-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AmMJOCtGsIPWf60fSKgWojH3nOCIqHzHGYIXbp3kEhpuBak77Lb0BcZfbOn/UReP DELoQGpAuPi98f457QKG5g== 0001012870-97-001581.txt : 19970818 0001012870-97-001581.hdr.sgml : 19970818 ACCESSION NUMBER: 0001012870-97-001581 CONFORMED SUBMISSION TYPE: SB-2/A PUBLIC DOCUMENT COUNT: 10 FILED AS OF DATE: 19970815 SROS: BSE SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: ISONICS CORP CENTRAL INDEX KEY: 0001023966 STANDARD INDUSTRIAL CLASSIFICATION: CHEMICALS & ALLIED PRODUCTS [2800] IRS NUMBER: 770338561 STATE OF INCORPORATION: CA FISCAL YEAR END: 0430 FILING VALUES: FORM TYPE: SB-2/A SEC ACT: 1933 Act SEC FILE NUMBER: 333-13289 FILM NUMBER: 97664312 BUSINESS ADDRESS: STREET 1: 4010 MOORPACK AVENUE STREET 2: SUITE 119 CITY: SAN JOSE STATE: CA ZIP: 95117 BUSINESS PHONE: 4082600155 MAIL ADDRESS: STREET 1: 4010 MOORPACK AVENUE STREET 2: SUITE 119 CITY: SAN JOSE STATE: CA ZIP: 95117 SB-2/A 1 AMENDMENT #7 TO SB-2 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON AUGUST 15, 1997 REGISTRATION NO. 333-13289 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------- AMENDMENT NO. 7 TO FORM SB-2 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 -------------- ISONICS CORPORATION (Name of Small Business Issuer in Its Charter) CALIFORNIA 2819 77-0338561 (STATE OF INCORPORATION) (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.) -------------- 4010 MOORPARK AVENUE, SUITE 119 SAN JOSE, CALIFORNIA 95117 (408) 260-0155 (ADDRESS AND TELEPHONE NUMBER OF PRINCIPAL EXECUTIVE OFFICES AND PRINCIPAL PLACE OF BUSINESS) -------------- JAMES E. ALEXANDER CHIEF EXECUTIVE OFFICER ISONICS CORPORATION 4010 MOORPARK AVENUE, SUITE 119 SAN JOSE, CALIFORNIA 95117 (408) 260-0155 (NAME, ADDRESS AND TELEPHONE NUMBER OF AGENT FOR SERVICE) -------------- COPIES TO: C. KEVIN KELSO, ESQ. GREGORY SICHENZIA, ESQ. BRUCE F. MACKLER, EXQ. SINGER ZAMANSKY LLP MARK PORTER, ESQ. 40 EXCHANGE PLACE, 20TH FLOOR FENWICK & WEST LLP NEW YORK, NEW YORK 10005 TWO PALO ALTO SQUARE (212)809-8550 PALO ALTO, CALIFORNIA 94306 (415) 494-0600 -------------- APPROXIMATE DATE 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. [X] 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 delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [_] CALCULATION OF REGISTRATION FEE
==================================================================================== PROPOSED TITLE OF EACH CLASS OF MAXIMUM PROPOSED MAXIMUM AMOUNT OF SECURITIES TO BE AMOUNT TO BE OFFERING PRICE AGGREGATE OFFERING REGISTRATION REGISTERED REGISTERED PER SHARE(1) PRICE(1) FEE - ------------------------------------------------------------------------------------ Units(2), each consisting of......... 805,000 $7.00 $5,635,000 $1,708 (a) 2 shares of Common Stock................ 1,610,000 -- -- -- (b) 2 Redeemable Class A Common Stock Purchase Warrants... 1,610,000 -- -- -- - ------------------------------------------------------------------------------------ Common Stock issuable upon exercise of Redeemable Warrants... 1,610,000 $4.00 $6,440,000 $1,952 - ------------------------------------------------------------------------------------ Underwriter's Warrants(3)........... 140,000 $.001 $140 1 - ------------------------------------------------------------------------------------ Common Stock issuable upon exercise of Underwriter's Warrants(4)........... 140,000 $5.61 $785,400 $238 - ------------------------------------------------------------------------------------ Redeemable Warrants issuable upon exercise of Underwriter's Warrants.............. 140,000 $0.165 $23,100 $7 - ------------------------------------------------------------------------------------ Common Stock issuable upon exercise of Redeemable Warrants issuable upon exercise of Underwriter's Warrants(4)........... 140,000 $4.00 $560,000 $170 - ------------------------------------------------------------------------------------ Total.................. 5,390,000 $13,443,640 $4,076(5) ====================================================================================
(1) Estimated solely for purpose of determining the registration fee pursuant to Rule 457 under the Securities Act. (2) Includes 210,000 shares of Common Stock and 210,000 Redeemable Warrants issuable upon exercise of the Underwriter's Over-Allotment Option. (3) No registration fee required pursuant to Rule 457 under the Securities Act. (4) Pursuant to Rule 416 of the Securities Act, there are also being registered hereby such additional indeterminate number of Shares of Common Stock as may become issuable pursuant to the anti-dilution provisions of the Redeemable Warrants and the Underwriter's Warrants. (5) 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. ================================================================================ ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ +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 AUGUST 15, 1997 700,000 UNITS CONSISTING OF 1,400,000 SHARES OF COMMON STOCK AND 1,400,000 REDEEMABLE CLASS A COMMON STOCK PURCHASE WARRANTS [LOGO OF ISONICS CORPORATION] Isonics Corporation, a California corporation ("Isonics" or the "Company"), hereby offers 700,000 units ("Units"), each Unit consisting of two shares (the "Shares") of Common Stock, no par value per share ("Common Stock"), and two redeemable Class A Common Stock Purchase Warrants ("Warrants"). The Units, the Shares and the Warrants are sometimes referred to collectively as the "Securities." Each Warrant entitles the registered holder thereof to purchase one share of Common Stock at a price currently expected to be $4.00 per share, subject to adjustment, for three years commencing one year from the date of this Prospectus. The Common Sock and Warrants comprising the Units will be separately transferable immediately upon issuance. The Company may redeem the Warrants commencing , 1999 (18 months from the date of the Prospectus) or earlier with the consent of Monroe Parker Securities, Inc. (the "Underwriter"), at a price currently expected to be $.10 per Warrant, on not less than 30 days' prior written notice, if the last sale price of the Common Stock has been at least 250% (currently expected to be $10.00 per share) of the current Warrant exercise price, subject to adjustment, for at least 20 consecutive trading days ending within three days prior to the date on which notice of redemption is given. See "Description of Capital Stock." Prior to this offering, there has been no public market for the Units, Common Stock or Warrants. The offering price of the Units and the exercise price and the terms of the Warrants have been determined by negotiations between the Company and the Underwriter, and are not necessarily related to net asset value, projected earnings or other established criteria of value. The Company has applied for listing of the Units, Common Stock and Warrants on the Boston Stock Exchange ("BSE") under the symbols " ," " " and " ," respectively and on the Nasdaq SmallCap Market ("Nasdaq SCM") under the symbols "ISNU," "ISNX" and "ISNXW," respectively. There can be no assurance that an active trading market in the Company's securities will develop after the completion of this offering, or be sustained. See "Underwriting." The Units are being offered on a "firm commitment" basis by the Underwriter, subject to prior sale, when, as and if delivered to and accepted by the Underwriter, and subject to the Underwriter's right to reject orders in whole or in part, and to the approval of certain legal matters by counsel and certain other conditions. It is expected that delivery of certificates representing the Units will be made against payment therefor on or about , 1997. ---------- THE SECURITIES OFFERED HEREBY ARE SPECULATIVE AND INVOLVE A HIGH DEGREE OF RISK AND IMMEDIATE AND SUBSTANTIAL DILUTION. SEE "RISK FACTORS" COMMENCING ON PAGE 5 AND "DILUTION" ON PAGE 17. ---------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
=================================================================================================== UNDERWRITING DISCOUNTS PROCEEDS TO PRICE TO PUBLIC AND COMMISSIONS(1) COMPANY(2) - --------------------------------------------------------------------------------------------------- Per Unit................................... $7.00 $.70 $ - --------------------------------------------------------------------------------------------------- Per Share................................. $3.40 $.34 $ - --------------------------------------------------------------------------------------------------- Per Warrant............................... $.10 $.01 $ - --------------------------------------------------------------------------------------------------- Total (3).................................. $ $ $ ===================================================================================================
(1) Excludes additional compensation to be received by the Underwriter in the form of (i) options to purchase 70,000 Units, exercisable over a period of four years commencing one year from the date of this Prospectus, at an exercise price equal to 165% of the public offering price of the Units being offered hereby; and (ii) a 3% non-accountable expense allowance of $147,000 (or $169,050 if the over-allotment option is exercised in full). The Company has agreed under certain circumstances to pay the Underwriter a warrant solicitation fee of 5% of the exercise price received for each warrant exercised. In addition, the Company and the Underwriter have agreed to indemnify each other against certain liabilities under the Securities Act of 1993 (the "Securities Act"). See "Underwriting." (2) Before deducting expenses, including the Underwriter's non-accountable expense allowance payable by the Company, estimated at $ (or $ if the over-allotment option is exercised in full). (3) The Company has granted to the Underwriter an option, exercisable within 45 days from the date of this Prospectus, to purchase up to an additional 105,000 Units on the same terms solely to cover over-allotments, if any. If the over-allotment option is exercised in full, the Price to Public, Underwriting Discounts and Commissions and Proceeds to Company would be $ , $ and $ respectively. ---------- MONROE PARKER SECURITIES, INC. THE DATE OF THIS PROSPECTUS IS , 1997 A Stable isotope labeled compounds used to determine structure of molecules B Ion implant tool utilizing stable isotopes C A carbon-13 diagnostic breath test sample being provided by a small child D Xenon and carbon stable isotope products packaged and ready for shipment E Depleted zinc in the form of sintered oxide pellets IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE UNITS, COMMON STOCK OR WARRANTS OF THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE BOSTON STOCK EXCHANGE, THE NASDAQ SMALLCAP MARKET OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. 2 PROSPECTUS SUMMARY The following summary is qualified in its entirety by the more detailed information and financial statements and notes thereto appearing elsewhere in this Prospectus. The Securities offered hereby involve a high degree of risk. See "Risk Factors." Except where otherwise indicated, all share and per share data in this Prospectus (including data with respect to options and warrants to purchase shares) have been adjusted to reflect a 1-for-6.89 reverse stock split of the Company's Common Stock effected in December 1996, a 1-for-1.26 reverse split of the Company's Common Stock effected in May 1997 and a 3-for-1 forward stock split of the Company's Common Stock which will occur before the closing of this offering. See "Description of Capital Stock." In addition, unless otherwise indicated, all information in this Prospectus assumes that the Underwriters' over-allotment option will not be exercised. THE COMPANY Isonics is an advanced materials and technology company which develops and commercializes products based on enriched stable isotopes. Stable isotopes can be thought of as ultra-ultra pure materials. This high degree of purification accomplished on the sub-atomic level provides enhanced performance properties compared to normal purity materials. Stable isotopes have commercial uses in several areas, including energy; medical, research, diagnostics and drug development; product tagging and stewardship; semiconductors; and optical materials. Isonics has successfully developed and commercialized two stable isotope products and intends to promote the emergence and growth of new stable isotope applications. The Company's principal product to date is isotopically depleted zinc ("DZ"). DZ, in different chemical forms, is used to prevent corrosion in nuclear power plants. Corrosion is a cause of high radiation fields in such plants which can result in radiation exposure to workers. DZ also reduces environmental cracking in certain kinds of nuclear reactors which, if not controlled, can require extremely costly repairs or can result in premature shutdown and de- commissioning of the facility. The Company believes that it provides substantially all of the DZ used in nuclear power plants worldwide. The application of DZ was developed by General Electric Company ("GE"), where the founders of the Company were previously employed. Before May 1996, all sales of DZ by the Company were made to GE pursuant to sales orders, and GE in turn resold the product to end users. In addition to sales to GE, in fiscal 1997 Isonics commenced direct sales to end users, and for the year ended April 30, 1997, approximately 30% of net revenues were from sales made directly to end users. The amount of future direct sales of DZ to certain end user customers may be limited by, among other things, certain rights or agreements of GE, and future direct sales could also be affected by GE's future intentions regarding sales or purchases of DZ independently of the Company, see "Risk Factors--Number of DZ Customers." New applications for stable isotopes are continually being developed by the Company and by third parties. The Company believes that many new applications have the potential to create new markets. One opportunity is to supply stable isotope labeled compounds for the diagnostic breath test ("DBT") market. DBTs provide early diagnosis of conditions that could otherwise lead to expensive procedures such as endoscopies and biopsies. DBTs under development by third parties which utilize stable isotopes in their application include tests to diagnose peptic ulcers, fat malabsorption and liver function. A urea DBT relating to peptic ulcers has recently been approved by the U.S. Food and Drug Administration (the "FDA"), and the Company believes that other companies have applied to the FDA or comparable agencies in foreign countries for approval of these tests, which must be obtained before any products can be sold. Certain DBTs are currently marketed in certain European countries. The Company has obtained an option to acquire an exclusive license to two Yale University patents which cover semiconductor devices made of isotopically pure silicon, germanium, gallium arsenide and most isotopically pure compound semiconductors. The patents claim that isotopic purity provides improved device speed and improved thermal conductivity, two properties which are of great importance to the semiconductor industry. According to the Semiconductor Industry Association, sales in 1995 of silicon wafers and other semiconductor substrates were approximately $6 billion. The Company is collaborating with Yale and others to evaluate these isotopically engineered semiconductor applications. The Company believes that if evaluations demonstrate the commercial feasibility of one or more products, demand could emerge in certain segments of the semiconductor market. There can be no assurance, however, that these evaluations will demonstrate the commercial feasibility of any products, that the Company will be able to commercialize any such products or that a market will emerge for any such products. The Company was formed in March 1992 and incorporated in California in March 1993 under the name A&R Materials, Inc. In October 1996, the Company changed its name to Isonics Corporation. The Company's principal executive offices are located at 4010 Moorpark Avenue, Suite 119, San Jose, California, 95117. Its telephone number is (408) 260-0155. 3 RISK FACTORS The Securities offered hereby involve a high degree of risk. This Prospectus contains forward-looking statements, including those discussed under "Business," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Use of Proceeds." These forward-looking statements involve a number of risks and uncertainties, including, but not limited to, those discussed under "Risk Factors." The Company's actual results may differ significantly from the results discussed in the forward-looking statements. See "Risk Factors." THE OFFERING Securities offered...... 700,000 Units, each Unit consisting of two shares and two Warrants. The Common Stock and Warrants comprising the Units will be separately transferable immediately upon issuance. See "Description of Capital Stock." Description of Warrants: Exercise of Warrants.. Subject to redemption by the Company, the Warrants may be exercised at any time during the three-year period commencing one year from the date of this Prospectus at an exercise price of $ per share, subject to adjustment. Redemption of Warrants............. The Warrants are redeemable by the Company commencing 18 months from the date of the Prospectus, or earlier with the consent of the Underwriter, at $ per Warrant, on not less than 30 days' prior written notice, if the last sale price of the Common Stock has been at least 250% ($ per share) of the current Warrant exercise price for at least 20 consecutive trading days ending within three days prior to the date on which notice of redemption is given. Common Stock to be outstanding after this offering.... 5,950,268 Shares(1) Use of proceeds......... For repayment of debt, research and development, capital expenditures and other general corporate purposes. BSE Symbols............. Units-- ; Common Stock-- ; Warrants-- Nasdaq SCM Symbols...... Units--ISNU; Common Stock--ISNX; Warrants--ISNXW
SUMMARY FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED APRIL 30, -------------- 1996 1997 ------ ------- STATEMENT OF OPERATIONS DATA: Net revenues................................................... $5,567 $ 4,539 Operating income (loss)........................................ 522 (915) Net income (loss).............................................. 281 (1,363) Net income (loss) per share(2)................................. .05 (.23) Shares used in computing per share information(2).............. 5,949 5,890 Pro forma (loss) per share(2).................................. (.16) Shares used in computing pro forma information(2).............. 6,430
APRIL 30, 1997 ---------------------- ACTUAL AS ADJUSTED(3) ------ -------------- BALANCE SHEET DATA: Cash and cash equivalents............................... $ 28 $2,344 Working capital (deficiency)............................ (441) 1,875 Total assets............................................ 2,684 4,338 Long-term debt, less current (deficit) portion.......... 1,268 115 Total shareholders' equity (deficit).................... (610) 2,752
- -------- (1) Based on shares outstanding as of July 31, 1997. Does not include 689,809 shares of Common Stock issuable at a weighted average exercise price of $.77 per share upon exercise of options granted under the Company's employee benefit plan as of July 31, 1997, 720,000 additional shares of Common Stock reserved for future grants under the Company's employee benefit plans, 1,572,034 shares of Common Stock issuable upon the exercise of outstanding warrants at a weighted average exercise price of $1.32 per share, and options to purchase 120,000 shares of Common Stock at an exercise price equal to 110% of the initial public offering price of the Shares. See "Capitalization--Recent Financing Transactions,""Management-- Employment and Consulting Agreements," "Management--Employee Benefit Plans," "Management--Directors Compensation" and notes 6 and 8 of Notes to the Company's financial statements appearing at the end of this Prospectus (the "Financial Statements"). (2) For an explanation of the determination of the number of shares used in per share calculations, see note 1 of Notes to the Financial Statements. (3) Adjusted to reflect the repayment of the Placement Notes with the proceeds from this offering, the sale by the Company in this offering of 1,400,000 Shares and 1,400,000 Warrants to purchase Common Stock at $4.00 per Share, and the issuance of Underwriter's Warrants to purchase 280,000 shares of Common Stock at a weighted average exercise price of $4.89 per share, and after deducting the estimated underwriting discounts and commissions and offering expenses and the application of the net proceeds therefrom. See "Capitalization" and "Use of Proceeds." 4 RISK FACTORS An investment in the Securities offered hereby involves a high degree of risk. In addition to the other information in this Prospectus, the following factors should be considered carefully in evaluating an investment in the Securities offered hereby. This Prospectus contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from the results discussed in the forward-looking statements. Factors that could cause or contribute to such differences include those discussed below and elsewhere in the Prospectus. Relationship With Certain Suppliers and Raw Materials. The Company depends upon a single processor, located in Russia, for one process involved in the manufacturing of its products, and upon a single supplier or a limited number of suppliers and processors for certain other manufacturing processes. Although the Company does have written agreements with certain of its suppliers and processors, the Company does not have any written agreements with other suppliers and processors. Although the Company seeks to reduce its dependence on its sole and limited suppliers, disruption or termination of any of the sources could occur, and such disruptions could have at least a temporary material adverse effect on the Company's business, financial condition and results of operations. Moreover, a prolonged inability to obtain alternative sources for processing could materially adversely affect the Company's relations with its customers. See "Risk Factors--Expansion of the Company's Product Offerings" and "Business--Manufacturing and Supply." Operations in Russia. The processing of the Company's products is dependent upon an isotope enrichment plant, located in Russia, which is owned by the Ministry of Atomic Energy of the Russian Federation, which is part of the cabinet of the government of the Russian Federation. The Company signed an agreement dated July 1996 (the "Supply Agreement") under which the plant and AO Techsnabexport, Co., Ltd. ("Techsnabexport") which is a commercial department of the Ministry, have agreed to supply the Company with zinc, cadmium, silicon, and carbon isotopes over the next three years. Under the Supply Agreement, the Company negotiates with the plant management annually regarding the price and certain other terms of the products to be supplied in the upcoming year. The Company entered into an agreement in February 1997 reflecting the most recent negotiations. The agreement provides, among other things, that the plant will not sell DZ to third parties located in North America or to other parties for resale in North America, that as long as the plant is able to meet all of the Company's requirements for DZ at prices competitive with other potential suppliers the Company will not buy DZ from other third parties located in the Russian Federation, and that any disputes arising under the agreement will be resolved by arbitration conducted in Sweden under the arbitration rules of the Stockholm Chamber of Commerce. The enforceability of the agreement might be subject to a greater degree of uncertainty than if the agreement was with a U.S. company and disputes were resolved in the United States. The plant is generally subject to the same government laws, policies, controls and regulations as apply to private enterprises in Russia. To date, these laws, policies, controls and regulations have not had any material adverse effect on the Company's business or relations with the plant, although there can be no assurance that this will be the case in the future. Operations in Russia entail certain risks. In recent years, the former republics of the Soviet Union have experienced political, social and economic change as constituent republics sought independence from the former central government in Moscow, and certain of the republics including Russia have attempted to transition from a centrally controlled economy toward market-based economies. These changes have involved, in certain cases, armed conflict in certain republics. There can be no assurance that political or economic instability in these republics will not continue or worsen. The supply of stable isotopes could be directly affected by political, economic and military conditions in Russia. Accordingly, the operations of the Company could be materially adversely affected if hostilities in Russia should occur, if trade between Russia and the United States were interrupted or curtailed, if political conditions in Russia disrupt transportation or processing concerning the Company's goods, if laws or governmental policies concerning foreign ownership or business operations in Russia change substantially, or if tariffs are introduced or freight rates change significantly. There can also be no assurance that the Company's relationship with the processing plant in Russia or with the Ministry of Atomic 5 Energy will be successfully maintained, even apart from these political, economic or military factors. In addition, there have been certain privatization programs in certain countries of the former Soviet Union, although the Company is not aware of any current proposals to privatize the plant or other government-controlled isotope production facilities in Russia. If at some future date the plant were privatized, the Company cannot predict whether any such privatization would result in a favorable or an unfavorable impact on the Company. Disruption or termination of the Company's supply sources could have a material adverse effect on the Company's business, financial condition and results of operations. The Company does not maintain political risk insurance. Additionally, Russian courts lack experience in commercial dispute resolution, and many of the procedural remedies for enforcement found in western jurisdictions are not available in Russia. Difficulties may be encountered in enforcing judgments of foreign courts or of arbitrators, in the case of the Company's agreements with suppliers or processors, or in otherwise protecting the Company's rights with its Russian suppliers and transporters. There can be no assurance that this difficulty in enforcing the rights will not have a material adverse effect on the Company. See "Business--Manufacturing and Supply." Customer Concentration. Historically, substantially all of the Company's net revenues in any particular period have been attributable to a limited number of customers. Net revenues from GE accounted for 88% and 49% of net revenues for the years ended April 30, 1996 and 1997, respectively. Three customers accounted for 20%, 13% and 10% of net revenues for the year ended April 30, 1997. A fourth customer accounted for 10% of net revenues for the year ended April 30, 1996. Consistent with the Company's historical experience, the Company's quarterly results are expected to be affected materially by the level of orders received from significant DZ users during such quarter and product shipments by the Company during such quarter in response to any such orders, factors which cannot be predicted with certainty until the third month of the quarter. The Company expects that if it continues to increase sales of depleted zinc products to end users and if it develops and sells products in the medical and research and electronic materials industries, concentration of net revenues from a limited number of customers will be reduced. None of the Company's customers have entered into long-term agreements to purchase the Company's products. In particular, the Company's sales of DZ to GE have been pursuant to sales orders placed from time to time by GE, and the Company does not have any written purchase or sales agreements with GE relating to sales of DZ or other products. If completed sales orders are not replaced on a timely basis by new orders from customers, the Company's net revenues could be materially and adversely affected. The Company's net revenues also could be adversely affected by a number of factors including the loss of a significant customer, reductions in orders from any significant customer compared to historical buying levels or otherwise, or the cancellation of a significant order from a customer. Any of these factors, many of which are outside the Company's control, could have a material adverse effect on the Company's business, financial condition and results of operations. Limited Operating History; History of Operating Losses. The Company was incorporated in March 1993 and has had only a limited operating history upon which evaluation of its prospects can be made. The Company had net losses of $171,000 and $143,000, respectively, for the years ended April 30, 1994 and 1995, had net income of $281,000 for the fiscal year ended April 30, 1996 and had a net loss of $1,363,000 for the year ended April 30, 1997. At April 30, 1997, the Company had negative working capital of $441,000 and an accumulated deficit of $1,396,000. In addition, the Company expects that it will incur a net loss for the fiscal year ended April 30, 1998, largely as a result of expenses associated with anticipated growth in research and development efforts and an extraordinary charge relating to payment of the Placement Notes upon completion of this offering. The Company's limited operating history makes the prediction of future operating results difficult. Future operating results will depend on many factors, including demand for the Company's products, the level of product and price competition, the ability of the Company to develop and market new products, the Company's ability to control costs, general economic conditions and other factors. There can be no assurance that the Company will achieve or sustain profitability. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Factors Affecting Operating Results; Fluctuations in Quarterly Results. The Company's operating results could be materially adversely affected by a number of factors, including failure of its suppliers to process a sufficient volume of products in a timely manner; introduction of new products by competitors; adequacy of the 6 Company's suppliers manufacturing capacity; changes in pricing policies of the Company, its customers, competitors or suppliers; economic conditions in the markets that the Company serves; the need to increase expenditures for research and development; failure to introduce new or improved products on a timely basis; and the rescheduling or cancellation of orders by its customers. The Company's quarterly operating results have varied in the past and may in the future vary significantly, depending on factors such as the size and timing of customer orders, pricing and other competitive conditions and the timing of new product announcements and releases by the Company and its competitors. The Company operates with little order backlog. Moreover, a significant portion of the Company's total revenues have been, and the Company believes will continue to be, derived from a limited number of orders in any particular quarter, and the timing of such orders and their fulfillment has caused, and is likely to continue to cause, material fluctuations in the Company's operating results, particularly on a quarterly basis. As has been the case in prior quarters, these factors will affect the Company's operating results for future periods. As a result, a lost or delayed sale could have a significant impact on the Company's operating results for a particular period. It is likely that in some future quarter, the Company's operating results will be below the expectations of public market analysts and investors. In such event, the price of the Common Stock and Warrants would likely be materially adversely affected. In addition, as a result of repayment of certain Placement Notes issued in a recent private placement transaction, the Company is likely to record an extraordinary charge to operations for the quarter in which the offering is completed, and as a result the Company expects to have a significant net loss for the quarter in which the offering occurs. See "Capitalization--Recent Financing Transactions." Number of DZ Customers. Patents have been granted to GE with respect to a method for inhibiting deposition of radioactive cobalt in a water-cooled nuclear reactor through the use of DZ. The nuclear power facilities that have purchased DZ to date directly from the Company have received correspondence from GE indicating that such customers may practice the method of utilizing DZ in such facilities and may purchase DZ from entities other than GE, such as the Company. In addition, certain nuclear power facilities are located in countries where GE does not have similar patents. Similarly, certain third party entities other than nuclear power plants, such as certain entities that construct nuclear power facilities or equipment, have licenses from GE which the Company believes may allow them to purchase DZ from the Company. Other facilities or third party entities may not be granted such licenses, and the Company's ability to sell DZ to such customers may be limited by applicable patent law and/or such customers' agreements with GE. GE may in the future grant licenses to additional end users entitling them to purchase DZ from third parties such as the Company, and GE may continue to purchase DZ directly from the Company, although there can be no assurance that this will be the case. GE could, among other actions, seek alternative sources of DZ to compete with the Company and seek to sell or purchase DZ independently of the Company. Nevertheless, it is possible that the Company's sales of DZ may be limited to only those entities described above that can purchase DZ from the Company without infringing on GE's intellectual property rights. Future Additional Capital Requirements. The Company's capital requirements will depend on numerous factors, including the level of future capital expenditures, the level of resources devoted to research and development and marketing of its products, market acceptance and demand for its products, and other factors. The Company believes the net proceeds of this offering, together with cash on hand and cash expected to be generated from operations, will provide adequate funding for the Company's anticipated operations for at least the next twelve months. Nevertheless, the Company may be required to raise additional funds through public or private debt or equity financings, collaborative relationships, bank facilities or other arrangements. There can be no assurance that the Company will not require additional funding sooner than expected or that such additional funding, if needed, will be available on terms attractive to the Company, if at all. Any additional equity financing may be dilutive to shareholders, and debt financing, if available, may involve restrictive covenants. See "--Expansion of the Company's Product Offerings," "Use of Proceeds," and "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." Competition. The markets for the Company's products are highly competitive, and the Company expects that competition will continue and increase as markets grow and new opportunities are realized. Some of the 7 Company's current competitors, and many of the Company's potential competitors, have significantly greater financial, marketing, product development, testing and other resources than the Company. As a result, they may have the capacity to respond more quickly to changes in customer requirements or to devote greater resources to the development, testing, marketing and sale of their products than the Company. Some of the Company's competitors may form partnerships or alliances with larger companies, with the resulting entity possessing more market strength than the Company. New competitors will likely emerge, and some new competitors may gain significant market share. There can be no assurance that the Company will be able to compete successfully against current and future competitors, or that competitive pressures will not have a material adverse effect on the Company's business, operating results and financial condition. See "Business-- Competition." Increased competition could result in price reductions, reduced transaction size, fewer customer orders and reduced gross margins, any of which could have a material adverse effect on the Company's business, operating results and financial condition. The Company's competition varies greatly depending on which product or industry is considered. At present, the Company believes it supplies substantially all of the DZ used in nuclear power plants worldwide, but believes that other entities or persons may begin producing DZ. Several such possible producers have adequate technical and financial resources to become viable competitors of the Company in the near future. In particular, GE, which to date has been the Company's largest customer, has indicated that it may seek to sell DZ to end users independently of the Company or may seek alternative sources of DZ other than the Company. The Company has several larger and numerous smaller competitors in the area of stable isotope labeled compounds and supplying materials for diagnostic breath test products. Due to the early stage of the electronic and optical materials opportunities, the Company has not identified material competitors in these markets. However, if viable commercial markets emerge for such products, the Company anticipates that substantial competition will emerge. Expansion of the Company's Product Offerings. The Company's future success will depend in part on its ability to enhance its current product offerings on a timely basis. The expansion of the Company into new products and processes will require significant future capital commitments. Substantial development work must be undertaken before such products are ready for commercial introduction. There can be no assurance that the Company will successfully develop new products or that it will be able to improve or expand its initial products to keep pace with the demands of the marketplace. Moreover, there can be no assurance that commercial markets will emerge for the potential products that the Company is developing and considering developing. In addition, other products or technologies currently exist, and will be developed in the future, that compete directly with the Company's current products and products that the Company may develop in the future. Dependence on Key Personnel. The Company's future success will depend in significant part upon the continued service of its key technical, sales and senior management personnel, including James E. Alexander, the Company's President and Chief Executive Officer, and Boris Rubizhevsky, the Company's Senior Vice President, Isotope Production and Supply. The Company maintains $1 million of key man life insurance on the lives of Messrs. Alexander and Rubizhevsky. The loss of the services of one or more of the Company's executive officers or other key technical personnel could have a material adverse effect on the Company's business, financial condition or results of operations. In addition, the Company's future operating results depend, in part, upon its ability to attract and retain qualified personnel for its operations. The failure to attract or retain such persons could materially adversely affect the Company's business, financial condition and results of operations. Reliance on Strategic Collaborations and Relationships. The Company's strategy for the development, processing and marketing of certain of its products includes entering into various collaborations with corporate partners, processors, suppliers and others. The Company has developed strategic relationships, including cooperative research and development projects, with certain third parties. There can be no assurance that existing collaborative arrangements will continue, or that the Company will be able to negotiate other successful collaborative arrangements in the future. The loss of any of these relationships could adversely affect the Company's business, financial condition and results of operations. If the Company is not able to maintain or establish such arrangements, it would likely face increased capital requirements to undertake such activities at its 8 own expense, and could also encounter significant delays in development, processing, marketing or sale of products into certain markets. See "Business--Manufacturing and Supply." Third Party Reimbursement of Healthcare Costs. Some of the Company's potential products, such as DBT products, are expected to compete in the medical diagnostics and healthcare markets. Demand for such products, and the prices at which such products can be sold, may depend in large part upon the extent to which purchasers will be reimbursed by governmental agencies and insurance companies for use of such products. Future federal or state legislation could result in a substantial restructuring of the healthcare delivery system. While the Company cannot predict whether any legislative or regulatory proposals will be adopted or the effect such proposals may have on its business, uncertainty regarding such proposals, as well as the adoption of such proposals, could have a material adverse effect on the Company's ability to develop and sell products that compete in these markets. Such reforms, if adopted, and ongoing changes in the healthcare industry, could adversely affect the pricing of therapeutic or diagnostic products in the United States or the amount of reimbursement available from governmental agencies or third party insurers, and consequently could have a material adverse effect on the Company. In both domestic and foreign markets, sales of such products, if any, will depend in part on the availability of reimbursement from third party payers, such as government and private insurance plans and other organizations. Product and Other Liability; Minimal Insurance Coverage. The Company's business exposes it to potentially substantial product, environmental, occupational and other liability risks which are inherent in research and development, preclinical study, clinical trials, manufacturing, marketing, distribution and use, of the Company's current and potential products, including, but not limited to, products for pharmaceutical, medical device and nuclear energy markets. The Company currently does not have product liability insurance, but may seek such coverage as it