets. Our software and related documentation, however, are protected principally under trade secret and copyright laws, which afford only limited protection, and the laws of some foreign jurisdictions provide less protection for our proprietary rights than the laws of the United States. Unauthorized use and misuse of our intellectual property could have a material adverse effect on our business, financial condition and results of operations, and there can be no assurance that our legal remedies would adequately compensate us for the damages caused by unauthorized use. In addition, licenses for a number of software products have been granted to us. Some of these licenses, individually and in the aggregate, are material to our business. Although we believe that the risk that we will lose any material license is remote, any loss could have a material adverse effect on our business, financial condition and results of operations. Intellectual Property Our products and services may infringe on claims of intellectual property rights of third parties, which could adversely affect our business and operating results. We do not believe that any of our products, services or activities infringe upon the intellectual property rights of third parties in any material respect. There can be no assurance, however, that third parties will not claim infringement by us with respect to current or future products, services or activities. Any infringement claim, with or without merit, could result in substantial costs and diversion of management and financial resources, and a successful claim could effectively block our ability to use or license products and services in the United States or abroad or cost us money. Any infringement claim, therefore, could have a material adverse effect on our business, financial condition and results of operations. Technological Change Rapid technological changes may render our technology obsolete or decrease the attractiveness of our products and services to customers. Our industry is subject to rapid technological change as travel suppliers, travel agencies and competitors create new and innovative products and services. Our ability to compete in our business and our future results will depend, in part, upon our ability to make timely, innovative and cost- TABLE OF CONTENTS Page effective enhancements and additions to our technology and to introduce new products and services that meet the demands of travel suppliers, travel agencies and other customers. The success of new products and services depends on several factors, including: identifying the needs of travel suppliers, travel agencies and other customers; developing and introducing effective new products and services in a timely and efficient manner; managing the cost of new product development and operations; differentiating new products and services from those of our competitors; and achieving market acceptance of new products and services. In addition, maintaining the flexibility to respond to technological and market changes may require substantial expenditures and lead time. There can be no assurance that we will successfully identify and develop new products or services in a timely manner, that products, technologies or services developed by others will not render our offerings obsolete or noncompetitive or that the technologies in which we focus our research and development investments will achieve acceptance in the marketplace. Our technology infrastructure is largely fixed. As a result, in the event of a significant reduction in transaction volumes or revenues, technology costs would remain relatively constant. If a reduction continued for a prolonged period, our business, financial condition and results of operations could be materially adversely affected. Regulatory Risks Regulatory developments could limit our ability to compete by restricting our flexibility to respond to competitive conditions. Changes and developments in the regulatory environment could have an adverse affect on our financial condition or results of operations, including by negatively impacting our transaction volume, transaction fees and by otherwise impacting the way we operate our business. GDSs are regulated by the U.S., the European Union ("E.U.") and other countries in which we operate. The U.S. Department of Transportation ("DOT") and the European Commission ("EC") are the relevant regulatory authorities in the U.S. and the E.U., respectively. Most of the regulating bodies have reexamined or are examining their GDS regulations and appear to be moving toward deregulation. Regulatory changes in the U.S., E.U. or other countries could have a material adverse effect on our business, financial condition and results of operations. On January 31, 2004, most DOT rules governing GDSs were lifted. The remaining DOT rules will be phased out at the end of July 2004. The DOT rules no longer contain any rules that apply uniquely to GDSs that are owned or marketed by airlines. In addition, deregulation in the U.S. could create uncertainty as to established GDS business models. Discontinuance of the rules could facilitate efforts by the airlines to divert travel bookings to distribution channels that they own and control and could also facilitate movement of travel agencies from one GDS to another. In addition, elimination of the rule prohibiting discrimination in airline fees could affect transaction fee revenues. E.U. regulations continue to address the participation of airline GDS owners in other GDSs. See "Business GDS Industry Regulation." The EC is engaged in a comprehensive review of its rules governing GDSs. It is unclear at this time when the EC will complete its review and what changes, if any, will be made to the E.U. rules. We could be unfairly and adversely affected if the E.U. rules are retained as to traditional global distribution systems used by travel agencies but are not applied to businesses providing comparable services, such as travel distribution websites owned by more than one airline. In addition, we could be adversely affected if changes to the rules, changes in interpretations of the rules, or new rules increase our cost of doing business, limit our ability to establish relationships with travel agencies, airlines, or others, impair the enforceability of existing agreements with travel agencies and other users of our system, prohibit or limit us from offering services or products, or limit our ability to establish or changes fees. Continued GDS regulation in the E.U. and elsewhere, while GDS regulations are being abolished in the U.S., could also create the operational challenge of supporting different products, services and business practices to conform to the different regulatory regimes. There are also GDS regulations in Canada, under the regulatory authority of the Canadian Department of Transport. On April 27, 2004, a significant number of these regulations were lifted. Amendments to the rules include eliminating the "obligated carrier" rule, which required larger airlines in Canada to participate equally in the GDSs, and elimination of the requirement that transaction fees charged by GDSs to airlines be non-discriminatory. Due to the elimination of the obligated carrier rule in Canada, Air Canada, the dominant Canadian airline, could choose distribution channels that it owns and controls or distribution through another GDS rather than through the Worldspan GDS. Privacy and Data Protection Our processing, storage, use and disclosure of personal data could give rise to liabilities as a result of governmental regulation, conflicting legal requirements or differing views of personal privacy rights. In our processing of travel transactions, we receive and store a large volume of personally identifiable data. This data is increasingly subject to legislation in numerous jurisdictions around the world, including the E.U. through its Data Protection Directive (and variations of this Directive in the E.U. Member States). This legislation is typically intended to protect the privacy of personal data that is collected, processed and transmitted in or from the governing jurisdiction. We could be adversely affected if the legislation is expanded to require changes in our business practices or if governing jurisdictions interpret or implement their legislation in ways that negatively affect our business, financial condition and results of operations. In addition, in the aftermath of the terrorist attacks of September 11, 2001, government agencies have been contemplating or developing initiatives to enhance national and aviation security, including the Transportation Security Administration's Computer-Assisted Passenger Prescreening System, known as CAPPS II. These initiatives may result in conflicting legal requirements with respect to data handling. As privacy and data protection has become a more sensitive issue, we may also incur legal defense costs and become exposed to potential liabilities as a result of differing views on the privacy of travel data. Travel businesses have also been subjected to investigations, lawsuits and adverse publicity due to allegedly improper disclosure of passenger information. For example, we were initially named as one of the defendants in a class action lawsuit arising from disclosures by Northwest of passenger data to a U.S. government agency. An amended and consolidated class action lawsuit was recently refiled in this case and we are no longer a named defendant in the matter. We are evaluating whether we have any future liability arising from this matter. While we do not believe that this matter is material, other privacy developments that are difficult to anticipate could impact our business, financial condition and results of operations. Key Employees Our ability to attract, train and retain executives and other qualified employees is crucial to results of operations and future growth. We depend substantially on the continued services and performance of our key executives, senior management and skilled personnel, particularly our professionals with experience in our business and operations and the GDS industry, including: Rakesh Gangwal, our Chairman and Chief Executive Officer; Gregory O'Hara, our Executive Vice President Corporate Planning and Development; Ninan Chacko, our Senior Vice President e-Commerce and Product Planning; David A. Lauderdale, our Chief Technology Officer and Senior Vice President Technical Operations; Michael B. Parks, our Senior Vice President and General Manager; Susan J. Powers, our Chief Information Officer and Senior Vice President Worldwide Product Solutions; Jeffrey C. Smith, our General Counsel, Secretary and Senior Vice President Human Resources; and Michael Wood, our Senior Vice President and Chief Financial Officer. We have entered into employment agreements with Messrs. Gangwal, O'Hara, Chacko and Wood to provide them with incentives to remain employed by us, all as more fully described in the section of this prospectus entitled "Management Employment Agreements." However, we cannot assure you that any of these individuals will continue to be employed by us. The specialized skills needed by our business are time-consuming and difficult to acquire and in short supply, and this shortage is likely to continue. A lengthy period of time is required to hire and train replacement personnel when skilled personnel depart the company. An inability to hire, train and retain a sufficient number of qualified employees could materially hinder our business by, for example, delaying our ability to bring new products and services to market or impairing the success of our operations. Even if we are able to maintain our employee base, the resources needed to attract and retain such employees may adversely affect our profits, growth and operating margins. Business Combinations and Strategic Investments We may not successfully make and integrate business combinations and strategic investments. We plan to continue to enter into business combinations, investments, joint ventures and other strategic alliances with other companies in order to maintain and grow revenue and market presence as well as to provide us with access to technology, products and services. Those transactions with other companies create risks such as difficulty in assimilating the technology, products and operations with our technology, products and operations; disruption of our ongoing business, including loss of management focus on existing businesses; impairment of relationships with existing executives, employees, customers and business partners; and losses that may arise from equity investments. In the past, in an effort to secure new technologies or obtain unique content for our GDS, we have invested in a number of early-stage technology companies. Each of these investments has required senior management attention. Many of these companies have failed, and most of our investments have been written down. If we enter into such transactions in the future, we may expend cash, incur debt, assume contingent liabilities or create additional expenses related to amortizing other intangible assets with estimable useful lives, any of which might harm our business, financial condition or results of operations. In addition, we may not be able to identify suitable candidates for these transactions or obtain financing or otherwise make these transactions on acceptable terms. Seasonality Because our business is seasonal, our quarterly results will fluctuate. The travel industry is seasonal in nature. Bookings, and thus transaction fee revenues charged for the use of our GDS, typically decrease each year in the fourth quarter, due to the early bookings by customers for travel during the holiday season and a decline in bookings for business travel during the holiday season. During 2002 and 2003, our transactions in the fourth quarter have averaged approximately 22% of total transactions for those years. Seasonality could cause our revenues to fluctuate significantly from quarter to quarter. Substantial fluctuations in our results of operations could have a material adverse effect on us. Trade Barriers We face trade barriers outside of the United States that limit our ability to compete. Trade barriers erected by non-U.S. travel suppliers, which are sometimes government-owned, have on occasion interfered with our ability to offer our products and services in their markets or have denied us content or features that they give to our competitors. Those trade barriers make our products and services less attractive to travel agencies in those countries than products and services offered by other GDSs that have these capabilities and have restricted our ability to gain market share outside of the U.S. Competition and trade barriers in those countries could require us to increase inducements, reduce prices, increase spending on marketing or product development, withdraw from or not enter certain markets or otherwise take actions adverse to us. 10.80 Amendment, dated as of May 12, 2004, to Employment Agreement among Worldspan Technologies Inc., M. Gregory O'Hara and Worldspan, L.P. 12.1 Computation of Ratio of Earnings to Fixed Charges 21.1 Subsidiaries of Worldspan, L.P.(4) 23.1 Consent of Dechert LLP* 23.2 Consent of PricewaterhouseCoopers LLP PROSPECTUS SUMMARY This following summary highlights certain significant aspects of our business and this offering, but you should read this entire prospectus, including the financial data and related notes, before making an investment decision. Unless the context otherwise requires, references to the "issuers" refer to Worldspan, L.P., exclusive of its subsidiaries, and WS Financing Corp. References to "WTI" refer to Worldspan Technologies Inc. References in this prospectus to "Worldspan," "we," "us," "our" and "our company" refer to the consolidated businesses of Worldspan, L.P. and all of its subsidiaries unless otherwise specified. References in this prospectus to the "Acquisition" refer to the acquisition by WTI, formerly named Travel Transaction Processing Corporation, through its wholly-owned subsidiaries, of the general partnership interests and limited partnership interest of Worldspan, L.P. You should carefully consider the information set forth under the heading "Risk Factors." Worldspan, L.P. We are a leading provider of mission-critical transaction processing and information technology services to the global travel industry. We are the second largest transaction processor for travel agencies in the United States (the world's largest travel market) and the largest processor globally for online travel agencies as measured by transactions. In 2003, we processed over 65% of online airline transactions made in the United States and processed by a global distribution system, or GDS. We provide subscribers (including traditional travel agencies, online travel agencies and corporate travel departments) with real-time access to schedule, price, availability and other travel information and the ability to process reservations and issue tickets for the products and services of approximately 800 travel suppliers (such as airlines, hotels, car rental companies, tour companies and cruise lines) throughout the world. During the year ended December 31, 2003, we processed approximately 193 million transactions. We also provide information technology services to the travel industry, primarily airline internal reservation systems, flight operations technology and software development. In recent years, the travel industry has been marked by the emergence and growth of the Internet as a travel distribution channel. The growth in use of the Internet has led to the establishment of online travel agencies that provide a link between the consumer and the travel supplier, typically through a GDS. In 2003, airline transactions generated through online travel agencies accounted for approximately 28% of all airline transactions in the United States processed by a GDS, up from approximately 23% in 2002 and approximately 17% in 2001. Between 1999 and 2003, the number of airline transactions in the United States generated through online travel agencies and processed by a GDS increased at a compound annual growth rate of 40.5% and an annual growth rate of 14.1% for the most recent year. The chart below illustrates airline transactions generated through online and traditional travel agencies in the United States and processed by a GDS.(1) International Operations Our international operations are subject to other risks which may impede our ability to grow internationally. Approximately 14% of our revenues during the twelve months ended December 31, 2003 were generated through our foreign subsidiaries. We face risks inherent in international operations, such as risks of: currency exchange rate fluctuations; local economic and political conditions, including conditions resulting from the continuing conflict in Iraq; restrictive governmental actions (such as trade protection measures, privacy rules, consumer protection laws and restrictions on pricing or discounts); changes in legal or regulatory requirements; limitations on the repatriation of funds; difficulty in obtaining distribution and support; nationalization; different accounting practices and potentially longer payment cycles; seasonal reductions in business activity; higher costs of doing business; lack of, or the failure to implement, the appropriate infrastructure to support our technology; lesser protection in some jurisdictions for our intellectual property; disruptions of capital and trading markets; laws and policies of the U.S. affecting trade, foreign investment and loans; and foreign tax and other laws. These risks may adversely affect our ability to conduct and grow business internationally, which could cause us to increase expenditures and costs, decrease our revenue growth or both. Exchange Rate Fluctuations Fluctuations in the exchange rate of the U.S. dollar and other foreign currencies could have a material adverse effect on our financial performance and results of operations. While we and our subsidiaries transact business primarily in U.S. dollars and most of our revenues are denominated in U.S. dollars, a portion of our costs and revenues are denominated in other currencies, such as the euro and the British pound sterling. As a result, changes in the exchange rates of these currencies or any other applicable currencies to the U.S. dollar will affect our operating expenses and operating margins and could result in exchange losses. The impact of future exchange rate fluctuations on our results of operations cannot be accurately predicted. In the past, we have incurred such losses, including a $1.0 million loss during 2001. Environmental, Health and Safety Requirements We could be adversely affected by environmental, health and safety requirements. We are subject to requirements of foreign, federal, state and local environmental and occupational health and safety laws and regulations. These requirements are complex, constantly changing and have tended to become more stringent over time. It is possible that these requirements may change or liabilities may arise in the future in a manner that could have a material adverse effect on our business, financial condition and results of operations. We cannot assure you that we have been or will be at all times in complete compliance with all those requirements or that we will not incur material costs or liabilities in connection with those requirements in the future. Additional Capital We may need additional capital in the future and it may not be available on acceptable terms. We may require more capital in the future to: fund our operations; finance investments in equipment and infrastructure needed to maintain and expand our network; fund the FASA credit payments; enhance and expand the range of services we offer; and respond to competitive pressures and potential strategic opportunities, such as investments, acquisitions and international expansion. We cannot assure you that additional financing will be available on terms favorable to us, or at all. The terms of available financing may place limits on our financial and operating flexibility. If adequate funds are not available on acceptable terms, we may be forced to reduce our operations or abandon expansion opportunities. Moreover, even if we are able to continue our operations, the failure to obtain additional financing could reduce our competitiveness as our competitors may provide better maintained networks or offer an expanded range of services. Securities Laws Compliance Recently enacted and proposed changes in securities laws and regulations are likely to increase our costs. The Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented by the Securities and Exchange Commission, have required changes in some of our corporate governance and accounting practices. In addition, the New York Stock Exchange has promulgated a number of regulations. We expect these laws, rules and regulations to increase our legal and financial compliance costs and to make some activities more difficult, time consuming and costly. We also expect these new rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage or incur significantly higher costs to obtain coverage. These new laws, rules and regulations could also make it more difficult for us to attract and retain qualified members of our board of directors, particularly to serve on our audit committee, and qualified executive officers. Principal Stockholders Our principal stockholders could exercise their influence over us to your detriment. As a result of their stock ownership of WTI, our ultimate parent, CVC, certain of its affiliates and OTPP together own beneficially about 91% of WTI's outstanding capital stock. By virtue of their stock ownership, these entities have significant influence over our management and will be able to determine the outcome of all matters required to be submitted to the stockholders for approval, including the election of our directors and the approval of mergers, consolidations and the sale of all or substantially all of our assets. The interests of CVC and OTPP as equity owners of WTI may differ from your interests, and, as such, they may take actions which may not be in your interest. For example, if we encounter financial difficulties or are unable to pay our debts as they mature, the interests of our equity owners might conflict with your interests as a noteholder. In addition, our equity owners may have an interest in pursuing acquisitions, divestitures, financings or other transactions that, in their judgment, could enhance their equity investments, even though such transactions might involve risks to you as a holder of the notes.

parsed_sections/risk_factors/2004/CIK0001260631_worldspan_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

parsed_sections/risk_factors/2004/CIK0001264006_north_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ RISK FACTORS You should carefully consider the risk factors set forth below as well as the other information contained in this prospectus before making a decision to participate in the exchange offer. Any of the following risks could materially adversely affect our business, financial condition or results of operations. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially and adversely affect our business operations. Risks Relating to the Notes Because there is no public market for the notes, you may not be able to resell your notes. There is no existing trading market for the exchange notes, and there can be no assurance regarding the development of an active or liquid trading market in the exchange notes or the ability of the holders of the exchange notes to sell their exchange notes or the price at which the holders may be able to sell their exchange notes. If a liquid market were to develop, the exchange notes could trade at prices that may be higher or lower than their initial offering price depending on many factors, including prevailing interest rates, our operating performance and financial condition, the interest of securities dealers in making a market in the exchange notes and the market for similar securities. Although it is not obligated to do so, CIBC World Markets Corp. intends to make a market in the exchange notes. Any such market-making activity may be discontinued at any time, for any reason, without notice at the sole discretion of CIBC World Markets Corp. No assurance can be given as to the liquidity of, or the trading market for, the exchange notes. Our substantial indebtedness could adversely affect our financial health and prevent us from fulfilling our obligations under the notes. We have a significant amount of indebtedness. As of December 31, 2003, our total debt was $257.2 million and our total senior debt was $101.4 million. Our substantial indebtedness could have important consequences to you. For example, it could: make it more difficult for us to satisfy our obligations with respect to the notes; increase our vulnerability to general adverse economic and industry conditions; require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, expansion through acquisitions and other general corporate purposes; limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; place us at a competitive disadvantage compared to our competitors that have less debt; and limit our ability, among other things, to borrow additional funds. Our substantial indebtedness may make it difficult for us to satisfy our obligations under the senior credit facility. If we cannot satisfy our obligations under the senior credit facility, our senior lenders could declare a default. A default, if not waived or cured, could result in an acceleration of our indebtedness and a foreclosure on our assets. A foreclosure would make it extremely difficult for us to operate as a going concern. In addition, a default, if not cured or waived, may permit the acceleration of our other indebtedness. (26,130 ) 192,138 26,544 192,552 Member's equity: Contributed capital 116,060 64,417 40,879 (105,296 ) 116,060 Accumulated deficit (71,708 ) (43,671 ) (12,002 ) 55,673 (71,708 ) Accumulated other comprehensive loss (14,831 ) (26,130 ) 192,138 26,544 192,552 Member's equity: Contributed capital 116,060 64,417 40,879 (105,296 ) 116,060 Accumulated deficit (71,708 ) (43,671 ) (12,002 ) 55,673 (71,708 ) Accumulated other comprehensive loss (14,831 ) David F. Myers, Jr. Executive Vice President, Secretary, and Chief Financial Officer 2211 York Road, Suite 215 Oak Brook, Illinois 60523 Telephone: (630) 572-5715 (Name, address, including zip code, and telephone number, including area code, of agent for service) Despite current indebtedness levels, we may still be able to incur substantially more debt. This could further exacerbate the risks described above. We and our subsidiaries may be able to incur substantial additional indebtedness in the future. The terms of the indenture governing the notes do not fully prohibit us or our subsidiaries from doing so. As of December 31, 2003 our senior credit facility permited borrowings of up to $30 million and C$10 million and revolving credit facilities at our European subsidiaries permitted borrowings of up to 3.1 million and borrowings under these revolving credit facilities would rank senior to the notes and the subsidiary guarantees. If new debt is added to our current debt levels, the related risks that we now face could intensify. To service our indebtedness, we require a significant amount of cash, the availability of which depends on many factors beyond our control. If we cannot service our indebtedness, we may not be able to satisfy our obligations under the notes. Our ability to make payments on and to refinance our indebtedness, including the notes, and to fund planned capital expenditures will depend on our ability to generate cash in the future from our operations. Our ability to generate cash is, to a certain extent, subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. Our business may not generate sufficient cash flow from operations and future borrowings may not be available to us under our senior credit facility in an amount sufficient to enable us to pay our indebtedness, including the notes, or to fund our other liquidity needs. As of December 31, 2003, the current portion (due within one year) of our debt service payments, which includes principal and interest, was approximately $23.5 million. We intend to service these obligations through our future cash flows from operations. If our future cash flow from operations and other capital resources are insufficient to pay our obligations as they mature or to fund our liquidity needs, we may be forced to reduce or delay our business activities and capital expenditures, sell assets, obtain additional equity capital or restructure or refinance all or a portion of our debt, including the notes, on or before maturity. We may not be able to refinance any of our indebtedness, including our senior credit facility and the notes, on satisfactory terms or at all. NSP conducts a substantial portion of its operations through subsidiaries, and NSP's subsidiaries are not obligated to make distributions to NSP to service the notes. NSP's subsidiaries conduct a substantial portion of its operations and own a substantial portion of its assets. NSP's cash flow and its ability to meet its debt service obligations depend upon the cash flow of its subsidiaries and the payment of funds by its subsidiaries in the form of loans and dividends. NSP's subsidiaries are not obligated to make distributions to NSP to service the notes. In addition, the ability of its subsidiaries to make payments to it will depend on their earnings, the terms of their debt, business and tax considerations and legal restrictions. NSP's foreign subsidiaries are not subsidiary guarantors, and as a result, any right of NSP to participate in any distribution of assets of its foreign subsidiaries upon liquidation or otherwise will be subject to the prior claims of its foreign subsidiaries' creditors. The subsidiary guarantors include only NSP's domestic direct and indirect subsidiaries. However, our historical consolidated financial information and the pro forma consolidated financial information included in this prospectus are presented on a consolidated basis, including both our domestic and foreign subsidiaries. The aggregate net sales and operating income of our subsidiaries that are not subsidiary guarantors were $82.1 million and $6.0 million, respectively, for the year ended December 31, 2002 and $78.0 million and $7.3 million, respectively, for the nine months ended September 27, 2003 and their consolidated tangible assets at September 27, 2003 were $76.6 million. In 9. Lease Commitments The Company leases certain facilities and equipment under various noncancelable operating lease agreements. Future minimum lease payments under noncancelable operating leases as of December 31, 2002, are as follows: 2003 23 2004 Copies to: Dennis M. Myers, P.C. Kirkland & Ellis LLP 200 E. Randolph Drive Chicago, Illinois 60601 Telephone: (312) 861-2000 * The Co-Registrants listed on the next page are also included in this Form S-4 Registration Statement as additional Registrants. The Co-Registrants are the direct and indirect domestic subsidiaries of the Registrant and the guarantors of the notes to be registered hereby. Approximate date of commencement of proposed sale of the securities to the public: The exchange will occur as soon as practicable after the effective date of this Registration Statement. If the securities being registered on this Form are being offered in connection with the formation of a holding company and there is compliance with General Instruction G, check the following box. If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. CALCULATION OF REGISTRATION FEE addition, the notes are effectively subordinated to all existing and future liabilities (including trade payables) of our non-guarantor subsidiaries. As of December 31, 2003, our non-guarantor subsidiaries had $19.8 million of indebtedness and other liabilities (including trade payables). As a result, any right of NSP to participate in any distribution of assets of its non-guarantor subsidiaries upon the liquidation, reorganization or insolvency of any such subsidiary (and the consequential right of the holders of the notes to participate in the distribution of those assets) will be subject to the prior claims of such subsidiaries' creditors. The indenture for the notes restricts our ability and the ability of most of our subsidiaries to engage in some business and financial transactions. Our failure to comply may result in an event of default under the indenture. The indenture for the notes, among other things, restricts our ability and the ability of our restricted subsidiaries to, among other things: incur additional debt or issue preferred stock; pay dividends and make distributions on, or redeem or repurchase, capital stock; issue stock of subsidiaries; make investments; create liens; enter into transactions with affiliates; enter into sale-leaseback transactions; merge or consolidate; and transfer and sell assets. Our failure to comply with obligations under the indenture for the notes may result in an event of default under the indenture. A default, if not cured or waived, may permit acceleration of our other indebtedness. We may not have funds available to remedy these defaults. If our indebtedness is accelerated, we may not have sufficient funds available to pay the accelerated indebtedness or the ability to refinance the accelerated indebtedness on terms favorable to us or at all. Your right to receive payments on the notes is junior to our senior indebtedness and possibly all of our future borrowings. Further, the guarantees of the notes are junior to all of our guarantors' senior indebtedness and all their future borrowings. The notes and the subsidiary guarantees rank behind all of our and our subsidiary guarantors' senior indebtedness (other than trade payables) and all of our and their future borrowings (other than trade payables), except any future indebtedness that expressly provides that it ranks equal with, or subordinated in right of payment to, the notes and the guarantees. In addition, the notes are structurally subordinated to indebtedness and other liabilities of our subsidiaries which are not guaranteeing the notes. As a result, upon any distribution to our creditors or the creditors of the guarantors in a bankruptcy, liquidation or reorganization or similar proceeding relating to us or the guarantors or our or their property, the holders of our senior debt and the guarantors' senior debt will be entitled to be paid in full in cash before any payment may be made with respect to the notes or the subsidiary guarantees. In the event of a bankruptcy, liquidation or reorganization or similar proceeding relating to us or the guarantors, holders of the notes will participate with trade creditors and all other holders of our and the guarantors' subordinated indebtedness in the assets remaining after we and the subsidiary Title of Each Class of Securities to be Registered Proposed Maximum Aggregate Offering Price Amount of Registration Fee guarantors have paid all of our senior debt. However, because the indenture requires that amounts otherwise payable to holders of the notes in a bankruptcy or similar proceeding be paid to holders of senior debt instead, holders of the notes may receive less, ratably, than holders of trade payables in any such proceeding. In any of these cases, we and the subsidiary guarantors may not have sufficient funds to pay all of our creditors and holders of notes may receive less, ratably, than the holders of our senior debt. As of December 31, 2003, the notes and the subsidiary guarantees were subordinated to $101.4 million of senior debt, and we had approximately $41.6 million of additional borrowing capacity under our senior revolving credit facilities. We will be permitted to borrow substantial additional indebtedness, including senior debt, in the future under the terms of the indenture. The notes are not secured by any assets, while our obligations under the senior credit facility are secured by liens on substantially all of our assets. Under certain circumstances, note holders may receive less, ratably, than holders of our senior debt. The notes are not secured by any collateral. However, our obligations under the senior credit facility are secured by liens on substantially all of our assets. Therefore, in a bankruptcy, liquidation or reorganization or similar proceeding relating to us or the guarantors, or our or their property, holders of the notes and all other holders of our and the guarantors' senior subordinated indebtedness will participate in the assets remaining after we and the subsidiary guarantors have paid all of our senior debt. In any of these cases, we and the subsidiary guarantors may not have sufficient funds to pay all of our creditors and the holders of notes may receive less, ratably, than the holders of our senior debt. We may not have the ability to raise the funds necessary to finance the change of control offer required by the indenture. Upon the occurrence of certain specific kinds of change of control events, we will be required to offer to repurchase all outstanding notes at 101% of their principal amount plus accrued and unpaid interest and liquidated damages, if any, to the date of repurchase. However, it is possible that we will not have sufficient funds at the time of the change of control to make any required repurchases or that restrictions in our senior credit facility will not allow such repurchases. A change in control of the Company can be the basis for the declaration of an event of default under our senior credit agreement, which, if not waived, accelerates our obligations under the credit agreement and, under the terms of the indenture, we would be prohibited from making, and the trustee from accepting, any payment with respect to the notes until the senior indebtedness was paid in full. If we do not repay all borrowings under our senior credit facility or obtain a consent of our lenders under our senior credit facility to repurchase the notes, we will be prohibited from purchasing the notes. Our failure to purchase tendered notes would constitute a default under the indenture governing the notes, which, in turn, would constitute a default under our senior credit facility. In addition to the outstanding notes as of December 31, 2003 we had $105.7 million of indebtedness outstanding that is payable in full at the option of the payees upon a change of control. Also, we could in the future enter into transactions, including acquisitions, refinancings or other recapitalizations or highly leveraged transactions, that would not constitute a change of control under the indenture, but that could increase the amount of indebtedness outstanding at such time or adversely affect our capital structure or credit ratings. See "Description of the Notes Change of Control Offer." Balance at January 1, 2001 4,602 2,666 7,268 Foreign currency translation adjustments 9 Net cash used in financing activities (219 ) (801 ) Effect of exchange rate changes on cash 97/8 Senior Subordinated Notes due 2011 $152,500,000 (1) The senior credit facility contains certain restrictive covenants, including leverage and interest coverage ratios. If we fail to comply with these financial covenants, a default could be declared, and the senior lenders could accelerate our repayment obligations. The senior credit facility contains certain restrictive covenants, including covenants that require us to maintain certain financial ratios. Those ratios include: a fixed charge coverage ratio of EBITDA less capital expenditures over fixed charges for the period, an interest coverage ratio of EBITDA over interest expense for the period, a senior leverage ratio of senior debt over EBITDA for the period, and a total leverage ratio of total debt over EBITDA for the period. The specific ratios we are required to maintain change over time. If we fail to maintain these ratios and the failure is not cured, the senior lenders could declare a default under the credit agreement, accelerate our payment obligations and foreclose on our assets. A foreclosure would make it extremely difficult for us to operate as a going concern. In addition, a default, if not cured or waived, may permit the acceleration of our other indebtedness. We may not have funds available to remedy these defaults. If our indebtedness is accelerated, we may not have sufficient funds available to pay the accelerated indebtedness or the ability to refinance the accelerated indebtedness on terms favorable to us or at all. Federal and state statutes allow courts, under specific circumstances, to void guarantees and require note holders to return payments received from guarantors. Under the federal bankruptcy law and comparable provisions of state fraudulent transfer laws, a guarantee could be voided, or claims in respect of a guarantee could be subordinated to all other debts of that guarantor if, among other things, the guarantor, at the time it incurred the indebtedness evidenced by its guarantee received less than reasonably equivalent value or fair consideration for the incurrence of such guarantee; and was insolvent or rendered insolvent by reason of such incurrence; or was engaged in a business or transaction for which the guarantor's remaining assets constituted unreasonably small capital; or intended to incur, or believed that it would incur, debts beyond its ability to pay such debts as they matured. In addition, any payment by that guarantor pursuant to its guarantee could be voided and required to be returned to the guarantor, or to a fund for the benefit of the creditors of the guarantor. The measures of insolvency for purposes of these fraudulent transfer laws will vary depending upon the law applied in any proceeding to determine whether a fraudulent transfer has occurred. Generally, however, a guarantor would be considered insolvent if: the sum of its debts, including contingent liabilities, were greater than the fair saleable value of all of its assets; or the present fair saleable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts, including contingent liabilities, as they became absolute and mature; or it could not pay its debts as they became due. On the basis of historical financial information, recent operating history and other factors, we believe that each guarantor, after giving effect to its guarantee of the notes, will not be insolvent, will not have unreasonably small capital for the business in which it is engaged and will not have incurred debts beyond its ability to pay such debts as they mature. We cannot predict with certainty, however, 2,580 2,449 Members' equity: Contributed capital 4,602 4,602 Retained earnings 3,525 4,563 Accumulated other comprehensive income 9 Balance at December 31, 2002 4,602 4,563 Guarantees on Senior Subordinated Notes (2) (3) what standard a court would apply in making these determinations or whether a court would agree with our conclusions in this regard. You should not rely on Norcross Capital in evaluating an investment in the notes. Norcross Capital was formed in connection with the offering of the outstanding notes and has no assets and no operations and is prohibited from engaging in any business activities, except in connection with the issuance of the notes. You should therefore not rely upon Norcross Capital in evaluating whether to invest in the notes. Risks Relating to our Business If we are unable to retain senior executives and other qualified professionals our growth may be hindered, which could negatively impact our results of operations and our ability to make payments on the notes. Our success depends in part on our ability to attract, hire, train and retain qualified managerial, sales and marketing personnel. Competition for these types of personnel is intense. We may be unsuccessful in attracting and retaining the personnel we require to conduct and expand our operations successfully. Our results of operations could be materially and adversely affected if we are unable to attract, hire, train and retain qualified personnel. Our success also depends to a significant extent on the continued service of our management team. The loss of any member of the management team could have a material adverse effect on our business, results of operations and financial condition. The markets in which we compete are highly competitive, and some of our competitors have greater financial and other resources than we do. The competitive pressures faced by us could materially and adversely affect our business, results of operations and financial condition. The personal protection equipment market is highly competitive, with participants ranging in size from small companies focusing on single types of safety products, to large multinational corporations which manufacture and supply many types of safety products. Our main competitors vary by region and product. We believe that participants in this industry compete primarily on the basis of product characteristics (such as functional performance, design and style), price, brand name recognition and service. Some of our competitors have greater financial and other resources than we do and our cash flows from operations could be adversely affected by competitors' new product innovations and pricing changes made by us in response to competition from existing or new competitors. Individual competitors have advantages and strengths in different sectors of the industry, in different products and in different areas, including manufacturing and distribution systems, geographic market presence, customer service and support, breadth of product, delivery time and price. We may not be able to compete successfully against current and future competitors and the competitive pressures faced by us could materially and adversely affect our business, results of operations and financial condition. See "Business Competition." Many of our products are subject to existing regulations and standards, changes in which could materially and adversely affect our results of operations. Our net sales may be materially and adversely affected by changes in safety regulations and standards covering industrial workers, firefighters and utility workers in the United States and Canada, including safety regulations of OSHA and standards of the NFPA, ANSI and ASTM. Our net sales could also be adversely affected by a reduction in the level of enforcement of such regulations. Changes in regulations could reduce the demand for our products or require us to reengineer our products, thereby creating opportunities for our competitors. (1)Pursuant to Rule 457(q) under the Securities Act of 1933, as amended, no filing fee is required for the registration of an indeterminate amount of securities to be offered solely for market-making purposes by an affiliate of the registrant. (2)All subsidiary guarantors are wholly owned direct or indirect subsidiaries of the Registrant and have guaranteed the Notes being registered. (3)Pursuant to Rule 457(n), no separate fee is payable with respect to the guarantees being registered hereby. A reduction in the spending patterns of government agencies could materially and adversely affect our net sales. We sell a significant portion of our products in the United States and Canada to various governmental agencies. In addition, a portion of our products are sold to government agencies through fixed price contracts awarded by competitive bids submitted to state and local agencies. Many of these governmental agency contracts are awarded on an annual basis. Accordingly, notwithstanding our long-standing relationship with various governmental agencies, we may lose our contracts with such agencies to lower bidders in the competitive bid process. Moreover, the terms and conditions of such sales and the government contract process are subject to extensive regulation by various federal, state and local authorities in the United States and Canada. In most markets in which we compete, there are frequent introductions of new products and product line extensions. If we fail to introduce successful new products, we may lose market position and our financial performance may be negatively impacted. If we are unable to identify emerging consumer and technological trends, maintain and improve the competitiveness of our products and introduce these products on a global basis, we may lose market position, which could have a material adverse effect on our business, financial condition and results of operations. Continued product development and marketing efforts have all the risks inherent in the development of new products and line extensions, including development delays, the failure of new products and line extensions to achieve anticipated levels of market acceptance and the cost of failed product introductions. Our international operations are subject to various uncertainties and a significant reduction in international sales of our products could have a material adverse effect on our results of operations. Our international operations are subject to various political, economic and other uncertainties which could adversely effect our business. A significant reduction of our international business due to any of these risks would adversely affect our revenues. In 2002, approximately 25% of our net sales were outside the United States. These risks include: unexpected changes in regulatory requirements; currency exchange rate fluctuations; changes in trade policy or tariff regulations; customs matters; longer payment cycles; higher tax rates and potentially adverse tax consequences, including restrictions on repatriating earnings and the threat of "double taxation"; additional tax withholding requirements; intellectual property protection difficulties; difficulty in collecting accounts receivable; complications in complying with a variety of foreign laws and regulations, many of which conflict with United States laws; costs and difficulties in integrating, staffing and managing international operations; and strains on financial and other systems to properly administer VAT and other taxes. Income before income taxes and minority interest 1,788 1,969 134 3,891 Income tax expense (benefit) 1,972 769 (162 )(7) 2,579 Minority interest (1 ) 13 586 Income before income taxes and minority interest 1,242 1,779 Income tax expense 508 694 Minority interest 5 The Registrant and the Co-Registrants hereby amend this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant and the Co-Registrants shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until this Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine. In addition, foreign operations involve uncertainties arising from local business practices, cultural considerations and international political and trade tensions. For example, in 2002, we recorded a non-cash impairment charge with regard to, our Zimbabwe subsidiary due to adverse economic and political conditions. In addition, a portion of our manufacturing and outsourcing relationships involve China. If we are unable to successfully manage the risks associated with expanding our global business or to adequately manage operational fluctuations internationally, it could have a material adverse effect on our business, financial condition or results of operations. We may incur restructuring or impairment charges that would reduce our earnings. We have in the past and may in the future restructure some of our operations, including our recently acquired subsidiaries. In such circumstances, we may take actions that would result in a charge related to discontinued operations, thereby reducing our earnings. These restructurings have or may be undertaken to realign our subsidiaries, eliminate duplicative functions, rationalize our operating facilities and products, and reduce our staff. For the year ended December 31, 2002, we recorded restructuring charges of approximately $9.3 million related to a restructuring plan to exit certain manufacturing facilities and move certain hand operations to China. Additionally, on January 1, 2002 we adopted Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets," which requires that goodwill and intangible assets that have an indefinite useful life be tested at least annually for impairment. We carry a very significant amount of goodwill and intangible assets and SFAS No. 142 requires us to perform an annual assessment for possible impairment. As of September 27, 2003, we had goodwill of approximately $134.5 million. We do not anticipate that our goodwill will be impaired for the year ended December 31, 2003. If we determine our goodwill to be impaired, the resulting non-cash charge could be substantial. We may be unable to successfully execute or effectively integrate acquisitions, including our acquisition of KCL, which may adversely affect our results of operations. One of our key operating strategies is to selectively pursue acquisitions. Acquisitions, including our acquisition of KCL, involve a number of risks including: failure of the acquired businesses to achieve the results we expect; diversion of our management's attention from operational matters; our inability to retain key personnel of the acquired businesses; risks associated with unanticipated events or liabilities; the potential disruption of our existing business; and customer dissatisfaction or performance problems at the acquired businesses. If we are unable to integrate or successfully manage KCL or any other business that we may acquire in the future, we may not realize anticipated cost savings, improved manufacturing efficiencies and revenue growth, which may result in reduced profitability or operating losses. In addition, we expect to face competition for acquisition candidates, which may limit the number of our acquisition opportunities and may lead to higher acquisition prices. Moreover, acquisitions of businesses may require additional debt financing, resulting in additional leverage. The covenants in our senior credit facility and the indenture may further limit our ability to complete acquisitions. The realization of all or any of the risks described above could materially and adversely affect our reputation and our results of operations. Net cash provided by (used in) financing activities 11,986 (8,669 ) 21,316 24,633 Effect of exchange rate changes on cash 3,179 Our continued success depends on our ability to protect our intellectual property. If we are unable to protect our intellectual property, our sales could be materially and adversely affected. Our success depends, in part, on our ability to obtain and enforce patents, maintain trade secret protection and operate without infringing on the proprietary rights of third parties. We have been issued patents and have registered trademarks with respect to many of our products, but our competitors could independently develop similar or superior products or technologies, duplicate any of our designs, trademarks, processes or other intellectual property or design around any processes or designs on which we have or may obtain patents or trademark protection. In addition, it is possible that third parties may have or acquire licenses for other technology or designs that we may use or desire to use, so that we may need to acquire licenses to, or to contest the validity of, such patents or trademarks of third parties. Such licenses may not be made available to us on acceptable terms, if at all, and we may not prevail in contesting the validity of third party rights. In addition to patent and trademark protection, we also protect trade secrets, know-how and other confidential information against unauthorized use by others or disclosure by persons who have access to them, such as our employees, through contractual arrangements. These agreements may not provide meaningful protection for our trade secrets, know-how or other proprietary information in the event of any unauthorized use, misappropriation or disclosure of such trade secrets, know-how or other proprietary information. If we are unable to maintain the proprietary nature of our technologies, our sales could be materially adversely affected. See "Business Intellectual Property." We do not have long-term contracts with many of our customers and they may terminate their relationship with us at any time, which could have a material adverse effect on our operating results. A significant portion of our contracts are not long-term contacts and are terminable at will by either party. If a significant number of our customers choose to terminate their contracts or to not renew their contracts with us upon expiration, it would have a material adverse effect on our business, financial condition and results of operations. We face an inherent business risk of exposure to product liability claims which could have a material adverse effect on our operating results. We face an inherent business risk of exposure to product liability claims arising from the claimed failure of our products to prevent the types of personal injury or death against which they are designed to protect. We have not experienced any material uninsured losses due to product liability claims, but it is possible that we could experience material losses in the future. In particular, our North Safety Products subsidiary, its predecessors and/or the former owners of such business are presently named as a defendant in approximately 670 lawsuits involving respirators manufactured and sold by it or its predecessors. We are also monitoring an additional 10 lawsuits in which we feel that North Safety Products, its predecessors and/or the former owners of such businesses may be named as defendants. Collectively, these 680 lawsuits represent a total of approximately 32,000 plaintiffs. Approximately 88% of these lawsuits involve plaintiffs alleging they suffer from silicosis, with the remainder alleging they suffer from other or combined injuries, including asbestosis. These lawsuits typically allege that these conditions resulted in part from respirators that were negligently designed or manufactured. Invensys plc ("Invensys"), formerly Siebe plc, is contractually obligated to indemnify us for any losses, including costs of defending claims, resulting from respiratory products manufactured prior to our acquisition of North Safety Products in October 1998. In addition, our North Safety Products subsidiary is contractually entitled to indemnification from Norton Company, an affiliate of Saint-Gobain, which owned the North Safety Products business prior to Invensys. Pursuant to a December 14, 1982 asset purchase agreement, Siebe Norton, Inc., a newly formed wholly-owned subsidiary of Norton Company, acquired the assets of Norton's Safety Products (1)Through December 2, 2003. Plaintiffs have asserted specific dollar claims in less than a quarter of the approximately 670 cases pending as of December 2, 2003 in which North Safety Products, its predecessors and/or the former owners of such businesses have been named as defendants. A majority of cases prohibit specifying damages in tort cases such as these, and most of the remaining jurisdictions do not require such specification. In those cases in which plaintiffs choose to assert specific dollar amounts in their complaints, brought in states that permit such pleading, the amounts claimed are typically not meaningful as an indicator of a company's potential liability. This is because (1) the amounts claimed typically bear no relation to the level of the plaintiff's injury, (2) the complaints typically assert claims against numerous defendants, and (3) many cases are brought on behalf of plaintiffs who have not suffered any medical injury, and, ultimately, are resolved without any payment or payment of a small fraction of the damages initially claimed. Of the 668 complaints maintained in our records, 506 do not Exact Name of Additional Registrants* specify the amount of damages sought, 1 generally alleges damages less than $50,000, 31 generally allege damages in excess of $50,000, 3 allege compensatory damages in excess of $50,000 and an unspecified amount of punitive damages, 26 allege compensatory damages and punitive damages, each in excess of $25,000, 8 generally allege damages in excess of $100,000, 51 allege compensatory damages and punitive damages, each in excess of $50,000, 37 generally allege damages of $15.0 million, 4 allege compensatory damages and punitive damages, each in the amount of $15.0 million and one alleges damages not to exceed $290.0 million. We currently do not have access to the complaints with respect to the additional approximately 2 cases that were pending as of December 2, 2003 in which North Safety Products, its predecessors and/or the former owners of such businesses have been named as defendants, or the previously mentioned 10 additional cases we are monitoring, and therefore do not know whether these cases allege specific damages, and, if so, the amount of such damages, but are in the process of seeking to obtain such information. Due to the reasons noted above and to the indemnification arrangements benefiting the Company, we do not believe that the damage amounts specified in these complaints are a meaningful factor in any assessment of the Company's potential liability. Bankruptcy filings of companies with asbestos and silica-related litigation could increase our cost over time. If we were found liable in these cases and either Invensys or Norton Company failed to meet their indemnification obligations to us or the suit involved products manufactured by us after our October 1998 acquisition of North Safety Products, it would have a material adverse effect on our business. For more information, see "Business Legal Proceedings." Also, in the event any of our products prove to be defective, we could be required to recall or redesign such products. We maintain insurance against product liability claims (with the exception of asbestosis and silicosis cases, for which coverage is not commercially available), but it is possible that our insurance coverage will not continue to be available on terms acceptable to us or that such coverage will not be adequate for liabilities actually incurred. A successful claim brought against us in excess of available insurance coverage, or any claim or product recall that results in significant expense or adverse publicity against us, could have a material adverse effect on our business, operating results and financial condition. We are subject to various environmental laws and any violation of these laws could adversely effect our results of operations. We are subject to federal, state and local laws, regulations and ordinances relating to the protection of the environment, including those governing discharges to air and water, handling and disposal practices for solid and hazardous wastes, and the maintenance of a safe workplace. These laws impose penalties for noncompliance and liability for response costs and certain damages resulting from past and current spills, disposals or other releases of hazardous materials. We could incur substantial costs as a result of noncompliance with or liability for cleanup pursuant to these environmental laws. We have identified three potential environmental liabilities, though we do not believe they are material. See "Business Environmental Matters." Environmental laws have changed rapidly in recent years, and we may be subject to more stringent environmental laws in the future. If more stringent environmental laws are enacted, these future laws could have a material adverse effect on our results of operations. The interests of our controlling equityholders could conflict with those of the holders of the notes. We are a wholly owned subsidiary of NSP Holdings. Equityholders of NSP Holdings that individually hold greater than 5% of a class of its voting securities, taken as a group, hold a total of 79.9% of its outstanding voting equity. See "Principal Equityholders." Pursuant to NSP Holdings' Amended and Restated Limited Liability Company Agreement, as amended, Argosy-Safety Products L.P. has the right to appoint three of the possible six members of Holdings' board of managers. These appointees have the authority to make decisions affecting our capital structure, including the issuance Jurisdiction of Formation of additional indebtedness and the making of distributions. Argosy-Safety Products L.P.'s limited partners include individuals who are employees of CIBC. NSP Holdings' Amended and Restated Limited Liability Company Agreement may be amended by the vote of the holders of the majority of its voting equity, so long as the amendment is also approved by John Hancock Life Insurance Company and Hancock Mezzanine Partners L.P., on the one hand, and Argosy, CIBC and CIBC's affiliates, on the other hand. Therefore, these entities, acting together, have sufficient voting power to amend NSP Holdings' Amended and Restated Limited Liability Company Agreement. Entities associated with some of our principal equityholders are lenders under our senior credit facilities. These entities may lend to us on a senior basis in the future. NSP Holdings' principal equityholders may pursue transactions that could enhance their investments while involving risks to your interests. The interests of these entities could conflict with the interests of the holders of the notes. I.R.S. Employer Identification No.

parsed_sections/risk_factors/2004/CIK0001264017_norcross_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