deems prudent in light of future operations. There can be no assurance that insurance coverage will be available at an acceptable cost, if at all, or that a product liability or other claim would not materially and adversely affect the business, financial condition and results of operations of the Company even if such insurance has been obtained. Management of Growth. The Company has experienced a period of rapid growth and expansion, which has placed and continues to place, a significant strain on its resources. To accommodate this growth, the Company will be required to implement a variety of new and upgraded operational and financial systems, procedures and controls, including the improvement of its other internal management systems. There can be no assurance that such efforts can be accomplished successfully. In addition, this growth, as well as the Company's market diversification and product development activities, will necessitate an increase in the number of the Company's employees. During fiscal 1997, the Company added a General Manager of Diagnostics and a Chief Financial Officer as well as other support personnel. If the Company sustains its growth in the future, the Company will need to continue to implement and improve its operational and management information systems and to hire, train, motivate and manage its employees. The Company's ability to successfully assimilate new operations and new personnel involved with any future expansion will have a material effect on the Company's future business, financial condition and results of operations. There can be no assurance that the Company will be able to manage these changes successfully or that the Company's systems, procedures and controls will be adequate to support the Company's operations. Any failure to improve the Company's operational and management systems or to hire, train, motivate or manage employees could have a material adverse effect on the Company's business, financial condition and results of operations. No Prior Market; Stock Price Volatility. Prior to this offering, there has been no public market for the Company's securities. Consequently, the initial public offering price will be determined by negotiations among the Company and the Underwriter. There can be no assurance that an active public market for the Units, Common Stock and Warrants will develop or be sustained after the offering or that the market price of the Units, Common Stock and Warrants will not decline below the initial public offering price. The trading price of the Company's securities could be subject to wide fluctuations in response to quarter to quarter variations in operating results, announcements of technological innovations or new products by the Company or its competitors, changes in earnings estimates by analysts, or other events or factors. In addition, the stock market 9 has experienced wide price and volume fluctuations, which have at times been unrelated to the operating performance of the companies whose securities are traded. These broad market fluctuations may adversely affect the market price of the Units, Common Stock and Warrants. Arbitrary Offering Price. The initial public offering price of the Units and the exercise price and terms of the Warrants have been determined by negotiations between the Company and the Underwriter. See "Underwriting" for a discussion of the factors considered in determining the initial public offering price. Regulatory developments and economic and other external factors, as well as period-to-period fluctuations in financial results, may also have a significant impact on the market price of such securities. Possible Restrictions on Market-Making Activities in Company's Securities. The Underwriter has advised the Company that it intends to make a market in the Company's securities. Regulation M, which was recently adopted to replace Rule 10b-6 and certain other rules promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), may prohibit the Underwriter from engaging in any market-making activities with regard to the Company's securities for the period from five business days (or such other applicable period as Regulation M may provide) prior to any solicitation by the Underwriter of the exercise of Warrants until the later of the termination of such solicitation activity or the termination (by waiver or otherwise) of any right that the Underwriter may have to receive a fee for the exercise of Warrants following such solicitation. As a result, the Underwriter may be unable to provide a market for the Company's securities during certain periods while the Warrants are exercisable. Underwriter's Warrants. The Company has agreed to sell to the Underwriter, at an aggregate price of $140, the right to purchase up to 140,000 Shares and 140,000 Warrants, each Warrant having the same terms as the Warrants to be sold to the public in this offering (the "Underwriter's Warrants"). Each Underwriter's Warrant will be exercisable, for a four-year period commencing one year after the date of the Prospectus, to purchase one share at a price of $5.61, which is 165% of the initial public offering price per Share (i.e., $3.40 per share), and upon payment of $.165, which is 165% of the initial public offering price per Warrant (i.e., $.10 per Warrant), to acquire one Warrant which is exercisable to purchase one share of Common Stock at a price of $4.00, which is the same exercise price as the Warrants. For the life of such Underwriter's Warrants, the holders thereof are given the opportunity to profit from a rise in the market price of the Common Stock or Warrants, which may result in a dilution of the interests of other shareholders. As a result, the Company may find it more difficult to raise additional equity capital if it should be needed for its business while such Underwriter's Warrants are outstanding. See "Underwriting." Potential Adverse Effect of Redemption of the Warrants. The Warrants may be redeemed by the Company commencing 18 months from the date of this Prospectus, or earlier with the consent of the Underwriter, at a redemption price of $.10 per Warrant upon not less than 30 days' prior written notice, provided that the last sale price of the Common Stock on Nasdaq (or another national securities exchange), for 20 consecutive trading days ending within three days of the notice of redemption, equals or exceeds 250% (i.e., $8.75 per share assuming an initial public offering price of $3.50 per Share) of the current Warrant exercise price, subject to adjustment. Redemption of the Warrants could force the holders to exercise the Warrants and pay the exercise price at a time when it may be disadvantageous for the holders to do so, sell the Warrants at the then current market price when they might otherwise wish to hold the Warrants, or to accept the redemption price, which is likely to be substantially less than the market value of the Warrants at the time of redemption. See "Description of Capital Stock--Class A Warrants." Underwriter's Influence on the Market. A significant amount of the units offered may be sold to customers of the Underwriter. Such customers subsequently may engage in transactions for the sale or purchase of such Units and may otherwise effect transactions in such securities. If they participate in the market, the Underwriter may exert substantial influence on the market, if one develops, for the Units, Common Stock and Warrants. Such market-making activity may be discontinued at any time. The price and liquidity of the Units, Common Stock and Warrants may be significantly affected by the degree, if any, of the Underwriter's participation in such market. See "Underwriting." 10 Current Prospectus and State Registration Required to Exercise Warrants. The Warrants are being registered pursuant to a Registration Statement filed with the Securities and Exchange Commission ("Commission") under the Securities Act, of which this Prospectus is a part, and after its effectiveness the Warrants may be traded, and upon exercise after the Warrants become exercisable, commencing one year after the date of this Prospectus, their underlying shares of Common Stock may be sold in the public market that may develop for the securities. However, unless such Registration Statement is kept current by the Company and measures to qualify or keep qualified such securities in certain states are taken, investors purchasing the Warrants in this offering, although exercisable, will not be able to exercise the Warrants or sell the underlying shares of Common Stock issuable upon exercise of the Warrants in the public market. The Company has agreed to use its best efforts to qualify and maintain a current registration statement covering such shares of Common Stock. There can be no assurance, however, that the Company will be able to maintain a current registration statement or to effect appropriate qualifications under applicable state securities laws, the failure of which may result in the exercise of the Warrants and the resale or other disposition of Common Stock issued, upon such exercise, being unlawful. See "Description of Capital Stock--Class A Warrants." Protection of Intellectual Property. The Company does not currently hold any patents, and has not filed any patent applications, regarding DZ or its other actual or potential products. The Company relies primarily on a combination of trade secrets, confidentiality procedures and contractual provisions to protect its technology. Despite the Company's efforts, unauthorized parties may attempt to obtain and use information that the Company regards as proprietary. Policing unauthorized use of the Company's technology and products is difficult. In addition, the laws of many countries do not protect the Company's information, technology and intellectual property that it regards as proprietary to as great an extent as do the laws of the United States. There can be no assurance that the Company's protective measures will be adequate or that the Company's competitors will not independently develop similar information, technology or intellectual property. To date, the Company has not been notified of any claim that the Company's products infringe the proprietary rights of third parties, but there can be no assurance that third parties will not claim infringement by the Company with respect to current or future products. Any such claims, with or without merit, could be time-consuming, result in costly litigation, cause product shipment delays or require the Company to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to the Company or at all, which could have a material adverse effect upon the Company's business, financial condition or results of operations. See "Business--Patents and Proprietary Rights." Risks Associated with International Sales. The Company may expand its sales and marketing activities outside of the United States, which will require management attention and financial resources. There can be no assurance that such efforts will be successful. International operations are subject to a number of risks, including longer receivable collection periods and greater difficulty in accounts receivable collections, unexpected changes in regulatory requirements, dependence on independent resellers, risks of foreign currency fluctuations relative to the U.S. dollar, import and export restrictions and tariffs, difficulties and costs of staffing and managing foreign operations, potentially adverse tax consequences, political instability, the burdens of complying with multiple, potential conflicting laws and the impact of business cycles and economic instability outside the United States. Government Regulation. The Company's operations are subject to extensive government regulations pertaining to product manufacture, marketing and distribution, and environmental, worker safety, export control and other matters. Certain of the Company's technology and products, especially those having nuclear energy or military applications, are subject to substantial controls, including requirements to obtain governmental approvals and licenses on their use, distribution, dissemination and export. Furthermore, the diagnostic and other medical products that the Company may develop in the future are subject to stringent regulation by the FDA and its foreign counterparts, and within the United States by certain state agencies. Regulations by the FDA and its counterparts impose significant restrictions on the development, testing, manufacture, marketing, distribution and export of such products, including in most cases the need for prior approval from such government agencies to manufacture, test and distribute such products. Regulatory approvals for commercial distribution of medical and 11 diagnostic products generally require substantial preclinical and human clinical testing to demonstrate their safety and effectiveness. There can be no assurance that clinical data from such studies will demonstrate the safety or efficacy of any product that the Company may in the future develop or of products utilizing components that the Company may desire to supply, nor could there be any assurance that the FDA or its foreign counterparts will approve the commercial distribution of any such products in a timely manner, if at all. Likewise, to the extent that other foreign or domestic government approvals or permits are required for the manufacture, export, import, distribution and marketing of the Company's products and operations, there can be no assurance that the Company will be able to obtain or maintain such approvals or permits or meet applicable requirements or standards, or that such approvals or permits will not contain restrictions or limitations that materially affect the sale and distribution of the Company's products. The Company's failure to obtain such approvals in a timely manner, or its failure to comply with applicable foreign or domestic laws, regulations or policies, including those applicable to its operations and products, or changes in such laws, regulations or policies, may have a material adverse effect on the Company's business, financial condition and results of operations. See "Business--Government Regulation." Control by Existing Shareholders. Upon completion of this offering, the directors, executive officers and principal shareholders of the Company and their affiliates will, in the aggregate, assuming the exercise in full of all options and warrants then outstanding, beneficially own approximately 72.6% of the Company's outstanding Common Stock assuming no exercise of the over- allotment option. As a result, these shareholders, acting together, will possess significant influence as shareholders of the Company, including concerning election of the Company's Board of Directors and the approval of significant corporate transactions. Such control could delay, defer or prevent a change in control of the Company, impede a merger, consolidation, takeover or other business combination involving the Company, or discourage a potential acquirer from making a tender offer or otherwise attempting to obtain control of the Company. See "Management" and "Principal Shareholders." The Company's bylaws provide that so long as the Company is a "listed company" as defined by applicable California law, there will not be cumulative voting in connection with the election of directors. Upon the closing of this offering, however, the Company will not be a listed company as so defined, and therefore cumulative voting will apply in connection with the election of directors. See "Description of Capital Stock--Common Stock." Effect of Certain Charter Provisions. The Company's Board of Directors has the authority to issue up to 10,000,000 shares of Preferred Stock and to determine the rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the shareholders. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of the holders of any Preferred Stock that may be issued in the future. The issuance of Preferred Stock could adversely affect the voting power of holders of Common Stock and the likelihood that such holders will receive dividend payments and payments upon liquidation. Additionally, issuance of Preferred Stock, while providing flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of the outstanding voting stock of the Company. The Company has no current plans to issue shares of Preferred Stock. Limits on Secondary Trading; Possible Illiquidity of Trading Market. The Company has applied to have the Units, Common Stock and Warrants listed on the BSE and Nasdaq SCM, which may be significantly less liquid markets than the Nasdaq National Market. Moreover, if the Units, Common Stock and Warrants should be listed on the BSE and Nasdaq SCM but the Company is unable to maintain the standards for continued quotation on the BSE and/or Nasdaq SCM, the Units, Common Stock and Warrants would be subject to removal from the BSE and/or Nasdaq SCM. If the Company's securities were removed from both the BSE and the Nasdaq SCM, trading, if any, in the Units, Common Stock and Warrants would therefore be conducted in the over-the-counter market on an electronic bulletin board established for securities that do not meet the BSE and Nasdaq SCM listing requirements, commonly referred to as the "pink sheets." As a result, an investor would find it more difficult to dispose of, or to obtain accurate quotations as to the price of, the Units, Common Stock 12 or Warrants. In addition, depending on several factors including the future market price of the Units, Common Stock and Warrants, the Units, Common Stock and Warrants could become subject to the so-called "penny stock" rules that impose additional sales practices and market making requirements on broker- dealers who sell and/or make a market in such securities, which could affect the ability or willingness of broker-dealers to sell or make a market in the Units, Common Stock and Warrants and the ability of purchasers of the Units, Common Stock and Warrants to sell their securities in the secondary market. Under the blue sky laws of most states, public sales of Units, Common Stock and Warrants after this offering by persons other than the Company in "nonissuer transactions" must either be qualified under applicable blue sky laws, or exempt from such qualification requirements. Applicable exemptions for secondary trading of the Units, Common Stock and Warrants may differ from state to state depending on the particular statutes and regulations of that state. In many states, secondary trading will be permitted only so long as information about the Company is published in a recognized manual such as manuals published by Moody's Investor Service or Standard & Poor's Corporation. The Company has applied for listing in a recognized manual and will attempt to be so listed as soon after the closing of this offering as reasonably practicable, but secondary trading in many states will be restricted for some period of time after the date of this Prospectus. Shares Eligible for Future Sale. Sales of a substantial number of shares of Common Stock in the public market following this offering could adversely affect the market price for the Common Stock or Warrants. However, the number of shares of Common Stock that can be traded in the public market is limited by restrictions under the Securities Act. In addition, holders of substantially all of the outstanding shares of Common Stock and options and warrants to acquire Common Stock have entered into lock-up agreements pursuant to which they have agreed not to sell or otherwise dispose of any of their shares for a period of three years after the initial closing date of this offering. As a result of these restrictions, based on shares outstanding as of July 31, 1997, on the date of this Prospectus, no shares other than the 1,400,000 Shares and 1,400,000 Warrants offered hereby will be eligible for public sale, and no currently outstanding shares of Common Stock will be eligible for public sale 12 months after the initial closing date of this offering. Shares of Common Stock will become eligible for public sale at various times thereafter. See "Description of Capital Stock--Registration Rights." The Company intends to register on a registration statement on Form S-8, shortly after the effective date of this offering, a total of approximately 2,160,707 shares of Common Stock granted under the Company's employee benefit plans. See "Shares Eligible for Future Sale." Use of Proceeds. Approximately 38% of the estimated net proceeds of this offering are expected to be used to repay existing outstanding notes of the Company issued in the Placement transaction, and approximately 27% of the estimated net proceeds of this offering are expected to be used for working capital and general corporate purposes. See "Use of Proceeds" and "Capitalization--Recent Financing Transactions." Immediate and Substantial Dilution. Investors participating in this offering will incur immediate, substantial dilution of $3.09 per share. To the extent options or warrants to purchase Common Stock are exercised, there may be further dilution. See "Dilution." 13 USE OF PROCEEDS The net proceeds to the Company from the sale of the 700,000 Units offered hereby are estimated to be approximately $3,713,000 ($4,302,000 if the Underwriters' over-allotment option is exercised in full), after deducting estimated underwriting discounts and commissions and offering expenses. The Company expects to use the net proceeds of this offering as follows:
APPROXIMATE APPROXIMATE PERCENTAGE OF NET APPLICATION OF NET PROCEEDS DOLLAR AMOUNT PROCEEDS --------------------------- ------------- ----------------- Repayment of outstanding debt(1)............... $1,397,000 38% Facilities and capital expenditures(2)......... $ 600,000 16% Research and development(3).................... $ 716,000 19% Working capital and general corporate purposes(4).................................... $1,000,000 27%
- -------- (1) The Company intends to apply these proceeds to repay approximately $1,397,000 payable under the notes issued in the Placement. See "Capitalization--Recent Financing Transactions" and "Certain Transactions." (2) The Company intends to conduct a feasibility study concerning construction of an isotope manufacturing facility, estimated at approximately $200,000, purchase equipment, estimated at approximately $400,000. See "Business-- Manufacturing and Supply." (3) The Company intends to use an estimated approximately $100,000 of the net proceeds to further develop and select technology associated with the diagnostic breath test market, an estimated approximately $566,000 of the net proceeds to develop and test isotopically pure silicon and an estimated approximately $50,000 of the net proceeds to continue research and development of existing products. (4) The Company intends to use a portion of the proceeds for general corporate purposes which may, among other purposes, include inventory purchases, accounts receivable financing and administrative salaries. The foregoing represent estimates only, and the actual amounts expended by the Company for these purposes and the timing of such expenditures will depend on numerous factors. The Company may use a portion of the net proceeds to acquire businesses or products complementary to the Company's business, although the Company currently has no specific plans or commitments in this regard. Pending use of the net proceeds for the above purposes, the Company intends to invest such funds in short-term, interest-bearing, investment-grade obligations and federally insured certificates of deposit. DIVIDEND POLICY The Company has never declared or paid any cash dividends on its capital stock. The payment of any future dividends will be at the discretion of the Company's Board of Directors and will depend upon, among other things, future earnings, operations, capital requirements, the general financial condition of the Company, general business conditions and contractual restrictions on payment of dividends, if any. The Company currently anticipates that it will retain all future earnings for use in its business and does not anticipate paying any cash dividends in the foreseeable future. 14 CAPITALIZATION The following table sets forth the short-term debt and capitalization of the Company as of April 30, 1997, and as adjusted to give effect to the sale and application of the 700,000 Units offered hereby at an assumed initial public offering price of $7.00 per Unit and the issuance of Underwriter's Warrants to purchase 70,000 Units, after deducting underwriting discounts and commissions and other estimated expenses of the offering.
APRIL, 1997 ---------------------- ACTUAL AS ADJUSTED(1) ------ -------------- (IN THOUSANDS) Short-term debt...................................... $ 403 $ 403 Long-term debt....................................... 1,268 115 Shareholders' equity: Class A Preferred stock, no par value, 10,000,000 shares authorized actual and as adjusted; no shares issued or outstanding actual and as adjusted ......................................... -- -- Common stock, no par value actual and as adjusted, 20,000,000 shares authorized actual and as adjusted: 4,550,268 shares issued and outstanding actual and 5,950,268 as adjusted.................. 1,129 4,842 Notes receivable from shareholders................. (343) (343) Accumulated deficit................................ (1,396) (1,747) ------ ------ Total stockholders' equity......................... (610) 2,752 ------ ------ Total capitalization............................. $1,061 $3,270 ====== ======
- -------- (1) The "As Adjusted" amount includes a charge to retained earnings and the statement of operations of $351,000, representing the unamortized value of the Warrants and discounts relating to the Placement (as defined below in "--Recent Financing Transactions"). The foregoing table excludes (i) 689,809 shares of Common Stock issuable upon exercise of outstanding options at a weighted average exercise price of $.77 per share, (ii) 720,000 shares reserved for future grants under the Company's employee benefit plans, (iii) 1,572,034 shares of Common Stock issuable upon the exercise of outstanding warrants at a weighted average exercise price of $1.32 per share, (iv) 280,000 shares of Common Stock issuable upon the exercise of the Underwriter's Warrants and the warrants included therein, (v) 1,400,000 shares of Common Stock issuable upon exercise of the Warrants offered hereby and (vi) options to purchase 120,000 shares of Common Stock at an exercise price equal to 110% of the IPO Price Per Share. RECENT FINANCING TRANSACTIONS In a fiscal 1997 private placement (the "Placement"), the Company issued approximately $1,397,000 principal amount of 12% nonconvertible promissory notes (the "Placement Notes") and warrants (the "Placement Warrants") to acquire 681,936 shares (the "Placement Shares") of Common Stock to a small number of sophisticated investors (the "Placement Investors"). Net proceeds were approximately $1,230,000. The Placement Notes as originally issued bear interest at 12% per annum and are due and payable in full at the earlier of five business days after the Company receives funds from this offering or May 1, 1998. Unless the Placement Notes are earlier paid in full (i) accrued but unpaid interest at 12% per annum became due and payable monthly from September 1996 through May 1997 and (ii) principal and accrued but unpaid interest at 15% per annum became due and payable in equal installments monthly from June 1997 through May 1998. The Company may prepay any or all of the amounts due under the Placement Notes at any time without penalty. To secure repayment of the Placement Notes, the Company entered into a security agreement, granting a security interest to the Placement Investors in substantially all of the assets of the Company. The security agreement and certain provisions of California law govern the rights of the Placement Investors in the collateral, the events of default 15 which authorize their resort to the collateral, and the procedures governing the treatment and disposition of the collateral if the Placement Investors elect to resort to the collateral in the event of such default. Upon repayment of the Placement Notes, the collateral will be released in full. Placement Warrants to purchase 340,968 Placement Shares are exercisable in whole at any time or in part at $0.1771 per share, and Placement Warrants to purchase 340,968 Placement Shares are exercisable in whole at any time or in part at $1.4165 per share, in each case for a period of five years. If the Company defaults in its payment obligations under the Placement Notes, then the Placement Investors may, in addition to exercising their rights in the collateral, exercise additional Placement Warrants to purchase a total of approximately 448,710 additional Placement Shares (such warrants referred to as "Default Warrants") at $0.01 per share, and can require the holders of approximately 3,801,234 shares of Common Stock to vote their shares to elect as a majority of the Company's Board of Directors the designees of the Placement Investors. In conjunction with the financing, the Company issued warrants to purchase 304,098 shares of Common Stock exercisable for a period of five years at $0.5788 per share to an advisor. On July 23, 1997, the terms of the Placement Notes were amended. Effective August 1, 1997, interest is payable monthly at 15% per annum. If the Placement Notes are not paid in full by April 1998, the remaining principal and interest is payable in equal monthly installments from May 1998 through April 1999. In connection with the amendment of the Placement Notes, the Company issued warrants to the noteholders to purchase a total of 450,000 shares of Common Stock, exercisable for a period of four years, at $2.083 per share. The Company intends to repay the Placement Notes out of a portion of the net proceeds of this offering. See "Use of Proceeds." As a result, after the closing of this offering no Placement Notes will remain outstanding, and no Default Warrants will be issued. The Company has agreed to file at its expense a registration statement under the Securities Act no later than nine months after the effectiveness of this offering registering the resale of the Placement Shares, and the Placement Investors have certain additional piggyback registration rights. See "Description of Capital Stock--Registration Rights." An aggregate discount of $561,000 is being amortized as interest expense over the contractual life of the Placement Notes. This discount is comprised of $394,000 representing the fair value of the warrants issued in connection with the Placement, $137,000 representing discounts on the Placement Notes and $30,000 representing expenses of the Placement. Accordingly, in the quarter in which this offering is completed, the unamortized discount will be recorded as a charge to operations for debt restructuring (as an extraordinary item) and will be reflected in the Company's statement of operations for that period. The charge is likely to have a material effect on the Company's reported earnings for that quarter, and as a result the Company expects to have a significant net loss for the quarter in which the offering occurs. Certain of the Company's directors, employees, and other related persons participated in the Placement. See "Certain Transactions." 16 DILUTION The pro forma net tangible book value of the Company as of April 30, 1997 was $(1,832,000) or $(.40) per share of Common Stock. Pro forma net tangible book value per share represents the amount of the Company's stockholders' equity, after deducting the value of intangible assets of $977,000 and the unamortized warrant discount of $245,000, divided by 4,550,268 shares of Common Stock outstanding at April 30, 1997. After giving effect to the sale of the 1,400,000 shares of Common Stock and 1,400,000 Warrants included in the 700,000 Units offered by the Company hereby at an assumed initial public offering price of $7.00 per Unit and ascribing no value to the Warrants for this purpose, and after deducting the estimated underwriting discounts and commissions and offering expenses, the pro forma net tangible book value of the Company as of April 30, 1997 would have been $2,437,000 or $.41 per share. This represents an immediate increase in net tangible book value of $.81 per share to existing shareholders and an immediate dilution of $3.09 per share to new investors purchasing Common Stock and Warrants at the assumed initial public offering price. The following table illustrates the per share dilution. Assumed initial public offering price per share................ $3.50 Net tangible book value per share at April 30, 1997.......... $(.40) Increase in net tangible book value per share attributable to new investors............................................... $ .81 Pro forma net tangible book value per share after the offering. .41 ----- Net tangible book value dilution per share to new investors.... $3.09 =====
The following table summarizes, on a pro forma basis as of April 30, 1997, the difference between the existing shareholders and the purchasers of shares of Common Stock and Warrants in this offering (at an assumed initial public offering price of $3.50 per share and ascribing no value to the Warrants) with respect to the number of shares of Common Stock purchased from the Company, the total consideration paid and the average price per share paid:
TOTAL SHARES PURCHASED CONSIDERATION ----------------- ------------------ AVERAGE NUMBER PERCENT AMOUNT PERCENT PRICE PER SHARE --------- ------- ---------- ------- --------------- Existing shareholders.. 4,550,268 76.5% $ 735,000 13.0% $0.16 New investors.......... 1,400,000 23.5% $4,900,000 87.0% $3.50 --------- ----- ---------- ----- Totals............. 5,950,268 100.0% $5,635,000 100.0% ========= ===== ========== =====
The foregoing table assumes no exercise of the Underwriters' over-allotment option and no other exercise of options and warrants. After giving effect to the Placement and this offering, as of July 31, 1997, there were (i) 689,809 shares of Common Stock issuable at a weighted average exercise price of $.77 per share upon exercise of options granted under the Company's employee benefit plan, (ii) 1,572,034 shares of Common Stock issuable at a weighted average exercise price of $1.32 per share upon the exercise of Placement Warrants and warrants issued in conjunction with the Placement, (iii) 1,400,000 shares of Common Stock issuable at an exercise price of $4.00 upon exercise of the Warrants, (iv) 280,000 shares of Common Stock issuable upon exercise of the Underwriter's Warrants, and (v) 120,000 shares of Common Stock issuable at an exercise price equal to 110% of the IPO Price Per Share. To the extent that any of these options or warrants are exercised, there may be further dilution to new investors. See "Capitalization," "Management--Employee Benefit Plans" and "Description of Capital Stock." 17 SELECTED FINANCIAL DATA The following selected financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Financial Statements and Notes thereto included elsewhere in this Prospectus. The selected financial data, insofar as it relates to each of the years ended April 30, 1996 and 1997, have been derived from audited financial statements, including the balance sheets at April 30, 1996 and 1997 and the related statements of operations for each of the two years ended April 30, 1997 and notes thereto appearing elsewhere herein.
YEAR ENDED APRIL 30, --------------- 1996 1997 ------ ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF OPERATIONS DATA: Net revenues............................................... $5,567 $ 4,539 Cost of revenues........................................... 3,835 3,616 ------ ------- Gross margin............................................. 1,732 923 Operating expenses: Selling, general and administrative...................... 902 1,183 Research and development................................. 308 655 ------ ------- 1,210 1,838 ------ ------- Operating income (loss).................................... 522 (915) Other expenses, net........................................ (66) (395) ------ ------- Income (loss) before income taxes.......................... 456 (1,310) Income tax expense......................................... 175 53 ------ ------- Net income (loss).......................................... $ 281 $(1,363) ====== ======= Net income (loss) per share ............................. $ .05 $ (.23) ====== ======= Shares used in computing per share information........... 5,949 5,890 ====== ======= Pro forma (loss) per share............................... (.16) ======= Shares used in computing pro forma information........... 6,430 ======= APRIL 30, --------------- 1996 1997 ------ ------- (IN THOUSANDS) BALANCE SHEET DATA: Cash and cash equivalents.................................. $ 116 $ 28 Working capital (deficiency)............................... (61) (441) Total assets............................................... 1,788 2,684 Long-term debt............................................. 276 1,268 Accumulated deficit........................................ (33) (1,396) Total shareholder's equity (deficit)....................... 170 (610)
18 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following Management's Discussion and Analysis of Financial Condition and Results of Operations, as well as other portions of this Prospectus, contains certain forward-looking statements that involve substantial risks and uncertainties. When used herein, unless the context otherwise requires, words such as "anticipates," "believes," "estimates," "expects" and similar expressions as they relate to the Company or its management are intended to identify such forward-looking statements. The Company's actual results, performance or achievements could differ materially from the results expressed in, or implied by, these forward-looking statements. Factors that could cause or contribute to such differences include those discussed in "Risk Factors." OVERVIEW The business of the Company was founded in March 1992 and was initially conducted as a partnership. In March 1993, the Company was incorporated and the business was transferred to the Company. The Company was initially engaged in the business of marketing non-radioactive stable isotopes for the energy industry. During fiscal 1996, the Company expanded its business operations to include developing specialty chemicals and materials, and conducting research and development concerning potential products, for the medical research, diagnostic, pharmaceutical and semiconductor industries. The Company believes that a substantial portion of its revenues in the future will depend on its success in developing and selling products in these markets. The Company's quarterly operating results have varied in the past and may in the future vary significantly, depending on factors such as the size and timing of customer orders, price and other competitive conditions and the timing of new product announcements and releases by the Company and its competitors. The Company operates with little order backlog. Moreover, a significant portion of the Company's total revenues have been, and the Company believes will continue to be, derived from a limited number of orders in any particular quarter, and the timing of such orders and their fulfillment has caused, and is likely to continue to cause, material fluctuations in the Company's operating results, particularly on a quarterly basis. As has been the case in prior quarters, these factors will affect the Company's operating results for the future periods. As a result, a lost or delayed sale could have a significant impact on the Company's operating results for a particular period. It is likely that in some future quarter, the Company's operating results will be below the expectations of public market analysts and investors. In such event, the price of the Common Stock would likely be materially adversely affected. The Company has experienced, and expects to continue to experience, significant fluctuations in its results of operations. See "Risk Factors." Some of the factors that affect the Company's results of operations include the volume and timing of orders received, changes in the mix of products sold, market acceptance of the Company's and its customers' products, competitive pricing pressures, the Company's ability to develop and introduce new products, and the timing and extent of research and development expenses. As a result of the foregoing or other factors, there can be no assurance that the Company will not experience material fluctuations in future operating results on a quarterly or annual basis, and such fluctuations could materially and adversely affect the Company's business, financial condition and results of operations. Historically, substantially all of the Company's net revenues in any particular period have been attributable to a limited number of customers. Consistent with the Company's historical experience, the Company's quarterly results are expected to be materially affected by the level of orders received from significant DZ users during such quarter and product shipments during such quarter in response to any such orders, factors which cannot be predicted with certainty until the third month of the quarter. The Company expects that if it continues to increase sales of depleted zinc products to end users and develop and sell products in the medical and research and electronic materials industries, concentration of net revenues from a limited number of customers will be reduced. None of the Company's customers have entered into long-term agreements to purchase the Company's products. If completed sales orders are not replaced on a timely basis by new orders from customers, the Company's net revenues could be materially and adversely affected. The Company's net revenues also could be 19 adversely affected by a number of factors including the loss of a significant customer, reductions in orders from any significant customer compared to historical buying levels or otherwise or the cancellation of a significant order from a customer. Any of these factors, many of which are outside the Company's control, could have a material adverse effect on the Company's business, financial condition and results of operations. In March 1995, the Company acquired certain assets and assumed certain liabilities of Isoserve, Inc. ("Isoserve"), a stable isotope supplier. The acquisition was accounted for as a purchase. Isoserve was the only other supplier of DZ in the world at the acquisition date. By virtue of its acquisition of the Isoserve assets and assumption of liabilities, the Company effectively became the sole source for DZ worldwide. Management believes this acquisition has had a significant positive impact on the Company's net revenues in fiscal 1996 and 1997. The Company cannot determine what the results of operations from sales of DZ would have been in fiscal 1996 had the Company not acquired Isoserve. RESULTS OF OPERATIONS The following table sets forth certain operating data as a percentage of total net revenues for the periods indicated.