parsed_sections/risk_factors/2004/CIK0001264242_quanta_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ RISK FACTORS An investment in our shares involves a high degree of risk. Before making an investment decision, you should carefully consider all of the risks described in this prospectus. If any of the risks discussed in this prospectus actually occur, our business, financial condition and results of operations could be materially and adversely affected. If this were to happen, the price of our shares could decline significantly and you may lose all or a part of your investment. Risks Related to our Business We have a limited operating history. If we are unable to implement our business strategy or operate our business as we currently expect, our results may be adversely affected. We were organized on May 23, 2003 and began our business operations after the closing of the Private Offering on September 3, 2003. Because we only recently commenced operations, we are just beginning to develop name recognition and a reputation in the insurance and reinsurance industry. Businesses, such as ours, that are starting up or in their initial stages of development, present substantial business and financial risks and may suffer significant losses. We must hire and retain additional key employees and other staff, develop and maintain business relations, continue to establish operating procedures, obtain additional facilities, implement new systems, obtain approvals from insurance regulatory agencies or organizations and complete other tasks necessary for the conduct of our intended business activities. If we are unable to implement these actions in a timely manner, our results may be adversely affected. As a result of industry factors or factors specific to us, we have altered and may continue to alter our methods of conducting our business, such as the nature, amount and types of risks we assume and the terms and limits of the products we write or intend to write. A future downgrade in our rating from A.M. Best would materially and adversely affect our competitive position. Competition in the types of insurance and reinsurance business that we intend to underwrite and reinsure are based on many factors, including the perceived financial strength of the insurer and ratings assigned by independent rating agencies. A.M. Best Company, Inc., or A.M. Best, is generally considered to be a significant rating agency with respect to the evaluation of insurance and reinsurance companies. Its ratings are based on a quantitative evaluation of a company's performance with respect to profitability, leverage and liquidity and a qualitative evaluation of spread of risk, investments, reinsurance programs, reserves and management. In addition, its rating of us took into consideration the fact that we have recently commenced our operations. Insurance ratings are used by customers, brokers, reinsurers and reinsurance intermediaries as an important means of assessing the financial strength and quality of insurers. In addition, the rating of a company seeking reinsurance, also known as a ceding company, may be adversely affected by the lack of a rating of its reinsurer. Therefore, the lack of a rating or a poor rating will dissuade a ceding company from reinsuring with us and will influence a ceding company to reinsure with a competitor of ours. Numerous insurers and reinsurers have been downgraded since September 11, 2001, and numerous ratings agencies have kept the reinsurance industry on negative outlook after many reinsurers posted disappointing 2002 and semi-annual 2003 results. We have received a rating of "A–" (excellent) from A.M. Best, which is the fourth highest of fifteen rating levels and indicates A.M. Best's opinion of our financial strength and ability to meet ongoing obligations to our future policyholders. We cannot assure you that we will be able to maintain this rating. A significant ratings downgrade would result in a substantial loss of business and business opportunities as insureds and ceding companies purchase insurance or reinsurance from companies with higher claims-paying and financial strength ratings instead of from us. For further discussion, see "Industry Background — Recent Industry Developments — Ratings Decline." We are dependent on our key executives and may not be able to hire and retain key employees or successfully integrate our management team. Our success will depend largely on our senior management, which includes, among others, Tobey J. Russ, our chairman and chief executive officer, and Michael J. Murphy, our deputy chairman and chief operating officer. We have employment agreements with Messrs. Russ and Murphy for employment through September 2008, which include non-competition obligations. Further, we have an arrangement with David R. Whiting, who manages our Bermuda-based reinsurance operations, for employment through September 2005. While we also have employment arrangements with John S. Brittain, Jr., our chief financial officer, and Gary G. Wang, our chief risk officer, and other key employees, many of them presently do not have non-competition or non-solicitation agreements with us. Therefore, these other executive officers and key employees may voluntarily terminate their employment with us at any time and are not restricted from seeking employment with our competitors or others who may seek their expertise. We do not currently maintain key man life insurance policies with respect to any of our employees other than a $10 million policy on the life of Mr. Murphy that we acquired in the ESC acquisition. While we have assembled a core group of underwriting officers, underwriters and other professionals to write insurance and reinsurance policies, we must attract and retain additional experienced underwriters, claims personnel, actuarial staff and risk analysis and modeling personnel in order to successfully operate and grow our businesses. We will continue to pursue hiring additional executives or other personnel, individually or in groups, from other companies in the insurance and reinsurance industry. For example, we are presently conducting a search for a permanent President of U.S. Insurance to replace Kevin J. McHugh, who served as Interim President of U.S. Insurance from September 2003 until his resignation on March 31, 2004. The number of available, qualified personnel in the insurance and reinsurance industry to fill these positions may be limited. Companies with qualified candidates may have agreements that restrict those persons and our existing employees from soliciting or hiring their employees and working for competitors and may seek to retain, or prevent us from hiring, their executives and other personnel. We cannot assure you that we will be successful in hiring executives or other personnel. In particular, we cannot assure you that we will be able to successfully employ any qualified candidate who is subject to these restrictions or whose employer seeks to prevent us from hiring them or that we will not incur any liability in connection with our hiring, or attempting to hire, such executives or other personnel. For an example, see the description of our settlement of claims made by CNA against some of our employees and against Thomas F. Taylor, one of our former executive officers, in "Business — Legal Proceedings." Our ability to implement our business strategy will depend on the retention and successful integration of our management team and other personnel. Our inability to attract, integrate and retain members of our management team, key employees and other personnel could delay or prevent us from fully implementing our business strategy and could significantly and negatively affect our business. Further, although we are not aware of any planned departures or retirements, if we were to lose the services of our senior executives or key employees, our business could be materially and adversely affected. We cannot assure you that we will successfully attract, retain and integrate our executives, key employees and other personnel. We will require additional capital in the future, which may not be available on favorable terms or at all. We will need to raise additional funds through financings in order to fully implement our business plan. We will require additional capital because some of the markets in which we intend to sell specialty insurance require higher capital levels than the capital we have currently available. We may also require additional funds to acquire other businesses or groups of underwriters or other personnel. The amount and timing of these capital requirements will depend on many factors, including our ability to write new business successfully in accordance with our expectations and to establish premium rates and reserves at levels sufficient to cover our losses. At this time, we are not able to quantify the amount of additional capital we will require in the future or predict the timing of our future capital needs. We intend for us or one or more of our subsidiaries to enter into a secured bank letter of credit and revolving credit facility with a syndicate of lenders. However, we currently have no commitment from any lender with respect to a credit facility. Any equity or debt financing, if available at all, may be on terms that are not favorable to us. If we are able to raise capital through equity financings, your interest in our company would be diluted, and the securities we issue may have rights, preferences and privileges that are senior to the shares offered under this prospectus. If we cannot obtain adequate capital, our business, financial condition and results of operations will be adversely affected. Our future performance cannot be predicted based on the financial information included in this prospectus. As a newly formed company, we have a limited operating history to base an estimate of our future earnings prospects. We are presenting in this prospectus our unaudited pro forma financial statements after giving effect to the acquisition of ESC and the NFU Standard acquisition as if they had occurred as of January 1, 2003. Additionally, this prospectus includes the consolidated historical financial statements of Quanta Holdings, ESC and NFU Standard. The present operating results of ESC, our predecessor, are intended to be only a small portion of our consolidated business in the future, and the business of ESC is not representative of or comparable with our primary business strategy. Additionally, the historical activity of NFU Standard is not indicative of future results since NFU is retaining NFU Standard's historical business other than statutory deposits. Further, because we have only recently commenced our operations, the historical financial results of Quanta Holdings will not provide a meaningful indication of our future performance. As a result, the historical financial information and unaudited pro forma financial information of ESC and NFU Standard presented in this prospectus are not comparable with or representative of the results that we expect to achieve in future periods and will not be helpful in deciding whether to invest in our shares. When purchasing our shares you cannot rely on the pro forma and historical financial information of Quanta Holdings, ESC and NFU Standard in this prospectus to form a meaningful basis on which to assess the value of an investment in Quanta Holdings. We compete with a large number of companies in the insurance and reinsurance industry for underwriting revenues. We compete with a large number of other companies in our selected lines of business. We compete with major insurers and reinsurers, such as ACE Limited ("ACE"), American International Group, Inc. ("AIG"), CNA Financial Corporation ("CNA"), The Chubb Corporation ("Chubb"), XL Capital Ltd., Arch Capital Group Ltd., Swiss Reinsurance Company, Berkshire Hathaway Inc., Munich Re Group, Travelers Property Casualty Corp. ("Travelers") and The St. Paul Companies ("St. Paul") and other new Bermuda insurers and reinsurers, such as Endurance Specialty Holdings Ltd., Axis Capital Holdings Limited, Allied World Assurance Company, Ltd., Platinum Underwriters Holdings, Ltd. and Montpelier Re Holdings Ltd. These insurers and reinsurers have more capital than we have, offer the lines of insurance and reinsurance that we offer or will offer, target the same markets as we do and utilize similar business strategies. We face competition both from specialty insurance companies, underwriting agencies and intermediaries, as well as diversified financial services companies. In addition, newly formed and existing insurance industry companies have recently raised capital to meet perceived demand in the current environment and address underwriting capacity issues. Other newly formed and existing insurance companies may also be preparing to enter the same market segments in which we compete or raise new capital. Since we have a limited operating history, many of our competitors have greater name and brand recognition than we have. Many of them also have more (in some cases substantially more) capital and greater marketing and management resources than we have and may offer a broader range of products and more competitive pricing than we expect to, or will be able to, offer. While we believe our unencumbered capital base, our experienced management team, our technical expertise and other elements of our business strategy will allow us to be competitive, we cannot assure you that we will be able to timely or effectively implement these strategies in a manner that will generate returns on capital superior to those of our competitors. Our competitive position is based on many factors, including our perceived financial strength, ratings assigned by independent rating agencies, geographic scope of business, client relationships, premiums charged, contract terms and conditions, products and services offered (including the ability to design customized programs), speed of claims payment, reputation, experience and qualifications of employees and local presence. Since we have recently commenced operations, we may not be able to compete successfully on many of these bases. If competition limits our ability to write new business at adequate rates, our return on capital may be adversely affected. A number of new, proposed or potential industry developments could further increase competition in our industry. These developments include: an increase in capital-raising activities by companies in our lines of business, which could result in additional new entrants to our markets and an excess of capital in the industry; programs in which state-sponsored entities provide property insurance in catastrophe-prone areas or other "alternative markets" types of coverage; and changing practices caused by the Internet, which may lead to greater competition in the insurance business. New competition from these developments could cause the supply and/or demand for insurance or reinsurance to change, which could affect our ability to price our products at attractive rates and adversely affect our underwriting results. We may misevaluate the risks we seek to insure in the underwriting and pricing of our products. If we misevaluate these risks, our actual insured losses may be greater than our loss reserves, which would negatively impact our business, reputation, financial condition and results of operations. We are a Bermuda company formed to provide specialty lines insurance and reinsurance products on a global basis through our operating subsidiaries. The market for specialty lines insurance and reinsurance products differs significantly from the standard market. In the standard market, insurance rates and forms are highly regulated, products and coverages are largely uniform and have relatively predictable exposures and companies tend to compete for customers on the basis of price and service. In contrast, the specialty market, especially the structured products market, provides coverage for risks that do not fit the underwriting criteria of the standard carriers. We have formed teams of experienced underwriting officers and underwriters with specialized knowledge of their respective market segments to manage each of our product lines where we currently write business. Our success will depend on the ability of these underwriters to accurately assess the risks associated with the businesses that we insure. Underwriting for specialty lines and structured products requires us to make assumptions about matters that are inherently unpredictable and beyond our control and for which historical experience and probability analysis may not provide sufficient guidance. Further, underwriting for specialty lines presents particular difficulties because there is usually limited information available on the client's loss history for the perils being insured and structured insurance products frequently involve coverages for multiple years and multiple business segments. If we fail to adequately evaluate the risks to be insured, our business, financial condition and results of operations could be materially and adversely affected. Significant periods of time often elapse between the occurrence of an insured loss, the reporting of the loss to an insurer and payment by the insurer of that loss. As we recognize liabilities for unpaid losses, we will continue to establish reserves. These reserves represent estimates of amounts needed to pay reported losses and unreported losses and the related loss adjustment expense. Loss reserves are only an estimate of what an insurer anticipates the ultimate costs of claims to be and do not represent an exact calculation of liability. Estimating loss reserves is a difficult and complex process involving many variables and subjective judgments, particularly for new companies, such as ours, that have no loss development experience. As part of our reserving process, we review historical data as well as actuarial and statistical projections and consider the impact of various factors such as: trends in claim frequency and severity; changes in operations; emerging economic and social trends; inflation; and changes in the regulatory and litigation environments. This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events. There is no precise method, however, for evaluating the impact of any specific factor on the adequacy of reserves, and actual results are likely to differ from original estimates. In addition, unforeseen losses, the type or magnitude of which we cannot predict, may emerge in the future. To the extent our loss reserves are insufficient to cover actual losses or loss adjustment expenses, we will have to add to these loss reserves and incur a charge to our earnings, which could have a material adverse effect on our financial condition, results of underwriting and cash flows. In addition, because we, like other insurers and reinsurers, do not separately evaluate each of the individual risks assumed under reinsurance treaties, we are largely dependent on the original underwriting decisions made by ceding companies. We are subject to the risk that our ceding companies may not have adequately evaluated the risks to be reinsured and that the premiums ceded to us may not adequately compensate us for the risks we assume. We may not be able to manage our growth effectively. We only began our business operations after the closing of the Private Offering on September 3, 2003, and we need to continue to rapidly and significantly expand our operations to realize our growth strategy. Our anticipated growth will place significant demands on our management and other resources. As we grow our business in the future, we will need to raise additional capital, continue to obtain, develop and implement systems and acquire human resources. These processes are time consuming and expensive, will increase management responsibilities and will absorb management attention. We cannot assure you that we will be able to meet our capital needs, expand our systems effectively, allocate our human resources optimally, identify and hire qualified employees or incorporate effectively the components of any businesses we may acquire in our effort to achieve growth. The failure to manage our growth effectively could have a material adverse effect on our business, financial condition and results of operations. We may pursue additional opportunities to acquire complementary businesses or groups of underwriters or other individuals, which could adversely affect our financial situation if we fail to successfully integrate the acquired business or group. Since our organization on May 23, 2003, we have acquired ESC, a provider of risk assessment and consulting services, Quanta Specialty Lines, an excess and surplus lines insurer, and Quanta Indemnity, a U.S. licensed insurer with licenses in approximately 41 states. We intend to continue to pursue selective acquisitions of complementary businesses or groups of underwriters or other individuals in the future. Inherent in any future acquisition are certain risks, such as the difficulty of assimilating operations, services, cultures, products and facilities of the acquired business or group, which could have a material adverse effect on our operating results, particularly during the period immediately following such acquisition. Additional debt or equity capital may be required to complete, integrate and fund future acquisitions of these businesses or groups, and there can be no assurance that we will be able to raise the required capital. Furthermore, acquisitions involve a number of risks and challenges, including: diversion of management's attention; the need to integrate acquired businesses, groups of underwriters or other individuals; potential loss of key employees and customers of the acquired business or group; lack of experience in operating in the geographical market of the acquired business or group; an increase in our expenses and working capital requirements; misjudgment of the value of the acquired businesses or groups of underwriters in determining the price paid for the acquisition; and inaccurate assessment of the amount or nature of the liabilities or obligations of the businesses being acquired or assuming liabilities unknown to us at the time of the acquisition. Any of these and other factors could adversely affect our ability to achieve anticipated cash flows at acquired operations or realize other anticipated benefits of acquisitions. Our business is dependent upon insurance and reinsurance brokers, and the failure to develop or maintain important broker relationships could materially adversely affect our ability to market our products and services. We market our insurance and reinsurance products primarily through brokers, and we derive a significant portion of our business from a limited number of brokers. Many of our competitors have had longer term relationships with the brokers that we use or intend to use than we have. Affiliates of at least two of the brokers through whom we market our products, Marsh & McLennan Companies, or Marsh, and Aon Corporation, have also co-sponsored the formation of Bermuda reinsurers that compete with us, and those brokers may decide to favor the companies they sponsored over other companies. While our senior management team and underwriting officers have industry relationships with major industry brokers that we believe are allowing us to establish our presence in the insurance and reinsurance markets, we cannot assure you that we will successfully cultivate and maintain these relationships. The failure to develop or maintain relationships with brokers from whom we expect to receive our business could have a material adverse effect on us. Our reliance on brokers subjects us to their credit risk. In accordance with industry practice, we anticipate that we will frequently pay amounts owed on claims under our insurance or reinsurance contracts to brokers, and these brokers, in turn, will pay these amounts over to the clients that have purchased insurance or reinsurance from us. If a broker fails to make such a payment, in a significant majority of business that we will write, it is highly likely that we will be liable to the client for the deficiency under local laws or contractual obligations. Likewise, when the client pays premiums for these policies to brokers for payment over to us, these premiums are considered to have been paid and, in most cases, the client will no longer be liable to us for those amounts, whether or not we actually receive the premiums from the brokers. Consequently, we will assume a degree of credit risk associated with brokers around the world with respect to most of our insurance and reinsurance business. The occurrence of severe catastrophic events may have a material adverse effect on us. We intend to underwrite property and casualty insurance and reinsurance and will have large aggregate exposures to natural and man-made disasters such as hurricane, typhoon, windstorm, flood, earthquake, acts of war, acts of terrorism and political instability. We expect that our loss experience generally will include infrequent events of great severity. The risks associated with natural and man-made disasters are inherently unpredictable, and it is difficult to predict the timing of such events with statistical certainty or estimate the amount of loss any given occurrence will generate. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. The occurrence of losses from catastrophic events may have a material adverse effect on our ability to write new business, results of operations and financial condition. These losses could eliminate our shareholders' equity and statutory surplus (which is the amount remaining after all liabilities, including loss reserves, are subtracted from all admitted assets, as determined under statutory accounting principles, or SAP). Increases in the values and geographic concentrations of insured property and the effects of inflation have resulted in increased severity of industry losses in recent years and we expect that those factors will increase the severity of catastrophe losses in the future. The availability of reinsurance and retrocessional coverage that we intend to use to limit our exposure to risks may be limited, and counterparty credit and other risks associated with our reinsurance arrangements may result in losses which could adversely affect our financial condition and results of operations. To limit our risk of loss, we use reinsurance and also may use retrocessional coverage, which is reinsurance of a reinsurer's business. The availability and cost of reinsurance and retrocessional protection is subject to market conditions, which are beyond our control. Currently, there is a high level of demand for these arrangements. Because we only recently commenced operations, we may experience difficulties in obtaining or renewing reinsurance and retrocessional protection. We cannot assure you that we will be able to obtain or renew adequate levels of reinsurance or retrocessional protection at cost-effective rates in the future. As a result of market conditions and other factors, we may not be able to successfully alleviate risk through reinsurance and retrocessional arrangements. Further, we will be subject to credit risk with respect to our reinsurance and retrocessional arrangements because the ceding of risk to reinsurers and retrocessionaires will not relieve us of our liability to the clients or companies we insure or reinsure. Our failure to establish adequate reinsurance or retrocessional arrangements or the failure of our reinsurance or retrocessional arrangements to protect us from overly concentrated risk exposure could adversely affect our business, financial condition and results of operations. We must develop, implement and integrate new software and systems. While we have acquired new software and systems responsible for accounting, claims management, modeling and other tasks relating to our insurance and reinsurance operations, we still must implement and integrate these software and systems with each other and with those that we are developing ourselves. In addition, we must acquire or obtain the right to use additional software and systems and continue to develop those systems that we are creating internally. Our failure to acquire, implement or integrate these systems in a timely and effective manner could impede our ability to achieve our business strategy and could significantly and adversely affect our business, financial condition and results of operations. Our business could be adversely affected by Bermuda employment restrictions. We intend to hire primarily non-Bermudians to work for us in Bermuda. Under Bermuda law, non-Bermudians (other than spouses of Bermudians) may not engage in any gainful occupation in Bermuda without an appropriate governmental work permit. Work permits may be granted or extended by the Bermuda government upon showing that, after proper public advertisement in most cases, no Bermudian (or spouse of a Bermudian) is available who meets the minimum standard requirements for the advertised position. The Bermuda government recently announced a new policy limiting the duration of work permits to six years, with certain exemptions for key employees. While we have been able to obtain work permits that we have needed for our employees to date, we can not assure you that we will not encounter difficulties in the future. We may not be able to use the services of one or more of our key employees if we are not able to obtain work permits for them, which could have a material adverse effect on our business. A significant amount of our invested assets will be subject to market volatility. We invest the premiums we receive from customers. Our investment portfolio currently contains highly rated and liquid fixed income securities. Because we classify substantially all of our invested assets as available for sale, we expect changes in the market value of our securities will be reflected in our consolidated balance sheet. Our funds are invested by several professional investment advisory management firms under the direction of our management team in accordance with our investment guidelines and are subject to market-wide risks and fluctuations, as well as to risks inherent in particular securities. The volatility of our claims may force us to liquidate securities, which may cause us to incur capital losses. Our investment results and, therefore, our financial condition may also be impacted by changes in the business, financial condition or results of operations of the entities in which we invest, as well as changes in interest rates, government monetary policies, general economic conditions and overall market conditions. For example, between 2000 and 2002 insurers and reinsurers experienced adverse investment returns as a result of, among other things, high profile bankruptcies and a low interest rate environment. For a further discussion, see "Industry — Recent Industry Developments — Adverse Investment Returns." Further, if we do not structure our investment portfolio so that it is appropriately matched with our insurance and reinsurance liabilities, we may be forced to liquidate investments prior to maturity at a significant loss to cover such liabilities. Investment losses could significantly decrease our asset base, which will affect our ability to conduct business. We may be adversely affected by interest rate changes. Our investment portfolio contains interest rate-sensitive instruments, such as bonds, which may be adversely affected by changes in interest rates. Because of the unpredictable nature of losses that may arise under insurance and reinsurance policies, we expect our liquidity needs will be substantial and may arise at any time. Increases in interest rates during periods when we sell investments to satisfy liquidity needs may result in losses. Changes in interest rates could also have an adverse effect on our investment income and results of operations. For example, if interest rates decline, reinvested funds will earn less than expected. In addition, we expect that our investment portfolio will include highly-rated mortgage-backed securities. As with other fixed income investments, the fair market value of these securities fluctuates depending on market and other general economic conditions and the interest rate environment. Changes in interest rates can expose us to prepayment risks on these investments. In periods of declining interest rates, mortgage prepayments generally increase and mortgage-backed securities are prepaid more quickly, requiring us to reinvest the proceeds at the then current market rates. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. Although we attempt to take measures to manage the risks of investing in a changing interest rate environment, we may not be able to mitigate interest rate sensitivity effectively. Our mitigation efforts include maintaining a high quality portfolio with a relatively short duration to reduce the effect of interest rate changes on book value. Despite our mitigation efforts, a significant increase in interest rates could have a material adverse effect on our book value. Fluctuations in currency exchange rates may cause us to experience losses. Our functional currency is the U.S. dollar. Our operating currency generally will also be the U.S. dollar. However, we expect the premiums receivable and losses payable in respect of a portion of our business will be denominated in currencies of other countries. We will attempt to manage our foreign currency risk by seeking to match our liabilities under insurance and reinsurance policies that are payable in foreign currencies either with forward purchase contracts or with investments that are denominated in these currencies. To the extent we believe that it may be practical, we may hedge our foreign currency exposure with respect to potential losses by maintaining assets denominated in the same currency or entering into forward purchase contracts for specific currencies. We intend to consider using forward purchase contracts when we are advised of known or probable significant losses that will be paid in non-U.S. currencies in order to manage currency fluctuation exposure. We may also consider using forward purchase contracts to hedge our non-U.S. dollar currency exposure with respect to premiums receivable, which will be generally collected over the relevant contract term to the extent practical and to the extent we do not expect we will need these receipts to fund potential losses in such currencies. We may make foreign currency-denominated investments, generally for the purpose of improving overall portfolio yield. However, we may not be successful in reducing foreign currency exchange risks. As a result, we may from time to time experience losses resulting from fluctuations in values of foreign currencies, which could have a material adverse effect on our results of operations. Our profitability may be adversely impacted by inflation. The effects of inflation could cause the severity of claims to rise in the future. Our reserve for losses and loss expenses will include assumptions about future payments for settlement of claims and claims handling expenses, such as medical treatments and litigation costs. To the extent inflation causes these costs to increase above reserves established for these costs, we would be required to increase our loss reserves with a corresponding reduction in our net income in the period in which the deficiency is identified. We have made certain decisions concerning the allocation of our capital base among our subsidiaries. Those decisions could have a major impact on our ability to meet our growth and return objectives. We have established operating subsidiaries in Bermuda, Ireland and the United States and we intend to establish a branch in the United Kingdom. We have attempted to allocate capital among our subsidiaries in such a way as to maximize the composite return to shareholders stemming from our overall capital base. These capital allocation decisions require us to make various operating, regulatory and tax assumptions. If our assumptions were not correct, we may not have allocated our capital in the most optimal manner. This could adversely affect our ability to meet our growth and return objectives. We may incur liability in connection with NFU Standard's past operations if NFU or the reinsurer with which NFU reinsures NFU Standard's liabilities fails to pay the liabilities assumed or reinsured. On December 19, 2003, we purchased all of the outstanding capital stock of NFU Standard, a U.S. licensed insurer with licenses in approximately 41 states, from NFU. NFU assumed from NFU Standard all of its underwriting contracts and associated liabilities except those for which regulatory approvals have not yet been received. NFU has reinsured NFU Standard for 100% of the underwriting contracts and their associated liabilities that are still subject to regulatory approval and will assume these contracts when it obtains regulatory approval. NFU's obligations are guaranteed by OneBeacon Insurance Company, the parent of NFU and a wholly-owned subsidiary of White Mountains Insurance Group, Ltd. In the event that NFU, OneBeacon Insurance Company or any reinsurer fails to pay or is unable to pay the liabilities assumed or reinsured in connection with the acquisition, we would be liable for such claims, which could have a material adverse effect on us. ESC's and Quanta Technical Services' work may expose us to liability. The assessment, analysis and assumption of environmental liabilities, and the management, remediation, and engineering of environmental conditions constitute a significant portion of our consulting business. From time to time, we may also offer a liability assumption program under which a special-purpose entity assumes specified liabilities (at times including taking title to property) associated with environmental conditions for which we provide consulting services, which may be insured or guaranteed by us. These businesses involve significant risks, including the possibility that we may be liable to clients, third parties and governmental authorities for property damage, personal injuries, breach of contract or breach of warranty claims, fines and penalties and regulatory action. As a result, we could be subject to substantial liabilities or fines in the future that could adversely affect our business. In addition, although ESC's former shareholders have indemnified us for certain losses we incur due to breaches of their representations and warranties in the purchase agreement for the acquisition of ESC, this protection is limited and we will be exposed to ESC's liabilities for actions taken prior to our acquisition of ESC to the extent they exceed the indemnification coverage or to the extent that we are not indemnified against these liabilities. ESC's and Quanta Technical Services' services may expose us to professional liability in excess of their current insurance coverage. ESC and Quanta Technical Services may have liability to clients for errors or omissions in the services they perform. These liabilities could exceed ESC's and Quanta Technical Services' insurance coverage and the fees they derive from those services. Prior to our acquisition of ESC, ESC maintained general liability insurance and professional liability insurance. The cost of obtaining these insurance policies is rising. We cannot assure you that this insurance will be sufficient to cover any liabilities ESC incurs or that we will be able to maintain ESC's insurance at reasonable rates or at all. If we terminate ESC's policies and do not obtain retroactive coverage, we will be uninsured for claims against ESC made after termination even if these claims are based on events or acts that occurred during the term of the policy. In addition, we cannot assure you that we will be able to obtain insurance coverage for the new services or areas into which we expand ESC's and Quanta Technical Services' services on favorable terms or at all. We do not yet have in place a bank letter of credit facility, and failure to arrange for such a facility could adversely affect our ability to compete for certain business. While we intend for us or one or more of our operating subsidiaries to enter into a secured bank facility with a syndicate of lenders providing for the issuance of letters of credit and loans on a revolving basis, we do not yet have such a facility or any commitment from a lender to provide that facility. Many U.S. jurisdictions do not permit insurance companies to take credit for reinsurance obtained from unlicensed or non-admitted insurers on their U.S. statutory financial statements without appropriate security, which can include a letter of credit. Quanta Bermuda, Quanta U.S. Re and Quanta Ireland are not, and will not be, licensed in any U.S. jurisdiction. We cannot assure you that we will be able to obtain a credit facility on terms that would be acceptable to us. If we fail to obtain an adequate letter of credit facility, and are unable to otherwise provide the necessary security, insurance companies may be unwilling to purchase our reinsurance products. If this is the case, there may be a material adverse effect on our results of operations. Our holding company structure and certain regulatory and other constraints affect our ability to pay dividends and make other payments. Quanta Holdings is a holding company. As a result, we do not, and will not, have any significant operations or assets other than our ownership of the shares of our subsidiaries. We expect that dividends and other permitted distributions from our operating subsidiaries will be our sole source of funds to pay dividends, if any, to shareholders and to meet ongoing cash requirements, including debt service payments and other expenses. Bermuda law and regulations, including, but not limited to Bermuda insurance regulation, will restrict the declaration and payment of dividends and the making of distributions by Quanta Bermuda and Quanta U.S. Re unless specific regulatory requirements are met. In addition, each of Quanta Ireland, Quanta Specialty Lines and Quanta Indemnity will be subject to significant regulatory restrictions limiting its ability to declare and pay dividends. In addition, any dividends paid by Quanta U.S. Holdings will be subject to a 30% withholding tax. Therefore, we do not expect to receive dividends from any of those subsidiaries, or any other subsidiaries we may form, for the foreseeable future. The inability of our operating subsidiaries to pay dividends in an amount sufficient to enable us to meet our cash requirements at the holding company level could have a material adverse effect on our operations. For a discussion of the legal limitations on our existing and future U.S. subsidiaries' ability to pay dividends and the taxation of these dividends, see "Regulation — U.S. Regulation — Regulation of Dividends and other Payments from Insurance Subsidiaries" and "Material Tax Considerations — Certain U.S. Federal Income Tax Considerations — U.S. Taxation of Quanta Holdings, Quanta Bermuda, Quanta Ireland, Quanta U.S. Holdings, Quanta Specialty Lines, Quanta U.S. Re and Quanta Indemnity." We are subject to Bermuda regulatory constraints that affect our ability to pay dividends on our shares and make other payments. Under the Bermuda Companies Act 1981, as amended (the "Companies Act"), we may declare or pay a dividend out of distributable reserves only if we have reasonable grounds for believing that we are, or would after the payment be, able to pay our liabilities as they become due and if the realizable value of our assets would thereby not be less than the aggregate of our liabilities and issued share capital and share premium accounts. For a discussion of the legal limitations on our existing and future Bermuda subsidiaries' ability to pay dividends to Quanta Holdings and of Quanta Holdings to pay dividends to its shareholders, see "Regulation — Bermuda Regulation — Minimum Solvency Margin and Restrictions on Dividends and Distributions." We are subject to extensive regulation in Bermuda and the United States, and, once authorized, will be subject to extensive regulation in Ireland and the United Kingdom, which may adversely affect our ability to achieve our business objectives. If we do not comply with these regulations, we may be subject to penalties, including fines, suspensions and withdrawals of licenses, which may adversely affect our financial condition and results of operations. We are subject to extensive governmental regulation and supervision. Most insurance regulations are designed to protect the interests of policyholders rather than shareholders and other investors. These regulations, generally administered by a department of insurance in each jurisdiction in which we will do business, relate to, among other things: approval of policy forms and premium rates; standards of solvency, including risk-based capital measurements; licensing of insurers and their agents; limits on the size and nature of risks assumed; restrictions on the nature, quality and concentration of investments; restrictions on the ability of our insurance company subsidiaries to pay dividends to us; restrictions on transactions between insurance company subsidiaries and their affiliates; restrictions on the size of risks insurable under a single policy; requiring deposits for the benefit of policyholders; requiring certain methods of accounting; periodic examinations of our operations and finances; prescribing the form and content of records of financial condition required to be filed; and requiring reserves for unearned premium, losses and other purposes. Insurance departments also conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to financial condition, holding company issues and other matters. These regulatory requirements may adversely affect or inhibit our ability to achieve some or all of our business objectives. In addition, regulatory authorities have relatively broad discretion to deny or revoke licenses for various reasons, including the violation of regulations. We intend to base some of our practices on our interpretations of regulations or practices that we believe are generally followed by the industry. These practices may turn out to be different from the interpretations of regulatory authorities. If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, insurance regulatory authorities could preclude or temporarily suspend us from carrying on some or all of our activities or otherwise penalize us. This could adversely affect our ability to operate our business. Further, changes in the level of regulation of the insurance or reinsurance industry or changes in the laws or regulations themselves or interpretations by regulatory authorities could adversely affect our ability to operate our business. Regulation in the United States. In recent years, the state insurance regulatory framework in the United States has come under increased federal scrutiny, and some state legislators have considered or enacted laws that may alter or increase state authority to regulate insurance companies and insurance holding companies. Moreover, the National Association of Insurance Commissioners ("NAIC"), which is an association of the senior insurance regulatory officials of all 50 states and the District of Columbia, and state insurance regulators regularly reexamine existing laws and regulations, interpretations of existing laws and the development of new laws, which may be more restrictive or may result in higher costs to us than current statutory requirements. Federal legislation is also being discussed that would require all states to adopt uniform standards relating to the regulation of products, licensing, rates and market conduct. We are unable to predict whether any of these or other proposed laws and regulations will be adopted, the form in which any such laws and regulations would be adopted, or the effect, if any, these developments would have on our operations and financial condition. The offshore insurance and reinsurance regulatory framework recently has also become subject to increased scrutiny in many jurisdictions, including in the United States and in various states within the United States. In the past, there have been congressional and other proposals in the United States regarding increased supervision and regulation of the insurance industry, including proposals to supervise and regulate reinsurers domiciled outside the United States. If Quanta Bermuda or Quanta U.S. Re were to become subject to any insurance laws and regulations of the United States or any U.S. state, which are generally more restrictive than those applicable to it in Bermuda, at any time in the future, they might be required to post deposits or maintain minimum surplus levels and might be prohibited from engaging in lines of business or from writing specified types of policies or contracts. Complying with those laws could have a material adverse effect on our ability to conduct business or on our results of operations Regulation in Bermuda. Quanta Bermuda and Quanta U.S. Re are registered Bermuda insurance companies and subject to regulation and supervision in Bermuda. The applicable Bermuda statutes and regulations generally are designed to protect insureds and ceding insurance companies, not our shareholders. Quanta Bermuda and Quanta U.S. Re are not registered or licensed as insurance companies in any jurisdiction outside Bermuda, conduct business through offices in Bermuda and do not maintain an office, and their personnel do not conduct any insurance activities in the United States or elsewhere. Inquiries or challenges to the insurance activities of Quanta Bermuda or Quanta U.S. Re. may be raised in the future. Regulation in Ireland. We expect that, once authorized, Quanta Ireland will be a non-life insurance company incorporated under the laws of Ireland and will be subject to the regulation and supervision of the Irish Financial Services Regulatory Authority, or IFSRA, under the Irish Insurance Acts, 1909 to 2000 and the regulations relating to insurance business and directions made under those regulations (together, the "Insurance Acts and Regulations"). In addition, Quanta Ireland, once authorized, will be subject to certain additional supervisory requirements of IFSRA for authorized non-life insurers that fall outside the strict legislative framework, such as guidelines issued by IFSRA in 2001 requiring actuarial certification of certain reserves. Among other things, without consent of IFSRA, Quanta Ireland may not be permitted to reduce the level of its initial capital, or make any dividend payments or loans. Quanta Ireland will be required to maintain a minimum solvency margin and reserves against underwriting liabilities. Assets constituting these reserves must comply with asset diversification, localization and currency matching rules. If Quanta Ireland writes credit insurance, it will be required to maintain a further equalization reserve. Additionally, Quanta Ireland, once authorized, will be required to agree, in connection with receiving its authorization to engage in the insurance business, to adhere to IFSRA's policy restricting the reinsurance business written by a direct insurer. Under this policy, a direct insurer is prohibited from engaging in reinsurance except to an extent that is not significant (to maximum 10% to 20% of overall business) and subject to certain conditions. In practice IFSRA generally expects a direct insurer to write reinsurance in very limited circumstances. An insurance company supervised by IFSRA may have its authorization revoked or suspended by IFSRA under various circumstances, including, among others, if IFSRA determines that it has not used its authorization for the last 12 months, it has expressly renounced its authorization, has ceased to carry on business covered by the authorization for more than six months; no longer fulfills the conditions required for granting authorization or fails seriously in its obligations under the Insurance Acts and Regulations. The appointment of the directors and senior managers of Quanta Ireland, once authorized, will be subject to prior approval from IFSRA. Changes to any of the Insurance Acts and Regulations, or to the interpretation of these or to the additional supervisory requirements of IFSRA referred to above could have a material adverse effect on our business, financial condition and results of operations. We may be subject to U.S. tax that may have a material adverse effect on our results of operations and your investment. Quanta Holdings and Quanta Bermuda are Bermuda companies and Quanta Ireland is an Irish company. We intend to manage our business so that each of these companies will not be treated as engaged in a trade or business within the United States and, as a result, will not be subject to U.S. tax (other than U.S. excise tax on insurance and reinsurance premium income attributable to insuring or reinsuring U.S. risks and U.S. withholding tax on certain U.S. source investment income). However, because there is considerable uncertainty as to what activities constitute being engaged in a trade or business within the United States, we cannot be certain that the U.S. Internal Revenue Service ("IRS") will not be able to successfully contend that any of Quanta Holdings or its foreign subsidiaries are engaged in a trade or business in the United States. If Quanta Holdings or any of its foreign subsidiaries were considered to be engaged in a business in the United States, we could be subject to U.S. corporate income and branch profits taxes on the portion of our earnings effectively connected to such U.S. business, in which case our results of operations and your investment could be materially adversely affected. See "Material Tax Considerations — Certain U.S. Federal Income Tax Considerations — U.S. Taxation of Quanta Holdings, Quanta Bermuda, Quanta Ireland, Quanta U.S. Holdings, Quanta Specialty Lines, Quanta U.S. Re and Quanta Indemnity." Quanta Holdings or one of its subsidiaries might be subject to U.S. tax on a portion of its income (which in the case of a foreign subsidiary would only include income from U.S. sources) if Quanta Holdings or a subsidiary is considered a personal holding company ("PHC") for U.S. federal income tax purposes. This status will depend on whether more than 50% of our shares by value could be deemed to be owned (under some constructive ownership rules) by five or fewer individuals and whether 60% or more of Quanta Holdings' adjusted ordinary income, or the income of any of its subsidiaries, as determined for U.S. federal income tax purposes, consists of "personal holding company income," which is, in general, certain forms of passive and investment income. We believe based upon information made available to us regarding our shareholder base that neither Quanta Holdings nor any of its subsidiaries should be considered a PHC. Additionally, we intend to manage our business to minimize the possibility that we will meet the 60% income threshold. However, because of the lack of complete information regarding our ultimate share ownership (i.e., as determined by the constructive ownership rules for PHCs), we cannot assure you that Quanta Holdings and/or any of its subsidiaries will not be considered PHC or that the amount of U.S. tax that would be imposed if it were not the case would be immaterial. See "Material Tax Considerations — Certain U.S. Federal Income Tax Considerations — U.S. Taxation of Quanta Holdings, Quanta Bermuda, Quanta Ireland, Quanta U.S. Holdings, Quanta Specialty Lines, Quanta U.S. Re and Quanta Indemnity — Personal Holding Companies." We may be subject to additional Irish tax or to U.K. tax. If any of our non-Irish companies were considered to be resident in Ireland, or to be doing business in Ireland, or, in the case of our U.S. subsidiaries which qualify for the benefits of an existing tax treaty with Ireland, to be doing business through a permanent establishment in Ireland, those companies would be subject to Irish tax. If we or any of our subsidiaries were considered to be resident in the United Kingdom, or to be carrying on a trade in the United Kingdom through a permanent establishment in the United Kingdom, those companies would be subject to United Kingdom tax. If any of our U.S. subsidiaries were subject to Irish tax or U.K. tax, that tax would generally be creditable against their U.S. tax liability, subject to limitations. If we or any of our Bermuda subsidiaries were subject to Irish tax or U.K. tax, that could have a material adverse impact on our results of operation and on the value of our shares. The impact of Bermuda's letter of commitment to the Organization for Economic Cooperation and Development to eliminate harmful tax practices is uncertain and could adversely affect our tax status in Bermuda. The Organization for Economic Cooperation and Development, which is commonly referred to as the OECD, has published reports and launched a global dialogue among member and non-member countries on measures to limit harmful tax competition. These measures are largely directed at counteracting the effects of tax havens and preferential tax regimes in countries around the world. In the OECD's report dated June 26, 2000, Bermuda was not listed as a tax haven jurisdiction because it had previously signed a letter committing itself to eliminate harmful tax practices by the end of 2005 and to embrace international tax standards for transparency, exchange of information and the elimination of any aspects of the regimes for financial and other services that attract business with no substantial domestic activity. We are not able to predict what changes will arise from the commitment or whether these changes will subject us to additional taxes. We may become subject to taxes in Bermuda after March 28, 2016, which may have a material adverse effect on our results of operations and your investment. The Bermuda Minister of Finance, under the Exempted Undertakings Tax Protection Act 1966, as amended, of Bermuda, has given each of Quanta Holdings, Quanta Bermuda and Quanta U.S. Re, an assurance that if any legislation is enacted in Bermuda that would impose tax computed on profits or income, or computed on any capital asset, gain or appreciation, or any tax in the nature of estate duty or inheritance tax, then the imposition of any such tax will not be applicable to Quanta Holdings, Quanta Bermuda and Quanta U.S. Re any of their operations, shares, debentures or other obligations until March 28, 2016. See "Material Tax Considerations — Certain Bermuda Tax Considerations." Given the limited duration of the Minister of Finance's assurance, we cannot be certain that we will not be subject to any Bermuda tax after March 28, 2016. Risks Related to the Industry The insurance and reinsurance business is historically cyclical, and we expect to experience periods with excess underwriting capacity and unfavorable premium rates. Historically, insurers and reinsurers have experienced significant fluctuations in operating results due to competition, frequency of occurrence or severity of catastrophic and other loss events, levels of capacity, general economic and social conditions and other factors. The supply of insurance and reinsurance is related to prevailing prices, the level of insured losses and the level of industry surplus which, in turn, may fluctuate in response to changes in rates of return on investments being earned in the insurance and reinsurance industry. As a result, the insurance and reinsurance business historically has been a cyclical industry characterized by periods of intense price competition due to excessive underwriting capacity as well as periods when shortages of capacity permitted favorable premium levels. Although premium levels for many products, including specialty line products, have increased in recent years, the supply of insurance and reinsurance may increase, either due to capital provided by new entrants or by the commitment of additional capital by existing insurers or reinsurers, which may cause prices to decrease. Any of these factors could lead to a significant reduction in premium rates, less favorable policy terms and fewer submissions for our underwriting services. In addition to these considerations, changes in the frequency and severity of losses suffered by insureds and insurers may affect the cycles of the insurance and reinsurance business significantly. While we believe that our specialty insurance and reinsurance lines may experience less volatility through different business cycles than more standard lines, we expect that our returns will be impacted by the cyclical nature of the insurance and reinsurance industry. A return to negative market conditions may affect our ability to write insurance and reinsurance at rates that we consider appropriate relative to the risk assumed. If we cannot write our specialty lines of insurance and reinsurance at appropriate rates, our ability to transact our business would be significantly and adversely affected. Consolidation in the insurance and reinsurance industry could lead to lower margins for us and less demand for our products and services. The insurance and reinsurance industry is undergoing a process of consolidation as industry participants seek to enhance their product and geographic reach, client base, operating efficiency and general market power through merger and acquisition activities. For example, two of our competitors, Travelers and St. Paul announced on November 17, 2003 that they have signed a definitive merger agreement that will create the nation's second largest commercial insurer. The merger is expected to be completed in the second quarter of 2004. We believe that the larger entities resulting from these merger and acquisition activities may seek to use the benefits of consolidation, including improved efficiencies and economies of scale, to, among other things, implement price reductions for their products and services to increase their market share. If competitive pressures compel us to reduce our prices, our operating margins will decrease. As the insurance industry consolidates, competition for customers may become more intense and the importance of acquiring and properly servicing each customer will become greater. We could incur greater expenses relating to customer acquisition and retention, which could reduce our operating margins. The effects of emerging claim and coverage issues on our business are uncertain. As industry practices and legal, judicial, social and other environmental conditions change, unexpected issues related to claims and coverage may emerge. These issues may adversely affect our business by either extending coverage beyond our underwriting intent or by increasing the number or size of claims. In some instances, these changes may not become apparent until some time after we have issued insurance or reinsurance contracts that are affected by the changes. As a result, the full extent of liability under our insurance or reinsurance contracts may not be known for many years after a contract is issued. Recent examples of emerging claims and coverage issues include: larger settlements and jury awards against professionals and corporate directors and officers covered by professional liability and directors' and officers' liability insurance; and a growing trend of plaintiffs targeting property and casualty insurers in purported class action litigation relating to claims-handling, insurance sales practices and other practices related to the conduct of business in our industry. The effects of these and other unforeseen emerging claim and coverage issues are extremely hard to predict and could harm our business, financial condition and results of operations. Recent federal legislation may negatively affect the business opportunities we perceive are available to us in the market. The Terrorism Risk Insurance Act of 2002 ("TRIA") was enacted by the U.S. Congress and became effective in November 2002 in response to the tightening of supply in some insurance markets resulting from, among other things, the terrorist attacks of September 11, 2001. TRIA applies to the commercial property and casualty insurance written by our U.S. operating subsidiaries. The U.S. Treasury has the power to extend the application of TRIA to our non-U.S. insurance operating subsidiaries as well. TRIA generally requires U.S. insurers, including Quanta Indemnity and Quanta Specialty Lines, to make insurance coverage for certified acts of terrorism available to their policyholders at the same limits and terms as are available for other coverages. Exclusions or sub-limited coverage for certified acts of terrorism may be established, but solely at the discretion of an insured. We are currently unable to predict the extent which TRIA may affect the demand for the products of our U.S. insurance operating subsidiaries, or the risks that may be available for them to consider underwriting. The extent to which coverage for acts of terrorism will be offered by the insurance and reinsurance markets in the future is uncertain. Risks Related to our Shares An active trading market for our shares may not develop. Our shares have no established trading market and are not currently listed on any securities exchange. Although the shares that were sold to qualified institutional buyers in the Private Offering are currently eligible for trading among qualified institutional buyers in The Portal Market of the National Association of Securities Dealers, Inc., shares sold pursuant to this prospectus will not continue to trade on The Portal Market. Our common shares have been approved for listing on the Nasdaq National Market System under the symbol "QNTA." However, an active trading market for the shares may not develop. If an active trading market does not develop or is not maintained, holders of the shares may experience difficulty in reselling, or an inability to sell, the shares. Future trading prices for the shares may be adversely affected by many factors, including changes in our financial performance, changes in the overall market for similar shares and performance or prospects for companies in our industry. We do not currently intend to pay dividends and any determination to pay dividends in the future will be at the discretion of our board of directors and will depend on a number of factors such as whether we have the resources to pay dividends. We currently intend to retain any profits to provide capacity to write insurance and reinsurance and to accumulate reserves and surplus for the payment of claims. As a result, our board of directors currently does not intend to declare dividends or make any other distributions. Our board of directors plans to periodically reevaluate our dividend policy. Any determination to pay dividends in the future will be at the discretion of our board of directors and will depend upon our results of operations, financial condition and other factors deemed relevant by our board of directors. Consequently, it is uncertain when, if ever, we will declare dividends to our shareholders. If you require dividend income, you should carefully consider these risks before investing in our company. Our results of operations and revenues may fluctuate as a result of many factors, including cyclical changes in the insurance and reinsurance industry, which may cause the price of our shares to decline. The results of operations of companies in the insurance and reinsurance industry historically have been subject to significant fluctuations and uncertainties. Our profitability can be affected significantly by: the differences between actual and expected losses that we cannot reasonably anticipate using historical loss data and other identifiable factors at the time we price our products; volatile and unpredictable developments, including man-made, weather-related and other natural catastrophes or terrorist attacks, or court grants of large awards for particular damages; cyclicality relating to the demand and supply of insurance and reinsurance products; changes in the level of reinsurance capacity; changes in the amount of loss reserves resulting from new types of claims and new or changing judicial interpretations relating to the scope of insurers' liabilities; and fluctuations in equity markets, interest rates, credit risk and foreign currency exposure, inflationary pressures and other changes in the investment environment, which affect returns on invested assets and may impact the ultimate payout of losses. In addition, the demand for the types of insurance we will offer can vary significantly, rising as the overall level of economic activity increases and falling as that activity decreases, causing our revenues to fluctuate. These fluctuations in results of operations and revenues may cause the price of our securities to be volatile. Future sales of shares may adversely affect their price. Future sales of common shares by our shareholders or us, or the perception that such sales may occur, could adversely affect the market price of our common shares. Currently, 56,798,218 common shares are outstanding. We have also issued options and Founder Warrants to purchase up to 5,426,213 of our common shares. All of our outstanding common shares, other than the 291,262 common shares sold to Nigel W. Morris as described below, are being registered for resale pursuant to the registration statement of which this prospectus is part. Additionally, all of the 2,542,813 common shares underlying the Founder Warrants are being registered pursuant to the registration statement of which this prospectus is a part, and when and if they are issued, will be freely tradable without restriction under the Securities Act, assuming they are not held by our affiliates. See "Shares Eligible for Future Sales." On December 22, 2003, we sold 291,262 common shares in a private placement to Nigel W. Morris, one of our directors. These shares are not being registered pursuant to the registration statement of which this prospectus is part, but we have entered into a registration rights agreement with Mr. Morris covering these shares. See "Certain Relationships and Related Transactions — Private Placement to Nigel Morris" and "Description of Share Capital — Registration Rights." Provisions in our charter documents may reduce or increase the voting power associated with our shares. Our bye-laws generally provide that shareholders have one vote for each share held by them and are entitled to vote, on a non-cumulative basis, at all meetings of shareholders. However, pursuant to a mechanism specified in our bye-laws, the voting rights exercisable by a shareholder may be limited so that certain persons or groups are not deemed to hold more than 9.5% of the voting power conferred by our shares. In addition, our board of directors retains certain discretion to make adjustments to the aggregate number of votes attaching to the shares of any shareholder that they consider fair and reasonable in all the circumstances to ensure that no person will hold more than 9.5% of the voting power represented by our then outstanding shares. Under these provisions, some shareholders may have the right to exercise their voting rights limited to less than one vote per share. Moreover, these provisions could have the effect of reducing the voting power of certain shareholders who would not otherwise be subject to the limitation by virtue of their direct share ownership. See "Description of Share Capital — Limitation on Voting Rights." As a result of any reduction in the votes of other shareholders, your voting power might increase above 5% of the aggregate voting power of the outstanding shares, which may result in your becoming a reporting person subject to Schedule 13D or 13G filing requirements under the Exchange Act of 1934, as amended (the "Exchange Act"). We also have the authority under our bye-laws to request information from any shareholder for the purpose of determining whether a shareholder's voting rights are to be reduced pursuant to the bye-laws. If a shareholder fails to respond to our request for information or submits incomplete or inaccurate information in response to our request, we may, in our sole discretion, determine that the votes of that shareholder shall be disregarded until the shareholder provides the requested information. It may be difficult for a third party to acquire us. Provisions of our organizational documents may discourage, delay or prevent a merger, tender offer or other change of control that holders of our shares may consider favorable. These provisions impose various procedural and other requirements that could make it more difficult for shareholders to effect various corporate actions. These provisions could: have the effect of delaying, deferring or preventing a change in control of us; discourage bids for our securities at a premium over the price; adversely affect the price of, and the voting and other rights of the holders of, our securities; or impede the ability of the holders of our securities to change our management. See "Description of Share Capital" for a summary of these provisions. U.S. persons who own our shares may have more difficulty in protecting their interests than U.S. persons who are shareholders of a U.S. corporation. The Companies Act, which applies to us, differs in certain material respects from laws generally applicable to U.S. corporations and their shareholders. As a result of these differences, U.S. persons who own our shares may have more difficulty protecting their interests than U.S. persons who own shares of a U.S. corporation. To further understand the risks associated with U.S. persons who own our shares, see "Description of Share Capital — Differences in Corporate Law" for more information on the differences between Bermuda and Delaware corporate laws. We are a Bermuda company and it may be difficult for you to enforce judgments against us or our directors and executive officers. We are incorporated under the laws of Bermuda and our business is based in Bermuda. In addition, some of our directors and officers and some of the experts named in this prospectus reside outside the United States, and all or a substantial portion of our assets and the assets of these persons are, and will continue to be, located in jurisdictions outside the United States. As such, it may be difficult or impossible to effect service of process within the United States upon us or those persons or to recover against us or them on judgments of U.S. courts, including judgments predicated upon civil liability provisions of the U.S. federal securities laws. Further, no claim may be brought in Bermuda against us or our directors and officers in the first instance for violation of U.S. federal securities laws because these laws have no extraterritorial jurisdiction under Bermuda law and do not have force of law in Bermuda. A Bermuda court may, however, impose civil liability, including the possibility of monetary damages, on us or our directors and officers if the facts alleged in a complaint constitute or give rise to a cause of action under Bermuda law. We have been advised by Conyers Dill & Pearman, our Bermuda counsel, that there is doubt as to whether the courts of Bermuda would enforce judgments of U.S. courts obtained in actions against us or our directors and officers, as well as the experts named in this prospectus, predicated upon the civil liability provisions of the U.S. federal securities laws or original actions brought in Bermuda against us or these persons predicated solely upon U.S. federal securities laws. Further, we have been advised by Conyers Dill & Pearman that there is no treaty in effect between the United States and Bermuda providing for the enforcement of judgments of U.S. courts, and there are grounds upon which Bermuda courts may not enforce judgments of U.S. courts. Some remedies available under the laws of U.S. jurisdictions, including some remedies available under the U.S. federal securities laws, may not be allowed in Bermuda courts as contrary to that jurisdiction's public policy. Because judgments of U.S. courts are not automatically enforceable in Bermuda, it may be difficult for you to recover against us based upon such judgments. If you acquire 10% or more of Quanta Holdings' shares, you may be subject to taxation under the "controlled foreign corporation" ("CFC") rules. Each "10% U.S. Shareholder" of a foreign corporation that is a CFC for an uninterrupted period of 30 days or more during a taxable year, and that owns shares in the CFC directly or indirectly through foreign entities on the last day of the CFC's taxable year, must include in its gross income for U.S. federal income tax purposes its pro rata share of the CFC's "subpart F income," even if the subpart income is not distributed. A foreign corporation is considered a CFC if "10% U.S. Shareholders" own more than 50% of the total combined voting power of all classes of voting stock of the foreign corporation, or the total value of all stock of the corporation. A 10% U.S. Shareholder is a U.S. person, as defined in the Internal Revenue Code, that owns at least 10% of the total combined voting power of all classes of stock entitled to vote of the foreign corporation. A CFC also includes a foreign corporation in which more than 25% of the total combined voting power of all classes of stock (or more than 25% of the total value of the stock) is owned by 10% U.S. Shareholders, on any day during the taxable year of such corporation, if the gross amount of premiums or other consideration for the reinsurance or the issuing of insurance or annuity contracts generating subpart F income exceeds specified limits. For purposes of determining whether a corporation is a CFC, and therefore whether the more-than-50% (or more-than-25%, in the case of insurance income) and 10% ownership tests have been satisfied, shares owned includes shares owned directly or indirectly through foreign entities or shares considered owned under constructive ownership rules. The attribution rules are complicated and depend on the particular facts relating to each investor. See "Material Tax Considerations — Certain U.S. Federal Income Tax Considerations — U.S. Taxation of Holders of Shares — Shareholders Who Are U.S. Persons." Quanta Holdings' bye-laws contain provisions that impose limitations on the concentration of voting power of its shares and that authorize the board to purchase its shares under specified circumstances. Accordingly, based upon these provisions and information we have about our shareholder base, we do not believe that we have any 10% U.S. shareholders. It is possible, however that the IRS could challenge the effectiveness of these provisions and that a court could sustain such a challenge. We may require you to sell your shares of Quanta Holdings to us. Our bye-laws provide that we have the option, but not the obligation, to require a shareholder to sell its shares at a purchase price equal to their fair market value to us, to other shareholders or to third parties if our board of directors in its absolute discretion determines that the share ownership of that shareholder may result in adverse tax consequences to us, any of our subsidiaries or any other shareholder. To the extent possible under the circumstances, the board of directors will use its best efforts to exercise this option equally among similarly situated shareholders. Our right to require a shareholder to sell its shares to us will be limited to the purchase of a number of shares that we determine is necessary to avoid or cure those adverse tax consequences. See "Description of Share Capital — Bye-laws." U.S. persons who hold shares could be subject to adverse tax consequences if we are considered a "passive foreign investment company" (a "PFIC") for U. S. federal income tax purposes. We do not intend to conduct our activities in a manner that would cause us to become a PFIC. However, it is possible that we could be deemed a PFIC by the IRS for 2003 or any future year. If we were considered a PFIC it could have material adverse tax consequences for an investor that is subject to U.S. federal income taxation, including subjecting the investor to a greater tax liability than might otherwise apply or subjecting the investor to tax on amounts in advance of when tax would otherwise be imposed. There are currently no regulations regarding the application of the PFIC provisions to an insurance company. New regulations or pronouncements interpreting or clarifying these rules may be issued in the future. We cannot predict what impact, if any, this guidance would have on a shareholder that is subject to U.S. federal income taxation. We have not sought and do not intend to seek an opinion of legal counsel as to whether or not we were a PFIC for the year ended December 31, 2003. See "Material Tax Considerations — Certain U.S. Federal Income Tax Considerations — U.S. Taxation of Holders of Shares — Shareholders Who Are U.S. Persons." U.S. persons who hold shares will be subject to adverse tax consequences if we or any of our subsidiaries are considered a "foreign personal holding company" ("FPHC") for U.S. federal income tax purposes. Quanta Holdings and/or any of its future non-U.S. subsidiaries could be considered to be a FPHC for U.S. federal income tax purposes. This status will depend on whether more than 50% of our shares by vote or value could be deemed to be owned by five or fewer individuals who are citizens or residents of the United States, and the percentage of our income, or that of our subsidiaries, that consists of "foreign personal holding company income," as determined for U.S. federal income tax purposes. We believe, based upon information made available to us regarding our shareholder base, that neither we nor any of our subsidiaries are, and we currently do not expect any of them or us to become, a FPHC for U.S. federal income tax purposes. Due to the lack of complete information regarding our ultimate share ownership, however, we cannot be certain that we will not be considered a FPHC. If we were considered a FPHC it could have material adverse tax consequences for an investor that is subject to U.S. federal income taxation including subjecting the investor to a greater tax liability than might otherwise apply and subjecting the investor to tax on amounts in advance of when tax would otherwise be imposed. See "Material Tax Considerations — Certain U.S. Federal Income Tax Considerations — U.S. Taxation of Holders of Shares — Shareholders Who Are U.S. Persons." U.S. persons who hold shares may be subject to U.S. income taxation on their pro rata share of our "related party insurance income" ("RPII"). If: Quanta Ireland's or Quanta Bermuda's RPII equals or exceeds 20% of that company's gross insurance income in any taxable year, direct or indirect insureds (and persons related to such insureds) own (or are treated as owning directly or indirectly) 20% or more of the voting power or value of the shares of Quanta Ireland or Quanta Bermuda, and U.S. persons are considered to own in the aggregate 25% or more of the stock of either corporation by vote or value, then a U.S. person who owns shares of Quanta Holdings directly or indirectly through foreign entities on the last day of the taxable year would be required to include in its income for U.S. federal income tax purposes the shareholder's pro rata share of Quanta Ireland's or Quanta Bermuda's RPII for the U.S. person's taxable year that includes the end of the corporation's taxable year determined as if such RPII were distributed proportionately to such U.S. shareholders at that date regardless of whether such income is distributed. In addition any RPII that is includible in the income of a U.S. tax-exempt organization will be treated as unrelated business taxable income. The amount of RPII earned by Quanta Ireland or Quanta Bermuda (generally, premium and related investment income from the direct or indirect insurance or reinsurance of any direct or indirect U.S. shareholder of Quanta Ireland or Quanta Bermuda or any person related to such shareholder) will depend on a number of factors, including the geographic distribution of Quanta Ireland's or Quanta Bermuda's business and the identity of persons directly or indirectly insured or reinsured by Quanta Ireland or Quanta Bermuda. Although we do not expect our RPII to exceed 20% of our gross insurance income in the foreseeable future, some of the factors which determine the extent of RPII in any period may be beyond Quanta Ireland's or Quanta Bermuda's control. Consequently, Quanta Ireland's or Quanta Bermuda's RPII could equal or exceed 20% of its gross insurance income in any taxable year and ownership of its shares by direct or indirect insureds and related persons could equal or exceed the 20% threshold described above. The RPII rules provide that if a shareholder that is a U.S. person disposes of shares in a foreign insurance corporation that has RPII (even if the amount of RPII is less than 20% of the corporation's gross insurance income or the ownership of its shares by direct or indirect insureds and related persons is less than the 20% threshold) and in which U.S. persons own 25% or more of the shares, any gain from the disposition will generally be treated as ordinary income to the extent of the shareholder's share of the corporation's undistributed earnings and profits that were accumulated during the period that the shareholder owned the shares (whether or not such earnings and profits are attributable to RPII). In addition, such a shareholder will be required to comply with reporting requirements, regardless of the amount of shares owned by the shareholder. These rules should not apply to dispositions of our shares because Quanta Holdings will not itself be directly engaged in the insurance business and because proposed U.S. Treasury regulations appear to apply only in the case of shares of corporations that are directly engaged in the insurance business. However, the IRS might interpret the proposed regulations in a different manner and the applicable proposed regulations may be promulgated in final form in a manner that would cause these rules to apply to dispositions of our shares. See "Material Tax Considerations — Certain U.S. Federal Income Tax Considerations — U.S. Taxation of Holders of Shares — Shareholders Who Are U.S. Persons." Changes in U.S. federal income tax law could materially adversely affect an investment in our shares. Legislation has been introduced in the U.S. Congress that is intended to eliminate some perceived tax advantages of companies (including insurance companies) that have legal domiciles outside the United States but have some U.S. connections, including legislation that would permit the IRS to reallocate or recharacterize items of income, deduction or some other items related to a reinsurance agreement between related parties to reflect the proper source, character and amount for each item (in contrast to current law, which only refers to source and character). While we do not believe that this proposal, or any other currently pending legislative proposal, if enacted, would have a material adverse effect on us, our subsidiaries or our shareholders, it is possible that broader based legislative proposals could emerge in the future that, if enacted, could have an adverse impact on us, our subsidiaries or our shareholders. Additionally, the U.S. federal income tax laws and interpretations regarding whether a company is engaged in a trade or business within the United States, or is a PFIC or whether U.S. persons would be required to include in their gross income the subpart F income or the RPII of a CFC are subject to change, possibly on a retroactive basis. There are currently no regulations regarding the application of the PFIC rules to insurance companies and the regulations regarding RPII are still in proposed form. New regulations or pronouncements interpreting or clarifying such rules may be issued in the future. We cannot be certain if, when or in what form such regulations or pronouncements may be provided and whether such regulations or guidance will have a retroactive effect.

parsed_sections/risk_factors/2004/CIK0001266914_bhc_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ RISK FACTORS You should consider carefully the following factors, as well as the information contained in the rest of this prospectus before deciding whether to participate in the exchange offer. Risk Factors Relating to the Exchange Offer You must carefully follow the required procedures in order to exchange your original notes. The exchange notes will be issued in exchange for original notes only after timely receipt by the exchange agent of a duly executed letter of transmittal and all other required documents. Therefore, if you wish to tender your original notes, you must allow sufficient time to ensure timely delivery. Neither we nor the exchange agent has any duty to notify you of defects or irregularities with respect to tenders of original notes for exchange. Any holder of original notes who tenders in the exchange offer for the purpose of participating in a distribution of the exchange notes will be required to comply with the registration and prospectus delivery requirements of the Securities Act in connection with any resale transaction. Each broker or dealer that receives exchange notes for its own account in exchange for original notes that were acquired in market-making or other trading activities must acknowledge that it will deliver a prospectus in connection with any resale of the exchange notes. If you do not exchange original notes for exchange notes, transfer restrictions will continue and trading of the original notes may be adversely affected. The original notes have not been registered under the Securities Act and are subject to substantial restrictions on transfer. Original notes that are not tendered for exchange for exchange notes or are tendered but are not accepted will, following completion of the exchange offer, continue to be subject to existing restrictions upon transfers. We do not currently expect to register the original notes under the Securities Act. To the extent that original notes are tendered and accepted in the exchange offer, the trading market for original notes, if any, could be adversely affected. Risks Relating to the Exchange Notes Our substantial indebtedness could adversely affect our cash flow and prevent us from fulfilling our obligations, including making payments on the exchange notes. We have a significant amount of debt. As of September 30, 2003, we had $261.7 million of total debt and members equity of $222.5 million. Our substantial amount of debt could have important consequences to you. For example, it could: make it more difficult for us to satisfy our obligations under the exchange notes and under the new senior secured credit facility; require us to dedicate a substantial portion of our cash flow from operations to make interest and principal payments on our debt, thereby limiting the availability of our cash flow to fund future capital expenditures, working capital and other general corporate requirements; limit our flexibility in planning for, or reacting to, changes in our business, which may place us at a competitive disadvantage compared with competitors that have less debt; increase our vulnerability to adverse economic and industry conditions; and limit our ability to borrow additional funds, even when necessary to maintain adequate liquidity. The terms of the agreement governing our new senior secured credit facility and the indenture governing the exchange notes allow us to incur substantial amounts of additional debt. Any such additional debt could increase the risks associated with our substantial leverage. (In thousands) Current $ 248 $ 460 $ 519 Deferred Table of Contents Your right to receive payments on the exchange notes will be junior to our existing and future senior debt, including borrowings under our new senior secured credit facility. Further, the guarantees of the exchange notes are junior to all of the guarantors existing and future senior debt. The exchange notes will rank behind all of our existing and future senior debt. The guarantees will rank behind all of the guarantors existing and future senior debt. As of September 30, 2003, we had $4.8 million of senior debt, none of which represented borrowings under our new senior secured credit facility, and all of which was incurred by the guarantors. Our new senior secured credit facility provides for borrowings of up to $125.0 million, subject to a borrowing base (which is the maximum amount we may borrow at any one time based upon the sum of a percentage of the book value of certain accounts receivable and a percentage of the net book value of certain fixed assets), and a $200.0 million incremental term loan facility in certain events. Any borrowings under our new senior secured credit facility would be senior debt when borrowed. As of September 30, 2003, we could have borrowed the maximum $125.0 million under the credit facility according to the borrowing base. We are permitted to borrow substantial additional senior indebtedness in the future under the terms of the indenture that will govern the exchange notes. As a result of such subordination, upon any distribution to our creditors in a bankruptcy, liquidation, reorganization or similar proceeding, the holders of our senior debt will be entitled to be paid in full before any payment will be made on the exchange notes. In addition, upon any distribution to the creditors of the guarantors in a bankruptcy, liquidation, reorganization or similar proceeding, the holders of the guarantors senior debt will be entitled to be paid in full before any payment will be made on the guarantees. In addition, we will be prohibited from making any payments on the exchange notes and the guarantees if we default on our payment obligations on our senior debt and we may be prohibited from making any such payments for up to 179 consecutive days if certain non-payment defaults on senior debt occur. In the event of a bankruptcy, liquidation or reorganization or similar proceeding relating to us or the guarantors, you, as a holder of the exchange notes, will participate with all other holders of subordinated indebtedness in the assets remaining after we and the guarantors have paid all of our and their senior debt. However, because the indenture requires that amounts otherwise payable to you in a bankruptcy or similar proceeding be paid to holders of senior debt instead, you may receive less, ratably, than holders of other subordinated debt in any such proceeding. In any of these cases, we may not have sufficient funds to pay all of our creditors and you may receive less, ratably, than the holders of senior debt. Not all of our subsidiaries will guarantee the exchange notes, and the assets of our non-guarantor subsidiaries may not be available to make payments on the exchange notes. The guarantors of the exchange notes will not include all of our subsidiaries. One of our subsidiaries, Lovelace Health Systems, Inc., is a regulated health maintenance organization, or HMO, and is therefore prohibited from providing a full and unconditional guarantee of the exchange notes. On October 1, 2003, our New Mexico operations (other than the operations of AHS S.E.D. Medical Laboratories, Inc.) were merged and consolidated into Lovelace Health Systems, Inc. and the note guarantees of certain New Mexico entities were released. The newly-created entity, Lovelace Sandia Health System, Inc., continues to be a regulated HMO and is therefore prohibited from providing a full and unconditional guarantee of the exchange notes. For the nine months ended September 30, 2003, the entities constituting Lovelace Sandia Health System, Inc. after this merger and consolidation had aggregate revenues of $693.2 million, which constituted 70.8% of our consolidated revenues for that period. As of September 30, 2003, these entities had aggregate total assets of $451.2 million, which represented 57.6% of our total assets, and $241.5 million of aggregate indebtedness and other liabilities, which represented 53.6% of our total indebtedness and other liabilities. In addition, the indenture governing the notes allows us to create additional non-guarantor subsidiaries and to release the guarantees of subsidiary guarantors upon the sale of a subsidiary guarantor or upon our designation of a subsidiary guarantor as a non-restricted subsidiary under the indenture, provided in each case that we meet certain tests under the indenture. In order to sell any subsidiary guarantor, the indenture requires that we receive consideration at least equal to the fair market value of the guarantor, of which at Table of Contents Primary State or Other Standard I.R.S. Address, including zip code, and Jurisdiction of Industrial Employer telephone number, including Exact Name of Registrant Incorporation Classification Identification area code, of Registrant s as Specified in its Charter or Organization Code Number principal executive offices Table of Contents least 75% must be in the form of cash, cash equivalents or replacement assets (which are non-current tangible assets to be used in our business), and that the proceeds of the sale must be applied to the repayment of senior debt, to purchase replacement assets or make a capital expenditure that is useful in our business. To the extent we have any amount of proceeds remaining, we are required to make an offer to purchase that amount of outstanding notes and any other indebtedness which ranks equally with the notes. The indenture also sets forth certain requirements we must meet in order to designate a subsidiary guarantor as a non-restricted subsidiary, including that the subsidiary s indebtedness must be permissible under the indenture, the aggregate fair market value of all investments owned by us and the other subsidiary guarantors in that subsidiary must be permissible under the indenture, and that the subsidiary cannot own any equity interests of, or hold any liens on any property of, us or the other subsidiary guarantor. Additionally, that subsidiary cannot be party to any agreement with us or any subsidiary guarantor the terms of which are less favorable than those that might be obtained from unrelated third parties, and that subsidiary cannot have guaranteed or provided credit support for any indebtedness of us or any other guarantor. That subsidiary is also required to have one director and one officer who do not serve as directors or officers of us or any other subsidiary guarantor and no event of default may be in existence at the time of our designation under the indenture. In the event that any non-guarantor subsidiary becomes insolvent, liquidates, reorganizes, dissolves or otherwise winds up, holders of its indebtedness and its trade creditors generally will be entitled to payment on their claims from the assets of that subsidiary before any of those assets are made available to us. Consequently, your claims in respect of the exchange notes will be effectively subordinated to all of the liabilities of our non-guarantor subsidiaries, including trade payables. We are a holding company and, as such, we do not have, and will not have in the future, any income from operations. We are a holding company and conduct substantially all of our operations through our subsidiaries. Consequently we do not have any income from operations and do not expect to generate income from operations in the future. As a result, our ability to meet our debt service obligations, including our obligations under the exchange notes, substantially depends upon our subsidiaries cash flow and payment of funds to us by our subsidiaries as dividends, loans, advances or other payments. The payment of dividends or the making of loans, advances or other payments to us by our subsidiaries may be subject to regulatory or contractual restrictions. As a regulated insurance company, Lovelace Sandia Health System, Inc. may be restricted from paying dividends to us, which may reduce the amount of cash available to us. The ability of Lovelace Sandia Health System, Inc. to pay dividends or make other distributions to us is restricted by state insurance company laws and regulations. These laws and regulations require Lovelace Sandia Health System, Inc. to give notice to the New Mexico Department of Insurance prior to paying dividends or making distributions to us. In addition, Lovelace Sandia Health System, Inc. is subject to state-imposed risk-based or other net worth-based capital requirements that effectively limit the amount of funds the subsidiary has available to distribute or pay to us. As a result of these capital requirements or other agreements we may enter into with state regulators, we may not be able to receive any funds from Lovelace Sandia Health System, Inc. and, moreover, we may be required to make contributions to Lovelace Sandia Health System, Inc. to enable the subsidiary to meet its capital requirements, thereby further limiting the funds we may have to make payments with respect to the exchange notes. At September 30, 2003, Lovelace Sandia Health System, Inc. was required to maintain a net worth of $34.1 million. Actual net worth as of that date exceeded the requirement by $16.9 million. As a result of the merger and consolidation of our New Mexico operations (other than the operations of AHS S.E.D. Medical Laboratories, Inc.) into Lovelace Sandia Health System, Inc., the entities constituting Lovelace Sandia Health System, Inc. (which, for the nine months ended September 30, 2003, accounted for approximately 71% of our total net revenues) are subject to the above restrictions and regulations. As of September 30, 2003, these entities had cash and cash equivalents of approximately $33.2 million. Table of Contents To service our debt, we will require a significant amount of cash, which may not be available to us. Our ability to make payments on, or repay or refinance, our debt, including the exchange notes, and to fund planned capital expenditures, will depend largely upon our future operating performance. Our debt service obligation, including principal and interest payments, for calendar year 2004 is anticipated to be approximately $29.5 million. Our future performance, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available to us under our new senior secured credit facility or from other sources in an amount sufficient to enable us to pay our debt, including the exchange notes, or to fund our other liquidity needs. In addition, prior to the repayment of the exchange notes, we will be required to refinance our new senior secured credit facility. We cannot assure you that we will be able to refinance any of our debt, including our new senior secured credit facility, on commercially reasonable terms or at all. If we were unable to make payments or refinance our debt or obtain new financing under these circumstances, we would have to consider other options, such as: sales of assets; sales of equity; and/or negotiations with our lenders to restructure the applicable debt. Our credit agreements and the indenture governing the exchange notes restrict, and market or business conditions may limit, our ability to sell assets or equity or restructure any debt. The agreements governing our debt, including the exchange notes and our new senior secured credit facility, contain various covenants that limit our discretion in the operation of our business and could lead to the acceleration of our debt. Our new senior secured credit facility imposes, and future financing agreements are likely to impose, operating and financial restrictions on our activities. These restrictions require us to comply with or maintain certain financial tests and ratios, including minimum net worth and interest coverage ratios and maximum total and senior leverage ratios and limit or prohibit our ability to, among other things: incur additional debt and issue preferred stock; create liens; redeem and/or prepay certain debt; pay dividends on our stock or repurchase stock; make certain investments; enter new lines of business; engage in consolidations, mergers and acquisitions; make certain capital expenditures; and pay dividends and make other distributions. These restrictions on our ability to operate our business could seriously harm our business by, among other things, limiting our ability to take advantage of financings, mergers, acquisitions and other corporate opportunities. Various risks, uncertainties and events beyond our control could affect our ability to comply with these covenants and maintain these financial tests and ratios. Failure to comply with any of the covenants in our existing or future financing agreements could result in a default under those agreements and under other agreements containing cross-default provisions. A default would permit lenders to accelerate the maturity for the debt under these agreements and to foreclose upon any collateral securing the debt. Under Pretax income (loss): United States $ 7,033 $ 4,258 $ (771 ) $ 1,803 $ (11,151 ) Foreign Table of Contents these circumstances, we might not have sufficient funds or other resources to satisfy all of our obligations, including our obligations under the exchange notes. In addition, the limitations imposed by financing agreements on our ability to incur additional debt and to take other actions might significantly impair our ability to obtain other financing. The exchange notes generally are not secured by our assets or those of the guarantors, whereas the lenders under our new senior secured credit facility are entitled to remedies available to a secured lender, which gives them priority over you to collect amounts due to them. In addition to being subordinated to all our existing and future senior debt, the exchange notes and the guarantees will not be secured by any of our assets other than the intercompany note pledged in connection with the consolidation of the majority of our New Mexico operations. Our obligations under our new senior secured credit facility are secured by, among other things, a first priority pledge of all of the common stock of our subsidiaries and substantially all our assets. If we become insolvent or are liquidated, or if payment under our new senior secured credit facility or in respect of any other secured indebtedness is accelerated, the lenders under our new senior secured credit facility or holders of other secured indebtedness are entitled to exercise the remedies available to a secured lender under applicable law (in addition to any remedies that may be available under documents pertaining to our new senior secured credit facility or other senior debt). These lenders will have a claim on all assets securing their debt before the holders of unsecured debt, including the exchange notes. The interests of the principal members of our parent may not be aligned with your interests as a holder of the exchange notes. Welsh, Carson, Anderson Stowe IX, L.P. and its related investors control a majority of the voting power of the outstanding common units of our parent, which in turn holds all of the voting power of our common stock. Consequently, these equity holders will control all of our affairs and policies. Circumstances may occur in which the interests of these equity holders could be in conflict with the interest of the holders of the exchange notes. Generally, holders of debt securities such as the exchange notes have limited opportunities for capital appreciation and therefore are primarily focused on an issuer s creditworthiness and ability to make interest and principal payments. Because we do not currently pay a dividend to our equity holders, they are focused primarily on capital appreciation. As a result, our equity holders may have an interest in causing us to pursue acquisitions, divestitures or other transactions that, in the judgment of such equity holders, have the potential to enhance the value of their equity investment, even though such transactions might also involve risks to holders of the exchange notes, including risks to our creditworthiness. Our senior secured credit facility prohibits our ability to make a change of control offer required by the indenture governing the exchange notes, which could lead to a default under the indenture. The terms of the exchange notes will require us to make an offer to repurchase the exchange notes upon the occurrence of a change of control at a purchase price equal to 101% of the principal amount of the exchange notes, plus accrued interest to the date of the purchase. We are prohibited under the new senior secured credit facility, and may be prohibited under future debt agreements, from purchasing any exchange notes prior to their stated maturity. In such circumstances, we will be required to repay or obtain the requisite consent from the affected lenders to permit the repurchase of the exchange notes. Absent a consent, we can only make a change in control offer if there are sufficient funds remaining after repaying all amounts outstanding under the senior secured credit facility. If we are unable to repay all of such debt or are unable to obtain the necessary consents, we will be unable to offer to repurchase the exchange notes, which would constitute an event of default under the indenture governing the exchange notes, which itself would also constitute a default under our new senior secured credit facility and our other existing financing arrangements. Table of Contents The guarantees may not be enforceable because of fraudulent conveyance laws. The guarantors guarantees of the exchange notes may be subject to review under U.S. federal bankruptcy law or relevant state fraudulent conveyance laws if a bankruptcy lawsuit is commenced by or on behalf of our or the guarantors unpaid creditors. Under these laws, if in such a lawsuit a court were to find that, at the time a guarantor incurred debt (including debt represented by the guarantee), such guarantor: incurred this debt with the intent of hindering, delaying or defrauding current or future creditors; or received less than reasonably equivalent value or fair consideration for incurring this debt and the guarantor: was insolvent or was rendered insolvent by reason of the related financing transactions; was engaged, or about to engage, in a business or transaction for which its remaining assets constituted unreasonably small capital to carry on its business; or intended to incur, or believed that it would incur, debts beyond its ability to pay these debts as they mature, as all of the foregoing terms are defined in or interpreted under the relevant fraudulent transfer or conveyance statutes; then the court could void the guarantee or subordinate the amounts owing under the guarantee to the guarantor s presently existing or future debt or take other actions detrimental to you. In addition, the subsidiary guarantors may be subject to the allegation that since they incurred their guarantees for our benefit, they incurred the obligations under the guarantees for less than reasonably equivalent value or fair consideration. The measure of insolvency for purposes of the foregoing considerations will vary depending upon the law of the jurisdiction that is being applied in any such proceeding. Generally, a company would be considered insolvent if, at the time it incurred the debt or issued the guarantee: it could not pay its debts or contingent liabilities as they become due; the sum of its debts, including contingent liabilities, is greater than its assets, at fair valuation; or the present fair saleable value of its assets is less than the amount required to pay the probable liability on its total existing debts and liabilities, including contingent liabilities, as they become absolute and mature. If a guarantee is voided as a fraudulent conveyance or found to be unenforceable for any other reason, you will not have a claim against that obligor and will only be our creditor or that of any guarantor whose obligation was not set aside or found to be unenforceable. In addition, the loss of a guarantee will constitute a default under the indenture, which default would cause all outstanding notes to become immediately due and payable. An active public market may not develop for the exchange notes, which may hinder your ability to liquidate your investment. The exchange notes are a new issue of securities with no established trading market, and we do not intend to list them on any securities exchange. The liquidity of the trading market in the exchange notes, and the market price quoted for the exchange notes, may be adversely affected by changes in the overall market for fixed income securities and by changes in our financial performance or prospects or in the prospects for companies in our industry in general. As a result, we cannot assure you that an active trading market will develop for the exchange notes. If no active trading market develops, you may not be able to resell your exchange notes at their fair market value or at all. Table of Contents Risks Relating to Our Business We may not successfully integrate our recent and future acquisitions and may be unable to achieve anticipated cost savings and other benefits from these acquisitions. Since August 2001, we have acquired seven acute care hospitals, including a significant health plan, two behavioral hospitals and various other ancillary services. These acquisitions have significantly increased the size and geographic scope of our operations. In addition, one of our primary growth strategies for the future is completing additional acquisitions. The integration of past and future acquisitions involves a number of risks and presents financial, managerial and operational challenges. For example, at one of our acquired hospitals, we experienced delays in billings related to information systems transitions, and as a result, our results of operations were negatively affected. In addition to risk associated with information systems integration, we face the following risks: we may have difficulty integrating personnel and physicians from acquired hospitals; we may have difficulty, and may incur unanticipated expenses related to, upgrading the financial systems and controls at our new facilities; we may uncover liabilities at our newly-acquired operations of which we are not aware or that are greater than expected and for which the previous owner may be unable or unwilling to indemnify us; and we may be unable to improve existing managed care agreements and the mix of specialties offered at our hospitals. Failure to integrate past and future acquisitions successfully and in a timely fashion may have an adverse effect on our business, results of operations and financial condition. In addition, we may be unable to achieve the anticipated cost savings from these acquisitions for many reasons, including: contractual constraints on our ability to reduce excess staffing, inability to achieve expected tax savings from a more streamlined legal structure or inability to extract lower prices from our suppliers. Our strategy depends in part on our ability to acquire hospitals that meet our target criteria. If we are unable to do so, our future growth could be limited and our operating results could be adversely affected. The competition to acquire acute care and behavioral hospitals in the selected markets that we will target is significant, including competition from healthcare companies with greater financial resources than us and larger development staffs focused on identifying and completing acquisitions. We may be unable to identify acquisitions opportunities and to negotiate and complete acquisitions on favorable terms. Our inability to complete such acquisitions may negatively impact our future growth and results of operations. We may have difficulty acquiring hospitals from not-for-profit entities due to increased regulatory scrutiny. Many states have enacted or are considering enacting laws affecting sales, leases or other transactions in which control of not-for-profit hospitals is acquired by for-profit entities. These laws, in general, include provisions relating to state attorney general approval, advance notification and community involvement, determination of appropriate valuation of assets divested and the use of proceeds of the sale by the not-for-profit entity. In addition, state attorneys general in states without specific conversion legislation governing such transactions may exercise authority based upon charitable trust and other existing laws. The increased legal and regulatory review of these transactions involving the change of control of not-for-profit hospitals may increase the costs and time required for such acquisitions, and therefore, limit our ability to acquire not-for-profit hospitals. In addition, as a condition to approving an acquisition, certain state attorneys general may require us to maintain certain services, such as emergency departments, or to continue to provide certain levels of charity care, which may affect our decision to acquire or the terms of an acquisition of these hospitals as well as the future profitability of any such hospitals we acquire. Net income (loss) from continuing operations $ 4,343 $ Table of Contents Our acquisition strategy may be limited by restrictions and covenants in our new senior secured credit facility and by the lack of adequate alternative sources of financing. Our senior secured credit facility contains limitations on acquisitions of regulated and non-regulated entities. If we are unable to obtain any required consents from our lenders for future acquisitions, our strategy of growing by selective acquisitions may be limited. In addition, our acquisition strategy may require that we obtain additional capital to finance future transactions. Sufficient capital or financing may not be available to us on satisfactory terms, if at all. Either of these factors would negatively affect our future operating performance. Our revenues may decline if federal or state programs reduce our Medicare or Medicaid payments or managed care companies reduce our reimbursements. A substantial portion of our total net revenues is derived from the Medicare and Medicaid programs. The Medicare program accounted for 42.2% of our acute care patient days and 9.4% of our behavioral patient days for the nine months ended September 30, 2003. The Medicaid program accounted for 7.4% of our acute care patient days and 33.8% of our behavioral patient days during the nine months ended September 30, 2003. In recent years, federal and state governments have made significant changes in the Medicare and Medicaid programs. In addition, due to budget deficits in many states, significant decreases in state funding for the Medicaid programs have occurred or are being proposed. These changes in the Medicare and Medicaid programs have decreased the amounts of money we receive for our services to patients who participate in these programs. In recent years, Congress and some state legislatures have introduced a number of other proposals to make major changes in the healthcare system. Medicare-reimbursed, hospital-outpatient services converted to a prospective payment system on August 1, 2000. This system creates limitations on levels of payment for a substantial portion of hospital outpatient procedures. Future federal and state legislation may further reduce the payments we receive for our services. A number of states have adopted legislation designed to reduce their Medicaid expenditures. Some states have enrolled Medicaid recipients in managed care programs (which generally tend to reduce the level of hospital utilization) and have imposed additional taxes on hospitals to help finance or expand the states Medicaid systems. Some states have also reduced the scope of Medicaid eligibility and coverage, making an increasing number of residents unable to pay for their care. Other states propose to take similar steps. In addition, insurance and managed care companies and other third parties from whom we receive payment for our services increasingly attempt to control healthcare costs by requiring that hospitals discount their fees in exchange for exclusive or preferred participation in their benefit plans. We believe that this trend may continue and may reduce the payments we receive for our services. We face intense competition from other hospitals and other healthcare providers which may result in a decline in revenues, profitability and market share. The healthcare business is highly competitive and competition among hospitals and other healthcare providers for patients has intensified in recent years. Most of our facilities operate in geographic areas where we compete with at least one other hospital that provides services comparable to those offered by our facilities. In addition, the number of freestanding specialty hospitals and outpatient surgery and diagnostic centers in the areas in which our hospitals operate has also increased significantly. Some of the hospitals that compete with us are owned or operated by tax-supported governmental bodies or by private not-for-profit entities supported by endowments and charitable contributions which can finance capital expenditures on a tax-exempt basis and are exempt from sales, property and income taxes. Some of our competitors are more established, offer highly specialized facilities, equipment and services, which may not be available at our hospitals, offer a wider range of services or have more capital or other resources. The intense competition we face from other healthcare providers may have an adverse effect on our market share, revenues and results of operations. (A) (A) (A) (B) (Dollars in thousands) Statement of Operations Data: Revenues: Net patient service revenue $ 369,539 $ 7,994 $ 113,902 $ 138,396 $ $ 629,831 Premium revenue 13,232 27,268 509,580 550,080 Other revenue 25,213 Table of Contents Primary State or Other Standard I.R.S. Address, including zip code, and Jurisdiction of Industrial Employer telephone number, including Exact Name of Registrant Incorporation Classification Identification area code, of Registrant s as Specified in its Charter or Organization Code Number principal executive offices Table of Contents Regional concentration of our business may subject us to economic downturns in the State of New Mexico and, in particular, the Albuquerque metropolitan area. With our recent acquisitions of five acute care hospitals (including one inpatient rehabilitation hospital), two health maintenance organizations (which we subsequently merged), and certain ancillary services in New Mexico, the majority of our revenue is generated in New Mexico. For the nine months ended September 30, 2003, our New Mexico operations accounted for approximately 72% of our total net revenues. This concentration of business in New Mexico exposes us to potential losses resulting from a downturn in the economy of the State of New Mexico and, in particular, Albuquerque. If economic conditions deteriorate, we may experience a reduction in existing and new business, which may have an adverse effect on our business, financial condition and results of operations. Our success depends on our ability to attract new physicians and maintain good relationships with physicians and other healthcare professionals at our hospitals. Because physicians working with acute care hospitals generally direct the majority of hospital admissions, our success in operating our acute care hospitals will be, in part, dependent upon the number and quality of physicians on these hospitals medical staffs, the admissions practices of the physicians at these hospitals and our ability to maintain good relations with our physicians. With the exception of approximately 320 employed physicians in Albuquerque, our physicians are generally not employees of the hospitals at which they practice and most physicians have admitting privileges at other hospitals in addition to our hospitals. Physicians may terminate their affiliation with our hospitals at any time. If we are unable to successfully maintain good relationships with physicians, our hospitals admissions may decrease and our results of operations may be adversely affected. For example, patient volume at Sandia Health System was negatively affected during the nine-month period ended September 30, 2003 by the departure of certain physicians. In addition, physicians are increasingly seeking to supplement their declining income by building facilities or offering services that compete with acute care hospitals, such as ambulatory surgery centers, diagnostic imaging centers, or specialty hospitals. These facilities and services may attract patients from the more profitable service lines of an acute care hospital, leaving the hospital with less profitable or unprofitable service lines, such as emergency departments, that the hospital may be unable to close for community relations and other reasons. We compete with other healthcare providers in recruiting and retaining qualified management and staff personnel responsible for the day-to-day operations of each of our hospitals, including nurses and other non-physician healthcare professionals. In the healthcare industry generally, including our markets, the scarcity of nurses and other medical support personnel has become a significant operating issue. This shortage may require us to increase wages and benefits to recruit and retain nurses and other medical support personnel, or to hire more expensive contract or temporary personnel. If our labor costs increase, we may not be able to raise rates to offset these increased costs. Because a significant percentage of our revenues are derived from fixed, prospective payments, our ability to pass along increased labor costs is constrained. Our failure to recruit and retain qualified management, nurses and other medical support personnel, or to control our labor costs, could have an adverse effect on our business and results of operations. We depend heavily on our senior and local management personnel, and the loss of the services of one or more of our key senior management personnel or our key local management personnel could weaken our management team and our ability to deliver healthcare services efficiently. We have been, and will continue to be, dependent upon the services and management experience of David T. Vandewater, our Chief Executive Officer, Jamie E. Hopping, our Chief Operating Officer, R. Dirk Allison, our Chief Financial Officer, and our other senior executive officers. We have entered into employment agreements with each of these senior executive officers, but we do not maintain key person life insurance for these executive officers. If Mr. Vandewater, Ms. Hopping, Mr. Allison or any of our other senior executive officers were to resign their positions or otherwise be unable to serve, our management could be weakened and operating results could be adversely affected. In addition, our success Substantially all of the Company s long-term investments are held in the CHI Investment Program. The Program is structured under a Limited Partnership Agreement between CHI, as managing general partner, and each participant. All investments in the Program are professionally managed by the Company under the administration of CHI. Investments held in the Program are represented by pool units valued monthly under a custodian accounting system. Investment income from the Program, including interest income, dividends, and realized gains or losses from the sale of securities, is distributed to participants based on the earnings per pool unit. Gains or losses also are realized by participants when pool units are sold, representing the difference between the cost basis and the market value of the pool units sold. The fair value of the assets held is an allocation of the underlying market value of the assets in the Program, based upon pool units held by the participants. The underlying fair value of investments in the Program, which are traded on national exchanges, is based on the last reported sales price on the last business day of the fiscal year. The market value of investments traded in over-the-counter markets is based on the average of the last recorded bid and asked prices. Net unrealized gains (losses) on investments was $(0.59 million) at August 31, 2002. Investment losses and gains for assets limited as to use, cash equivalents, and other investments for the two-month period ended August 31, 2002 is as follows: Income (loss): Interest income $ 112 Realized gains (losses) on sales of securities (467 ) Dividend income Table of Contents depends on our ability to attract and retain local managers at our hospitals and related facilities, on the ability of our officers and key employees to manage growth successfully and on our ability to attract and retain skilled employees. If we are unable to attract and retain local management, our operating performance could be adversely affected. We conduct business in a heavily regulated industry; changes in regulations or violations of regulations may result in increased costs or sanctions that could reduce revenue and profitability. Healthcare providers are required to comply with many laws and regulations at the federal, state and local government levels. These laws and regulations relate to: licensing; the conduct of operations; the relationships among hospitals and their affiliated providers; the ownership of facilities; the addition of facilities and services; confidentiality, maintenance and security issues associated with medical records; billing for services; and prices for services. If we fail to comply with applicable laws and regulations, we could suffer civil and criminal penalties, including the loss of our licenses to operate and our ability to participate in Medicare, Medicaid, and other federal and state healthcare programs. In addition, there are heightened coordinated civil and criminal enforcement efforts by both federal and state government agencies relating to the healthcare industry, including the hospital segment. The ongoing investigations in this industry relate generally to various referral, cost reporting and billing practices, laboratory and home healthcare services, and physician ownership and joint ventures involving hospitals. In the future, different interpretations or enforcement of these laws and regulations could subject our current practices to allegations of impropriety or illegality or could require us to make changes in our operations. We may be subjected to actions brought by individuals on the government s behalf under the False Claims Act s qui tam or whistleblower provisions. Whistleblower provisions allow private individuals to bring actions on behalf of the government alleging that the defendant has defrauded the federal government. Because qui tam lawsuits are filed under seal, we could be named in one or more such lawsuits of which we are not aware. Several of our subsidiaries have been named as defendants in two qui tam lawsuits. Defendants determined to be liable under the False Claims Act may be required to pay three times the actual damages sustained by the government, plus mandatory civil penalties of between $5,500 and $11,000 for each separate false claim. Typically, each fraudulent bill submitted by a provider is considered a separate false claim, and thus the penalties under a false claim case may be substantial. Liability arises when an entity knowingly submits a false claim for reimbursement to the federal government. In some cases, whistleblowers or the federal government have taken the position that providers who allegedly have violated other statutes, such as the anti-kickback statute or the Stark Law and have submitted claims to a governmental payor during the time period they allegedly violated these other statutes, have thereby submitted false claims under the False Claims Act. In addition, a number of states have adopted their own false claims provisions as well as their own whistleblower provisions allowing a private party to file a civil lawsuit in state court. The cost of our malpractice insurance and the malpractice insurance of physicians who practice at our facilities or who participate in our networks continues to rise. Successful malpractice or tort claims asserted against us, our providers or our employees could adversely affect our financial condition and profitability. In recent years, physicians, hospitals and other healthcare providers have become subject to an increasing number of legal actions alleging malpractice or related legal theories. Many of these actions involve large claims and significant defense costs. To protect ourselves from the cost of these claims, we generally maintain professional malpractice liability insurance and general liability insurance coverage in amounts and with deductibles that we believe to be appropriate for our operations. Effective October 31, 2003, we established a wholly owned captive insurance subsidiary to insure our professional and general liability risk for claims up to $2.0 million. In addition, effective October 31, 2003, we purchased excess insurance coverage with independent third-party carriers for claims up to $75.0 million per occurrence and Net income (loss) 3,904 5,007 5,053 2,716 17,869 3,336 (7,829 ) Accrued preferred dividends 5,892 3,944 5,993 1,210 8 12 (Unaudited) Property, plant, and equipment $ $ 203 $ 19 $ 279 $ $ 2,550 Other assets, net 350 Table of Contents in the aggregate. However, our insurance coverage may not cover all claims against us or continue to be available at a reasonable cost for us to maintain adequate levels of insurance. In addition, physicians malpractice insurance costs have dramatically increased to the point where some physicians are either choosing to retire early or leave certain markets. If physician malpractice costs continue to escalate in markets in which we operate, some physicians may choose not to practice at our facilities, which could reduce our patient volume and thus our revenue. Our managed care providers involved in medical care decisions may be exposed to the risk of medical malpractice claims. Many of our network providers are our employees for whose acts we may be liable as an employer. In addition, managed care organizations may be sued directly for various types of alleged negligence, such as in connection with the credentialing of network providers or improper denials or delay of care. Finally, Congress is considering legislation that would permit managed care organizations to be held liable for negligent treatment decisions or benefits coverage determinations. If this or similar legislation were enacted, claims of this nature could result in substantial damage awards against us and our providers that could exceed the limits of any applicable medical malpractice insurance coverage and could have a material adverse effect on our financial condition. Our business depends on our information systems, and our inability to effectively integrate and manage our information systems could disrupt our operations. Our business is dependent on effective information systems that assist us in, among other things, monitoring utilization and other cost factors, supporting our healthcare management techniques, processing provider claims and providing data to our regulators. Our managed care providers also depend upon our information systems for membership verifications, claims status and other information. If we experience a reduction in the performance, reliability or availability of our information systems, our operations and ability to produce timely and accurate reports could be adversely impacted. Our information systems and applications require continual maintenance, upgrading and enhancement to meet our operational needs. Moreover, our acquisition activity requires transitions to or from, and the integration of, various information systems. We regularly upgrade and expand our information systems capabilities and are currently in the process of rolling out new clinical and financial reporting systems throughout our operations. If we experience difficulties with the transition to or from information systems or are unable to properly implement, maintain or expand our systems, we could suffer, among other things, from operational disruptions, loss of membership in our networks, regulatory problems and increases in administrative expenses. Failure to maintain the privacy and security of patients medical records could expose us to liability. The Health Insurance Portability and Accountability Act of 1996 required the Department of Health and Human Services to issue regulations requiring hospitals and other providers to implement measures to ensure the privacy and security of patients medical records and the use of uniform data standards for the exchange of information between the hospitals and health plans, including claims and payment transactions. The privacy standard became effective October 15, 2002. Full compliance with the privacy standard was required by April 14, 2003. Although we believe we have met the April 14, 2003 privacy standard compliance deadline, compliance will be an ongoing process. The transaction standard and the security standard became effective on October 16, 2000 and February 20, 2003, respectively. Full compliance with the transaction standard was required by October 16, 2003 and full compliance with the security standard is required by April 20, 2005. We are in the process of complying with the transaction standard and security standard. We may incur additional expenses in order to comply with these standards. We cannot predict the full extent of our costs of implementing all of the requirements at this stage. If we violate these standards, we may be subject to civil monetary fines and sanctions and criminal penalties. Further, a substantial portion of our revenue is derived from payments by governmental health plans, such as Medicare, and private health plans. Our failure, or the failure of the health plans with which we transact, to comply with the transaction standard may result in significant disruptions in the payments we Table of Contents receive from such health plans. Finally, because of the confidential nature of the health information we store and transmit, privacy or security breaches could expose us to a risk of regulatory action, litigation, possible liability and loss. Our privacy or security measures may be inadequate to prevent breaches, and our business operations would be adversely impacted by cancellation of contracts and loss of members if they are not prevented. A reduction in enrollment in our health plan or the failure to maintain satisfactory relationships with providers could affect our business and profitability. Premium revenue from our health plan accounted for approximately 46.1% of our total net revenues for the nine months ended September 30, 2003. A reduction in the number of members in our health plan could reduce our revenues and profitability. Factors that could contribute to a reduction in membership include premium increases, benefit changes and reductions in workforce by existing customers. In recent years, the managed care industry has received considerable negative publicity. This publicity has led to increased review of industry practices, legislation, regulation and litigation. These factors may adversely affect our ability to market our health plan services, require us to change our health plan procedures or services, and increase the regulatory burdens under which our health plan operates, further increasing the costs of doing business and adversely affecting our operating results. The profitability of our health plan depends, in large part, upon its ability to contract favorably with hospitals, physicians and other healthcare providers in appropriate numbers and at locations appropriate for the health plan s members in New Mexico. Providers could refuse to contract, demand higher payments or take other actions that could result in higher healthcare costs. If any of the key providers to our health plan refuses or is otherwise unavailable to contract with our health plan, uses its market position to negotiate more favorable contracts or otherwise places our health plan at a competitive disadvantage, our operating results could be adversely affected. Provider arrangements for our health plan with contracted primary care physicians, specialists and hospitals in its network usually have one-year terms and automatically renew for successive one-year periods. Generally, these contracts may also be cancelled by either party without cause upon 30 to 90 days prior written notice. Our health plan may be unable to continue to renew such contracts or enter into new contracts enabling our health plan to service its members profitably. If our health plan is unable to retain its current provider contracts or enter into new provider contracts on a timely basis or on favorable terms, our results of operations could be adversely affected. If we are unable to effectively price our health plan premiums or manage medical costs, our profitability will be reduced. A large amount of revenues of our health plan consists of fixed monthly payments per member. These payments are fixed by contract, and the health plan is obligated during the contract period to provide or arrange for the provision of all healthcare services required by such member. Historically, medical care costs of our health plan as a percentage of premium and other operating revenue has fluctuated. If premiums are not increased and medical care costs rise, the earnings of our health plan on insured business could decrease. In addition, actual medical care costs of our health plan may exceed its estimated costs on insured business. The premiums our health plan receives under its current insurance contracts may therefore be inadequate to cover all claims, which may cause our profits to decline. Our health plan profitability depends, to a significant degree, on our ability to predict and effectively manage medical costs. Historically, there have been fluctuations in the medical care cost ratio of our health plan. Relatively small changes in these medical care cost ratios can create significant changes in our financial results. Changes in healthcare laws, regulations and practices, utilization of services, hospital costs, pharmaceutical costs, major epidemics, terrorism or bioterrorism, new medical technologies and other external factors, including general economic conditions such as inflation levels, could reduce our ability to predict and effectively control the costs of providing healthcare services. If our medical care costs increase, our profits could be reduced or we may not remain profitable. Beginning temporarily restricted net assets $ 2,148 $ 2,184 $ 4,733 Temporarily restricted contributions 1,097 669 834 Net assets released from restrictions (503 ) (775 ) (3,055 ) Investment income (14 ) 44 278 Other changes 5 Table of Contents Our medical care costs also include estimates of claims incurred but not reported, or IBNR. We, together with our independent actuaries, estimate our medical claims liabilities using actuarial methods based on historical data for payment patterns, cost trends, product mix, seasonality, utilization of healthcare services and other relevant factors. The estimation methods and the resulting accrued liabilities are continually reviewed and updated, and adjustments, if necessary, are reflected in the period when they become known. While our IBNR estimates generally have been adequate in the past, they may be inadequate in the future, which would negatively affect our results of operations. Further, our inability to accurately estimate IBNR may also affect our ability to take timely corrective actions, further exacerbating the extent of the negative impact on our results. We maintain accrued liabilities on our financial statements in amounts we believe are adequate to provide for actuarial estimates of medical claims. We also maintain reinsurance to protect us against certain catastrophic medical claims by Medicaid beneficiaries who participate in our health plan. While we believe our reinsurance coverage with respect to these Medicaid claims is adequate, in the future such reinsurance coverage may be inadequate or unavailable to us or the cost of such reinsurance coverage may limit our ability to obtain other insurance. We do not maintain reinsurance to protect us against other catastrophic medical claims under our health plan. Recently enacted or proposed legislation, regulations and initiatives could adversely affect our business by increasing our operating costs, reducing our health plan membership or subjecting us to additional litigation. In recent years, an increasing number of legislative initiatives have been introduced or proposed in Congress and in state legislatures that would effect major changes in the healthcare system, either nationally or at the state level. Among the proposals that have been introduced are price controls on hospitals, insurance market reforms to increase the availability of group health insurance to small businesses, requirements that all businesses offer health insurance coverage to their employees and the creation of a government health insurance plan or plans that would cover all citizens, and increased payments by beneficiaries. Increased regulations, mandated benefits and more oversight, audits and investigations and changes in laws allowing access to federal and state courts to challenge healthcare decisions may increase our administrative, litigation and healthcare costs. We cannot predict whether any of the above proposals or any other proposals will be adopted, and if adopted, no assurance can be given that the implementation of such reforms will not have a material adverse effect on our business and results of operations. Net cash (used in) provided by discontinued operations (67 ) 20 (1 ) (112 ) 34 You should rely only on the information contained in this prospectus. We have not authorized any person to provide you with any information or represent anything about us or this offering that is not contained in this prospectus. If given or made, any such other information or representation should not be relied upon as having been authorized by us. We are not making an offer of the exchange notes in any jurisdiction where an offer is not permitted. Table of Contents Primary State or Other Standard I.R.S. Address, including zip code, and Jurisdiction of Industrial Employer telephone number, including Exact Name of Registrant Incorporation Classification Identification area code, of Registrant s as Specified in its Charter or Organization Code Number principal executive offices Table of Contents THE EXCHANGE OFFER Purposes and Effect of the Exchange Offer We sold the original notes on August 19, 2003 to Banc of America Securities LLC, UBS Securities LLC, Banc One Capital Markets, Inc. and Merrill Lynch, Pierce, Fenner Smith Incorporated (the initial purchasers ), who resold the original notes to qualified institutional buyers in reliance on Rule 144A under the Securities Act and outside the United States to non-U.S. persons in compliance with Regulation S under the Securities Act. In connection with the issuance of the original notes, we, our parent and our subsidiaries that guarantee the original notes (the subsidiary guarantors ) entered into a registration rights agreement with the initial purchasers of the original notes. The following description of the registration rights agreement is a summary only. It is not complete and does not describe all of the provisions of the registration rights agreement. For more information, you should review the provisions of the registration rights agreement that we filed with the SEC as an exhibit to the registration statement of which this prospectus is a part. Under the registration rights agreement, we agreed that, promptly after the effectiveness of the registration statement of which this prospectus is a part, we would offer to the holders of original notes who are not prohibited by any law or policy of the SEC from participating in the exchange offer, the opportunity to exchange their original notes for a new series of notes, which we refer to as the exchange notes, that are identical in all material respects to the original notes, except that the exchange notes do not contain transfer restrictions, have been registered under the Securities Act and are not subject to further registration rights. We, our parent and our subsidiary guarantors have agreed to use our reasonable best efforts to keep the exchange offer open for not less than 20 business days, or longer if required by applicable law, after the date on which notice of the exchange offer is mailed to the holders of the original notes. We, our parent and our subsidiary guarantors also have agreed to use our reasonable best efforts to cause the exchange offer to be consummated on the earliest practicable date after the registration statement of which this prospectus is a part has become effective, but in no event later than 30 business days after such date of effectiveness. If: (1) we, our parent and our subsidiary guarantors are not permitted to file an exchange offer registration statement or consummate the exchange offer because the exchange offer is not permitted by applicable law or SEC policy; (2) for any reason the exchange offer is not consummated within 30 business days after the registration statement of which this prospectus is a part is declared effective; or (3) any holder of transfer restricted securities notifies us that: (a) it is prohibited by law or SEC policy from participating in the exchange offer; or (b) it may not resell the exchange notes acquired by it in the exchange offer to the public without delivering a prospectus and the prospectus contained in the registration statement of which this prospectus is a part is not appropriate or available for such resales; or (c) it is a broker-dealer and owns original notes acquired directly from us or one of our affiliates, then we, our parent and the subsidiary guarantors will: (1) as soon as practicable but in any event on or prior to 45 days after the filing obligation arises, file a shelf registration statement with the SEC covering resales of the transfer restricted securities by the holders thereof who satisfy certain conditions relating to the provision of information in connection with the shelf registration statement; Table of Contents (2) use reasonable best efforts to cause the shelf registration statement to become effective on or before 135 days after the filing obligation arises; and (3) use reasonable best efforts to keep the shelf registration statement effective until the earliest to occur of (a) two years from the date on which the shelf registration statement is declared effective and (b) the time when all notes covered by the shelf registration statement have been sold pursuant to the shelf registration statement or are no longer transfer restricted securities. For purposes of the foregoing, a transfer restricted security is each original note until the earliest to occur of: (1) the date on which the original note has been exchanged in the exchange offer and may be resold to the public by the holder without complying with the prospectus delivery requirements of the Securities Act; (2) the date on which the original note has been effectively registered under the Securities Act and disposed of in accordance with the shelf registration statement; and (3) the date on which the original note is distributed to the public pursuant to Rule 144 under the Securities Act or by a broker-dealer pursuant to the procedures described in Plan of Distribution. A registration default will be deemed to occur under the registration rights agreement if: (1) any registration statement required by the registration rights agreement is not filed with the SEC on or prior to the date specified for such filing in the registration rights agreement; (2) any registration statement required by the registration rights agreement has not been declared effective by the SEC on or prior to the date specified for such effectiveness in the registration rights agreement; (3) the exchange offer has not been consummated within 30 business days of the effective date of the registration statement of which this prospectus is a part; or (4) any registration statement required by the registration rights agreement is filed and declared effective by the SEC but thereafter shall cease to be effective or fail to be usable for its intended purpose during the periods specified in the registration statement. Upon the occurrence of a registration default, we will pay liquidated damages to each holder of transfer restricted securities, with respect to the first 90-day period immediately following the occurrence of the first registration default in an amount equal to a per annum rate of 0.50% on the principal amount of transfer restricted securities held by such holder. The amount of the liquidated damages will increase by an additional per annum rate of 0.50% with respect to each subsequent 90-day period until all registration defaults have been cured, up to a maximum amount of liquidated damages for all registration defaults of 1.50% per annum on the principal amount of transfer restricted securities. Following the cure of all registration defaults, the accrual of liquidated damages will cease. By acquiring transfer restricted securities, a holder will be deemed to have agreed to indemnify us, our parent and our subsidiary guarantors against certain losses arising out of information furnished by the holder in writing for inclusion in any registration statement. Holders of transfer restricted securities will also be required to suspend their use of the prospectus included in the registration statement under certain circumstances upon receipt of notice to that effect from us. Resale of the Exchange Notes Based on an interpretation by the staff of the SEC set forth in no-action letters issued to third parties, we believe that, unless you are a broker-dealer or an affiliate of us, you may offer for resale, resell or otherwise transfer the exchange notes issued to you pursuant to the exchange offer without compliance with the registration and prospectus delivery provisions of the Securities Act, provided that you acquire the Balance at September 30, 2003 5,000 $ 131,252 30,005 $ Table of Contents exchange notes in the ordinary course of business and you do not intend to participate and have no arrangement or understanding with any person to participate in the distribution of the exchange notes. If you are an affiliate of us or if you tender in the exchange offer with the intention to participate, or for the purpose of participating, in a distribution of the exchange notes, you may not rely on the position of the staff of the SEC enunciated in Exxon Capital Holdings Corporation (available May 13, 1988) and Morgan Stanley Co., Incorporated (available June 5, 1991), or similar no-action letters, but rather must comply with the registration and prospectus delivery requirements of the Securities Act in connection with any resale transaction. In addition, any such resale transaction should be covered by an effective registration statement containing the selling security holder information required by Item 507 or 508, as applicable, of Regulation S-K of the Securities Act. Each broker-dealer that receives exchange notes for its own account in exchange for original notes, where the original notes were acquired by such broker-dealer as a result of market-making activities or other trading activities, must acknowledge that it will deliver a prospectus in connection with any resale of the exchange notes. See Plan of Distribution. By tendering in the exchange offer, you represent to us that, among other things: (1) you are not an affiliate of us; (2) you are not engaged in, and do not intend to engage in, and have no arrangement or understanding with any person to participate in, a distribution of the exchange notes to be issued in the exchange offer; (3) you are acquiring the exchange notes in the ordinary course of business; and (4) you acknowledge and agree that if you are a broker-dealer or are using the exchange offer to participate in a distribution of the exchange notes acquired in the exchange offer: (a) you cannot rely on the no-action letters described above; and (b) you must, in the absence of an exemption, comply with the registration and prospectus delivery requirements of the Securities Act in connection with any resale of the exchange notes. Terms of the Exchange Offer Upon satisfaction or waiver of all the conditions of the exchange offer, we will accept any and all original notes properly tendered and not validly withdrawn prior to the expiration date and will promptly issue the exchange notes. See Conditions to the Exchange Offer and Procedures for Tendering. We will issue $1,000 principal amount of exchange notes in exchange for each $1,000 principal amount of original notes accepted in the exchange offer. As of the date of this prospectus, there is $225,000,000 in principal amount of original notes. Holders may tender some or all of their original notes pursuant to the exchange offer. However, original notes may be tendered only in integral multiples of $1,000. The exchange offer is not conditioned upon any number or aggregate principal amount of original notes being tendered. The form and terms of the exchange notes will be the same in all material respects as the form and terms of the original notes, except that the exchange notes will be registered under the Securities Act and therefore will not bear legends restricting their transfer. The exchange notes will evidence the same debt as the original notes and will be issued pursuant to, and entitled to the benefits of, the indenture pursuant to which the original notes were issued. Original notes that are accepted for exchange will be cancelled and retired. Interest on the exchange notes will accrue from the most recent date to which interest has been paid on the original notes or, if no interest has been paid on the original notes, the issue date. Accordingly, registered holders of exchange notes on the relevant record date for the first interest payment date following the completion of the exchange offer will receive interest accruing from the most recent date to which interest has been paid or, if no interest has been paid on the original notes, the issue date. Original notes accepted for exchange will cease to accrue interest from and after the date the exchange offer closes. Table of Contents If your original notes are accepted for exchange, you will not receive any payment in respect of interest on the original notes for which the record date occurs on or after completion of the exchange offer. You do not have any appraisal or dissenters rights under the indenture in connection with the exchange offer. We intend to conduct the exchange offer in accordance with the provisions of the registration rights agreement. If you do not tender for exchange or if your tender is not accepted, the original notes will remain outstanding and you will be entitled to the benefits of the indenture, but will not be entitled to any registration rights under the registration rights agreement. For purposes of the exchange offer, we will be deemed to have accepted validly tendered original notes when, and if, we have given oral or written notice thereof to the exchange agent. The exchange agent will act as our agent for the purpose of distributing the appropriate exchange notes from us to the tendering holders. If we do not accept any tendered original notes because of an invalid tender, the occurrence of certain other events set forth in this prospectus or otherwise, we will return the unaccepted original notes, without expense, to the tendering holder thereof promptly after the expiration date. If you tender your original notes in the exchange offer, you will not be required to pay brokerage commissions or fees or, subject to the instructions in the letter of transmittal, transfer taxes with respect to the exchange of original notes pursuant to the exchange offer. We will pay all charges and expenses, other than certain applicable taxes described below, in connection with the exchange offer. See Fees and Expenses below. Expiration Date; Extension; Termination; Amendments The exchange offer will expire at 5:00 p.m., New York City time, on , 2004, unless extended (the expiration date ). We reserve the right to extend the exchange offer at our discretion, in which event the term expiration date shall mean the time and date on which the exchange offer as so extended shall expire. We will notify the exchange agent of any extension by oral or written notice and will make a public announcement of any extension and specify the principal amount of original notes tendered to date, each prior to 9:00 a.m., New York City time, on the next business day after the previously scheduled expiration date. We reserve the right, in our sole discretion, to: (1) delay accepting for exchange any original notes for exchange notes or to extend or terminate the exchange offer and not accept for exchange any original notes for exchange notes if any of the events set forth under the caption Conditions of the Exchange Offer occur and we do not waive the condition by giving oral or written notice of the delay or termination to the exchange agent; or (2) amend the terms of the exchange offer in any manner. We will not delay payment of accepted original notes after the expiration date other than in anticipation of our receipt of any necessary government approvals. If we amend the exchange offer in any manner material to investors or if we extend or terminate the exchange offer, we will promptly file a post-effective amendment to the registration statement of which this prospectus is a part. We will also announce any such change in media outlets, including PR Newswire. Any delay in acceptance for exchange, extension or amendment will be followed as promptly as practicable by a public announcement of the delay. If we amend the exchange offer in a manner we determine constitutes a material change, we will promptly disclose the amendment in a manner reasonably calculated to inform the holders of original notes of the amendment, and we will extend the exchange offer for a period of five to ten business days, depending upon the significance of the amendment and the manner of disclosure to the holders of the original notes, if the exchange offer would otherwise expire during that five to ten business day period. The rights we have reserved in this paragraph are in addition to our rights set forth under the caption Conditions of the Exchange Offer. Table of Contents Conditions of the Exchange Offer Our obligation to consummate the exchange offer is not subject to any conditions, other than that the exchange offer does not violate any applicable law or SEC staff interpretation. Accordingly, we will not be required to accept for exchange any original notes tendered and may terminate or amend the exchange offer as provided herein before the acceptance of any original notes if: (1) any action or proceeding is instituted or threatened in any court or by or before any governmental agency or regulatory authority with respect to the exchange offer which, in our judgment, could reasonably be expected to materially impair our ability to proceed with the exchange offer; or (2) there shall have been proposed, adopted or enacted any law, statute, rule, regulation, order or SEC staff interpretation which, in our judgment, could reasonably be expected to materially impair our ability to proceed with the exchange offer. The foregoing conditions are for our sole benefit and may be asserted regardless of the circumstances giving rise to the conditions or may be waived by us in whole or in part at any time and from time to time in our sole discretion prior to the expiration date. If we waive or amend the foregoing conditions, we will, if required by applicable law, extend the exchange offer for a minimum of five business days from the date that we first give notice, by public announcement or otherwise, of such waiver or amendment, if the exchange offer would otherwise expire within that five business-day period. Our determination concerning the events described above will be final and binding upon all parties. Procedures For Tendering Only a holder of original notes may tender them in the exchange offer. To validly tender in the exchange offer by book-entry transfer, you must deliver an agent s message or a completed and signed letter of transmittal (or facsimile thereof), together with any required signature guarantees and any other required documents, to the exchange agent prior to 5:00 p.m., New York City time, on the expiration date, and the original notes must be tendered pursuant to the procedures for book-entry transfer set forth below. To validly tender by means other than book-entry transfer, you must deliver a completed and signed letter of transmittal (or facsimile thereof), together with any required signature guarantees and any other required documents and the original notes, to the exchange agent prior to 5:00 p.m., New York City time, on the expiration date. Any financial institution that is a participant in DTC s Book-Entry Transfer Facility system may make book-entry delivery of the original notes by causing DTC to transfer the original notes into the exchange agent s account in accordance with DTC s ATOP procedures for transfer. However, although delivery of original notes may be effected through book-entry transfer into the exchange agent s account at DTC, an agent s message or a completed and signed letter of transmittal (or facsimile thereof), with any required signature guarantees and any other required documents, must, in any case, be transmitted to and received or confirmed by the exchange agent at its addresses set forth under the caption Exchange Agent prior to 5:00 p.m., New York City time, on the expiration date, or the guaranteed delivery procedure set forth below must be complied with. DELIVERY OF DOCUMENTS TO DTC IN ACCORDANCE WITH DTC S PROCEDURES DOES NOT CONSTITUTE DELIVERY TO THE EXCHANGE AGENT. The term agent s message means, with respect to any tendered original notes, a message transmitted by DTC to and received by the exchange agent and forming part of a book-entry confirmation, stating that DTC has received an express acknowledgment from each tendering participant to the effect that, with respect to those original notes, the participant has received and agrees to be bound by the letter of transmittal and that we may enforce the letter of transmittal against the participant. The term book-entry confirmation means a timely confirmation of a book-entry transfer of original notes into the exchange agent s account at DTC. Table of Contents If you tender an original note, and do not validly withdraw your tender, your actions will constitute an agreement with us in accordance with the terms and subject to the conditions set forth in this prospectus and in the letter of transmittal. The method of delivery of your original notes and the letter of transmittal and all other required documents to the exchange agent is at your election and risk. Instead of delivery by mail, we recommend that you use an overnight or hand delivery service. In all cases, you should allow sufficient time to assure delivery to the exchange agent before the expiration date. No letter of transmittal or original note should be sent to us; instead, they should be sent to the exchange agent. You may request that your broker, dealer, commercial bank, trust company or nominee effect the tender for you. Signatures on a letter of transmittal or a notice of withdrawal, as the case may be, must be guaranteed by an eligible institution (as defined below) unless the original notes are being tendered: (1) by a registered holder who has not completed the box entitled Special Issuance Instructions or Special Delivery Instructions on the letter of transmittal; or (2) for the account of an eligible institution. If signatures on a letter of transmittal or a notice of withdrawal, as the case may be, are required to be guaranteed, the guarantee must be by a member of a signature guarantee program within the meaning of Rule 17Ad-15 under the Exchange Act (an eligible institution ). If the letter of transmittal or any original notes or bond powers are signed by trustees, executors, administrators, guardians, attorneys-in-fact, officers of corporations or others acting in a fiduciary or representative capacity, those persons should so indicate when signing, and unless we waive it, evidence satisfactory to us of their authority to act must be submitted with the letter of transmittal. We will determine, in our sole discretion, all questions as to the validity, form, eligibility (including time of receipt) and acceptance and withdrawal of tendered original notes. Our determination will be final and binding. We reserve the absolute right to reject any and all original notes not properly tendered or any original notes our acceptance of which would, in the opinion of our counsel, be unlawful. We also reserve the right to waive any defects, irregularities or conditions of tender as to particular original notes. Our interpretation of the terms and conditions of the exchange offer (including the instructions in the letter of transmittal) will be final and binding on all parties. Unless waived, you must cure any defects or irregularities in connection with tenders of your original notes within a time period we will determine. Although we intend to request that the exchange agent notify you of defects or irregularities with respect to your tender of original notes, we will not, nor will the exchange agent or any other person, incur any liability for failure to give you any notification. Tenders of original notes will not be deemed to have been made until any defects or irregularities have been cured or waived. Any original notes received by the exchange agent that are not properly tendered and as to which the defects or irregularities have not been cured or waived will be returned by the exchange agent to the tendering holders, unless otherwise provided in the letter of transmittal, promptly after the expiration date. In addition, we reserve the right in our sole discretion (subject to the limitations contained in the indenture for the exchange notes): (1) to purchase or make offers for any original notes that remain outstanding after the expiration date; and (2) to the extent permitted by applicable law, to purchase original notes in the open market, in privately negotiated transactions or otherwise. The terms of any purchases or offers could differ from the terms of the exchange offer. 16,092 Other assets Table of Contents The information in this prospectus is not complete and may be changed. We may not exchange these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to exchange these securities and it is not soliciting an offer to exchange these securities in any state where the offer or exchange is not permitted. SUBJECT TO COMPLETION, DATED JANUARY 26, 2004 PROSPECTUS Ardent Health Services, Inc. Offer to Exchange up to $225,000,000 of 10% Senior Subordinated Notes due 2013 for up to $225,000,000 of 10% Senior Subordinated Notes due 2013 that have been registered under the Securities Act of 1933 We are offering to exchange our 10% senior subordinated notes due 2013, or the exchange notes, for our currently outstanding 10% senior subordinated notes due 2013, or the original notes. We sometimes refer to the exchange notes and the original notes collectively as the notes. Terms of the exchange notes: The exchange notes are substantially identical to the original notes, except that the exchange notes have been registered under the Securities Act of 1933, or the Securities Act, and will not contain restrictions on transfer or have registration rights. The exchange notes will represent the same debt as the original notes, and we will issue the exchange notes under the same indenture. The exchange notes will be subordinated to any existing and future senior indebtedness, including borrowings under our senior secured credit facility, and will rank equally with any future senior subordinated indebtedness. Assuming the exchange offer had been completed on September 30, 2003, the exchange notes would have been subordinated to approximately $4.8 million of our outstanding indebtedness. Terms of the exchange offer: The exchange offer expires at 5:00 p.m., New York City time, on , 2004, unless extended. We will exchange all original notes that are validly tendered and not validly withdrawn prior to the expiration of the exchange offer. You may withdraw tendered original notes at any time prior to the expiration of the exchange offer. We do not intend to apply for listing of the exchange notes on any securities exchange or to arrange for them to be quoted on any quotation system. The exchange offer is subject to customary conditions, including the condition that the exchange offer not violate applicable law or any applicable interpretation of the staff of the Securities and Exchange Commission, or the SEC. The exchange of original notes for exchange notes pursuant to the exchange offer will not constitute a taxable event for U.S. federal income tax purposes. We will not receive any proceeds from the exchange offer. Broker-dealers who acquired original notes from us in the initial offering are not eligible to participate in the exchange offer with respect to such original notes. Each broker-dealer that receives exchange notes for its own account pursuant to the exchange offer must acknowledge that it will deliver a prospectus in connection with any resale of the exchange notes. The letter of transmittal states that by so acknowledging and by delivering a prospectus, a broker-dealer will not be deemed to admit that it is an underwriter within the meaning of the Securities Act of 1933. This prospectus, as it may be amended or supplemented from time to time, may be used by a broker-dealer in connection with any resales of exchange notes received in exchange for original notes where the original notes were acquired by the broker-dealer as a result of market-making activities or other trading activities. We have agreed that, for up to 180 days after the expiration date, as defined in this prospectus, we will make this prospectus available to any broker-dealer for use in connection with any such resale. See Plan of Distribution. Investing in the exchange notes involves risks. See Risk Factors beginning on page 15. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of the securities to be distributed in the exchange offer or determined that this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. The date of this prospectus is , 2004. Table of Contents By tendering, you represent to us, among other things, that: (1) you are not affiliate of us (as defined in Rule 405 under the Securities Act); (2) you are not engaged in, and do not intend to engage in, and have no arrangement or understanding with any person to participate in, a distribution of the exchange notes; and (3) you are acquiring the exchange notes in the ordinary course of business. If you are a broker-dealer that will receive exchange notes for your own account in exchange for original notes that were acquired as a result of market-making activities or other trading activities, you must acknowledge that you will deliver a prospectus in connection with any resale of the exchange notes. Guaranteed Delivery Procedures If you wish to tender your original notes and either your original notes are not immediately available, or you cannot deliver your original notes and other required documents to the exchange agent, or cannot complete the procedure for book-entry transfer prior to the expiration date, you may effect a tender if: (1) you make a tender through an eligible institution; (2) prior to the expiration date, the exchange agent receives from the eligible institution a properly completed and duly executed notice of guaranteed delivery (by facsimile transmission, mail or hand delivery) setting forth your name and address, the certificate number(s) of the original notes (if available) and the principal amount of original notes tendered together with a duly executed letter of transmittal (or a facsimile thereof), stating that the tender is being made thereby and guaranteeing that, within three business days after the expiration date, the certificate(s) representing the original notes to be tendered, in proper form for transfer (or a confirmation of a book-entry transfer into the exchange agent s account at DTC of original notes delivered electronically) and any other documents required by the letter of transmittal, will be deposited by the eligible institution with the exchange agent; and (3) the certificate(s) representing all tendered original notes in proper form for transfer (or confirmation of a book-entry transfer into the exchange agent s account at DTC of original notes delivered electronically) and all other documents required by the letter of transmittal are received by the exchange agent within three business days after the expiration date. Upon request to the exchange agent, you will be sent a notice of guaranteed delivery if you wish to tender your original notes according to the guaranteed delivery procedures set forth above. Withdrawal of Tenders Except as otherwise provided in this prospectus, you may withdraw any tenders of original notes at any time prior to 5:00 p.m., New York City time, on the expiration date, unless previously accepted for exchange. For your withdrawal to be effective, the exchange agent must receive a written or facsimile transmission notice of withdrawal at its address set forth herein prior to 5:00 p.m., New York City time, on the expiration date, and prior to our acceptance for exchange. Any notice of withdrawal must: (1) specify the name of the person having tendered the original notes to be withdrawn; (2) identify the original notes to be withdrawn (including the certificate number or numbers, if applicable, and principal amount of the original notes); (3) be signed in the same manner as the original signature on the letter of transmittal by which the original notes were tendered (including any required signature guarantees) or be accompanied by documents of transfer sufficient to have the trustee with respect to the original notes register the transfer of the original notes into the name of the person withdrawing the tender; and TABLE OF CONTENTS SUMMARY RISK FACTORS

parsed_sections/risk_factors/2004/CIK0001266923_ahs_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

parsed_sections/risk_factors/2004/CIK0001266929_bhc_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

parsed_sections/risk_factors/2004/CIK0001267033_bhc_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