YEAR ENDED APRIL 30, ------------ 1996 1997 ----- ----- Net revenues.................................................. 100.0% 100.0 % Cost of revenues.............................................. 68.9 79.7 ----- ----- Gross margin................................................ 31.1 20.3 Operating expenses: Selling, general and administrative......................... 16.2 26.1 Research and development.................................... 5.5 14.4 ----- ----- Total operating expenses...................................... 21.7 40.5 ----- ----- Operating income (loss)....................................... 9.4 (20.2) Other expense, net............................................ (1.2) (8.7) ----- ----- Income (loss) before income taxes............................. 8.2 (28.9) Income tax expense (benefit).................................. 3.2 (1.1) ----- ----- Net income (loss)............................................. 5.0% (30.0)% ===== =====
Net Revenues. Net revenues decreased from $5.6 million in fiscal 1996 to $4.5 million in fiscal 1997, a decrease of approximately $1.1 million or 20%. The decrease was due primarily to reduced sales of energy products and to a lesser extent cadmium which was offset in part by sales of stable isotope labeled compounds ("SILCs"). The decrease in net revenues from energy products of approximately $1.3 million was the result of reduced unit sales of approximately 29%, which was offset in part by increases in average unit prices during the period from direct sales to end users and for additional processing performed by the Company. The decrease in revenues from sales of energy products was also due in part to a significant order to an end user being deferred from the fourth quarter of fiscal 1997 to the first quarter of fiscal 1998, and as well due to the decision of GE, which is the Company's largest customer, and a reseller of the Company's products, to minimize inventory levels and delay purchases until the first and second quarters of fiscal 1998. Net revenues from cadmium decreased approximately $346,000 on reduced unit sales of approximately 7%. The decrease was due primarily to reduced average unit prices as a result of market competition and the availability of superior lasers which do not utilize cadmium. The Company anticipates that future sales of cadmium will continue to decrease as the next generation of lasers, which do not require the use of cadmium, enter the market. Net revenues from SILCs increased from approximately $5,000 during fiscal 1996 to approximately $632,000 during fiscal 1997. The increase was the result of the Company's entry into the SILC market. 20 International sales represented approximately 13% of net revenues in fiscal 1996 and less than 10% in fiscal 1997. International sales were principally to Asia and are denominated in U.S. dollars. Gross Margin. Gross margin is affected by the volume of product sales, product mix and average selling price. The Company's gross margin percentage decreased to 20.3% of net revenues in fiscal 1997 from 31.1% in fiscal 1996, due to increased raw material and processing costs associated with energy related products, which was offset in part by increased per unit sales prices. Gross margin percentage was also negatively affected by a charge of approximately $50,000 to reduce the Company's cadmium inventory to reflect a decline in its value and a decrease in the average unit sales price of cadmium and unchanged average unit costs. The gross margin percentage was also negatively affected by the increased proportion of net revenues associated with SILCs. During fiscal 1997, approximately 14% of net revenues were generated from sales of SILCs, which at present have lower gross margins than energy and cadmium products. During fiscal 1996, less than 1% of net revenues were generated from sales of SILCs. Selling, General and Administrative Expenses. Selling general and administrative expenses increased from $902,000, or 16.2% of net revenues, to $1,183,000, or 26.1% of net revenues, for fiscal 1996 and 1997, respectively. The increase was due to additional finance and administrative staffing and increased professional costs. The Company anticipates selling, general and administrative expenses will generally continue to increase in absolute dollars, but may vary as a percentage of net revenues. Research and Development Expenses. Research and development increased from $308,000, or 5.5% of revenues, to $655,000, or 14.4% of net revenues, for fiscal 1996 and 1997, respectively. The increase was due to material and outside consulting costs associated with the development of isotopically pure silicon wafers and to increased staffing for product development. The Company believes that the development and introduction of new product applications is critical to its future success and expects that research and development expenses will increase on a dollar basis, but may vary as a percentage of net revenues. Other Expense, Net. Other expense reflects interest, amortization of issuance costs and discounts on long and short term borrowings. Other expense, net, increased from $16,000 in fiscal 1996 to $395,000 in fiscal 1997. The increase was due to cash payments of interest on debt issued in fiscal 1997, as well as amortization of approximately $210,000 in issuance costs and discount related to warrants issued in conjunction with the debt. See "Capitalization--Recent Financing Transactions." Income Taxes. The provision for income taxes was $175,000 and $53,000 for fiscal 1996 and 1997, respectively. The Company's effective tax rate of 38% for fiscal 1996 differs from the statutory rate due to state income taxes, net of the federal benefit. The provision for income taxes of $53,000 for fiscal 1997 and effective rate of 4% were the result of providing a valuation allowance on deferred tax assets, as the Company believes realization of such assets is uncertain. The provision was offset in part by a benefit from net operating losses which will result in a refund of certain taxes paid in the prior year. Extraordinary Item. As a result of the Placement Notes issued in the Placement, the Company is amortizing to interest expense an aggregate discount of $561,000 over the contractual life of the Placement Notes. In the quarter in which this offering is completed, the amount of the discount which has not already been amortized will be recorded as a charge to operations for debt restructuring and is expected to be shown as an extraordinary item and will be reflected in the Company's statement of operations for that quarter, and as a result the Company expects to have a significant net loss for the quarter in which the offering occurs. As of April 30, 1997, approximately $351,000 of the discount remained to be amortized. See "Capitalization--Recent Financing Transactions." LIQUIDITY AND CAPITAL RESOURCES Since inception, the Company has primarily financed its operations through a combination of cash flow from operations, borrowed funds, lease financing and private sales of equity securities. The Company generated cash 21 flow from operating activities of $180,000 in fiscal 1996, principally as a result of net income, adjusted for noncash items, increases in accounts payable and income taxes payable offset by increased inventory. Cash used by operating activities $1,021,000 for fiscal 1997 was principally the result of the net loss of $1,363,000 and increases of inventory, offset by adjustments for noncash expense items and increases in accounts payable and accrued liabilities. The Company's investing activities used cash of $7,000 and $10,000 in fiscal 1996 and 1997, respectively. Such investing activities were for purchases of property and equipment. Financing activities used cash of $95,000 in fiscal 1996. Such financing activities consisted of the issuance of notes which were more than offset by principal payments on outstanding debt. Financing activities provided cash of $943,000 in fiscal 1997, consisting of the issuance of notes and common stock which were offset in part by payment of debt, debt issuance costs, and deferred offering costs. The Company is required to make royalty payments to Isoserve for each gram of depleted zinc metal sold until March 2000. Minimum annual royalty payments of $100,000 are required regardless of sales volume until the Company has paid $500,000 in the aggregate. The maximum royalty payments under the agreement are $1,000,000. As of April 30, 1997, the Company has paid cumulative royalties of $338,000 to Isoserve. As of April 30, 1996 and 1997 the Company had negative working capital of $61,000 and $441,000, respectively. These working capital deficiencies were the result of the significant losses from operations in the Company's early stages, and losses incurred in fiscal 1997 to increase its market position for DZ and develop new products associated with the DBT and semiconductor market. The Company believes that the net proceeds of this offering will eliminate these working capital deficiencies upon the closing of this offering. At present, the Company has no credit facility with a bank or other financial institution and no in-place source of capital, other than the approximately $1,230,000 net proceeds of the Placement, see "Capitalization--Recent Financing Transactions." The Company intends to use a portion of the net proceeds of this offering to repay the Placement Notes. The Company also intends to use a portion of the net proceeds of this offering to conduct an engineering study to determine the feasibility of purchasing or building an isotope production facility. If the Company decides to proceed with purchasing or constructing such a facility, additional financing would be required. The Company currently has no arrangements for loans or other financing relating to any such construction. The unavailability of such financing could adversely affect its ability to increase sales of new products. The additional funding, if needed, may not be available on terms attractive to the Company, if at all. While the timing and amount of capital requirements cannot be predicted with certainty, the Company believes that cash on hand at April 30, 1997, together with the net proceeds from this offering will be sufficient to allow the Company to continue its expected level of operations for at least 12 months from the date of this Prospectus. Any additional equity financing may be dilutive to shareholders, and debt financing, if available, may involve restrictive covenants. See "Use of Proceeds" and "Risk Factors--Future Additional Capital Requirements." 22 BUSINESS Isonics is an advanced materials and technology company which develops and commercializes products based on enriched stable isotopes. Stable isotopes can be thought of as ultra-ultra pure materials. This high degree of purification accomplished on the sub-atomic level provides enhanced performance properties compared to normal purity materials. Stable isotopes have commercial uses in several areas, including energy; medical, research, diagnostics and drug development; product tagging and stewardship; semiconductors; and optical materials. Isonics has successfully developed and commercialized two stable isotope products and intends to promote the emergence and growth of new stable isotope applications. The Company's principal product to date is isotopically depleted zinc ("DZ"). DZ, in different chemical forms, is used to prevent corrosion in nuclear power plants. Corrosion is a cause of high radiation fields in such plants and can result in radiation exposure to workers. DZ also reduces environmental cracking in certain kinds of nuclear reactors which, if not controlled, can require extremely costly repairs or can result in premature shutdown and de-commissioning of the facility. The Company believes that it provides substantially all of the DZ used in nuclear power plants worldwide. The application of DZ was developed by General Electric Company ("GE"), where the founders of the Company were previously employed. Before fiscal 1997, all sales of DZ by the Company were made to GE pursuant to sales orders, which in turn resold the product to end users. In addition to sales to GE, in fiscal 1997 Isonics commenced direct sales to end users, and for the year ended April 30, 1997, approximately 30% of net revenues were from sales made directly to end users. New applications for stable isotopes are continually being developed by the Company and by third parties. The Company believes that many new applications have the potential to create new markets. One opportunity is to supply stable isotope labeled compounds for the diagnostic breath test ("DBT") market. DBTs provide early diagnosis of conditions that could otherwise lead to expensive procedures such as endoscopies and biopsies. DBTs under development by third parties which utilize stable isotopes in their application include tests to diagnose peptic ulcers, fat malabsorption and liver function. A urea DBT relating to peptic ulcers has recently been approved by the U.S. Food and Drug Administration (the "FDA"), and the Company believes that other companies have applied to the FDA or comparable agencies in foreign countries for approval of these tests, which must be obtained before any products can be sold. Certain DBTs are currently marketed in certain European countries. The Company has obtained an option, to acquire an exclusive license to two Yale University patents which cover semiconductor devices made of isotopically pure silicon, germanium, gallium arsenide and most isotopically pure compound semiconductors. The patents claim that isotopic purity provides improved device speed and improved thermal conductivity, two properties which are of great importance to the semiconductor industry. According to the Semiconductor Industry Association, sales in 1995 of silicon wafers and other semiconductor substrates were approximately $6 billion. The Company is collaborating with Yale and others to evaluate these isotopically engineered semiconductor applications. The Company believes that if evaluations demonstrate the commercial feasibility of one or more products, demand could emerge in certain segments of the semiconductor market. There can be no assurance, however, that these evaluations will demonstrate the commercial feasibility of any products, that the Company will be able to commercialize any such products or that a market will emerge for any such products. The Company was formed in March 1992 and incorporated in California in March 1993 under the name A&R Materials, Inc. In September 1996, the Company changed its name to Isonics Corporation. The Company's principal executive offices are located at 4010 Moorpark Avenue, Suite 119, San Jose, California, 95117. Its telephone number is (408) 260-0155. 23 BACKGROUND The following discussion utilizes several technical terms which are explained in greater detail in the Glossary preceding the financial statements at the end of this Prospectus. An isotope is one of two or more species of the same chemical element which differ from one another only in the number of neutrons in the nucleus of the atom. The different number of neutrons can create significantly different nuclear physics characteristics. To take advantage of some of these different characteristics, it is usually necessary to increase ("enrich") or decrease ("deplete") the concentration of a particular isotope. There are over 280 naturally occurring stable isotopes of 83 elements. Some elements have only one naturally occurring stable isotope, while others have many. Stable isotopes are not radioactive. Stable isotopes of an element differ in mass and diameter as well as several nuclear properties, such as cross-section, spin and magnetic moment. Differences in these properties can result in substantially different effects, and some of these differences have the potential for commercial application. For example, in ultra chemically pure crystals grown for electronics or optical applications, isotopic impurities are the greatest contributor to crystal disorder due to mass and diameter variations. Eliminating this disorder by using a single enriched isotope results in increased thermal conductivity and optical transparency, and thus in improved product performance. Similarly, enriching or depleting isotopes based upon their cross-sections allows materials to be engineered for applications in the nuclear power industry, for controlled doping of some semiconductors and for use as targets to produce radioisotopes for medicine and industry. Stable isotopes of an element do not differ significantly in their chemical behavior. Tagging of materials can be performed by varying the natural abundance of isotopes to give a compound its own mass or nuclear magnetic signature without changing its chemical properties. Though chemically equivalent, the "tagged" or labeled compound is discernible from its unlabeled twin through the use of several types of instruments called spectrometers. COMPANY STRATEGY The Company believes that its strength is the ability to bring the necessary elements together to identify, evaluate, develop, engineer and successfully commercialize applications for stable isotopes and value-added products manufactured from stable isotopes. This is evidenced by management's experience (at the Company and in prior employment) in developing DZ from a cost prohibitive concept to a commercial product. DZ is now one of the largest worldwide commercial applications of a stable isotope product. The Company believes it has created a product development model that can serve as a basis for current and future expansion efforts of the Company. Isonics believes that coordination with the ultimate user to establish a product specification and, with the Company's Russian partners, to establish a cost effective product manufacturing process to meet that specification, has the potential to make the Company a viable competitor. This coordination process also includes initiating and managing development projects necessary to adapt existing manufacturing methods to new missions, assembling and coordinating necessary project-specific product and service suppliers, obtaining appropriate regulatory approvals, and verifying product conformance to stringent customer requirements. To capitalize on the commercial opportunities that have been identified for stable isotopes, the Company has adopted a business strategy designed to maximize the value of its technologies, business development and management resources, while attempting to minimize capital costs arising from addressing multiple markets. This strategy involves: . focusing on development of high value-added products which have a perceived competitive advantage in large or growing markets; 24 . leveraging research and development expenditures through collaborations, government programs and corporate partnerships, including performing substantial work in Russia, where the Company believes an attractive value per dollar of cost can be obtained; . minimizing early capital needs by obtaining stable isotopes through alliances and supply agreements with Russian stable isotope sources, followed by investment in Company owned isotope production facilities when markets are more established and the optimum production technology has been determined; . obtaining value-added processing technology through sub-contract manufacturing agreements, joint ventures and acquisitions of strategically important technologies and companies; and . developing a time-balanced product pipeline to provide a continual supply of new business opportunities. PRODUCTS The Company's product pipeline includes products with current revenues (consisting of DZ, stable isotope labeled compounds, cadmium and medical imaging target materials), and other potential products that may, but will not necessarily, generate revenues beginning in future years (such as electronic materials and isotopically pure semiconductor fabrication materials, diagnostic breath test substrates, manufactured labeled compounds). Isotopically Depleted Zinc Maintaining radiation exposure of nuclear power plant workers to levels as low as reasonably achievable is mandated in the U.S. by the Nuclear Regulatory Commission. Also of significant concern is cracking of nuclear power plant structural materials due to the corrosive nature of the water used to cool the nuclear reactor core. Nuclear power plants are designed with substantial safety margins against such cracking, and frequent surveillance is performed to assure that this safety margin is not compromised. If not controlled, cracking can require extremely costly repairs or, if not reparable, can result in premature shutdown and de-commissioning of a facility which may have cost hundreds of millions of dollars or more to construct. Testing sponsored by the Electric Power Research Institute has shown that the addition of a soluble form of zinc to the nuclear reactor coolant reduces plant radiation fields, and in some cases, substantially mitigates environmentally induced cracking. Zinc acts as a corrosion inhibitor for the stainless steel and other metal components of the nuclear reactor systems. In boiling water reactors ("BWRs"), zinc prevents the development and concentration of corrosion products, the cause of high radiation fields which can result in radiation exposure to plant workers. In pressurized water reactors ("PWRs"), zinc not only prevents radiation field build-up, but has been shown in a PWR test to substantially reduce environmental cracking. Zinc provides the important benefits outlined above, but one isotope of natural zinc becomes radioactive in the nuclear reactor, thus offsetting a substantial portion of the desired benefits. By depleting this zinc isotope, the desired benefits are still obtained while the detrimental side effect is essentially eliminated. This product is known as isotopically depleted zinc ("DZ"). DZ is currently sold to 26 of the approximately 95 BWRs in the world including 23 of the 37 U.S. BWRs. Typical current annual DZ requirements for a BWR utilizing DZ are approximately $250,000 to $350,000, based on current prices. One PWR is currently adding DZ on a routine basis. The Company believes that six to eight more PWRs will begin zinc injection by the end of 1998, and that many will use DZ. Programs to evaluate the effectiveness of utilizing DZ at PWRs are underway in the United States and certain foreign countries. These programs are demonstrating the commercial effectiveness of DZ for PWRs.The Company believes that a market may develop for DZ use in PWRs, due in part to the importance of environmental cracking mitigation. Initial test results suggest that PWRs will probably use a smaller amount of DZ per plant as compared to BWRs, but there are approximately 200 PWRs in the world. At present prices, the Company estimates the potential market for sales to nuclear power plants to be between approximately $50-$70 million. There can be no assurance that a 25 market will develop for DZ sales to PWRs, that the Company will be able to sell DZ to all such potential customers, or that selling prices of DZ will not decrease. Sales of DZ are presently the Company's largest source of revenues, representing approximately 88% and 89% of net revenues in fiscal 1996 and 1997 respectively. In March 1995, Isonics acquired the stable isotope business of Isoserve. The Company and Isoserve have supplied substantially all of the DZ used in nuclear power plants in the world to date. Until fiscal 1997, DZ was sold only to GE, which in turn resold it to the end-user nuclear power utilities. The Company's sales of DZ to GE have been pursuant to sales orders placed from time to time by GE, and the Company does not have any written purchase or sales agreements with GE relating to sales of DZ or other products. In addition to sales to GE, the Company currently is marketing DZ directly to U.S. and foreign utilities and direct end-users and, for the year ended April 30, 1997, approximately 30% of net revenues were from end-users. The Company believes that direct sales to end users may increase in the future, while sales to GE may remain level or decrease. There can be no assurance as to the size of orders, if any, from direct end users in the future or as to the number of customers that can purchase DZ from the Company. See "Risk Factors--Number of DZ Customers." The Company believes that the decision to purchase DZ is price sensitive. The Company is actively working to further reduce costs by utilizing in-house production of raw materials, developing and implementing low-cost zinc oxide processing technologies, and providing DZ in innovative forms which lowers the utilities' overall cost. Cadmium Sales of cadmium isotopes represented approximately 12% and less than 10% of net revenues in fiscal 1996 and 1997, respectively. The Company sells enriched cadmium for use in helium cadmium lasers. Cadmium isotopes may also be used for the manufacture of radioisotopes and might be used in semiconductors and cadmium vapor lighting products. Future sales will likely decrease rapidly as a new solid state laser, capable of higher power and generally improved performance, is already commercially available. Stable Isotope Labeled Compounds Stable isotope labeled compounds ("SILCs") are created by incorporating carbon, nitrogen, hydrogen and oxygen isotopes into several thousand relevant chemical compounds. Sales of SILCs represented approximately 14% of net revenues in fiscal 1997 and were insignificant in fiscal 1996. SILCs allow researchers to probe the metabolism of living systems, determine the structures of important biological compounds, design new drugs and measure extremely low levels of environmental toxins. The Company believes that greater availability of stable isotopes and advances in instrumentation (improvements in sensitivity and reduced cost) will promote increased demand for SILCs. Examples of existing and emerging applications include: . Metabolic studies. Increasingly, drug studies are performed with labeled drugs to facilitate research on metabolism, distribution, mode of action and elimination. The FDA may eventually mandate the labeling of all new drugs for investigational use during some or all phases of pre-clinical and clinical evaluations of these drugs, but there can be no assurance that the FDA will make this mandate in the near future, if at all. . Rational drug design. Nuclear magnetic resonance ("NMR") spectroscopy is being developed as a tool to determine the structure of larger and larger molecules in solution, many of which cannot be analyzed by the more traditional x-ray crystallography techniques. The Company believes that this new NMR sensitivity combined with the sophisticated isotopically labeled cell growth media needed to produce the labeled human proteins will require an increasing supply of the stable isotopes of carbon, nitrogen and deuterium. . Product tagging and stewardship applications. The source of materials and explosives may be identified, without changing their chemistry, by tagging with the stable isotopes of carbon, nitrogen, oxygen and hydrogen. Several other approaches are currently being implemented, and other technologies have also 26 been proposed. These other approaches involve the addition of extraneous materials such as dyes, exotic chemical compounds or radioactive compounds. The Company believes that adding such extraneous materials can sometimes detract from the performance of the product. Tagging with small amounts of isotopically engineered versions of the material itself results in a unique identifier which behaves chemically in exactly the same way as the host material. The Company's efforts to date in the production and sales of SILCs have focused on structurally simple "building block" compounds which are used by its customers to synthesize more complex and higher value SILCs. The Company presently markets carbon-13 and nitrogen-15 building block SILCs which it obtains through its supply alliance with several stable isotope producers. In the near term, the Company will continue this strategy of supplying "building block" forms of stable isotopes while at the same time increasing its production capacity both at its alliance producers and Company facilities. See "--Manufacturing and Supply." In addition to providing additional revenue potential and possibly higher margins, the Company believes that developing complex SILC synthesis capability would be synergistic with any Company efforts to develop the breath test diagnostics product area, and would also aid in early identification of future stable isotope business opportunities. Diagnostic Breath Tests Healthcare consumes a large amount of resources in the U.S. and worldwide. The Company believes that substantial changes are taking place to control or reduce the high costs of health maintenance. A significant trend is a general shift from therapy to cost-effective prevention. Early diagnosis of conditions which otherwise could require expensive therapies, such as surgical and invasive diagnostic gastrointestinal procedures, could help diminish the risks and expense of such subsequent procedures. The Company has elected to pursue what it believes is a promising segment of this market: Diagnostic Breath Tests ("DBTs"). Breath tests are all based on the same principle and use a common instrument to measure the result: . a small amount of a carbon-13 SILC (referred to as a substrate) is swallowed by the patient; . breath samples are collected at regular intervals; and . breath samples are analyzed for their carbon-13 content. Most DBTs are intended to replace unpleasant, costly and sometimes risky procedures such as endoscopies and biopsies of the digestive system. The Company believes that DBTs may become a widely used and accepted diagnostic tool. Certain DBTs are currently being sold in certain European countries. Their ease of administration may allow medical internists and general practitioners to use them, potentially resulting in lower cost, earlier diagnosis and broader application. The market for DBTs is defined by the incidence of diseases addressed and existing alternative diagnostic procedures. The urea breath test is the most established DBT. As they become commercially available, carbon-13 urea breath tests ("UBTs") may address a potential population of approximately 8 million peptic ulcer patients in the U.S., who presently utilize drugs and procedures with an estimated cost of at least $2 billion each year. The Company believes that the UBT, coupled with antibiotic treatment, can reduce the cost of peptic ulcer management. One company in the U.S. has recently received FDA approval for a carbon-13 UBT. The Company believes that another company has applied for FDA approval for a carbon-13 UBT, and that several companies in Europe, including Sanofi and Inbiomed in France, are also pursuing regulatory approval. The Company intends first to enter this market as a carbon-13 and a pharmaceutical-grade substrate supplier. 27 The following table identifies additional breath tests which are at various stages of clinical research and pre-clinical and clinical trials by various third parties.