parsed_sections/risk_factors/2004/CIK0001271193_superior_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ Risk factors The following risk factors should be considered carefully in addition to the other information contained in this prospectus. This prospectus contains forward looking statements that involve risks and uncertainties. Our actual results could differ materially from those contained in the forward looking statements. Factors that may cause these differences include those discussed below as well as those discussed elsewhere in this prospectus. Risks Relating to Our Business Our net sales, net income and growth depend largely on the economies in the geographic markets that we serve. Many of our customers use our products as components in their own products, systems or networks or in projects undertaken for their customers. Our ability to sell our products is largely dependent on general economic conditions, including how much our customers and end-users spend on information technology, new construction and building, maintaining or reconfiguring their communications network, industrial manufacturing assets and power transmission and distribution infrastructures. Over the past few years, many companies have significantly reduced their capital equipment and information technology budgets, and construction activity that necessitates the building or modification of communication networks and power transmission and distribution infrastructures has slowed considerably as a result of a weakening of the U.S. and foreign economies. As a result, our net sales and financial results have declined significantly. In the event that these markets do not improve, or if they were to become weaker, we could suffer further decreased sales and net income and we may not be able to service our debt. The increased use of fiber optic cable in the "local loop" may reduce the market for our products. Through our communications cable segment, we are the largest supplier, based on sales, of copper OSP cables used by the RBOCs and other telephone companies in the "local loop" portion of the telecommunications infrastructure. Copper OSP is the communications cable segment's largest product group. Over the past several years, fiber optic cable has been deployed in trunking line applications connecting central office to central office and in some feeder lines that connect central offices to the "local loop." Fiber optic cable provides increased bandwidth and transmission speeds as compared to copper cable. While the cost to install and operate fiber optic cable in the "local loop" currently exceeds that for copper cable, the cost of installing, operating and maintaining fiber optic cable and related systems in the "local loop" has continued to decline. Furthermore, the RBOCs have been forced through government regulation into wholesaling of their copper cabling infrastructure to competitors. Recent regulatory rulings by the Federal Communication Commission do not require such wholesaling of fiber optic networks. Although these rulings have been challenged in court, if allowed to stand they could provide increased economic incentives for our customers to deploy fiber optic cable in the "local loop." If the rate of introduction of fiber optic cable into the "local loop" accelerates, then the demand for our copper OSP cable would likely decrease. This decrease could result in a significant decline in sales of copper OSP cable, our revenues and liquidity. Advancing technologies, such as fiber optic and wireless technologies, may make some of our products less competitive. Technological developments could have a material adverse effect on our business. For example, a significant decrease in the cost and complexity of installation of fiber optic systems or increase in the cost of copper based systems could make fiber optic systems superior on a price performance basis to copper systems and may have a material adverse effect on our business. The superior technological characteristics of fiber optic cables has caused companies increasingly to deploy it in the local loop. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, as amended, check the following box. If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box. Also, competitive alternatives to traditional telephone service, such as wireless and cable telephony and "voice over Internet Protocol," or VOIP, services, have had a negative impact on the demand for copper OSP wire and cable, and these threats are not expected to diminish and may increase. While we sell some fiber optic cable and components and cable that is used in certain wireless applications, if fiber optic systems or wireless technology were to significantly erode the markets for copper based systems, our sales of fiber optic cable and products for wireless applications may not be sufficient to offset any decrease in sales or profitability of other products that may occur. Spending reductions by the telephone industry could adversely affect our business. Our largest customer segments for the communications cable segment are the RBOCs and independent telephone operating companies. Over 60% of sales of the communications cable segment are attributable to these customers. Beginning in the second half of 2001 and continuing through 2003, the RBOCs and the independent telephone companies have substantially reduced their capital expenditure levels, including substantial reductions in purchases of the communications cable products that we supply. The telephone companies are experiencing extreme competitive pressures from CATV companies and other alternative providers of local exchange service, resulting in negative access line growth and loss of subscribers. These market conditions could result in further reductions in the demand for our communications cable products. Further reductions in demand could lead to a substantial decrease in our revenues and liquidity. Substantial spending reductions by the RBOCs and independent telephone operating companies contributed to significant revenue declines in the past three years with the most pronounced reductions in revenues occurring in 2002. Declines in access lines, including a decline in the new start housing market, could adversely affect our business. A decrease in access lines to homes and businesses could have a negative impact on our business. Competitive alternatives, such as wireless and cable telephony, digital subscriber lines or "DSL", VOIP services, and cable modems have had a negative impact on the demand for additional access lines. Furthermore, the demand for access lines is impacted by new housing starts. Any negative access line growth resulting from these factors could result in further reductions in the demand for our communications cable products. Migration of magnet wire demand to China may adversely affect our business. Our business may suffer due to the migration of magnet wire demand to China. Our magnet wire and distribution segment's principal product is magnet wire, which is used primarily in motors for industrial, automotive, appliance and other applications. We currently service the North American market, with limited sales elsewhere. Several of our major magnet wire customers are shifting, or have plans to shift, certain levels of product manufacturing to China. We do not currently have production capabilities in China, but are evaluating entering the China market to service the growing demand there, including the requirements of existing customers who are located in, or are relocating production to, China. There can be no assurance that we will be able to establish production facilities or other arrangements in China, or that we will be able to successfully compete in China and/or offset any loss of business resulting from the decline in demand of our products in North America from this shift of customer requirements to China. Fluctuations in the supply or pricing of copper and other principal raw materials could harm our business. Copper is the primary raw material that we use to manufacture our products. There are a limited number of copper suppliers in the United States. If we are unable to maintain good relations with our The registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the registrant files a further amendment that specifically states that this Registration Statement will thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement becomes effective on such date as the Securities and Exchange Commission, acting pursuant to Section 8(a), determines. copper suppliers or if there are any business interruptions at our copper suppliers, we may not have access to a sufficient supply of copper. If we were to suffer the loss of one or more important suppliers of copper, we may not be able to meet customer demand, which could result in the loss of customers and revenues. In addition, copper is a commodity and is therefore subject to price volatility. We may not be able to adjust product pricing to properly match the price of copper billed with the copper cost component of the inventory shipped. Any fluctuations in the cost of copper that we cannot effectively manage could cause us to increase prices for our products, which could hinder our ability to sell those products. Copper pricing under our major telephone companies contracts is generally based on the average copper price for the preceding quarter. To minimize the risk of fluctuations in the price of copper, we forward price copper purchases with our suppliers based on forecasted demand. To the extent forecasted demand differs significantly from actual demand, changes in the price of copper may have a negative impact on our operating profit. Beginning in the fourth quarter of 2003 and continuing through the first six months of 2004, copper prices have escalated rapidly, increasing from an average of $0.88 per pound for the month of October 2003 to an average of $1.23 per pound for the first six months of 2004. Additionally, the daily spot price for copper has fluctuated from a low of $1.06 per pound to a high of $1.39 per pound during the first six months of 2004. The rapid increase in copper prices can impact profitability in the short term based upon the timing of product price adjustments to match the increased copper costs. While we did not experience a material negative impact from this situation in 2003 or the first quarter of 2004, our results in the second quarter of 2004 were negatively impacted due to accelerated orders by some communications cable customers in the first quarter of 2004 in anticipation of future contractual price adjustments related to increased copper costs. There can be no assurance that continued volatility in copper prices will not impact our future profitability. In addition, significant increases in the price of copper and the resultant increase in accounts receivable and, to a lesser degree, inventory impacts our working capital requirements. As a result of the increase in copper prices, we have experienced an increase in our working capital financing requirements of $15 million to $25 million. See "Management's discussion and analysis of financial condition and results of operations Liquidity and Capital Resources" below. The other raw materials we use in the manufacture of our wire and cable products are aluminum, bronze, steel, optical fibers and plastics, such as polyethylene and polyvinyl chloride. Although Superior TeleCom had not experienced any shortages in the recent past, no assurance can be given that we will be able to procure adequate supplies of our essential raw materials to meet our future needs. Our indebtedness may limit cash flow available to invest in the ongoing needs of our business to generate future cash flow. Our outstanding debt, including Superior Essex Holding's series A preferred stock (which is classified as debt for accounting purposes), as of June 30, 2004 was $311.9 million. We may also incur additional debt from time to time to finance working capital, acquisitions, capital expenditures and other general corporate purposes. Our indebtedness could have important consequences to holders of our common stock. For example, it could: require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, reducing the availability of our cash flow to fund working capital, acquisitions, capital expenditures, research and development efforts and other general corporate purposes; increase the amount of interest expense that we have to pay, because some of our borrowings (approximately $49.7 million as of June 30, 2004) are at variable rates of interest, which, if interest rates increase, could result in higher interest expense; Cash flows from investing activities: Capital expenditures (1,739 ) (2,838 ) (10,123 ) (27,264 ) Net proceeds from the sale of assets 5,681 83,576 6,389 Superior Israel customer loan repayments (advances) 6,157 (13,018 ) Other 633 1,013 Cash flows provided by operating activities $ 357 $ 32,590 $ 7,268 $ 18,680 $ 58,895 Cash flows from investing activities: Capital expenditures (20,013 ) (3,226 ) (4,025 ) (27,264 ) Net proceeds from sale of assets 4,325 10 2,054 6,389 Superior Israel customer loan advances, net (13,018 ) (13,018 ) Other 11 (in thousands) Net income (loss) $ 3,396 $ (49,444 ) Foreign currency translation adjustment (53 ) 1,712 Change in unrealized gains on derivatives, net (7 ) 1,183 Additional minimum pension liability (291 ) Other 65 increase our vulnerability to adverse general economic or industry conditions; limit our flexibility in planning for, or reacting to, changes in our business or the industry in which we operate; or place us at a competitive disadvantage compared to some of our competitors that have less debt. We may be unable to meet our covenant obligations under our senior secured revolving credit facility which could adversely affect our business. Our operations are dependent on the availability and cost of working capital financing and may be adversely affected by any shortage or increased cost of such financing. We entered into a senior secured revolving credit facility upon emergence from bankruptcy. The senior secured revolving credit facility contains covenants that we may not be able to meet. If we cannot meet these covenants, events of default would arise, which could result in payment of the applicable indebtedness being accelerated and a cross default to our other indebtedness. In addition, if we require working capital greater than that provided by our senior secured revolving credit facility, we may be required either to (1) seek to increase the availability under the senior secured revolving credit facility, (2) obtain other sources of financing or (3) reduce our operations. There can be no assurance that any amendment of our senior secured revolving credit facility or replacement financing would be available on terms that are favorable or acceptable to us. Moreover, there can be no assurance that we will be able to obtain an acceptable new credit facility upon expiration of our senior secured revolving credit facility or that the terms of any such new credit facility would be acceptable. We may be unable to raise additional capital to meet capital expenditure needs if our operations do not generate sufficient funds to do so. Our business is expected to have continuing capital expenditure needs. While we anticipate that our operations will generate sufficient funds to meet our capital expenditure needs for the foreseeable future, our ability to gain access to additional capital, if needed, cannot be assured, particularly in view of competitive factors and industry conditions. If we are unable to obtain additional capital, or unable to obtain additional capital on favorable terms, our business and financial condition could be adversely affected. Declining returns in the investment portfolio of our defined benefit plans will require us to increase cash contributions to the plans. Funding for the defined benefit pension plans we sponsor is based upon the funded status of the plans and a number of actuarial assumptions, including an expected long-term rate of return on assets and discount rate. On December 1, 2003, we announced that benefit accruals under our defined benefit pension plans for salaried employees and for eligible employees who are not included in a unit of employees covered by a collective bargaining agreement would be frozen as of January 22, 2004. Due to declining returns in the investment portfolio of our defined benefit pension plans in recent years, the defined benefit plans were underfunded as of December 31, 2003 by approximately $35.8 million, based on the actuarial methods and assumptions utilized for purposes of FAS 87 and after giving effect to the planned curtailment of benefits. As a result, we expect to experience an increase in our future cash contributions to our defined benefit pension plans. Our required cash contributions are expected to increase to $11.9 million in 2004 from $3.8 million in 2003. In 2005, total cash contributions are expected to be approximately $2.1 million. In the event that actual results differ negatively from the actuarial assumptions, the funded status of our defined benefit plans may change and any such deficiency could result in additional charges to equity and against earnings and increase our required cash contributions. Our inability to compete with other manufacturers in the wire and cable industry could harm our business. The market for wire and cable products is highly competitive. Each of our businesses competes with at least one major competitor. Many of our products are made to industry specifications and, therefore, may be interchangeable with competitors' products. We are subject to competition in many markets on the basis of price, delivery time, customer service and our ability to meet specialty needs. Some of our competitors are significantly larger and have greater resources, financial and otherwise, than we do. There can be no assurance that we will be able to compete successfully with our existing competitors or with new competitors. Failure to compete successfully could result in a significant decrease in sales of our products and our revenues. If we are unable to retain senior management, our business operations could be adversely affected. Our success and future prospects depend on the continued contributions of our senior management. There can be no assurances that we would be able to find qualified replacements for these individuals if their services were no longer available. The loss of services of one or more members of our senior management team, and the process of integrating their replacements, could severely disrupt our operations. Failure to negotiate extensions of our labor agreements as they expire may result in a disruption of our operations. Approximately 21% of our employees are represented by various labor unions. Labor agreements covering approximately 10% of our employees expire during 2004. We cannot predict what issues may be raised by the collective bargaining units representing our employees and, if raised, whether negotiations concerning such issues will be successfully concluded. A protracted work stoppage could result in a disruption of our operations which could adversely affect our ability to deliver certain products and our financial results. We may not be able to realize the benefits of the Belden Asset Acquisition or to identify, finance or integrate other acquisitions. We cannot assure you that we will be able to realize the benefits of the Belden Asset Acquisition. Customers of Belden that have agreed to have their contracts assigned to us may not continue to purchase at past or anticipated future levels. In addition to the Belden Asset Acquisition, we evaluate possible acquisition opportunities from time to time. We cannot assure you that we will be able to consummate acquisitions in the future on terms acceptable to us, if at all. We cannot assure you that any future acquisitions will be successful or that the anticipated strategic benefits of any future acquisitions will be realized. We recently emerged from a Chapter 11 bankruptcy reorganization and have a history of losses. On March 3, 2003, Superior TeleCom and certain of its U.S. subsidiaries filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware. In accordance with the plan of reorganization, on November 10, 2003, the effective date of the plan, we acquired the business formerly conducted by Superior TeleCom and its subsidiaries. Superior TeleCom incurred net losses of approximately $32.5 million in 2001 and $961.3 million in 2002. We adopted fresh-start reporting as of November 10, 2003, and our emergence from Chapter 11 resulted in a new reporting entity. The net effect of all fresh start reporting adjustments resulted in a charge of $12.1 million, which is reflected in Superior TeleCom's statement of operations for the period January 1, 2003 to November 10, 2003. We may continue to incur losses in the future. The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted. SUBJECT TO COMPLETION, DATED NOVEMBER 9, 2004 PROSPECTUS 5,392,405 Shares Superior Essex Inc. Common Stock Our historical financial information is not comparable to our current financial condition and results of operations. As a result of our emergence from bankruptcy, we are operating our business with a new capital structure. We are also subject to the fresh-start reporting prescribed by GAAP and our financial statements for periods subsequent to November 10, 2003 reflect the application of these rules. Accordingly, our financial condition and results of operations will not be comparable to the financial condition and results of operations reflected in the historical financial statements of Superior TeleCom contained in this prospectus, which may make it difficult for you to assess our future prospects based on historical performance. You are unlikely to be able to seek remedies against Arthur Andersen LLP, Superior TeleCom's former independent auditor. The audited consolidated financial statements and schedules of Superior TeleCom as of December 31, 2001 and for the year ended December 31, 2001 included in this prospectus have been audited by Arthur Andersen LLP, or Arthur Andersen, independent accountants, whose report thereon is also included in this prospectus. On August 31, 2002, Arthur Andersen ceased practicing before the Commission. Commission rules require us to present our audited financial statements in various Commission filings. We do not expect to receive Arthur Andersen's consent in any filing that we make with the Commission, including this registration statement. Without this consent, it may become more difficult for you to seek remedies against Arthur Andersen. Furthermore, relief in connection with claims, which may be available to investors under the federal securities laws against auditing firms, may not be available as a practical matter against Arthur Andersen. You are unlikely to be able to exercise effective remedies or judgments against Arthur Andersen. Risks Relating to our Common Stock An active trading market may not develop for our common stock, and we cannot assure you as to the market price for our common stock if a market does develop. Our common stock is currently listed on the Nasdaq National Market under the trading symbol SPSX, but no established market exists for our common stock. There can be no assurance that an active market for our common stock will develop or, if any such market does develop, that it will continue to exist or the degree of price volatility in any such market. In addition, our common stock was issued under the plan of reorganization to holders of pre-petition senior secured debt claims of Superior TeleCom, some of which may prefer to liquidate their investment rather than to hold it on a long-term basis. Accordingly, it is anticipated that the market for our common stock will be volatile, at least for an initial period after the effective date of the plan of reorganization. The market price of our common stock will be subject to significant fluctuation in response to numerous factors, including variations in our annual or quarterly financial results or those of our competitors, changes by financial analysts in their estimates of our future earnings, conditions in the economy in general or in the wire and cable industry in particular and other factors beyond our control. No assurance can be given as to the market price for our common stock. If our share price declines significantly, then our common stock may be deemed to be penny stock, which could adversely affect the liquidity of, and market for, our common stock. If our common stock is considered penny stock, it would be subject to rules that impose additional sales practices on broker-dealers who sell our securities. Penny stocks generally are equity securities with a price of less than $5.00, other than securities registered on some national securities exchanges or quoted on Nasdaq. In this event, some brokers may be unwilling to effect transactions in our common stock because of the additional obligations imposed. This could adversely affect the liquidity of our This prospectus is part of a registration statement that we filed with the Securities and Exchange Commission using the "shelf" registration process. It relates to the public offering, which is not being underwritten, of 5,392,405 shares of our common stock that are held by the selling stockholders identified in this prospectus. We issued such shares to these selling stockholders in connection with the plan of reorganization of Superior TeleCom Inc. The selling stockholders may sell these shares from time to time in the over-the-counter market in regular brokerage transactions, in transactions directly with market makers or in privately negotiated transactions. For additional information on the methods of sale that may be used by the selling stockholders, see the section entitled "Plan of distribution." We will not receive any of the proceeds from the sale of these shares. We will bear the costs relating to the registration of these shares. Our common stock is currently listed on the Nasdaq National Market under the trading symbol "SPSX." Our common stock was quoted on the OTC Bulletin Board under the trading symbol "SESX.OB" until November 8, 2004. On November 3, 2004, the last sale price of our common stock on the OTC Bulletin Board was $17.20 per share. common stock and the ability of investors to sell our common stock. For example, broker-dealers must make a special suitability determination for the purchaser and have received the purchaser's written consent to the transaction prior to sale. Also, a disclosure schedule must be prepared prior to any transaction involving a penny stock, and disclosure is required about sales commissions payable to both the broker-dealer and the registered representative and current quotations for the securities. Furthermore, monthly statements are required to be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stock. Our dividend policies and other restrictions on the payment of dividends may prevent the payment of dividends for the foreseeable future. We do not anticipate paying any dividends on our common stock for the foreseeable future. In addition, covenants in our debt instruments restrict our ability to pay cash dividends and may prohibit the payment of dividends and certain other payments. Some institutional investors may only invest in dividend-paying equity securities or may operate under other restrictions that may prohibit or limit their ability to invest in our common stock. Provisions of our certificate of incorporation and bylaws could discourage potential acquisition proposals and could deter or prevent a change in control. Some provisions of our certificate of incorporation and bylaws, as well as Delaware statutes, may have the effect of delaying, deferring or preventing a change in control. These provisions, including those providing for the possible issuance of preferred stock and regulating the nomination of directors, may make it more difficult for other persons, without the approval of our board of directors, to make a tender offer or otherwise acquire substantial amounts of our common stock or to launch other takeover attempts that a stockholder might consider to be in such stockholder's best interest. These provisions could limit the price that some investors might be willing to pay in the future for shares of our common stock. An investment in our common stock involves risks. See "Risk factors" beginning on page 9.

parsed_sections/risk_factors/2004/CIK0001271245_fremont_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ RISK FACTORS An investment in our common stock involves a number of risks. You should carefully consider the following information about these risks, together with the other information contained in this prospectus, before investing in shares of our common stock. Any of the risks described below could result in a significant or material adverse effect on our results of operations or financial condition and a corresponding decline in the market price of our common stock. RISKS RELATED TO OUR COMPANY If our financial results continue to be inconsistent, our profitability and share price may suffer. For the first quarter ended March 31, 2004 we generated a net loss of $361,000. For the year ended December 31, 2003, we had net income of $226,000. We generated net losses of $574,000 and $1,393,000 in 2002 and 2001, respectively. In 2000 we had net income of $1,017,000. We cannot assure investors that we will be profitable in the future. The fluctuations in our earnings can be attributed to several factors such as large catastrophe losses, severe weather losses, rate inadequacy and other factors that may occur again in the future. Because we concentrate all of our business in Michigan, its weather will affect our results. All insurance policies we write are generated in Michigan, with a significant portion in four counties (Kent, Newaygo, Berrien and Van Buren). Companies that have a more diversified geographic portfolio would not be as exposed to Michigan weather as we are. Catastrophe and natural peril losses may hurt our financial condition. By their nature, catastrophe losses are unpredictable in their number and severity. They can be caused by various severe weather events, including snow storms, ice storms, freezing temperatures, tornadoes, wild fires, wind and hail. The extent of net losses from catastrophes depends upon three factors: the total amount of insured exposure in the area affected by the event, the severity of the event, and the amount and structure of our reinsurance coverage. We obtain reinsurance to aid in paying catastrophe loss claims, but we may experience operating losses in years when catastrophe claims are higher than expected. We experienced higher than expected catastrophe losses in 2001 and 1999 that significantly affected our underwriting results. In 2001 and 1999 we incurred catastrophe losses net of reinsurance recoveries of approximately $2,464,000 and $1,413,000, respectively. Natural perils such as freezing rain, snow storms, wind storms and tornadoes, which may occur frequently but not rise to the level of a catastrophe, may cause us to lose money because they are not classified as a catastrophe under our reinsurance program. If our reinsurance pays catastrophe loss claims, we may still incur substantial expense to reinstate the coverage used. If we underestimated the amount of our required loss reserves, our results may suffer. We maintain reserves to cover our estimated liability for losses and loss adjustment expenses ( LAE ) with respect to reported and unreported claims incurred. Our reserves for loss and loss adjustment expenses as of We are converting Fremont Mutual Insurance Company into a company owned by shareholders. As part of this conversion, we are offering you the opportunity to become shareholders of a new holding company, Fremont Michigan InsuraCorp, Inc., which will own all of the shares of the Insurance Company. This offering is made only to Michigan residents and this prospectus will be used for all three of the following components of the offering which will be conducted concurrently: first, a Surplus Note Exchange Offering to the holders of the Insurance Company s surplus notes due September 30, 2007, of up to approximately 363,000 shares; second, a Subscription Offering to eligible policyholders, directors and officers of the Insurance Company for any and all shares not exchanged for surplus notes; and third, a Community Offering to the general public for any and all shares not exchanged or subscribed for in the Surplus Note Exchange Offering and the Subscription Offering. The offering will occur after completion of the conversion of the Insurance Company from a mutual to a stock company. We will not sell any shares unless the Insurance Company s policyholders approve our conversion to a stock company and unless a minimum of 680,000 shares is subscribed for in the offering. The Holding Company will place all funds submitted to buy shares in an escrow account with The Huntington National Bank until the offering terminates and at least the minimum number of shares are sold or the funds are returned. Minimum Table of Contents March 31, 2004 and December 31, 2003, 2002 and 2001 were approximately $17,148,000, $13,878,000, $8,677,000 and $11,060,000, respectively. Reserves are estimates involving actuarial and statistical projections at a given point in time of what we expect to be the cost of the ultimate settlement and administration of claims based on facts and circumstances then known, actual and historical information, predictions of future events, estimates of future trends in claims severity and judicial theories of liability, legislative activity and other variable factors, such as inflation, investment returns, and price increases because of local shortages. The Insurance Company s overall reserving practice provides for ongoing claims evaluation and adjustment (if necessary) based on the development of related data and other relevant information pertaining to such claims. Loss and LAE reserves, including reserves for claims that have been incurred but not yet reported, are analyzed regularly and we adjust our reserves based on such reviews. We believe our reserves are adequate. However, establishing appropriate reserves is an uncertain process. There is no guarantee that our ultimate losses will not exceed our reserves. To the extent that reserves prove to be inadequate in the future, we would have to increase reserves, which would reduce our earnings and could have a material adverse effect on the Insurance Company s results of operations and financial condition. We face strong competition from large companies, which may reduce our earnings and profits. We principally insure against property and casualty losses. This segment of the market is highly competitive. We compete against other Michigan-based insurance carriers as well as major regional and national carriers. The national carriers we compete with on a regular basis are Citizens Insurance Company of America, State Farm Mutual Automobile Insurance Company and the Allstate Corporation. Regional companies that are important competitors include Auto Owners Insurance Group, Allied Insurance, Farm Bureau Mutual Insurance Company of Michigan, Frankenmuth Insurance and Hastings Mutual Insurance Company. Smaller state competitors would include Michigan Insurance Company, Pioneer State Mutual Insurance Company and Wolverine Mutual Insurance Company. Many of our competitors have substantially greater financial, technical and operating resources than we do. As a result, many of our lines of insurance are subject to strong price competition and heavy advertising by larger companies, which could result in loss of business and adversely affect our earnings. Our reliance on independent insurance agencies to sell our products as well as their ability to sell products of our competitors could adversely affect the sale of our products. We market our property and casualty insurance products exclusively in Michigan through approximately 170 independent agencies. Our independent insurance agencies represent other insurance companies, including our competitors, which also compete for the service and allegiance of these agencies. If a significant number of the independent agencies shift profitable accounts from us to our competitors, it could adversely affect our business. No single agency accounted for more than 10% of our direct written premiums for 2003, 2002 or 2001. The percentage of direct written premiums attributable to our 10 largest independent agency producers was 20%, 20% and 18% for 2003, 2002 and 2001, respectively. Our experience in commercial insurance and personal automobile insurance is limited, which could hurt our ability to respond to market changes. In the recent past, we have entered the commercial insurance and personal automobile insurance markets. Our skills, resources and operating experiences in these product lines are limited, creating the additional risk that we may not be able to respond to market changes or forces in ways that our more seasoned competitors do. Anti-takeover provisions in our articles of incorporation and bylaws may discourage takeover attempts and prevent or frustrate attempts to replace or remove our management, which could limit your opportunity to receive a high value for your stock if another company seeks to acquire us. Our articles of incorporation and bylaws contain provisions that have the effect of discouraging or preventing takeover attempts not supported by our board of directors. In addition, these provisions may also 25,044 247 162 Equity securities: Preferred stocks 518 19 Common stocks 2,242 455 2,760 474 Total $ 2,760 $ 13 $ Maximum Table of Contents prevent or frustrate attempts to replace or remove our management. Management entrenchment may also have the effect of discouraging potential purchasers from making takeover offers. Examples of these provisions include, among other things: Staggered three-year terms for the members of the board of directors; Super-majority provisions for amendment of our articles of incorporation or bylaws; Restrictions on voting of common stock by any individual, entity or group owning more than 10% of the common stock; and Provisions allowing the directors to issue preferred stock with voting rights. In addition, the Michigan Insurance Code provides that no person may acquire 10% or more of our voting stock, or more than 5% of our voting stock within 5 years of the conversion, without approval of the Commissioner of Michigan s Office of Financial and Insurance Services ( Insurance Commissioner ). Takeover attempts generally include offering shareholders a premium for their stock. Therefore, preventing a takeover attempt may cause you to lose an opportunity to sell your shares at a premium. A downgrade in our A.M. Best rating could hurt our premium volume. Ratings assigned by A.M. Best Company, Inc. influence the competitive position of insurance companies. Their ratings are based upon factors of concern to policyholders and are not directed toward the protection of investors. Our current rating is B+ (Very Good). Our business is sensitive to those ratings. If we were to experience a rating downgrade, our independent agents could be inclined to place their customers with higher-rated insurance carriers, which could result in a loss of premium volume and could have a material adverse effect on us. In addition, a downgrade in our A.M. Best rating could make it more difficult or costly to obtain reinsurance. If we are unable to obtain adequate reinsurance coverage at reasonable rates in the future, we may be unable to manage our underwriting risks and operate our business profitably. Reinsurance is the practice of transferring part of the liabilities and the premiums under an insurance policy to another insurance company. Like other insurance companies, we use reinsurance arrangements to limit and manage the amount of risk we retain and to stabilize our underwriting results. Reinsurance can be facultative reinsurance or treaty reinsurance. Under facultative reinsurance, each risk or portion of a risk is reinsured individually. Under treaty reinsurance, an agreed-upon portion of business written is automatically reinsured. Treaty reinsurance can also be classified as quota share reinsurance, pro-rata insurance or excess of loss reinsurance. Under quota share reinsurance and pro-rata insurance, the ceding company cedes a percentage of its insurance liability to the reinsurer in exchange for a like percentage of premiums, less a ceding commission, and, in turn, will recover from the reinsurer the reinsurer s share of losses and loss adjustment expenses incurred on those risks. Under excess of loss reinsurance, an insurer limits its liability to all or a particular portion of the amount in excess of a predetermined deductible or retention. Regardless of type, reinsurance does not legally discharge the ceding insurer from primary liability for the full amount due under the reinsured policies. However, the assuming reinsurer is obligated to reimburse the ceding company to the extent of the coverage ceded. The availability and cost of reinsurance are subject to prevailing market conditions and may vary significantly over time. Reinsurance rates have risen significantly in the past several years as a result of high insurance losses, including those experienced by us, and the recent terrorist events in the United States. Reinsurance rates are not regulated and reinsurers are able to quickly raise their rates in response to changing market conditions. On the other hand, the Insurance Company s rates are regulated, and it could take us years to obtain regulatory approval and collect rate increases based on the rising costs of reinsurance. There is no assurance that regulators would approve a rate increase based on these costs. Reinsurance may not be available to us in the future at commercially reasonable rates. If it is not available at reasonable rates, we may be unable to manage our underwriting risks and operate our business profitably. Offering price per share $ 10.00 $ 10.00 Number of shares 680,000 920,000 Underwriting commissions and other expenses $ 600,000 $ 800,000 Net proceeds to the Holding Company $ 6,200,000 $ 8,400,000 Net proceeds per share $ 9.11 $ 9.13 The minimum purchase requirement for all of the offerings is 250 shares and the maximum purchase amount for any person is 5% of the total shares sold, which will range from 34,000 to 46,000 shares depending on the total shares issued in the offerings. All three components of the offering will commence concurrently on , 2004. The Surplus Note Exchange and the Subscription Offerings will remain open for 30 days. No subscriptions will be accepted in the Community Offering until immediately after the Surplus Note Exchange and Subscription Offerings have concluded. The Community Offering will remain open for an additional 30 days or until the maximum number of shares have been sold, whichever occurs first. We have engaged Centennial Securities Company, Inc. to advise us with respect to this offering. Centennial has agreed to use its best efforts to assist us with our solicitation of subscriptions and purchase orders for shares of common stock in the offering. Centennial will not purchase any shares of common stock in the offering and is not obligated to sell any specific number of shares. Because this is our initial offering of common stock, there is currently no public market for the common stock. We expect that brokers will publish bid and ask quotations for our shares in the Pink Sheets centralized quotation service after the completion of the offering under the symbol FMIC. The common stock offered by this prospectus involves a significant amount of risk. Please refer to Risk Factors beginning on page 12 of this prospectus for a discussion of risks that you should consider before investing. Neither the Securities and Exchange Commission, nor any state securities agency, nor any state insurance bureau has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense. Centennial Securities Company, Inc. THE DATE OF THIS PROSPECTUS IS , 2004 Table of Contents If our reinsurers do not fulfill their financial obligations to us it may jeopardize our earnings and financial condition. We are subject to loss and credit risk relating to the reinsurers we deal with because buying reinsurance does not relieve us of our liability to policyholders. The insolvency or inability of any reinsurer to meet its obligations may have a material adverse effect on the business, results of operations and financial condition of the Insurance Company. If we do not have adequate reinsurance coverage, our earnings and financial condition would be in jeopardy. It is possible that the losses we experience on risks we have reinsured will exceed the coverage limits on the reinsurance. If the amount of our reinsurance is not sufficient, our insurance losses would increase which could jeopardize our earnings and financial condition. In 2004, we have the following types of reinsurance: Multi-Lines Excess of Loss Coverage. The multi-lines excess of loss program is designed to help stabilize financial results, limit exposure on larger risks, and increase capacity. The largest exposure retained by us on any one risk in 2004 is $125,000. The 2004 property coverage for this program provides up to $2,375,000 of coverage over the $125,000 retention per risk. The 2004 casualty coverage for this program provides up to $4,875,000 over the $125,000 retention. Our 2004 workers compensation reinsurance provides up to $9,875,000 of coverage above the $125,000 retention. Catastrophe Excess of Loss Coverage. Catastrophe reinsurance protects us from significant aggregate loss exposure arising from a single event such as windstorm, hail, tornado, hurricane, earthquake, blizzard, freezing temperatures, and other extraordinary events. In 2004, we have three layers of catastrophe excess of loss reinsurance providing coverage for up to $20,000,000 above the $1,000,000 retention. Facultative. We utilize facultative reinsurance to provide additional underwriting capacity, to mitigate the effect of individual losses and to reduce net liability on individual risks. In 2004, we purchased this reinsurance where our liability is greater than $2,500,000 for all lines of business. Quota Share Coverage. In 2003 we also utilized quota share reinsurance under agreements that provide coverage on all lines of business. In 2003, we ceded 45% of our net written premium and losses to the quota share reinsurers. The Insurance Company placed the multi-line quota share agreement into runoff after December 31, 2003. Because we are not renewing our use of quota share reinsurance, we will retain more risk, which could result in losses. In recent years, the Insurance Company ceded 45% of its direct written premium to its quota share reinsurers. Quota share reinsurance refers to a form of pro rata reinsurance arrangement pursuant to which the reinsurer participates in a specified percentage of the premiums and losses on every risk that comes within the scope of the reinsurance agreement. For the year 2004, we have decided not to renew our use of quota share reinsurance for new and renewal policies, although we still maintain other treaty and facultative reinsurance coverages, including the excess of loss and catastrophe reinsurance coverages. Thus, we will retain and earn more of the premiums we write, but also retain more of the related losses. Terminating our use of quota share reinsurance has increased our risk and exposure to such losses, which could have a material adverse effect on our business, financial condition and results of operations. As a holding company, our primary source of income is dividends from the Insurance Company, which is limited by and dependent upon the ability of the Insurance Company to pay dividends to us. We have no present intention of adding to our holdings or paying dividends in the foreseeable future. Our immediate primary function is to serve as the holding company for the Insurance Company after its conversion. The Holding Company s sole source of income for operations will depend upon the ability of the Insurance Company to pay dividends to us. Table of Contents TABLE OF CONTENTS Page Table of Contents The payment of dividends by the Insurance Company is subject to limitations imposed by the Michigan Insurance Code. The Insurance Company may not pay an extraordinary dividend unless it notifies the Insurance Commissioner and the Insurance Commissioner does not disapprove the payment. An extraordinary dividend includes any dividend which, when taken together with other dividends paid within the preceding 12 months, exceeds the greater of 10% of an insurance company s statutory policyholders surplus as of December 31 of the immediately preceding year or its statutory net income, excluding realized capital gains, for the 12-month period ending December 31 of the immediately preceding year. Also, in the absence of approval of the Insurance Commissioner, dividends may only be paid from statutory earned surplus. The Michigan Insurance Code gives the Commissioner the authority to disallow any dividend that renders the surplus of the insurer inadequate, so, in order to pay any dividends, the Insurance Company must be in a position to satisfy the requirement that it continues to be safe, reliable and entitled to public confidence. Changes in prevailing interest rates may reduce our revenues, cash flows and shareholders equity. We have invested a significant portion of our investment portfolio in fixed income securities. In recent years, we have earned our investment income primarily from interest income on this portfolio. Lower interest rates could reduce the return on our portfolio and the amount of this income if we must reinvest at rates below those we have on securities currently in the portfolio. The reduced investment income could also reduce our cash flows. In addition, in a declining interest rate environment, we may lower our credit quality standards in order to maintain yield on the investment portfolio, which would negatively impact the quality of our investment portfolio. A decline in the quality of our portfolio could result in realized losses on securities, creating additional volatility in our statement of operations. Higher interest rates could reduce the market value of our fixed income investments. We could be forced to sell investments to meet our liquidity requirements. We believe that we maintain adequate amounts of cash and short-term investments to pay claims, and do not expect to sell securities prematurely for such purposes. We may, however, decide to sell securities as a result of changes in interest rates, credit quality, the rate of repayment or other similar factors. A significant increase in market interest rates could result in a situation in which we are required to sell securities at depressed prices to fund payments to our insureds. Since we carry debt securities at fair value, we expect that these securities would be sold with no material impact on our net equity. However, if these securities are sold, future net investment income may be reduced if we are unable to reinvest in securities with similar or better yields. Declining debt and equity markets could adversely affect our investment portfolio. A declining market could stress the values of investments of all firms and could cause the investment ratings of the issuers of debt or equity to decline. Therefore, a declining market could negatively impact the credit quality of our investment portfolio as adverse equity markets also affect issuers of securities held by us. Declines in the quality of the portfolio could cause additional realized losses on securities, thus causing volatility in our statement of operations. Summary 1 Risk Factors 12

parsed_sections/risk_factors/2004/CIK0001273397_procentury_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ RISK FACTORS Investing in our common shares involves a high degree of risk. Before you invest in our common shares, you should carefully consider the following risks and cautionary statements. If any of the events described in the following risks actually occur, our business, financial condition or results of operations may suffer. As a result, the trading price of our common shares could decline, and you could lose all or a substantial portion of your investment. Risks Related To Our Business Our actual incurred losses may be greater than our loss and loss expense reserves, which could cause our future earnings, liquidity and financial rating to decline. We are liable for loss and loss expenses under the terms of the insurance policies we underwrite. In many cases, several years may elapse between the occurrence of an insured loss, the reporting of the loss to us and our payment of the loss. We establish loss and loss expense reserves for the ultimate payment of all loss and loss expenses incurred. If any of our reserves should prove to be inadequate, we will be required to increase reserves resulting in a reduction in our net income in the period in which the inadequacy is identified. Future loss experience substantially in excess of established reserves could also cause our future earnings, liquidity and financial rating to decline. These reserves are based on historical data and estimates of future events and by their nature are imprecise. Our ultimate loss and loss expenses may vary from established reserves. Furthermore, factors that are subject to change, such as: claims inflation; claims development patterns; legislative activity; social and economic patterns; and litigation and regulatory trends may have a substantial impact on our future loss experience. Additionally, we have established loss and loss expense reserves for certain lines of business we have exited, but circumstances could develop that would make these reserves insufficient. As of December 31, 2003, unpaid loss and loss expense reserves (net of reserves ceded to our reinsurers) were $95.2 million, consisting of case loss and loss expense reserves of $41.4 million and incurred but not reported loss and loss expense reserves of $53.8 million. We have re-estimated our loss and loss expense reserves attributable to insured events in prior years, which includes re-estimations with respect to excess and surplus lines and products we no longer write. These re-estimations resulted in an increase in reserves of $3.1 million, $5.3 million, $17.5 million and $26.3 million for the years ended December 31, 2000, 2001, 2002 and 2003, respectively. A decline in our financial rating assigned by A.M. Best may result in a reduction of new or renewal business. Our insurance subsidiaries currently have a pooled A- (excellent) rating from A.M. Best, the fourth highest of 16 A.M. Best ratings. A.M. Best assigns ratings that generally are based on an insurance company s ability to pay policyholder obligations (not towards protection of investors) and focus on capital adequacy, loss and loss expense reserve adequacy and operating performance. A reduction in our performance in these criteria could result in a downgrade of our rating. In addition, as part of the Evergreen and Continental transactions, we will terminate the intercompany pooling agreement among Century, Evergreen and Continental effective January 1, 2004. As a result of the termination of the intercompany pooling agreement, we will no longer qualify for a pooled rating, and we will lose the ability to use the surplus from Evergreen and Continental. We believe the contribution of surplus from ProCentury to Century from the Initial public offering price $ $ Underwriting discount Proceeds (before expenses) to us Proceeds (before expenses) to selling shareholders We have granted the underwriters a 30-day option to purchase up to an additional 1,335,000 common shares at the public offering price, less the underwriting discount, to cover over-allotments, if any. Neither the Securities and Exchange Commission nor any state securities commission or regulatory authority has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. The underwriters expect to deliver the common shares to purchasers on or about , 2004. Table of Contents proceeds of this offering will exceed the amount of surplus lost from the disposition of Evergreen and Continental. As a result, we do not believe that the Evergreen and Continental transactions will have an adverse effect on our rating with A.M. Best. A downgrade of our rating could cause our current and future general agents, retail brokers and insureds to choose other, more highly rated competitors. We are subject to extensive regulation, which may adversely affect our ability to achieve our business objectives. In addition, if we fail to comply with these regulations, we may be subject to penalties, including fines and suspensions, which may adversely affect our financial condition and results of operations. General. Century is subject to regulations, administered primarily by Ohio, our domiciliary state, and to a lesser degree, the five other states in which Century is licensed or admitted to sell insurance. Most insurance regulations are designed to protect the interests of insurance policyholders, as opposed to the interests of shareholders. These regulations, generally are administered by a department of insurance in each state and relate to, among other things, excess and surplus lines of business authorizations, capital and surplus requirements, rate and form approvals, investment parameter restrictions, underwriting limitations, affiliate transactions, dividend limitations, changes in control and a variety of other financial and non-financial components of our business. Significant changes in these laws and regulations could further limit our discretion or make it more expensive to conduct our business. State insurance departments also conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to financial condition, holding company issues and other matters. These regulatory requirements may adversely affect or inhibit our ability to achieve some or all of our business objectives. Required Licensing. In addition, regulatory authorities have broad discretion to deny or revoke licenses for various reasons, including the violation of regulations. In some instances, where there is uncertainty as to applicability, we follow practices based on our interpretations of regulations or practices that we believe generally to be followed by the industry. These practices may turn out to be different from the interpretations of regulatory authorities. If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, insurance regulatory authorities could preclude or temporarily suspend us from carrying on some or all of our activities or otherwise penalize us. This could adversely affect our ability to operate our business. Further, changes in the level of regulation of the insurance industry or changes in laws or regulations themselves or interpretations by regulatory authorities could adversely affect our ability to operate our business. Risk-Based Capital. The National Association of Insurance Commissioners (the NAIC ) has adopted a system to test the adequacy of statutory capital, known as risk-based capital. This system establishes the minimum amount of risk-based capital necessary for a company to support its overall business operations. It identifies property and casualty insurers that may be inadequately capitalized by looking at certain inherent risks of each insurer s assets and liabilities and its mix of net written premiums. Insurers falling below a calculated threshold may be subject to varying degrees of regulatory action, including supervision, rehabilitation or liquidation. Failure to maintain our risk-based capital at the required levels could cause our insurance subsidiary to lose its regulatory authority to conduct its business. See Management s Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources for a discussion of our risk-based capital as of December 31, 2003. IRIS Ratios. The NAIC Insurance Regulatory Information System ( IRIS ) is part of a collection of analytical tools designed to provide state insurance regulators with an integrated approach to screening and analyzing the financial condition of insurance companies. IRIS has two phases of screening: statistical and analytical. In the statistical phase, the NAIC database generates financial ratios based on financial information obtained from insurance companies annual statutory statements. The analytical phase is a review of the annual statements, financial ratios and other automated solvency tools. A ratio result falling outside the usual range of IRIS ratios is viewed as part of the regulatory early monitoring system. As of December 31, 2003, Century had five IRIS ratios outside the usual range, as described in Business Regulatory Environment IRIS Ratios, which could result in regulatory action. Friedman Billings Ramsey A.G. Edwards Sons, Inc. Raymond James The date of this prospectus is , 2004. Table of Contents Our general agents may exceed their authority and bind us to policies outside our underwriting guidelines, and until we affect a cancellation, we may incur loss and loss expenses related to that policy. As of December 31, 2003, we underwrote 59.4% of our property and casualty premiums on a binding authority basis. Binding authority business represents risks that may be quoted and bound by our general agents prior to our underwriting review. If a general agent exceeds this authority by binding us on a risk that does not comply with our underwriting guidelines, we are at risk for claims under that policy that occur during the period from its issue date until we receive the policy and cancel it. We have not suffered material adverse consequences due to our general agents exceeding their underwriting authority. Since current management assumed control in 2000, there have been two instances in which we have recovered paid loss amounts from a general agent due to a violation of underwriting authority. Such funds were covered by the required errors and omissions insurance carried by each of our agents. To cancel a policy for exceeding underwriting authority, we must receive and cancel the policy within statutorily prescribed time limits, typically 60 days. Our general agents are required by contract to have bound policies issued and a copy sent to our office within 30 days of the effective date of coverage. Our policy review generally takes two to four weeks, depending on the time of year. Upon review of a policy, we issue instructions to cure any material errors discovered. If cancellation of the policy is the only cure, we order the cancellation of the policy at that time pursuant to state law. As a result, we may be bound by a policy that does not comply with our underwriting guidelines, and until we can effect a cancellation, we may incur loss and loss expenses related to that policy. If we lose key personnel or are unable to recruit qualified personnel, our ability to implement our business strategies could be delayed or hindered. Our future success will depend, in large part, upon the efforts of our executive officers and other key personnel. We rely substantially upon the services of Edward F. Feighan, our Chairman of the Board, President and Chief Executive Officer, Charles D. Hamm, our Chief Financial Officer and Treasurer, Christopher J. Timm, our Executive Vice President and Director, and John A. Marazza, our Executive Vice President, Chief Operating Officer, Secretary and Director. Each of Messrs. Feighan, Hamm, Timm and Marazza has an employment agreement with us. The loss of any of these officers or other key personnel could cause our ability to implement our business strategies to be delayed or hindered. We do not have key person insurance on the lives of any of our key management personnel, except one officer. As we continue to grow, we will need to recruit and retain additional qualified personnel, but we may not be able to do so. As we have grown, we have generally been successful in filling key positions, but our ability to continue to recruit and retain such personnel will depend upon a number of factors, such as our results of operations, prospects and the level of competition then prevailing in the market for qualified personnel. Our investment results and, therefore, our financial condition may be impacted by changes in the business, financial condition or operating results of the entities in which we invest, as well as changes in government monetary policies, general economic conditions and overall capital market conditions, all of which impact interest rates. Our results of operations depend, in part, on the performance of our invested assets. Fluctuations in interest rates affect our returns on and the fair value of fixed-income securities. Unrealized gains and losses on fixed-income securities are recognized in accumulated other comprehensive income, net of taxes and minority interest, and increase or decrease our shareholders equity. Interest rates in the United States are currently low relative to historical levels. An increase in interest rates could reduce the fair value of our investments in fixed-income securities. In addition, defaults by third parties who fail to pay or perform obligations could reduce our investment income and realized investment gains and could result in investment losses in our portfolio. 3 .2 Form of Amended and Restated Code of Regulations of ProCentury Corporation 4 .1 Specimen Certificate for common shares, without par value, of ProCentury Corporation 4 .2 Indenture, dated as of December 4, 2002, by and between ProFinance Holdings Corporation and State Street Bank and Trust Company of Connecticut 4 .3 Amended and Restated Declaration of Trust, dated as of December 4, 2002, by and among State Street Bank and Trust Company of Connecticut, ProFinance Holdings Corporation and Steven R. Young and John Marazza, as Administrators 4 .4 Guarantee Agreement, dated as of December 4, 2002, by and between ProFinance Holdings Corporation and State Street Bank and Trust Company of Connecticut 4 .5 Indenture, dated as of May 15, 2003, by and between ProFinance Holdings Corporation and U.S. Bank National Association 4 .6 Amended and Restated Declaration of Trust, dated as of May 15, 2003, by and among U.S. Bank National Association, ProFinance Holdings Corporation and Steven R. Young and John Marazza, as Administrators 4 .7 Guarantee Agreement, dated as of May 15, 2003, by and between ProFinance Holdings Corporation and U.S. Bank National Association 4 .8 Universal Note and Security Agreement, dated as of October 5, 2001, by and between ProFinance Holding Corporation and Eaton National Bank Trust Co., as supplemented and amended 5 Opinion of Baker Hostetler LLP regarding legality 10 .1 Employment Agreement, dated as of December 15, 2003, by and between ProCentury Corporation and Edward F. Feighan 10 .2 Employment Agreement, dated as of December 15, 2003, by and between ProCentury Corporation and John A. Marazza 10 .3 Employment Agreement, dated as of December 15, 2003, by and between ProCentury Corporation and Christopher J. Timm 10 .4 Employment Agreement, dated as of December 15, 2003, by and between ProCentury Corporation and Charles D. Hamm 10 .6 Form of ProCentury Corporation Indemnification Agreement by and between ProCentury Corporation and director 10 .7 ProCentury Corporation 2004 Stock Option and Award Plan 10 .8 ProCentury Corporation Deferred Compensation Plan 10 .9 ProCentury Corporation Deferred Compensation Plan Rabbi Trust Agreement 10 .10 ProCentury Corporation Annual Incentive Plan 10 .11* Transitional Administrative Agreement, effective as of January 1, 2004, by and among ProCentury Corporation, Evergreen National Indemnity Corporation and Continental Heritage Insurance Company 10 .12* Loss Portfolio Transfer Reinsurance Contract, effective as of January 1, 2004, issued to Century Surety Company by Evergreen National Indemnity Company 10 .13* Loss Portfolio Transfer Reinsurance Contract, effective as of January 1, 2004, issued to Continental Heritage Insurance Company by Century Surety Company 10 .14* Loss Portfolio Transfer Reinsurance Contract, effective as of January 1, 2004, issued to Evergreen National Indemnity Company by Century Surety Company 10 .15* Quota Share Reinsurance Contract, effective as of January 1, 2004, issued to Evergreen National Indemnity Company by Century Surety Company 10 .16* Quota Share Reinsurance Contract, effective as of January 1, 2004, issued to Continental Heritage Insurance Company by Century Surety Company 1 Proposed form of Underwriting Agreement among ProCentury Corporation, the selling shareholders and the underwriters 3 .1 Form of Amended and Restated Articles of Incorporation of ProCentury Corporation 3 .2 Form of Amended and Restated Code of Regulations of ProCentury Corporation 4 .1 Specimen Certificate for common shares, without par value, of ProCentury Corporation 4 .2 Indenture, dated as of December 4, 2002, by and between ProFinance Holdings Corporation and State Street Bank and Trust Company of Connecticut 4 .3 Amended and Restated Declaration of Trust, dated as of December 4, 2002, by and among State Street Bank and Trust Company of Connecticut, ProFinance Holdings Corporation and Steven R. Young and John Marazza, as Administrators 4 .4 Guarantee Agreement, dated as of December 4, 2002, by and between ProFinance Holdings Corporation and State Street Bank and Trust Company of Connecticut 4 .5 Indenture, dated as of May 15, 2003, by and between ProFinance Holdings Corporation and U.S. Bank National Association 4 .6 Amended and Restated Declaration of Trust, dated as of May 15, 2003, by and among U.S. Bank National Association, ProFinance Holdings Corporation and Steven R. Young and John Marazza, as Administrators 4 .7 Guarantee Agreement, dated as of May 15, 2003, by and between ProFinance Holdings Corporation and U.S. Bank National Association 4 .8 Universal Note and Security Agreement, dated as of October 5, 2001, by and between ProFinance Holding Corporation and Eaton National Bank Trust Co., as supplemented and amended 5 Opinion of Baker Hostetler LLP regarding legality 10 .1 Employment Agreement, dated as of December 15, 2003, by and between ProCentury Corporation and Edward F. Feighan 10 .2 Employment Agreement, dated as of December 15, 2003, by and between ProCentury Corporation and John A. Marazza 10 .3 Employment Agreement, dated as of December 15, 2003, by and between ProCentury Corporation and Christopher J. Timm 10 .4 Employment Agreement, dated as of December 15, 2003, by and between ProCentury Corporation and Charles D. Hamm 10 .6 Form of ProCentury Corporation Indemnification Agreement by and between ProCentury Corporation and director 10 .7 ProCentury Corporation 2004 Stock Option and Award Plan 10 .8 ProCentury Corporation Deferred Compensation Plan 10 .9 ProCentury Corporation Deferred Compensation Plan Rabbi Trust Agreement 10 .10 ProCentury Corporation Annual Incentive Plan 10 .11* Transitional Administrative Agreement, effective as of January 1, 2004, by and among ProCentury Corporation, Evergreen National Indemnity Corporation and Continental Heritage Insurance Company 10 .12* Loss Portfolio Transfer Reinsurance Contract, effective as of January 1, 2004, issued to Century Surety Company by Evergreen National Indemnity Company 10 .13* Loss Portfolio Transfer Reinsurance Contract, effective as of January 1, 2004, issued to Continental Heritage Insurance Company by Century Surety Company 10 .14* Loss Portfolio Transfer Reinsurance Contract, effective as of January 1, 2004, issued to Evergreen National Indemnity Company by Century Surety Company TABLE OF CONTENTS PROSPECTUS SUMMARY RISK FACTORS