BREATH TEST CONDITION DIAGNOSED ----------- ------------------- /13/ C-Urea Helicobacter pylori /13/ C-Triolein Fat malabsorption /13/ C-Galactose Liver function /13/ C-Xylose Small Bowel Bacterial Overgrowth (the major cause of chronic diarrhea) /13/ C-Aminopyrine Liver function /13/ C-Caffeine Liver function Cyclosporin dosage following /13/ C-Erythromycin transplantation Genotype of MSUD (Maple Syrup Urine /13/ C-Valine Disease) /13/ C-Phenylalanine Genotype of PKU (Phenylketonuria) /13/ C-Sucrose Sucrose malabsorption (sucrase-isomaltase complex deficiency) /13/ C-Starch Pancreas amylase function /13/ C-Cholesteryl Octanoate Pancreas esterase function
The DBT business is subject to extensive government regulation. The products and instruments used, which may be regulated as drugs and devices, are subject to the scrutiny of FDA review and approval as well as ongoing FDA inspection of most aspects of the production, marketing, distribution and use of these tests. The Company believes that the production and marketing of DBTs is also subject to similar regulatory controls in the foreign countries where the Company would likely seek to market products. Consequently, such products cannot be commercially introduced for several years, and there can be no assurance that the products would ever be approved for use. Medical Imaging and Therapy Materials Stable isotopes of thallium, zinc, cadmium, xenon, oxygen, strontium and many others are routinely used in a variety of medical imaging and therapy applications. In their enriched form or converted to a specific radioactive isotope in a cyclotron or nuclear reactor, these materials are incorporated in chemical compounds which concentrate in specific parts of the human body upon injection, inhalation or ingestion. Measuring the distribution of the materials in the patient can assist physicians in diagnosing disease states and developing appropriate treatment therapies, some of which incorporate radioactive materials produced from stable isotopes. Most phases of the development and ongoing production of these materials are controlled by the FDA and similar foreign regulatory agencies. This fact, combined with the complexities of production and distribution, has resulted in a market with only a few manufacturers. Tight quality control requirements and the importance to the health care industry of a ready supply of these drugs leads these manufacturers to pay close attention to their stable isotope suppliers. Quality, supply reliability, ultimate source, breadth of offerings, price and track record are principal factors that a manufacturer considers in evaluating a potential stable isotope supplier. Much of the material used to manufacture such products originates in countries of the former Soviet Union. While the U.S. Department of Energy ("DOE") has facilities that can, and do, manufacture stable isotopes, its costs are usually substantially higher because of the full cost recovery mandated by legislation governing the DOE's operations. The Company is capable of supplying many of the stable isotopes currently sold in this market. Since the original impetus for new applications of stable isotopes in health care frequently comes from the drug manufacturers, the Company has recently begun marketing its products, services and capabilities to the existing and emerging manufacturers. Isotopically Pure Semiconductors Isotopic purification of carbon used to manufacture synthetic diamonds has resulted in substantially improved physical properties. Published tests conducted by GE and others have shown that the removal of a 28 small amount of carbon-13 to produce isotopically pure carbon-12 synthetic diamonds can result in a 50% improvement in room temperature thermal conductivity of the diamond. At cryogenic (i.e., extremely cold) temperatures, the heat conductivity is so great that it cannot be measured using conventional techniques. Additionally the new diamond was found to be highly transparent, and the transmission of certain frequencies of light was increased by approximately 10 times without the diamond sustaining damage. GE has stated that isotopically pure carbon-12 diamonds may enable faster, more reliable computers due to their superior heat removal capability and may result in more efficient laser cutting tools and more accurate laser measurement devices, and that the new diamonds may enable designers to use lasers in semiconductor fabrication techniques. Synthetic diamonds made from isotopically pure carbon-13 have been estimated by Ford Motor Company scientists to have more atoms per cubic centimeter than any other solid known to exist on earth. These isotopically pure carbon-13 diamonds would be harder than any other presently-known material. Studies conducted at Lawrence Berkeley Laboratory and the Max Planck Institute on isotopically pure germanium have shown thermal conductivity improvements similar to those found in isotopically pure carbon-12 diamonds. The Company believes that these and other improved properties might be found in other isotopically pure materials and may result in commercial opportunities, particularly in the area of semiconductors. According to the Semiconductor Industry Association, the 1995 market for silicon wafers and other semiconductor substrates was approximately $6 billion. This market is projected to grow 50% by the year 1999 to over $9 billion. Improvement in the thermal conductivity of these materials is important since as the feature size continuously decreases, the power density increases. As power density increases, more heat is generated per unit volume, causing device operating temperature to rise. The semiconductor industry is moving toward lower operating voltages and is using mechanical means to remove bulk heat, but the Company believes that greater heat dissipation on the micro scale will become even more important to the industry in the future. Better thermal conductivity directly affects heat removal capability and indirectly improves device speed. As the industry moves toward multi-layer devices and true 3-D chips, the ability to remove heat will be a material consideration for the semiconductor industry. Natural silicon contains three isotopes, silicon-28 (92%), silicon-29 (5%) and silicon-30 (3%). An otherwise perfect crystal of silicon will contain imperfections in the form of isotopes of different mass, with the density of these imperfections amounting to nearly 8%. This far exceeds the doping levels and density of imperfections ordinarily found in device-quality crystals. The Company believes that removal of the minor isotopes should result in substantially improved thermal conductivity. The Company believes that if commercial opportunities emerge, isotopically pure silicon-28 (99.5%) deployed as wafers or substrates and as silane for building epitaxial layers should find a niche in the manufacture of high performance silicon semiconductors. Even at the premium price required for isotopically pure silicon, the Company believes that it can compete in high performance, less cost driven market segments. Isonics has obtained an option entitling it to acquire an exclusive license regarding two U.S. patents concerning isotopically pure semiconductor devices, which are owned by Yale University. Yale's prior efforts to license its technology to semiconductor manufacturers was hindered by Yale's inability to obtain the necessary isotopically pure and chemically pure materials to evaluate its use. Since the Company's stable isotopes could enable the development and commercialization of the Yale technology, Yale chose to collaborate with the Company in evaluating isotopically pure semiconductors. These patents cover silicon, germanium, gallium arsenide and most isotopically pure compound semiconductors. The Company is collaborating with Yale to evaluate possible isotopically engineered semiconductor applications and their commercial feasibility, including cost. The Company believes that if evaluations demonstrate the commercial feasibility of one or more products, demand could emerge in certain segments of the semiconductor market. There can be no assurance, however, that these evaluations will demonstrate the commercial feasibility of any products, that the Company will be able to commercialize any such products or that a market will emerge for any such products. To exercise the option, the Company delivered to Yale specimens of isotopically pure silicon-28 meeting certain specifications. The option specifies that the terms of the license shall be reasonable, but the terms may be no less favorable to the Company than those specified in the option. The license, when finalized, will require payment 29 by the Company of an annual royalty based on a percentage of the Company's or its sublicensees' net sales of products derived from technology covered by the Yale patents. In addition, the license will permit deduction of one-half of the Company's reasonable cost of securing the silicon-28 from its future royalty payments to Yale University. Upon notice by the Company of its exercise of the option, the Company and Yale are required to negotiate in good faith to arrive at a license agreement within 90 days. In addition to silicon, the Company plans to evaluate a number of compound semiconductors, such as gallium arsenide, which may particularly benefit from enhanced heat dissipation capability. RESEARCH AND DEVELOPMENT Consistent with the Company's product development strategy, a variety of new stable isotope products and potential markets are continually being identified and evaluated for economic and technical feasibility, and the Company intends to devote a portion of the net proceeds of this offering for research and development. See "Use of Proceeds." The Company funds research and development to improve technologies for isotope separation and materials processing technologies performed at Moscow State University and has retained consultants to supervise the progress of such research. The Company's arrangements with the university do not obligate the Company to fund any particular level of expenditures. Payments to fund such research at the university have not been, and are not currently expected to be, in amounts material to the Company. Much of the expenditures to date have been in Russia to capitalize on the high quality of technology and economical labor rates. The Company's activities in Russia could, however, be directly affected by political, economic and military conditions in Russia. See "Risk Factors--Operations in Russia." PATENTS AND PROPRIETARY RIGHTS The Company relies primarily on a combination of trade secrets, confidentiality procedures and contractual provisions to protect its technology. Despite the Company's efforts to protect its rights, unauthorized parties may attempt to copy aspects of the Company's products or to obtain and use information that the Company regards as proprietary. Policing unauthorized use of the Company's technology and products is difficult. In addition, the laws of many countries do not protect the Company's rights in information, materials and intellectual property that it regards as proprietary to which it regards as great an extent as do the laws of the United States. There can be no assurance that the Company's means of protecting its rights in proprietary information, materials and technology will be adequate or that the Company's competitors will not independently develop similar information, technology or intellectual property. The Company currently has no patents and has not filed any patent applications. The Company has rights to several isotopically engineered innovations regarding electronic and optical materials which it believes may be patentable. Ongoing work in the area of isotope separation by chemical means may also lead to patentable inventions. To date, the Company has not been notified of any claim that the Company's products infringe the proprietary rights of third parties, but there can be no assurance that third parties will not claim infringement by the Company with respect to current or future products. Any such claims, with or without merit, could be time-consuming, result in costly litigation, cause product shipment delays or require the Company to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to the Company or at all, which could have a material adverse effect upon the Company's business, financial condition or results of operations. See "Risk Factors--Protection of Intellectual Property." COMPETITION The markets for the Company's products and proposed products are highly competitive, and the Company expects that competition will continue and increase as markets grow and new opportunities are realized. Some of the Company's current competitors, and many of the Company's potential competitors, are larger and have 30 significantly greater financial, technical, marketing and other resources. Some of the Company's competitors may form partnerships or alliances with large pharmaceutical or electronics companies, with the resulting entity possessing more market strength than the Company. The Company's competition varies greatly depending on which product or industry is considered. DZ. At present, the Company is the only producer of DZ, but believes that other entities or persons may begin producing DZ. Several such possible producers have adequate technical and financial resources to become viable competitors of the Company in the near future. In particular, Siemens has indicated that it has a relationship with Ultracentrifuge Netherlands ("UCN") and GE has indicated that it may establish a second Russian source to compete with the Company for GE purchases. UCN also competes with the Company in the markets for cadmium and in medical target isotopes. SILCs. The Company has several larger and numerous smaller competitors in the markets for the SILC products that the Company currently supplies, and will have additional competitors if it offers breath test diagnostic products and additional SILCs in the future. Two of these companies, Cambridge Isotope Laboratories Inc., and Isotec, Inc., have their own isotope separation capability, while all of the competitors produce some combination of SILCs and DBT substrates. One company in the U.S. has recently received FDA approval for a carbon-13 UBT. The Company believes that another company has applied for FDA approval for a carbon-13 UBT. Several companies in Europe are also pursuing regulatory approval. The Company's principal current competitors and potential competitors also include massTrace, euriso.top, Aldrich Chemicals, Icon Services, Omicron, C/D/N Isotopes and Martek Biosciences. The Company has in the past, and may in the future, sell products to or purchase products from these companies. Electronics and Optical Materials. Due to the early stage of the electronic and optical materials opportunities, the Company has not identified material competitors in these markets. However, given the potential size and importance of these new potential markets, the Company anticipates that substantial competition will emerge if these markets develop. Many of the areas in which the Company is or intends to compete are rapidly evolving. There can be no assurance that an existing or potential competitor has already developed, or may develop, a patentable product or process which will substantially prevent the Company from competing in its intended markets. The Company competes primarily on the basis of product performance, proprietary position and price. Some of the Company's products may also compete based on product efficacy, safety, patient convenience and reliability. In many cases the first company to introduce a product to the market will obtain at least a temporary competitive advantage over subsequent market entrants. MANUFACTURING AND SUPPLY Consistent with the Company's strategy to minimize capital expenditures, the Company obtains stable isotopes through a multi-year supply agreement and, to a lesser extent, from time to time from a variety of other Russian stable isotope sources and may invest in Company-owned isotope production facilities in the future upon determining the optimum production technology. Currently, the Company obtains substantially all its isotopes from Russia and the Republic of Georgia (which was part of the former Soviet Union). The production of DZ is an international activity involving several distinct steps which require up to nine months for the complete production cycle. First the feed material, high purity diethylzinc, is procured from a chemical plant in the United States and shipped by freighter to St. Petersburg, Russia. There it is transported by truck or train to the gas centrifuge plant where it is depleted of the zinc-64 isotope and converted to depleted zinc oxide. The oxide form of DZ, which is acceptable for air freight, is then shipped to a processing facility in the United States where additional chemical and mechanical operations are performed to prepare the powder for use in nuclear plants either as pellets or as a very fine grained powder. If the final product form is pellets, further 31 processing is performed in Ireland, but the Company is pursuing development of the technology to perform this manufacturing step in-house in the future. The Company has entered into the Supply Agreement dated July 1996 with Techsnabexport and an isotope enrichment plant located in Russia, which is owned by the Ministry of Atomic Energy of the Russian Federation, which is part of the cabinet of the government of the Russian Federation. The term of the Supply Agreement is through 1999. Under the Supply Agreement, the plant will produce DZ and other stable isotopes for the Company will allocate its stable isotope production capacity to the Company and will produce other isotopes to respond to marketplace demand on the Company for other stable isotopes. Under the Supply Agreement, the specific terms for each year's production, including pricing terms, are negotiated between the parties by November 1 of the preceding year. The Company entered into an agreement in February 1997 reflecting the most recent negotiations. The agreement provides, among other things, that the plant will not sell DZ to third parties located in North America or to other parties for resale in North America, that as long as the plant is able to meet all of the Company's requirements for DZ at prices competitive with other potential suppliers the Company will not buy DZ from other third parties located in the Russian Federation, and that disputes arising thereunder will be resolved by arbitration conducted in Sweden under the arbitration rules of the Stockholm Chamber of Commerce. The enforceability of the agreement might be subject to the greater degree of uncertainty than if the agreement was with a U.S. company and disputes were resolved in the U.S. The supply of stable isotopes could be directly affected by political, economic and military conditions in Russia. Accordingly, the operations of the Company could be materially adversely affected if hostilities involving Russia should occur, if trade between Russia and the United States were interrupted or curtailed, or if the Company should fail to obtain and maintain all necessary governmental approvals. Operations in Russia entail certain other risks, including, among others, supply disruptions as well as introduction of tariffs and fluctuations in freight rates. See "Risk Factors--Operations in Russia." There can be no assurance that the Company's relationship with its processor in Russia will be successfully maintained. Disruption or termination of the Company's supply sources could delay shipments by the Company and could have a material adverse effect on the Company's business, financial condition and results of operations. The Company does not presently maintain political risk insurance but will evaluate the desirability and availability of such insurance in the future. The plant with which the Company has the agreement described above is one of four similar plants which were designed to address the needs of the former Soviet Union and certain other countries' needs for low enriched uranium for commercial nuclear power plant fuel and for highly enriched uranium for military purposes. Following the nuclear accident at Chernobyl, certain of the Russian nuclear power plants have been shut down, reducing demand on these enrichment plants. In addition, in recent years the demand on these plants to produce products for military purposes has declined. In part in response to these trends, the plant has converted a portion of its capacity to processing stable isotopes, and the Company believes that additional capacity could be converted if the plant decided to do so. The Company believes that the plant has the potential capacity to meet all of the Company's foreseeable needs for processing of stable isotopes. The Company believes that one or more of the other similar enrichment plants may convert part of its capacity to the production of stable isotopes should market demand grow substantially. Certain other facilities elsewhere in the world, including the Oak Ridge National Laboratory in Oak Ridge, Tennessee, and certain private and pseudo- governmental organizations in Great Britain, Germany, The Netherlands and South Africa, have the potential to produce stable isotopes and, in certain cases, actually produce isotopes. To increase capacity and to geographically diversify the Company's production of certain isotopes, the Company is considering constructing a facility outside of Russia. The Company believes that owning this facility may improve its profitability and will improve the security of its supply. The Company intends to conduct a feasibility study to evaluate the nature and timing of such a facility, and a portion of the net proceeds of this offering will be used to fund that study. See "Use of Proceeds." The nature and timing of any such construction will depend on several factors, including the results of the study. If such a facility is constructed, it is likely that the facility would be located in North America. 32 The Company depends upon a single processor, located in Russia, for one process involved in the manufacturing of its products, and upon a single supplier or a limited number of suppliers and processors for certain other manufacturing processes. Although the Company does have written agreements with certain of its suppliers and processors, the Company does not have any written agreements with other suppliers and processors. The Company seeks to reduce its dependence on its sole and limited suppliers, but disruption or termination of any of the sources could occur, and such disruptions could have at least a temporary material adverse affect on the Company's business, financial condition and results of operations. Moreover, a prolonged inability to obtain alternative sources for processing could materially adversely affect the Company's relations with its customers. GOVERNMENT REGULATION Regulation by government authorities in the United States and other countries is a significant consideration in the development, production, distribution and marketing of the Company's products and in its continuing research, development, and other activities. In order to clinically test, manufacture, distribute, market and sell products, especially those intended for therapeutic or diagnostic use, mandatory procedures and safety and other standards established by applicable regulatory authorities must be followed. In many cases, specific approval to clinically test and commercially distribute such products must be obtained from numerous governmental authorities. Furthermore, the Company is subject to various laws, regulations and requirements relating to such matters as the import and export of its products, ensuring safe working conditions, laboratory and manufacturing practices, the use and disposal of hazardous or potentially hazardous substances used in connection with the Company's research, development and manufacturing activities. Some of the regulations are summarized below. See "Risk Factors--Government Regulation." FDA Regulation The Company's testing, manufacture, marketing, distribution, export and sale of diagnostic products, such as any DBT it might in the future develop and seek to sell, are subject to extensive and rigorous regulation by United States and other countries in which the Company may choose to test, manufacture or market its proposed diagnostic products. As of the date of this Prospectus, the Company has not determined those countries, other than the United States, where it might seek regulatory approvals to market any such products it may develop. The products the Company intends to develop are subject to rigorous preclinical and clinical testing and other FDA approval requirements, and similar requirements in most other countries. The process for obtaining the required regulatory approvals from the FDA and other regulatory authorities takes many years and can be expensive. The Company has limited experience in conducting and managing the preclinical and clinical testing necessary to obtain regulatory approvals and expects to rely on experienced outside experts to assist as well as develop its own resources. The various diagnostic products of which the Company is contemplating development are subject to different regulations and other requirements. Various components of the DBT and other products proposed for development are regulated as drugs or medical devices under the Federal Food, Drug, and Cosmetic Act ("FDCA"). The applicable FDA requirements for approval may be different for different types or components of products. There can be no assurance that any product developed by the Company, or other entities to which the Company may sell bulk or other materials, will prove to meet all of the applicable standards to receive marketing approval, or that any such approvals will be granted on a timely basis, if at all, or that such products if approved will be commercially successful. Delays and costs in obtaining these regulatory approvals could adversely affect the Company's ability to commercialize its products and its ability to receive market revenues. Even if regulatory approvals for a product are obtained, such approvals may involve restrictions and limitations on the labeling and clinical use of the product. Following market approval, the product will continue to be subject to compliance with applicable federal and state laws and regulations. The Company or the FDA may suspend clinical trials or commercial distribution at any time if either determines that the subjects or patients are being exposed to an unacceptable health risk related to the 33 manufacturing, testing and use of the Company's investigational or approved products, or if the FDA determines that the Company has violated applicable laws or regulations. If clinical studies are suspended, the Company may be unable to continue development of the investigational products affected. Violation of applicable laws and regulations, particularly those dealing with medical products, can result in the imposition of substantial penalties against the Company and its employees and officers, such as product seizures, recalls, fines, injunctions and withdrawal or suspensions of approvals to test, manufacture, export or market products. Delays and costs in obtaining or reinstating these approvals and the subsequent compliance with applicable federal and state statutes and regulations, and any penalties imposed for their violation, could adversely affect the Company's ability to commercialize products. Diagnostic Medical Device Products Certain diagnostic products that the Company may pursue, such as the DBT products, are regulated as medical devices. Diagnostic products may be subject to one of two marketing approval procedures. One procedure, known as a "510(k) review," is available when the manufacturer can demonstrate that the proposed product is "substantially equivalent" to another product that either was in commercial distribution in the United States before May 28, 1976, or that has been subsequently classified as a Class I or Class II medical device. When a 510(k) review is used, a sponsor is required to submit a Pre-Market Notification to the FDA, at least 90 days before it plans to initiate commercial distribution of the product. The Company cannot proceed with sales of such products for human clinical use until it receives notification from the FDA that FDA agrees with the Company's assertion of substantial equivalence, a process that can take six to eighteen months, or longer. In the event that the FDA requests additional information for the Pre-Market Notification, there could be multiple cycles of submissions, each involving an additional waiting period, until clearance is obtained. The FDA also has statutory authority to require clinical or other study data to support a Pre-Market Notification 510(k). Where there is no existing legally marketed product "substantially equivalent" to the Company's product, the Company will be required to seek marketing approval of its product by the second procedure. This second procedure, a Pre-Market Approval ("PMA") application, involves a lengthier and more burdensome procedure, which would likely require clinical studies. Together with the FDA review of the PMA, this application process may take 3-5 years before commercial marketing can occur, if the PMA is approved. There can be no assurance that any future product the Company develops which is the subject to FDA review will be found to have an intended use and characteristics that would qualify the new test for commercial distribution for clinical use under 510(k) Pre-Market Notification. Thus, PMAs may be required for some or all of the Company's future proposed products. The FDA invariably requires clinical data before approving either a PMA or a 510(k). The FDA is empowered to grant a 510(k) clearance without supporting clinical data. If clinical studies are necessary for either a PMA approval or 510(k) clearance, the FDA may require the Company to obtain an investigational device exemption ("IDE"). An IDE normally restricts the transfer of an investigational device to a limited number of institutions, and use to a limited number of investigators. Before the approval and/or clearance is issued, such institution or investigators may receive the Company's investigational devices only for the purpose of performing the clinical studies that are to be submitted to the FDA in support of a 510(k) or a PMA application. The Company believes that DBT instruments, if any, that it may develop in the future will be eligible for marketing under a 510(k) Premarket Notification, if cleared by FDA, but that the substrate would require approval of a New Drug Application as described in the following section. The Company believes that clinical studies would be required to obtain FDA approval of the 510(k)/NDA the DBT instrument/substrate, and would be conducted under IDE approved by FDA. There can be no assurances that FDA will allow the Company to conduct such clinical studies or that such studies will provide the data necessary to obtain the approval of the 510(k)/NDA for any DBT or other product that the Company may develop, or that FDA will in fact provide the necessary approval of the 510(k)/NDA in a timely manner, if at all. 34 In addition, use of the DBT and other diagnostic products developed by the Company may be subject to regulation under the Comprehensive Laboratory Improvement Act of 1986 ("CLIA"). Under CLIA, clinical laboratories must be certified to perform diagnostic tests. Such certification specifies the highest "complexity level" of tests that the laboratory can perform. The specific complexity level of a given diagnostic product is determined by governmental agencies, currently the U.S. Centers for Disease Control. The Company's ability to successfully market diagnostic products within the U.S. may depend on its obtaining a complexity level determination that allows the broadest use. There can be no assurance that such complexity level determination can be obtained in a timely manner, if at all, and that such failure will not have a material adverse effect on the Company and its operations. Drug Products Certain products that may be developed by the Company may be classified, depending on their characteristics, as drugs regulated under the FDCA. Development of a drug product for use in humans is a multistep process. First, laboratory and animal testing establishes reasonable safety of the experimental product for testing in humans and suggests potential efficacy with respect to a given disease. Once the general investigative plan and protocols for specific human studies are developed, an investigational new drug application ("IND") is submitted to the FDA. Under FDA regulations, the Agency does not approve an IND. Rather, assuming compliance with applicable requirements, the IND becomes effective, thus allowing a clinical investigation to commence unless FDA notifies the sponsor to the contrary within 30 days of receipt of the IND. That approval may come within 30 days of IND submission but may involve substantial delays if the FDA requests additional information before approving any clinical testing. The initial phase of clinical testing (Phase 1) is conducted on a relatively small number of subjects (e.g., 20-50) to evaluate the pharmacological actions and side effects of the experimental product in humans and, if possible, to gain early evidence of effectiveness. Phase 1 studies evaluate various routes, dosages and schedules of product administration. The demonstration of diagnostic performance is not required in order to complete such studies successfully. If acceptable product safety is demonstrated, then Phase 2 studies may be initiated. The Phase 2 studies are designed to evaluate the effectiveness of the product in the diagnosis of a given disease and, typically, are well-controlled, closely monitored studies on a relatively moderate number of patients (e.g., 50-200). The optimal routes, dosages and schedules of administration, and other matters, are determined in these studies. If Phase 2 trials are successfully completed, Phase 3 trials will be commenced. Phase 3 trials are the larger controlled trials and uncontrolled studies, often involving hundreds of patients (400-500 or more) that are intended to gather additional information about safety and effectiveness in order to demonstrate the overall risk/benefit relationship of the experimental product and to provide an adequate basis for labeling and marketing approval. It is not possible to estimate the time in which Phase 1, 2 and 3 studies will be completed with respect to a given product, although the time period required is often four to ten years in duration, depending on the clinical protocol design, endpoints and FDA requirements. Following the successful completion of these clinical trials, the clinical evidence that has been accumulated is submitted to the FDA as part of a new drug application ("NDA"). Approval of the NDA is necessary before a company may market the product. The approval process can be very lengthy, frequently taking one to two years, or more, after submission and depends in part upon the speed of FDA's review of the application and the time required for the company to provide satisfactory answers or additional clinical or other data when requested. With any given product, there is no assurance that an NDA will ever be approved in a timely manner or at all. Failure to obtain such approvals would prevent the Company from commercializing its products and would have a material adverse effect on the Company's business. Furthermore, the process of seeking and obtaining FDA approval for a new product generally requires substantial funding, and there can be no assurance such funding will be available. 35 cGMPs and Other Controls The FDA also has extensive regulations concerning manufacturing of regulated products in accordance with current good manufacturing practices ("cGMPs"). The Company's compliance with cGMPs, including compliance of its third-party manufacturers, and its ability to ensure the potency, purity and quality of the drugs and medical devices manufactured, must be documented in the NDAs, 510(k)s and PMAs submitted for the products. Continued compliance with cGMPs is required to continue to market both drugs and medial devices once they are approved. Failure to comply with the cGMP regulations or other applicable legal requirements can lead to federal seizure of violating products, injunctive relief actions brought by the federal government and potential criminal investigation and prosecution of the Company and its officers and employees who are responsible for the activities that lead to the violations. The Company and the facilities used by it also are required to comply with environmental and other regulations concerning the operations of and the materials used by the Company, as well as handling and distribution of products and waste materials. Failure to ensure compliance with such federal, state or local laws and regulations could have a material adverse effect on the Company. In addition, the manufacture, distribution and export of some of the Company's current or potential products and technology may be subject to governmental controls pertaining to materials and technology that might have been used for military, nuclear power, or nuclear weapons purposes. These controls include, in certain cases, export license requirements or other restrictions. There can be no assurances that the Company will be able to obtain or maintain such licenses, or that the failure to obtain or maintain such licenses, or comply with other restrictions that might be placed on such manufacturing and exports, will not have a material adverse effect on the Company and its operations. Export and Environmental Controls Certain of the Company's products and technology, particularly those having potential nuclear energy or military applications, such as DZ and related technology, are subject to stringent controls over their manufacture, use, distribution, dissemination and export. In many cases, such activities may require approvals or licenses from various U.S. and foreign governmental agencies, and compliance with substantial regulatory controls. Such approvals can be difficult to obtain and maintain and may not be obtainable from certain countries. Furthermore, such approvals or licenses may be restricted or terminated because of changes in laws, regulations, policies governing those approvals and licenses, or changes in the political or other matters in the countries granting such approvals or licenses to which the Company's products and technology would be exported. Likewise, certain current and potential operations of the Company may necessitate submitting registrations or notifications to federal and state regulatory authorities responsible for environmental and related matters, including the U.S. Environmental Protection Agency ("EPA") and complying with stringent controls pertaining to the handling and distribution of the Company's products and operations, including under certain conditions obtaining governmental approvals and licenses, either of which may be subject to significant restrictions. Violation of any of these regulatory controls may subject the Company to significant administrative civil and criminal penalties, including loss of its approvals and licenses, or the imposition of additional restrictions on the Company's operations. There can be no assurances that the Company will be able to obtain and maintain the approvals or licenses necessary to successfully market its products and technology, or that it will be able to comply with applicable laws and regulations. Any such failure to obtain such licenses or approvals, where required, and comply with such laws and regulations may materially and adversely affect the business, financial condition and results of operations of the Company. Regulation of Non-Medical Chemical Products The import, export, handling, transportation, sale, storage and other activities undertaken in connection with the Company's non-medical products are subject, or potentially subject, to substantial federal, state, local and 36 foreign government controls pertaining to hazardous chemical and chemical wastes, import export controls and other matters. These regulations are complex, pervasive and evolving. The Company's ability to effect and maintain compliance with these controls is important to its commercial success. With respect to transportation of its products, the Company relies predominantly on Russian and U.S. freight carriers to handle and deliver all its shipments, and utilizes domestic overnight courier services for shipments to its customers. These carriers must comply with Department of Transportation ("DOT") regulations in the shipping and packaging of the stable isotope chemicals. The Company must also comply with DOT regulations when packaging material kept in inventory for domestic shipment. As required under federal and state law, the Company has prepared Material Safety Data Sheets ("MSDS"), which are enclosed with each product shipment. The Company must periodically update its MSDS sheets based on new literature reports. The Company cannot assure that its MSDS sheets will continue to be in compliance with applicable requirements. The shipments received at the Company's Columbia, Maryland facility are subject to federal and Maryland regulations pertaining hazardous chemicals and hazardous waste disposal. These shipments are stored in an area of the facility designated for such materials. Currently, the Company is considered a small quantity generator of hazardous waste and will rely on certified haulers to dispose of its minimal amounts of hazardous waste. The Company believes it is in compliance in all material respects with applicable federal and state environmental regulatory requirements. Should the levels of hazardous waste increase as its inventory and handling operations increase in volume, then it would have to comply with Environmental Protection Agency ("EPA") requirements and obtain an EPA ID number, which are costly and require an increased investment of personnel and money. The Company has no experience in this area of compliance and would have to rely on outside consultants or hire additional employees with pertinent experience and training. Potentially, if substantially larger inventories of hazardous chemicals must be maintained at the Maryland facility, the Company might have to move to new facilities in order to meet EPA requirements for the storage of hazardous chemicals. The shipments from Russian manufacturing sources now enter the U.S. duty (without tariff) free; however, there can be no assurance that such duty-free importation will continue. If the shipments are subject to tariff, the Company cannot assure that it will be able to sell the imported products will be commercially viable because of these increased tariff costs. The Nuclear Regulatory Commission ("NRC") has authority to regulate importation and exports of deuterium containing chemicals whose ratio of deuterium atoms to hydrogen atoms exceed 1:5000. At present, the deuterium containing compounds which the Company imports do not require any special licenses or importation authorization. There can be no assurances that the NRC will continue these policies. The NRC regulates exports of deuterium containing chemicals under general license. The Company will not be able to ship these chemicals to certain countries which require a special license for such shipments; none of these countries represent significant current or expected future markets for the Company. In addition, certain technology or products that the Company is or may in the future develop, may be subject to other government controls pertaining to armaments, including the need to obtain special licenses for exports. The imposition of such controls may impair the ability to broadly market such products. PRODUCT LIABILITY AND INSURANCE The Company's business exposes it to potentially substantial product, environmental, occupational and other liability risks which are inherent in product research and development, manufacturing, marketing distribution and use of its products and operations, including, but not limited to, products used in nuclear power plants and medical device products. The Company currently does not have product liability insurance, but may seek such insurance before it begins commercial distribution of medical or other products that it may develop. There can be no assurance that adequate or necessary insurance coverage will be available at an acceptable cost, if at all, or that even if such insurance were obtained, a product liability or other claim would not materially and adversely affect the business or financial condition of the Company. See "Risk Factors--Product Liability; Minimal Insurance Coverage." 37 The terms of the Company's agreements with its customers provide that liability to nuclear power plant utilities is limited to the Company's standard warranty to replace non-conforming product, and liability for consequential damages caused by the improper use of the Company's products is limited by contractual terms. Nevertheless, one or more third parties could bring an action against the Company based on product liability, breach of warranty or other claims, and, there can be no assurance that the foregoing contract clauses would effectively limit the Company's liability in any such actions. EMPLOYEES As of July 31, 1997, the Company had 11 full-time employees, of whom 4 have Ph.D.s and 4 others have advanced degrees in chemistry, engineering and related fields. Approximately 3 employees are involved in research and product development, 2 in manufacturing and sourcing, and 5 in business development and administration, but such employees' responsibilities may also encompass areas other than their primary area of responsibility. The Company considers its relations with its employees to be good. None of the Company's employees are covered by a collective bargaining agreement. LEGAL PROCEEDINGS The Company is not a party to any legal proceedings. FACILITIES The Company leases 3,000 square feet of administrative and technical space in San Jose, California. The lease expires January 1998. The Company leases 650 square feet for an administrative office in Columbia, Maryland. This lease expires in December 1997. The Company leases office and laboratory space on a month-to-month basis at Moscow State University where it performs its research on isotope separation. 38 MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS The members of the Board of Directors ("Board") and the executive officers of the Company are as follows:
NAME AGE POSITION ---- --- -------- James E. Alexander 48 President, Chief Executive Officer and Chairman of the Board Boris Rubizhevsky 46 Senior Vice President, Vice Chairman and Director Joe Friscia 64 Vice President, Energy and Environmental Products Daniel J. Grady 43 Vice President, Medical, Research & Diagnostics Paul J. Catuna 33 Vice President, Finance, Chief Financial Officer, Director of Administration and Secretary Lindsay A. 45 Director Gardner(1)(2) Larry J. Wells(1)(2) 52 Director
- -------- (1) Member of the Compensation Committee. (2) Member of the Audit Committee. Each director holds office until the next annual meeting of shareholders and until his or her successor is elected and qualified or until his or her earlier death, resignation or removal. Each officer serves at the discretion of the Board. Mr. Alexander is a founder of the Company and has served as its President, Chief Executive Officer and a director since its inception. He has worked full-time for the Company since January 1994. From June 1972 to December 1993, he worked in a variety of technology positions at GE in the aircraft engine and nuclear power businesses, where his last position was Manager of Technology Programs. Mr. Alexander received his bachelors degree in Metallurgical Engineering from the University of Cincinnati and performed graduate work in materials science there. He earned a masters degree in Business Administration from Santa Clara University. Mr. Rubizhevsky is a founder of the Company and has been a Senior Vice President and a director of the Company since inception and became Vice Chairman in March 1997. From November 1986 through December 1994, he owned and operated SAR Marketing, a consulting firm providing business advice and services to large multinational corporations. From June 1977 to May 1986, Mr. Rubizhevsky worked at GE as Business Development Manager in various international locations. He received his bachelors degree in Engineering from the Stevens Institute of Technology. Mr. Friscia joined the Company in April 1995 as Vice President Energy and Environmental Products. From October 1994 through the Company's acquisition of Isoserve in April 1995, he served as President of Isoserve. From January 1990 through October 1994, he served as a Vice President of Concord Trading Company. Mr. Friscia was employed by GE from August 1954 until September 1987, and held a number of sales and marketing positions in the power systems business including Manager of Marketing, Europe for Nuclear Power Plants. He received his bachelors degree in Electrical Engineering and a masters degree in Nuclear Engineering from Georgia Institute of Technology. Dr. Grady joined the Company as Vice President, Medical, Research & Diagnostics in October 1995. From March 1994 through September 1995, Dr. Grady was Vice President of Research and Development at Sopha Medical Systems. From April 1991 until March 1994, he served as Marketing Manager, Nuclear Energy for GE. From May 1998 through March 1991, Dr. Grady served as Software Engineering Manager, Nuclear Medicine for GE in England. From October 1984 through May 1988, he served as Clinical Applications Manager for GE Nuclear Medicine. Between June 1981 and October 1984, he served as the Engineering Analysis Section Head for TRW. Dr. Grady received his bachelors and masters degree, and Ph.D. in Nuclear Engineering from the University of Michigan. 39 Mr. Catuna joined the Company in July 1996 as Chief Financial Officer and Director of Administration. From January 1994 to July 1996, Mr. Catuna was employed at Deloitte & Touche LLP, an international accounting and consulting firm, where he most recently served as an audit senior manager. From January 1988 to January 1994, Mr. Catuna worked for Grant Thornton LLP, an international accounting and consulting firm, where he most recently served as an audit manager. Mr. Catuna received his bachelors degree in Business Administration-Accounting from California State University Fresno, and is a certified public accountant. Ms. Gardner has served from 1991 through the present as President of LG Associates, a US-based management consulting firm providing materials management expertise to foreign company affiliates of US companies in developing countries. She began performing consulting services for Isonics in September 1992 and was elected a director in September 1993. During her tenure at LG Associates, she resided in Moscow, Russia from September 1991 to January 1994 when she moved to Beijing, China, where she currently resides. From 1977 to 1991, Ms. Gardner worked for GE in a variety of management and functional positions including international marketing, quality assurance and materials. Ms. Gardner received her bachelors degree in International Economics from The George Washington University Elliott School of International Affairs, and earned a masters in Business Administration from the University of Louisville. Mr. Wells was elected a director of the Company in September 1996. He is the founder of Sundance Venture Partners, L.P. ("Sundance"), a venture capital fund, and is the chairman of the entity that acts as the manager of Sundance. From 1983 to 1987, Mr. Wells served as Vice President of Citicorp Venture Capital and then became Senior Vice President of Inco Venture Capital. From May 1969 to June 1983, Mr. Wells was the founder and President of Creative Strategies International, a market research consulting firm specializing in emerging markets. Mr. Wells is a director of Identix, Inc., Atlanta Technology Group, Cellegy Pharmaceuticals, Gateway Data Sciences and Telegen Corporation as well as several privately held companies. Mr. Wells received his bachelor's degree in Economics and earned a master's degree in Business Administration from Stanford University. SCIENTIFIC ADVISORY PANEL The Company has established relationships with a group of scientific advisors with expertise in physics, material science, isotope separation, nuclear medicine and chemical synthesis. The Company's advisors consult with management and key scientific employees of the Company to assist the Company in identifying stable isotope and other product development opportunities, to help structure and review the progress of the Company's development projects and to aid in the recruitment and evaluation of the Company's scientific staff. The nature, scope and frequency of consultations between the Company and each scientific advisor varies depending upon the Company's current activities, the need for specific assistance and the individual scientific advisor. Although the Company expects to receive guidance from its scientific advisors, all of the advisors have substantial commitments to third parties and are able to devote only a small portion of their time to the business of the Company. To date the scientific advisory panel has not been compensated for its services. Michael Alferieff, Ph.D. Dr. Alferieff currently serves as an independent consultant. He received a bachelors degree in Mathematics and Physics from the Massachusetts Institute of Technology and earned his masters degree in Theoretical Physics from Columbia University and Ph.D. in Theoretical Physics from the University of California. He has worked at the GE R&D Center in Santa Barbara and at IBM's Thomas J. Watson Research Center, among other assignments. More recently, Dr. Alferieff has focused on translation of Russian technical articles for a number of international journals, universities, and private companies. Vladimir Yu. Baranov, Ph.D. Dr. Baranov is currently a director of the Institute of Molecular Physics at the I.V. Kurchatov Institute in Moscow, an institution specializing in theoretical physics, fusion energy research and isotope separation technology development. He earned a doctor of science degree in Physics from the I.V. Kurchatov Institute and a Ph.D., from the Moscow Institute of Electrical Engineering. In 1991, he was appointed a member of the Academy of Sciences of the Russian Federation. Dr. Baranov has special expertise in separation of stable isotopes utilizing high power lasers. 40 John Engdahl, Ph.D. Dr. Engdahl is currently the director of Advanced Research for Siemans Nuclear Medicine. Dr. Engdahl serves as President of Applied Nuclear Imaging, Inc., a consulting company, which he founded in 1996. Since 1982, Dr. Engdahl has worked in nuclear medicine in design of equipment and image processing applications. Dr. Engdahl was Vice President of Clinical Science at Sopha Medical Systems from 1990 to 1996. Dr. Engdahl was employed as radiologic physicist in nuclear medicine at Henry Ford Hospital from 1987 to 1990, and from 1982 to 1987 he was employed at GE Medical Systems as manager of product development for GE's nuclear imaging business. Dr. Engdahl chaired the National Electrical Manufacturers Association, Nuclear Diagnostic Imaging Section from 1992 to 1995, is a member of the IEEE and Society of Nuclear Medicine. Dr. Engdahl received his bachelors and earned a masters degree, and Ph.D. in Nuclear Engineering from the University of Michigan. Eugene E. Haller, Ph.D. Dr. Haller is currently a Professor of Material Science at the University of California at Berkeley and program leader of the Advanced Electronic Materials Program at the Lawrence Berkeley Laboratory. Dr. Haller earned a doctorate degree in Solid State and Applied Physics from the University of Basel, Switzerland. Dr. Haller has published many works on, among other subjects, isotopically engineered semiconductors. Ward Rigot. Mr. Rigot is a research associate at the Dow Chemical Company. He received his bachelors degree in Chemistry from Eastern Michigan University and earned a masters degree in Nuclear Engineering from the University of Michigan. He has also served as an adjunct professor at Saginaw Valley State University. Mr. Rigot is experienced in radiation detection and measurement, analytical chemistry, and synthesis of organic and inorganic compounds. Mammem Thomas. Mr. Thomas currently serves as Chief Executive Officer of Technology Management Consultants, Inc., a consulting company, and Vice President of Technology at Elan Microsystems, Inc., a semiconductor company. Mr. Thomas received his bachelors degree in Engineering from the University of Kerala, India, and earned a masters of Business Administration from the Indian Institute of Management in Calcutta, and a masters in Electrical Engineering from the University of Michigan. Mr. Thomas is experienced in the manufacture of semiconductor devices and in the transfer of semiconductor manufacturing technology. EXECUTIVE COMPENSATION The following table sets forth all compensation awarded to, earned by, or paid for services rendered to the Company in all capacities during the year ended April 30, 1997 by (i) the Company's chief executive officer and (ii) the Company's other executive officers whose salary and bonus exceeded $100,000 during fiscal 1997 (each a "Named Person"). SUMMARY COMPENSATION TABLE
ANNUAL LONG-TERM COMPENSATION COMPENSATION AWARDS -------------- ------------------- SECURITIES NAME AND PRINCIPAL OTHER ANNUAL UNDERLYING POSITION YEAR SALARY BONUS COMPENSATION(1) OPTIONS(#) - ------------------ ---- -------- ----- --------------- ------------------- James E. Alexander .... 1997 $174,000 $ -- $ -- -- President and Chief Executive Officer Boris Rubizhevsky...... 1997 $147,000 $ -- $ -- -- Senior Vice President Daniel J. Grady........ 1997 $107,000 $ -- $ -- -- Vice President, Medical, Research and Diagnostics
- -------- (1) Excludes other compensation, the aggregate amount of which does not exceed the lesser of $50,000 or 10% of such Named Person's annual compensation. 41 In September 1996, Mr. Alexander and Mr. Rubizhevsky each exercised his option to acquire 259,175 shares at $0.64 per share. In payment of the exercise price, the Company accepted a full recourse promissory note from each officer in the principal amount of approximately $165,000. The principal bears interest at the minimum applicable federal rate, which is payable in annual installments over the term of the note. All accrued and unpaid interest and all principal is due five years after the exercise date. The purchased shares have been pledged to secure repayment of the loan. Upon a sale of any shares, a portion of the net proceeds equal to the exercise price per share of the shares sold will be used to repay the loan. See "--Certain Transactions." The following table sets forth certain information with respect to the exercise of options to purchase Common Stock during fiscal 1997, and the unexercised options, if any, and the value thereof at that date, for each of the Named Persons. AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
VALUE OF NUMBER OF UNEXERCISED SHARES VALUE UNEXERCISED IN-THE-MONEY ACQUIRED ON REALIZED OPTIONS AT OPTIONS AT NAME EXERCISE (#)(1) ($)(1) FY-END (#) FY-END ($) - ---- --------------- -------- ----------- ------------ James E. Alexander............ 259,175 $742,200 $ 0 0 Boris Rubizhevsky............. 259,175 $742,200 $ 0 0 Daniel J. Grady............... 0 0 207,340 $606,000
- -------- (1) Represents the exercise of options to purchase 259,175 shares of Common Stock at an exercise price of $.636636 per share. (2) Based on the deemed fair market value of the Common Stock at fiscal year end (April 30, 1997) of $3.40 per share, as determined by the Company's Board of Directors, less the exercise price payable for such shares. DIRECTOR COMPENSATION Directors of the Company do not receive cash compensation for their services as directors but are reimbursed for their reasonable expenses in attending meetings of the Board. Directors are eligible to participate in the Executives Plan and Incentive Plan. See "--Employee Benefit Plans." EMPLOYMENT AND CONSULTING AGREEMENTS The Company has employment agreements dated January 1, 1996 with James E. Alexander and Boris Rubizhevsky. Effective upon the closing of this offering, those agreements will be amended by new employment agreements. The new agreements become effective upon the closing of this offering. The agreements have a term of four years and provide for annual salaries of $200,000 and $180,000, respectively. Either the Company or the officer may terminate the agreement at any time upon notice to the other party. Under the agreements, the officer is entitled to receive executive compensation up to 50% of the officer's annual salary, as approved by the Company pursuant to such Executive Compensation Plan as the Company may approve. The agreements provide that upon a termination of employment other than for cause (as defined in the agreements), the officer is entitled to severance compensation of 18 months of his salary, paid at the same time as salary payments, and in addition all outstanding stock options held by the officer will be accelerated and will become exercisable in full and the Company's right of repurchase will terminate with respect to such shares. The agreements provide for similar accelerated vesting of outstanding stock options, upon a change in control of the Company. The Company has also entered into an agreement with Paul Catuna, the Company's Chief Financial Officer, providing for the grant of a stock option to acquire 120,000 shares of Common Stock at an exercise price equal to 110% of the IPO Price Per Share. The shares subject to the option are subject to a right of repurchase that lapses based upon the achievement of certain financial requirements. The Company has also entered into a number of employment agreements with certain of its officers and employees, including Daniel J. Grady, Martin Laurent, Joe Friscia, Paul J. Catuna, Jacques Delente and Stephen 42 Burden. The terms of these agreements are similar in material respects except for the compensation payable to such officers. The agreements have an indefinite term and provide for at-will employment, terminable at any time by either party. The agreements provide for a rate of annual compensation, which the Company will review annually. Under the agreements, the employees are entitled to participate in the Company's standard plans and policies. The agreements also include customary confidentiality and invention assignment provisions. EMPLOYEE BENEFIT PLANS The Company currently has a 1996 Stock Option Plan (the "Existing Plan"). After the closing of this offering, no further options will be granted under the Existing Plan, and future awards will be granted pursuant to the Company's 1996 Executives Equity Incentive Plan (the "Executives Plan") and the 1996 Equity Incentive Plan (the "Incentive Plan"). The terms of the Existing Plan are, in material respects, similar to the terms of the Executives Plan and the Incentive Plan. The Executives Plan and Incentive Plan are sometimes referred to collectively as the "Plans." The Company's shareholders approved these Plans in October 1996, and the Plans will become effective upon the effective date of this offering. 1996 Executives Plan and Incentive Plan. In November 1996, the Board adopted the Executives Plan and Incentive Plan. A total of 570,000 shares of Common Stock and 150,000 shares of Common Stock are reserved for issuance under the Executives Plan and the Incentive Plan, respectively. Except for the number of shares reserved under each Plan, the terms of vesting of options or other awards upon a Change of Control (as defined below) and as otherwise set forth below, the Executives Plan and the Incentive Plan are similar in material respects. Under each of the Executives Plan and the Incentive Plan, shares that (i) are subject to an option under that Plan but cease to be subject to such option for any reason other than exercise of such option, (ii) are awarded under that Plan but are forfeited or are repurchased by the Company at the original issue price or (iii) are subject to an award that otherwise terminates without shares being issued will, in each case, be redesignated as available for grant or issuance under that Plan. Both Plans will terminate in September 2006, unless terminated earlier in accordance with their provisions. The Executives Plan and Incentive Plan provide for grants of stock options, stock bonuses and awards of restricted stock by the Company to its officers, directors who are employees of the Company, other employees, consultants, independent contractors and advisors. No person will be eligible to receive awards covering more than 200,000 shares in any calendar year under the Executives Plan, and no person will be eligible to receive more than 50,000 shares in any calendar year pursuant to grants under the Incentive Plan. The Plans will be administered by the Compensation Committee of the Board (the administrator referred to as the "Committee"). The Plans permit the Committee to grant options that are either incentive stock options, as defined in Section 422 of the Code or nonqualified stock options, on terms (including the exercise price, which may not be less than 85% of the fair market value of the Common Stock, and the vesting schedule) determined by the Committee, subject to certain statutory and other limitations in the Plans and certain limitations imposed by state blue sky authorities. In addition to, or in tandem with, awards of stock options, the Committee may grant participants restricted stock awards to purchase Common Stock for not less than 85% of its fair market value at the time of grant. The other terms of such restricted stock awards may be determined by the Committee. The Committee may also grant stock bonus awards of Common Stock either in addition to, or in tandem with, other awards under the Plans, under such terms, conditions and restrictions as the Committee may determine. Under the Plans, stock bonuses may be awarded for the satisfaction of performance goals established in advance. In the event of a dissolution, merger, consolidation or similar corporate transaction (each such transaction a "Change of Control") (other than a merger into a parent, wholly owned subsidiary or a reincorporation, in each event without substantial change of equity interest), outstanding awards may be assumed, converted, replaced or substituted by the successor corporation, which assumption, conversion, replacement or substitution will be binding on all participants in the Plans. If such successor corporation does not assume or substitute awards under the Plans, such awards will expire on the consummation of such Change in Control, on such terms and conditions as the Board determines. 43 401(k) Plan. The Board has adopted the Isonics Corporation 401(k) Savings & Retirement Plan (the "401(k) Plan"), a defined contribution profit-sharing plan intended to qualify under Section 401 of the Code. The shareholders of the Company approved the 401(k) Plan in November 1996. Under the 401(k) Plan, a participating employee can make pre-tax contributions, subject to limitations under the Code, of a percentage (not to exceed 15%) of his or her total compensation. Employee contributions and the investment earnings thereon are fully vested at all times. The Company may make matching contributions for the benefit of eligible participating employees. INDEMNIFICATION OF DIRECTORS AND OFFICERS AND LIMITATION OF LIABILITY The Company's Restated Articles of Incorporation (the "Restated Articles") include a provision that eliminates to the fullest extent permitted by law the personal liability of its directors to the Company and its shareholders for monetary damages for breach of the directors fiduciary duties. This limitation has no effect on a director's liability (i) for acts or omissions that involve intentional misconduct or a knowing and culpable violation of law, (ii) for acts or omissions that a director believes to be contrary to the best interests of the Company or its shareholders or that involved the absence of good faith on the part of the director, (iii) for any transaction from which the director derived an improper personal benefit, (iv) for acts or omissions that show a reckless disregard for the director's duty to the Company or its shareholders in circumstances in which the director was aware, or should have been aware, in the ordinary course of performing a director's duties, of a risk of serious injury to the Company or its shareholders, (v) for acts or omissions that constitute an unexcused pattern of inattention that amounts to an abdication of the director's duty to the Company or its shareholders, (vi) under Section 310 of the California Corporations Code (the "California Code") concerning contracts or transactions between the Company and a director or (vii) under Section 316 of the California Code concerning directors' liability for improper dividends, loans and guarantees. The provision does not extend to acts or omissions of a director in his or her capacity as an officer. Further, the provision will not affect the availability of injunctions and other equitable remedies available to the Company's shareholders for any violation of a director's fiduciary duty to the Company or its shareholders. The Restated Articles further authorize the Company to indemnify its agents (as defined in Section 317(a) of the Code, which includes directors and officers) through Bylaw provisions, agreements with agents, votes of shareholders or disinterested directors or otherwise, to the fullest extent permissible under California law. Pursuant to this provision, the Company's Bylaws provide for indemnification of directors and officers. The Bylaws also permit the Company to enter into indemnity agreements with individual directors, officers, employees and other agents. The Company has entered into such agreements with its directors and executive officers effective upon the closing of this offering. These agreements, together with the Company's Bylaws and Restated Articles, may require the Company, among other things, to indemnify directors or officers against certain liabilities that may arise by reason of their status or service as directors (other than liabilities resulting from willful misconduct of a culpable nature), to advance expenses to them as they are incurred (provided that they undertake to repay the amount advanced if it is ultimately determined by a court that they are not entitled to indemnification), and to obtain and maintain directors and officers insurance if available on reasonable terms. Section 317 of the California Code, the Company's Bylaws and the indemnity agreements provide for the indemnification of officers, directors and other corporate agents in terms sufficiently broad to indemnify such persons, under certain circumstances, for liabilities (including reimbursement of expenses incurred) arising under the Securities Act. At present, there is no pending litigation or proceeding involving a director, officer or employee of the Company regarding which indemnification is sought, nor is the Company aware of any threatened litigation that may result in claims for indemnification. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Company pursuant to the foregoing provisions, or otherwise, the Company has been advised that, in the opinion of the Securities and Exchange Commission (the "Commission"), such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. 44 CERTAIN TRANSACTIONS Since May 1, 1994, there has not been, nor is there currently proposed, any transaction or series of similar transactions to which the Company was or is to be a party in which the amount involved exceeds $60,000 and in which any director, executive officer, holder of more than 5% of the Common Stock, or any member of the immediate family of any such person had or will have a direct or indirect material interest other than compensation arrangements, see "Management," and as described below. In connection with the Placement, Placement Notes in an aggregate principal amount of $395,000 were issued to Lindsay Gardner, a director of the Company, one employee of the Company and four affiliates of directors or officers of the Company at a discount totalling approximately $41,000 and otherwise on the same terms as the other Private Investors. In addition, DayStar Partners, an entity of which Larry J. Wells, a director of the Company, is an affiliate, acquired $225,000 principal amount of Placement Notes and Placement Warrants to acquire approximately 99,393 shares of Common Stock on the same terms as other Private Investors, and the Company entered into a consulting agreement with Larry Wells Co., Inc., another entity of which Mr. Wells is an affiliate, pursuant to which the Company paid the entity $85,000. Pursuant to the consulting agreement, that entity advised the Company concerning the Placement and following completion of the Placement has consulted with the Company as requested concerning financing matters and acquisition opportunities. On July 23, 1997, the terms of the Placement Notes were amended. Effective August 1, 1997, interest is payable monthly at 15% per annum. If the notes are not paid in full by April 1998, the remaining principal and interest is payable in equal monthly installment from May 1998 through April 1999. In connection with the amendment of the notes, the Company issued warrants to the noteholders to purchase a total of 450,000 shares of Common Stock, exercisable for a period of four years, at $2.083 per share. DayStar Partners received 72,464 of the warrants issued in connection with the amendment. On July 31, 1997, two employees purchased $200,000 of Placement Notes that were previously issued to unrelated third parties. See "Capitalization--Recent Financing Transactions." In September 1996, in part in order to allow the Company to establish a pool of shares available for future awards pursuant to the Plans in amounts that comply with the guidelines established by certain state blue sky authorities, Mr. Alexander and Mr. Rubizhevsky exercised stock options to acquire 259,175 and 259,175 shares, respectively, of Common Stock at an exercise price of $0.64 per share. The exercise price for the shares was paid by means of a loan from the Company in the principal amount of the exercise price. The purchased shares are pledged as collateral for the loans pursuant to a pledge agreement. The loans bear interest at an annual rate equal to the minimum applicable federal rate, and interest is payable annually. Principal and accrued but unpaid interest is due five years from the date of the note. For each optionee, until the note has been paid in full, upon any sale of such option shares by the optionee a portion of the sales proceeds equal to the exercise price per share of the shares sold will be used to pay amounts owed under the note. In addition, the Company has agreed to loan to such officers, pursuant to a five-year note with interest at the minimum applicable federal rate, an amount equal to the federal and state tax liability incurred by them as a result of exercising such options, and to pay compensation to such officers equal to the amount of interest payable under the loans and the amount of taxes payable as a result of such compensation. The predecessor entity to the Company was a general partnership. At the time of incorporation in 1993, Mr. Alexander and Mr. Rubizhevsky exchanged their partnership interests for 1,805,587 and 1,477,296 shares of Common Stock, respectively. The Company is also a party to several employment and consulting agreements. See "Management--Employment and Consulting Agreements." All future transactions between the Company and its officers, directors and affiliates will be on terms no less favorable to the Company than could be obtained from unaffiliated third parties and will be approved by a majority of the independent, disinterested directors of the Company. 45 PRINCIPAL SHAREHOLDERS The following table sets forth certain information known to the Company regarding beneficial ownership of the Common Stock as of July 31, 1997, and as adjusted to reflect the sale of the Securities offered hereby, by (i) each person known by the Company to be the beneficial owner of more than 5% of the Common Stock, (ii) each of the Company's directors, (iii) each Named Person and (iv) all executive officers and directors as a group. The address of each person is in care of the Company, 4010 Moorpark Avenue Suite 119, San Jose, CA 95117.
SHARES BENEFICIALLY SHARES BENEFICIALLY OWNED PRIOR TO OWNED AFTER OFFERING(1) OFFERING(1)(2) ---------------------------------------------- DIRECTORS, NAMED PERSONS, AND 5% SHAREHOLDERS NUMBER PERCENT NUMBER PERCENT -------------------------------- ------------ ---------------------- ---------- James E. Alexander(3)(10).......... 2,155,764 46.4 2,155,764 35.7 Boris Rubizhevsky(3)(8)(9)......... 1,919,201 41.4 1,919,201 31.8 Jacques Delente(4)................. 355,401 7.6 355,401 5.9 Lindsay Gardner(5)................. 263,785 5.7 263,785 4.4 Larry Wells(6)..................... 171,857 3.6 171,857 2.8 Daniel J. Grady(11)................ 207,340 4.4 207,340 3.4 All executive officers and directors as a group (7 persons)(7)........................ 4,994,399 91.2 4,994,399 72.6
- -------- (1) The persons named in the table have sole voting and sole investment power with respect to all shares beneficially owned, subject to community property laws where applicable. (2) Assumes that the Underwriters' over-allotment option to purchase up to 210,000 Shares and 210,000 Warrants included in 105,000 Units from the Company is not exercised. See "Underwriting." (3) Includes 164,144 shares of Common Stock subject to a repurchase right in favor of the Company. (4) Includes 217,707 shares of Common Stock subject to a repurchase right in favor of the Company, and warrants to purchase 122,854 shares of Common Stock issued in connection with the Placement. (5) Includes warrants to purchase 91,003 shares of Common Stock issued in connection with the Placement. (6) Includes 171,857 shares issuable upon the exercise of Placement Warrants held by an entity with which Mr. Wells is affiliated. (7) Includes 328,288 shares of Common Stock subject to a repurchase right in favor of the Company, options to purchase 483,794 shares of Common Stock, and warrants to purchase 444,865 shares of Common Stock issued in connection with the Placement and 91,729 shares of Common Stock held by Mr. Rubizhevsky's wife. (8) Includes 91,729 shares of Common Stock held by Mr. Rubizhevsky's wife. (9) Includes 91,002 shares issuable upon the exercise of Placement Warrants held by the mother, father, mother-in-law and father-in-law of Mr. Rubizhevsky. (10) Includes 91,002 shares issuable upon the exercise of Placement Warrants held by the brother-in-law, mother-in-law and father-in-law of Mr. Alexander. (11) Includes 207,340 shares issuable upon the exercise of fully exercisable stock options. 46 DESCRIPTION OF CAPITAL STOCK The Company's authorized capital stock consists of 20,000,000 shares of Common Stock and 10,000,000 shares of Preferred Stock. As of July 31, 1997, there were outstanding 4,550,268 shares of Common Stock held of record by seven shareholders and options and warrants to purchase 2,261,843 shares of Common Stock, which included options to purchase 689,809 shares of Common Stock issued under the Company's employee benefit plans and warrants to purchase 1,572,034 shares of Common Stock associated with the Placement. COMMON STOCK Subject to preferences that may be applicable to any Preferred Stock outstanding at the time, the holders of outstanding shares of Common Stock are entitled to receive dividends out of assets legally available therefor at such times and in such amounts as the Board of Directors may from time to time determine. Each shareholder is entitled to one vote for each share of Common Stock held on all matters submitted to a vote of shareholders. Cumulative voting for the election of directors is specifically authorized by the Bylaws. Under cumulative voting for the election of directors, upon a proper and timely request by a shareholder, each shareholder is entitled to cast a number of votes equal to the number of shares held multiplied by the number of directors to be elected. The votes may be cast for one or more candidates. Thus, under cumulative voting, a majority of the outstanding shares will not necessarily be able to elect all of the directors, and minority shareholders may be entitled to greater voting power with respect to election of directors than if cumulative voting did not apply. The Company's bylaws provide that so long as the Company is a "listed company" as defined by applicable California law, there will not be cumulative voting in connection with the election of directors. Upon the closing of this offering, however, the Company will not be a listed company as so defined, and therefore cumulative voting will continue to apply in connection with the election of directors. The Common Stock is not entitled to preemptive rights and is not subject to conversion or redemption. Upon liquidation, dissolution or winding up of the Company, the remaining assets legally available for distribution to shareholders, after payment of claims or creditors and payment of any liquidation preferences, if any, on outstanding Preferred Stock, are distributable ratably among the holders of the Common Stock and any participating Preferred Stock outstanding at that time. Each outstanding share of Common Stock is, and all shares of Common Stock to be outstanding upon completion of this offering will be, fully paid and nonassessable. PREFERRED STOCK The Board of Directors is authorized, subject to any limitations prescribed by California law, to provide for the issuance of shares of Preferred Stock in one or more series, to establish from time to time the number of shares to be included in each such series, to fix the rights, preferences and privileges of the shares of each unissued series and any qualifications, limitations or restrictions thereon, and to increase or decrease the number of shares of any such series (but not below the number of shares of such series then outstanding), without any further vote or action by the shareholders. The Board of Directors may authorize the issuance of Preferred Stock with voting or conversion rights that could adversely affect the voting power or other rights of the holders of Common Stock. Thus, the issuance of Preferred Stock may have the effect of delaying, deferring or preventing a change in control of the Company. The Company has no current plans to issue any shares of Preferred Stock. OTHER SECURITIES Underwriter's Warrants In connection with this offering, the Company has authorized the issuance to the Underwriter of the Underwriter's Warrants and has reserved 280,000 shares of Common Stock for issuance upon exercise of the Underwriter's Warrants and the Warrants issuable upon exercise of the Underwriter's Warrants. Each Underwriter's Warrant will entitle the holder to purchase one share of Common Stock at a price of $5.61 per 47 share (assuming a public offering price of $3.40 per share of Common Stock), which is 165% of the initial public offering price per Share, and, upon payment of $.165, which is 165% of the initial public offering price of the Warrants (assuming the effective public offering price for the Warrants is $.10) to acquire one Warrant. Each such Warrant will entitle the holder to purchase one share of Common Stock at a price of $4.00 per share at the same exercise price as that of the Warrants to be sold to the public in this offering. The Underwriter's Warrants will, subject to certain conditions, be exercisable at any time commencing one year after the date of this Prospectus until the expiration of five years from the date of this Prospectus. See "Underwriting." The Underwriter's Warrants also contain provisions to protect the holder against dilution by adjustment of the exercise price in certain events, such as stock dividends and distributions, stock splits and recapitalizations. The Company is not required to issue fractional shares upon the exercise of an Underwriter's Warrant, and the holder thereof will not possess any rights as a shareholder of the Company until such holder exercises the Underwriter's Warrants. The other terms of the Underwriter's Warrants are similar in material respects to the Warrants, except that the Underwriter's Warrants will not be publicly tradeable and will not be redeemable by the Company. The foregoing discussion of certain terms and provisions of the Underwriter's Warrants is qualified in its entirety by reference to the detailed provisions of the Underwriter's Warrant Agreement, the form of which has been filed as an exhibit to the Registration Statement of which this Prospectus is a part. Units Each Unit consists of two shares of Common Stock and two Warrants, each Warrant entitling the holder thereof to purchase one share of Common Stock. The Common Stock and Warrants comprising the Units are separately transferable immediately upon issuance. Class A Warrants The following is a brief summary of certain provisions of the Warrants. Reference is made to the actual text of the Warrant Agreement between the Company, the Underwriter and Continental Stock Transfer & Trust Company (the "Warrant Agent"), a copy of which has been filed as an exhibit to the Registration Statement of which this Prospectus is a part, for a more complete description of the Warrants. The Company has authorized the issuance of Warrants to purchase an aggregate of 1,400,000 shares of Common Stock (exclusive of up to 210,000 Warrants issuable upon exercise of the Underwriter's over-allotment option and 140,000 Warrants underlying the Underwriter's Warrants), and has reserved an equivalent number of shares for issuance upon exercise of such Warrants. Each Warrant entitles the registered holder thereof to purchase one share of Common Stock at a price of $4.00, subject to adjustment, for three years commencing one year from the date of this Prospectus. After expiration, the Warrants will be void and of no value. The Warrants underlying the Underwriter's Warrants have the same terms and conditions as the Warrants to be sold to the public in this offering, except that they are not subject to redemption by the Company until the Underwriter's Warrants have been exercised and the underlying Warrants are outstanding. The Company may redeem the Warrants commencing , 1999 (18 months from the date of the Prospectus), or earlier with the consent of the Underwriter, at a price of $.10 per Warrant, on not less than 30 days' prior written notice, if the closing bid price of the Common Stock (if the Common Stock is then traded in the over-the-counter market) or the last sale price of the Common Stock (if the Common Stock is then traded on a national securities exchange or the Nasdaq National Market or SmallCap System) has been at least 250% ($8.75 per share) of the current Warrant exercise price, subject to adjustment, for at least 20 consecutive trading days ending within three days prior to the date on which notice of redemption is given. The Warrants contain provisions that protect the holders thereof against dilution by adjustment of the exercise price and number of shares issuable upon exercise, on the occurrence of certain events, such as stock 48 dividends, stock splits and recapitalizations. The Company is not required to issue fractional shares. In lieu of the issuance of such fractional shares, the Company will pay cash to such holders of the Warrants. In computing the cash payable to such holders, a share of Common Stock will be valued at its price immediately prior to the close of business on the expiration date. The holder of a Warrant will not possess any rights as a shareholder of the Company unless such shareholder exercises such Warrant. CERTAIN FEDERAL INCOME TAX CONSIDERATIONS The following discussion sets forth certain federal income tax consequences, under current law, relating to the purchase and ownership of the Units, the Common Stock and the Warrants constituting the units. The Company has not requested and does not intend to request a ruling from the Internal Revenue Service or a tax opinion from its counsel on any tax aspect of the offering. This tax discussion does not purport to be a complete analysis or list of all potential federal income tax consequences of the purchase, ownership and sale of the Common Stock or Warrants. The discussion does not address the tax treatment for certain unique taxpayers, such as insurance companies, tax exempt organizations, financial institutions, and dealers in securities which may be subject to special rules not discussed herein. This discussion presents no analysis of the tax attributes of the Company either before or after this offering. PROSPECTIVE PURCHASERS OF THE COMMON STOCK AND WARRANTS SHOULD CONSULT THEIR OWN TAX ADVISERS WITH RESPECT TO THE TAX CONSEQUENCES TO THEM OF THE PURCHASE, OWNERSHIP AND SALE OF SUCH SECURITIES AND THE APPLICABILITY OF FEDERAL, STATE, LOCAL, FOREIGN AND OTHER TAX LAWS. An investor must allocate the cost of each unit between its two elements (one Share and one Warrant to purchase one share of Common Stock) in accordance with their relative fair market values at the time of issuance. The portion of the aggregate cost allocated to each element will constitute the investor's initial federal income tax basis for that element. No gain or loss will be recognized by a holder of a Warrant held for investment on the holder's purchase of Common Stock for cash upon exercise of the Warrant. The adjusted tax basis of the Common Stock so acquired will be equal to the tax basis of the Warrant plus the exercise price. The holding period of the Common Stock acquired upon the exercise of the Warrant will begin on the date the Warrant is exercised and the Common Stock is purchased. The sale of a share of Common Stock or the sale of a Warrant will result in the recognition of gain or loss to the holder in an amount equal to the difference between the amount realized (generally the cash and the fair market value of any other property received) and the holder's adjusted tax basis for the property sold. The sale of Common Stock will result in capital gain or loss, provided the Common Stock is a capital asset in the hands of the holder. The sale of a Warrant (other than a sale to the Company) will also result in a capital gain or loss, provided the Warrant is a capital asset in the hands of the holder and the Common Stock underlying the Warrant would be a capital asset to the holder if acquired by the holder. Such capital gain or loss will be long-term capital gain or loss if the Common Stock or Warrant being sold or exchanged has been held for more than 18 months at the time of such sale or exchange. If the repurchase of a Warrant by the Company is treated as a sale or exchange of a capital asset, any gain or loss recognized on the transaction will be capital gain or loss and will be long-term capital gain or loss if the holding period of the Warrant exceeds one year at the time of repurchase. However, it is unclear whether the repurchase of a Warrant by the Company will be treated as the sale or exchange of a capital asset, and if such repurchase is not treated as the sale or exchange of a capital asset, the holder of a Warrant could potentially recognize ordinary income on such repurchase because of a constructive distribution recharacterization. 49 Long-term capital gains of individuals, trusts and estates are currently taxed at a maximum rate of 20%, while certain ordinary income is currently taxed at a maximum rate of 39.6%. Section 1202 of the Code in certain circumstances allows certain noncorporate taxpayers to exclude from income one-half of the gain (up to certain limits) from the sale or exchange of "qualified small business stock" held for more than five years. In addition, 25% of such gain (up to certain limits) is excluded for alternative minimum tax purposes. In order for stock to be "qualified small business stock," the issuer of the stock must meet certain requirements, some of which apply to the period after the stock is issued. Consequently, it is unclear whether the Common Stock acquired upon exercise of a Warrant will qualify as qualified small business stock. Under Section 305 of the Code, certain actual or constructive distributions of stock (including warrants to purchase stock) with respect to such stock (or warrants) may be taxable to the shareholders (or Warrant holders) of the Company. Adjustments in the exercise price of the Warrants, or the number of shares purchasable upon exercise of the Warrants, in each case made pursuant to the anti-dilution provisions of the Warrants, among other things, may result in a distribution which is taxable as a dividend to the holders of Warrants. Distributions may be taxed as ordinary dividend income, return of capital, or gain from the sale or exchange of stock, depending on the earnings and profits of the Company and the tax basis of each of its shareholders or Warrant holders. A Warrant that expires unexercised will be deemed to have been sold or exchanged for no consideration on the expiration date. The holder of an expired Warrant would recognize loss to the extent of the holder's basis in that Warrant. Any loss to the holder of an expired Warrant will be a capital loss if the Warrant was held as a capital asset and if the Common Stock underlying the Warrant would have been a capital asset had such Warrant been exercised. Any capital loss will be long-term if the holding period of the Warrant exceeds one year when it expires. The use of capital losses to offset ordinary income is strictly limited for noncorporate shareholders and prohibited for corporate shareholders. No gain or loss will be recognized by the Company upon the acquisition, exercise or expiration of any Warrants. REGISTRATION RIGHTS In connection with the Placement, the Company agreed to file a registration statement no later than nine months after the date of this Prospectus to register the resale of the Placement Shares. Issuable upon exercise of the Placement Warrants. The Company has also agreed to keep such a registration statement effective until such shares have been sold or until such shares can be sold without restrictions pursuant to Rule 144. If such registration statement does not remain effective, then the Private Investors have certain additional demand registration rights. In addition, the Private Investors have piggyback registration rights to require the Company to include the Placement Shares in registration statements filed by the Company registering Common Stock under the Securities Act, either for its own account or for the account of any other stockholder. The Company has also agreed to register the shares of Common Stock issuable upon exercise of a warrant granted to a law firm. See "Management--Employment and Consulting Agreements." As part of the Registration Statement of which this Prospectus forms a part, the Company has registered the Warrants and the shares of Common Stock obtainable upon exercise of the Underwriter's Warrants (including shares obtainable upon exercise of the Warrants included therein). The holders of the Underwriter's Warrants have the right to require the Company to file a registration statement on two separate occasions, commencing one year after the date of this Prospectus, to register the resale of the shares of Common Stock issuable upon exercise of the Underwriter's Warrants and the warrants included therein. The Company is required to bear all registration expenses, other than underwriting discounts and selling commissions, incurred in connection with the first such registration of the shares underlying Underwriter's Warrants, and the second registration is at the expense of the Underwriter. These registration rights could result in substantial future expense to the Company and could adversely affect the Company's ability to complete future equity or debt financings. Furthermore, the registration and sale 50 of Common Stock held by or issuable to the holders of registration rights, or even the potential of such sales, could have an adverse effect on the market price of the Common Stock or Warrants. TRANSFER AGENT AND REGISTRAR AND WARRANT AGENT The Transfer Agent and Registrar for the Company's Common Stock and the Warrant Agent for the Warrants is Continental Stock Transfer & Trust Company. LISTING The Units, Common Stock and Warrants on the Nasdaq SmallCap Market under the trading symbols "ISNU," "ISNX" and "ISNXW," respectively, and on the Boston Stock Exchange under the trading symbols " ," " " and " ," respectively. 51 SHARES ELIGIBLE FOR FUTURE SALE Prior to this offering, there has been no market for the Common Stock. Future sales of substantial amounts of Common Stock in the public market could adversely affect market prices prevailing from time to time. Upon completion of this offering, and assuming no exercises of options or warrants after July 31, 1997, the Company will have outstanding approximately 5,950,268 shares of Common Stock. Of these shares, the 1,400,000 shares sold in this offering and the shares obtainable upon exercise of the Warrants, if and when such Warrants are exercised, will be freely tradeable without restriction under the Securities Act, unless purchased by "affiliates" of the Company as that term is defined in Rule 144 under the Securities Act. The remaining 4,550,268 shares of Common Stock held by existing shareholders were issued and sold by the Company in reliance on exemptions from the registration requirements of the Securities Act. These shares may be sold in the public market only if registered or sold pursuant to an exemption from registration such as Rule 144, 144(k) or 701 under the Securities Act. Substantially all of the Company's securities holders have executed lock-up agreements providing that they will not directly or indirectly sell, contract to sell, grant any option to purchase or otherwise transfer or dispose of any securities of the Company until three years from the initial closing of this offering (the "Lock-up Period"), subject to certain exceptions, without the consent of the Underwriter. As a result of the foregoing lock-up agreements and securities law restrictions, assuming no exercises of options or warrants after July 31, 1997, no shares of Common Stock will be eligible for resale without restriction on the effective date of this offering pursuant to Rules 144 or 144(k). Without giving effect to the foregoing lock-up agreements, of the 4,550,268 shares that are outstanding on the date of this Prospectus, 251,976 shares would be eligible for resale, pursuant to Rule 144 or Rule 701 without volume restriction and the remaining 3,779,942 shares would become eligible for resale subject to the volume limit restrictions of Rule 144 or Rule 701, beginning 90 days from the closing of this offering. In addition to such shares of Common Stock outstanding on July 31, 1997, 1,572,028 shares of Common Stock issuable upon exercise of the warrants issued in connection with the Placement and Underwriter's Warrants will become eligible for public sale as a result of registration rights agreements with the Company. "Description of Capital Stock--Registration Rights." Shortly after this offering, the Company intends to file a registration statement on Form S-8 covering approximately 2,160,707 shares of Common Stock subject to certain outstanding options or reserved for issuance under the Existing Plan (and the other Plans), and covering the resale for shares held by certain directors, officers and employees of the Company that were acquired upon the exercise of such options, thus permitting the resale of such shares of Common Stock in the public market, except to the extent such shares are subject to the lock-up agreements during the Lock-up Period. Accordingly, shares covered by such registration statement will, if and when issued, be available for sale in the open market, subject to the volume limitations of Rule 144 that may be applicable to the resale of such shares, immediately following the expiration of the Lock-up Period. Under the revised Rule 144, beginning 90 days after the date of this Prospectus, a person (or persons whose shares are aggregated) who has beneficially owned restricted shares for at least one year (including the holding period of any prior owner except an affiliate) is entitled to sell, within any three-month period, a number of shares that does not exceed the greater of (i) one percent of the number of shares of Common Stock then outstanding (which will equal approximately 5,950,268 shares immediately after this offering) or (ii) the average weekly trading volume of the Common Stock during the four calendar weeks preceding the filing of a Form 144 with respect to such sale. Sales under Rule 144 are also subject to certain manner of sale provisions and notice requirements and to the availability of current public information about the Company. Under Rule 144(k), a person who is not deemed to have been an affiliate of the Company at any time during the 90 days preceding a sale, and who has beneficially owned the shares to be sold for at least two years (including the holding period of any prior owner except an affiliate), is entitled to sell such shares without complying with the manner of sale, public information, volume limitation or notice provisions of Rule 144. Rule 701 permits resales of shares in reliance upon Rule 144 but without compliance with the holding period requirements of Rule 144. Any employee, officer or director of or consultant to the Company who purchased his or her shares pursuant to a written compensatory plan or contract may be entitled to rely on the resale provisions of Rule 701 if the other conditions of Rule 701 are satisfied. Securities issued in reliance on Rule 701 are deemed to be restricted shares and, beginning 90 days after the date of this Prospectus (unless subject to the lock-up agreements described above), may be sold by persons other than affiliates subject only to the manner of sale provisions of Rule 144 and by affiliates of the Company under Rule 144 without compliance with its one-year minimum holding period requirements. 52 UNDERWRITING Subject to the terms and conditions set forth in the underwriting agreement by and between the Company and the Underwriter (the "Underwriting Agreement"), the Underwriter has agreed to purchase from the Company, and the Company has agreed to sell to the Underwriter, an aggregate of 700,000 Units, at the initial public offering price less the underwriting discounts and commissions set forth on the cover page of this Prospectus. The Underwriting Agreement provides that the obligation of the Underwriter to pay for and accept delivery of the Units is subject to certain conditions precedent, and that the Underwriter will purchase all of the Units offered hereby on a "firm commitment" basis if any are purchased. The Underwriter has advised the Company that it proposes initially to offer the Units directly to the public at the initial public offering price set forth on the cover page of this Prospectus and to certain dealers at such price less a concession not in excess of $ per Unit. After the initial public offering, the public offering price and concession may be changed. The Company has granted to the Underwriter an option, exercisable during the 45-day period after the date of this Prospectus, to purchase up to an aggregate of 105,000 additional Units at the initial per Unit public offering price less the Underwriting discounts and commissions set forth on the cover page of this Prospectus. The Underwriter may exercise this option only to cover over-allotments, if any, made in connection with the sale of the Units offered hereby. The Company has agreed to pay to the Underwriter a non-accountable expense allowance equal to 3% of the gross proceeds of this offering, including any Units purchased pursuant to the Underwriter's over-allotment option, no portion of which has been paid to date. The Company and the Underwriter have agreed to indemnify each other against, or to contribute to losses arising out of, certain civil liabilities in connection with this offering, including liabilities under the Securities Act. The Company and all of its current shareholders have agreed not to offer, sell, contract to sell or otherwise dispose of any shares of Common Stock or rights to acquire shares of Common Stock subject to certain exceptions without the prior written consent of the Underwriter for a period of three years after the date of this Prospectus. The Company has agreed to sell to the Underwriter, for an aggregate price of $140, the Underwriter's Warrants to purchase up to 140,000 shares of Common Stock and 140,000 Warrants. Each Underwriter's Warrant will be exercisable, for a four-year period commencing one year after the date of the Prospectus, to purchase one share of Common Stock at a price of $ , which is 165% of the initial public offering price per share, and upon payment of $ , which is 165% of the initial public offering price per Warrant, to acquire one Warrant, which is exercisable to purchase one share of Common Stock at a price of $ , which is the same exercisable price as that of the Warrants. The Warrants underlying the Underwriter's Warrants have the same terms and conditions as the Warrants to be sold to the public in this offering, except that they are not subject to redemption by the Company until the Underwriter's Warrants have been exercised and the underlying warrants are outstanding. The Underwriter's Warrants may not be sold, assigned, transferred, pledged or hypothecated for a period of five years from the date of the Prospectus except to the Underwriter of its officers. The Company has agreed to file, during the three-year period beginning one year from the date of the Prospectus, on two separate occasions (on only one occasion at the cost of the Underwriter), at the request of the holders of a majority of the Underwriter's Warrants and the underlying shares of Common Stock and Warrants, and to use its best efforts to cause to become effective, a post-effective amendment to the Registration Statement or a new registration statement under the Securities Act, as required to permit the public sale of the shares of 53 Common Stock and Warrants issued or issuable upon exercise of the Underwriter's Warrants. In addition, the Company has agreed to give advance notice to holders of the Underwriter's Warrants of its intention to file certain registration statements commencing one year and ending five years after the date of the Prospectus, and in such case, holders of such Underwriter's Warrants or underlying shares of Common Stock and Warrants shall have the right to require the Company to include all or part of such shares of Common Stock and Warrants underlying such Underwriter's Warrants in such registration statement at the Company's expense. For the life of the Underwriter's Warrants the holders thereof are given the opportunity to profit from a rise in the market price of the shares of Common Stock and Warrants, which may result in a dilution of the interests of other shareholders. As a result, the Company may find it more difficult to raise additional equity capital if it should be needed for the business of the Company while the Underwriter's Warrants are outstanding. The holders of the Underwriter's Warrants might be expected to exercise them at a time when the Company would, in all likelihood, be able to obtain additional equity capital or terms more favorable to the Company than those provided by the Underwriter's Options. Any profit realized on the sale of the shares of Common Stock issuable upon the exercise of the Underwriter's Warrants may be deemed additional underwriting compensation. The underwriting agreement provides for the Underwriter to receive a finder's fee, ranging from 5% of the first $3,000,000 down to 1% of the excess over $10,000,000 of the consideration involved in any capital business transaction (including mergers and acquisitions) consummated by the Company in which the Underwriter introduced the other party to the Company during the five-year period following the completion of the offering. The Underwriting Agreement provides that, for a period of two years from the date of the Prospectus, the Company will nominate a person selected by the Underwriter, and reasonably acceptable to the Company, for election to serve as a member of the Company's Board of Directors. Upon the exercise of the Warrants, the Company will pay the Underwriter a fee of 5% of the aggregate exercise price if (i) the market price of its Common Stock on the date the Warrant is exercised is greater than the then exercise price of the Warrants; (ii) the exercise of the Warrant was solicited by a member of NASD and the customer states in writing that the transaction was solicited and designates in writing the broker-dealer to receive compensation for the exercise; (iii) the Warrants are not held in a discretionary account; (iv) disclosure of compensation arrangements was made both at the time of the offering and at the time of exercise of the Warrants; and (v) the solicitation of exercise of the Warrant was not in violation of Regulation M promulgated under the Exchange Act. The Commission has recently adopted Regulation M to replace Rule 10b-6 and certain other rules promulgated under the Exchange Act. Regulation M may prohibit the Underwriter from engaging in any market making activities with regard to the Company's securities for the period from five business days (or such other applicable period as Regulation M may provide) prior to any solicitation by the Underwriter of the exercise of Warrants until the later of the termination of such solicitation activity or the termination (by waiver or otherwise) of any right that the Underwriter may have to receive a fee for the exercise of Warrants following such solicitation. As a result, the Underwriter may be unable to provide a market for the Company's securities during certain periods while the Warrants are exercisable. Prior to this offering there has been no public trading market for the Company's securities. The initial public offering price of the Units and the exercise price and the term of the Warrants have been determined by negotiation between the Company and the Underwriter. Factors considered in determining the initial public offering price, in addition to prevailing market conditions, included the history of and prospects for the industry in which the Company competes, and assessment of the Company's management, the prospects of the Company, its capital structure and such other factors as were deemed relevant. The foregoing includes a summary of all of the material terms of the Underwriting Agreement and does not purport to be complete. Reference is made to the copy of the Underwriting Agreement that is on file as an exhibit to the Registration Statement of which this Prospectus is a part. The Underwriter has informed the Company that no sales will be made to any account over which the Underwriter exercises discretionary authority. 54 LEGAL MATTERS The validity of the issuance of the shares of Common Stock offered hereby will be passed upon for the Company by Fenwick & West LLP, Palo Alto, California. Fenwick & West LLP holds a warrant to purchase 20,000 shares of Common Stock. Certain legal matters in connection with this offering will be passed upon for the Underwriter by Singer Zamansky LLP, New York, New York. EXPERTS The balance sheets as of April 30, 1996 and 1997, and the statements of operations, shareholders' (deficit) equity, and cash flows for the years then ended, have been audited by Grant Thornton LLP, independent certified public accountants, as set forth in their report thereon appearing elsewhere herein and in the Registration Statement, and are included in reliance upon such report given upon the authority of such firm as experts in accounting and auditing. ADDITIONAL INFORMATION The Company has filed with the Commission a Registration Statement on Form SB-2 under the Securities Act with respect to the shares of Common Stock and Warrants offered hereby. This Prospectus does not contain all of the information set forth in the Registration Statement and its exhibits. For further information with respect to the Company and the Units, Common Stock and Warrants offered hereby, reference is made to the Registration Statement and exhibits. Statements contained in this Prospectus regarding the contents of any contract or any other document to which reference is made are not necessarily complete, and in each instance reference is made to the copy of such contract or other document filed as an exhibit to the Registration Statement, each such statement being qualified in all respects by such reference. A copy of the Registration Statement, including the exhibits thereto, may be inspected without charge at the Commission's principal office in Washington, D.C., and copies of all or any part thereof may be obtained from the Public Reference Section of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, upon payment of certain prescribed rates. 55 GLOSSARY OF TERMS CELL GROWTH MEDIA: Substances used in a gel or solution that promote the growth and multiplication of cells from simple or more complex organisms. Organisms grown (fed) cell growth media labeled with enriched stable isotopes result in new and more complex stable isotope labeled compounds. CGMP (CURRENT GOOD MANUFACTURING PRACTICE): Part of quality assurance aimed at ensuring that products are consistently manufactured to a quality appropriate to their intended use; it incorporates manufacturing, engineering, quality control and quality assurance activities. CROSS SECTION: A fundamental property of the nucleus of an isotope, cross section is a measure of the probability of interaction of the nucleus with another nucleus, particle or photon. DEPLETED STABLE ISOTOPE: An isotope of an element whose concentration or "abundance" has been decreased with respect to that of the naturally occurring element. DEPLETED ZINC (DZ): Zinc oxide in which the stable isotope Zn-64 has been depleted for application in nuclear power plants for corrosion control and the mitigation of radiation fields. DOPING: An impurity, such as boron, is added in small amounts to a pure semiconductor to alter its conductive properties. ENRICHED STABLE ISOTOPE: An isotope of an element whose concentration or "abundance" has been increased with respect to that of the naturally occurring element. HIGH PURITY MATERIALS, CHEMICAL: Materials in which the relevant chemical compound makes up more than >99.99% of the material. H.PYLORI (Helicobacter pylori): A pathogenic bacterium found in the human stomach, responsible for most peptic ulcers and some stomach cancers. ISOTOPE: One of two or more naturally occurring species of atom having the same atomic number, hence constituting the same element, but differing in mass number. As atomic number is equivalent to the number of protons in the nucleus, and mass number is the sum total of the protons plus the neutrons in the nucleus, isotopes of the same element differ from one another only in the number of neutrons in their nuclei. Isotopes may be radioactive or stable. Isonics deals only with stable isotopes. ISOTOPICALLY PURE MATERIALS: Materials in which a particular isotope has been enriched to 99.5% abundance or greater in an element or in a compound. ISOTOPICALLY ENGINEERED MATERIALS (IEM): Materials in which the natural abundance of isotopes of constituent elements has been substantially altered to enhance performance characteristics or provide unique properties. MAGNETIC MOMENT: A fundamental property of the nucleus of an isotope, magnetic moment is a vector quantity related to the intrinsic spin of a charged particle. It is unique to each isotope and can be used to describe how a spinning, charged particle will interact with an externally imposed magnetic field (as in an NMR instrument or imaging scanner). MASS SPECTROMETER: An apparatus that converts molecules and atoms into ions and then separates the ions according to their mass-to-charge ratio. Mass spectrometers are used to identify atoms and isotopes, and determine the chemical composition of a sample. NUCLEAR MAGNETIC RESONANCE (NMR): A phenomenon exhibited by a large number of atomic nuclei, in which nuclei in a static magnetic field absorb energy from a radio-frequency field at certain characteristic frequencies. 56 The frequency at which resonance occurs is a function of the chemical form of the nuclei of interest. This property is exploited in NMR instruments used to determine the make-up and structure of chemicals. It is also employed in medicine to produce 3-dimensional images of the distribution of protons (the 1H isotope of hydrogen) incorporated in the chemicals of the human body. SPIN: A fundamental property of all elementary particles, spin is the intrinsic angular momentum of a sub-atomic particle--present even if the particle is not moving. If the particle is charged, the spin results in a magnetic moment. STABLE ISOTOPE LABELED COMPOUND (SILC): Also referred to as a "labeled compound," a chemical which has been "tagged" by substitution of a common isotope with a rare one (i.e., an enriched stable isotope). X-RAY CRYSTALLOGRAPHY: The study of crystal lattices using diffraction patterns of X-ray waves that reflect the atomic structure based on atomic size and position in space. 57 ISONICS CORPORATION INDEX TO FINANCIAL STATEMENTS
PAGE ---- Report of Independent Certified Public Accountants......................... F-2 Balance Sheets............................................................. F-3 Statements of Operations................................................... F-4 Statements of Shareholders' Equity (Deficit)............................... F-5 Statements of Cash Flows................................................... F-6 Notes to Financial Statements.............................................. F-7
F-1 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The Board of Directors and Shareholders Isonics Corporation We have audited the accompanying balance sheets of Isonics Corporation as of April 30, 1996 and 1997, and the related statements of operations, stockholders' equity (deficit) and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Isonics Corporation as of April 30, 1996 and 1997, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles. Grant Thornton LLP San Jose, California August 13, 1997 F-2 ISONICS CORPORATION BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
APRIL 30, --------------- 1996 1997 ------ ------- ASSETS CURRENT ASSETS: Cash and cash equivalents................................... $ 116 $ 28 Accounts receivable......................................... 2 4 Note receivable from shareholder............................ 33 -- Inventories................................................. 1,006 1,539 Prepaid expenses............................................ 10 14 Deferred income taxes....................................... 114 -- ------ ------- Total current assets...................................... 1,281 1,585 PROPERTY AND EQUIPMENT, net................................... 81 70 GOODWILL (net of accumulated amortization of $79 and $157).... 393 315 NOTES RECEIVABLE FROM SHAREHOLDERS............................ -- 41 OTHER ASSETS.................................................. 4 11 DEFERRED OFFERING COSTS....................................... -- 556 DEBT ISSUANCE COSTS (net of accumulated amortization of $61).. -- 106 DEFERRED INCOME TAXES......................................... 29 -- ------ ------- TOTAL......................................................... $1,788 $ 2,684 ====== ======= LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES: Current portion of long-term debt........................... $ 176 $ 403 Accounts payable............................................ 792 1,105 Accrued liabilities......................................... 285 518 Income taxes payable........................................ 89 -- ------ ------- Total current liabilities................................. 1,342 2,026 LONG-TERM DEBT................................................ 276 1,268 COMMITMENTS................................................... -- -- STOCKHOLDERS' EQUITY (DEFICIT) Class A Preferred Stock--no par value; 100,000 shares authorized 1996; 10,000,000, 1997; issued and outstanding: 1996, 6,250; 1997, none.................................... 125 -- Common stock--$.001 par value 1996; no par value 1997; 100,000,000 shares authorized 1996; 20,000,000, 1997; issued and outstanding: 1996, 3,570,046; 1997, 4,550,268... 1 1,129 Additional paid-in capital.................................. 77 -- Notes receivable from shareholders.......................... -- (343) Accumulated deficit......................................... (33) (1,396) ------ ------- Total stockholders' equity (deficit)...................... 170 (610) ------ ------- TOTAL......................................................... $1,788 $ 2,684 ====== =======
See Notes to Financial Statements. F-3 ISONICS CORPORATION STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED APRIL 30, --------------- 1996 1997 ------ ------- Net revenues.................................................. $5,567 $ 4,539 Cost of revenues.............................................. 3,835 3,616 ------ ------- Gross margin................................................ 1,732 923 Operating expenses: Selling, general and administrative......................... 902 1,183 Research and development.................................... 308 655 ------ ------- Total operating expenses.................................. 1,210 1,838 ------ ------- Operating income (loss)....................................... 522 (915) Other income (expense) Interest income............................................. 1 14 Interest expense............................................ (67) (409) ------ ------- Total other expense, net.................................. (66) (395) ------ ------- Income (loss) before income taxes............................. 456 (1,310) Income tax expense............................................ 175 53 ------ ------- NET INCOME (LOSS)............................................. $ 281 $(1,363) ====== ======= Net income (loss) per share................................... $ .05 $ (.23) ====== ======= Shares used in computing per share information................ 5,949 5,890 ====== ======= Pro forma (loss) per share.................................... $ (.16) ======= Shares used in computing per share information................ 6,430 =======
See Notes to Financial Statements. F-4 ISONICS CORPORATION STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT) (IN THOUSANDS, EXCEPT SHARE AMOUNTS) TWO YEARS ENDED APRIL 30, 1997
NOTES PREFERRED STOCK COMMON STOCK ADDITIONAL RECEIVABLE ----------------- ---------------- PAID-IN FROM (ACCUMULATED SHARES AMOUNT SHARES AMOUNT CAPITAL SHAREHOLDERS DEFICIT) TOTAL -------- ------- --------- ------ ---------- ------------ ------------ ------- BALANCES, May 1, 1995... 6,250 $ 125 3,570,046 $ 1 $ 77 $ -- $ (314) $ (111) Net income............ -- -- -- -- -- -- 281 281 -------- ------- --------- ------ ------- ----- ------- ------- BALANCES, April 30, 1996................... 6,250 125 3,570,046 1 77 -- (33) 170 Exercise of stock options.............. -- -- 750,898 1 531 (330) -- 202 Interest on notes receivable from shareholders......... -- -- -- -- -- (13) -- (13) Conversion of preferred stock...... (6,250) (125) 229,324 -- 125 -- -- -- Issuance of warrants with promissory notes................ -- -- -- -- 394 -- -- 394 Recapitalization...... -- -- -- 1,127 (1,127) -- -- -- Net loss.............. -- -- -- -- -- -- (1,363) (1,363) -------- ------- --------- ------ ------- ----- ------- ------- BALANCES, April 30, 1997................... -- $ -- 4,550,268 $1,129 $ -- $(343) $(1,396) $ (610) ======== ======= ========= ====== ======= ===== ======= =======