parsed_sections/risk_factors/2004/CIK0001274692_naviera_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ RISK FACTORS You should carefully consider the following factors in addition to the other information presented in this prospectus. Factors relating to the Senior Secured Notes There is no active trading market for the Senior Secured Notes The Senior Secured Notes are new securities and therefore do not currently have an active trading market. If the Senior Secured Notes are traded after their initial issuance, they may trade at a discount from their nominal price, depending upon prevailing interest rates, the market for similar securities, general economic conditions and our financial condition. The Senior Secured Notes are not listed on any exchange. As a result, we cannot assure you that an active trading market will develop for the Senior Secured Notes or that the market for the Notes will provide any liquidity for holders that wish to sell their Senior Secured Notes. We may not be able to finance a change of control offer Under the terms of the indenture governing the Senior Secured Notes, we are required to offer to repurchase all of the Senior Secured Notes if a change of control (as defined under "Description of the Senior Secured Notes Offer to Purchase Upon a Change of Control") occurs. However, it is possible that we will not have sufficient funds at the time of the change of control to make the required repurchase. Other financing arrangements to which we and our subsidiaries are or may become a party may also require that we repay, or offer to repurchase, other obligations upon a change of control. In addition, other agreements to which we and our subsidiaries are or may become subject, including other financing arrangements, may contain provisions that prohibit us from making such a repurchase. Therefore, there can be no assurance that we will be permitted to consummate a repurchase if a change of control occurs without causing a default under or breach of such other financing arrangements. We are primarily a holding company and we depend upon funds received from our operating subsidiaries to make payments on our indebtedness We are primarily a holding company and conduct the majority of our operations, and hold a substantial portion of our operating assets, through numerous direct and indirect subsidiaries. As a result, we rely on income from dividends and fees related to administrative services provided to our operating subsidiaries for our operating income, including the funds necessary to service our indebtedness. As a matter of Mexican law, profits of our subsidiaries may only be distributed upon approval by the subsidiaries' shareholders, and no profits may be distributed by our subsidiaries to us until all losses incurred in prior fiscal years have been offset against any sub-account of our capital or net worth account. In addition, at least 5% of the profits of our subsidiaries must be separated to create a reserve (fondo de reserva) until such reserve is equal to 20% of the aggregate value of such subsidiary's capital stock (as calculated based on the actual nominal subscription price received by such subsidiary for all issued shares that are outstanding at the time). There is no restriction under Mexican law upon our subsidiaries remitting funds to us in the form of loans or advances in the ordinary course of business, except to the extent that such loans or advances would result in the insolvency of our subsidiaries, or for our subsidiaries to pay to us fees or other amounts for services. In addition, the indentures governing TFM's notes and TFM's First Amended and Restated Credit Agreement restrict TFM's ability to pay dividends under certain circumstances and limit the dividends payable to an accrued maximum aggregate amount or "basket" based on Grupo TFM's accumulated consolidated net income after a specified date. Furthermore, we do not own 100% of all of our subsidiaries and, to the extent that we rely on dividends or other distributions from subsidiaries that we do not wholly own, we will only be entitled to a pro rata share of the dividends or other distributions. In May 2002, TFM completed a consent solicitation of holders of its notes as a result of which the indentures were amended to, among other things, further restrict TFM's ability to pay dividends. There is currently no availability under TFM's dividend basket to pay dividends. Consequently, it is unlikely that TFM will provide us with funds necessary to service our debt obligations. In addition to operations at our subsidiaries, we are a party to a number of arrangements with other parties where we and those parties have jointly invested in our subsidiaries and we may enter into other similar arrangements in the future. Our partners in these subsidiaries may at any time have economic, business or legal interests or goals that are inconsistent with our interests or those of the entity itself. Any of these partners may also be unable to meet their economic or other obligations to the subsidiaries, and we may be required to fulfill those obligations. Furthermore, any dividends that are distributed from subsidiaries that we do not wholly own would be shared pro rata with our partners according to our relative ownership interests. Disagreements for these or any other reasons with companies with which we have a strategic alliance or relationship could impair or adversely affect our ability to conduct our business and to receive distributions from, and return on our investments in, those subsidiaries. In December 2001, a dispute arose between us and KCS, resulting from a dividend declaration by Grupo TFM and a lease transaction between TFM and Mexrail, Inc. ("Mexrail"). Although we settled the dispute, both we and KCS preserved our respective interpretations of the operative agreements governing our investment in Grupo TFM. In addition, in connection with the dispute with KCS regarding the termination of the agreement for the sale of our interest in Grupo TFM to KCS for a combination of cash and stock of KCS and an additional earnout (the "TFM Sale"), KCS has commenced numerous legal proceedings against us and our officers in Mexico seeking, among other things, to nullify actions taken at board meetings of Grupo TFM and TFM. It is possible that similar or other disputes may arise with respect to other matters relating to Grupo TFM. See "Legal Proceedings" for a more detailed description of disputes. A portion of the security for the Senior Secured Notes is subject to rights of first refusal or other restrictions on transfer Some of the shares which are owned by the guarantors which are part of the security for the obligations under the Senior Secured Notes and the guarantees are subject to rights of first refusal or other rights in favor of third parties. Our ability to sell such shares upon foreclosure could be adversely affected if bidders prove to be unwilling to make an offer to purchase such shares due to the existence of such rights in favor of third parties. The shares of our direct and indirect subsidiaries may be difficult to sell in the event the Company cannot fulfill its obligations with respect to the Senior Secured Notes, or the guarantors are called upon to satisfy their guarantees of the Senior Secured Notes There is no public market for the shares of our and our guarantors' subsidiaries, including Grupo TFM, TMM Multimodal or TMM Holdings, and the shares of these entities cannot be easily liquidated. Accordingly, the number of potential purchasers of such shares is very limited, and may include competitors of the Company. In the event that the holders of Senior Secured Notes seek to foreclose on the shares that the Company or the guarantors have pledged under the security agreements, there can be no assurance that such foreclosure would be able to generate sufficient funds to pay the Senior Secured Notes in full, or that any sale would not be delayed, possibly for a long period of time. Furthermore, certain shareholder agreements and other contracts relating to the shares of our and our guarantors' subsidiaries contain significant restrictions on the sale of those shares, including, with respect to Grupo TFM, our agreement not to sell those shares to a competitor of the Company or KCS. In addition, existing foreign investment restrictions, as well as Mexican antitrust law Transportation revenues $ 40,949 $ 127,226 $ 889,825 $ (49,384 ) $ 1,008,616 Costs and expenses 56,875 $ and the governing concession, could also significantly limit the number of potential purchasers for the shares of our and our guarantors' subsidiaries, and could thus negatively impact our ability to sell such shares. See "Business Grupo TMM's Strategic Partners." Mexican law and regulations may impair your ability to enforce in Mexico certain rights in connection with the Senior Secured Notes Under Mexican law, as our creditors, your rights are limited in the following ways: service of process by mail does not constitute effective service under Mexican law, and if a final judgment based on service of process by mail was made outside of Mexico, it would not be enforceable in Mexico; and any judgments as a result of enforcement proceedings in Mexico would be payable in pesos. You may not be able to receive your payments on the Senior Secured Notes in U.S. dollars in certain circumstances We are required to make payments of amounts owed under the Senior Secured Notes and the guarantees in U.S. dollars. However, under the Mexican Monetary Law (Ley Monetaria de los Estados Unidos Mexicanos), obligations to make payments in Mexico in foreign currency may be discharged in pesos at the rate of exchange for pesos prevailing at the time and place of payment. Although we are contractually required, and intend, to make all payments of amounts owed under the Senior Secured Notes and the guarantees in U.S. dollars, we are legally entitled to pay in pesos if payment on the Senior Secured Notes or the guarantees is sought in Mexico (through the enforcement of a non-Mexican judgment or otherwise). In the event that we make payment in pesos, you may experience a U.S. dollar shortfall when converting the pesos to U.S. dollars. The indenture for the Senior Secured Notes restricts our ability to take certain actions The indenture for the Senior Secured Notes imposes significant operating and financial restrictions. These restrictions affect, and in many respects significantly limit or prohibit, our ability and the ability of our restricted subsidiaries to, among other things: incur indebtedness; create or suffer to exist liens; make prepayments of particular indebtedness; pay dividends; make investments; engage in transactions with shareholders or affiliates; use assets as security in other transactions; create any unrestricted subsidiary; sell assets; and engage in mergers and consolidations or in sale-leaseback transactions. If we do not comply with these restrictions, a default could occur even if we could at that time pay the amounts required under the Senior Secured Notes. If there were a default, the holders of Senior Secured Notes could demand immediate payment of the Senior Secured Notes. Should that occur, we might not be able to pay or refinance the Senior Secured Notes on acceptable terms. SCHEDULE A CO-REGISTRANTS SUBSIDIARY GUARANTORS The following direct and indirect wholly-owned subsidiaries of Grupo TMM are guarantors of the Senior Secured Notes and are Co-Registrants, each of which is incorporated in the jurisdiction opposite its name set forth below and none of which has an I.R.S. Employer Identification Number. Name of Co-Registrant Factors relating to Grupo TMM Our dispute with Kansas City Southern could result in a material adverse effect on our business We are currently involved in a dispute with KCS regarding the Acquisition Agreement (the "Acquisition Agreement") executed by us and KCS on April 20, 2003, relating to the TFM Sale. Under the terms of the Acquisition Agreement, KCS was to purchase our interest in Grupo TFM in exchange for cash, shares of KCS and an additional cash earnout payment which was contingent on the timing of certain events, such as receipt of the VAT Proceeds and repurchase of the shares of TFM owned by the Mexican government. Subsequent to the execution of the Acquisition Agreement, we believe that KCS representatives undertook certain activities that threatened to jeopardize the value of the earnout. Thereafter, on August 18, 2003, our shareholders voted to reject the Acquisition Agreement and we notified KCS that we were terminating the Acquisition Agreement on August 22, 2003. KCS disputed our right to terminate the Acquisition Agreement and alleged certain breaches by us of the Acquisition Agreement. Under the terms of the Acquisition Agreement, the parties submitted these disputes to binding arbitration. An arbitration panel (the "panel") was chosen in accordance with the terms of the Acquisition Agreement. KCS obtained a preliminary injunction from the Delaware Chancery Court enjoining us from violating the terms of the Acquisition Agreement pending a subsequent decision by a panel of arbitrators regarding whether the Acquisition Agreement was properly terminated. On December 8, 2003, we and KCS participated in a preliminary hearing with the arbitrators during which the arbitrators deliberated whether the issue of the Acquisition Agreement's continued effectiveness should be bifurcated from the other issues in the case. On December 22, 2003, the panel bifurcated the issue of whether Grupo TMM properly terminated the Acquisition Agreement from the other disputed issues between the parties and scheduled a hearing on that issue. On February 2, 3 and 4, 2004, a hearing was held in New York on the issue of whether Grupo TMM's termination was proper. We maintained that we properly terminated the Acquisition Agreement while KCS sought a declaration that the Acquisition Agreement was wrongfully terminated. On February 19, 2004, we and KCS filed post-hearing briefs with the panel. On March 19, 2004, the panel issued an Interim Award in which it concluded that the rejection of the Acquisition Agreement by Grupo TMM's shareholders in its vote on August 18, 2003, did not authorize Grupo TMM's purported termination of that Agreement, dated August 22, 2003. Accordingly, the Acquisition Agreement remains in force and binding on the parties until otherwise terminated according to its terms or by law. In reaching this conclusion, the panel found it unnecessary to determine whether approval by Grupo TMM's shareholders is a "condition" of the Agreement. On April 4, 2004, the panel issued an order, which was stipulated to by KCS and Grupo TMM (the "Order and Stipulation"), providing that the parties agreed "not to request a scheduling order for a further hearing in the arbitration at this time" and that "[e]ach party reserves the right to request a scheduling order for a further hearing at any time." Since the issuance in April 2004 of the Order and Stipulation, the Company and KCS and their respective representatives have engaged in discussions regarding the potential settlement of the dispute and the possible amendment of the existing Acquisition Agreement. There is no assurance that the parties will be able to agree on the terms of any settlement or amendment or, if an agreement is reached, as to the terms of that agreement. The transaction contemplated by the existing Acquisition Agreement would constitute a "Qualifying Disposition" under the indenture governing the Senior Secured Notes that would permit the Company to complete the transaction without any further consent or approval of the holders of the Senior Secured Notes, subject to compliance with certain conditions, such as receipt of required fairness opinions and a limitation on the ability of KCS to exercise a right to pay a portion of the cash purchase price in additional shares of KCS common stock if the cash consideration would be less than 35% of the principal amount of, and accrued unpaid interest on, the Senior Secured Notes outstanding at the time the transaction is completed. The Company expects that any transaction pursuant to any amended Acquisition Agreement would also constitute a Qualifying Disposition. As a result, if an agreement is reached on that basis, the Company would be permitted State or Other Jurisdiction of Incorporation or Organization under the indenture governing the Senior Secured Notes to complete any transaction provided for under an amended agreement without any further consent or approval from the holders of the Senior Secured Notes. See "Description of the Senior Secured Notes Certain Convenants Restrictions on Asset Dispositions; Use of Proceeds of Asset Dispositions, Grupo TFM Dispositions, VAT Proceeds." We cannot predict the ultimate outcome of any further arbitration on the remaining disputed issues. If KCS were to be awarded substantial damages in any such proceeding, it could have a material adverse effect on our business. For a more complete discussion of the legal dispute with KCS, see "Legal Proceedings Dispute with Kansas City Southern." We have a contingent obligation to purchase shares of TFM owned by the Mexican government The Mexican government retained a 20% interest in TFM in connection with the privatization of TFM in 1997, and pursuant to the original agreements relating to the concession, Grupo TFM has an obligation to purchase such interest at the original peso purchase price per share paid by Grupo TFM, indexed to account for Mexican inflation. If Grupo TFM does not purchase the Mexican government's interest, the Mexican government may require that we and KCS, either jointly or individually, purchase the Mexican government's interest at this price. The price of the Mexican government's interest, as indexed for Mexican inflation, was approximately 1,570.3 million UDIs (representing ps. 5,357 million pesos, or approximately $464.6 million, as of June 30, 2004). The estimated fair market value of the Mexican government's interest as of June 30, 2004, was $476.6 million. As a result of legal proceedings initiated by the Company in Mexico, the exercise of the put by the Mexican government has been enjoined by a court in Mexico; however, there is no assurance that the injunction will remain in place. Although our purchase of the Mexican government's interest would not result in a default under any of our obligations in connection with the Senior Secured Notes, we cannot assure you that we will have sufficient resources to acquire the Mexican government's interest if required to do so, or that we will not be prohibited by other agreements from completing the purchase. See "Business The Mexican Government Put." Our substantial indebtedness, and that of our subsidiary TFM, could adversely affect our business and, consequently, our ability to pay interest and repay our indebtedness We and TFM each have a significant amount of indebtedness, which requires significant debt service. After giving effect to our restructuring, at June 30, 2004, we had consolidated indebtedness of approximately $1,474.2 million, which includes $959.7 million of TFM's indebtedness. At such date, after giving effect to our restructuring, our shareholders' equity, including minority interest in consolidated subsidiaries, was $720.2 million, and TFM's shareholders' equity, including minority interest, was $977.6 million resulting in a debt to equity ratio of 204.7% and 98.2%, respectively. The level of our and TFM's consolidated indebtedness could have important consequences. For example, it could: limit cash flow available for capital expenditures, acquisitions, working capital and other general corporate purposes because a substantial portion of our cash flow from operations must be dedicated to servicing debt; increase our vulnerability to general adverse economic and industry conditions; expose us to risks inherent in interest rate fluctuations because some borrowings are at variable rates of interest, which could result in higher interest expenses in the event of increases in interest rates; limit our flexibility in planning for, or reacting to, competitive and other changes in our business and the industries in which we operate; place us at a competitive disadvantage compared to our competitors that have less debt and greater operating and financing flexibility than we do; and I.R.S. Employer Identification Number limit, through covenants in our indebtedness, our ability to borrow additional funds. Our and TFM's ability to pay interest and to repay or refinance indebtedness will depend upon future operating performance, including the ability to increase revenues significantly and control expenses. Future operating performance depends upon prevailing economic, financial, competitive, legislative, regulatory, business and other factors that are beyond our control. We cannot assure you that our business will generate sufficient cash flow from operations, that currently anticipated revenues and operating performance will be realized or that future borrowings will be available to us in amounts sufficient to enable us to pay our indebtedness or to fund our other liquidity needs. In addition, we may have difficulty accessing cash flows generated by our subsidiaries and joint ventures in which we participate. See "Business Our Liquidity Position" and "Risk Factors Factors relating to the Senior Secured Notes We are primarily a holding company and we depend upon funds received from our operating subsidiaries to make payments on our indebtedness." If we or TFM are unable to meet our debt service obligations or fund our other liquidity needs, we could attempt to restructure or refinance our indebtedness, seek additional equity capital or sell assets. We cannot assure you that we will be able to accomplish those actions on satisfactory terms, if at all. The indentures relating to our and TFM's debt securities contain a number of restrictive covenants and any additional financing arrangements we enter into may contain additional restrictive covenants. These covenants restrict or prohibit many actions, including our ability, or that of our subsidiaries, to: incur indebtedness; create or suffer to exist liens; make prepayments of particular indebtedness; pay dividends; make investments; engage in transactions with shareholders and affiliates; use assets as security in other transactions; create any unrestricted subsidiary; sell assets; and engage in mergers and consolidations or in sale-leaseback transactions. If we fail to comply with these restrictive covenants, our obligation to repay our debt may be accelerated. TFM has sought waivers under its credit agreements and may require additional waivers in the future TFM would not have met certain required maintenance covenants under its bank credit facilities during 2003. Accordingly, TFM sought and received waivers from the lenders under its bank credit facilities for such expected non-compliance. In October 2003 and March 2004, TFM received waivers from the banks which participate in its credit facilities of the term loan facility and U.S. commercial paper program. The waivers applied to the three months ended September 30, 2003, the three months ended December 31, 2003 and the three months ended March 31, 2004, respectively. It is possible that TFM may require additional waivers under its bank credit facilities. If TFM requires such waivers in the future, there can be no assurance that such waivers will be obtained. If such waivers are not obtained, TFM would be in default under its bank credit facilities and such default could result in acceleration of amounts due under the bank credit facilities and in cross-defaults under other obligations. TMM Holdings, S.A. de C.V. United Mexican States N/A Operadora de Apoyo Log stico, S.A. de C.V. United Mexican States N/A Compa a Arrendadora TMM, S.A. de C.V. United Mexican States N/A Transportes Mar timos M xico, S.A. United Mexican States N/A Divisi n de Negocios Especializados, S.A. de C.V. United Mexican States N/A Inmobiliaria TMM, S.A. de C.V. United Mexican States N/A Lacto Comercial Organizada, S.A. de C.V. United Mexican States N/A L nea Mexicana TMM, S.A. de C.V. United Mexican States N/A Naviera del Pacifico, S.A. de C.V. United Mexican States N/A Operadora Mar tima TMM, S.A. de C.V. United Mexican States N/A Operadora Portuaria de Tuxpan, S.A. de C.V. United Mexican States N/A Personal Mar timo, S.A. de C.V. United Mexican States N/A Servicios Administrativos de Transportaci n, S.A. de C.V. United Mexican States N/A Servicios de Log stica de M xico, S.A. de C.V. United Mexican States N/A Servicios en Operaciones Log sticas, S.A. de C.V. United Mexican States N/A Servicios en Puertos y Terminales, S.A. de C.V. United Mexican States N/A Terminal Mar tima de Tuxpan, S.A. de C.V. United Mexican States N/A TMG Overseas S.A. Republic of Panama N/A TMM Agencias, S.A. de C.V. United Mexican States N/A TMM Logistics, S.A. de C.V. United Mexican States N/A Transportaci n Portuaria Terrestre, S.A. de C.V. United Mexican States N/A The address, including zip code, of each of the principal executive offices of the Co-Registrants listed above is Avenida de la C spide, No. 4755, Colonia Parques del Pedregal, 14010 Mexico, D.F. The name and address, including zip code, area code and telephone number of the above listed Co-Registrants' agent for service of process is CT Corporation System, 111 Eighth Avenue, 13th Floor, New York, NY 10011, (212) 590-9200. The I.R.S. Employer Identification Number requirement is not applicable to the above listed Co-Registrants. Uncertainties relating to our financial condition and other factors currently raise substantial doubt about our ability to continue as a going concern The Company's audited consolidated financial statements as of December 31, 2003 and 2002 have been prepared assuming that it will continue as a going concern. The auditors' report on the Company's financial statements as of and for the three-year period ended December 31, 2003, includes an explanatory paragraph describing the existence of substantial doubt about the Company's ability to continue as a "going concern." The report indicates that (i) we had outstanding obligations amounting to $176.9 million which became due on May 15, 2003 and we did not make the payment of principal amount thereof nor the accrued interest on the due date; (ii) as a result we entered into default under the terms of the 2003 notes resulting in a cross-default under the 2006 notes with a principal amount of $200.0 million; (iii) payments of interest on the Old Senior Notes amounting to $45.7 million became due on May 15, 2003 and November 15, 2003; (iv) outstanding commercial paper and obligations for sale of receivables amounting to $85.0 million and $15.3 million will become effective September 2004, and on a monthly basis during 2004, respectively; (v) during the year ended December 31, 2003, we incurred a net loss of $86.7 million; and (vi) at December 31, 2003, we had an excess of current liabilities over current assets of $497.0 million and a deficit of $68.0 million. Following the consummation of the Exchange Offer, we are no longer in default under the Old Senior Notes, see "Management's Discussion and Analysis of Financial Condition and Results of Operations Our Current Liquidity Difficulties and Outlook" and " Contractual Obligations." We may be unable to successfully expand our business Future growth of our business will depend on a number of factors, including: identification and continued evaluation of niche markets; identification of joint venture opportunities or acquisition candidates; our ability to enter into acquisitions or joint ventures on favorable terms; our ability to hire and train qualified personnel; the successful integration of any acquired businesses with our existing operations; and our ability to effectively manage expansion and to obtain required financing. In order to maintain and improve operating results from new businesses, as well as our existing business, we will be required to manage our growth and expansion effectively. However, the management of new businesses involves numerous risks, including difficulties in assimilating the operations and services of the new businesses, the diversion of management's attention from other business concerns and the disadvantage of entering markets in which we may have no or limited direct or prior experience. Our failure to effectively manage our expansion could have a material adverse effect on our operational results. The Company is controlled by the Serrano Segovia family Members of the Serrano Segovia family control the Company through their direct and indirect ownership of our Series A Shares. Since the Series A Shares underlying our CPOs are required to be voted by the CPO Trustee in the same manner as the majority of the Series A Shares not so owned vote on any matter submitted to our stockholders, the Serrano Segovia family effectively controls all matters as to which a shareholder vote is required. As a result, the Serrano Segovia family will be able to direct and control the policies of the Company and its subsidiaries, including mergers, sales of assets and similar transactions. See "Major Shareholders and Related Party Transactions Major Shareholders." The indenture for the Senior Secured Notes contains covenants that prohibit transactions between the Company and its subsidiaries, affiliates and associates, such as the Serrano The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and is not soliciting an offer to buy these securities in any state or jurisdiction where the offer or sale is not permitted. SUBJECT TO COMPLETION, DATED SEPTEMBER 10, 2004 PRELIMINARY PROSPECTUS $392,646,832 Grupo TMM, S.A. Senior Secured Notes Due 2007 This prospectus covers the resale by certain selling noteholders named in this prospectus of up to $392,646,832 of our Senior Secured Notes due 2007 plus such additional amounts of Senior Secured Notes that may be issued from time to time in connection with payments in kind of interest on the Senior Secured Notes. We refer to all of our Senior Secured Notes due 2007 from time to time outstanding as the "Senior Secured Notes" and we refer to the Senior Secured Notes that may be sold pursuant to this prospectus as the "Notes." All of the Senior Secured Notes being registered may be offered and sold from time to time by the selling noteholders. You should read this prospectus carefully before you invest. The Notes were initially issued (i) to certain holders of our 91/2% Notes due 2003, which we refer to as our 2003 notes, and our 101/4% Senior Notes due 2006, which we refer to as our 2006 notes (we refer to the 2003 notes and the 2006 notes collectively as the "Old Senior Notes"), in a private exchange offer that closed simultaneously with a public exchange offer (we refer to both exchange offers collectively as the "Exchange Offer") of Senior Secured Notes for Old Senior Notes and (ii) in a private placement to certain holders of the Old Senior Notes who agreed to purchase additional Notes to fund our debt restructuring and to certain other creditors of the Company as consideration for cancellation of outstanding obligations of the Company. The Notes are being registered pursuant to registration rights granted in connection with the initial issuance and sale of the Notes. The Senior Secured Notes are guaranteed by each of our wholly-owned subsidiaries that is listed on Schedule A hereto. We may redeem the Senior Secured Notes at any time, in whole or in part, at the applicable redemption price described herein. Investing in the Senior Secured Notes involves risks. See "Risk Factors" beginning on page 11 of this prospectus. The persons listed as the selling noteholders in this prospectus are offering up to $392,646,832 aggregate principal amount of the Notes plus such additional amounts of Senior Secured Notes that may be issued from time to time in connection with payments in kind of interest on the Senior Secured Notes. The selling noteholders may offer their Notes through public or private transactions, in the Private Offering Resales and Trading through Automated Linkages or "PORTAL" market and at prevailing market prices or at privately negotiated prices. The Notes may be sold directly or through agents or broker-dealers acting as principal or agent. The selling noteholders may engage underwriters, brokers, dealers or agents, who may receive commissions or discounts from the selling noteholders. We will not receive any proceeds from the sale of the Notes by the selling noteholders. We will pay all of the expenses incident to the registration of the Notes, except for the selling commissions, if any. See "Plan of Distribution." Neither the Securities and Exchange Commission nor any state or foreign securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense. Segovia family. See "Description of the Senior Secured Notes Certain Covenants Limitation on Transactions with Affiliates." A substantial portion of the Series A Shares and ADSs of the Company held by the Serrano Segovia family is currently pledged to secure indebtedness of the Serrano Segovia family and entities controlled by them and may from time to time in the future be pledged to secure obligations of other of their affiliates. A foreclosure upon any such Series A Shares held by the Serrano Segovia family could constitute a change of control under the Indenture governing the Senior Secured Notes and certain other debt instruments of the Company and its subsidiaries. Such occurrence of a change of control would enable holders of the Senior Secured Notes to require the Company to repurchase their Senior Secured Notes. There can be no assurance that upon a change of control the assets of the Company would be sufficient to repurchase the Senior Secured Notes. See "Risk Factors Factors relating to the Senior Secured Notes We may not be able to finance a change of control offer." If we sell our interest in Grupo TFM, we may be classified as an investment company If we sell our interest in Grupo TFM, we may receive as consideration securities of another issuer. Consequently, since a significant portion of the Company's assets may then consist of the shares of an unrelated entity, we risk becoming an inadvertent "investment company" under the U.S. Investment Company Act of 1940 (the "Investment Company Act"). Generally, an issuer is deemed to be an investment company subject to registration if its holdings of "investment securities," which usually are securities other than securities issued by majority owned subsidiaries and government securities, exceed 40% of the value of its total assets, exclusive of government securities and cash items, on an unconsolidated basis. Registered investment companies are subject to extensive, restrictive and potentially adverse regulation relating to, among other things, operating methods, management, capital structure, dividends and transactions with affiliates. Registered investment companies are not permitted to operate their business in the manner in which we operate our business. Securities we could receive through the sale of our interest in Grupo TFM would be considered investment securities. However, a company that otherwise would be deemed to be an investment company may be excluded from such status for a one-year period provided that such company has a bona fide intent to be engaged as soon as reasonably possible, and in any event within that one-year period, primarily in a business other than that of investing, reinvesting, owning, holding or trading in securities. If we would otherwise be deemed to be an investment company under the Investment Company Act, we intend to rely on this exemption while we attempt to redeploy assets, effectuate a combination with another operating business or take other steps to avoid classification as an investment company. If we have not taken such steps within the one-year period referred to above, we may be required to (1) apply to the SEC for exemptive relief from the requirements of the Investment Company Act, or (2) invest certain of our assets in government securities and cash equivalents that are not considered "investment securities" under the Investment Company Act. There can be no assurance that we will be able to obtain exemptive relief from the SEC. Investing our assets in government securities and cash equivalents could yield a significantly lower rate of return than other investments we could make if we chose to register as an investment company (although there is no assurance we could successfully register as an investment company even if we chose to do so). If we are deemed an unregistered investment company, there would be a risk, among other material adverse consequences, that we could become subject to monetary penalties or injunctive relief, or both, in an action brought by the SEC, that we would be unable to enforce contracts with third parties or that third parties could seek to obtain rescission of transactions with us undertaken during the period in which it was established that we were an unregistered investment company. In addition, if we are unable to take steps to avoid becoming an investment company or to obtain exemptive relief from the SEC, we may be in default under the indenture governing the Senior Secured Notes. See "Description of the Senior Secured Notes Certain Covenants Restriction on Investment Activity." [ ], 2004. We may be, or may become, subject to Passive Foreign Investment Company rules If we are, or were in the future to become, a "passive foreign investment company" ("PFIC") for United States federal income tax purposes, United States holders of our ADSs or our shares generally will be subject to special United States tax rules that would differ in certain respects from the tax treatment described herein. We do not believe that we are currently a PFIC for United States federal income tax purposes. However, PFIC status is determined annually based on the composition of an entity's assets and income from time to time. As a result, our PFIC status may change. In general, if 50% or more of our assets are "passive assets," or 75% or more of our income is "passive income," we would be deemed a PFIC. Passive assets generally include any interest in another corporation in which we own less than a 25% interest (by value). Thus, a reduction in our ownership interest in Grupo TFM, either as a result of our sale of our shares or through dilution due to the sale of shares in Grupo TFM or any of our subsidiaries through which we own shares, could result in our interest in Grupo TFM being considered a passive asset. If this were to occur, we could become a PFIC. In general, if we are classified as a PFIC, United States holders of our ADSs or shares will be subject to a special tax at ordinary income tax rates on "excess distributions," including certain distributions by us with respect to ADSs or shares as well as gain that such holders recognize on the sale of ADSs or shares. The amount of income tax on any excess distributions will be increased by an interest charge to compensate for tax deferral, calculated as if the excess distributions were earned ratably over the period a holder held the ADSs or shares. With respect to ADSs and shares, a United States holder can avoid the unfavorable rules described in the preceding paragraph by electing to mark its ADSs and shares to market. If a United States holder makes this mark-to-market election, such holder will be required in any year in which we are a PFIC to include as ordinary income the excess of the fair market value of its ADSs and shares at year-end over its basis in those ADSs and shares. In addition, any gain a United States holder recognizes upon the sale of its ADSs and shares will be taxed as ordinary income in the year of sale. Alternatively, if we provide the necessary information, a United States holder may elect to treat its ADSs and shares as an interest in a "qualified electing fund" ("QEF Election"). Such a QEF Election is available only if we comply with applicable information reporting requirements, and we have not yet determined whether we can or will do so. If a United States holder makes a "QEF Election," such holder will be required to include in income its proportionate share of our income and net capital gain in years in which we were a PFIC, but any gain that such holder subsequently recognizes upon the sale of its ADSs and shares generally will be taxed as capital gain. TFM's business is very capital intensive TFM's business is capital intensive and requires substantial ongoing expenditures for, among other things, improvements to roadway, structures and technology, acquisitions, leases and repair of equipment, and maintenance of its rail system. TFM's failure to make necessary capital expenditures could impair its ability to accommodate increases in traffic volumes or service its existing customers. In addition, TFM's railroad concession from the Mexican government requires TFM to make investments and undertake capital projects, including capital projects described in a business plan filed every five years with the Mexican government. TFM may defer capital expenditures with respect to its five-year business plan with the permission of the Secretar a de Comunicaciones y Transportes (Ministry of Communications and Transports or "Ministry of Transportation"). However, the Ministry of Transportation may not grant this permission, and TFM's failure to comply with the commitments in its business plan could result in the Mexican government revoking the concession. TFM's concession is subject to revocation or termination in certain circumstances The Mexican government may terminate the concession granted to TFM as a result of TFM's surrender of its rights under the concession, or for reasons of public interest, by revocation or upon TFM's liquidation or bankruptcy. (The Mexican government would not, however, be entitled to revoke the concession upon the occurrence of a liquidation or bankruptcy of Grupo TMM or Grupo TFM.) The Mexican government may also temporarily seize TFM's assets and its rights under the concession. The Ley Reglamentaria del Servicio Ferroviario (Law Regulating Railroad Services or "Mexican railroad services law and regulations") provides that the Ministry of Transportation may revoke the concession upon the occurrence of specified events, some of which will trigger automatic revocation. Revocation or termination of the concession would prevent TFM from operating its railroad and would materially adversely affect TFM's operations and its ability to make payments on its debt. In the event that the concession is revoked by the Ministry of Transportation, TFM will receive no compensation, and its interest in its rail lines and all other fixtures covered by the concession, as well as all improvements made by it, will revert to the Mexican government. See "Business Railroad Operations The Concession." Our interest in TFM is held with our partner, KCS, and we may not be able to control significant operating decisions We and KCS are the principal shareholders of Grupo TFM. Although we hold a majority voting interest in Grupo TFM, decisions on certain matters that may be material to TFM's operations and business require the approval of both shareholders or of their representatives on Grupo TFM's board of directors. Differences of views between us and KCS have in the past resulted, and may in the future result, in delayed decisions or the failure to reach an agreement, which could adversely affect TFM's operations and business. See "Legal Proceedings Dispute with Kansas City Southern." TFM's results from operations are heavily dependent on fuel expenses Approximately 98% of the locomotives TFM operates are diesel-powered, and TFM's fuel expenses are significant. TFM currently meets, and expects to continue to meet, its fuel requirements almost exclusively through purchases at market prices from Petr leos Mexicanos, the national oil company of Mexico ("PEMEX"), a government-owned entity exclusively responsible for the distribution and sale of diesel fuel in Mexico. TFM is party to a fuel supply contract with PEMEX of indefinite duration. Either party may terminate the contract upon 30 days' written notice to the other at any time. If the fuel contract is terminated and TFM is unable to acquire diesel fuel from alternate sources on acceptable terms, TFM's operations could be materially adversely affected. Crude oil prices in August 2004 have been at or near record levels and continued instability in the Middle East and Venezuela may result in continued high fuel prices or further increases in fuel prices. Since TFM's fuel expense represents a significant portion of its operating expenses, high diesel fuel prices have a material adverse effect on TFM's results of operations. TFM may be unable to generate sufficient cash to service or refinance its debt TFM's ability to satisfy its obligations under its debt in the future will depend upon TFM's future performance, including its ability to increase revenues significantly and control expenses. TFM's future operating performance depends upon prevailing economic, financial, business and competitive conditions and other factors, many of which are beyond its control. If TFM's cash flow from operations is insufficient to satisfy its obligations, TFM may take specific actions, including delaying or reducing capital expenditures, attempting to refinance its debt at or prior to its maturity or, in the absence of such refinancing, attempting to sell assets quickly in order to make up for any shortfall in payments under circumstances that might not be favorable to getting the best price for the assets, or seeking additional equity capital. TFM's ability to refinance its debt and take other actions will depend on, among other things, its financial condition at the time, the restrictions in the instruments governing its debt and other factors, including market conditions, beyond TFM's control. TFM may be unable to take any of these actions on satisfactory terms or in a timely manner. TFM route $ 1,473,326 $ 1,473,326 Cruise ship terminal on Cozumel Island 7,148 20 API Acapulco 6,783 6,783 20 Tugboats in the port of Manzanillo 2,170 2,170 10 Manzanillo port 2,589 20 Progreso port 4,577 TFM Lines 1,473,326 1,473,326 International cruise ship terminal on Cozumel Island 7,148 20 Integral Acapulco Port Administration 6,783 6,783 20 Tugboats in the Port of Manzanillo 2,170 2,170 10 Manzanillo Port 2,589 20 Progreso Port 4,577 Further, any of these actions may not be sufficient to allow TFM to meet its debt obligations. TFM's indentures and commercial paper credit agreement limit its ability to take certain of these actions. TFM's failure to successfully undertake any of these actions or to earn enough revenues to pay its debts, or significant increases in the peso cost to service its dollar-denominated debt, could materially and adversely affect TFM's business or operations. Certain regulatory and market factors could adversely affect our ability to expand our rail transportation operations The trucking industry is TFM's primary competition. In February 2001, a North American Free Trade Agreement ("NAFTA") tribunal ruled in an arbitration between the United States and Mexico that the United States must allow Mexican trucks to cross the border and operate on U.S. highways. NAFTA called for Mexican trucks to have unrestricted access to highways in U.S. border states by 1995 and full access to all U.S. highways by January 2000. However, the United States has not followed the timetable because of concerns over Mexico's trucking safety standards. On March 14, 2002, as part of its agreement under NAFTA, the U.S. Department of Transportation issued safety rules that allow Mexican truckers to apply for operating authority to transport goods beyond the 20-mile commercial zones along the U.S.-Mexico border. These safety rules require Mexican carriers seeking to operate in the United States to pass, among other things, safety inspections, obtain valid insurance with a U.S. registered insurance company, conduct alcohol and drug testing for drivers and to obtain a U.S. Department of Transportation identification number. Mexican commercial vehicles with authority to operate beyond the commercial zones will be permitted to enter the United States only at commercial border crossings and only when a certified motor carrier safety inspector is on duty. Given these recent developments, we cannot assure you that truck transport between Mexico and the United States will not increase substantially in the future. Such an increase could affect TFM's ability to continue converting traffic to rail from truck transport because it may result in an expansion of the availability, or an improvement of the quality, of the trucking services offered in Mexico. In recent years, there has been significant consolidation among major North American rail carriers. The resulting merged railroads could attempt to use their size and pricing power to block other railroads' access to efficient gateways and routing options that are currently and have been historically available. We cannot assure you that further consolidation will not have an adverse effect on us. Approximately 50% of TFM's expected revenue growth during the next few years is expected to result from increased truck-to-rail conversion. If the railroad industry in general, and TFM in particular, are unable to preserve their competitive advantages vis- -vis the trucking industry, TFM's business plan may not be achieved and its projected revenue growth could be adversely affected. Additionally, TFM's revenue growth could be affected by, among other factors, its inability to grow its existing customer base, negative macroeconomic developments impacting the United States and Mexican economies, and failure to capture additional cargo transport market share from the shipping industry and other railroads. Significant competition could adversely affect our future financial performance Certain of our business segments face significant competition, which could have an adverse effect on our results of operations. TFM faces significant competition from trucks and other rail carriers as well as limited competition from the shipping industry in its freight operations. Our parcel tanker and supply ship services operating in the Gulf of Mexico have faced significant competition, mainly from U.S. shipping companies. Although we expect that a Mexican law, enacted in January 1994, and amended in May 2000, which restricts cabotage of ships (movement of ships within Mexico and Mexican waters) at Mexican ports to Mexican-owned vessels carrying the Mexican flag, will reduce competition from non-Mexican companies in this sector, there can be no assurance that such competition will be reduced. In our land operations division, our trucking transport and automotive EXCHANGE RATES We maintain our financial records in dollars. However, we keep our tax records in pesos. We record in our financial records the dollar equivalent of the actual peso charges for taxes at the time incurred using the prevailing exchange rate. In 2003, approximately 57% of our net consolidated revenues and 54% of our operating expenses from continuing operations were generated or incurred in dollars. Most of the remainder of our net consolidated revenues and operating expenses from continuing operations were denominated in pesos. The following tables set forth, for the periods and dates indicated, information regarding the noon buying rate for cable transfers payable in pesos as certified by the Federal Reserve Bank of New York for customs purposes, expressed in pesos per dollar. On December 31, 2003, the noon buying rate was 11.23 pesos per dollar. On August 13, 2004, the noon buying rate was 11.42 pesos per dollar. Noon Buying Rate(a) Year ended December 31, logistics services have faced intense competition, including price competition, from a large number of Mexican, U.S. and international trucking lines. We cannot assure you that we will not lose business in the future due to our inability to respond to competitive pressures by decreasing our prices without adversely affecting our gross margins and operational results. TFM faces significant competition from the trucking industry, as well as from some industry segments from other railroads, in particular Ferrocarril Mexicano, S.A. de C.V. ("Ferromex"), which operates the Pacific-North Rail Lines. In particular, TFM has experienced, and continues to experience, competition from Ferromex with respect to the transport of grain, minerals and steel products. The rail lines operated by Ferromex run from Guadalajara and Mexico City to four U.S. border crossings west of Laredo, Texas, providing a potential alternative to TFM's routes for the transport of freight from those cities to the U.S. border. Ferromex directly competes with TFM in some areas of its service territory, including Tampico, Saltillo, Monterrey and Mexico City. Ferrocarril del Sureste, S.A. de C.V. ("Ferrosur"), which operates the Southeast Rail Lines, also competes directly with TFM for traffic to and from southeastern Mexico. Ferrosur, like TFM, serves Mexico City, Puebla and Veracruz. Ferromex and Ferrosur are privately owned companies that may have greater financial resources than TFM. Among other things, this advantage may give them greater ability to reduce freight prices. Price reductions by competitors would make TFM's freight services less competitive and we cannot assure you that TFM would be able to match these rate reductions. Under TFM's concession, TFM must grant to Ferromex the right to operate over a north-south portion of its rail lines between Ramos Arizpe near Monterrey and the city of Quer taro that constitutes over 600 kilometers of TFM's main track. Using these trackage rights, Ferromex may be able to compete with TFM over its rail lines for traffic between Mexico City and the United States. TFM's concession also requires it to grant rights to use certain portions of its tracks to Ferrosur and the "belt railroad" operated in the greater Mexico City area by the Ferrocarril y Terminal del Valle de M xico, S.A. de C.V. (the Mexico City Railroad and Terminal), thereby providing Ferrosur with more efficient access to certain Mexico City industries. As a result of having to grant trackage rights to other railroads, TFM incurs additional maintenance costs and also loses the flexibility of using its tracks at all times. In February 2002, Ferromex and Ferrosur announced that they agreed to the acquisition of Ferrosur by Ferromex. TFM filed a notice with the Mexican Antitrust Commission objecting to the proposed acquisition on the grounds that it would limit competition. The acquisition was reviewed by the Mexican Antitrust Commission and on May 16, 2002, the Mexican Antitrust Commission announced that it had notified Ferromex that authorization to consummate the acquisition was denied on antitrust grounds. Ferromex subsequently filed an appeal for review of the order, and on September 18, 2002, the Mexican Antitrust Commission confirmed its prior ruling denying authorization to consummation of the acquisition. Ferromex requested that the Federal Courts in Mexico review the decision of the Mexican Antitrust Commission. TFM also requested a Federal Court in Mexico to review its complaint against the acquisition, requesting to be recognized as a party to the proceedings of the Mexican Antitrust Commission, and obtained a favorable ruling (amparo). Ferromex and Ferrosur subsequently withdrew their petition before the Mexican Antitrust Commission, which terminated the acquisition request in October 2003. The rates for trackage rights set by the Ministry of Transportation may not adequately compensate TFM Pursuant to TFM's concession, TFM is required to grant rights to use portions of its tracks to Ferromex, Ferrosur and the Mexico City Railroad and Terminal. Applicable law stipulates that Ferromex, Ferrosur and the Mexico City Railroad and Terminal are required to grant to TFM rights to use portions of their tracks. Applicable law provides that the Ministry of Transportation is entitled to set the rates in the event that TFM and the party to whom it is granting the rights cannot agree on a rate. TFM and Ferromex have not been able to agree upon the rates each of them is required to pay High the other for interline services and haulage and trackage rights. Therefore, in accordance with its rights under the Mexican railroad services law and regulations, TFM initiated an administrative proceeding in February 2001, requesting a determination of such rates by the Ministry of Transportation, which subsequently issued a ruling establishing rates using the criteria set forth in the Mexican railroad services law and regulations. TFM and Ferromex appealed the rulings before the Mexican Federal Courts due to, among other things, a disagreement with the methodology employed by the Ministry of Transportation in calculating the trackage rights and interline rates. TFM and Ferromex also requested and obtained a suspension of the effectiveness of the ruling pending resolution of this appeal. We cannot predict whether TFM will ultimately prevail in this proceeding and whether the rates TFM is ultimately allowed to charge will be adequate to compensate it. See "Business Railroad Operations" for more information. If our time charter arrangements are terminated or expire, our business could be adversely affected We currently time charter three product tankers to PEMEX. In the event that our time charter arrangements with PEMEX are terminated or expire, we will be required to seek new time charter arrangements for these vessels. We cannot be sure that time charters will be available for the vessels following termination or expiration or that time charter rates in effect at the time of such termination or expiration will be comparable to those in effect under the existing time charters or in the present market. In the event that time charters are not available on terms acceptable to us, we may employ those tankers in the spot market. Because charter rates in the spot market are subject to greater fluctuation than time charter rates, any failure to maintain existing, or enter into comparable, charter arrangements could adversely affect our operating results. Terrorist activities and geopolitical events and their consequences could adversely affect our operations As a result of the terrorist attacks in the United States on September 11, 2001 and the March 11, 2004, terrorist attacks in Spain, and the continuation of armed hostilities involving, among others, the United States and Iraq, there has been increased short-term market volatility, and there may be long-term effects on U.S. and world economies and markets. Terrorist attacks may negatively affect our operations. The continued threat of terrorism within the United States and abroad and the potential for military action and heightened security measures in response to such threats may cause significant disruption to commerce throughout the world, including restrictions on cross-border transport and trade. In addition, related political events may cause a lengthy period of uncertainty that may adversely affect our business. Political and economic instability in other regions of the world, including the United States and Canada, may also result and could negatively impact our operations. The consequences of terrorism and the responses thereto are unpredictable and could have an adverse effect on our operations. Downturns in the U.S. economy or in trade between the United States and Mexico and fluctuations in the peso dollar exchange rate would likely have adverse effects on our business and results of operations The level and timing of our business activity are heavily dependent upon the level of U.S.-Mexican trade and the effects of NAFTA on such trade. Downturns in the U.S. or Mexican economy or in trade between the United States and Mexico would likely have adverse effects on our business and results of operations. Our business of logistics and transportation of products traded between Mexico and the United States depends on the U.S. and Mexican markets for these products, the relative position of Mexico and the United States in these markets at any given time and tariffs or other barriers to trade. Our revenues as well as TFM's were affected by the downturn in the U.S. economy in 2003. However, we believe the U.S. economy started to reflect a recovery in the third quarter of 2003, and in general, continued improving in the first half of 2004. Any future downturn in the U.S. economy could have a Low material adverse effect on our results of operations and our ability to meet our debt service obligations as described above. Also, fluctuations in the peso dollar exchange rate could lead to shifts in the types and volumes of Mexican imports and exports. Although a decrease in the level of exports of some of the commodities that we transport to the United States may be offset by a subsequent increase in imports of other commodities we haul into Mexico and vice versa, any offsetting increase might not occur on a timely basis, if at all. Future developments in U.S.-Mexican trade beyond our control may result in a reduction of freight volumes or in an unfavorable shift in the mix of products and commodities we carry. Downturns in certain cyclical industries in which our customers operate could have adverse effects on our results of operations The shipping, transportation and logistics industries are highly cyclical, generally tracking the cycles of the world economy. Although transportation markets are affected by general economic conditions, there are numerous specific factors within each particular market segment that may influence operating results. Some of our customers do business in industries that are highly cyclical, including the oil and gas, automotive and agricultural sectors. Any downturn in these sectors could have a material adverse effect on our operating results. For example, during the first half of 2004, our results were negatively impacted by continued sluggish conditions in the automotive sector. Also, some of the products we transport have had a historical pattern of price cyclicality which has typically been influenced by the general economic environment and by industry capacity and demand. For example, global steel and petrochemical prices have decreased in the past. We cannot assure you that prices and demand for these products will not decline in the future, adversely affecting those industries and, in turn, our financial results. We are exposed to the risk of loss and liability Our business is affected by a number of risks, including mechanical failure of vessels and equipment, collisions, property loss of vessels and equipment, cargo loss or damage, as well as business interruption due to political circumstances in foreign countries, hostilities and labor strikes. In addition, the operation of any ocean-going vessel is subject to the inherent possibility of catastrophic marine disaster, including oil spills and other environmental accidents, and the liabilities arising from owning and operating vessels in international trade. We maintain insurance to cover the risk of partial or total loss of or damage to all of our assets, including, but not limited to, railtrack, rail cars, port facilities, port equipment, trucks, land facilities and offices. In particular, we maintain marine hull and machinery and war risk insurance on our vessels, which covers the risk of actual or constructive total loss. Additionally, we have protection and indemnity insurance for damage caused by our operations to third persons. We do not carry insurance covering the loss of revenue resulting from a downturn in our operations or resulting from off-hire time on certain vessels. We cannot assure you that our insurance would be sufficient to cover the cost of damages suffered by us or damages to others, that any particular claim will be paid or that such insurance will continue to be available at commercially reasonable rates in the future. We face potential environmental liability Our operations are subject to Mexican federal and state laws and regulations relating to the protection of the environment. The primary environmental law in Mexico is the General Law of Ecological Balance and Environmental Protection (the "Ecological Law"). The Mexican federal agency in charge of overseeing compliance with and enforcement of the federal environmental law is the Ministry of Environmental Protection and Natural Resources (Secretar a del Medio Ambiente y Recursos Naturales, or "Semarnat"). As part of its enforcement powers, Semarnat is empowered to bring Year-end Average(b) administrative and criminal proceedings and impose economic sanctions against companies that violate environmental laws, and temporarily or even permanently close non-complying facilities. Under the Ecological Law, the Mexican government has implemented a program to protect the environment by promulgating rules concerning water, land, air and noise pollution, and hazardous substances. We are also subject to the laws of various jurisdictions and international conferences with respect to the discharge of materials into the environment. While we maintain insurance against certain of these environmental risks in an amount which we believe is consistent with industry norms, we cannot assure you that our insurance would be sufficient to cover damages suffered by us. We cannot predict the effect, if any, that the adoption of additional or more stringent environmental laws and regulations would have on our results of operations, cash flows or financial condition. Under the United States Oil Pollution Act of 1990, or "OPA 90," owners and operators of ships could be exposed to substantial liability, and in some cases, unlimited liability for removal costs and damages resulting from the discharge of oil, petroleum or related substances into United States waters by their vessels. In some jurisdictions, including the United States, claims for removal costs and damages would enable claimants to immediately seize the ships of the owning and operating company and sell them in satisfaction of a final judgment. The existence of statutes enacted by individual states of the United States on the same subject, but requiring different measures of compliance and liability, creates the potential for similar claims being brought under state law. In addition, several international conventions that impose liability for the discharge of pollutants have been adopted by other countries. We time-charter product tankers to PEMEX, which PEMEX uses to transport refined petroleum products domestically. Pursuant to these time-charters, PEMEX has the right to transport crude oil and operate internationally. We also operate parcel tankers in the international market. See "Business Specialized Maritime Services." If a spill were to occur in the course of operation of one of our vessels carrying petroleum products, and such spill affected the United States or another country that had enacted legislation similar to OPA 90, we could be exposed to substantial or unlimited liability. Additionally, our vessels carry bunkers (ship fuel) and certain goods that could, if spilled, under certain conditions, cause pollution and result in substantial claims against us, including claims under OPA 90 and other United States federal, state and local laws. Our railroad operations are subject to the provisions of the Ecological Law. The regulations issued under the Ecological Law and technical environmental requirements issued by the Semarnat have promulgated standards for, among other things, water discharge, water supply, emissions, noise pollution, hazardous substances and transportation and handling of hazardous and solid waste. In addition, TFM's ownership of Mexrail may also create certain environmental liabilities with respect to U.S. environmental laws. The U.S. Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA" or "Superfund") and similar state laws (known as Superfund laws) impose liability for the cost of remedial or removal actions, natural resources damages and related costs at certain sites identified as posing a threat to the environment or public health. CERCLA imposes strict liability on the owners and operators of facilities in which hazardous waste and other hazardous substances are deposited or from which they are released or are likely to be released into the environment. Liability may be imposed, without regard to fault or the legality of the activity, on certain classes of persons, including the current and certain prior owners or operators of a site and persons that arranged for the disposal or treatment of hazardous substances. Liability is imposed on a joint and several basis. In addition, other potentially responsible parties, adjacent landowners or other third parties may initiate cost recovery actions or toxic tort litigation against sites subject to CERCLA or similar state laws. Potential labor disruptions could adversely affect our financial condition and our ability to meet our obligations under our debt Approximately 67.7% of our employees are covered by a labor agreement. The compensation terms of the labor agreement are subject to renegotiation on an annual basis and all other terms are renegotiated every two years. We may not be able to negotiate these provisions favorably, and strikes, boycotts or other disruptions could occur. These potential disruptions could have a material adverse effect on our financial condition and results of operations and on our ability to meet our payment obligations under our debt agreements. Our customers may take actions that may reduce our revenues If our customers believe that we may not be able to continue as a going concern or if they believe that our weakened financial condition will result in a lower quality of service, they may discontinue use of our services. Additionally, some customers may demand lower prices. While we have contracts with some of our customers that prevent them from terminating the services we provide them or which impose penalties on customers who terminate their services with us, it may be impractical or uneconomical to enforce these agreements in Mexican courts. If any of these events occur, our revenues will be reduced. Factors Relating to Mexico Mexico is an emerging market economy, with attendant risks to our results of operations and financial condition The Mexican government has exercised, and continues to exercise, significant influence over the Mexican economy. Accordingly, Mexican governmental actions concerning the economy and state-owned enterprises could have a significant impact on Mexican private sector entities in general and on us in particular, as well as on market conditions, prices and returns on Mexican securities, including our securities. The national elections held on July 2, 2000, ended 71 years of rule by the Institutional Revolutionary Party ("PRI") with the election of President Vicente Fox Quesada, a member of the National Action Party ("PAN"), and resulted in the increased representation of opposition parties in the Mexican Congress and in mayoral and gubernatorial positions. Although there have not yet been any material adverse repercussions resulting from this political change, multiparty rule is still relatively new in Mexico and could result in economic or political conditions that could materially and adversely affect our operations. We cannot predict the impact that this new political landscape will have on the Mexican economy. Furthermore, our financial condition, results of operations and prospects and, consequently, the market price for our securities, may be affected by currency fluctuations, inflation, interest rates, regulation, taxation, social instability and other political, social and economic developments in or affecting Mexico. The Mexican economy in the past has suffered balance of payment deficits and shortages in foreign exchange reserves. There are currently no exchange controls in Mexico. However, Mexico has imposed foreign exchange controls in the past. Pursuant to the provisions of NAFTA, if Mexico experiences serious balance of payment difficulties or the threat thereof in the future, Mexico would have the right to impose foreign exchange controls on investments made in Mexico, including those made by U.S. and Canadian investors. Any restrictive exchange control policy could adversely affect our ability to obtain dollars or to convert pesos into dollars for purposes of making interest and principal payments to holders of Senior Secured Notes, to the extent that we may have to effect those conversions. This could have a material adverse effect on our business and financial condition. Securities of companies in emerging market countries tend to be influenced by economic and market conditions in other emerging market countries. Emerging market countries, including Argentina and Brazil, have recently been experiencing significant economic downturns and market volatility. These Land $ 132,878 $ 132,878 50 Buildings 33,113 33,113 27-30 Bridges 75,350 75,350 41 Tunnels 94,043 94,043 40 Rail 317,268 317,268 29 Concrete and wood ties 137,351 137,351 27 Yards 106,174 106,174 35 Ballast 107,189 107,189 27 Grading 391,808 391,808 50 Culverts 14,942 14,942 21 Signals 1,418 1,418 Land $ 132,878 $ 132,878 50 Buildings 33,113 33,113 27 30 Bridges 75,350 75,350 41 Tunnels 94,043 94,043 40 Rail 317,268 317,268 29 Concrete and wood ties 137,351 137,351 27 Yards 106,174 106,174 35 Ballast 107,189 107,189 27 Grading 391,808 391,808 50 Culverts 14,942 14,942 21 Signals 1,418 1,418 Land $ 132,878 $ 132,878 50 Buildings 33,113 33,113 27-30 Bridges 75,350 75,350 41 Tunnels 94,043 94,043 40 Rail 317,268 317,268 29 Concrete and wood ties 137,351 137,351 27 Yards 106,174 106,174 35 Ballast 107,189 107,189 27 Grading 391,808 391,808 50 Culverts 14,942 14,942 21 Signals 1,418 1,418 (a)Source: Federal Reserve Bank of New York. (b)Average of month-end rates. Noon Buying Rate(a) Month end events have had an adverse effect on the economic conditions and securities markets of emerging market countries, including Mexico. Any devaluation of the peso would cause the peso cost of our dollar-denominated debt to increase, adversely affecting our ability to make payments on our indebtedness After a five-year period of controlled devaluation of the peso, on December 19, 1994, the value of the peso dropped sharply as a result of pressure against the currency. Although the peso had been appreciating relative to the dollar over the past few years, the peso depreciated 13.8% in 2002, 7.5% in 2003 and 1.6% in the six months ended June 30, 2004, against the dollar. Any additional devaluation in the peso would cause the peso cost of our dollar-denominated debt to increase. In addition, currency instability may affect the balance of trade between the United States and Mexico. Mexico may experience high levels of inflation in the future which could adversely affect our results of operations Mexico has a history of high levels of inflation, and may experience inflation in the future. During most of the 1980s and during the mid- and late-1990s, Mexico experienced periods of high levels of inflation. The annual rates of inflation for the last five years, as measured by changes in the National Consumer Price Index, as provided by Banco de M xico, were: 1999 12.32 % 2000 8.96 % 2001 4.40 % 2002 5.70 % 2003 3.98 % 2004 (January through June) 1.63 % In 2003, the Mexican inflation rate hit its lowest levels in over 30 years. We cannot give any assurance that the Mexican inflation rate will continue to decrease or maintain its current level for any significant period of time. A substantial increase in the Mexican inflation rate would have the effect of increasing some of our costs, which could adversely affect our results of operations and financial condition, as well as the market value of our Senior Secured Notes. High levels of inflation may also affect the balance of trade between Mexico and the United States, and other countries, which could adversely affect our results of operations. High

parsed_sections/risk_factors/2004/CIK0001274701_servicios_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

parsed_sections/risk_factors/2004/CIK0001274766_yvc-inc_risk_factors.txt ADDED Viewed

The diff for this file is too large to render. See raw diff

parsed_sections/risk_factors/2004/CIK0001279529_uap_risk_factors.txt ADDED Viewed