See Notes to Financial Statements. F-5 ISONICS CORPORATION STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED APRIL 30, -------------- 1996 1997 ----- ------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss).............................................. $ 281 $(1,363) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization................................. 87 310 Interest on notes receivable from shareholders................ -- (13) Deferred income taxes......................................... 73 143 Changes in assets and liabilities: Accounts and notes receivable................................ (8) (10) Inventories.................................................. (723) (533) Prepaid expenses............................................. (6) (4) Other assets................................................. 4 (8) Accounts payable............................................. 378 313 Accrued liabilities and other................................ 5 233 Income taxes payable......................................... 89 (89) ----- ------- Net cash provided by (used in) operating activities......... 180 (1,021) CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment............................ (7) (10) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of debt and warrants.................... 142 1,751 Payments of debt............................................... (237) (339) Proceeds from issuance of common stock......................... -- 202 Payment of debt issuance costs................................. -- (115) Payment of deferred offering costs............................. -- (556) ----- ------- Net cash provided by (used in) financing activities......... (95) 943 ----- ------- NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS............. 78 (88) Cash and cash equivalents at beginning of period................ 38 116 ----- ------- Cash and cash equivalents at end of period...................... $ 116 $ 28 ===== ======= Supplemental disclosure of noncash financing activities: Stock issued for note receivable............................... $ -- $ 330 ===== ======= Supplemental disclosures of cash flow information: Cash paid during the period for: Interest...................................................... $ 67 $ 135 Income taxes.................................................. 14 9
See Notes to Financial Statements. F-6 ISONICS CORPORATION NOTES TO FINANCIAL STATEMENTS NOTE 1--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION Isonics Corporation, (the "Company") develops and markets products worldwide based on enriched stable isotopes for applications in the energy, medical research, diagnostic, pharmaceutical and semiconductor industries. CASH EQUIVALENTS Cash equivalents consist of money market investments with an original maturity of less than ninety days. CONCENTRATION OF CREDIT RISK Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash equivalents and trade accounts receivable. Cash equivalents are maintained with high quality institutions and are regularly monitored by management. The Company extends credit to its customers, most of whom are large, established companies. Credit risk is mitigated by performing ongoing credit evaluations of its customers' financial condition and generally does not require collateral. INVENTORIES Inventories are stated at the lower of cost (first-in, first-out) or market. PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Depreciation is computed using the straight-line method over five to seven years. Leasehold improvements are amortized over the shorter of their estimated useful lives or the lease term. GOODWILL Goodwill resulted from the acquisition of Isoserve, Inc., and is being amortized on a straight-line basis over six years. The Company evaluates the realizability of goodwill annually to determine potential impairment by comparing the undiscounted future cash flows of the related assets. The Company modifies or adjusts goodwill if an impairment is indicated. Based upon its most recent evaluation, the Company believes that no material impairment of goodwill exists as of April 30, 1997. INCOME TAXES The Company accounts for income taxes using an asset and liability approach for financial accounting and reporting purposes. REVENUE RECOGNITION Revenue from product sales is recognized upon shipment. Product warranty costs have not been material in any period. USE OF ESTIMATES IN THE FINANCIAL STATEMENTS In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as revenues and expenses during the reporting period. Actual results could differ from those estimates. F-7 ISONICS CORPORATION NOTES TO FINANCIAL STATEMENTS--(CONTINUED) NOTE 1--ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) FAIR VALUES OF FINANCIAL INSTRUMENTS The fair value of cash and equivalents approximates carrying value due to the short maturity of such instruments. The fair value of long-term debt approximates carrying value based on terms available for similar instruments. NET INCOME (LOSS) PER SHARE Net income (loss) per share is based on the weighted average number of common and common equivalent shares outstanding during the period. Common equivalent shares include convertible preferred stock (using the if-converted method) and common stock options and warrants (using the treasury stock method). Common equivalent shares are excluded from the computation in loss periods as their effect is antidilutive, except that, pursuant to Securities and Exchange Commission rules, all shares issuable from the exercise of warrants issued and stock options granted by the Company at a price less than the estimated initial public offering price during the twelve months preceding the offering date have been included in the calculation (using the treasury stock method) as if they had been outstanding for all periods. Pro forma net loss per share has been presented to depict what the net loss per share would have been had the common shares issuable upon the conversion of the outstanding preferred stock and for debt repayment been outstanding during that period. NOTE 2--INVENTORIES Inventories consist of the following (in thousands):
APRIL 30, ------------- 1996 1997 ------ ------ Finished goods.............................................. $ 892 $1,387 Work in process............................................. 107 -- Raw Materials............................................... 7 152 ------ ------ $1,006 $1,539 ====== ======
NOTE 3--PROPERTY AND EQUIPMENT Property and equipment consists of the following (in thousands):
APRIL 30, ---------- 1996 1997 ---- ---- Office furniture and equipment................................ $ 88 $ 93 Leasehold Improvements........................................ 3 4 ---- ---- 91 97 Accumulated depreciation and amortization..................... (10) (27) ---- ---- $ 81 $ 70 ==== ====
F-8 ISONICS CORPORATION NOTES TO FINANCIAL STATEMENTS--(CONTINUED) NOTE 4--ACCRUED LIABILITIES Accrued liabilities consist of the following (in thousands):
APRIL 30, --------- 1996 1997 ---- ---- Compensation.................................................... $268 $328 Other........................................................... 17 190 ---- ---- $285 $518 ==== ====
NOTE 5--INCOME TAXES Deferred tax assets are comprised of the following (in thousands):
APRIL 30, ---------- 1996 1997 ---- ----- Deferred tax assets Accruals and reserves deductible in future periods.......... $143 $ 226 Net operating loss carryforwards............................ -- 508 Valuation allowance......................................... -- (734) ---- ----- $143 $ -- ==== =====
Income tax expense consists of the following (in thousands):
APRIL 30, --------- 1996 1997 ---- ---- Current Federal...................................................... $ 78 $(78) State........................................................ 24 (12) ---- ---- 102 (90) Deferred Federal...................................................... 69 110 State........................................................ 4 33 ---- ---- 73 143 ---- ---- $175 $ 53 ==== ====
A reconciliation of the statutory federal income tax rate to the effective tax rate is as follows:
APRIL 30, ----------- 1996 1997 ---- ----- Statutory federal income tax rate........................... 35.0% (35.0)% State income taxes (net of federal income tax benefit)...... 3.5 (5.5) Amortization of warrants issued with promissory notes....... -- 3.9 Other....................................................... .3 .5 Change in valuation allowance............................... -- 40.1 ---- ----- Effective tax rate.......................................... 38.8% 4.0% ==== =====
F-9 ISONICS CORPORATION NOTES TO FINANCIAL STATEMENTS--(CONTINUED) NOTE 5--INCOME TAXES--(CONTINUED) The valuation allowance for deferred tax assets as of April 30, 1996 and 1997 was none and $734,000, respectively. The Company provided a valuation allowance for its deferred tax asset as it believes realization of such asset is uncertain. The Company has $1,100,000 and $1,000,000 of net operating loss carryforwards for state and federal purposes available through 2002 and 2112, respectively. NOTE 6--LONG TERM DEBT Long term debt consists of the following (in thousands):
APRIL 30, ----------- 1996 1997 ---- ------ Note payable, guaranteed by the SBA, payable in monthly installments of $700 including interest at prime (8.5% at April 30, 1997) plus 2.75%, final payment due January 2005.. $ 46 $ 43 Notes payable, unsecured; payable upon demand, plus interest ranging from 8.0% to 24.0%.................................. 85 291 Nonconvertible promissory notes, net of unamortized discount of $245,000................................................. -- 1,153 Capital leases (see Note 7).................................. 69 49 Royalty payable to Isoserve, Inc. (see Note 7)............... 252 135 ---- ------ 452 1,671 Less current maturities...................................... 176 403 ---- ------ $276 $1,268 ==== ======
Maturities of long-term debt as of April 30, 1997 are as follows (in thousands): 1998............................................................... $ 403 1999............................................................... 1,232 2000............................................................... 5 2001............................................................... 5 2002............................................................... 6 Thereafter......................................................... 20 ------ $1,671 ======
During fiscal 1997, the Company issued $1,397,000 in nonconvertible promissory notes, collateralized by the Company's assets. Interest is payable monthly at 12% through May 1, 1997. If the notes are not paid in full by May 1, 1997, the remaining principal and interest at 15% is payable in equal monthly payments from June 1997 through May 1998. In the event of an initial public offering of the Company's common stock, all principal and accrued but unpaid interest is due five days after the closing of such offering. In connection with the issuance of the promissory notes, the Company issued warrants to the noteholders to purchase a total of 681,938 shares of common stock, exercisable for a period of five years commencing in August 1996. Of the warrants issued, 340,968 are exercisable at $0.1771 per share and 340,968 are exercisable at $1.4165 per share. If the Company defaults in its payment obligations, then additional warrants totaling 898,709 are exercisable at $.01 per share. In conjunction with the financing, the Company issued warrants to purchase 304,098 shares of common stock F-10 ISONICS CORPORATION NOTES TO FINANCIAL STATEMENTS--(CONTINUED) NOTE 6--LONG TERM DEBT--(CONTINUED) exercisable for a period of five years, at $0.5788 per share to a financial advisor. The aggregate fair value of the warrants issued in connection with the financing was $394,000 and is being amortized to operations as additional interest expense over the term of the promissory notes. Of the total promissory notes and warrants issued, $620,000 and 303,696 warrants were purchased by related parties. On July 23, 1997, the terms of the nonconvertible promissory notes were amended. Effective August 1, 1997, interest is payable monthly at 15%. If the notes are not paid in full by April 1998, the remaining principal and interest is payable in equal monthly payments from May 1998 through April 1999. In connection with the amendment of the notes, the Company issued warrants to the noteholders to purchase a total of 450,000 shares of common stock, exercisable for a period of four years, at $2.083 per share. NOTE 7--COMMITMENTS At April 30, 1997, furniture and equipment with a cost and accumulated amortization of $68,000 and $16,000 has been acquired under capital leases. The Company also rents office and research facilities, equipment and vehicles under operating leases expiring through 1998. Future minimum annual operating and capital lease commitments are as follows (in thousands):
APRIL 30, 1997 ----------------- OPERATING CAPITAL --------- ------- 1998.................................................... $ 54 $ 31 1999.................................................... -- 25 ---- ---- Total minimum lease payments.......................... $ 54 56 ==== Amount representing interest............................ (7) ---- Present value of minimum lease payments................. 49 Current portion......................................... (25) ---- Long-term portion....................................... $ 24 ====
Rent expense for operating leases was approximately $19,000 and $61,000 for the years ended April 30, 1996 and 1997, respectively. The Company is required to make royalty payments to Isoserve, Inc. for depleted zinc metal sold through fiscal 2000. Minimum annual royalty payments of $100,000 are required regardless of sales volume until the Company has paid $500,000 in aggregate. The maximum royalty payments under the agreement are $1,000,000. The Company has accrued a liability for the present value of the expected royalty payments. The royalty payments are secured by certain assets of the Company. The Company paid royalties of $198,000 and $140,000 for the years ended April 30, 1996 and 1997, respectively. NOTE 8--STOCKHOLDERS' EQUITY On September 30, 1996 and March 26, 1997, the Board of Directors approved a 1 for 6.89 and a 1 for 1.26 reverse stock split of its common shares, respectively. On August 11, 1997, the Board of Directors approved a 3 for 1 stock split of its common shares. All per share amounts, number of shares, stock options and warrant data have been restated to reflect the reverse stock splits and stock split. In December 1996, the shareholders approved an increase in the authorized shares of Preferred and Common Stock to 10,000,000 and 20,000,000, respectively. F-11 ISONICS CORPORATION NOTES TO FINANCIAL STATEMENTS--(CONTINUED) NOTE 8--STOCKHOLDERS' EQUITY--(CONTINUED) CONVERTIBLE PREFERRED STOCK The Articles of Incorporation authorized the issuance of 100,000 shares of nonvoting Class A and B convertible preferred stock of which 6,250 of Series A-1 and A-2 Preferred were outstanding at April 30, 1996. Each 10 shares of Series A-1 and A-2 preferred stock along with $5 per share were convertible at the option of the stockholder into 384 shares of common stock. The preferred shares can be redeemed at the option of the Company for $40 per share. The stockholders of Series A-1 and A-2 convertible preferred stock were entitled to quarterly noncumulative dividends of $1.60 per share, if and when declared by the Company's Board of Directors. At April 30, 1996, no such dividends had been declared. In the event of liquidation or winding up of the Company, stockholders of Series A-1 and A-2 preferred stock were entitled to a liquidation preference of $5 per share, plus declared and unpaid dividends, over holders of common shares. In December 1996, all shares of then outstanding Series A-1 and A-2 preferred stock were converted to common stock in a cashless conversion, and the Company concurrently eliminated the designation of rights, preferences and restriction for such Series A-1 and A-2 preferred stock from its Articles of Incorporation. RESERVED COMMON STOCK The Company has reserved shares of common stock for issuance as follows:
APRIL 30, 1997 --------- Exercise of stock options....................................... 1,696,933 Exercise of warrants............................................ 986,035 --------- 2,682,968 =========
F-12 ISONICS CORPORATION NOTES TO FINANCIAL STATEMENTS--(CONTINUED) NOTE 8--STOCKHOLDERS' EQUITY--(CONTINUED) STOCK OPTION PLAN The Company's 1996 Stock Option Plan authorizes the granting of 1,727,832 incentive and nonqualified stock options to key employees, directors or consultants of the Company. Incentive stock options are granted at a price not less than fair market value, and nonqualified stock options are granted at a price not less than 85% of the fair market value, as determined by the Board of Directors. Options generally become exercisable upon issuance and are subject to redemption rights typically over three years and generally expire ten years after the date of grant. In November 1996, the Board of Directors adopted the Executive and Incentive Stock Option Plans. A total of 720,000 shares of common stock are reserved for issuance under the plans. The options, which have terms of 5 or 10 years when issued, vest over a three to five year period. The exercise price of each option generally approximates the fair market value per share of the Company's stock on the date of grant. Accordingly, no compensation cost has been recognized for the plan. Had compensation cost for the plan been determined based on the fair value of the options at the grant dates consistent with the method of Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation, the Company's net earnings (loss) and earnings (loss) per share would have been changed to the pro forma amounts indicated below.
1996 1997 -------- ----------- Net earnings (loss) As reported........................................ $281,000 $(1,363,000) Pro forma.......................................... 263,000 (1,465,000) Earnings (loss) per share As reported........................................ $0.05 $(0.23) Pro forma.......................................... 0.05 (0.25)
The fair value of each option grant is estimated on the date of grant using the Black-Scholes options-pricing model with the following weighted average assumptions used for grants in 1996 and 1997, respectively; no expected dividends; no volatility; risk-free interest rates ranging from 5.8% to 7.1%; and expected lives of 10 years. A summary of the status of the Company's stock option plan as of April 30, 1996 and 1997, and changes during the years ending on those dates is presented below.
WEIGHTED AVERAGE EXERCISE SHARES PRICE -------- -------- Outstanding at May 1, 1995.............................. -- -- Granted............................................... 993,503 $0.61 Exercised............................................. -- -- Forfeited............................................. -- -- -------- Outstanding at April 30, 1996........................... 993,503 0.61 Granted............................................... 476,761 0.94 Exercised............................................. (750,898) 0.71 Forfeited............................................. (34,557) 0.87 -------- Outstanding at April 30, 1997........................... 684,809 0.72 ========
The weighted-average fair value of options granted during the years ended April 30, 1996 and 1997 was $0.23 and $0.44, respectively. F-13 ISONICS CORPORATION NOTES TO FINANCIAL STATEMENTS--(CONTINUED) NOTE 8--STOCKHOLDERS' EQUITY--(CONTINUED) The following information applies to options outstanding at April 30, 1997: Range of exercise prices............................... $0.58--$0.87 $1.35 Options outstanding.................................... 613,380 71,429 Weighted average exercise price........................ $0.64 $1.35 Weighted average remaining contractual life (years).... 9 10 Options exercisable.................................... 613,380 71,429 Weighted average exercise price........................ $0.64 $1.35
Options to purchase 34,557 and 399,285 shares of common stock at weighted average exercise prices of $0.58 and $0.61 per share were not subject to rights of repurchase at April 30, 1996 and 1997, respectively. Two executive officers of the Company exercised stock options to each acquire 259,175 shares of Common Stock at an exercise price of $0.64 per share. In each case, the Company loaned the executive officer $165,000, representing the exercise price of the option, and the officer executed a promissory note reflecting the loan. Each executive officer pledged the purchased shares as collateral for the loan pursuant to a pledge agreement. Each loan bears interest at an annual rate equal to the minimum applicable federal rate, and interest is payable annually; principal and accrued but unpaid interest is due five years from the date of the note. Until each note has been paid in full and upon any sale of such option shares by the respective executive, a portion of the sales proceeds will be used to pay amounts owed under the note. In addition, the Company has agreed to loan to each such officer, pursuant to a five-year note with interest at the minimum applicable federal rate, an amount equal to the federal and state tax liability incurred by him as a result of exercising such option, and to pay compensation to such officer equal to the amount of interest payable under his loan and the amount of taxes payable as a result of such compensation. At April 30, 1997, principal and interest due on the loans totaled $330,000 and $13,000, respectively. NOTE 9--SIGNIFICANT CUSTOMERS AND SUPPLIERS In 1997, four customers accounted for approximately 49%, 20%, 13% and 10% of net revenues. In 1996, two customers accounted for 88% and 11% of net revenues. Export sales were 13% of net revenues in 1996 and less than 10% in 1997. Export sales are principally to Asia. The Company currently uses a single source processor in its manufacturing process; a disruption of this relationship could have an adverse impact on the operating results of the Company. The Company has not experienced a disruption; however, the Company recognizes the risks and is actively pursuing alternative sources. F-14 Gas centrifuge enrichment facility owned by a third party where several of Isonics' products are processed. ================================================================================ NO PERSON HAS BEEN AUTHORIZED IN CONNECTION WITH THE OFFERING MADE HEREBY TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY TO ANY PERSON OR ANYONE IN ANY JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN IMPLICATION THAT INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF. --------------- TABLE OF CONTENTS
PAGE ---- Prospectus Summary........................................................ 3 Risk Factors.............................................................. 5 Use of Proceeds........................................................... 14 Dividend Policy........................................................... 14 Capitalization............................................................ 15 Dilution.................................................................. 17 Selected Financial Data................................................... 18 Management's Discussion and Analysis of Financial Condition and Results of Operations............................................................... 19 Business.................................................................. 23 Management................................................................ 39 Certain Transactions...................................................... 45 Principal Shareholders.................................................... 46 Description of Capital Stock.............................................. 47 Shares Eligible for Future Sale........................................... 52 Underwriting.............................................................. 53 Legal Matters............................................................. 55 Experts................................................................... 55 Additional Information.................................................... 55 Index to Financial Statements............................................. F-1
--------------- UNTIL , 1997 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS EFFECTING TRANSACTIONS IN THE UNITS, COMMON STOCK OR WARRANTS OFFERED HEREBY, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. ================================================================================ ================================================================================ 700,000 UNITS, CONSISTING OF 1,400,000 SHARES OF COMMON STOCK AND 1,400,000 REDEEMABLE CLASS A COMMON STOCK PURCHASE WARRANTS [LOGO OF ISONICS CORPORATION] --------------- PROSPECTUS --------------- MONROE PARKER SECURITIES, INC. , 1997 ================================================================================ PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 24 INDEMNIFICATION OF DIRECTORS AND OFFICERS. The Company's Articles of Incorporation include a provision that eliminates to the fullest extent permitted by law the personal liability of its directors to the Company and its shareholders for monetary damages for breach of the directors fiduciary duties. This limitation has no effect on a director's liability (i) for acts or omissions that involve intentional misconduct or a knowing and culpable violation of law, (ii) for acts or omissions that a director believes to be contrary to the best interests of the Company or its shareholders or that involved the absence of good faith on the part of the director, (iii) for any transaction from which the director derived an improper personal benefit, (iv) for acts or omissions that show a reckless disregard for the director's duty to the Company or its shareholders in circumstances in which the director was aware, or should have been aware, in the ordinary course of performing a director's duties, of a risk of serious injury to the Company or its shareholders, (v) for acts or omissions that constitute an unexcused pattern of inattention that amounts to an abdication of the director's duty to the Company or its shareholders, (vi) under Section 310 of the California Corporations Code (the "California Code") concerning contracts or transactions between the Company and a director or (vii) under Section 316 of the California Code concerning directors liability for improper dividends, loans and guarantees. The provision does not extend to acts or omissions of a director in his capacity as an officer. Further, the provision will not affect the availability of injunctions and other equitable remedies available to the Company's shareholders for any violation of a director's fiduciary duty to the Company or its shareholders. The Company's Articles of Incorporation further authorize the Company to indemnify its agents (as defined in Section 317(a) of the Code which includes directors and officers) through Bylaw provisions, agreements with agents, votes of shareholders or disinterested directors or otherwise, to the fullest extent permissible under California law. Pursuant to this provision, the Company's Bylaws provide for indemnification of directors and officers. The Bylaws also permit the Company to enter into indemnity agreements with individual directors, officers, employees and other agents. The Company intends to enter into such agreements with its directors and executive officers effective upon the closing of this offering. These Agreements, together with the Company's Bylaws and Articles, may require the Company, among other things, to indemnify directors or officers against certain liabilities that may arise by reason of their status or service as directors (other than liabilities resulting from willful misconduct of a culpable nature), to advance expenses to them as they are incurred, provided that they undertake to repay the amount advanced if it is ultimately determined by a court that they are not entitled to indemnification, and to obtain and maintain directors and officers' insurance if available on reasonable terms. In addition to the rights to indemnification provided under California law, in the Articles of Incorporation and in the Bylaws, the 1996 Stock Option Plan provides indemnification to members of the Board of Directors, officers, or employees of the Company to whom authority to act for the Board in connection with the Existing Plan is delegated shall be indemnified against all reasonable expenses, including attorneys' fees, actually and necessarily incurred in defense of any proceeding to which he or she is made a party because of any action allegedly taken or alleged failure to act in connection with the Plan, and against amounts paid in settlement (if approved by independent legal counsel), or in satisfaction of any judgment in such proceeding, unless the director, officer, or employee, as the case may be, is adjudged to have behaved in bad faith, in a grossly negligent manner, or with intentional misconduct as to duties. The Company currently has directors and officers' liability insurance. At present, there is no pending litigation or proceeding involving a director, officer or employee of the Company pursuant to which indemnification is sought, nor is the Company aware of any threatened litigation that may result in claims for indemnification. II-1 Section 317 of the Code and the Company's Bylaws make provision for the indemnification of officers, directors and other corporate agents in terms sufficiently broad to indemnify such persons, under certain circumstances, for liabilities (including reimbursement of expenses incurred) arising under the Securities Act. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons pursuant to the foregoing provisions, or otherwise, the Company has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. Reference is made to the following documents filed as exhibits to this Registration Statement regarding relevant indemnification provisions described above and elsewhere herein:
DOCUMENT EXHIBIT NUMBER -------- -------------- Underwriting Agreement ....................................... 1.01 Registrant's Certificate of Incorporation..................... 3.01 Registrant's Bylaws........................................... 3.02 Form of Indemnity Agreement................................... 10.09
ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. The following table sets forth the costs and expenses to be paid in connection with the sale of the shares of Common Stock being registered hereby. All amounts are estimates except for the Securities and Exchange Commission registration fee, the NASD filing fee and the Nasdaq SmallCap National Market filing fee. Securities and Exchange Commission registration fee................ $ 4,076 NASD filing fee.................................................... 1,845 Nasdaq SmallCap Market filing fee.................................. 10,000 Accounting fees and expenses....................................... 85,000 Legal fees and expenses............................................ 200,000 Printing fees and expenses......................................... 125,000 Blue sky fees and expenses......................................... 50,000 Transfer agent and registrar fees and expenses..................... 5,000 Miscellaneous...................................................... 96,579 Boston Stock Exchange listing fee.................................. 22,500 -------- Total.............................................................. $600,000 ========
ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES.
NUMBER AGGREGATE FORM OF CLASS OF PURCHASERS DATE OF SALE TITLE OF SECURITIES OF SHARES PURCHASE PRICE CONSIDERATION - ------------------- ------------ ------------------- --------- -------------- ------------- 2 Founders 5/10/93 Common Stock 3,282,879 $ 12,000 Property 1 Investor 11/20/93 Common Stock 172,785 $ 6,000 Cash 2 Investors 12/1/94 and 12/7/95 Preferred Stock 6,250 $ 125,000 Cash 1 Acquired Entity 3/31/95 Common Stock 114,382 $ 60,000 Property 1 Advisor 9/96 Warrants 304,098 $ 141,000 Services 1 Investor 8/96 Common Stock 115,200 100,000 Cash 1 Investor 9/96 Common Stock 117,348 $ 101,885 Cash 2 Investors 9/96 Common Stock 518,352 $ 330,000 Notes 11 Investors 6/96 Notes and Warrants 681,939 $1,397,000 Loans 11 Investors 7/97 Warrants 450,000 $ -- Amendment of Loans
All sales of Common Stock, Preferred Stock and warrants were made in reliance on Section 4(2) of the Securities Act. The purchasers were sophisticated investors who represented to the Registrant that the shares were being acquired for investment. All issuances of shares and options under the Company's existing plan were made in reliance on Section 4(2) or Rule 701. Between January 1996 and the date of this registration statement, the Company granted options under the Company's Existing Plan to purchase a total of 1,475,266 shares of Common Stock at exercise prices ranging from $0.58 to $3.50 per share, to a limited number of employees. No consideration was paid to the Company by any recipient of any of the foregoing options for the grant of any such options. As of the date of this Prospectus, such options have been exercised to acquire a total of 750,898 shares of Common Stock. II-2 ITEM 27. EXHIBITS.
EXHIBIT NUMBER EXHIBIT TITLE ------- ------------- 1.01 Form of Underwriting Agreement. 3.01 Registrant's Form of Amended and Restated Articles of Incorporation. 3.02 Registrant's Bylaws.* 3.03 Registrant's Amended and Restated Articles of Incorporation, to be in effect at the closing of this offering.* 4.01 Specimen Common Stock Certificate.* 4.02 Form of Underwriter's Warrant Agreement. 4.03 Form of Warrant Agreement between the Registrant and Continental Stock Transfer & Trust Company, and Monroe Parker Securities, Inc. 4.04 Specimen Warrant Certificate. 5.01 Opinion of Fenwick & West LLP. 10.01 Registrant's 1996 Stock Option Plan.* 10.02 Form of Employment Agreement between the Registrant and certain officers of the Registrant.* 10.03 Registrant's 1996 Executives Equity Incentive Plan.* 10.04 Registrant's 1996 Equity Incentive Plan.* 10.05 Memorandum of Agreement between Electrochemical Plant, AO Techsnabexport, Co., Ltd. and Registrant.* 10.06 Option Agreement between the Registrant and Yale University.*/** 10.07 Office Lease Agreement between Paulsen Properties and the Registrant as of January 1, 1996, as amended.* 10.08 Letter from Yale University to Registrant dated February 10, 1996.* 10.09 Form of Indemnity Agreement to be entered into by Registrant with each of its directors and executive officers.* 10.10 Warrant Agreement dated as of September 27, 1996 by and among Registrant and certain investors.* 10.11 Registration Rights Agreement dated as of September 27, 1996 by and among Registrant and certain investors.* 10.12 Employment Agreement between the Registrant and James E. Alexander.* 10.13 Employment Agreement between the Registrant and Boris Rubizhevsky.* 10.14 Security Agreement dated March 31, 1995 between the Company and Isoserve, Inc.* 10.15 Consulting Agreement between the Registrant and Larry Wells Co., Inc.* 10.16 February 1997 Agreement between the Registrant, Electrochemical Plant and AO Techsnabexport, Co., Ltd.*/** 10.17 Letter from Yale University to Registrant dated January 28, 1997.* 11.01 Statement regarding computation of per share earnings. 21.01 Subsidiaries of the Registrant.* 23.01 Consent of Fenwick & West LLP (included in Exhibit 5.01). 23.02 Consent of Grant Thornton LLP, independent certified public accountants. 24.01 Power of Attorney.* 27.01 Financial Statement Schedule.
- -------- * Previously filed. ** Confidential Treatment Requested. II-3 ITEM 28. UNDERTAKINGS. The Registrant hereby undertakes the following: (1) To file, during any period in which it offers or sells securities, a post-effective amendment to this registration statement to: (i) include any prospectus required by Section 10(a)(3) of the Securities Act; (ii) reflect in the prospectus any facts or events which, individually or together, represent a fundamental change in the information in the registration statement; and (iii) include any additional or changed material information of the plan of distribution. (2) To provide to the Underwriters at the closing specified in the Underwriting Agreement certificates in such denominations and registered in such names as required by the Underwriters to permit prompt delivery to each purchaser. (3) For determining liability under the Securities Act, to treat the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant under Rule 424(b)(1) or (4) or 497(h) under the Securities Act as part of this registration statement as of the time the Commission declared it effective. (4) For determining liability under the Securities Act, each post- effective amendment that contains a form of prospectus shall be deemed as a new registration statement for the securities offered therein, and that offering of the securities at that time shall be deemed to be the initial bona fide offering of those securities. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Registrant pursuant to the provisions described under Item 24 above, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. II-4 SIGNATURES IN ACCORDANCE WITH TO THE REQUIREMENTS OF THE SECURITIES ACT, THE REGISTRANT CERTIFIES THAT IT HAS REASONABLE GROUNDS TO BELIEVE THAT IT MEETS ALL OF THE REQUIREMENT FOR FILING ON FORM SB-2 AND AUTHORIZED THIS AMENDMENT TO REGISTRATION STATEMENT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, IN THE CITY OF SAN JOSE, STATE OF CALIFORNIA, ON AUGUST 14, 1997. Isonics Corporation /s/ Paul J. Catuna By: _________________________________ PAUL J. CATUNA, CHIEF FINANCIAL OFFICER IN ACCORDANCE WITH THE REQUIREMENTS OF THE SECURITIES ACT, THIS AMENDMENT TO REGISTRATION STATEMENT WAS SIGNED BY THE FOLLOWING PERSONS IN THE CAPACITIES AND ON THE DATES STATED.
SIGNATURES TITLE DATE ---------- ----- ---- PRINCIPAL EXECUTIVE OFFICER: James E. Alexander* President, Chief August 14, 1997 - ------------------------------- Executive Officer JAMES E. ALEXANDER and Director PRINCIPAL FINANCIAL OFFICER AND PRINCIPAL ACCOUNTING OFFICER: /s/ Paul J. Catuna Vice President, August 14, 1997 - ------------------------------- Finance, Chief PAUL J. CATUNA Financial Officer and Director of Administration ADDITIONAL DIRECTORS Boris Rubizhevsky* Senior Vice August 14, 1997 - ------------------------------- President and BORIS RUBIZHEVSKY Director Lindsay A. Gardner* Director August 14, 1997 - ------------------------------- LINDSAY A. GARDNER Larry J. Wells* Director August 14, 1997 - ------------------------------- LARRY J. WELLS *By: /s/ Paul J. Catuna --------------------------------- PAUL J. CATUNA, ATTORNEY-IN-FACT
II-5 EXHIBIT INDEX
EXHIBIT NUMBER EXHIBIT TITLE PAGE ------- ------------- ---- 1.01 Form of Underwriting Agreement. 3.01 Registrant's Form of Amended and Restated Articles of Incorporation. 3.02 Registrant's Bylaws.* 3.03 Registrant's Amended and Restated Articles of Incorporation, to be in effect at the closing of this offering.* 4.01 Specimen Common Stock Certificate.* 4.02 Form of Underwriter's Warrant Agreement. 4.03 Form of Warrant Agreement between the Registrant and Continental Stock Transfer & Trust Company, and Monroe Parker Securities, Inc. 4.04 Specimen Warrant Certificate. 5.01 Opinion of Fenwick & West LLP. 10.01 Registrant's 1996 Stock Option Plan.* 10.02 Form of Employment Agreement between the Registrant and certain officers of the Registrant.* 10.03 Registrant's 1996 Executives Equity Incentive Plan.* 10.04 Registrant's 1996 Equity Incentive Plan.* 10.05 Memorandum of Agreement between Electrochemical Plant, AO Techsnabexport, Co., Ltd. and Registrant.* 10.06 Option Agreement between the Registrant and Yale University.*/** 10.07 Office Lease Agreement between Paulsen Properties and the Registrant as of January 1, 1996, as amended.* 10.08 Letter from Yale University to Registrant dated February 10, 1996.* 10.09 Form of Indemnity Agreement to be entered into by Registrant with each of its directors and executive officers.* 10.10 Warrant Agreement dated as of September 27, 1996 by and among Registrant and certain investors.* 10.11 Registration Rights Agreement dated as of September 27, 1996 by and among Registrant and certain investors.* 10.12 Employment Agreement between the Registrant and James E. Alexander.* 10.13 Employment Agreement between the Registrant and Boris Rubizhevsky.* 10.14 Security Agreement dated March 31, 1995 between the Company and Isoserve, Inc.* 10.15 Consulting Agreement between the Registrant and Larry Wells Co., Inc.* 10.16 February 1997 Agreement between the Registrant, Electrochemical Plant and AO Techsnabexport, Co., Ltd.*/** 10.17 Letter from Yale University to Registrant dated January 28, 1997.* 11.01 Statement regarding computation of per share earnings. 21.01 Subsidiaries of the Registrant.* 23.01 Consent of Fenwick & West LLP (included in Exhibit 5.01). 23.02 Consent of Grant Thornton LLP, independent certified public accountants. 24.01 Power of Attorney.* 27.01 Financial Statement Schedule.