The diff for this file is too large to render. See raw diff

parsed_sections/risk_factors/2004/CIK0001282269_valor_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ Risk Factors Before you invest in the IDSs (including the shares of our Class A common stock and our senior subordinated notes represented by the IDSs) or the senior subordinated notes, you should carefully consider the various risks of the investment, including those described below, together with all of the other information included in this prospectus. If any of these risks actually occur, our business, financial condition or operating results could be adversely affected. Risks Relating to the IDSs, the Shares of Class A Common Stock and Senior Subordinated Notes Represented by the IDSs, the Senior Subordinated Notes Offered Separately (not in the Form of IDSs), and our New Credit Facility Our substantial indebtedness could restrict our ability to pay interest and principal on the senior subordinated notes and to pay dividends with respect to shares of our Class A common stock represented by the IDSs and impact our financing options and liquidity position. Upon the consummation of this offering, we will have approximately $ million of total debt outstanding, $ million of which will rank senior to the senior subordinated notes. The degree to which we are leveraged on a consolidated basis could have important consequences to the holders of the IDSs and of separate senior subordinated notes, including: it may be more difficult to satisfy our obligations under the senior subordinated notes and to pay dividends on our Class A common stock; our ability to obtain additional financing in the future for working capital, capital expenditures or acquisitions may be limited; we may be unable to refinance our indebtedness on terms acceptable to us or at all; a significant portion of our cash flow from operations is likely to be dedicated to the payment of the principal of and interest on our indebtedness, thereby reducing funds available for other corporate purposes; and our substantial indebtedness may make us more vulnerable to economic downturns and limit our ability to withstand competitive pressures. We may be able to incur substantially more debt, which could exacerbate the risks associated with our substantial indebtedness described above. While our new credit facility will contain total leverage, senior leverage and interest coverage covenants and the indenture governing the senior subordinated notes will contain incurrence covenants that will restrict our ability to incur debt as described under Description of Certain Indebtedness New Credit Facility, and Description of Senior Subordinated Notes Additional Notes, as long as we meet these financial covenants we will be allowed to incur additional indebtedness, including senior subordinated notes with terms identical to the senior subordinated notes offered hereby. The terms of our new credit facility restrict our ability to pay interest on our senior subordinated notes and dividends on shares of our common stock and we may amend these terms or enter into new agreements that are more restrictive. Our new credit facility contains significant restrictions on our ability to pay interest on the senior subordinated notes and dividends on shares of common stock based on meeting our interest coverage ratio and senior leverage ratio and compliance with other conditions. As a result of general economic conditions, conditions in the lending markets, the results of our business or for any other reason, we may elect or be required to amend or refinance our new credit facility, at or prior to maturity, or enter into additional agreements for senior indebtedness. Regardless of any protection you have in the indenture governing the senior subordinated notes, any such amendment, refinancing or additional indebtedness may contain covenants that could limit in a significant manner our ability to make interest payments and pay dividends to you. Table of Contents Table of Additional Registrant Guarantors Address Including Zip Code, State or Other Telephone Number Jurisdiction of I.R.S. Employer Including Area Code of Exact Name of Registrant Guarantor as Incorporation or Identification Registrant Guarantor s Specified in its Charter Organization Number Principal Executive Offices Table of Contents We are subject to restrictive debt covenants that impose operating and financial restrictions on our operations and could limit our ability to grow our business. The agreements governing our indebtedness impose significant operating and financial restrictions on us. These restrictions prohibit or limit, among other things: the incurrence of additional indebtedness and the issuance of preferred stock and certain redeemable capital stock; a number of other restricted payments, including investments and acquisitions; specified sales of assets; specified transactions with affiliates; the creation of a number of liens; consolidations, mergers and transfers of all or substantially all of our assets; and our ability to change the nature of our business. These restrictions could limit our ability to obtain future financing, make acquisitions, withstand downturns in our business or take advantage of business opportunities. If we fail to comply with the restrictive debt covenants in the agreements governing our indebtedness, our senior lenders may accelerate the payment of indebtedness outstanding under our new credit facility which is senior to the senior subordinated notes. The terms of the new credit facility include several restrictive covenants that prohibit us from prepaying our other indebtedness, including the senior subordinated notes, while indebtedness under the new credit facility is outstanding. The new credit facility also requires us to maintain specified financial ratios and satisfy financial condition tests. Our ability to comply with the ratios or tests may be affected by events beyond our control, including prevailing economic, financial and industry conditions. See the information under Description of Certain Indebtedness for a fuller description of these restrictions and covenants. A breach of any of these covenants, ratios or tests could result in a default under the new credit facility and/or the indenture. Events of default under the new credit facility would prohibit us from making payments on the senior subordinated notes in cash, including payment of interest when due. In addition, upon the occurrence of an event of default under the new credit facility, the lenders could elect to declare all amounts outstanding under the new credit facility, together with accrued interest, to be immediately due and payable. If we were unable to repay those amounts, the lenders could proceed against the security granted to them to secure that indebtedness. If the lenders accelerate the payment of the indebtedness, our assets may not be sufficient to repay in full this indebtedness and our other indebtedness, including the senior subordinated notes. We are a holding company with no operations, and unless we receive dividends and other payments, advances and transfers of funds from our subsidiaries, we will be unable to meet our debt service and other obligations. We are a holding company and conduct all of our operations through our subsidiaries. We currently have no significant assets other than equity interests in our subsidiaries. As a result, we will rely on dividends and other payments or distributions from our subsidiaries to meet our debt service obligations and enable us to pay dividends. The ability of our subsidiaries to pay dividends or make other payments or distributions to us will depend on their respective operating results and may be restricted by, among other things, the laws of their jurisdiction of organization (which may limit the amount of funds available for the payment of dividends), agreements of those subsidiaries, the terms of the new credit facility (under which the equity interests of our subsidiaries will be pledged), and the covenants of any future outstanding indebtedness we or our subsidiaries incur. Table of Contents You may not receive interest payments on your senior subordinated notes on the regularly scheduled payment dates as we may defer the payment of interest to you for a significant period of time, subject to restrictions set forth in the indenture. We may, subject to restrictions set forth in the indenture, defer interest payments on our senior subordinated notes on one or more occasions. For any interest deferred during the first five years, we are not obligated to pay any deferred interest until , 2009. As a result, you may not receive interest payments on the regularly scheduled payment dates and you may be owed a substantial amount of deferred interest that will not be due and payable for a significant period of time. See Description of Senior Subordinated Notes Interest Deferral. You may not receive the level of dividends provided for in the dividend policy that our board of directors is expected to adopt upon the closing of this offering or any dividends at all. Our board of directors may, in its discretion, amend or repeal the dividend policy it is expected to adopt upon the closing of this offering. Our board of directors may decrease the level of dividends provided for in this dividend policy or entirely discontinue the payment of dividends. The amount of future dividends with respect to shares of our capital stock, if any, will depend on, among other things, our results of operations, cash requirements, financial condition, contractual restrictions, business opportunities, provisions of applicable law and other factors that our board of directors may deem relevant. In addition, the indenture governing our senior subordinated notes and the new credit facility each contain significant restrictions which could affect your receipt of dividends, because among other things, if we defer interest on the senior subordinated notes, we may not pay dividends until we have paid all deferred interest and accrued interest thereon. Furthermore, if the senior subordinated notes were treated as equity rather than as debt for United States federal income tax purposes, then the stated interest on the senior subordinated notes could be treated as a dividend and would not be deductible by us for United States federal income tax purposes. Our inability to deduct interest on the senior subordinated notes could materially increase our taxable income and, thus, our United States federal and applicable state income tax liability. If this were to occur, our after-tax cash flow available for dividend and interest payments would be reduced. You will be immediately diluted by $ per share of Class A common stock if you purchase IDSs in this offering. If you purchase IDSs in this offering, based on the book value of the assets and liabilities reflected on our balance sheet, you will experience an immediate dilution of $ per share of Class A common stock represented by the IDSs which exceeds the entire price allocated to each share of Class A common stock represented by the IDSs in this offering because there will be a net tangible book deficit for each share of Class A common stock outstanding immediately after this offering. Our net tangible book value as of March 31, 2004, after giving effect to this offering, was approximately $ million, or $ per share of Class A common stock. Our interest expense may increase significantly and could cause our net income and distributable cash to decline significantly. The new credit facility will be subject to periodic renewal or must otherwise be refinanced. We may not be able to renew or refinance the new credit facility, or if renewed or refinanced, the renewal or refinancing may occur on less favorable terms, including higher interest rates. Borrowings under the revolving facility will be made at a floating rate of interest. In the event of an increase in the base reference interest rates, our interest expense will increase and could have a material adverse effect on our ability to make cash dividend payments to our shareholders. Our ability to continue to expand our business will, to a large extent, be dependent upon our ability to borrow funds under our new credit facility and to obtain other third party financing, including through the sale of IDSs or other securities. We cannot assure you that such financing will be available to us on favorable terms or at all. 2003 $ 168 $ 2004 141 198 2005 86 130 2006 71 107 2007 58 92 2008 62 Thereafter 68 Table of Contents If we are unable to generate sufficient funds from operations we will be unable to pay our indebtedness at maturity or upon the exercise by holders of their rights upon a change of control. Because a significant portion of our cash flow from operations will be dedicated to servicing our debt requirements and making capital expenditures to maintain the quality of our physical plant, we may not have sufficient funds from operations to repay the principal amount of our indebtedness at maturity or in case you exercise your right to require us to purchase your notes upon a change of control. In addition, we currently expect to distribute a significant portion of any remaining cash earnings to our stockholders in the form of quarterly dividends. Moreover, prior to the maturity of our senior subordinated notes, we will not be required to make any payments of principal on our senior subordinated notes. We may, therefore, need to refinance our debt or raise additional capital to meet our obligations. These alternatives may not be available to us when needed or on satisfactory terms due to prevailing market conditions, a decline in our business or restrictions contained in our senior debt obligations. We may pay a significant portion of our free cash flow to stockholders in the form of dividends thereby reducing the amounts available to us to satisfy our obligations on the senior subordinated notes. Our new credit facility and the indenture governing our senior subordinated notes permit us to pay a significant portion of our free cash flow to stockholders in the form of dividends, subject to certain limitations. Following completion of this offering, we intend to pay quarterly dividends. Any amounts paid by us in the form of dividends will not be available in the future to satisfy our obligations under the senior subordinated notes. The limitations on our ability to pay dividends are more fully described in Description of Senior Subordinated Notes Certain Covenants and Description of Certain Indebtedness New Credit Facility. If the realizable value of our assets is insufficient to satisfy claims, you could lose all or part of your investment upon a liquidation of our company. At March 31, 2004, our assets included goodwill of $1,057 million and deferred financing costs of $52 million. Combined, these items represent approximately 54.8% of our total consolidated assets. The value of these assets will continue to depend significantly upon the success of our business as a going concern and the growth in cash flows. As a result, in the event of a default under our new credit facility or on our senior subordinated notes or any bankruptcy or dissolution of our company, the realizable value of these assets may be substantially lower and may be insufficient to satisfy the claims of our creditors. Deferral of interest payments would have adverse tax consequences for you. If we defer interest payments on the senior subordinated notes, you will be required to recognize interest income for United States federal income tax purposes in respect of the senior subordinated notes before you receive any cash payment of this interest. In addition, we will not pay you this cash if you sell the IDSs or the senior subordinated notes, as the case may be, before the end of any deferral period or before the record date relating to interest payments that are to be paid. Deferral of interest payments may also adversely affect the trading price of the senior subordinated notes. The IDSs or the senior subordinated notes may trade at a price that does not fully reflect the value of accrued but unpaid interest on the senior subordinated notes if we defer interest payments. In addition, the requirement that we defer payments of interest on the senior subordinated notes under certain circumstances may mean that the market price for the IDSs or the senior subordinated notes may be more volatile than other securities that do not have this requirement. Because of the subordinated nature of the notes, holders of our senior subordinated notes may not be entitled to be paid in full, if at all, in a bankruptcy, liquidation or reorganization or similar proceeding. As a result of the subordinated nature of our notes and related guarantees, upon any distribution to our creditors or the creditors of the subsidiary guarantors in bankruptcy, liquidation or reorganization or similar proceeding relating to us or the subsidiary guarantors or our or their property, the holders of our senior indebtedness and senior indebtedness of the subsidiary guarantors will be entitled to be paid in full in cash Table of Contents before any payment may be made with respect to our senior subordinated notes or the subsidiary guarantees. Holders of our senior subordinated notes would participate with all other holders of unsecured indebtedness of ours or the subsidiary guarantors that are similarly subordinated in the assets remaining after we and the subsidiary guarantors have paid all senior indebtedness. However, because of the existence of the subordination provisions, including the requirement that holders of the senior subordinated notes pay over distributions to holders of senior indebtedness, holders of the senior subordinated notes may receive less, ratably, than our other unsecured creditors, including trade creditors. In any of these cases, we and the subsidiary guarantors may not have sufficient funds to pay all of our creditors. Holders of our senior subordinated notes may, therefore, receive less, ratably, than the holders of our senior indebtedness. On a pro forma basis as of March 31, 2004, our senior subordinated notes and the associated subsidiary guarantees would have ranked junior, on a consolidated basis, to $ million of outstanding senior secured indebtedness plus approximately $100,000 of letters of credit and the subsidiary guarantees would have ranked junior to no senior unsecured debt and pari passu with approximately $ million of outstanding indebtedness of ours and the subsidiary guarantors. In addition, as of March 31, 2004, on a pro forma basis, we would have had the ability to borrow up to an additional amount of $ million under the new credit facility (less amounts reserved for letters of credit), which would have ranked senior in right of payment to our senior subordinated notes. Holders of our senior subordinated notes will be structurally subordinated to the debt of our non-guarantor subsidiaries. Our partially owned domestic subsidiaries will not be guarantors of our senior subordinated notes. As a result, no payments are required to be made to us from the assets of these subsidiaries. In the event of a bankruptcy, liquidation or reorganization or similar proceeding of any of the non-guarantor subsidiaries, holders of their indebtedness, including their trade creditors, would generally be entitled to payment of their claims from the assets of those subsidiaries before any assets are made available for distribution to us for payment to you. In the event of bankruptcy or insolvency, the senior subordinated notes and guarantees could be adversely affected by principles of equitable subordination or recharacterization. In the event of bankruptcy or insolvency, a party in interest may seek to subordinate the senior subordinated notes or the guarantees under the principles of equitable subordination or to recharacterize the senior subordinated notes as equity. There can be no assurance as to the outcome of such proceedings. In the event a court subordinates the senior subordinated notes or guarantees or recharacterizes the senior subordinated notes as equity, we cannot assure you that you would recover any amounts owed on the senior subordinated notes or the guarantees and you may be required to return any payments made to you within six years before the bankruptcy on account of the senior subordinated notes. In addition, should the court equitably subordinate the senior subordinated notes or the guarantees or recharacterize the senior subordinated notes as equity, you may not be able to enforce the guarantees. The senior subordinated notes and the guarantees may not be enforceable because of fraudulent conveyance laws. Under federal bankruptcy law and comparable provisions of state fraudulent transfer laws, a court could void the obligations under the senior subordinated notes or the guarantees, further subordinate the senior subordinated notes or the guarantees or take other action detrimental to you, if, among other things, at the time the indebtedness under the senior subordinated notes or the guarantees, as applicable, was incurred, we or a guarantor: issued the senior subordinated notes or the guarantee to delay, hinder or defraud present or future creditors; or received less than reasonably equivalent value or fair consideration for issuing the senior subordinated notes or the guarantee and, at the time of the issuance: was insolvent or rendered insolvent by reason of issuing the senior subordinated notes or the guarantee and the application of the proceeds of the senior subordinated notes; Table of Contents 10 .26 Wholesale Solutions Switched Services Agreement, dated as of August 11, 2003, by and between Sprint Communications Company L.P. and Valor Telecommunications Enterprises, LLC. 10 .27 First Amendment to Wholesale Solutions Switched Services Data and Private Line Agreement, dated as of October 3, 2003, between Sprint Communications Company L.P. and Valor Telecommunications Enterprises, LLC. ** 10 .28 Employment Agreement, dated as of June 18, 2000, by and between Valor Telecommunications, LLC and Kenneth R. Cole.** 10 .29 Amendment One to Employment Agreement, dated January 18, 2000, by and between Valor Telecommunications, LLC and Kenneth R. Cole.** 10 .30 Employment Agreement, dated as of January 2, 2002 by and between Valor Telecommunications, LLC and John J. Mueller.* 10 .31 Employment Agreement, dated as of March 20, 2000, by and between Valor Telecommunications, LLC and John A. Butler.** 10 .32 Employment Agreement, dated as of November 13, 2000, by and between Valor Telecommunications, LLC and William M. Ojile, Jr.** 10 .33 Amendment One to Employment Agreement, dated as of January 2, 2002, by and between Valor Telecommunications, LLC and William M. Ojile, Jr. 10 .34 Employment Agreement, dated as of February 28, 2000, by and between Valor Telecommunications, LLC and W. Grant Raney.** 10 .35 Amendment One to Employment Agreement, dated as of January 2, 2002, by and between Valor Telecommunications, LLC and W. Grant Raney.** 10 .36 Amended and Restated Employment Agreement, dated April 9, 2004, between Valor Telecommunications, LLC and John J. Mueller.* 12 .1 Ratio of Earnings to Fixed Charges.** 12 .2 Pro Forma Ratio of Earnings to Fixed Charges.** 23 .1 Consent of Deloitte Touche LLP and report on schedule. 23 .2 Consent of Kirkland Ellis LLP (included in Exhibit 5.1).* 23 .3 Consent of Kirkland Ellis LLP (included in Exhibit 8.1).* 23 .4 Consent of Houlihan Lokey Howard Zukin Financial Advisors, Inc.** 24 .1 Powers of Attorney (included on signature page).** 10 .26 Wholesale Solutions Switched Services Agreement, dated as of August 11, 2003, by and between Sprint Communications Company L.P. and Valor Telecommunications Enterprises, LLC. 10 .27 First Amendment to Wholesale Solutions Switched Services Agreement, dated as of October 3, 2003, between Sprint Communications Company L.P. and Valor Telecommunications Enterprises, LLC. ** 10 .28 Employment Agreement, dated as of June 18, 2000, by and between Valor Telecommunications, LLC and Kenneth R. Cole.** 10 .29 Amendment One to Employment Agreement, dated January 18, 2000, by and between Valor Telecommunications, LLC and Kenneth R. Cole.** 10 .30 Employment Agreement, dated as of January 2, 2002, by and between Valor Telecommunications, LLC and John J. Mueller.* 10 .31 Employment Agreement, dated as of March 20, 2000, by and between Valor Telecommunications, LLC and John A. Butler.** 10 .32 Employment Agreement, dated as of November 13, 2000, by and between Valor Telecommunications, LLC and William M. Ojile, Jr.** 10 .33 Amendment One to Employment Agreement, dated as of January 2, 2002, by and between Valor Telecommunications, LLC and William M. Ojile, Jr.** 10 .34 Employment Agreement, dated as of February 28, 2000, by and between Valor Telecommunications, LLC and W. Grant Raney.** 10 .35 Amendment One to Employment Agreement, dated as of January 2, 2002, by and between Valor Telecommunications, LLC and W. Grant Raney.** 10 .36 Amended and Restated Employment Agreement, dated April 9, 2004, between Valor Telecommunications, LLC and John J. Mueller.* 12 .1 Ratio of Earnings to Fixed Charges.** 12 .2 Pro Forma Ratio of Earnings to Fixed Charges.** 23 .1 Consent and report on schedule of Deloitte Touche LLP. 23 .2 Consent of Kirkland Ellis LLP (included in Exhibit 5.1).* 23 .3 Consent of Kirkland Ellis LLP (included in Exhibit 8.1).* 23 .4 Consent of Houlihan Lokey Howard Zukin Financial Advisors, Inc.** 24 .1 Powers of Attorney (included on signature page).** Valor Telecommunications, LLC Delaware 52-2171586 201 E. John Carpenter Freeway, Suite 200 Irving, TX 75062 (972) 373-1000 Valor Telecommunications of Texas, LP Texas 52-2194219 201 E. John Carpenter Freeway, Suite 200 Irving, TX 75062 (972) 373-1000 Valor Telecommunications Equipment, LP Texas 75-2884400 201 E. John Carpenter Freeway, Suite 200 Irving, TX 75062 (972) 373-1000 Valor Telecommunications Services, LP Texas 75-2884846 201 E. John Carpenter Freeway, Suite 200 Irving, TX 75062 (972) 373-1000 Valor Telecommunications Investments, LLC Delaware 47-0902124 201 E. John Carpenter Freeway, Suite 200 Irving, TX 75062 (972) 373-1000 Valor Telecommunications Enterprises, LLC Delaware 75-2884398 201 E. John Carpenter Freeway, Suite 200 Irving, TX 75062 (972) 373-1000 Valor Telecommunications LD, LP Delaware 75-2884847 201 E. John Carpenter Freeway, Suite 200 Irving, TX 75062 (972) 373-1000 Southwest Enhanced Network Services, LP Delaware 75-2885419 201 E. John Carpenter Freeway, Suite 200 Irving, TX 75062 (972) 373-1000 Western Access Services, LLC Delaware 20-0081823 201 E. John Carpenter Freeway, Suite 200 Irving, TX 75062 (972) 373-1000 Western Access Services of Arizona, LLC Delaware 20-0081863 201 E. John Carpenter Freeway, Suite 200 Irving, TX 75062 (972) 373-1000 Western Access Services of Arkansas, LLC Delaware 20-0081902 201 E. John Carpenter Freeway, Suite 200 Irving, TX 75062 (972) 373-1000 Table of Contents was engaged or about to engage in a business or a transaction for which our or the guarantor s remaining unencumbered assets constituted unreasonably small capital to carry on its business; intended to incur, or believed that it would incur, debts beyond its ability to pay the debts as they mature; or was a defendant in an action for money damages, or had a judgment for money damages docketed against it if, in either case, after final judgment, the judgment is unsatisfied. The measures of insolvency for the purposes of fraudulent transfer laws vary depending upon the law applied in any proceeding to determine whether a fraudulent transfer has occurred. Generally, however, a person would be considered insolvent if, at the time it incurred the debt: the present fair saleable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts, including contingent liabilities, as they become absolute and mature; or it could not pay its debts as they become due. Regardless of the standard that a court uses to determine whether we or a guarantor were solvent at the relevant time, the issuance of the senior subordinated notes or the guarantees may be voided or further subordinated to the claims of creditors if it concludes that we or a guarantor was insolvent. The guarantee of the senior subordinated notes by any subsidiary guarantor could be subject to the claim that, since the guarantee was incurred for our benefit, and only indirectly for the benefit of the guarantor, the guarantee was incurred for less than fair consideration. A court could therefore void the obligations of the subsidiary guarantor, under the guarantees or subordinate these obligations to the subsidiary guarantor s other debt or take action detrimental to holders of the senior subordinated notes. If the guarantee of any subsidiary guarantor were voided, the holders of the senior subordinated notes would not have a debt claim against that subsidiary guarantor. In addition, in the event that we meet any of the fraudulent transfer tests relating to financial condition, as described above, at the time of or as a result of this offering, a court could view the issuance of the senior subordinated notes, the guarantees and other transactions occurring on the issue date, such as repayment of our existing debt and various distributions described under Use of Proceeds as a single transaction and, as a result, conclude that we did not get fair value for the offering. In such a case, a court could hold the debt (including the guarantees) owed to the noteholders void or unenforceable or may further subordinate it to the claims of other creditors. Interest on the senior subordinated notes may not be deductible for United States federal income tax purposes, which could significantly reduce our future cash flow and impair our ability to make interest and dividend payments. No statutory, judicial or administrative authority has directly addressed the treatment of the IDSs or the senior subordinated notes, or instruments similar to the IDSs or the senior subordinated notes, for United States federal income tax purposes. As a result, the United States federal income tax consequences of the purchase, ownership and disposition of IDSs and senior subordinated notes are unclear. We will receive an opinion from our counsel, Kirkland Ellis, LLP, to the effect that an IDS should be treated as a unit representing a share of common stock and senior subordinated notes, and that the senior subordinated notes should be classified as debt for United States federal income tax purposes. However, the IRS or the courts may take the position that the IDSs are a single security classified as equity, or that the senior subordinated notes are properly classified as equity for United States federal income tax purposes, which could adversely affect the amount, timing and character of income, gain or loss in respect of your investment in IDSs or senior subordinated notes, and materially increase our taxable income and, thus, our United States federal and applicable state income tax liability. This would reduce our after-tax cash flow and could materially and adversely impact our ability to make interest and dividend payments on the senior subordinated notes and the common stock. Foreign holders could be subject to withholding or estate taxes with regard to the senior subordinated notes in the same manner as they will be with regard to the common stock. Payments to foreign holders would not be grossed-up for any such taxes. Further, we have Table of Contents Address Including Zip Code, State or Other Telephone Number Jurisdiction of I.R.S. Employer Including Area Code of Exact Name of Registrant Guarantor as Incorporation or Identification Registrant Guarantor s Specified in its Charter Organization Number Principal Executive Offices Table of Contents not received any opinion of counsel as to the treatment of senior subordinated notes that we may issue in any subsequent issuance, including in connection with an exchange of Class B common stock for IDSs and any subsequently issued senior subordinated notes may be treated as equity for United States federal income tax purposes. Apart from the exchanges of Class B common stock for IDSs, subsequent issuances of senior subordinated notes underlying IDSs will be made, subject to certain requirements, at the determination of our board of directors. For discussion of these tax-related risks, see Material United States Federal Income Tax Consequences. The allocation of the purchase price of the IDSs may not be respected, which may lead to you having to include original issue discount in your income even if you have not received the cash attributable to that income. The purchase price of each IDS must be allocated for tax purposes between the share of common stock and senior subordinated notes comprising the IDS in proportion to their respective fair market values at the time of purchase. It is possible that the IRS will successfully challenge our allocation. If the allocation of the purchase price to the senior subordinated notes were determined to be too high, then it is possible that the senior subordinated notes would be treated as having been issued with OID, and you generally would be required to include the OID in income in advance of the receipt of cash attributable to that income. If, on the other hand, the allocation of purchase price to the senior subordinated notes were determined to be too low, then it is possible that the senior subordinated notes would be treated as having been issued with amortizable bond premium, and you would generally be able to elect to amortize such bond premium over the term of the senior subordinated notes. Because of the deferral of interest provisions, the senior subordinated notes may be treated as issued with original issue discount. Under applicable Treasury regulations, a remote contingency that stated interest will not be timely paid is disregarded in determining whether a debt instrument is issued with OID. Although there is no authority directly on point, based on our financial forecasts, we believe that the likelihood of deferral of interest payments on the senior subordinated notes is remote within the meaning of the Treasury regulations. Based on the foregoing determination made by us, although the matter is not free from doubt because of the lack of direct authority, our counsel is of the opinion that the possibility that interest payments on the senior subordinated notes may be deferred should not cause the senior subordinated notes to be considered to be issued with OID at the time of their original issuance. If deferral of any payment of interest were determined not to be remote, then the senior subordinated notes would be treated as issued with OID at the time of issuance. In such case, all stated interest on the senior subordinated notes would be treated as OID, with the consequence that all holders would be required to include the yield on the senior subordinated notes in income as it accrued on a constant yield basis, possibly in advance of their receipt of the associated cash and regardless of their method of tax accounting. Subsequent issuances of senior subordinated notes may cause you to recognize taxable gain and/or original issue discount. The United States federal income tax consequences to you of a subsequent issuance of senior subordinated notes with OID (or any issuance of senior subordinated notes thereafter) are unclear and our counsel is unable to opine on this issue. The indenture governing the senior subordinated notes and our agreements with DTC will provide that, in the event that there is a subsequent issuance of senior subordinated notes with OID, and in connection with each issuance of senior subordinated notes thereafter, including an issuance of senior subordinated notes upon an exchange of shares of Class B common stock, each holder of senior subordinated notes or IDSs, as the case may be, agrees that a portion of such holder s senior subordinated notes will be automatically exchanged for a portion of the senior subordinated notes acquired by the holders of such subsequently issued senior subordinated notes. Such subsequent issuance and exchange will not change the aggregate stated principal amount of senior subordinated notes owned by you and each other holder. Due to the lack of applicable authority, it is unclear whether an exchange of senior subordinated notes for subsequently issued senior subordinated notes will result in a taxable exchange for United States federal income tax purposes. It is possible that the IRS might successfully assert that such an exchange should be Table of Contents treated as a taxable exchange. In such case, you would recognize any gain realized on the exchange, but a loss might be disallowed. For a more complete description of the tax consequences of a subsequent issuance, see Material United States Federal Income Tax Consequences Senior Subordinated Notes Additional Issuances. Regardless of whether the exchange is treated as a taxable event, such exchange may result in an increase in the amount of OID, if any, that you are required to accrue with respect to the senior subordinated notes. Following any subsequent issuance of senior subordinated notes with OID or any issuance of senior subordinated notes thereafter and resulting exchange, we and our agents will report any OID on any subsequently issued senior subordinated notes ratably among all holders of senior subordinated notes and IDSs. By purchasing senior subordinated notes or IDSs, as the case may be, each holder of senior subordinated notes and IDSs agrees to report OID in a manner consistent with this approach. As a result of a subsequent issuance, therefore, you may be required to report OID even though you purchased senior subordinated notes having no OID. This will generally result in you reporting more interest income over the term of the senior subordinated notes than you would have reported had no such subsequent issuance and exchange occurred. The IRS, however, may assert that OID should be reported only to the persons that initially acquired such subsequently issued senior subordinated notes and their transferees. In such case, the IRS might further assert that, unless a holder can establish that it is not an initial holder of subsequently issued senior subordinated notes or a transferee thereof, all senior subordinated notes held by such holder will have OID. Any of these assertions by the IRS could create significant uncertainties in the pricing of IDSs and senior subordinated notes and could adversely affect the market for IDSs and senior subordinated notes. If we subsequently issue senior subordinated notes with significant OID, then we may be unable to deduct all the interest on the senior subordinated notes. It is possible that the senior subordinated notes that we issue in a subsequent issuance will be issued at a discount to their face value and, accordingly, may have significant OID and thus be classified as applicable high yield discount obligations. If any such senior subordinated notes were so treated, then a portion of the OID on such notes could be nondeductible by us and the remainder would be deductible only when paid. This treatment would have the effect of increasing our taxable income and may adversely affect our cash flow available for interest payments and distributions to our shareholders. A subsequent issuance of senior subordinated notes or an allocation of IDS purchase price that results in OID may reduce the amount you can recover upon an acceleration of the payment of principal due on the senior subordinated notes or in the event of our bankruptcy. Under New York and federal bankruptcy law, holders of subsequently issued senior subordinated notes having original issue discount may not be able to collect the portion of the principal face amount of such senior subordinated notes that represents unamortized original issue discount as of the acceleration or filing date, as the case may be, in the event of an acceleration of the senior subordinated notes or in the event of our bankruptcy prior to the maturity date of the senior subordinated notes. As a result, a treatment of the senior subordinated notes as having been issued with OID or an automatic exchange that results in a holder receiving a senior subordinated note with original issue discount could have the effect of ultimately reducing the amount such holder can recover from us in the event of an acceleration or bankruptcy. Before this offering, there has not been a public market for our IDSs. The price of the IDSs may fluctuate substantially, which could negatively affect the value of your investment. Our IDSs have no public market history. In addition, there has not been an established market in the United States or in Canada for securities similar to the IDSs. We cannot assure you that an active trading market for the IDSs will develop in the future. The initial public offering price of the IDSs has been determined by negotiations among us, the existing equity holders and the representatives of the underwriters and may not be indicative of the market price of the IDSs after the offering. Factors such as quarterly variations in our financial results, announcements by Table of Contents us or others, developments affecting us, our clients and our suppliers, general interest rate levels and general market volatility could cause the market price of the IDSs to fluctuate significantly. If the IDSs separate, the limited liquidity of the market for the senior subordinated notes and Class A common stock may adversely affect your ability to sell the senior subordinated notes and Class A common stock. We do not intend to list the senior subordinated notes represented by the IDSs on any exchange or quotation system. Our Class A common stock will not initially be listed for separate trading on the New York Stock Exchange or any other exchange or quotation system other than the Toronto Stock Exchange (on which we do not anticipate an active trading market for the Class A common stock to develop). We will not apply to list our shares of Class A common stock for separate trading on the New York Stock Exchange or any other exchange or quotation system until the number of shares held separately is sufficient to satisfy applicable requirements for separate trading on such exchange or quotation system. The Class A common stock may not be approved for listing at such time. Upon separation of the IDSs, no sizable market for the senior subordinated notes and the Class A common stock may ever develop and the liquidity of any trading market for the notes or the Class A common stock that does develop may be limited. As a result, your ability to sell your notes or Class A common stock, and the market price you can obtain, could be adversely affected. The limited liquidity of the trading market for the senior subordinated notes sold separately (not represented by IDSs) may adversely affect the trading price of the separate senior subordinated notes. We are separately selling (not represented by IDSs) $ million aggregate principal amount of senior subordinated notes, representing approximately 10% of the total principal amount of the outstanding senior subordinated notes. While the senior subordinated notes sold separately (not represented by IDSs) are part of the same series of notes as, and are identical to, the senior subordinated notes represented by IDSs at the time of the issuance of the separate senior subordinated notes, the senior subordinated notes represented by the IDSs will not be separable for at least 45 days and will not be separately tradeable until separated. As a result, the initial trading market for the senior subordinated notes sold separately (not represented by IDSs) will be very limited. Even after holders of the IDSs are permitted to separate their IDSs, a sufficient number of holders of IDSs may not separate their IDSs into shares of our Class A common stock and senior subordinated notes to create a sizable and more liquid trading market for the senior subordinated notes not represented by IDSs. Therefore, a liquid market for the senior subordinated notes may not develop, which may adversely affect the ability of the holders of the separate senior subordinated notes to sell any of their separate senior subordinated notes and the price at which these holders would be able to sell any of the senior subordinated notes sold separately. Future sales or the possibility of future sales of a substantial amount of IDSs, shares of our common stock or our senior subordinated notes may depress the price of the IDSs and the shares of our common stock and our senior subordinated notes. Future sales or the availability for sale of substantial amounts of IDSs or shares of our common stock or a significant principal amount of our senior subordinated notes in the public market could adversely affect the prevailing market price of the IDSs and the shares of our common stock and senior subordinated notes and could impair our ability to raise capital through future sales of our securities. We may issue shares of our Class A common stock and senior subordinated notes, which may be in the form of IDSs, or other securities from time to time as consideration for future acquisitions and investments. In the event any such acquisition or investment is significant, the number of shares of our Class A common stock and the aggregate principal amount of senior subordinated notes, which may be in the form of IDSs, or the number or aggregate principal amount, as the case may be, of other securities that we may issue may in turn be significant. In addition, we may also grant registration rights covering those IDSs, shares of our common stock, senior subordinated notes or other securities in connection with any such acquisitions and investments. Any or all of these occurrences could depress the trading prices of our securities. Balance, March 31, 2004 $ Table of Contents Regulatory Risks We received 24.1% of our 2003 revenues from the Texas and federal Universal Service Funds and any adverse regulatory developments with respect to these funds could curtail our profitability. We receive Texas and federal Universal Service Fund, or USF, revenues to support the high cost of providing affordable telecommunications services in rural markets. Such support payments constituted 24.1% of our revenues for the year ended December 31, 2003 and 23.9% of our revenues for the three months ended March 31, 2004. Of these support payments, in the year ended December 31, 2003, $103.1 million, or 20.7% of our revenues, and in the three months ended March 31, 2004, $25.5 million, or 20.2% of our revenues, were received from the Texas USF. In addition, we are required to make contributions to the Texas USF and federal USF each year. Current state and federal regulations allow us to recover these costs by including a surcharge on our customers bills. Furthermore, we incur no incremental costs associated with the support payments we receive or the contributions we are required to make. Thus, if Texas and/or federal regulations changed and we were unable to receive support, such support was reduced, or we are unable to recover the amounts we contribute to the Texas USF and federal USF from our customers, our earnings would be directly and adversely affected. For a more detailed discussion of the regulations affecting our company, see Regulation. The rules governing USF could be altered or amended as a result of regulatory, legislative or judicial action and impact the amount of USF support that we receive and our ability to recover our USF contributions by assessing surcharges on our customers bills. For example, the enabling statute for the Texas USF will become subject to review and renewal in late 2005 and may be modified. Similarly, the FCC asked the Federal-State Joint Board on Universal Service to review the federal rules relating to universal service support mechanisms for rural carriers, including addressing the relevant costs and the definition of rural telephone company in June 2004. It is not possible to predict at this time whether state or federal regulators, Congress or state legislatures will order modification to those rules or statutes, or the ultimate impact any such modification might have on us. In addition, the Texas USF rules provide that the Texas Public Utility Commission must open an investigation within 90 days after any changes are made to the federal USF. Therefore, changes to the federal USF may prompt similar or conforming changes to the Texas USF. The outcome of any of these legislative or regulatory changes could affect the amount of Texas USF support that we receive, and could have an adverse effect on our business, revenue or profitability. Reductions in the amount of network access revenue that we receive could negatively impact our results of operations. In the year ended December 31, 2003, we derived $132.0 million, or 26.6% of our revenues, and in the three months ended March 31, 2004, we derived $33.0 million, or 26.3% of our revenues, from network access charges. Our network access revenue consists of (1) usage sensitive fees we charge to long distance companies for access to our network in connection with the completion of interstate and intrastate long distance calls, (2) fees charged for use of dedicated circuits and (3) end user fees, which are monthly flat-rate charges assessed on access lines. Federal and state regulatory commissions set these access charges, and they could change the amount of the charges or the manner in which they are charged at any time. The FCC is currently examining proposals to revise interstate access charges and other intercarrier compensation. Also, as people in our markets decide to use Internet, wireless or cable television providers for their local or long distance calling needs, rather than using our wireline network, the reduction in the number of access lines or minutes of use over our network could reduce the amount of access revenue we collect. As penetration rates for these technologies increase in rural markets, our revenues could decline. In addition, if our customers take advantage of favorable calling plans offered by wireless carriers for their long distance calling needs, it could reduce the number of long distance calls made over our network, thereby decreasing our access revenue. Furthermore, disputes are pending as to whether providers of Voice over Internet Protocol, or VoIP technology, which allow customers to make voice calls over the Internet or using Internet Protocol, are subject to FCC or state regulations that would require them to pay network charges. With the emergence of VoIP technology, the FCC and state commissions are considering the Western Access Services of Colorado, LLC Delaware 20-0081934 201 E. John Carpenter Freeway, Suite 200 Irving, TX 75062 (972) 373-1000 Western Access Services of Oklahoma, LLC Delaware 20-0081944 201 E. John Carpenter Freeway, Suite 200 Irving, TX 75062 (972) 373-1000 Western Access Services of New Mexico, LLC Delaware 20-0081922 201 E. John Carpenter Freeway, Suite 200 Irving, TX 75062 (972) 373-1000 Western Access Services of Texas, LP Delaware 20-0081952 201 E. John Carpenter Freeway, Suite 200 Irving, TX 75062 (972) 373-1000 Valor Telecommunications Corporate Group, LP Texas 75-2895493 201 E. John Carpenter Freeway, Suite 200 Irving, TX 75062 (972) 373-1000 Valor Telecommunications Southwest, LLC Delaware 52-2194218 201 E. John Carpenter Freeway, Suite 200 Irving, TX 75062 (972) 373-1000 Valor Telecommunications Southwest II, LLC Delaware 75-2950066 201 E. John Carpenter Freeway, Suite 200 Irving, TX 75062 (972) 373-1000 Valor Telecommunications Enterprises II, LLC Delaware 75-2950064 201 E. John Carpenter Freeway, Suite 200 Irving, TX 75062 (972) 373-1000 Kerrville Communications Corporation Texas 74-2197091 201 E. John Carpenter Freeway, Suite 200 Irving, TX 75062 (972) 373-1000 Kerrville Communications Management, LLC Delaware 30-0135974 201 E. John Carpenter Freeway, Suite 200 Irving, TX 75062 (972) 373-1000 Kerrville Communications Enterprises, LLC Delaware 32-0047694 201 E. John Carpenter Freeway, Suite 200 Irving, TX 75062 (972) 373-1000 Advanced Tel-Com Systems, LP Texas 74-2228603 201 E. John Carpenter Freeway, Suite 200 Irving, TX 75062 (972) 373-1000 Table of Contents status of VoIP and other Internet services and there can be no assurance that the FCC and state regulators will require such providers to pay access charges. Any or all of these developments could reduce the amount of access revenue that we receive which could negatively impact our revenues and profitability. The introduction of new competitors or the better positioning of existing competitors due to regulatory changes could cause us to lose customers and impede our ability to attract new customers. Changes in regulations that open our markets to more competitors offering substitute services could impact our profitability because of increases in the costs of attracting and retaining customers and decreases in revenues due to lost customers and the need to offer competitive prices. We face competition from current and potential market entrants, including: domestic and international long distance providers seeking to enter, reenter or expand entry into the local telecommunications marketplace; other domestic and international competitive telecommunications providers, wireless carriers, resellers, cable television companies and electric utilities; and providers of broadband and Internet services. Regulatory requirements designed to facilitate the introduction of competition, the applicability of different regulatory requirements between our competitors and us, or decisions by legislators or regulators to exempt certain providers or technologies from the same level of regulation that we face, could adversely impact our market position and our ability to offer competitive alternatives. In November 2003, the FCC ordered us and other local exchange carriers to adopt wireline-to-wireless local number portability. This may help wireless carriers compete against us because if customers switch from traditional local telephone service to wireless service, they can now transfer their local telephone number to their wireless provider. In addition, federal and state regulators and courts are addressing many aspects of our obligations to provide unbundled network elements and discounted wholesale rates to competitors. New regulations and changes in existing regulations may force us to incur significant expenses. Our business may also be impacted by legislation and regulation that impose new or greater obligations related to assisting law enforcement, bolstering homeland security, minimizing environmental impacts or addressing other issues that impact our business. For example, existing provisions of the Communications Assistance for Law Enforcement Act, or CALEA, and FCC regulations implementing CALEA require telecommunications carriers to ensure that their equipment, facilities, and services are able to facilitate authorized electronic surveillance. We cannot predict whether and when the FCC might modify its CALEA rules or any other rules or what compliance with new rules might cost. Similarly, we cannot predict whether or when federal or state legislators or regulators might impose new security, environmental or other obligations on our business. For a more thorough discussion of the regulation of our company and how that regulation may affect our business, see Regulation. Certain transactions related to the enforceability of the guarantees of the senior subordinated notes by certain of our subsidiaries may require FCC or state regulatory commission approval, which may not be granted or which may be subject to delays or conditions that could affect your ability to enforce the guarantees. In the event that it becomes necessary to enforce the guarantees of the senior subordinated notes, approvals may be required for certain of our subsidiaries that are subject to federal or state regulatory authority, including approval for the transfer of control of various radio licenses held by our operating subsidiaries or the transfer of control over or sale of the assets of our operating subsidiaries. Such approvals may not be obtained, in which case such guarantees would be unenforceable, or may be subject to delays or conditions that could affect your ability to enforce the guarantees. Table of Contents Address Including Zip Code, State or Other Telephone Number Jurisdiction of I.R.S. Employer Including Area Code of Exact Name of Registrant Guarantor as Incorporation or Identification Registrant Guarantor s Specified in its Charter Organization Number Principal Executive Offices Table of Contents A reduction by a state regulatory body or the FCC of the rates we charge our customers would reduce our revenues and earnings. The prices, terms and conditions of the services that we offer to local telephone customers are subject to state regulatory approval. If a state regulatory body orders us to reduce a price, withdraws our approval to charge a certain price, changes material terms or conditions of a service we offer or refuses to approve or limits our ability to offer a new or existing service, both our revenues and our earnings may be reduced. FCC regulations also affect the rates that are charged to customers. The FCC regulates tariffs for interstate access and subscriber line charges, both of which are components of our revenues. The FCC currently is considering proposals to reduce interstate access charges for carriers like us. If the FCC lowers interstate access charges without adopting an adequate revenue replacement mechanism, we may be required to recover more revenue through subscriber line charges and universal service funds or forego this revenue altogether. This could reduce our revenue or impair our competitive position. Risks Relating to Our Business We provide services to our customers over access lines and if we continue to lose access lines our revenues and earnings may decrease. Our business generates revenue by delivering voice and data services over access lines. We have experienced net access line loss over the past few years, and during the year ended December 31, 2003, the number of access lines we serve declined by 2.6% due to challenging economic conditions and increased competition. We may continue to experience net access line loss in our markets for an unforeseen period of time. Our inability to retain access lines could adversely affect our revenue and earnings. Rapid and significant changes in technology in the telecommunications industry could adversely affect our ability to compete effectively in the markets in which we operate. The rapid introduction and development of enhanced or alternative services that are more cost effective, more efficient or more technologically advanced than the services we offer is a significant source of potential competition in the telecommunications industry. Technological developments may reduce the competitiveness of our networks, make our service offerings less attractive or require expensive and time-consuming capital improvements. If we fail to adapt successfully to technological changes or fail to obtain timely access to important new technologies, we could lose customers and have difficulty attracting new customers or selling new services to our existing customers. We cannot predict the impact of technological changes on our competitive position, profitability or industry. Wireless and cable technologies that have emerged in recent years provide certain advantages over traditional wireline voice and data services. The mobility afforded by wireless voice services and its competitive pricing appeal to many customers. The ability of cable television providers to offer voice, video and data services as an integrated package provides an attractive alternative to traditional voice services from local exchange carriers. In addition, as the emerging VoIP services develop, some customers may be able to bypass network access charges. Increased penetration rates for these technologies in our markets could cause our revenues to decline. The competitive nature of the telecommunications industry could adversely affect our revenues, results of operations and profitability. The telecommunications industry is very competitive. Increased competition could lead to price reductions, declining sales volumes, loss of market share, higher marketing costs and reduced operating margins. Significant and potentially larger competitors could enter our markets at any time, including local service providers, cable television companies and wireless telecommunications providers. For a more thorough discussion of the competition that may affect our business, see Business Competition. Table of Contents Weak economic conditions may decrease demand for our services. We are sensitive to economic conditions and downturns in the economy. Downturns in the economies in the markets we serve could cause our existing customers to reduce their purchases of our basic and enhanced services and make it difficult for us to obtain new customers. We depend on a few key vendors and suppliers to conduct our business and any disruption in our relationship with any one or more of them could adversely affect our results of operations. We rely on vendors and suppliers to support many of our administrative functions and to enable us to provide long distance services. For example, we currently outsource much of our operational support services to ALLTEL, including our billing and customer care services. Transitioning these support services to another provider could take a significant period of time and involve substantial costs. In addition, we have resale agreements with MCI and Sprint to provide our long distance transmission services. Replacing these resale agreements could be difficult as there are a limited number of national long distance providers. Any disruptions in our relationship with these third party providers could have an adverse effect on our business and operations. Disruption in our networks and infrastructure may cause us to lose customers and incur additional expenses. To be successful, we will need to continue to provide our customers with reliable service over our networks. Some of the risks to our networks and infrastructure include: physical damage to access lines, breaches of security, capacity limitations, power surges or outages, software defects and disruptions beyond our control, such as natural disasters and acts of terrorism. Disruptions may cause interruptions in service or reduced capacity for customers, either of which could cause us to lose customers and incur expenses, and thereby adversely affect our business, revenue and cash flow. Recent difficulties in the telecommunications industry could negatively impact our revenues and results of operations. We originate and terminate long distance phone calls on our networks for other interexchange carriers, some of which are our largest customers in terms of revenues. In the year ended December 31, 2003 and the three months ended March 31, 2004, we generated 17.5% and 17.2%, respectively, of our total revenues from originating and terminating phone calls for interexchange carriers. Several of these interexchange carriers have declared bankruptcy during the past two years or are experiencing substantial financial difficulties. MCI WorldCom (now MCI), which declared bankruptcy in 2002, is one of the major interexchange carriers with which we conduct business. We recorded a net $1.6 million charge due to MCI s failure to pay amounts owed to us. Further bankruptcies or disruptions in the businesses of these interexchange carriers could have an adverse effect on our financial results and cash flows. Following the consummation of this offering, our equity sponsors will collectively be able to exercise substantial influence over matters requiring stockholder approval and their interests may diverge from the interests of the holders of the IDSs. Following the consummation of this offering, affiliates of Welsh, Carson, Anderson Stowe, or WCAS, affiliates of Vestar Capital Partners, or Vestar, and affiliates of Citicorp Venture Capital, or CVC, will beneficially own %, % and %, respectively, of our outstanding shares of Class A common stock as part of the IDSs, and %, % and %, respectively, of our outstanding shares of Class B common stock. As a result, WCAS, Vestar and CVC collectively exercise substantial influence over matters requiring stockholder approval, including decisions about our capital structure. In addition, WCAS has two designees and Vestar has one designee serving on our board of directors. The interests of our equity sponsors may conflict with your interests as a holder of the IDSs. Table of Contents Our amended and restated certificate of incorporation and by-laws and several other factors could limit another party s ability to acquire us and deprive our investors of the opportunity to obtain a takeover premium for their securities. A number of provisions in our amended and restated certificate of incorporation and by-laws will make it difficult for another company to acquire us and for you to receive any related takeover premium on our securities. For example, our amended and restated certificate of incorporation provides that stockholders may not act by written consent and that only our board of directors may call a special meeting. In addition, stockholders are required to provide us with advance notice if they wish to nominate any persons for election to our board of directors or if they intend to propose any matters for consideration at an annual stockholders meeting. Our amended and restated certificate of incorporation authorizes the issuance of preferred stock without stockholder approval and upon such terms as the board of directors may determine. The rights of the holders of shares of our common stock will be subject to, and may be adversely affected by, the rights of holders of any class or series of preferred stock that may be issued in the future. Table of Contents

parsed_sections/risk_factors/2004/CIK0001282280_western_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

parsed_sections/risk_factors/2004/CIK0001282288_western_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

parsed_sections/risk_factors/2004/CIK0001282400_mewbourne_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ RISK FACTORS You should recognize that oil and gas drilling and exploration is a high risk venture. Therefore, we recommend that you invest in a partnership only if you are prepared to assume the substantial risks discussed below and elsewhere in this prospectus. The nature of these risks requires persons who purchase interests to be in a position: to hold such investment for a substantial number of years, and to absorb the possible loss of such investment. Particular Risks Relating to the Interests Liability of Limited Partners. Each partnership will be governed by the Delaware Revised Uniform Limited Partnership Act. Under Delaware law, as a general rule, a limited partner s liability for the obligations of a partnership is limited to such limited partner s capital contribution and such limited partner s share of the partnership s assets. A limited partner of the partnership will not otherwise be liable for the obligations of the partnership unless, in addition to the exercise of his or her rights and powers as a limited partner, such limited partner participates in the control of the business of a partnership. In such case the limited partner is liable only to persons who transact business with the partnership with actual knowledge of the limited partner s participation in control. Accordingly, if a limited partner were to take an action which was subsequently determined to constitute participating in the control of the business of a partnership, such limited partner could become liable for the partnership debts and obligations. See Liability of Investor Partners Limited Partners. Liability of Investor General Partners. Under Delaware law, each general partner in a partnership will be liable for all of the liabilities and recourse obligations of the partnership. Furthermore, each partnership will own working interests in oil and gas leases subject to some portion of the costs of development, operation or maintenance. We, and likely others, will also own similar working interests in these oil and gas leases. Therefore, a general partner could be liable for the obligations of all such joint working interest owners. The managing partner will indemnify each general partner from any liability in excess of his share of a partnership s undistributed assets. However, a general partner still could be subject to such liability if we should become bankrupt or for any other reason we are unable to meet our financial commitment to indemnify the general partners. This liability could obligate a general partner to make additional payments to the partnership. The possible amount of such a liability cannot be predicted. The subsequent conversion of a general partner interest into a limited partner interest will have no effect on the converted general partner s liability as to events that occurred prior to the conversion. See Liability of Investor Partners General Partners. Liability of Joint Working Interest Owners. Under the drilling program agreement, each drilling program participant, including the managing partner and each partnership, will hold its working interest in oil and gas leases in its own name and will be a joint working interest owner with the other drilling program participants and also with third parties. It has not been clearly established under the laws of some of the jurisdictions where a portion of each drilling program s properties will be located whether a single joint working interest owner is liable with respect to all obligations relating to the entire jointly owned working interest. The operating agreements relating to drilling program oil and gas leases will specify that the liabilities of joint working interest owners will be limited to their individual joint working interest, though we cannot assure that such a provision would be enforceable against a third party. As a result it is possible that a general partner could be determined liable for all obligations relating to the entire jointly owned working interest. Possibility of Reduction or Unavailability of Insurance Coverage of a Partnership. It is possible that some or all of the insurance coverage which a partnership has available may become unavailable or prohibitively expensive. If the program manager and its affiliates cease to retain the coverage described for any reason for a period of more than 20 days during the subscription period for a partnership, the offering of interests in that partnership shall cease, and subscribers for interests in any partnership in which investors have not been admitted shall receive a refund of their subscription funds. The managing partner will also promptly notify those investors of any material reduction in the insurance coverage of the drilling programs and the partnerships. The managing CURTIS W. MEWBOURNE Copies to: Mewbourne Development Corporation 3901 S. Broadway Tyler, Texas 75701 (903) 561-2900 A. WINSTON OXLEY Vinson Elkins L.L.P. 3700 Trammell Crow Center 2001 Ross Avenue Dallas, Texas 75201 (214) 220-7700 Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement. If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. CALCULATION OF REGISTRATION FEE Amount of Title of Securities Proposed Maximum Registration to be Registered Aggregate Offering Price Fee Table of Contents partner shall give investors this notice as soon as possible after it learns of such change and if possible at least 30 days in advance of the change in insurance coverage. In addition, if a drilling program or a partnership, after the admission of investors, has its insurance coverage materially reduced for any reason, that partnership will halt all drilling activity until such time as comparable replacement coverage is obtained. If a partnership has its insurance coverage materially reduced after you invest, you could be subject to a greater risk of loss of your investment since less insurance would be available to protect your investment from casualty losses. See Proposed Activities Insurance. Sole Reliance on Us for Management of a Partnership. Under the partnership agreement, Mewbourne Development Corporation is designated as the managing partner of each partnership and is given the exclusive authority to manage and operate each partnership s business. As the managing partner, we will have complete and total authority and broad discretion to determine the manner in which all of the offering proceeds will be expended. Also, we are required to devote only such time as is reasonably needed to the operations of the partnerships. Accordingly, if you invest in a partnership you must rely solely on us to make all decisions on behalf of each partnership. Investors will have no role in the management of the business of either partnership. Therefore, each partnership s success will depend, in part, upon the management we provide, our ability, and the ability of Mewbourne Oil Company as manager of each drilling program to: select and acquire oil and gas leases on which oil and gas wells capable of producing oil and natural gas in commercial quantities may be drilled, successfully drill and develop oil and gas well on the properties selected, and market oil and natural gas produced from such oil and gas wells. Sole Reliance on Our Financial Status. No financial information will be provided to the investors concerning any investor who has elected to invest in a partnership as a general partner. In no event should investors rely on the financial wherewithal of investor general partners, including in the event we should become bankrupt or are otherwise unable to meet our financial commitments. Prospects Not Yet Identified or Selected; No Opportunity to Evaluate Prospects. Although we maintain an inventory of leasehold acreage covering numerous prospects, we have not, as of the date of this prospectus, selected or agreed to transfer from such owned inventory any particular oil and gas leases to a partnership or related drilling program. The drilling program manager will select all oil and gas leases that the partnerships and the related drilling programs will acquire or drill. You will not have an opportunity to review those oil and gas leases before investing in a partnership. You will also not have an opportunity to participate in the selection of oil and gas leases after an investment is made. We may during the course of this offering select, and cause this prospectus to be amended or supplemented to describe, prospects designated for acquisition by participants in a drilling program. If you subscribe for interests prior to any such amendment or supplement you will not be permitted to withdraw your subscription as a result of the selection of any such designated prospect and you may not be notified of the selection of any such designated prospect prior to funding of the partnership or partnerships in which you have invested. See Proposed Activities Acquisition of Leases. Limited Ability to Spread Risk. A partnership could be formed with as little as $5,000,000 in subscriptions from investors. To the extent that the funds available to a partnership are limited, its ability to spread risks over a large number of oil and gas wells and prospects will be reduced. The number of oil and gas wells which can be drilled based on the minimum investment amount cannot be determined because prospects have not been selected. However, even if a drilling program is formed with substantially more than the minimum required capital, investors must rely on us to diversify drilling activities of the related partnership. Additional Partnership Financing May Become Necessary Due to Unforeseen Circumstances. We anticipate that the net proceeds from the sale of interests in a particular partnership will be sufficient to finance that partnership s share of the related drilling program s costs of: drilling and completing oil and gas wells, and Table of Contents providing necessary production equipment and facilities to service such oil and gas wells and plugging and abandoning non-productive oil and gas wells. However, due to unforeseen circumstances, it could become necessary to finance the costs of additional partnership operations through partnership borrowings, utilization of partnership revenues obtained from production or other methods of financing. These additional operations may include the acquisition of additional oil and gas leases and the drilling, completing and equipping of additional wells to further develop drilling program prospects. Each partnership agreement provides that outstanding partnership borrowings may not at any time exceed 20% of its aggregate capital contributions. Furthermore, a partnership may borrow funds only if the lender agrees that it will have no recourse against individual general partners. If the above-described method of financing should prove insufficient to maintain the desired level of development operations for the drilling program, such operations could be continued through farmout arrangements with third parties, including the managing partner and/or its affiliates. These farmouts could result in the drilling program giving up a substantial interest in any oil and gas revenues so developed. Uncertainty of Partnership Cash Distributions. No distributions will be made from a partnership to the general or limited partners of that partnership until that partnership has funds which the managing partner determines are not needed for the operation of the partnership and the drilling program. Accordingly, we cannot assure that any distributions from a partnership will be made to its general and limited partners. Distributions will depend primarily on a partnership s net cash receipts from oil and gas operations. Moreover, distributions could be delayed to repay the principal and interest on partnership borrowings, if any, or to fund partnership costs. Partnership income will be taxable to the general and limited partners in the year earned, even if cash is not distributed. Conflicts of Interest of Managing Partner. Investors will not be involved in the day-to-day operations of the partnerships. Accordingly, if you invest in a partnership, you must rely on our judgment in such matters. Inherent with the exercise of our judgment, we will be faced with conflicts of interest, including: We will participate in the drilling programs in our individual capacity. As a result, actions taken by a partnership may be more beneficial to us than the partnership. We or our affiliates may participate in oil and gas activities on behalf of other programs that we sponsor, will sponsor or are for our account. We owe a duty of good faith to each of the partnerships which we manage, and it is possible that actions taken with regard to other partnerships may not be advantageous to a partnership. We and/or our affiliates may provide services to a partnership. We and/or our affiliates will be compensated for these services at rates competitive with the rates charged by unaffiliated persons for similar services. If we or our affiliates own interests in a partnership, this ownership may dilute the voting power of the other general and limited partners in that partnership. The oil and gas leases that may be contributed to a partnership may be adjacent to acreage or oil and gas leases which we or our affiliates hold or will hold. While the drilling program will not drill any well for the purpose of proving or disproving the existence of oil or gas on any adjacent acreage, such drilling activities may incidentally develop information valuable to us or our affiliates in evaluating our nearby acreage at no cost to us. Accordingly, a conflict of interest will exist between our interests and the interest of a partnership in selecting the location and type of operations which the drilling program will conduct on drilling program oil and gas leases. We will attempt, in good faith, to resolve all conflicts of interest in a fair and equitable manner with respect to all persons affected by those conflicts of interest. However, we cannot assure that transactions between a partnership and its affiliates will be on terms as favorable as could have been negotiated with unaffiliated third parties. You should be aware that we have not formally adopted any procedures or criteria to avoid or to resolve any conflicts of interest that may arise between us and a partnership. You are urged to review the discussion under Conflicts of Interest for a more complete description of possible conflicts of interests. Table of Contents Inside Board of Directors and Other Family Relationships of Managing Partner and Program Director. The Board of Directors of both the managing partner and the program manager are comprised entirely of employees and family members of Mr. Mewbourne. Therefore, the activities of the managing partner and the program manager are not subject to the review and scrutiny of an independent Board of Directors. Limitations on the Fiduciary Obligations of the Managing Partner and the Managing Partner s Responsibility to Determine the Application of the Limitations. The partnership agreement contains provisions which modify what would otherwise be the applicable Delaware law relating to the fiduciary standards of the managing partner to the general and limited partners. The fiduciary standards in the partnership agreement could be less advantageous to the general and limited partners and more advantageous to the managing partner than the corresponding fiduciary standards otherwise applicable under Delaware law, specifically: we and our affiliates may be indemnified and held harmless by a partnership, we are required to devote only so much of its time as is necessary to manage the affairs of a partnership, we and our affiliates may conduct business with a partnership in a capacity other than as a manager of the partnership, we and/or our affiliates may pursue business opportunities that are consistent with a partnership s investment objectives for our own account if we determine that such opportunity cannot be pursued by the partnership either because of insufficient funds or because it is not appropriate for the partnership under the existing circumstances, and we may manage multiple programs simultaneously. In addition, the partnership agreement limits the liability of us or our affiliates to a partnership or to general and limited partners for acts or omissions if we determine in good faith, as of the time of the conduct or omission, that the course of conduct or omission was in the best interest of that partnership and that such conduct or omission did not constitute negligence or misconduct. Your purchase of an interest in a partnership may be deemed as consent to the limitations upon the fiduciary standards set forth in the partnership agreement. As a result of these provisions in the partnership agreement, the general and limited partners may find it more difficult to hold us responsible for not acting in the best interests of a partnership and its general and limited partners than if the fiduciary standards of the otherwise applicable Delaware law governed the situation. Partnership s Joint Activities With Others. We anticipate that the participants in the drilling programs, including the related partnerships, will not own the full working interest in most prospects to be explored and developed under the drilling program agreement. It is likely that a third party or parties will own a partial working interest in a prospect to be developed under the drilling program agreement. These third parties could be either our affiliates or unrelated to us and could also include Mr. Mewbourne. While Mewbourne Oil Company, on behalf of each drilling program, would participate in decisions affecting the development of such prospects, decisions with respect to development activities might be controlled or affected by the other owners of working interests in such prospects. Furthermore, a partnership could be held liable for the joint activity obligations of such other working interest owners, and this liability could in turn result in individual liability for the general partners in that partnership. See Particular Risks Relating to the Interests Liability of Joint Working Interest Owners. Lack of Liquidity for Investors. We anticipate that there will not be any market for resale of the interests. Although the partnership agreement permits the assignment of interests by general and limited partners, transfers of interests are subject to restrictions. As one example, an assignee of an interest may not become a substituted general or limited partner without our consent. Accordingly, if you purchase an interest you should be prepared to bear the investment risks attendant upon your investment for an indefinite period of time. See Summary of Partnership Agreement and Drilling Program Agreement Assignability of Interests for a description of transfer restrictions. General and limited partners will not have the right to withdraw any capital from a partnership or to receive the return of all or any portion of their capital contributions, except out of distributions of operating revenues, upon a sale or other disposition of that partnership s property or the dissolution and liquidation of that partnership. Limited Partner Interests (2 ) (3 ) General Partner Interests (2 ) (3 ) Table of Contents Although general and limited partners may under certain circumstances require us, or an affiliate that we have designated, to purchase their interest in whole but not in part, this obligation is limited and does not assure the liquidity of an investor s investment. See Terms of the Offering Right of Presentment. Indemnification of Managing Partner and its Affiliates. The partnership agreement provides for indemnification of us, our affiliates and the officers and directors of such persons against claims arising from conduct on behalf of a partnership or the related drilling program. In addition, the drilling program agreement provides for indemnification of Mewbourne Oil Company, its affiliates, and the officers and directors of such persons against claims arising from conduct on behalf of the related drilling program. In the event of any such indemnification for losses, liabilities or expenses arising from or out of an alleged violation of federal or state securities laws, a court must approve the indemnification. In all other instances of indemnification, we will decide whether or not indemnification is appropriate under the partnership agreement or drilling program agreement. Therefore, if you invest, in such situations you must rely upon our integrity to cause a partnership to indemnify us and our affiliates only when the indemnification is justified under the partnership agreement or drilling program agreement. You should also bear in mind that in any situation involving indemnification, a partnership s funds could be applied to the indemnification of us and our affiliates rather than to make distributions to the general and limited partners. See Summary of Partnership Agreement and Drilling Program Agreement Indemnification of the Managing Partner and its Affiliates. Investor s Lack of Substantial Voting Rights. In order to preserve the limited liability of the limited partners of the partnerships, the limited partners may not take part in the day to day operations of a partnership. Although those investors who elect to invest as general partners will not initially be limited partners of a partnership, we are presuming that the vast majority, if not all, of the general partner interests will be converted into limited partner interests upon completion of the partnership s drilling activities. In order to preserve the limited liability of the limited partners, limited partners are not permitted to take actions which generally may be taken by stockholders of public corporations, such as annual votes to approve important matters. Because limited partners are not permitted to take part in the day to day operations of a partnership, limited partnerships, such as the partnerships, do not generally hold annual meetings such as those at which stockholders may express their views and confront management directly. As a result of the control of the day to day operations of a partnership is vested exclusively in us, and you must rely on us to fulfill our fiduciary duties to you and the other partners and to maximize the partnership s economic performance. Investor s Lack of Appraisal Rights. Unlike most modern corporation laws and the solid body of judicial case law which provides most corporate stockholders with appraisal rights to have their shares of stock redeemed by the corporation in certain instances, limited partnership acts generally provide no such rights. Although the partnership agreement does provide general and limited partners with limited appraisal rights in the case of mergers and similar events, an investor may not have appraisal rights in as many situations as would some corporate stockholders. There is no extensive judicial case law interpreting and upholding the appraisal rights of limited partners. See Proposed Activities The Managing Partner s Policy Regarding Roll-Up Transactions for a description of the limited appraisal rights provided to general and limited partners. Limitations on Right of Presentment. General and limited partners may under certain circumstances request that we, or an affiliate that we have designated, purchase their interests in whole but not in part. Partners in a partnership formed in 2004 may make this request in each of the years 2008 through 2013 and partners in a partnership formed in 2005 may make this request in each of the years 2009 through 2014. However, our obligation to purchase interests is limited and does not assure the liquidity of an investor s investment. Our obligation to purchase interests in a partnership in any single calendar year is limited to no more than 5% of the total number of interests of that partnership outstanding at the beginning of such calendar year; provided, however, the total amount of funds that we directly and by means of a purchaser designee are required to expend in any calendar year to purchase partnership interests from investors in all of the oil and gas drilling partnerships as to which we or an affiliate serve as sponsor shall not exceed $500,000. Additionally, if subsequent to December 31 of the year immediately preceding the year in which the right of presentment is being exercised, the price for either oil or gas received by a partnership from its program wells decreases by 20% or more as compared to the price being received as of that date, then we may in our sole and absolute discretion refuse to purchase any interests in that partnership. See Terms of the Offering Right of Presentment. Table of Contents Limited Ability to Remove Managing Partner and Difficulty in Finding a Successor Managing Partner. We may be removed from our position as the managing partner and/or Mewbourne Oil Company may be removed from its position as the drilling program manager only by the affirmative vote of investors holding at least 50% of the then outstanding general and limited interests of such partnership. The general and limited partners in certain circumstances must, in order to continue the partnership, elect a successor to the removed managing partner if the removal of the managing partner causes a dissolution of that partnership. In the event the drilling program manager is removed, the related partnership must elect a successor to the removed drilling program manager. There is a risk that the general and limited partners could not find a new managing partner or drilling program manager if we or Mewbourne Oil Company were to be removed from such positions. Withdrawal of Partners. Under the partnership agreement, each general partner will agree that he will not voluntarily withdraw from a partnership. We agree that we will not voluntarily withdraw from a partnership prior to the later to occur of: completion of the partnership s primary drilling activities under the related drilling program, and the fifth anniversary of the date that general and limited partners were admitted to the partnership. In order to exercise its right of withdrawal, the managing partner must give the general and limited partners at least 120 days advance written notice. A general partner who withdraws in violation of this agreement will be obligated to reimburse the partnership and the other partners for any expenses associated with such withdrawal. We expect that such expenses may be substantial and could exceed the amount of the withdrawing general partner s original investment in the partnership. Furthermore, a withdrawing general partner will no longer be entitled to receive any distributions nor shall such general partner have any rights as a partner under the partnership agreement. Dissolution of a Partnership and Termination of the Drilling Program. A partnership will be dissolved and terminated upon the occurrence of any of the events listed under Summary of Partnership Agreement and Drilling Program Agreement Dissolution, Liquidation and Termination. These events include: the expiration of that partnership s term, or the vote or consent in writing at any time by a majority in interest of the general and limited partners. However, a partnership could also be dissolved and both it and the related drilling program terminated as a result of events which do not include the passage of time or the consent of the general and limited partners. These events include our bankruptcy, insolvency, dissolution, or withdrawal from the partnership. The general and limited partners have the right to reconstitute a partnership under such circumstances and, in so doing, avoid termination of that partnership. However, there is no certainty that the general and limited partners could find a new managing partner to replace us in such circumstances. We currently have no intention of withdrawing as the managing partner of a partnership. Ability of the Managing Partner to Cause Dissolution of a Partnership and the Related Drilling Program. The partnership agreement and applicable law provide our withdrawal from a partnership, directly or as a result of bankruptcy, dissolution or similar event, will cause dissolution of that partnership. We have undertaken not to withdraw as the managing partner of a partnership prior to the later to occur of completion of that partnership s primary drilling activities under the related drilling program, and the fifth anniversary of the date that general and limited partners were admitted to that partnership. However, we have the power under applicable law to withdraw from a partnership in violation of the partnership agreement. We currently do not intend to withdraw from a partnership. The partners of each partnership are given the right under the partnership agreement to reconstitute a partnership upon our withdrawal, but there is an additional risk in such event that the partners of a partnership could not find a successor managing partner. TOTAL $ 60,000,000 (1)(2) $ 7,602 (4) Table of Contents Unauthorized Acts of General Partners Could Be Binding Against the Partnership. Under Delaware law, the act of a general partner of a partnership apparently carrying on the business of the partnership binds the partnership, unless the general partner in fact has no authority to act for the partnership and the person with whom the partner is dealing has knowledge in good faith of the fact that such general partner has no such authority. While there is a risk that a general partner might bind a partnership by his acts, we believe that the managing partner will have such exclusive control over the conduct of the business of the partnerships that it is unlikely that a third party, in the absence of bad faith, would deal with a general partner in connection with a partnership s business. The participation by a general partner in the management and control of a partnership s business is expressly prohibited by the partnership agreement, and a violation of such prohibition would give rise to a cause of action by the partnership against such general partner. Nevertheless, there is always the possibility that a general partner could attempt to take unauthorized actions on behalf of a partnership, and if a court were to hold that such actions were binding against the partnership such unauthorized actions could be contrary to the best interests of that partnership and could adversely impact such partnership. General Risks Relating to Oil and Natural Gas Operations Loss of Investment Due to Speculative Nature of Oil and Gas Activities. Development of oil and gas properties is not an exact science and involves a high degree of risk which could result in a loss of a partner s investment or personal liability on the part of a general partner. Under the drilling program agreement, the activities of each partnership will focus upon the acquisition of oil and gas leases, the drilling of development wells, the development of prospects, and the production and operation of the resulting properties. In addition to development wells, at our discretion, up to 20% of a partnership s capital contributions may be expended in connection with activities relating to exploratory wells. All drilling activities involve a high degree of risk with exploratory wells presenting a higher degree of risk than development wells. We cannot assure that the objective formation(s) will be encountered or that any or sufficient oil or gas production will be obtained through drilling program activities, or if production is obtained, that such production will be sold at sufficient prices to enable an investor to recoup his investment in a partnership. During the drilling and completion of wells, a drilling program could encounter hazards such as unusual or unexpected formations, pressures or other conditions, blow-outs, fires, failure of equipment, downhole collapses, and other hazards, whether similar or dissimilar to those enumerated. Although a partnership will maintain the insurance coverage described under Proposed Activities Insurance, the drilling program may suffer losses due to hazards against which it cannot insure or against which it may elect not to insure. Such liabilities could result in personal liability for a general partner. The Partnerships and the General Partners Could be Liable for Environmental Hazards. There are numerous natural hazards involved in the drilling of wells, including unexpected or unusual formations, pressures, blowouts, and accidental leakage involving possible damage to property and third parties. Such hazards may cause substantial liabilities to third parties or governmental entities. Although we anticipate that customary insurance will be obtained, a partnership may be subject to liability for pollution and other damages due to hazards which cannot be insured against or will not be insured against due to prohibitive premium costs or for other reasons. Liabilities to third parties or governmental entities for pollution could reduce funds available for distributions and for drilling operations, result in the loss of partnership property, or result in the personal liability of the general partners if the liability exceeded insurance proceeds, a partnership s assets, and the managing partner s ability to indemnify such general partners. Return on Investment is Dependent on Future Prices, Supply and Demand for Oil and Gas. The revenues generated from the activities of each partnership and the return on the investments made by the partner s will be highly dependent upon the future prices and demand for oil and gas which can be volatile. The high and low average monthly posted price for crude oil received by the drilling program manager during 2003 was approximately $32.38 per barrel and $24.87 per barrel, respectively. The high and low monthly average price received by the drilling program manager for gas produced and sold during 2003 was approximately $8.34 per mmbtu and $4.18 per mmbtu, respectively. Factors which may affect prices and demand include the world-wide supply of oil and gas, the price of foreign imports, the levels of consumer demand, price and availability of alternative fuels and changes in existing and proposed federal regulation and taxation. Also, gas prices remain somewhat seasonal in nature and, for this reason, it is particularly difficult to estimate accurately future prices of gas, and any assumptions concerning future prices may prove to be incorrect. Table of Contents The United States average daily production of oil declined from 9.0 million barrels in 1985 to approximately 5.6 million barrels in 2003. The reduced production level is in part the result of decreased drilling activity in the United States which has only recently increased. Drilling activity is measured by the United States rig count which averaged 1,030 during 2003 compared to 830 for 2002. Another factor contributing to the reduction of United States oil production is the plugging and abandoning of wells which are uneconomical due to the significant decrease in the price of oil. The United States import levels for oil have increased significantly since 1985. In 1985, imports of foreign oil represented 27% of the United States demand. During the year 2003, imports averaged approximately 57% of the United States consumption. Government Regulation of a Partnership s Activities. The oil and gas business is subject to extensive governmental regulation under which, among other things, rates of production from oil and gas wells may be regulated. Governmental regulation also may affect the market for a partnership s production. Governmental regulations relating to environmental matters could also affect a partnership s operations. We cannot predict the nature and extent of various regulations, the nature of other political developments and their overall effect upon a partnership and the related drilling program. Tax Risks General. We have not requested, and we will not request, a ruling from the IRS regarding the tax consequences of investing in interests. Based on our representations and various assumptions and qualifications, our counsel has rendered an opinion that the material federal income tax benefits of an investment in interests, in the aggregate, more likely than not will be realized in substantial part by a partner who is an individual United States citizen and who acquires his interests for profit, provided that an investor who acquires limited partner interests either is not subject to the passive activity loss limitations of Section 469 of the Internal Revenue Code or has sufficient passive income against which he can deduct his share of any partnership deductions and losses. See Tax Aspects Opinion of Counsel. Partnership Classification for Tax Purposes; No IRS Ruling Sought. In order for income and deductions to be passed through to the general and limited partners, a partnership and the related drilling program must be classified as partnerships for federal income tax purposes. If a partnership or the related drilling program were taxed as a corporation for federal income tax purposes, the tax consequences resulting from the ownership of interests would be adversely affected and any anticipated federal income tax benefits would be reduced or eliminated. Based on our representations and various assumptions and qualifications, our counsel is of the opinion that, at the time of formation, each partnership and each related drilling program will be treated as a partnership for federal income tax purposes and that neither partnership will be treated as a corporation under the publicly traded partnership rules of Section 7704 of the Internal Revenue Code. We cannot assure, however, that future legislative, judicial or administrative action will not affect the classification of a partnership or a drilling program for federal income tax purposes. See Tax Aspects Partnership Taxation Partnership Classification. Allocations. The partnership agreement and the drilling program agreement contain provisions that allocate federal income tax consequences of a drilling program s activities among us and the general and limited partners. If such allocation provisions were not recognized for federal income tax purposes: a portion of the federal income tax deductions allocated to and claimed by the general and limited partners, including deductions for intangible drilling costs, could be reallocated to us. This reallocation could occur notwithstanding the fact that such general and limited partners had been charged with the expenditures giving rise to such deductions, and a portion of the taxable income allocated to us could be taxed to the general and limited partners. This allocation could occur notwithstanding the fact that the revenues giving rise to such taxable income had been credited to us. (1) This registration statement covers all limited partner interests that may be acquired by limited partners and all general partner interests that may be acquired by general partners, including additional limited partner interests into which general partner interests are convertible if the maximum aggregate subscriptions contemplated by this offering are obtained. No subscriber will be admitted as an investor partner in a partnership unless, at the end of the subscription period for interests in that partnership, subscription funds have been received and accepted by Mewbourne Development Corporation in an amount of $5,000,000 or more and Mewbourne Development Corporation determines, in its sole discretion, to proceed with the funding of that partnership. (2) The proposed maximum offering price is comprised of any combination of limited partner interests and general partner interests. (3) Pursuant to Rule 457(o), the registration fee is calculated on the basis of the maximum aggregate offering price of all securities listed. (4) Calculated pursuant to Rule 457(o) at the statutory rate of $126.70 per $1,000,000 of securities registered. A portion of this fee equal to $6,335.00 was previously paid in connection with the filing of the Registration Statement. Table of Contents Based on our representations and various assumptions and qualifications, our counsel is of the opinion that, except as noted below, the allocation of income, gains, losses, and deductions between us and the general and limited partners under the partnership agreement and between us and a partnership under the drilling program agreement will be recognized for federal income tax purposes. Our counsel s opinion is not binding on the IRS, however, and we cannot assure that the IRS will not challenge such allocations. Passive Activity Limitations. A limited partner s interest in a partnership will be treated as a passive activity, and any tax losses derived by a limited partner from a partnership will be allowable only to the extent of such limited partner s passive income. Disallowed passive losses in any year can be carried forward indefinitely and used to offset future passive income or can be deducted in full when the limited partner disposes of his entire interest in the partnership to an unrelated person in a fully taxable transaction. A taxpayer s interest in an oil or gas well drilled or operated under a working interest does not constitute a passive activity so long as the taxpayer owns the working interest directly or through an entity that does not limit the taxpayer s liability with respect to such drilling or operation. Based on our representations and various assumptions and qualifications, our counsel is of the opinion that the passive activity loss limitations of Section 469 of the Internal Revenue Code should not apply to general partners in a partnership, prior to any conversion of a general partner interest to a limited partner interest, to the extent that a partnership drills or operates wells under working interests. Consequently, each general partner should be entitled to deduct currently his share of intangible drilling and development costs and other deductible expenses allocable to the drilling or operation of wells under working interests without regard to the passive activity loss limitations. However, a general partner s ability to take deductions will be subject to basis and at risk limitations. The exception for working interests would not be applicable to any operations of a partnership other than the drilling and operation of wells under working interests. Therefore, if a partnership acquires an interest or participates in other activities, such activities will be treated as passive activities to the general partners and any losses derived by them with respect to such activities will be passive losses allowable only to the extent of their passive income. In addition, the exception for working interests will not apply from and after a conversion of a general partner interest to a limited partner interest. See Tax Aspects Special Features of Oil and Gas Taxation Passive Activity Loss Limitations. The treatment of a partnership as a publicly traded partnership for purposes of applying the passive activity loss limitations would even more severely restrict or eliminate a limited partner s ability to use any partnership losses to offset income from other sources. Based on our representations and various assumptions and qualifications, our counsel is of the opinion that neither partnership will be treated as a publicly traded partnership for purposes of the application of the passive activity loss limitations of Section 469 of the Internal Revenue Code. Our counsel s opinion is not binding on the IRS, however, and we cannot assure that the IRS will not assert that a partnership is a publicly traded partnership for purposes of applying the passive activity loss limitations. Tax Shelter Registration. Although an investment in a partnership may generate tax benefits, a partnership should not be considered a tax shelter as that term is commonly understood. Nevertheless, because of the expansive definition of the term tax shelter under applicable Treasury Regulations, we will apply to the IRS for a tax shelter registration number with respect to each partnership. We will furnish the registration number to each partner. Each partner must include the registration number on his individual tax return and must furnish the number and certain other information to any transferee of his interests. We will also maintain and make available to the IRS on request a list of the general and limited partners in each partnership. There may be a greater likelihood that partners in a partnership will be audited by the Internal Revenue Service because the partnership has been registered as a tax shelter. Current Tax Deductions. We will use reasonable efforts to expend or contract for the expenditure of the capital contributions of each partnership in the year such contributions are received. However, some of the expenses may be incurred prior to the actual drilling of the oil and gas wells. We cannot assure that any intangible drilling costs incurred in a year prior to the year of the actual drilling of the oil and gas wells will be deductible in the year incurred. In particular, a partnership might not expend or contract for the expenditure of a substantial portion of its capital contribution in the year in which general and limited partners are admitted to a partnership, in which event no substantial partnership tax deductions would be available in that year. We have sponsored a series of sixteen public limited partnerships similar to the partnerships being offered by this prospectus since December 1992 and, based on the historic results of these previous limited partnerships, we anticipate that no more than 65% of the total intangible The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine. Table of Contents drilling costs incurred by a partnership will be incurred and deductible by investors in that partnership in the year they are admitted as general or limited partners to such partnership. See Tax Aspects Anticipated Federal Income Tax Deductions. Organization and Offering Expenses, Sales Commissions and Due Diligence Fees. The organization and offering expenses, sales commissions and due diligence fees incurred in connection with the syndication and organization of each Partnership must be capitalized by the partnership. Syndication costs are not amortizable or otherwise deductible; however, the cost of organizing a partnership may, at the election of the partnership, be amortized for a period of not less than 60 months. The partnerships intend to elect to amortize their organization expenses over a 60 month period. The Treasury Regulations under Section 709 of the Internal Revenue Code provide that non-amortizable syndication costs include brokerage fees, registration fees, legal fees of the underwriter or placement agent and the issuer for securities advice and for advice pertaining to the adequacy of tax disclosures in the prospectus for securities law purposes, printing costs, and other items. It is possible that the IRS may attempt to recharacterize any costs treated as organization costs as non-amortizable syndication costs. Due to the factual nature of this issue, our counsel has not rendered an opinion with respect to the classification of such amounts. Conversion of General Partner Interests. We anticipate that the general partner interests in a partnership will be converted to limited partner interests following the completion of the partnership s drilling activities. We anticipate a partnership will complete drilling activities within approximately 8 to 15 months after the funding of the partnership. The tax consequences of such a conversion will depend upon the law in existence at the time of conversion and upon the results of that partnership s operations prior to that time. Such consequences may be adverse if the conversion is deemed a constructive termination of the partnership for federal income tax purposes or may be adverse under the passive loss rules as a result of a partner s particular circumstances. If we determine that the conversion of the general partner interests in a partnership to limited partner interests will have an adverse effect on the general partners or the partnership, due to adverse tax consequences or other reasons, we may elect not to convert those interests. Accordingly, we cannot assure that any general partner interests will be converted to limited partner interests or when any such conversion will occur. Tax Liabilities in Excess of Cash Distributions. A partner must report and pay income tax on his share of partnership income, regardless of whether such income is retained and used for debt service, working capital, or other reasons, any of which uses may not give rise to deductions for federal income tax purposes. The receipt of cash distributions by the general and limited partners may be delayed due to various factors, such as the use of revenues to finance permitted activities. To the extent that the general and limited partners are credited with net income from a partnership, an income tax liability will be incurred even though the general and limited partners may not yet have received any cash distributions from the partnership. The timing and amount of cash distributions will be determined by us in our complete discretion. If you invest in a partnership, you will be required to report your share of any partnership income on your federal, state and local tax returns and you will be responsible for the payment of taxes attributable to such income. In any year, your resulting tax liability may exceed the amount of cash distributed to you by a partnership. Risks of Borrowings. We are authorized to cause a partnership to obtain additional loans from banks or other financial sources, or from us or our affiliates, provided that the total amount of such loans may not in the aggregate exceed 20% of the capital contributions to the partnership. A partner s share of revenue applied to the repayment of loans, will be included in his taxable income. Although such income may be offset in part by deductions for depletion, cost recovery, depreciation, and intangible drilling costs, such loans could cause a partner to become subject to an income tax liability in excess of the amount of cash distributions he receives from the partnership. Percentage Depletion. Percentage depletion deductions are tax deductions calculated based upon a percentage of gross income from the property, but are limited to 100% of the total taxable income of the partner from the property for each taxable year, and are only available to limited partners qualifying as independent producers. Because depletion deductions must be computed separately by each partner and not at the partnership level, the availability of percentage depletion will depend in part upon a partner s individual circumstances. Therefore, each individual investor may not be eligible to claim percentage depletion deductions. See Tax Aspects Special Features of Oil and Gas Taxation Depletion. Table of Contents Farmouts and Backin Interests. If a partnership acquires working interests in oil and gas leases under the terms of a farmout agreement, a portion of the value of such working interests may have to be reported as taxable income. In addition, the ability of a partnership to deduct all intangible drilling costs paid by it with respect to oil and gas leases burdened by a backin working interest may be limited. A backin working interest is a right held by another party to become a working interest owner in the oil and gas lease on payout of the initial well on the oil and gas lease. See Tax Aspects Special Features of Oil and Gas Taxation Farmouts and Backin Interests. Recapture. Certain deductions for intangible drilling costs, depletion, and depreciation must be recaptured as ordinary income on disposition of property by a partnership or on disposition of interests by a partner. If a partnership disposes of property or a partner transfers an interest, the partnership, and the partners may recognize ordinary income (instead of capital gain) to the extent such deductions for intangible drilling costs, depletion and depreciation must be recaptured. See Tax Aspects Special Features of Oil and Gas Taxation Intangible Drilling and Development Costs, Depletion and Depreciation. Audits. The IRS may audit the tax returns of the partnership you invest in or its related drilling program, in which case an audit of your individual tax returns also may result. If such audits occur, tax adjustments may be made, including adjustments to items on your returns unrelated to the partnership. Furthermore, any settlement or judicial determination of the partnership s or the drilling program s income may be binding on you. This is the case even though you may not have participated directly in the settlement proceedings or litigation. See Tax Aspects Partnership Taxation Elections and Returns. Changes in Federal Income Tax Laws. Significant and fundamental changes in the nation s federal income tax laws have been made in recent years and additional changes are likely. Any such change may affect the partnerships and the general and limited partners. Moreover, judicial decisions, regulations or administrative pronouncements could unfavorably affect the tax consequences of an investment in a partnership. See Tax Aspects Other Tax Consequences Changes in Federal Income Tax Laws. Significance of Tax Aspects. These interests are being offered to parties who may avail themselves of the benefits presently allowed oil and gas activities under federal income tax laws. We cannot assure that: money invested in a partnership will be recovered, any capital contributions to a partnership will be expended and result in any tax deductions in the year such contributions are received by a partnership, federal income tax laws or the present interpretation of those laws will not be changed, or that any position taken by a partnership or a drilling program on its federal income tax returns will not be challenged by the IRS. In addition, federal income tax provisions may: limit deductions, trigger or increase a partner s liability for the alternative minimum tax on tax preference items, increase tax liability on the disposition of interests, or otherwise increase the federal income tax liability of a partner. Notwithstanding enactment of additional legislation or interpretations of legislation which might require different treatment from the discussion under Tax Aspects, a partnership is authorized to expend the proceeds from the sale of interests and to conduct its business and operations as described in this prospectus. Each item of partnership income, gain, loss, or deduction will be shared or borne financially in the manner specified in this prospectus. It is Table of Contents suggested that you obtain professional guidance from your tax advisor in evaluating the tax risks involved in investing in a partnership. Forward Looking Statements Forward-looking statements are inherently uncertain. Some statements under the captions Summary of Offering, Risk Factors, Application of Proceeds, and elsewhere in this prospectus are forward-looking statements. These forward-looking statements include, but are not limited to, statements about our industry, plans, objectives, expectations, intentions and assumptions and other statements contained in the prospectus that are not historical facts. When used in this prospectus, the words expect, anticipate, intend, plan, believe, seek, estimate and similar expressions are generally intended to identify forward-looking statements. Because these forward-looking statements involve risks and uncertainties, including those described in this Risk Factors section, actual results may differ materially from those expressed or implied by these forward-looking statements. We do not intend to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Market data and forecasts used in this prospectus have been obtained from independent industry sources. Although we believe these sources are reliable, we do not guarantee the accuracy and completeness of historical data obtained from these sources and we have not independently verified these data. Forecasts and other forward-looking information obtained from these sources are subject to the same qualifications and the additional uncertainties accompanying any estimates of future market size. APPLICATION OF PROCEEDS Interests in each partnership may be sold in an aggregate amount from $5,000,000 to $30,000,000. An amount equal to 8.5% of the proceeds realized from the sale of interests to investors will not be received by the partnership and will be deducted to pay sales commissions and due diligence fees to the soliciting dealers. Therefore, not all of such sales proceeds will be available to each partnership for the partnership s operations. The managing partner under the terms of each drilling program agreement will pay all organization and offering expenses. See Application of Proceeds and Participation in Costs and Revenues. A partnership may receive subscriptions by the investor partners ranging from a minimum of $5,000,000 to a maximum of $30,000,000. Regardless of the amount of capital contributions received, each partnership will have sufficient capital to engage in the proposed activities as set forth under Proposed Activities. However, to the extent that a partnership receives the minimum capital contributions from the investor partners, the ability of that partnership to participate in a large number of program wells and prospects will be reduced, and therefore, the partnership may have a concentration of

parsed_sections/risk_factors/2004/CIK0001282453_friendco_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

parsed_sections/risk_factors/2004/CIK0001282582_first_risk_factors.txt ADDED Viewed

The diff for this file is too large to render. See raw diff

parsed_sections/risk_factors/2004/CIK0001283827_fairpoint_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ Risk Factors An investment in the IDSs and the shares of our class A common stock and/or our senior subordinated notes involves a number of risks. In addition to the other information contained in this prospectus, prospective investors should give careful consideration to the following factors. Any of the following risks could materially and adversely affect our business, consolidated financial conditions, results of operations or liquidity. In such case, you may lose all or part of your original investment. The risks described below are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially and adversely affect our business operations. Risks Relating to the IDSs, the Shares of Class A Common Stock and the Senior Subordinated Notes You may not receive the level of dividends provided for in the dividend policies our board of directors expects to adopt upon the closing of this offering or any dividends at all. Our board of directors may, in its discretion, amend or repeal the dividend policies it expects to adopt upon the closing of this offering. Future dividends with respect to shares of our class A common stock, if any, will depend on, among other things, our cash flows, cash requirements, financial condition, contractual restrictions, business opportunities, provisions of applicable law and other factors that our board of directors may deem relevant. Our board of directors may decrease the level of dividends provided for in the dividend policies or entirely discontinue the payment of dividends. The indenture governing our senior subordinated notes and the new credit facility contain significant restrictions on our ability to make dividend payments, including, if we have been required to defer interest on the senior subordinated notes under the new credit facility or the indenture, restrictions on the payment of dividends until we have paid all deferred interest. We have reported a loss from continuing operations in each of our last five fiscal years. We cannot assure you that we will generate sufficient cash from continuing operations in the future, or have sufficient surplus or net profits, as the case may be, under Delaware law, to pay dividends on our class A common stock in accordance with the dividend policy established by our board of directors. In addition, the subordination of the dividends on our class B common stock will terminate upon our achieving certain specified financial performance targets (including Adjusted EBITDA of at least $143.5 million in any fiscal year). If we satisfy such targets and subordination terminates, there can be no assurance that we will generate cash flow in future periods at the same or higher levels than such performance targets, which could result in our inability to pay the target dividends on our class A common stock. If we were unable to generate sufficient cash to pay the target dividends on our class A common stock and class B common stock in any period after subordination has terminated, dividends on each class would be reduced by the same percentage until the aggregate dividends paid in such period equaled the cash available for distribution. If we were to use borrowings under our new credit facility's revolving facility to fund dividends, we would have less cash available for future dividends. For the year ended December 31, 2003, on a pro forma basis after giving effect to the transactions as if they had occurred on January 1, 2003, we would not have been able to pay dividends on both our outstanding shares of class A common stock and class B common stock in accordance with the dividend policies established by our board of directors. To expand our business through acquisitions and service our indebtedness, we will require a significant amount of cash. Our ability to generate cash depends on many factors beyond our control. We may not generate sufficient funds from operations to consummate acquisitions, pay interest on the senior subordinated notes, pay dividends with respect to shares of our class A common stock or repay or refinance our indebtedness at maturity or otherwise. Our ability to consummate acquisitions and to make payments on our indebtedness, including the senior subordinated notes, will depend on our ability to generate cash flow from operations in the future. This ability, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. Our ability to continue to expand through State of Incorporation/Formation acquisitions will, to a certain extent, be dependent upon our ability to borrow funds under our new credit facility and to obtain other third-party financing, including through the sale of IDSs or other securities. We cannot assure you, however, that our business will generate sufficient cash flow from operations or that future borrowings will be available to us in an amount sufficient to enable us to pay our indebtedness, including the senior subordinated notes, or to fund our other liquidity needs. A significant portion of our cash flow from operations will be dedicated to capital expenditures and debt service. In addition, we currently expect to distribute a significant portion of our cash earnings to our stockholders in the form of periodic dividends. As a result, we may not retain a sufficient amount of cash to finance growth opportunities, including acquisitions, or unanticipated capital expenditures or to fund our operations. In addition, if we reduce capital expenditures, the regulatory settlement payments we receive may decline. Borrowings under our new credit facility will bear interest at variable interest rates. In connection with this offering, we intend to purchase an interest rate cap which will fix the interest rates on such borrowings for a period of three years after the closing of this offering. After the interest rate cap expires, our annual debt service obligations under our new credit facility will vary from year to year unless we purchase a new interest rate cap or interest rate hedge. An increase of one percentage point in the annual interest rate applicable to borrowings under our new credit facility which would be outstanding on the closing date of this offering would result in an increase of approximately $4.0 million in our annual cash interest expense, and a corresponding decrease in cash available to pay dividends on our common stock. If we choose to purchase a new interest rate cap or interest rate hedge in the future, the amount of cash available to pay dividends on our common stock would decrease. However, to the extent interest rates increase in the future, we may not be able to purchase a new interest rate cap or interest rate hedge on acceptable terms. In addition, prior to the maturity of our new credit facility and the senior subordinated notes, we will not be required to make any payments of principal on our senior subordinated notes or our new credit facility, and it is not likely that we will generate sufficient funds from operations to repay the principal amount of our indebtedness at maturity. We therefore will need to refinance our debt. We may not be able to refinance our new credit facility, or if refinanced, the refinancing may occur on less favorable terms, which may materially adversely affect our ability to pay dividends. In particular, some of the terms of the senior subordinated notes that may be viewed as favorable to the senior lenders, such as our ability to defer interest, become less favorable in 2009, which may materially adversely affect our ability to refinance our new credit facility. If we were unable to refinance our new credit facility, our failure to repay all amounts due on the maturity date would cause a default under our new credit facility and the indenture governing the senior subordinated notes. We expect our required principal repayments under our new credit facility to be approximately $400.0 million at its maturity in 2009. Our interest expense may increase significantly if we refinance our new credit facility on terms that are less favorable to us than the terms of our new credit facility. We may also be forced to raise additional capital or sell assets and, if we are forced to pursue any of these options under distressed conditions, our business and the value of your investment in our IDSs or senior subordinated notes could be adversely affected. In addition, these alternatives may not be available to us when needed or on satisfactory terms due to prevailing market conditions, a decline in our business, legislative and regulatory factors or restrictions contained in our senior indebtedness. If we have insufficient cash flow to cover the expected dividend payments under the dividend policy to be adopted by our board of directors we would need to reduce or eliminate dividends or, to the extent permitted under our debt agreements, fund a portion of our dividends with additional borrowings. If we do not have sufficient cash to fund dividend payments, we would either reduce or eliminate dividends or, to the extent we were permitted to do so under the indenture governing the senior subordinated notes and the new credit facility, fund a portion of our dividends with borrowings or from CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 121,568 $ 97,369 $ 67,220 Adjustments to reconcile net income to net cash provided by operating activities: Provision for uncollectible accounts receivable, net of recoveries 30 0 (31 ) Depreciation and amortization 5,179 4,225 3,583 Changes in certain assets and liabilities: Accounts receivable 14 378 1,795 Unbilled revenue 259 420 (433 ) Prepaid expenses and other current assets (14 ) 104 (30 ) Deferred charges and other assets 1 3 2 Accounts payable and accrued liabilities (887 ) 901 (1,646 ) Advance billings 63 51 Primary Standard Industrial Classification Code Number other sources. If we were to use working capital or permanent borrowings under our new credit facility's revolving facility to fund dividends, we would have less cash available for future dividends and other purposes, which could negatively impact our financial condition, our results of operations and our ability to maintain or expand our business. In addition, we will need to generate additional cash flow in the future to fund dividend payments on 1,266,132 IDSs issued under our new retention and incentive plan to the extent such IDSs are distributed from the trust created in connection with our new retention and incentive plan. These IDSs are subject to certain vesting requirements and will begin to vest and be distributed from the trust as early as the second anniversary of the closing of this offering. See "Management New Retention and Incentive Plan." If we are unable to generate additional cash flow in the future to fund dividends on these IDSs, we may be forced to reduce or eliminate dividends or, to the extent we are permitted by the indenture governing our senior subordinated notes and the new credit facility, fund these additional dividends from borrowings. The indenture governing our senior subordinated notes and our new credit facility permit us to pay a significant portion of our free cash flow to stockholders in the form of dividends. Our senior subordinated notes and our new credit facility permit us to pay a significant portion of our cash flow to stockholders in the form of dividends and, following completion of this offering, we currently expect to pay periodic dividends per share on our class A common stock in the aggregate of $0.9450 per year. The indenture governing our senior subordinated notes and our new credit facility permit us to pay such dividends as long as we meet specified thresholds. See "Description of Senior Subordinated Notes Certain Covenants" and "Description of Certain Indebtedness New Credit Facility." Any amounts paid by us in the form of dividends will not be available in the future to satisfy our obligations under the senior subordinated notes. Standard & Poor's Corporation, or Standard & Poor's, has adopted a policy of downgrading certain issuers of IDSs or similar securities as a result of the high dividend payout provisions of such securities and the liberal restrictive payment covenants contained in the agreements governing the indebtedness of such issuers. Accordingly, Standard & Poor's has advised us that it has placed our "B+" corporate credit rating on creditwatch with negative implications and that it intends to downgrade our corporate credit rating from "B+" to "B" if we consummate this offering. Subject to certain limitations, we may defer interest on our senior subordinated notes at any time at our option. If we defer interest we will not be permitted to make any payment of dividends on our class A common stock so long as any deferred interest or interest on deferred interest remains outstanding. Prior to 2009, subject to certain limitations, we may, at our option, defer interest payments on the senior subordinated notes, and such deferred interest will not be required to be repaid until , 2009. Consequently, you may be owed a substantial amount of deferred interest that will not be due and payable until such date. In addition, after , 2009, subject to certain limitations, we may, at our option, defer interest on the senior subordinated notes, and such deferred interest will not be required to be repaid until , 2019. Consequently, you may be owed a substantial amount of deferred interest that will not be due and payable until such date. During any interest deferral period and so long as any deferred interest or interest on deferred interest remains outstanding, we will not be permitted to make any payment of dividends with respect to our class A common stock. Deferral of interest payments would have adverse tax consequences for you and may adversely affect the trading price of the IDSs or the separately held senior subordinated notes. If interest payments on the senior subordinated notes are deferred, you will be required to recognize interest income for U.S. federal income tax purposes under the rules related to original issue discount in respect of interest payments on the senior subordinated notes represented by the IDSs or IRS Employer Identification No. the separately-held senior subordinated notes, as the case may be, held by you before you receive any cash payment of this interest. In addition, you will not receive any cash in respect of accrued and unpaid interest if you sell the IDSs or the separately held senior subordinated notes, as the case may be, before the end of any deferral period or before the record date relating to interest payments that are to be paid. If interest is deferred, the IDSs or the separately-held senior subordinated notes may trade at a price that does not fully reflect the value of accrued but unpaid interest on the senior subordinated notes. In addition, the requirement that we defer payments of interest on the senior subordinated notes under certain circumstances may mean that the market price for the IDSs or the separately held senior subordinated notes may be more volatile than other securities that do not have this requirement. The U.S. federal income tax consequences of the purchase, ownership and disposition of IDSs are uncertain and our cash available for dividends and interest could be reduced if the senior subordinated notes were treated as equity for tax purposes. No statutory, judicial or administrative authority directly addresses the treatment of the IDSs or instruments similar to the IDSs for U.S. federal income tax purposes. As a result, the U.S. federal income tax consequences of the purchase, ownership and disposition of IDSs are uncertain. We have received an opinion from our counsel, Paul, Hastings, Janofsky & Walker LLP, that an IDS should be treated as representing both a share of class A common stock and senior subordinated notes, and that the senior subordinated notes should be treated as debt, for U.S. federal income tax purposes. However, the Internal Revenue Service or a court of law may take the position that the IDSs are a single equity investment for tax purposes, or that both the class A common stock and the senior subordinated notes represented by IDSs are equity, which, if such position were to prevail, would result in our inability to take tax deductions on the interest that accrues on such senior subordinated notes and could adversely affect the amount, timing and character of income, gain or loss in respect of your investment in IDSs. In addition, it would materially increase our taxable income and, thus, our U.S. federal and applicable state income tax liability. This could reduce our after-tax cash flow and materially and adversely impact our ability to make interest and dividend payments on the senior subordinated notes and the class A common stock represented by the IDSs. In such an event, the interest paid on the senior subordinated notes could be treated as a dividend (or a return of capital, depending on our current and accumulated earnings and profits). Foreign holders would be subject to withholding or estate taxes with regard to the senior subordinated notes in the same manner as they will be with regard to the class A common stock. Payments to foreign holders would not be grossed-up for any such taxes. For discussion of these tax-related risks, see "Certain United States Federal Tax Considerations Considerations for U.S. Holders Senior Subordinated Notes Characterization of Senior Subordinated Notes" and "Certain United States Federal Tax Considerations Considerations for Non-U.S. Holders Senior Subordinated Notes Characterization of Senior Subordinated Notes." If the Internal Revenue Service challenges the allocation of the purchase price of the IDSs, there may be adverse U.S. federal income tax consequences. The purchase price of each IDS must be allocated between the share of class A common stock and senior subordinated note represented by such IDS. The purchase price of each IDS will be so allocated on the basis of the fair market value of the class A common stock and senior subordinated note at the time of purchase. On the cover page of this prospectus, we set forth a range within which we expect the actual initial public offering price of an IDS to fall. The midpoint of that range is $16.00. Assuming that $16.00 is the actual initial public offering price of an IDS, we expect to report the initial fair market value of each share of class A common stock represented by an IDS as $11.50 and the initial fair market value of each senior subordinated note represented by an IDS as $4.50. By purchasing IDSs, you agree to be bound by this allocation. However, this allocation is not binding on the Internal Revenue Service and the Internal Revenue Service may challenge this allocation (including by asserting ST Enterprises, Ltd. Kansas 4813 480996774 MJD Ventures, Inc. Delaware 4813 481177379 MJD Services Corp. Delaware 4813 561922213 FairPoint Carrier Services, Inc. Delaware 4813 621729497 FairPoint Broadband, Inc. Delaware 4813 582256315 MJD Capital Corp. South Dakota 4813 562047160 The address, including zip code, of the principal offices of the additional registrants listed above is: c/o FairPoint Communications, Inc., 521 East Morehead Street, Suite 250, Charlotte, North Carolina 28202 and the telephone number, including area code, of such additional registrants at that address is (704) 344-8150. that the interest rate on the senior subordinated notes does not represent an arms-length rate). If the Internal Revenue Service successfully challenges our allocation of the purchase price of an IDS between the share of class A common stock and senior subordinated note represented by such IDS on the basis that the senior subordinated note actually has a fair market value that is less than that which we allocated to it, or that the stated interest rate is too low, it is possible that the senior subordinated notes will be treated as having been issued with original issue discount. If the senior subordinated notes were treated as having original issue discount, you generally would have to include original issue discount in income in advance of the receipt of cash attributable to that income. If the Internal Revenue Service successfully asserts that the senior subordinated note actually has a fair market value greater than that which we allocate to it, it is possible that the senior subordinated notes will be treated as having been issued with amortizable bond premium. If the senior subordinated notes were treated as having amortizable bond premium, you would be able to elect to amortize bond premium over the term of the senior subordinated notes. If we subsequently issue senior subordinated notes with significant original issue discount, we may not be able to deduct all of the interest on those senior subordinated notes. It is possible that senior subordinated notes we issue in a subsequent issuance (including senior subordinated notes represented by IDSs issued in exchange for our class B common stock) will be issued at a discount to their face value and, accordingly, may have "significant original issue discount" and thus be classified as "applicable high yield discount obligations." If any such senior subordinated notes were so treated, a portion of the original issue discount on such notes could be nondeductible by us and the remainder would be deductible only when paid. This treatment would have the effect of increasing our taxable income and, depending on the availability of net operating loss carryovers, may adversely affect our cash flow available for interest payments and distributions to our stockholders. Subsequent issuances of senior subordinated notes may cause you to recognize original issue discount and subject you to other adverse consequences. A subsequent issuance of senior subordinated notes issued with original issue discount (including senior subordinated notes represented by IDSs issued in exchange for our class B common stock) may adversely affect your tax treatment. As discussed in "Prospectus Summary The Offering What will happen if we issue additional IDSs or senior subordinated notes of the same series in the future?" and "Certain United States Federal Tax Considerations Considerations for U.S. Holders Senior Subordinated Notes Additional Issuances", upon a subsequent issuance of senior subordinated notes with original issue discount (and upon each subsequent issuance of senior subordinated notes thereafter), there will be an automatic exchange of a portion of the senior subordinated notes you held prior to such subsequent issuance for new senior subordinated notes that will be identical except that a different amount of original issue discount may exist between the different issues of senior subordinated notes. If you were already accruing original issue discount into your income with respect to the senior subordinated notes that you held prior to such subsequent issuance, you may have to increase the amount of accrual of such original issue discount due to the automatic exchange into the new senior subordinated notes that may have greater original issue discount than the senior subordinated notes you held prior to such automatic exchange. If you were not already accruing original issue discount, you may have to begin accruing original issue discount as a result of such automatic exchange. This could happen if the subsequent issuance of senior subordinated notes occurs pursuant to an IDS offering or a separate offering of senior subordinated notes. In addition, the Internal Revenue Service may assert that the exchange of a portion of your senior subordinated notes for the newly-issued senior subordinated notes is a taxable exchange for U.S. federal income tax purposes. This could apply whether the senior subordinated notes are held as part of an IDS or separately. EXPLANATORY NOTE This Registration Statement contains three forms of prospectus. One is to be used in connection with the initial public offering of IDSs (the "IDS Prospectus"), one is to be used in connection with the offer to exchange certain shares of the Company's existing class A common stock and class C common stock for IDSs (the "Common Stock Prospectus") and one is to be used in connection with the offer to exchange certain of the Company's existing stock options and restricted stock units for IDSs or awards of IDSs under the Company's new retention and incentive plan (the "Option Prospectus"), as applicable. The IDS Prospectus follows. The additional pages relating to the Common Stock Prospectus and the Option Prospectus follow the IDS Prospectus. The IDS Prospectus, the Common Stock Prospectus and the Option Prospectus are identical in all material respects with the exception that the additional pages relating to the Common Stock Prospectus will be used solely in connection with the offers to certain of the Company's common stockholders and the additional pages relating to the Option Prospectus will be used solely in connection with the offers to certain of the Company's optionholders and restricted stock unitholders. Upon a subsequent issuance of senior subordinated notes with original issue discount, we will report any original issue discount on the newly-issued senior subordinated notes ratably among all holders, and by purchasing IDSs, you agree to report original issue discount in a manner consistent with this approach. We cannot assure you that the Internal Revenue Service will not assert that any original issue discount should be reported only to the persons that initially acquired the newly-issued senior subordinated notes and their transferees and further claim that, unless a holder can establish that it is not a person that initially acquired the newly-issued senior subordinated notes or their transferee, all of the senior subordinated notes held by such holder have original issue discount. These potential actions by the Internal Revenue Service could create significant uncertainties in the pricing of IDSs and senior subordinated notes and could adversely affect the market for IDSs and senior subordinated notes. For a discussion of these tax related risks, see "Certain United States Federal Tax Considerations." We may have to establish a reserve for contingent tax liabilities in the future, which could adversely affect our ability to make dividend payments on our class A common stock. Even if the Internal Revenue Service does not challenge the tax treatment of the senior subordinated notes, it is possible that as a result of changes in circumstances or facts that come to light after this offering, we may in the future need to change our anticipated accounting treatment and establish a reserve for contingent tax liabilities associated with a disallowance of all or part of the interest deductions on the senior subordinated notes, although our present view is that no such reserve is necessary or appropriate. If we were required to maintain such a reserve, our ability to make dividend payments on our class A common stock could be materially impaired and the market for the IDSs or our class A common stock would be adversely affected. A subsequent issuance of senior subordinated notes may reduce the amount you can recover upon an acceleration of the payment of principal due on the senior subordinated notes or in the event of our bankruptcy. Under New York and federal bankruptcy law, holders of subsequently issued senior subordinated notes having original issue discount (including the recipients of such senior subordinated notes in the involuntary exchanges pursuant to the indenture governing the senior subordinated notes) may not be able to collect the portion of their principal face amount that represents unamortized original issue discount as of the acceleration or filing date, as the case may be, in the event of an acceleration of the senior subordinated notes or in the event of our bankruptcy prior to the maturity date of the senior subordinated notes. As a result, an automatic exchange that results in a holder receiving a senior subordinated note with original issue discount could have the effect of ultimately reducing the amount such holder can recover from us in the event of an acceleration or bankruptcy. If interest rates rise, the trading value of our IDSs or senior subordinated notes or class A common stock represented thereby may decline. We cannot predict the interest rate environment or guarantee that interest rates will not rise in the near future. Should interest rates rise or should the threat of rising interest rates develop, debt markets may be adversely affected. As a result, the trading value of our IDSs or senior subordinated notes or class A common stock represented thereby may decline. Our substantial indebtedness could restrict our ability to pay interest and principal on the senior subordinated notes and to pay dividends on our class A common stock and have an adverse impact on our financing options and liquidity position. As of June 30, 2004, after giving pro forma effect to the transactions, we would have had approximately $677.5 million of total consolidated indebtedness (excluding the senior subordinated notes represented by IDSs that will be held in a Company controlled trust, which IDSs are subject to The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is declared effective. This prospectus is not an offer to sell these securities and is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted. Subject to Completion, Dated November 9, 2004 40,937,500 Income Deposit Securities (IDSs) representing 40,937,500 Shares of Class A Common Stock and $184.2 million % Senior Subordinated Notes due 2019 and $30.0 million % Senior Subordinated Notes due 2019 This is an offering of 40,937,500 IDSs by us. The IDSs represent 40,937,500 shares of our class A common stock and $184.2 million aggregate principal amount of our % senior subordinated notes due 2019. Each IDS represents: one share of our class A common stock; and a % senior subordinated note with $4.50 principal amount. We are also offering separately (not in the form of IDSs) $30.0 million aggregate principal amount of our % senior subordinated notes due 2019. The senior subordinated notes will be fully and unconditionally guaranteed by our first tier subsidiaries on an unsecured senior subordinated basis. This is the initial public offering of our IDSs and senior subordinated notes. We anticipate that the public offering price per IDS will be between $15.00 and $17.00 and the public offering price of the senior subordinated notes sold separately (not in the form of IDSs) will be % of their stated principal amount. Holders of IDSs will have the right to separate IDSs into the shares of class A common stock and senior subordinated notes represented thereby at any time after the earlier of 45 days from the closing of this offering or the occurrence of a change of control. Similarly holders of our class A common stock and senior subordinated notes may, at any time, unless the IDSs have automatically separated, combine the applicable number of shares of class A common stock and principal amount of senior subordinated notes to form IDSs. Separation of IDSs will occur automatically upon a redemption or upon the maturity of the senior subordinated notes. Upon a subsequent issuance by us of IDSs or senior subordinated notes of the same series (not in the form of IDSs), a portion of your senior subordinated notes may be automatically exchanged for an identical principal amount of the senior subordinated notes issued in such subsequent issuance and, in such event, your IDSs or senior subordinated notes will be replaced with new IDSs or new senior subordinated notes, as the case may be. In addition to the senior subordinated notes offered hereby, the registration statement of which this prospectus is a part also registers the senior subordinated notes and new IDSs to be issued to you upon any such subsequent issuance. For more information regarding these automatic exchanges and the effect they may have on your investment, see "Risk Factors Subsequent issuances of senior subordinated notes may cause you to recognize original issue discount and subject you to other adverse consequences" on page 27, "Risk Factors A subsequent issuance of senior subordinated notes may reduce the amount you can recover upon an acceleration of the payment of principal due on the senior subordinated notes or in the event of our bankruptcy" on page 28, "Description of Senior Subordinated Notes Additional Notes" on page 148 and "Certain United States Federal Tax Considerations Considerations for U.S. Holders Senior Subordinated Notes Additional Issuances" on page 201. Our IDSs have been approved for listing on the New York Stock Exchange under the trading symbol "FRP", subject to official notice of issuance. We have applied to list the IDSs on the Toronto Stock Exchange under the Trading symbol "FPC.un" and we have applied to list our shares of class A common stock on the Toronto Stock Exchange under the trading symbol "FPC". Investing in the IDSs, our class A common stock and/or our senior subordinated notes involves risks. See "Risk Factors" beginning on page 23. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. Per IDS certain vesting requirements and are not considered outstanding under generally accepted accounting principles). Our substantial indebtedness could have important adverse consequences to the holders of the IDSs and to the holders of the senior subordinated notes, including: limiting our ability to pay interest and principal on the senior subordinated notes, pay dividends on our class A common stock or make payments in connection with our other obligations, including, under our new credit facility; limiting our ability in the future to obtain additional financing for working capital, capital expenditures or acquisitions; we may not be able to refinance our indebtedness on terms acceptable to us or at all; limiting our flexibility in planning for, or reacting to, changes in our business and the communications industry; a significant portion of our cash flow from operations is likely to be dedicated to the payment of the principal of and interest on our indebtedness, thereby reducing funds available for future operations, acquisitions, dividends on our class A common stock and/or capital expenditures; we may be more vulnerable to economic and industry downturns and conditions, including changes in interest rates; and placing us at a competitive disadvantage compared to those of our competitors that have less indebtedness. Despite our substantial indebtedness, we may still be able to incur substantially more debt, which could further exacerbate the risks described above. Subject to certain covenants, the indenture governing our senior subordinated notes and our new credit facility will permit us to incur additional indebtedness. The indenture governing the senior subordinated notes will also permit our subsidiaries to incur certain additional indebtedness. Any additional indebtedness that we may incur would exacerbate the risks described in the preceding risk factor. Our new credit facility will contain significant limitations on distributions and other payments. Our new credit facility contains significant restrictions on our ability to pay interest on the senior subordinated notes and dividends on the class A common stock based on meeting our total leverage ratio, interest coverage ratio and compliance with other conditions, as described in detail under "Description of Certain Indebtedness New Credit Facility." We may amend the terms of our new credit facility, or we may enter into new agreements that govern our senior indebtedness, and the amended terms or new agreements may further significantly affect our ability to pay interest to holders of our IDSs and our senior subordinated notes and dividends to holders of our IDSs. As a result of general economic conditions, conditions in the lending markets, the results of our business or for any other reason, we may elect or be required to amend or refinance our new credit facility, at or prior to maturity, or enter into additional agreements for senior indebtedness. Regardless of any protection you have in the indenture governing the senior subordinated notes, any such amendment, refinancing or additional agreement may contain covenants which could limit in a significant manner our ability to pay interest payments and dividends to you. Total The Company and the subsidiary guarantors are holding companies and rely on dividends, interest and other payments, advances and transfers of funds from the Company's non-guarantor operating subsidiaries and investments to meet their debt service and other obligations. The Company and the subsidiary guarantors are holding companies and conduct all of their operations through the Company's non-guarantor operating subsidiaries. The Company currently has no significant assets other than equity interests in its first tier subsidiaries, all of which will be subject to the first priority claims of the lenders under our new credit facility. The subsidiary guarantors have no significant assets other than direct or indirect equity interest in the Company's non-guarantor operating subsidiaries. As a result, the Company and the subsidiary guarantors will rely on dividends and other payments or distributions from the Company's non-guarantor operating subsidiaries to pay interest on the senior subordinated notes, pay dividends with respect to our class A common stock and to meet their debt service obligations generally. The ability of the Company's subsidiaries to pay dividends or make other payments or distributions to the Company and/or the subsidiary guarantors will depend on their respective operating results and may be restricted by, among other things: the laws of their jurisdiction of organization, which may limit the amount of funds available for the payment of dividends; agreements of those subsidiaries; the terms of our new credit facility; and the covenants of any future outstanding indebtedness we or our subsidiaries incur. The Company's non-guarantor operating subsidiaries have no obligation, contingent or otherwise, to pay amounts pursuant to the senior subordinated notes or to make funds available to the Company and/or the subsidiary guarantors, whether in the form of loans, dividends or other distributions. In addition, we have a number of minority investments and investments in joint ventures from which we receive distributions. For example, in 2003 we received $10.8 million of distributions from such investments, which represented a material portion of our cash flow. These investments represent passive ownership interests in partnerships. We do not control the timing or amount of distributions from such investments and we may not have access to the cash flows of these entities. Accordingly, our ability to pay interest on the senior subordinated notes, pay dividends with respect to shares of our class A common stock and to repay the senior subordinated notes at maturity or otherwise may be dependent upon factors beyond our control. Subject to limitations in the indenture governing the senior subordinated notes, the Company's subsidiaries may also enter into agreements that contain covenants prohibiting them from distributing or advancing funds or transferring assets to us under certain circumstances, including to fund interest payments in respect of the senior subordinated notes and pay dividends. We may not have sufficient funds to purchase the senior subordinated notes upon the exercise by holders of their rights upon a change of control. Under the indenture governing the senior subordinated notes, upon the occurrence of specified change of control events, we will be required to offer to repurchase all outstanding senior subordinated notes. However, we may not have sufficient funds at the time of the change of control event to make the required repurchase of the senior subordinated notes. In addition, a change of control would require the repayment of all borrowings under our new credit facility. Our failure to make or complete an offer to repurchase the senior subordinated notes would place us in default under the indenture governing the senior subordinated notes. We may therefore need to refinance our debt, raise additional capital or sell assets and, if we are forced to pursue any of these options under distressed conditions, our business and the value of your investment in our IDSs or senior subordinated notes could be adversely affected. In addition, these alternatives may not be available to us when needed or on satisfactory terms due to prevailing market conditions, a decline in our business, legislative and Per Senior Subordinated Note(1) regulatory factors or restrictions contained in our senior indebtedness. You should also be aware that a number of important corporate events, such as leveraged recapitalizations that would increase the level of our indebtedness, would not constitute a change of control under the indenture governing the senior subordinated notes. We are subject to covenants related to our outstanding debt that limit our business flexibility by imposing operating and financial restrictions on our operations. Covenants in the indenture governing the senior subordinated notes impose significant operating and financial restrictions on us. These restrictions prohibit or limit, among other things: the incurrence of additional indebtedness and the issuance by our restricted subsidiaries of preferred stock; the ability to incur layered indebtedness; the payment of dividends on, and purchase or redemption of, capital stock; a number of other restricted payments, including investments; the creation of liens; the ability of our restricted subsidiaries to guarantee our and their indebtedness; specified sales of assets; the creation of encumbrances or restrictions on the ability of restricted subsidiaries to distribute and advance funds or transfer assets to us or any other restricted subsidiary; specified transactions with affiliates; sale and leaseback transactions; our ability to designate restricted and unrestricted subsidiaries; our ability to enter lines of business outside the communications business; and certain consolidations, mergers and sales and transfers of assets by or involving us. The new credit facility includes most of these covenants and other and more restrictive covenants and prohibits us from prepaying our other indebtedness, including the senior subordinated notes, while indebtedness under the new credit facility is outstanding. The new credit facility also contains covenants which require us to maintain specified financial ratios and satisfy financial condition tests, including, without limitation, the following: a maximum total leverage ratio, a maximum senior secured leverage ratio and a minimum interest coverage ratio. If we are unable to comply with the covenants governing our outstanding debt, we could be in default under our indebtedness which could result in our inability to make payments under the senior subordinated notes or the acceleration of our indebtedness. Our ability to comply with the covenants, ratios or tests contained in the agreements governing our indebtedness may be affected by events beyond our control, including prevailing economic, financial and industry conditions. A breach of any of these covenants, ratios or tests could result in a default under the new credit facility and/or the indenture governing the senior subordinated notes. Certain events of default under the new credit facility would prohibit us from making payments on the senior subordinated notes, including payment of interest when due. In addition, upon the occurrence of an event of default under the new credit facility, the lenders could elect to declare all amounts outstanding under the new credit facility, together with accrued interest, to be immediately due and payable. If we were unable to repay those amounts, the lenders could proceed against the security granted to them to secure that indebtedness. An acceleration by the lenders of payments of indebtedness under the new credit facility may cause an acceleration of amounts outstanding under the senior subordinated notes which we may not be able to repay. If the lenders accelerate the payment of the indebtedness under Total the new credit facility, our assets may not be sufficient to repay in full the indebtedness under our new credit facility and our other indebtedness, including the senior subordinated notes. Because of the subordinated nature of the senior subordinated notes and the related note guarantees, holders of our senior subordinated notes may not be entitled to be paid in full, if at all, in the event of a payment default on our senior indebtedness or senior indebtedness of the subsidiary guarantors or a bankruptcy, liquidation or reorganization or similar proceeding. As a result of the subordinated nature of our senior subordinated notes and related note guarantees, in the event of a payment default on our senior indebtedness or senior indebtedness of the subsidiary guarantors or upon any distribution to our creditors or the creditors of the subsidiary guarantors in bankruptcy, liquidation or reorganization or similar proceeding relating to us or the subsidiary guarantors or our or their property, the holders of our senior indebtedness and senior indebtedness of the subsidiary guarantors will be entitled to be paid in full in cash before any payment may be made with respect to our senior subordinated notes or the note guarantees. In such case, we and the subsidiary guarantors may not have sufficient funds to pay all of our creditors, and holders of our senior subordinated notes may receive less, ratably, than the holders of senior indebtedness. The senior subordinated notes will be senior subordinated obligations of the Company ranking equal in right of payment to all of the Company's existing and future senior subordinated indebtedness, senior to all of the Company's future subordinated indebtedness and junior in right of payment to all of the Company's existing and future senior indebtedness. As of June 30, 2004, on a pro forma basis after giving effect to the transactions, the Company would have had $400.0 million of senior indebtedness outstanding and would have had the ability to borrow up to an additional $100.0 million under the new credit facility, all of which would have ranked senior in right of payment to our senior subordinated notes. If we are unable to repurchase all of the outstanding 91/2% notes, floating rate notes, 121/2% notes and 117/8% notes in the tender offers for such notes, the mix of our senior and senior subordinated indebtedness outstanding may change. See "Description of Certain Indebtedness." In addition, the subsidiary guarantors are guarantors under our new credit facility, so any claims of holders of the senior subordinated notes will be subordinated in right of payment to the satisfaction of the claims that the lenders may have under the guarantees granted pursuant to our new credit facility. Holders of our senior subordinated notes and the note guarantees will be structurally subordinated to the debt of our non-guarantor subsidiaries. The Company and the subsidiary guarantors are holding companies, which means that they conduct substantially all of their operations through subsidiaries. The Company's operating subsidiaries will not be guarantors of the senior subordinated notes. As a result, no payments are required to be made to the Company from the assets of these subsidiaries. Claims of holders of the notes and the note guarantees will be structurally subordinated to the indebtedness and other liabilities and commitments of the Company's non-guarantor subsidiaries, and claims by the Company and any subsidiary guarantor as an equity holder in such subsidiaries will be limited to the extent of their respective direct or indirect investment in such entities. The ability of creditors, including the holders of the senior subordinated notes, to participate in the assets of any of the Company's non-guarantor subsidiaries upon any bankruptcy, liquidation or reorganization or similar proceeding of any such entity will be subject to the prior claims of that entity's creditors, including trade creditors, and any prior or equal claim of any other equity holder. In addition, the ability of the Company's creditors, including the holders of senior subordinated notes, to participate in distributions of assets of the Company's non-guarantor subsidiaries will be limited to the extent that the outstanding shares of any of the Company's subsidiaries are either pledged to secure other creditors (including lenders under our new credit facility) or are not owned by the Company. Cash flows from financing activities of continuing operations: Proceeds from issuance of long-term debt 295,180 295,180 Repayment of long-term debt (278,452 ) (2,053 ) (974 ) (281,479 ) Repurchase of shares of common stock subject to put options (1,000 ) (1,000 ) Repurchase of redeemable preferred stock (8,645 ) (8,645 ) Loan origination costs (14,826 ) (14,826 ) Investment in subsidiaries /from parent 31,349 (31,349 ) Common Stock dividends paid 29,258 (29,258 ) Capital contributed from parent (1,570 ) 1,538 Public offering price(2) $ $ % $ Underwriting discount $ $ % $ Proceeds to FairPoint Communications, Inc. (before expenses) $ $ % $ In the event of the bankruptcy or insolvency of the Company or one or more of the subsidiary guarantors, the senior subordinated notes and the senior subordinated note guarantees could be adversely affected by principles of equitable subordination or recharacterization. In the event of the bankruptcy or insolvency of the Company or one or more of the subsidiary guarantors, a party in interest may seek to subordinate our debt, including the senior subordinated notes or the senior subordinated note guarantees, under principles of equitable subordination or to recharacterize the senior subordinated notes as equity. In the event a court exercised its equitable powers to subordinate the senior subordinated notes or the senior subordinated note guarantees, or recharacterize the senior subordinated notes as equity, you may not recover any amounts owed on the senior subordinated notes or the senior subordinated note guarantees and you may be required to return any payments made to you within six years before the bankruptcy on account of the senior subordinated notes or the senior subordinated note guarantees. In addition, should the court treat the senior subordinated notes or the senior subordinated note guarantees as equity either under principles of equitable subordination or recharacterization, you may not be able to enforce your rights under the senior subordinated notes or the senior subordinated note guarantees. If the note guarantees of the senior subordinated notes by the subsidiary guarantors are held to be invalid or unenforceable or are limited in accordance with their terms, the senior subordinated notes also would be structurally subordinated to the debt of the subsidiary guarantors. Under federal bankruptcy law and comparable provisions of state fraudulent transfer laws, a note guarantee could be voided, or claims in respect of a note guarantee could be subordinated to all other debt of a subsidiary guarantor, if, among other things, the subsidiary guarantor, at the time that it assumed the guarantee: issued the note guarantee to delay, hinder or defraud present or future creditors; or received less than reasonably equivalent value or fair consideration for issuing the note guarantee and, at the time it issued the note guarantee: was insolvent or rendered insolvent by reason of issuing the note guarantee and the application of the proceeds of the note guarantee; was engaged or about to engage in a business or a transaction for which the subsidiary guarantor's remaining assets available to carry on its business constituted unreasonably small capital; intended to incur, or believed that it would incur, debts beyond its ability to pay the debts as they mature; or was a defendant in an action for money damages, or had a judgment for money damages docketed against it if, in either case, after final judgment, the judgment is unsatisfied. In addition, any payment by a subsidiary guarantor under its note guarantee could be voided and required to be returned to the guarantor or to a fund for the benefit of the creditors of the subsidiary guarantor or the note guarantee could be subordinated to other debt of such subsidiary guarantor. Ownership change will limit our ability to use certain losses for U.S. federal income tax purposes and may increase our tax liability. The transactions will result in an "ownership change" within the meaning of the U.S. federal income tax laws addressing net operating loss carryforwards, alternative minimum tax credits and other similar tax attributes. As a result of such ownership change, there will be specific limitations on our ability to use our net operating loss carryforwards and other tax attributes from periods prior to the transactions. Although it is not expected that such limitations will materially affect our U.S. federal income tax liability in the near-term, it is possible in the future that such limitations could limit our ability to utilize such tax attributes and, therefore, result in an increase in our U.S. federal income tax (1)We are selling $30.0 million aggregate principal amount of senior subordinated notes separately (not in the form of IDSs) in this offering. (2)The public offering price in Canada for the IDSs is payable in Canadian dollars and is the approximate equivalent of the U.S. dollar public offering price based on the noon buying rate on the date of this prospectus as quoted by the Federal Reserve Bank of New York. We have granted the underwriters an option to purchase up to 3,275,000 additional IDSs at the public offering price, less the underwriting discount, within 30 days from the date of this prospectus, to cover over-allotments. This prospectus also relates to 2,242,862 IDSs representing 2,242,862 shares of our class A common stock and $10.1 million aggregate principal amount of our % senior subordinated notes due 2019 being issued to certain of our stockholders, optionholders, restricted stock unitholders and employees. See "The Transactions." The underwriters expect to deliver the IDSs and the senior subordinated notes sold separately to purchasers on or about , 2004. liability. Such an increase would reduce the funds available for the payment of dividends and might require us to reduce or eliminate the dividends on our class A common stock. Before this offering, there has not been a public market for our IDSs, class A common stock or senior subordinated notes. The price of the IDSs may fluctuate substantially, which could negatively affect holders of IDSs or holders of senior subordinated notes sold separately. None of the IDSs, class A common stock or senior subordinated notes has a public market history. In addition, there has not been an active market in the United States or in Canada for securities similar to the IDSs. We cannot assure you that an active trading market for the IDSs and the senior subordinated notes sold separately in this offering will develop in the future, which may cause the price of the IDSs and the senior subordinated notes sold separately in this offering to fluctuate substantially, and we currently do not expect that an active trading market for the shares of our class A common stock will develop until the senior subordinated notes are redeemed or mature. We do not intend to list our shares of class A common stock for separate trading on the New York Stock Exchange until the number of shares of our class A common stock held separately and not represented by IDSs is sufficient to satisfy applicable requirements for separate trading on the New York Stock Exchange. If the senior subordinated notes represented by your IDSs are redeemed or mature, your IDSs will automatically separate and you will then hold the shares of our class A common stock. We do not intend to list our senior subordinated notes on any securities exchange. Accordingly, we cannot assure you that there will be a market for the senior subordinated notes. The initial public offering price of the IDSs and the senior subordinated notes sold separately in this offering has been determined by negotiations among us, the existing equity investors and the representatives of the underwriters and may not be indicative of the market price of the IDSs and the senior subordinated notes sold separately in this offering after the offering. Factors such as announcements by us or others, developments affecting us, general interest rate levels and general market volatility could cause the market price of the IDSs and the senior subordinated notes sold separately in this offering to fluctuate significantly. The limited liquidity of the trading market for the senior subordinated notes sold separately (not in the form of IDSs) may adversely affect the trading price of the separate senior subordinated notes. We are separately selling $30.0 million aggregate principal amount of senior subordinated notes (not in the form of IDSs), representing approximately 10% of the total outstanding senior subordinated notes (assuming all of the shares of class B common stock are exchanged for IDSs). While the senior subordinated notes sold separately (not in the form of IDSs) are part of the same series of senior subordinated notes as, and identical to, the senior subordinated notes represented by the IDSs, at the time of the issuance of the separate senior subordinated notes, the senior subordinated notes represented by the IDSs will not be separable for at least 45 days and will not be separately tradeable until separated. As a result, the initial trading market for the senior subordinated notes sold separately (not in the form of IDSs) will be very limited. Even after holders of the IDSs are permitted to separate their IDSs, a sufficient number of holders of IDSs may not separate their IDSs into the shares of our class A common stock and senior subordinated notes represented thereby to create a sizable and more liquid trading market for the senior subordinated notes not represented by IDSs. Therefore, a liquid market for the senior subordinated notes may not develop, which may adversely affect the ability of the holders of the separate senior subordinated notes to sell any of their separate senior subordinated notes and the price at which these holders would be able to sell any of the senior subordinated notes sold separately (not in the form of IDSs). ASSETS CURRENT ASSETS: Accounts receivable, net of allowances of $20 and $1 in 2003 and 2002, respectively $ 73 $ 117 Unbilled revenue 866 1,125 Due from general partner 19,766 33,881 Prepaid expenses and other current assets 48 CIBC World Markets Deutsche Bank Securities UBS Investment Bank Future sales or the possibility of future sales of a substantial amount of IDSs, shares of our class A common stock or our senior subordinated notes may depress the price of the IDSs and the shares of our class A common stock and our senior subordinated notes. Future sales or the availability for sale of substantial amounts of IDSs or shares of our class A common stock or a significant principal amount of our senior subordinated notes in the public market could adversely affect the prevailing market price of the IDSs and the shares of our class A common stock and our senior subordinated notes and could impair our ability to raise capital through future sales of our securities. Upon consummation of this offering and assuming the exchange of all of our class B common stock for IDSs, we anticipate that our existing equity investors will own % of the outstanding shares of our class A common stock, or % if the underwriters exercise their over-allotment option in full. Sales of IDSs by our existing equity investors could cause a decline in the market price of the IDSs. Subject to certain limitations set forth under our indebtedness and our amended and restated by-laws, we may issue additional shares of our class A common stock and senior subordinated notes, which may be in the form of IDSs, or other securities as consideration for future acquisitions and investments. In the event that an acquisition or investment is significant, the number of shares of our class A common stock and the aggregate principal amount of senior subordinated notes, which may be in the form of IDSs, or the number or aggregate principal amount of other securities that we may issue may be significant. In addition, we may also grant registration rights covering those IDSs, shares of our class A common stock, senior subordinated notes or other securities in connection with any such acquisitions and investments. Our restated certificate of incorporation and amended and restated by-laws and several other factors could limit another party's ability to acquire us and deprive our investors of the opportunity to obtain a takeover premium for their securities. A number of provisions in our restated certificate of incorporation and amended and restated by-laws will make it difficult for another company to acquire us and for you to receive any related takeover premium for your securities. For example, our restated certificate of incorporation provides that certain provisions of our restated certificate of incorporation can only be amended by a vote of two-thirds or more in voting power of all the outstanding shares of capital stock and that stockholders generally may not act by written consent and only stockholders representing at least 50% in voting power may request that our board of directors call a special meeting. Our restated certificate of incorporation provides for a classified board of directors and authorizes the issuance of preferred stock without stockholder approval and upon such terms as the board of directors may determine. The rights of the holders of shares of our class A common stock will be subject to, and may be adversely affected by, the rights of holders of any class or series of preferred stock that may be issued in the future. We may, under certain circumstances, suspend your rights of stock ownership the exercise of which would result in any inconsistency with, or violation of, any applicable communications law. Our restated certificate of incorporation will provide that so long as we hold any authorization, license, permit, order, filing or consent from the Federal Communications Commission or any state regulatory commission having jurisdiction over us, we will have the right to request certain information from our stockholders. If any stockholder from whom such information is requested should fail to respond to such a request or we conclude that the ownership of, or the existence or exercise of any rights of stock ownership with respect to, shares of our capital stock by such stockholder, could result in any inconsistency with, or violation of, any applicable communications law, we may suspend those rights of stock ownership the existence or exercise of which would result in any inconsistency with, or violation of, any applicable communications law, and we may exercise any and all appropriate remedies, at law or in equity, in any court of competent jurisdiction, against any stockholder, with a view towards obtaining such information or preventing or curing any situation which would cause an inconsistency Banc of America Securities LLC Citigroup Credit Suisse First Boston RBC Capital Markets Wachovia Securities , 2004 with, or violation of, any provision of any applicable communications law. See "Description of Capital Stock Regulatory Ownership Provisions." Risks Related to our Business We provide services to our customers over access lines, and if we lose access lines, our business and results of operations may be adversely affected. Our business generates revenue by delivering voice and data services over access lines. We have experienced net voice access line loss of 0.5% for the period from December 31, 2000 through December 31, 2003 and 2.3% for the period from June 30, 2003 through June 30, 2004 due to challenging economic conditions and increased competition. We may continue to experience net access line loss in our markets. Our inability to retain access lines could adversely affect our business and results of operations. We are subject to competition that may adversely impact us. As an incumbent carrier, we historically have experienced little competition in our rural telephone company markets. Nevertheless, the market for telecommunications services is highly competitive. Regulation and technological innovation change quickly in the telecommunications industry, and changes in these factors historically have had, and may in the future have, a significant impact on competitive dynamics. In certain of our rural markets, we face competition from wireless telephone system operators, which may increase as wireless technology improves. We also face competition from cable television operators. In the future, we may face additional competition from new market entrants, such as providers of wireless broadband, voice over internet protocol, satellite telecommunications and electric utilities. The Internet services market is also highly competitive, and we expect that competition will intensify. Some of our competitors have brand recognition and financial, personnel, marketing and other resources that are significantly greater than ours. In addition, consolidation and strategic alliances within the communications industry or the development of new technologies could affect our competitive position. We cannot predict the number of competitors that will emerge, especially as a result of existing or new federal and state regulatory or legislative actions, but increased competition from existing and new entities could have a material adverse effect on our business. Competition may lead to loss of revenues and profitability as a result of numerous factors, including: loss of customers (in general, when we lose a customer for local service we also lose that customer for all related services); reduced usage of our network by our existing customers who may use alternative providers for long distance and data services; reductions in the prices for our services which may be necessary to meet competition; and/or increases in marketing expenditures and discount and promotional campaigns. In addition, our provision of long distance service is subject to a highly competitive market served by large nation-wide carriers that enjoy brand name recognition. We may not be able to successfully integrate new technologies, respond effectively to customer requirements or provide new services. The communications industry is subject to rapid and significant changes in technology, frequent new service introductions and evolving industry standards. We cannot predict the effect of these changes on our competitive position, profitability or industry. Technological developments may reduce the competitiveness of our networks and require unbudgeted upgrades or the procurement of additional products that could be expensive and time consuming. In addition, new products and services arising out of technological developments may reduce the attractiveness of our services. If we fail to adapt successfully to technological changes or obsolescence or fail to obtain access to important new [Map of United States indicating the locations of our operations and the names by which certain companies do business] technologies, we could lose customers and be limited in our ability to attract new customers and/or sell new services to our existing customers. An element of our business strategy is to deliver enhanced and ancillary services to customers. The successful delivery of new services is uncertain and dependent on many factors, and we may not generate anticipated revenues from such services. We rely on a limited number of key suppliers and vendors to operate our business. If these suppliers or vendors experience problems or favor our competitors, we could fail to obtain sufficient quantities of products and services we require to operate our business successfully. We depend on a limited number of suppliers and vendors for equipment and services relating to our network infrastructure. If these suppliers experience interruptions or other problems delivering these network components on a timely basis, subscriber growth and our operating results could suffer significantly. If proprietary technology of a supplier is an integral component of our network, we could be effectively locked into one of a few suppliers for key network components. As a result we have become reliant upon a limited number of network equipment manufacturers, including Nortel Networks Corporation and Siemens Information and Communication Networks, Inc. In addition, when our new billing platform is completed, we will rely on a single outsourced supplier to support our billing and related customer care services. In the event it becomes necessary to seek alternative suppliers and vendors, we may be unable to obtain satisfactory replacement suppliers or vendors on economically attractive terms, on a timely basis, or at all, which could increase costs and may cause disruptions in services. Our relationships with other telecommunications companies are material to our operations and their financial difficulties may adversely affect our business and results of operations. We originate and terminate calls for long distance carriers and other interexchange carriers over our network and for that service we receive payments for access charges. These payments represent a significant portion of our revenues. Should these carriers go bankrupt or experience substantial financial difficulties, our inability to then collect access charges from them could have a negative effect on our business and results of operations. We face risks associated with acquired businesses and potential acquisitions. We have grown rapidly by acquiring other businesses. Since 1993, we have acquired 30 rural telephone businesses and we continue to own and operate 26 such businesses. We expect that a portion of our future growth will result from additional acquisitions, some of which may be material. Growth through acquisitions entails numerous risks, including: strain on our financial, management and operational resources, including the distraction of our management team in identifying potential acquisition targets, conducting due diligence and negotiating acquisition agreements; difficulties in integrating the network, operations, personnel, products, technologies and financial, computer, payroll and other systems of acquired businesses; difficulties in enhancing our customer support resources to adequately service our existing customers and the customers of acquired businesses; the potential loss of key employees or customers of the acquired businesses; unanticipated liabilities or contingencies of acquired businesses; not achieving projected cost savings or cash flow from acquired businesses; fluctuations in our operating results caused by incurring considerable expenses to acquire businesses before receiving the anticipated revenues expected to result from the acquisitions; difficulties in finding suitable acquisition candidates; Investment tax credits 138 85 TABLE OF CONTENTS Page difficulties in making acquisitions based on attractive terms due to increased competitiveness; and difficulties in obtaining and maintaining any required regulatory authorizations in connection with acquisitions. We cannot assure you that we will be able to successfully complete the integration of the businesses that we have already acquired or successfully integrate any businesses that we might acquire in the future. If we fail to do so, or if we do so but at greater cost than we anticipated, or if our acquired businesses do not experience significant growth, there will be a risk that our business may be adversely affected. We may need additional capital to continue growing through acquisitions. We may need additional financing to continue growing through acquisitions. Such additional financing may be in the form of additional debt, which would increase our leverage. We may not be able to raise sufficient additional capital at all or on terms that we consider acceptable. In addition, sellers may not accept IDSs as acquisition currency to finance future acquisitions. Moreover, as a result of the restrictions in the indenture governing the senior subordinated notes and the restrictions in the other agreements governing our indebtedness, we may be prevented from issuing additional IDSs. If we are unable to issue additional IDSs, we may be forced to rely on equity-only securities as an additional source of capital. Although we are not contractually restricted from issuing certain equity-only securities, as a result of this offering, most of our equity holders will hold their investment in us in the form of IDSs, and consequently equity-only securities may be a comparatively less attractive investment. A system failure could cause delays or interruptions of service, which could cause us to lose customers. To be successful, we will need to continue to provide our customers reliable service over our network. Some of the risks to our network and infrastructure include: physical damage to access lines; power surges or outages; software defects; and disruptions beyond our control. Disruptions may cause interruptions in service or reduced capacity for customers, either of which could cause us to lose customers and incur expenses. We depend on third parties for our provision of long distance services. Our provision of long distance services is dependent on underlying agreements with other carriers that provide us with transport and termination services. These agreements are based, in part, on our estimate of future supply and demand and may contain minimum volume commitments. If we overestimate demand, we may be forced to pay for services we do not need. If we underestimate demand, we may need to acquire additional capacity on a short-term basis at unfavorable prices, assuming additional capacity is available. If additional capacity is not available, we will not be able to meet this demand. In addition, if we cannot meet any minimum volume commitments, we may be subject to underutilization charges, termination charges, or rate increases which may adversely affect our results of operations. We may face significant future liabilities or compliance costs in connection with environmental and worker health and safety matters. Our operations and properties are subject to federal, state and local laws and regulations relating to protection of the environment, natural resources, and worker health and safety, including laws and regulations governing the management, storage and disposal of hazardous substances, materials and wastes. Under certain environmental laws, we could be held liable, jointly and severally and without regard to fault, for the costs of investigating and remediating any contamination at owned or operated properties; or for contamination arising from the disposal by us or our predecessors of hazardous wastes at formerly-owned properties or at third-party waste disposal sites. In addition, we could be held responsible for third-party property or personal injury claims relating to any such contamination or relating to violations of environmental laws. Changes in existing laws or regulations or future acquisitions of businesses could require us to incur substantial costs in the future relating to such matters. Risks Related to our Regulatory Environment We are subject to significant regulations that could change in a manner adverse to us. We operate in a heavily regulated industry, and the majority of our revenues generally have been supported by regulations, including access revenue and Universal Service Fund support for the provision of telephone services in rural areas. Laws and regulations applicable to us and our competitors may be, and have been, challenged in the courts, and could be changed by Congress or regulators. In addition, any of the following have the potential to have a significant impact on us: Risk of loss or reduction of network access charge revenues. Almost 48% of our revenues come from network access charges, which are paid to us by intrastate and interstate long distance carriers for originating and terminating calls in the regions served. In recent years, several of these long distance carriers have declared bankruptcy. Future declarations of bankruptcy by a carrier that utilizes our access services could negatively impact our financial results. The amount of access charge revenues that we receive is based on rates set by federal and state regulatory bodies, and such rates could change. Further, from time to time federal and state regulatory bodies conduct rate cases and/or "earnings" reviews, which may result in rate changes. The Federal Communications Commission has reformed and continues to reform the federal access charge system. States often mirror these federal rules in establishing intrastate access charges. In October 2001, the Federal Communications Commission reformed the system to reduce interstate access charges and shift a portion of cost recovery, which historically have been based on minutes-of-use, to flat-rate, monthly per line charges on end-user customers rather than long distance carriers. As a result, the aggregate amount of access charges paid by long distance carriers to access providers, such as our rural local exchange carriers, has decreased and may continue to decrease. Although these changes were implemented on a revenue neutral basis (with commensurate increases in other charges and Universal Service Fund support), there is no assurance that future changes in access charge rates will be implemented on a revenue neutral basis. It is unknown at this time what additional changes, if any, the Federal Communications Commission may eventually adopt. Furthermore, to the extent our rural local exchange carriers become subject to competition, such access charges could be paid to competing communications providers rather than to us. Additionally, the intrastate access charges we receive may be reduced as a result of wireless competition. Regulatory developments of this type could adversely affect our business, revenue or profitability. Risk of loss or reduction of Universal Service Support. We receive Universal Service Fund revenues to support the high cost of our operations in rural markets. For the year ended December 31, 2003, approximately 8% of our revenues resulted from the high cost loop support we received from the Universal Service Fund and was based upon our average cost per loop compared to the national average cost per loop. For example, if the national average cost per loop increases and our operating costs (and average cost per loop) remain constant or decrease, the payments we receive from the Universal Service Fund would decline. Conversely, if the national average cost per loop decreases and our operating costs (and average cost per loop) remain constant or increase, the payments we receive from the Universal Service Fund would increase. Over the past year, the national average cost per loop in relation to our average cost per loop has increased and management believes the national average In making your investment decision, you should rely only on the information contained in this prospectus or to which we have referred you. We have not authorized anyone to provide you with information that is different. If anyone provided you with different or inconsistent information, you should not rely on it. This prospectus may only be used where it is legal to sell these securities. You should assume the information appearing in this prospectus is accurate only as of the date on the front cover of this prospectus. Our business, consolidated financial condition, results of operations, liquidity and prospects may have changed since that date. Neither the delivery of this prospectus nor any sale made hereunder shall under any circumstances imply that the information in this prospectus is correct as of any date subsequent to the date on the cover of this prospectus. cost per loop may continue to increase in relation to our average cost per loop and, as a result, the payments we receive from the Universal Service Fund could decline. This support fluctuates based upon the historical costs of our operating companies. In addition to the Universal Service Fund high cost loop support, we also receive Universal Service Fund support payments, which include local switching support, long term support, and interstate common line support that used to be included in our interstate access charge revenues (the Federal Communications Commission has recently merged long term support into interstate common line support). If our rural local exchange carriers were unable to receive support from the Universal Service Fund, or if such support was reduced, many of our rural local exchange carriers would be unable to operate as profitably as they have historically, in the absence of our implementation of increases in charges for other services. Moreover, if we raise prices for services to offset loss of Universal Service Fund payments, the increased pricing of our services may disadvantage us competitively in the marketplace, resulting in additional potential revenue loss. The Telecommunications Act of 1996, or the Telecommunications Act, provides that eligible telecommunications carriers, including competitors to rural local exchange carriers, may obtain the same per line support as the rural local exchange carriers receive if a state commission determines that granting such support to competitors would be in the public interest. In fact, wireless telecommunications providers in certain of our markets have obtained matching support payments from the Universal Service Fund, but that has not led to a loss of revenues for our rural local exchange carriers under existing regulations. Any shift in universal service regulation, however, could have an adverse effect on our business, revenue or profitability. During the last three years, pursuant to recommendations made by the Multi-Association Group and the Rural Task Force, the Federal Communications Commission has made certain modifications to the universal service support system that changed the sources of support and the method for determining the level of support. These changes have been revenue neutral to our operations. It is unclear whether the changes in methodology will continue to accurately reflect the costs incurred by our rural local exchange carriers, and whether it will provide for the same amount of universal service support that our rural local exchange carriers have received in the past. In addition, several parties have raised objections to the size of the universal service support fund and the types of services eligible for support. A number of issues regarding the source and amount of contributions to, and eligibility for payments from, the Universal Service Fund are pending and will likely be addressed by the Federal Communications Commission or Congress in the near future. The outcome of any regulatory proceedings or legislative changes could affect the amount of universal service support that we receive, and could have an adverse effect on our business, revenue or profitability. The Federal State Joint Board has recently issued recommendations for the resolution of portability of Universal Service Fund support. The Federal State Joint Board recommended that: a set of permissive federal guidelines be developed to ensure that the public interest is served before eligible telecommunications carriers are designated; support be limited to a single connection that provides access to the public telephone network; and the basis for providing support be considered and further clarified during the comprehensive review of the Universal Service Fund to be completed in 2006. The Federal Communications Commission statutorily must act on these recommendations by February 27, 2005. In addition, the Federal Communications Commission is considering resolution of the method by which contributions to the Universal Service Fund are determined. Risk of loss of statutory exemption from burdensome interconnection rules imposed on incumbent local exchange carriers. Our rural local exchange carriers are exempt from the Telecommunications Act's more burdensome requirements governing the rights of competitors to interconnect to incumbent local (unaudited) Net income (loss), as reported $ (211,600 ) 13,239 1,671 790 (8,701 ) Stock-based compensation expense included in reported net income (loss) 2,203 1,260 15 88 Stock-based compensation determined under fair value based method exchange carrier networks and to utilize discrete network elements of the incumbent's network at favorable rates. If state regulators decide that it is in the public's interest to impose these more burdensome interconnection requirements on us, we would be required to provide unbundled network elements to competitors. As a result, more competitors could enter our traditional telephone markets than are currently expected and we could incur additional administrative and regulatory expenses, and experience additional revenue losses. Risks posed by costs of regulatory compliance. Regulations create significant compliance costs for us. Our subsidiaries that provide intrastate services are generally subject to certification, tariff filing and other ongoing regulatory requirements by state regulators. Our interstate access services are provided in accordance with tariffs filed with the Federal Communications Commission. Challenges to our tariffs by regulators or third parties or delays in obtaining certifications and regulatory approvals could cause us to incur substantial legal and administrative expenses, and, if successful, such challenges could adversely affect the rates that we are able to charge our customers. Our business also may be impacted by legislation and regulation imposing new or greater obligations related to assisting law enforcement, bolstering homeland security, minimizing environmental impacts, or addressing other issues that impact our business. For example, existing provisions of the Communications Assistance for Law Enforcement Act and Federal Communications Commission regulations implementing the Communications Assistance for Law Enforcement Act require telecommunications carriers to ensure that their equipment, facilities, and services are able to facilitate authorized electronic surveillance. We cannot predict whether and when the Federal Communications Commission might modify its Communications Assistance for Law Enforcement Act rules or any other rules or what compliance with new rules might cost. Similarly, we cannot predict whether or when federal or state legislators or regulators might impose new security, environmental or other obligations on our business. For a more thorough discussion of the regulatory issues that may affect our business, see "Regulation." Regulatory changes in the telecommunications industry could adversely affect our business by facilitating greater competition against us, reducing potential revenues or raising our costs. The Telecommunications Act provides for significant changes and increased competition in the telecommunications industry, including the local telecommunications and long distance industries. This statute and the Federal Communications Commission's implementing regulations remain subject to judicial review and additional rulemakings of the Federal Communications Commission, thus making it difficult to predict what effect the legislation will have on us, including our operations and our revenues and expenses, and our competitors. Several regulatory and judicial proceedings have recently concluded, are underway or may soon be commenced, that address issues affecting our operations and those of our competitors. We cannot predict the outcome of these developments, nor can we assure that these changes will not have a material adverse effect on us or our industry. For a more thorough discussion of the regulatory issues that may affect our business, see "Regulation." The failure to obtain necessary regulatory approvals could impede the consummation of a potential acquisition. Our acquisitions likely will be subject to federal, state and local regulatory approvals. We cannot assure you that we will be able to obtain any necessary approvals, in which case a potential acquisition could be delayed or not consummated. For example, in June 2003, we executed an agreement and plan of merger with respect to the Berkshire acquisition and we have not yet received the regulatory approvals required to consummate that transaction.

parsed_sections/risk_factors/2004/CIK0001286686_collegiate_risk_factors.txt ADDED Viewed

	@@ -0,0 +1 @@

+ RISK FACTORS You should carefully consider the following risk factors and all other information contained in this prospectus before investing in shares of our common stock. Investing in our common stock involves a high degree of risk. If any of the following risks actually occur, our business, financial condition and results of operations could be materially and adversely affected. In that event, the trading price of our common stock could decline and you may lose part or all of your investment. Risks Related to Our Industry and Our Company Changes in federal laws and regulations relating to education loans, particularly legislation affecting federally guaranteed consolidation loans, could materially adversely affect our results of operations. The Higher Education Act of 1965 must be reauthorized by Congress every five years and the FFEL Program is periodically amended. The United States Congress is currently considering reauthorization of the Act, which is scheduled to expire in 2004. Changes in the Higher Education Act made in the two most recent reauthorizations have resulted in reductions in education loan yields paid to lenders, increased fees paid by lenders and a decreased level of federal guarantee. Federally guaranteed consolidation loans made up 94.9% of our loan originations for the year ended December 31, 2003 and 99.9% of our loan portfolio as of March 31, 2004, and efforts underway to pass legislation that affects federal consolidation loans would have a significant impact on us. Some of the key changes that may be considered in the reauthorization debate that could have a negative effect on our business include: Eliminating fixed-rate consolidation loans and requiring that all consolidation loans be made at a variable rate. If consolidation loans are required to be made at a variable rate rather than a fixed rate, as virtually all consolidation loans are currently made, it could reduce the amount of income we can earn on the loans we originate in the future and reduce the demand for consolidation loans. A bill recently introduced by the Chair of the House Committee on Education and the Workforce contains this provision. Permitting borrowers to refinance consolidation loans. If borrowers holding consolidation loans are permitted to refinance their consolidation loans under the FFEL Program, this would open the consolidation loans in our portfolio to refinancing. Any of these legislative changes, if enacted, could materially reduce our loan originations and earnings. Senator John Kerry, the presumptive Democratic candidate for president, has proposed as part of his presidential campaign, a requirement that lenders bid in an auction in order to offer FFELP loans, effectively replacing the current government guaranteed minimum interest rate. This proposal would also eliminate the Special Allowance Payments made by the federal government to lenders to provide them a guaranteed rate of return on FFELP loans made after enactment of such proposal. If the Kerry proposal is enacted, it could materially reduce our loan originations and earnings. In addition, legislation has been introduced proposing a number of initiatives aimed at supporting the William D. Ford Federal Direct Loan Program, which we refer to as the FDL Program or FDLP. Under the FDL Program, the U.S. Department of Education, or DOE, makes loans directly to student borrowers through the educational institutions they attend. If legislation promoting the FDL Program to the detriment of the FFEL Program were to be enacted, it could materially reduce our loan originations and earnings. Further amendments, the nature of which we cannot currently anticipate, could also hurt our business and our results of operations. Moreover, there can be no assurance that the provisions of the Higher Education Act will be reauthorized this year. While Congress has consistently extended the effective date of the Higher Education Act, it may elect not to reauthorize the DOE s ability to provide interest Proposed Maximum Title of Each Class Amount to be Proposed Maximum Aggregate Offering Amount of of Securities to be Registered Registered(1) Offering Price Per Unit Price(2) Registration Fee(3) Table of Contents subsidies and federal guarantees for student loans. Such a failure to reauthorize would reduce the number of federally guaranteed student loans available for us to originate in the future and could materially reduce our results of operations. Changes in the interpretations of the Higher Education Act issued by the U.S. Department of Education could negatively impact our loan originations. The U.S. Department of Education oversees and implements the Higher Education Act and periodically issues regulations and interpretations of that Act. Changes in such regulations and interpretations could negatively impact our business. Currently, if only one lender holds all of a student s FFELP loans, then another lender cannot consolidate the loans away from the current holder unless the current holder refuses to, or does not offer to, consolidate the loans for the borrower. We refer to this as the single holder rule. Historically, we did not believe the single holder rule limited the ability of a borrower to consolidate FFELP loans held by a single lender with FDLP loans. However, the U.S. Department of Education issued a letter on April 29, 2004 that limits the ability of borrowers having FFELP loans that are held by a single lender and FDLP loans to obtain a FFELP consolidation loan with any lender other than the lender holding all of the borrower s FFELP loans. This new ruling is scheduled to go into effect in September 2004. During the second half of 2003 and the first quarter of 2004, we marketed to borrowers who had FDLP loans and FFELP loans made by a single lender. In May 2004, as a result of this ruling, we reduced marketing to these types of borrowers and increased our marketing efforts to other types of borrowers. We estimate that our loan originations of this type peaked in the fourth quarter of 2003 at approximately $133 million and declined to approximately $94 million in the first quarter of 2004. Unless our new marketing campaigns are as successful as the prior ones, this new ruling could adversely affect the volume of our loan originations. In addition, until recently, we marketed and offered FFELP consolidation loans to borrowers seeking to refinance only their FDLP consolidation loans. However, in June 2004, the U.S. Department of Education s servicers for the FDL Program informed us and, we believe, other FFELP loan originators that FFELP loans which refinance only FDLP consolidation loans will no longer be permitted. We can provide no assurance that this position will not be officially endorsed by the U.S. Department of Education or that we will be able to originate these loans in the future. As a result, we have currently ceased marketing loans to these types of borrowers and are reallocating marketing resources to other types of borrowers. For 2002, 2003 and the first quarter of 2004, we estimate that approximately $0, $250 million and $140 million, respectively, of our loan originations were FFELP consolidation loans that refinanced only FDLP consolidation loans. Because this change is effective immediately, we expect that, in the short term, this change will adversely affect the volume of our loan originations. Furthermore, unless our new marketing campaigns are as successful as the prior ones, this new ruling could adversely affect the volume of our loan originations in the future. Significantly decreased demand for consolidation loans would materially reduce our revenue. A combination of increased consumer awareness, rising education debt volume and historically low interest rates available to borrowers in the last three years has increased the number of borrowers seeking to consolidate their variable-rate education loans into one loan. For the year ended December 31, 2003, 94.9% of our loan originations were consolidation loans. One of the advantages of consolidation loans is that borrowers are able to fix the interest rate on their variable rate student loans at the then existing rate. If rates rise, students may have less incentive to consolidate their loans at a fixed rate. Demand for consolidation loans could also decrease in the future as a result of a decrease in the pool of potential borrowers eligible to consolidate their loans. The DOE projects that FFELP consolidation loan volume will decrease from $35.3 billion in federal fiscal year 2003 to an estimated $25.9 billion in federal fiscal year 2004 and to $22.3 billion in federal fiscal year 2005. A significant portion of the borrowers eligible to consolidate their loans have loans held by one lender and, as a result of the single holder rule discussed in the prior risk factor, those loans are not available for consolidation by other lenders unless the original Common Stock, par value $.001 per share 10,781,250 shares $ 17.00 $ 183,281,250 $ 23,222.00 Table of Contents lender does not offer or refuses to consolidate those loans. Demand for consolidation loans could also decrease as a result of regulatory changes or if any of the legislative proposals described above are enacted. A significant decrease in demand for consolidation loans would have a material adverse effect upon our revenue, particularly our fees on loan sales. We must comply with governmental regulations relating to our FFELP loans and guaranty agency rules and our business and results of operations could be materially adversely affected if we fail to meet these requirements. Our principal business is comprised of originating, holding and servicing education loans made and guaranteed pursuant to the FFEL Program. Most significant aspects of our lines of business are governed by the Higher Education Act. We must also meet various requirements of the guaranty agencies, which are private not-for-profit organizations or state agencies that have entered into federal reinsurance contracts with the DOE, in order to maintain the federal guarantee on our FFELP loans. These requirements establish origination and servicing requirements and procedural guidelines and specify school and borrower eligibility criteria. The federal guarantee of FFELP loans is conditioned on compliance with origination, servicing and collection standards set by the DOE and guaranty agencies. FFELP loans that are not originated, disbursed or serviced in accordance with DOE regulations risk loss of their guarantee, in full or in part. Our failure to comply with the regulatory regimes described above may arise from: breaches of our internal control system, such as a failure to adjust manual or automated servicing functions following a change in regulatory requirements; unintentional employee errors, such as inputting erroneous data or failure to adhere to established company processes; technological defects, such as a malfunction in or destruction of our computer systems; fraud by third parties who refer loan applications to us or from whom we acquire originated loan applications; or fraud by our employees or other persons in activities such as origination or borrower payment processing. If we fail to comply with any of the above requirements, we could incur penalties or lose the federal guarantee on some or all of our FFELP loans. In addition, even if we comply with the above requirements, a failure to comply by third parties with whom we conduct business may be attributable to us and result in us incurring penalties or losing the federal guarantee on some or all of our FFELP loans. If we experience a high rate of servicing deficiencies, we could incur costs associated with remedial servicing, and, if we are unsuccessful in curing such deficiencies, the eventual losses on the loans that are not cured could be material. In addition, failure to comply with these laws and regulations could result in our liability to borrowers and potential class action suits. Our actual loss experience on denied guarantee claims historically has not been material to our operations, but the impact on us could become material if denied guarantee claims were to increase substantially in future periods. In 2002, we lost $32,000 and, in 2003, we lost $8,000 due to denied guarantee claims. We have only recently begun retaining a significant portion of the loans we originate in our portfolio and servicing loans and we cannot predict whether we will suffer losses as a result of the performance of our assets and operations over the long term. We were formed in June 1998. Prior to 2002, we did not retain in our portfolio a significant amount of the loans we originated. We retained approximately 50% and 21% of the FFELP loans we originated in 2003 and 2002, respectively. Although we believe that the retained loans are valuable assets, due to their long duration and high quality (due to the federal guarantee), we cannot assure you that over the long term our earnings from retaining loans in our portfolio will exceed the value of the income we would have Table of Contents received from selling those loans. The loans retained in our portfolio may be repaid prior to maturity which would reduce the amount of interest we earn and expose us to reinvestment risk. Moreover, the loans retained in our portfolio could perform poorly in the future and our allowance for loan losses could be insufficient, which could materially reduce our earnings and impair our ability to access the asset-backed securitization market in the future on favorable terms. In addition, we only began servicing loans in April 2003, following our acquisition of SunTech. Although SunTech has been in business for more than 15 years and has serviced a significant portion of the loans we have originated since our formation in 1998, we have operated as a vertically integrated company offering loan servicing for only one year. If SunTech does not perform at the level of its historical performance, our business and results of operations could be materially adversely affected. Our quarterly results of operations have varied significantly in the past and are expected to continue to do so, which may cause our stock price to fluctuate. Our quarterly results of operations have varied significantly in the past and are expected to continue to do so in the future. Over the past two fiscal years, our quarterly income (loss) before income tax provision (benefit) and accretion of dividends on preferred stock has ranged from a low of a $13.5 million loss in the second quarter of 2003 to a high of $18.2 million of income in the third quarter of 2002. In addition, over this period, our quarterly originations as a percentage of total annual originations have ranged from a low of 9.4% to a high of 36.4%. The market price of our common stock may decline significantly if our future quarterly results of operations fall below the expectations of securities or industry analysts or investors. Our quarterly results of operations in any period will be particularly affected by the amount and timing of our loan sales. Because we target a percentage of our loan originations to be retained on an annual, rather than quarterly basis, our quarterly results of operations will fluctuate. A number of additional factors, some of which are outside of our control, will also cause our quarterly results to fluctuate, including: an increase in loan consolidation in November and December, as a result of the expiration of the six-month grace period; the effects of the July 1 reset in borrower interest rates. We give borrowers who complete loan applications during the second quarter the option to fund their loans prior to July 1, when the old rate is effective, or after July 1, when the new rate is effective. Accordingly, if any year s borrower rate decreases over the prior year s borrower rate, the origination of a significant portion of the loan applications completed in the second quarter will be shifted to the third quarter; conversely, if any year s borrower rate increases from the prior year s borrower rate, a higher percentage of completed applications will be originated in the second quarter. seasonal patterns affecting private in-school loans, primarily an increase in private in-school loan originations in the third and fourth quarter as students obtain loans to pay tuition, and a decrease in private in-school loan activity in the second quarter; seasonal patterns affecting marketing expenses, as we generally market most heavily in the second and third quarters of the year in an effort to inform recent college graduates of their consolidation options and offer private in-school loans to students paying tuition; the impact of general economic conditions; changes in interest rates; and the introduction of new product offerings. (1) Includes 1,406,250 shares subject to the underwriters over-allotment option. (2) Estimated solely for the purpose of calculating the amount of the registration fee pursuant to Rule 457(a). (3) $21,856 of which was previously paid. The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, or until this registration statement shall become effective on such date as the Securities And Exchange Commission, acting pursuant to said Section 8(a), may determine. Table of Contents We forecast the volume and timing of our loan originations for our operational and financial planning on the basis of many factors and subjective judgments. Therefore, failure to generate originations according to our expectations in a particular quarter could materially decrease our net income for that quarter and the next, at a minimum. Do not call registries may limit our ability to market our products and services. Our direct marketing operations are subject to various federal and state do not call list requirements and may become subject to additional state do not call list requirements. The Federal Trade Commission has recently amended its rules to provide for a centralized national do not call registry. Under these new federal regulations, consumers may have their phone numbers added to the national do not call registry. Generally, we are prohibited from calling anyone on that registry unless we have an existing relationship with that person. We also are required to pay a fee to access the registry on a quarterly basis. Federal enforcement of the do not call provisions began in the fall of 2003, and the rule provides for fines of up to $11,000 per violation and other possible penalties. This rule may restrict our ability to market effectively our products and services to new customers. Furthermore, compliance with this new rule may prove difficult, and we may incur penalties for improperly conducting our marketing activities. In addition, failure to comply with the terms of this new rule could have a negative impact on our reputation. Nineteen states continue to maintain state do not call lists with varying penalties and fines for noncompliance. Compliance and coordination with these state lists and with federal lists may prove difficult and we may incur additional penalties for failure to comply with any of these lists, which could also have a negative impact on our business. We derive a significant portion of our fee income under a small number of forward purchase agreements, and if we are not able to retain these agreements, or if our counterparties under these agreements reduce their willingness to acquire originated loans from us, our net revenue would be reduced and our results of operations would suffer. We enter into forward purchase agreements with financial institutions who agree to purchase and require that we sell to them, a portion of the FFELP consolidation loan applications we originate. We also enter into forward purchase agreements with financial institutions who agree to purchase all of the private consolidation applications we originate. Under these agreements, which are typically one- to three-year agreements, we generate loan applications that are then forwarded to partnering financial institutions over pre-determined periods of time and for agreed upon fees. Three of our forward purchase agreements accounted for approximately 72.5% of our fee income and 60.5% of our net revenue in fiscal 2003. Revenue under our largest forward purchase agreement in fiscal 2003, with Citibank (New York State), represented 43.4% of our fee income and 36.2% of our net revenue for that year. We may not be able to retain or renew our key forward purchase agreements or our counterparties may decrease the level of originated loans they are willing to acquire from us. If a large forward purchase contract were cancelled or not renewed and not replaced, our fee income would significantly decline, and the loss of or a significant reduction of purchases by, one or more of our significant forward purchase agreement counterparties could materially adversely affect our business, operating results and financial condition. We can provide no assurance that we will be able to renew these agreements or that suitable replacements can be found at acceptable rates or on acceptable terms. Our inability to maintain relationships with our eligible lender or with lenders that originate our private loans could have material adverse effect on our ability to sustain or increase our business. When we originate FFELP loans on our own behalf or when we acquire FFELP loans from others, we engage U.S. Bank National Association as our eligible lender, as defined in the Higher Education Act, to act as our trustee to hold title to all such originated and acquired FFELP loans. This eligible lender trustee holds the legal title to our FFELP loans, and we hold 100% of the beneficial interests in Table of Contents those loans. If we are unable to renew our contract with U.S. Bank, or if the contract is terminated, we would have to find another institution to serve as our eligible lender. We can provide no assurance that we will be able to renew this contract or that a replacement eligible lender can be found at acceptable rates or on acceptable terms. Moreover, we have a relationship with a lender for whom we market and facilitate the origination of private in-school loans. The number of financial institutions willing to originate and finance these private in-school loans will be a significant factor in the growth of this market. As the market is less mature than that for federally guaranteed loans, there are, at present, fewer institutions originating and acquiring these loans. Accordingly, we can provide no assurance that we will be able to renew this contract or that suitable replacements could be found or that we will find additional lenders willing to finance the volume of private loans that we may seek to market or originate. Any failure to maintain or replace contractual relationships with these financial institutions or lenders could seriously impair our ability to originate loans and generate revenue from originated loans, and to sustain or increase our business. If we are unable to increase our private education loan originations and expand our channels of distribution as we plan, our business may not grow. Our strategy includes increasing the amount of private loans we originate or whose origination we facilitate, as well as expanding our channels of distribution. We have much more limited experience in these products and channels than in our business of marketing and originating FFELP consolidation loans through our DTC channel. In connection with these strategies, we have invested and will continue to invest resources in market research and technology and have hired and trained and will continue to hire and train additional personnel, when necessary. If these strategies are not successful, our earnings may be adversely affected. We may not be able to successfully make acquisitions or increase our profits from these acquisitions. We intend to pursue continued growth through acquisitions in the education finance industry. Such an acquisition strategy includes certain risks. For example: we may be unable to identify acquisition candidates, negotiate definitive agreements on acceptable terms or, as necessary, secure additional financing; we may encounter unforeseen expenses, difficulties, complications or delays in connection with the integration of acquired entities; we may fail to achieve acquisition synergies; our acquisition strategy, including the focus on the integration of operations of acquired entities, may divert management s attention from the day-to-day operation of our businesses; acquired loan or servicing portfolios may have unforeseen problems; or key personnel at acquired companies may leave employment. In addition, we may compete for certain acquisition targets with companies having greater financial resources than us. We cannot assure you that we will be able to successfully make future acquisitions or what effects those acquisitions may have on our financial condition and results of operations. Inherent in any future acquisition is the risk of transitioning company cultures and facilities. The failure to efficiently and effectively achieve such transitions could have a material adverse effect on our financial condition and results of operations, particularly during the period immediately following any acquisitions. Table of Contents We anticipate that we would finance potential acquisitions through cash provided by operating activities and/or borrowings, which would reduce our cash available for other purposes and our debt capacity, as well as our debt service requirements. We cannot assure you, however, that we would be able to obtain needed financing in the event acquisition opportunities are identified. We may also consider financing acquisitions by issuing additional shares of common stock to raise capital or as consideration, which would dilute your ownership. Our inability to maintain our relationships with third parties for whom we service loans could reduce our net income. Our inability to maintain strong relationships with servicing customers could result in loss of loan servicing volume generated by some of our loan servicing customers. We cannot assure you that these relationships will continue. As of December 31, 2003, approximately 69.4% of the loans we serviced were owned by third parties. Of these, a majority are governed by agreements with terms of three years or less. To the extent that our third-party servicing clients reduce the volume of education loans that we service on their behalf, our income would be reduced, and, to the extent the related costs could not be reduced correspondingly, our net income could be reduced. We might lose third-party servicing volume for a variety of reasons, including if our third-party servicing clients begin or increase internal servicing activities, shift volume to another service provider, exit the FFEL Program completely or if we fail to comply with applicable laws and regulations. The loss of such loan servicing volume could result in an adverse effect on our business. If loan applications for federally guaranteed loans that we sell are subsequently found to be ineligible for the federal guarantee, we may be required to purchase such loans and reimburse the DOE for certain fees. Pursuant to the terms of our forward purchase agreements, FFELP loans that we originate must comply with all applicable laws and regulations and must be eligible for federal guarantee. A portion of the loan applications that we originate and sell are generated by third-party marketing entities with whom we have marketing contracts. If any of the loan applications that we sell under our forward purchase agreements, whether marketed by us or by a third-party marketer, are deemed ineligible for federal guarantee by a guaranty agency, we may be obligated to purchase those loans. We would also be required to reimburse the DOE for fees associated with those loans. Prior to 2001, a portion of the loan applications we originated were generated by referrals from collection agencies, including approximately $3.9 million in principal amount of loans generated by referrals from the Valley Acceptance Corporation. Individuals associated with Valley Acceptance have been charged with improper processing of loans, including loan applications which we originated and sold to third parties. To date, a small number of claims relating to these loans have been returned to us by the applicable guarantee agency, and, accordingly, we may be required to purchase these loans and reimburse the DOE for the associated fees. If any loan applications which we originated are found to be ineligible for federal guarantee after they are funded, including loans referred by other third-party marketers, we may be required to purchase additional loans in the future and reimburse the DOE for the associated fees which could have an adverse effect on our results of operations. We could experience cash flow problems if a guaranty agency defaults on its guarantee obligation. A deterioration in the financial status of guaranty agencies, which are private not-for-profit organizations or state agencies, or in their ability to honor guarantee claims on defaulted student loans could result in a failure of these guaranty agencies to make their guarantee payments in a timely manner, if at all. If the DOE has determined that a guaranty agency is unable to meet its guarantee obligations, we may submit claims directly to the DOE, and the DOE would be required to pay the full guarantee claim. In such event, payment of the guarantee claims may not be made in a timely manner, which could adversely affect our liquidity. Table of Contents The information in this preliminary prospectus is not complete and may be changed. The securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any state where the offer or sale is not permitted. Subject to Completion. Preliminary Prospectus dated July 13, 2004 PROSPECTUS 9,375,000 Shares Common Stock This is an initial public offering of shares of common stock of Collegiate Funding Services, Inc. All of the shares of common stock are being sold by us. The Lightyear Fund, L.P. and its affiliates and other investors will receive approximately $93.4 million of the net proceeds of this offering as described in this prospectus. We are a vertically integrated education finance company that markets, originates, finances and services education loans. We market education loans primarily through direct-to-consumer programs, which involve marketing campaigns where we acquire customers through direct contact with us, including targeted direct mail, telemarketing and the Internet. As described in this prospectus, our net revenue was $118.2 million for 2003 and $34.6 million for the first quarter of 2004, which was primarily generated through the origination and financing of federally guaranteed consolidation education loans. We had a net loss of $7.5 million in 2003 and net income of $1.2 million for the first quarter of 2004. Prior to this offering, there has been no public market for the common stock. We currently estimate that the initial public offering price per share will be between $15.00 and $17.00. We have applied for quotation of our common stock on the Nasdaq National Market under the symbol CFSI . See Risk Factors beginning on page 8 to read about factors you should consider before buying shares of the common stock. Per Share Total Table of Contents Fluctuations in interest rates may materially and adversely affect our net income. Because we expect to generate a significant portion of our earnings from the difference, or spread, between the yield we receive on our portfolio of loans and the cost of financing these loans, changes in interest rates could have a material effect on our results of operations. Substantially all the loans in our portfolio are FFELP consolidation loans which bear interest at a fixed rate, however, the yield we receive is the higher of the fixed rate or a variable rate determined under the FFEL Program. For consolidation loans in our portfolio, the FFELP-determined variable rate is 2.64% over the 91-day financial commercial paper rate. Substantially all interest costs on our debt obligations are determined based upon LIBOR, commercial paper or the result of auctions. Using the portfolio as of December 31, 2003 and assuming normal portfolio payment patterns for the following 12-month period, an increase in interest rates of 200 basis points would decrease our net interest income for that period by approximately $20.3 million and an increase in interest rates of 100 basis points would decrease our net interest income for that period by approximately $13.5 million, while a corresponding decrease in these interest rates of 100 basis points would increase our net interest income for that period by approximately $21.8 million. Changes in interest rates, the composition of our loan portfolio and derivative instruments will impact the effect of interest rates on our earnings, and we cannot predict any such impact with any level of certainty. See Management s Discussion and Analysis of Financial Condition and Results of Operations Interest Rate Risk. The effect of our borrower benefit programs may adversely affect our net interest income. Our borrower benefit programs, which reduce the interest rates borrowers pay on their loans, could significantly reduce our net interest income. We offer borrower benefits as incentives to attract new borrowers and to improve our borrowers payment behavior. One incentive program reduces a borrower s interest rate by 0.25% per annum for so long as the borrower makes monthly payments through automatic deductions from his or her checking or savings account. Approximately 30% of our borrowers currently participate in this program. In addition, we offer borrowers an on-time incentive program that reduces their interest rates by 1.00% per annum after they have made their initial 36 payments on time and for so long as they continue to make subsequent payments on time. Although the on-time program has not been in place for sufficient time to have had any impact on our net interest income, our borrower benefits will in the future reduce the yield on our loan portfolio and reduce our net interest income. Our derivative instruments may not be successful in managing our interest rate risk and failure of counterparties to perform under certain derivative instruments could harm our business. When we utilize derivative instruments, we utilize them to manage our interest rate sensitivity. Although we do not use derivative instruments for speculative purposes, our derivative instruments do not meet the criteria set forth in Statement of Financial Accounting Standards, or SFAS, No. 133, Accounting for Derivatives Instruments and Hedging Activities, which allow offset of the changes in the fair value of the derivative instrument against the effects of the changes in the hedged item in the statement of income. Therefore, we only mark-to-market the derivative instruments with changes reflected in the income statement. The derivative instruments we use are typically in the form of interest rate swaps and interest rate caps, which have a duration of between twelve and twenty four months. Our interest rate hedging strategy is designed to address fluctuations in the short term, rather than the long term. Developing an effective strategy for dealing with movements in interest rates is complex, and no strategy can completely insulate us from risks associated with such fluctuations. In addition, a counterparty to a derivative instrument could default on its obligation, thereby exposing us to credit risk. Further, we may have to repay certain costs, such as transaction fees or brokerage costs, if a derivative instrument is terminated by us. As a result, we cannot assure you that our economic hedging activities will not have an adverse impact on our results of operations or financial condition. Table of Contents If we fail to renew our warehouse facility and revolving line of credit, our liquidity and results of operations could be adversely affected. Our primary funding needs are those required to finance our loan portfolio and satisfy our cash requirements for acquisitions, operating expenses and technological development. We rely upon a conduit warehouse facility to support our funding needs on a short-term basis. The term of the facility is one year, and it is renewable at the option of the lender and may be terminated at any time for cause. Currently, the aggregate short-term availability under our warehouse facility is $500 million. There can be no assurance that we will be able to maintain such conduit facility, increase the availability under such facility or find alternative funding, if necessary. Our revolving line of credit may be terminated at any time upon the occurrence of an event of default. Unavailability of warehouse or revolving financing sources may subject us to the risk that we may be unable to meet our financial commitments to borrowers and creditors when due, unless we find alternative funding mechanisms. If the availability under our warehouse facility were to decrease or terminate, our ability to retain loans could be adversely affected, which could adversely affect our results of operation on a short- and/ or long-term basis. If we are unable to access the asset-backed securitization market, which we rely on for substantially all our long-term funding of loan originations, our liquidity and results of operations could be adversely affected. We have begun to rely upon, and expect to rely increasingly upon, asset-backed securitizations as our most significant source of long-term funding for our loan portfolio. We have issued approximately $4.0 billion in asset-backed notes since 2001. Our access to the asset-backed securitization market is subject to conditions in the asset-backed securitization market over which we have no control. If the loans in our securitizations perform poorly, our ability to access the asset-backed securitization market may be impaired or the terms of future securitization may be more costly. If our access to the asset-backed securitization market were to decrease, we would have to find other methods to finance our loan originations on a long-term basis or be required to sell a larger portion of our originated loan applications either of which option, if available, may be less favorable than the asset-backed securitization market has been historically. In such event, our liquidity and results of operations could be adversely affected on a short- and/or long-term basis. Our right to receive cash in excess of the principal balance of the loans funded from our securitizations is limited by their terms and performance. As part of our securitization transactions since 2002, we borrowed funds in excess of the principal balance of the loans included in the applicable securitization transactions. A portion of these additional funds was used to repay other indebtedness and to fund our operations. We are also entitled to receive excess spread from securitizations in the future, generally after the principal balance of the loans and restricted cash held in the securitizations equals the outstanding indebtedness. We currently expect to receive excess spread from our November 2001, February 2003 and November 2003 issuances in September 2006, October 2005 and April 2008, respectively. However, our rights to cash flows from securitized loans are subordinate to noteholder interests, and these loans may fail to generate any cash flows beyond what is due to pay noteholders. Moreover, the cash generated from these loans may be restricted by these securitization vehicles for certain periods. Accordingly, adverse developments in the performance of our current and future securitizations could adversely affect our liquidity and cash flows. Higher rates of prepayments of student loans could reduce our profits. Pursuant to the Higher Education Act, borrowers may prepay loans made under the FFEL Program at any time. Prepayments may result from consolidating student loans, which has historically tended to occur more frequently in low interest rate environments, from borrower defaults, which will result in the receipt of a guarantee payment and from voluntary full or partial prepayments, among other things. The Initial public offering price $ $ Underwriting discount $ $ Proceeds, before expenses, to Collegiate Funding Services, Inc. $ $ To the extent that the underwriters sell more than 9,375,000 shares of common stock, the underwriters have the option to purchase up to an additional 1,406,250 shares from us at the initial public offering price less the underwriting discount. Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense. The shares will be ready for delivery on or about July , 2004. Table of Contents rate of voluntary prepayments of student loans may be influenced by a variety of economic, social and other factors affecting borrowers, including interest rates, the availability of alternative financing and legislative changes. Any legislation that permits borrowers to refinance existing consolidation loans at possibly lower interest rates could significantly increase the rate of prepayments on our student loans. Higher loan prepayments reduce the amount of cash generated in our securitizations, which, as described above, would adversely affect the amount of excess cash we receive from securitizations. In addition, loan prepayments generally result in a reduction in aggregate net interest income over the life of the loan. If auctions for our auction-rate asset-backed notes are not successful, our cost of funding will increase and future securitizations may become more costly. The interest rates on certain of our asset-backed securities are set and periodically reset via a dutch auction utilizing remarketing agents for varying intervals ranging from seven to 91 days. Of our $3.9 billion of asset-backed notes outstanding at April 30, 2004, 54% bear interest at rates based on auction rates. If there are insufficient potential bid orders in the auctions to purchase all of the notes offered for sale or being repriced, we could be subject to interest costs substantially above the anticipated and historical rates paid on these types of securities. A failed auction or remarketing could also reduce the investor base of our future securitizations and other financing and debt instruments. Future losses due to defaults on loans held by us present credit risk which could adversely affect our earnings. As of March 31, 2004, 100% our loan portfolio was comprised of FFELP loans. These loans benefit from a federal guarantee of 98% of their principal balance and accrued interest. We bear full risk of losses experienced with respect to the 2% non-guaranteed portion of the loans. The performance of the FFELP loans in our portfolio is affected by the economy and other factors outside of our control, and a prolonged economic downturn may have an adverse effect on the credit performance of these loans. While we provide allowances estimated to cover losses that may be experienced in our loans that are federally guaranteed under the FFEL Program, there can be no assurance that such allowances will be sufficient to cover actual losses in the future, particularly since we do not have a long history of holding these loans. Increases in losses in excess of our allowance could adversely affect our results of operations in the future. Access to alternative means of financing the costs of education may reduce demand for government guaranteed and private education loans. The demand for government guaranteed and private education loans could weaken if borrowers use other sources of funds to finance their post-secondary education. These sources include, among others: home equity loans or lines of credit, under which families borrow money based on the value of their real estate; Federal Direct Loan Program loans, if the DOE or schools increase the education loans available through the FDL Program; pre-paid tuition plans, which allow students to pay tuition at today s rates to cover tuition costs in the future; 529 plans, which are state-sponsored investment plans that allow a family to save funds for education expenses; and education IRAs, now known as Coverdell Education Savings Accounts, under which a holder can make annual contributions for education savings. JPMorgan Merrill Lynch Co. Table of Contents If demand for government guaranteed or private education loans weakens, we would experience reduced demand for our products and services. Competition from other originators, lenders and servicers and competition created by the Federal Direct Loan Program may materially adversely impact our business. We face significant competition from SLM Corporation, the parent company of Sallie Mae. SLM Corporation originated $15.2 billion of education loans through its preferred channel in 2003, services nearly half of all outstanding FFELP loans and is the largest holder of education loans, with a managed portfolio of approximately $92 billion as of March 31, 2004. We also face intense competition from other education-related entities, such as Education Lending Group and College Loan Corporation. As we seek to further expand our business, we will face numerous other competitors, many of which will be well established in the markets we seek to penetrate. Some of our current and potential competitors are much larger than we are, have better name recognition than we do and have greater financial and other resources than we do. Several of these competitors have large market capitalizations or cash reserves and are better positioned to acquire companies or portfolios in order to gain market share than we are. Consequently, such competitors may have more flexibility to address the risks inherent in the education finance business. Finally, some of our competitors are tax-exempt organizations that do not pay federal or state income taxes. As a result of their tax-exempt status, these organizations may have access to a lower cost of funding their education loans than we do. These factors could give our competitors significant advantages. In 1992, Congress created the William D. Ford Federal Direct Loan Program, which we refer to as the FDL Program or the FDLP. Under the FDL Program, the DOE makes loans directly to student borrowers through the educational institutions they attend. FDL loans are available to students only if the institution they attend participates in the FDL Program. The volume of student loans made under the FFEL Program and available for us to originate may be reduced to the extent loans are made to students under the FDL Program. Failures in our information technology system could materially disrupt our business. Our servicing and operating processes are highly dependent upon our information technology system infrastructure, and we face the risk of business disruption if failures in our information systems occur, which could have a material impact upon our business and operations. We depend heavily on our own computer-based data processing systems in servicing both our own loans and those of third-party servicing customers. Problems or errors may occur in the future in connection with the conversion of newly originated and acquired loans to our platform. If servicing errors do occur, they may result in a loss of the federal guarantee on the FFELP loans that we service or in a failure to collect amounts due on the student loans that we service. A major physical disaster or other calamity that causes significant damage to our information systems could adversely affect our business. Additionally, loss of our information systems for a sustained period of time could have a negative impact on our performance and ultimately on our cash flow in the event we were unable to process borrower payments. If we fail to comply with governmental regulations relating to our private loan business, our business and results of operations could be adversely affected. We are expanding our private loan business and currently originate and facilitate the origination of private loans for third parties. The origination of private loans is subject to federal and state consumer protection laws and regulations, including state usury and disclosure laws and related regulations, and the Federal Truth in Lending Act. These laws and regulations impose substantial requirements upon lenders and their agents and servicers involved in consumer finance. Failure to comply with these governmental regulations could have an adverse effect on our business and results of operations. Citigroup Credit Suisse First Boston Table of Contents If we become subject to the licensing laws of any jurisdiction or any additional government regulation, our compliance costs could increase significantly. In addition to being subject to certain state and federal consumer protection laws, which may change, we are currently licensed as telemarketers in two states. We could also become subject to other licensing laws due to changes in existing federal and state regulations. As a result, we could be required to (1) implement additional or different programs and information technology systems, (2) meet new licensing capital and reserve requirements or (3) incur additional administrative, compliance and third-party service costs. Furthermore, we could become subject to licensing laws in other states if we engage in licensable activities in the future. This includes the risk that even if we were not physically present, a state could assert jurisdiction over our operations for services we provide through the mail, by phone, through the Internet or by other remote means. Our failure to comply with such requirements could subject us to civil or criminal penalties and could curtail our ability to continue to conduct business in that jurisdiction. Moreover, compliance with such requirements could involve additional costs. Either of these consequences could have a material adverse effect on our business. Additionally, other organizations with which we work are subject to licensing and extensive governmental regulations, including truth-in-lending laws and other consumer protection regulations. From time to time we have, and we may in the future, become responsible for compliance with these regulations under contractual arrangements with our clients. If we fail to comply with these regulations, we could be subject to civil or criminal penalties. A failure to obtain trademark registrations and potential trademark infringement claims could cause us to incur additional costs and impede our marketing efforts. We believe that our success depends to a degree upon our ability to develop and maintain awareness of our corporate identifiers and brand names. We have applied for a U.S. service mark registration to protect our corporate name and will continue to evaluate the registration of additional service marks and trademarks, as appropriate. We cannot guarantee that any of our pending applications will be approved by the applicable governmental authorities, and we are aware that one of our applications has initially been rejected and is now under appeal. We may be subject to claims of alleged infringement of the trademarks or other intellectual property rights of third parties. Any such claims, whether or not meritorious, could result in litigation and divert the efforts of our personnel. Moreover, should we be found liable for infringement, we may be required to enter into licensing agreements (if available on acceptable terms or at all) or to pay damages and to cease using certain names or identifiers. Any of the foregoing could cause us to incur additional costs and impede our marketing efforts. Failure to comply with restrictions on inducements under the Higher Education Act could harm our business. The Higher Education Act generally prohibits a lender from providing inducements to educational institutions or individuals in order to secure applicants for FFELP loans. However, the DOE permits de minimis gifts in connection with advertising FFELP loans. If the DOE were to change its position on these matters, this could potentially result in the DOE imposing sanctions upon us if we fail to adapt our policies to comply with the new guidelines, and such failure could impact our business. We have also entered into various agreements to use marketing lists of prospective borrowers from sources such as associations. On occasion, we pay to acquire these lists and for completed loan applications resulting from these lists. We believe that such arrangements are permissible and do not violate restrictions on inducements, as they fit within a regulatory exception recognized by the DOE for generalized marketing and advertising activities. The DOE has provided subregulatory guidance that such arrangements do not raise any improper inducement issues, since such arrangements fall within the generalized marketing exception. If the DOE were to change its position, this could hurt our reputation and potentially result in the DOE imposing sanctions on us. These sanctions could negatively impact our business. Banc of America Securities LLC Keefe, Bruyette Woods The date of this prospectus is July , 2004. Table of Contents Risks Related to This Offering Future sales of our common stock may depress our stock price. The market price of our common stock could decline as a result of sales of substantial amounts of our common stock in the public market after this offering or the perception that these sales could occur. In addition, these factors could make it more difficult for us to raise funds through future equity offerings. There will be 30,446,523 shares of our common stock and warrants to purchase 1,430,099 shares of common stock for nominal consideration outstanding immediately after this offering. All of the shares of our common stock sold in this offering will be freely transferable by persons other than our affiliates without restriction or further registration under the Securities Act of 1933. Substantially all of the remaining shares of our outstanding common stock will be eligible for immediate sale in the public market pursuant to Rule 144 under the Securities Act of 1933 (other than shares of common stock held by our affiliates, who after completion of this offering will own approximately 51.8% of our outstanding common stock, and who will be subject to volume limitations), subject to 180-day lock-up agreements with the underwriters described below. See Shares Eligible for Future Sale. We and our executive officers and directors and substantially all of our existing stockholders intend to enter into 180-day lock-up agreements. The lock-up agreements prohibit each of us from selling or otherwise disposing of shares of common stock except in limited circumstances. The lock-up agreements are only contractual agreements, and J.P. Morgan Securities Inc. and Merrill Lynch, Pierce, Fenner Smith Incorporated, at their discretion, can waive the restrictions of any lock-up agreement at an earlier time without prior notice or announcement and allow any of us to sell shares of our common stock. If the restrictions in the lock-up agreement are waived, shares of our common stock will be available earlier for sale into the public market, subject to applicable securities laws, which could reduce the market price for shares of our common stock. In addition, we cannot assure you that our directors or stockholders will maintain their ownership position of our common stock after the end of the lock-up period. Under the terms of a stockholders agreement between Lightyear, our other principal stockholders and the Company, holders of our common stock that are party to the agreement holding at least 50% of our common stock will have the ability to require us to register the resale of its shares. Lightyear will beneficially own approximately 15,346,079 shares, or 50.4%, of our common stock after this offering, assuming the underwriters do not exercise their over-allotment option. In addition, TCW, which will beneficially own approximately 2,151,191 shares of our common stock, or 6.9%, after this offering, will also have the ability to require us to register the resale of its shares. Lightyear and minority investors will have the ability to exercise certain piggyback registration rights in connection with other registered offerings. See Certain Relationships and Related Transactions and Shares Eligible for Future Sale. In addition, pursuant to our stock incentive plan, we have granted options to purchase approximately 450,481 shares of common stock. Of these granted options, as of May 31, 2004, options for 81,087 shares were vested and exercisable and, on or about July 6, 2004, in connection with the execution of new employment agreements with our management, options for 184,697 shares became vested and exercisable. Upon consummation of this offering, we expect to grant certain of our officers and employees approximately 314,575 shares of restricted and unrestricted stock and options to purchase 1,013,646 shares of common stock. We have reserved an additional 2,788,250 shares for future issuance under our stock incentive plan. We intend to file one or more registration statements on Form S-8 under the Securities Act to register the sale of shares issued or issuable upon the exercise of stock options. In the future, we may issue our common stock in connection with acquisitions. The amount of such common stock issued could constitute a material portion of our then outstanding common stock. The issuance of additional shares of common stock could result in dilution to our stockholders and a decline in the market price of our common stock. Cash payments (receipts) for income taxes $ 28 $ TABLE OF CONTENTS Page Table of Contents Lightyear controls us and may have conflicts of interest with us or you in the future and is party to agreements with us which provide additional benefits to them. Prior to this offering, Lightyear beneficially owned approximately 72.8% of our outstanding shares of common stock, and, after giving effect to this offering, Lightyear will beneficially own 50.4% of our common stock, or 48.2% if the underwriters exercise their over-allotment option in full. As a result, Lightyear will have the ability to control or strongly influence the outcome of the election of our directors, which may give Lightyear substantial influence over our decisions to enter into any corporate transaction. For example, Lightyear, through their control of our board of directors, could cause us to make acquisitions that increase the amount of our indebtedness or dilute our equity. Lightyear also will have the effective ability to prevent any transaction that requires the approval of stockholders, regardless of whether or not other stockholders believe that any such transactions are in their own best interests. Additionally, Lightyear is in the business of making investments in companies and may from time to time acquire and hold interests in businesses that compete directly or indirectly with our business. Lightyear may also pursue acquisition opportunities that may be complementary to our business, and, as a result, those acquisition opportunities may not be available to us. So long as Lightyear continues to own a significant amount of the outstanding shares of our common stock, it will continue to be able to strongly influence or effectively control our decisions. In addition, Lightyear, or shareholders owning in the aggregate 50% of our common stock, will have the right to demand registration of all or part of its common stock beginning 180 days after the consummation of this offering, so long as the shares to be offered pursuant to the request have an aggregate offering price of at least $5.0 million (based on the then current market price). We will be required to fulfill such obligations except in limited circumstances. We are obligated to pay certain expenses and indemnify Lightyear against certain liabilities, including liabilities under the Securities Act, in connection with any such registration. Pursuant to the terms of a management agreement with Lightyear, we have agreed to pay Lightyear an annual management fee of $1.25 million plus reasonable out-of-pocket expenses until May 17, 2012, as well as customary fees for advisory services rendered to us, which fees will be negotiated with independent members of our board of directors. Under the management agreement, we paid Lightyear $312,500 for the three months ended March 31, 2004, $1.25 million in 2003 and $625,000 in 2002. Our board of directors will have the ability to terminate the management agreement at any time and pay Lightyear an amount equal to the discounted present value of future fees payable under the agreement. See Certain Relationships and Related Transactions. There is no existing market for our common stock, and we do not know if one will develop to provide you with adequate liquidity. There has not been a public market for our common stock. We cannot predict the extent to which investor interest in our company will lead to the development of a trading market on the Nasdaq National Market or otherwise or how liquid that market might become. The initial public offering price for the shares will be determined by negotiations between us and the representatives of the underwriters and may not be indicative of prices that will prevail in the open market following this offering. After this offering, our stock price may vary significantly from the initial offering price in response to the risk factors described in this section as well as other factors which are beyond our control. Provisions in our certificate of incorporation and bylaws and Delaware corporate law may discourage a takeover attempt. Provisions contained in our certificate of incorporation and bylaws, as they will be in effect immediately prior to the consummation of this offering, and the corporate law of Delaware, the state in which we are incorporated, could make it more difficult for a third party to acquire us, even if doing so might be beneficial to our stockholders. Provisions of our certificate of incorporation and bylaws will Prospectus Summary 1 Risk Factors 8