- -------- * Previously filed. ** Confidential Treatment Requested. EX-1.01 2 FORM OF UNDERWRITING AGREEMENT EXHIBIT 1.01 700,000 UNITS, EACH UNIT CONSISTING OF TWO SHARES OF COMMON STOCK AND TWO CLASS A REDEEMABLE COMMON STOCK PURCHASE WARRANTS ISONICS CORPORATION UNDERWRITING AGREEMENT August __, 1997 Monroe Parker Securities, Inc. 2500 Westchester Avenue Purchase, NY 10577 Ladies and Gentlemen: Isonics Corporation, a California corporation (the "Company"), hereby agrees with Monroe Parker Securities, Inc. (the "Underwriter," in such capacity, shall hereinafter be referred to as "Monroe" or "you"), with respect to the sale by the Company and the purchase by the Underwriter of the 700,000 Units (the "Units") attached hereto, each Unit consisting of two shares of the Company's common stock, no par value per share (the "Common Stock"), and two Class A redeemable common stock purchase warrants (the "Warrants"). The aggregate 1,400,000 shares of Common Stock and 1,400,000 Warrants will be separately tradeable upon issuance and are hereinafter referred to as the "Firm Securities." Each Warrant entitles the holder thereof to purchase one (1) share of Common Stock during the period commencing twelve (12) months from the effective date of the Registration Statement, as defined below, (the "Effective Date") and expiring at the close of business on the last day of the four (4) year period following the Effective Date, unless previously redeemed by the Company, at an initial exercise price of $4.00 per share of Common Stock. The Warrants may be redeemed by the Company at a redemption price of $.10 per Warrant commencing eighteen (18) months after the Effective Date (or earlier at the sole discretion of the Underwriter), on not less than thirty (30) days' prior written notice, provided that the closing sale price of the Common Stock equals or exceeds 250% of the then exercise price of the Warrants on all twenty (20) of the trading days ending on the third day prior to the day on which notice is given, all in accordance with the terms and conditions of the Warrant Agreement (herein deemed). Upon your request, as provided in Section 2(b) of this Agreement, the Company shall also issue and sell to the Underwriter, up to an additional 105,000 Units consisting of 210,000 shares of Common Stock and 210,000 Warrants for the purpose of covering over-allotments, if any. Such Units of Common Stock and Warrants are hereinafter collectively referred to as the "Option Securities." The Company also proposes to issue and sell to you warrants (the "Underwriter's Warrants") pursuant to the Underwriter's Warrant Agreement (the "Underwriter's Warrant Agreement") for the purchase of an additional 140,000 shares of Common Stock and/or 140,000 Warrants. The shares of Common Stock and Warrants issuable upon exercise of the Underwriter's Warrants are hereinafter referred to as the "Underwriter's Securities." The Firm Securities, the Option Securities, the Underwriter's Warrants and the Underwriter's Securities (collectively, hereinafter referred to as the "Securities") are more fully described in the Registration Statement and the Prospectus referred to below. 1. Representations and Warranties of the Company. The Company represents --------------------------------------------- and warrants to, and agrees with, the Underwriter as of the date hereof, and as of the Closing Date and the Option Closing Date, if any, as follows: (a) The Company has prepared and filed with the Securities and Exchange Commission (the "Commission") a registration statement, and an amendment or amendments thereto, on Form SB-2 (No. 333-13289) including any related preliminary prospectus (the "Preliminary Prospectus"), for the registration of the Firm Securities, the Option Securities and the Underwriter's Securities under the Securities Act of 1933, as amended (the "Act"), which registration statement and amendment or amendments have been prepared by the Company in conformity with the requirements of the Act, and the Regulations (as defined below) of the Commission under the Act. The Company will not file any other amendment thereto to which the Underwriter shall have objected in writing after having been furnished with a copy thereof. Except as the context may otherwise require, such registration statement, as amended, on file with the Commission at the time the registration statement becomes effective (including the prospectus, financial statements, schedules, exhibits and all other documents filed as a part thereof or incorporated therein and all information deemed to be a part thereof as of such time pursuant to paragraph (b) of Rule 430(A) of the Regulations), is hereinafter called the "Registration Statement," and the form of prospectus in the form first filed with the Commission pursuant to Rule 424(b) of the Regulations, is hereinafter called the "Prospectus." For purposes hereof, "Regulations" mean the rules and regulations adopted by the Commission under either the Act or the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as applicable. (b) Neither the Commission nor any state regulatory authority has issued any order preventing or suspending the use of any preliminary prospectus, the Registration Statement or the Prospectus and no proceedings for a stop order suspending the effectiveness of the Registration Statement have been instituted, or, to the Company's knowledge, are threatened. Each of any preliminary prospectus, the Registration Statement and the Prospectus at the time of filing thereof conformed in all material respects with the requirements of the Act and Regulations, and none of any preliminary prospectus, the Registration Statement or the Prospectus at the time of filing thereof contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein and necessary to make the statements therein, in light of the circumstances under which they were made, not misleading, except that this representation and warranty does not apply to (i) statements made in reliance upon and in conformity with written information furnished to the Company with respect to the Underwriter by or on behalf of the Underwriter expressly for use in such preliminary prospectus, Registration Statement or Prospectus, or (ii) statements made in the initial preliminary prospectus which were revised in any subsequent preliminary prospectus or the Registration Statement and Prospectus. (c) When the Registration Statement becomes effective and at all times subsequent thereto up to the Closing Date (as defined in Section 2(c) hereof) and each Option Closing Date (as defined in Section 2(b) hereof), if any, and during such longer period as the Prospectus may be required to be delivered in connection with sales by the Underwriter or a dealer, the Registration Statement and the Prospectus, as amended or supplemented as required, will contain all statements which are required to be stated therein in accordance with the Act and the Regulations, and will conform in all material respects to the requirements of the Act and the Regulations; neither 2 the Registration Statement nor the Prospectus, nor any amendment or supplement thereto, will contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading, provided, however, that this representation and warranty does not apply to statements made or statements omitted in reliance upon and in conformity with information furnished to the Company in writing by or on behalf of the Underwriter expressly for use in the Registration Statement or the Prospectus or any amendment thereof or supplement thereto. (d) The Company and each of its subsidiaries have been duly organized and are validly existing as corporations in good standing under the laws of the respective states of their incorporation. The Company does not own or control, directly or indirectly, any corporation, partnership, trust, joint venture or other business entity other than the subsidiaries listed in Exhibit 21 of the Registration Statement. The Company and each of its subsidiaries are duly qualified and licensed and in good standing as a foreign corporation in each jurisdiction in which its ownership or leasing of any properties or the character of its operations require such qualification or licensing, except where the failure to be so qualified or licensed would not have a material and adverse effect on the condition, financial or otherwise, or the business affairs, operations, properties, or results of operations of the Company and its subsidiaries, taken as a whole (the "Business"). The Company and each of its subsidiaries have all requisite power and authority (corporate and other), and have obtained any and all necessary authorizations, approvals, orders, licenses, certificates, franchises and permits of and from all governmental or regulatory officials and bodies (including, without limitation, those having jurisdiction over environmental or similar matters), to own or lease its properties and conduct its business as described in the Prospectus, except where the failure to have such authorizations, approvals, orders, licenses, certificates, franchises or permits would not have a material and adverse effect on the Business; the Company and each of its subsidiaries have been doing business in compliance in all material respects with all such authorizations, approvals, orders, licenses, certificates, franchises and permits and all federal, state, local and foreign laws, rules and regulations; and neither the Company nor any of its subsidiaries have received any notice of proceedings relating to the revocation or modification of any such authorization, approval, order, license, certificate, franchise, or permit which, singly or in the aggregate, if the subject of an unfavorable decision, ruling or finding, would materially and adversely affect the Business. The disclosures in the Registration Statement concerning the effects of federal, state, local, and foreign laws, rules and regulations on the Company's business as currently conducted and as contemplated are correct in all material respects and do not omit to state a material fact necessary to make the statements contained therein not misleading in light of the circumstances in which they were made. (e) At the dates as of which such information is set forth in the Prospectus, the Company had a duly authorized, issued and outstanding capitalization as set forth in the Prospectus under the headings "Capitalization" and "Description of Capital Stock" and will have the adjusted capitalization set forth therein on the Closing Date and the Option Closing Date, if any, based upon the assumptions set forth therein, and the Company is not a party to or bound by any instrument, agreement or other arrangement providing for it to issue any capital stock, rights, warrants, options or other securities, except for this Agreement and as described in the Prospectus. The Securities and all other securities issued or issuable by the Company conform or, when issued and paid for, will conform, in all material respects to all statements with respect thereto contained in the Registration Statement and the Prospectus. All issued and outstanding shares of capital stock of each subsidiary 3 of the Company have been duly authorized and validly issued and are fully paid and non assessable. Except as disclosed in or contemplated by the Prospectus and the financial statements of the Company and the related notes thereto included in the Prospectus, neither the Company nor any subsidiary has outstanding any options to purchase, or any preemptive rights or other rights to subscribe for or to purchase, any securities or obligations convertible into, or any contracts or commitments to issue or sell, shares of its capital stock or any such options, rights, convertible securities or obligations. The description of the Company's stock option, stock bonus and other stock plans or arrangements and the options or other rights granted and exercised thereunder as set forth in the Prospectus conforms in all material respects with the requirements of the Act. All issued and outstanding securities of the Company have been duly authorized and validly issued and are fully paid and non assessable, and the holders thereof have no rights of rescission with respect thereto and are not subject to personal liability by reason of being such holders; and none of such securities were issued in violation of the preemptive rights of any holders of any security of the Company or similar contractual rights granted by the Company. (f) The Securities are not and will not be subject to any preemptive or other similar rights of any stockholder, have been duly authorized and, when issued, paid for and delivered in accordance with the terms hereof, will be validly issued, fully paid and non assessable and will conform in all material respects to the description thereof contained in the Prospectus; the holders thereof will not be subject to any liability solely as such holders; all corporate action required to be taken for the authorization, issue and sale-of the Securities has been duly and validly taken; and the certificates representing the Securities will be in due and proper form. Upon the issuance and delivery pursuant to the terms hereof of the Securities to be sold by the Company hereunder, the Underwriter will acquire good and marketable title to such Securities free and clear of any lien, charge, claim, encumbrance, pledge, security interest, defect, or other restriction or equity of any kind whatsoever. No stockholder of the Company has any right which has not been waived in writing to require the Company to register the sale of any shares owned by such stockholder under the Act in the public offering contemplated by this Agreement. No further approval or authority of the stockholders or the Board of Directors of the Company will be required for the issuance and sale of the Shares, the Option Shares and the Underwriter's Warrants to be sold by the Company as contemplated herein. (g) The financial statements of the Company, together with the related notes and schedules thereto, included in the Registration Statement, each Preliminary Prospectus and the Prospectus fairly present the financial position, changes in stockholders' equity and the results of operations of the Company and its consolidated subsidiaries (of which there are none) at the respective dates and for the respective periods to which they apply and such financial statements have been prepared in conformity with generally accepted accounting principles and the Regulations, consistently applied throughout the periods involved. Except as disclosed in the Prospectus, there has been no material adverse change or development involving a material prospective change in the Business, whether or not arising in the ordinary course of business since the date of the financial statements included in the Registration Statement and the Prospectus and the outstanding debt, the property, both tangible and intangible, and the business of the Company and its subsidiaries taken as a whole conform in all material respects to the descriptions thereof contained in the Registration Statement and the Prospectus. Financial information set forth in the Prospectus under the headings "Prospectus Summary - Selected Financial Data," "Capitalization," and "Management's Discussion 4 and Analysis of Financial Condition and Results of Operations," fairly present, on the basis stated in the Prospectus, the information set forth therein and have been derived from or compiled on a basis consistent with that of the audited and unaudited financial statements included in the Prospectus. (h) The Company (i) has paid all federal, state, local, franchise, and foreign taxes for which it is liable (except for immaterial non payments, if any), including, but not limited to, withholding taxes and amounts payable under Chapters 21 through 24 of the Internal Revenue Code of 1986, as amended (the "Code"), and has furnished all information returns it is required to furnish pursuant to the Code, (ii) has established adequate reserves for such taxes which are not due and payable, and (iii) does not have any material tax deficiency or claims outstanding, proposed or assessed against it. (i) No transfer tax, stamp duty or other similar tax is payable by or on behalf of the Underwriter in connection with (i) the issuance by the Company of the Securities, (ii) the purchase by the Underwriter of the Firm Securities, the Option Securities and the Underwriter's Warrants from the Company, (iii) the consummation by the Company of any of its obligations under this Agreement, or (iv) resales of the Firm Securities and the Option Securities in connection with the distribution contemplated hereby. (j) There is no action, suit, proceeding, inquiry, arbitration, mediation, investigation, litigation or governmental proceeding (including, without limitation, any involving environmental or similar matters), domestic or foreign, pending or threatened against (or circumstances that may give rise to the same), or involving the properties or businesses of, the Company which (i) questions the validity of the capital stock of the Company, this Agreement or the Underwriter's Warrant Agreement, or of any action taken or to be taken by the Company pursuant to or in connection with this Agreement or the Underwriter's Warrant Agreement, (ii) is required to be disclosed in the Registration Statement which is not so disclosed (and such proceedings as are summarized in the Registration Statement are accurately summarized in all material respects), or (iii) could reasonably be expected to materially and adversely affect the Business. (k) The Company has the corporate power and authority to authorize, issue, deliver, and sell the Securities and to enter into this Agreement, the Warrant Agreement, and the Underwriter's Warrant Agreement, and to consummate the transactions provided for in such agreements; and this Agreement, the Warrant Agreement and the Underwriter's Warrant Agreement have each been duly and properly authorized, executed, and delivered by the Company. This Agreement, the Warrant Agreement and the Underwriter's Warrant Agreement constitutes a legal, valid and binding obligation of the Company enforceable against the Company in accordance with its respective terms (except as the enforceability thereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other laws of general application relating to or affecting enforcement of creditors' rights and the application of equitable principles in any action, legal or equitable, and except as rights to indemnity or contribution may be limited by applicable law), and none of the issue and sale of the Securities, execution, delivery or performance by the Company of this Agreement, the Warrant Agreement, and the Underwriter's Warrant Agreement, the consummation by the Company of the transactions contemplated herein and therein, or the conduct of the Company's businesses as described in the Registration Statement, the Prospectus, and any 5 amendments or supplements thereto, conflicts with or will conflict with or results or will result in any breach or violation of any of the terms or provisions of, or constitutes or will constitute a default under, or result in the creation or imposition of any lien, charge, claim, encumbrance, pledge, security interest, defect or other restriction or equity of any kind whatsoever upon, any property or assets (tangible or intangible) of the Company pursuant to the terms of (i) the articles of incorporation or by-laws of the Company, as amended and restated, (ii) any license, contract, indenture, mortgage, deed of trust, voting trust agreement, stockholders agreement, note, loan or credit agreement or any other agreement or instrument to which the Company is a party or by which it is or may be bound or to which its properties or assets (tangible or intangible) is or may be subject, or (iii) any statute, judgment, decree, order, rule or regulation applicable to the Company of any arbitrator, court, regulatory body or administrative agency or other governmental agency or body (including, without limitation, those having jurisdiction over environmental or similar matters), domestic or foreign, having jurisdiction over the Company or any of its activities or properties, in each of the above instances-in subparagraph (ii) and (iii), which could reasonably be expected to materially and adversely affect the Business. (1) No consent, approval, authorization or order of, and no filing with, any court, regulatory body, government agency or other body, domestic or foreign, is required for the issuance and sale of the Securities pursuant hereto, and the Prospectus and the Registration Statement, the performance of this Agreement, the Warrant Agreement, and the Underwriter's Warrant Agreement, and the transactions contemplated hereby and thereby, including without limitation, any waiver of any preemptive, first refusal or other rights that any entity or person may have for the issue and/or sale of any of the Securities, except such as have been or may be obtained under the Act or may be required under state securities or Blue Sky laws in connection with the Underwriter's purchase and distribution of the Firm Securities, the Option Securities, and the Underwriter's Warrants to be sold by the Company hereunder. (m) All executed agreements, contracts or other documents or copies of executed agreements, contracts or other documents filed as exhibits to the Registration Statement to which the Company is a party or by which it may be bound or to which its assets, properties or businesses may be subject have been duly and validly authorized, executed and delivered by the Company and constitute the legal, valid and binding agreements of the Company enforceable against the Company in accordance with their respective terms (except as such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other laws of general application relating to or affecting enforcement of creditors' rights and the application of equitable principles in any action, legal or equitable, and except as rights to indemnity or contribution may be limited by applicable law). The descriptions in the Registration Statement of such agreements, contracts and other documents are accurate in all material respects and fairly present the information required to be shown with respect thereto by Form SB-2, and there are no contracts or other documents which are required by the Act to be described in the Registration Statement or filed as exhibits to the Registration Statement which are not- described or filed as required, and the exhibits which have been filed are complete and correct copies of the documents of which they purport to be copies. (n) Since the respective dates as of which information is given in the Registration Statement and Prospectus, and except as described in or specifically contemplated by the Prospectus: (i) the Company has not incurred any material liabilities or obligations, indirect, direct or contingent, 6 or entered into any material verbal or written agreement or other transaction which is not in the ordinary course of business or which could reasonably be expected to result in a material reduction in the future earnings of the Company; (ii) the Company has not sustained any material loss or interference with its business or properties from fire, flood, windstorm, accident or other calamity, whether or not covered by insurance; (iii) the Company has not paid or declared any dividends or other distributions with respect to its capital stock, and the Company is not in default in the payment of principal or interest on any outstanding debt obligations; (iv) there has not been any change in the capital stock (other than upon the sale of the Firm Securities, the Option Securities and the Underwriter's Warrants hereunder and upon the exercise of options and warrants described in the Registration Statement) of, or indebtedness material to, the Company (other than in the ordinary course of business); (v) the Company has not issued any securities or incurred any liability or obligation, primary or contingent, for borrowed money; and (vi) there has not been any material adverse change in the Business. (o) Except as disclosed in or specifically contemplated by the Prospectus, and subject to the risks and uncertainties described in the Prospectus under the headings entitled "Risk Factors -Protection of Intellectual Property" and "Business -- Patents and Proprietary Rights:" (i) the Company has sufficient trade names, licenses, approvals and governmental authorizations to conduct its business as now conducted; (ii) the expiration of any trade names, licenses, approvals or governmental authorizations would not have a material adverse effect on the Business; (iii) the Company has no knowledge of any infringement by it or its subsidiaries of trademark, trade name rights, patent rights, copyrights, licenses, trade secret or other similar rights of others; and (iv) there is no claim being made against the Company regarding trademark, trade name, patent, copyright, license, trade secret or other infringement which could reasonably be expected to have a material adverse effect on the Business. (p) No default exists in the due performance and observance of any term, covenant or condition of any material license, contract, indenture, mortgage, installment sale agreement, lease, deed of trust, voting trust agreement, stockholders agreement, note, loan or credit agreement, or any other material agreement or instrument evidencing an obligation for borrowed money, or any other material agreement or instrument to which the Company is a party or by which the Company may be bound or to which the property or assets (tangible or intangible) of the Company are subject or affected, except for such defaults, if any, which individually and in the aggregate would not have a material adverse effect on the Business. (q) To the Company's knowledge, there are no investigations involving the Company by any governmental agency. There are no unfair labor practice charges or complaints against the Company pending before the National Labor Relations Board or any strikes, pickets, boycotts, disputes, slowdowns or stoppages pending or to its knowledge threatened against or involving the Company. No representation question exists with respect to the employees of the Company. No collective bargaining agreement, or modification thereof is currently being negotiated by the Company. No grievance or arbitration proceeding is pending under any expired or existing collective bargaining agreements of the Company. No labor disputes with the employees of the Company exist or to its knowledge are imminent. (r) Except as described in the Prospectus, the Company does not maintain, 7 sponsor or contribute to any program or arrangement that is an "employee pension benefit plan," an "employee welfare benefit plan," or a "multi-employer plan" as such terms are defined in Sections 3(2), 3(1) and 3(37), respectively, of the Employee Retirement Income Security Act of 1974, as amended ("ERISA") ("ERISA Plans"). The Company does not maintain or contribute to a defined benefit plan, as defined in Section 3(35) of ERISA. No ERISA Plan (or any trust created thereunder) has engaged in a "prohibited transaction" within the meaning of Section 406 of ERISA or Section 4975 of the Code, which could subject the Company to any tax penalty on prohibited transactions and which has not adequately been corrected. Each ERISA Plan is in compliance with all material reporting, disclosure and other requirements of the Code and ERISA as they relate to any such ERISA Plan. Determination letters have been received from the Internal Revenue Service with respect to each ERISA Plan which is intended to comply with Code Section 401(a), stating that such ERISA Plan and the attendant trust are qualified thereunder. The Company has never completely or partially withdrawn from a "multi employer plan." (s) Neither the Company nor any of its employees, directors, stockholders, or affiliates (within the meaning of the Regulations) of any of the foregoing has taken or will take, directly or indirectly, any action designed to or which has constituted or which might be expected to cause or result in unlawful stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Securities. (t) Except for a security interest granted to Isoserve, Inc., pursuant to a Security Agreement between Isoserve and the Company, a security interest granted to lenders in the bridge financing transaction as described in the Prospectus, and a security interest granted to Wells Fargo Bank pursuant to an SBA loan from such bank to the Company, the Company has good and marketable title to, or valid and enforceable leasehold estates in, all items of real and personal property stated in the Prospectus to be owned or leased by it, free and clear of all liens, charges, claims, encumbrances, pledges, security interests, or other restrictions or equities of any kind whatsoever, other than those referred to in the Prospectus and liens for taxes not yet due and payable or for such as do not materially affect the value of the Company's real and personal property, taken as a whole. (u) To the Company's knowledge, Grant Thornton LLP ("Grant Thornton"), whose report is filed with the Commission as a part of the Registration Statement, is an independent certified public accountant as required by the Act and the Regulations. (v) The Company has caused to be duly executed legally binding and enforceable agreements pursuant to which all persons or entities, other than as set forth in the Prospectus, that directly or beneficially own Common Stock, as of the effective date of the Registration Statement, have agreed not to, directly or indirectly, offer, offer to sell, sell, grant any option for the sale of, transfer, assign, pledge, hypothecate or otherwise encumber or dispose of any shares of Common Stock or securities convertible into Common Stock, exercisable or exchangeable for or evidencing any right to purchase or subscribe for any shares of Common Stock (either pursuant to Rule 144 of the Regulations or otherwise) or dispose of any interest therein for a period from the date of the Prospectus until and including the day of like number in the twelfth consecutive month next following the date that the Registration Statement becomes effective, without the prior written consent of Monroe (the "Lock-up Agreements"). The Company will cause the Transfer Agent (as 8 defined herein) to place "stop transfer" orders on the Company's stock ledgers in order to effect the Lock-up Agreements. (w) Except as disclosed to the Underwriter, there are no claims, payments, arrangements or understandings, whether oral or written, for services in the nature of a finder's or origination fee with respect to the sale of the Securities hereunder or any other arrangements, agreements, understandings, payments or issuance with respect to the Company or any of its officers, directors, stockholders, employees or affiliates that may affect the Underwriter's compensation as determined by the Commission and the National Association of Securities Dealers, Inc. (the "NASD"). (x) The Securities have been approved for quotation on the Nasdaq SmallCap Market. (y) Neither the Company nor any of its officers, employees, agents or any other person acting on behalf of the Company have, directly or indirectly, given or agreed to give any money, gift or similar benefit (other than legal price concessions to customers in the ordinary course of business) to any customer, supplier, employee or agent of a customer or supplier, or official or employee of any governmental agency (domestic or foreign) or instrumentality of any government (domestic or foreign) or any political party or candidate for office (domestic or foreign) or other person who was, is, or may be in a position to help or hinder the business of the Company (or assist the Company in connection with any actual or proposed transaction) which might subject the Company or any other such person to any damage or penalty in any civil, criminal or governmental litigation or proceeding (domestic or foreign). The Company's internal accounting controls are sufficient to cause the Company to comply with the Foreign Corrupt Practices Act of 1977, as amended. (z) Except as set forth in the Prospectus, no officer, director or stockholder of the Company, or any "affiliate" or "associate" (as these terms are defined in Rule 405 of the Regulations) of any of the foregoing persons or entities has or has had, either directly or indirectly, (i) an interest in any person or entity which (A) furnishes or sells services or products which are furnished or sold or are proposed to be furnished or sold by the Company, or (B) purchases from or sells or furnishes to the Company any goods or services, or (ii) a beneficial interest in any contract or agreement to which the Company is a party or by which it may be bound or affected. Except as set forth in the Prospectus, there are no existing agreements, arrangements, understandings or transactions, or proposed agreements, arrangements, understandings or transactions, between or among the Company, and any officer, director, principal shareholder (as such term is used in the Prospectus) of the Company, or any affiliate or associate of any of the foregoing persons or entities which are required to be disclosed in the Prospectus. (aa) The Company is not, and does not intend to conduct its business in a manner in which it would become an "investment company" within the meaning of the Investment Company Act of 1940, as amended. (ab) Any certificate signed by any officer of the Company and delivered to the Underwriter or to the Underwriter's Counsel (as defined in Section 4(d) herein) shall be deemed a 9 representation and warranty by the Company to the Underwriter as to the matters covered thereby. (ac) The minute books of the Company have been made available to the Underwriter and contain a complete summary of all meetings and actions of the directors and stockholders of the Company since the time of its incorporation, and reflect all transactions referred to in such minutes accurately in all material respects. (ad) The Company has not distributed and will not distribute any offering material in connection with the offering and sale of the Shares in this offering other than the Prospectus, the Registration Statement and the other materials permitted by the Act. Except as described in the Prospectus, no holders of any securities of the Company or of any options, warrants or other convertible or exchangeable securities of the Company have the right to include any securities issued by the Company as part of the Registration Statement or to require the Company to file a registration statement under the Act and no person or entity holds any antidilution rights with respect to any securities of the Company. (ae) Except for policies the absence of which is disclosed in the Prospectus, the Company maintains insurance by insurers of recognized financial responsibility of the types and in the amounts as the Company believes are prudent and adequate for the business in which it is engaged, including, but not limited to, insurance covering real and personal property owned or leased by the Company against theft, damage, destruction, acts of vandalism and all other risks customarily insured against, all of which insurance is in full force and effect. The Company has delivered to the Underwriter's Counsel satisfactory summaries of these insurance policies. The Company has no reason to believe that it will not be able to renew existing insurance coverage with respect to the Company as and when such coverage expires or to obtain similar coverage from similar insurers as may be necessary to continue its business, in either case, at a cost that would not have a material adverse effect on the financial condition, operations, business, assets or properties of the Company. The Company has not failed to file any material claims, has no material disputes with its insurance company regarding any claims submitted under its insurance policies, and has complied in material respects with all material provisions contained in its insurance policies, except where such failure or noncompliance could not reasonably be expected to have a material adverse effect on the Business. 2. Purchase, Sale and Delivery of the Securities. ---------------------------------------------- (a) On the basis of the representations, warranties, covenants and agreements herein contained, but subject to the terms and conditions herein set forth, the Company agrees to sell to the Underwriter, and the Underwriter agrees to purchase from the Company 700,000 Units, at a price equal to $6.30 per Unit. (b) In addition, on the basis of the representations, warranties, covenants and agreements, herein contained, but subject to the terms and conditions herein set forth, the Company hereby grants an option to the Underwriter to purchase all or any part of an additional 105,000 Units at a price of $6.30 per Unit. The option granted hereby will expire 45 days after (i) the date the Registration Statement becomes effective, if the Company has elected not to rely on Rule 430A under the Regulations, or (ii) the date of this Agreement if the Company has elected to rely upon 10 Rule 430A under the Regulations, and may be exercised in whole or in part from time to time (but not on more than two (2) occasions) only for the purpose of covering over-allotments which may be made in connection with the offering and distribution of the Firm Securities upon notice by the Underwriter to the Company setting forth the number of Option Securities as to which the Underwriter is then exercising the option and the time and date of payment and delivery for any such Option Securities. Any such time and date of delivery (an "Option Closing Date") shall be determined by the Underwriter, but shall not be later than three full business days after the exercise of said option, nor in any event prior to the Closing Date, as hereinafter defined, unless otherwise agreed upon by the Underwriter and the Company. Nothing herein contained shall obligate the Underwriter to exercise the over-allotment option described above. No Option Securities shall be delivered unless the Firm Securities shall be simultaneously delivered or shall theretofore have been delivered as herein provided. (c) Payment of the purchase price for, and delivery of certificates for, the Firm Securities shall be made at the offices of Singer Zamansky, LLP, 40 Exchange Place, 20/th/ Floor, New York, New York 10005, or at such other place as shall be agreed upon by the Underwriter and the Company. Such delivery and payment shall be made at 9:00 a.m. (New York time) on ____ __, 1997, or at such other time and date as shall be agreed upon by the Underwriter and the Company, but no more than four (4) business days after the date hereof (such time and date of payment and delivery being herein called the "Closing Date"). In addition, in the event that any or all of the Option Securities are purchased by the Underwriter, payment of the purchase price for, and delivery of certificates for, such Option Securities shall be made at the above mentioned office of Monroe or at such other place as shall be agreed upon by the Underwriter and the Company on each Option Closing Date as specified in the notice from the Underwriter to the Company. Delivery of the certificates for the Firm Securities and the Option Securities, if any, shall be made to the Underwriter against payment by the Underwriter of the purchase price for the Firm Securities and the Option Securities, if any, to the order of the Company. Certificates for the Firm Securities and the Option Securities, if any, shall be in definitive, fully registered form, shall bear no restrictive legends and shall be in such denominations and registered in such names as the Underwriter may request in writing at least three (3) business days prior to the Closing Date or the relevant Option Closing Date, as the case may be. The certificates for the Firm Securities and the Option Securities, if any, shall be made available to the Underwriter at such office or such other place as the Underwriter may designate for inspection, checking and packaging no later than 9:30 a.m. on the last business day prior to the Closing Date or the relevant Option Closing Date, as the case may be. (d) On the Closing Date, the Company shall issue and sell the Underwriter's Warrants to the Underwriter at an aggregate purchase price of $140.00, which Warrants shall entitle the holders thereof to purchase an aggregate of 140,000 shares of Common Stock and 140,000 Warrants. The Underwriter's Warrants shall expire five (5) years after the effective date of the Registration Statement, shall be exercisable for a period of four (4) years commencing on the first anniversary of the effective date of the Registration Statement, and will entitle the holder to purchase one share of Common Stock at a price equaling one hundred sixty five percent (165%) of the effective initial public offering price of the Shares which for the purposes of this paragraph shall be $3.40 per Share (the "IPO Price Per Share") and, upon payment of one hundred sixty five (165%) of the initial public offering price of the Warrants which for purposes of this paragraph shall be $.10 11 per Warrant, to acquire one Warrant at exercisable at $4.00 per Share. The Underwriter's Warrant Agreement and form of Warrant Certificate shall be substantially in the form filed as Exhibit 4.02 to the Registration Statement. Payment for the Underwriter's Warrants shall be made on the Closing Date. 3. Public Offering of the Units. As soon after the Registration ---------------------------- Statement becomes effective as the Underwriter deems advisable, the Underwriter shall make a public offering of the Units (other than to residents of or in any jurisdiction in which qualification of the Units is required and has not become effective) at the price and upon the other terms set forth in the Prospectus. The Underwriter may from time to time increase or decrease the public offering price to such extent as the Underwriter, in its sole discretion, deems advisable and as permitted by the Act and Regulations. The Underwriter may enter into one or more agreements as the Underwriter, in its sole discretion, deems advisable with one or more broker-dealers who shall act as dealers in connection with such public offering. 4. Covenants of the Company. The Company covenants and agrees with the ------------------------ Underwriter as follows: (a) The Company shall use its best efforts to cause the Registration Statement and any amendments thereto to become effective as promptly as practicable and will not at any time, whether before or after the effective date of the Registration Statement, file any amendment to the Registration Statement or supplement to the Prospectus or file any document under the Act or Exchange Act before termination of the offering of the Units by the Underwriter of which the Underwriter shall not previously have been advised and furnished with a copy, or to which the Underwriter shall have objected or which is not in compliance with the Act, the Exchange Act or the Regulations. (b) As soon as the Company is advised or obtains knowledge thereof, the Company will advise the Underwriter and confirm the notice in writing, (i) when the Registration Statement, as amended, becomes effective, if the provisions of Rule 430A promulgated under the Act will be relied upon, when the Prospectus has been filed in accordance with said Rule 430A and when any post- effective amendment to the Registration Statement becomes effective, (ii) of the issuance by the Commission of any stop order or of the initiation, or the threatening, of any proceeding, suspending the effectiveness of the Registration Statement or any order preventing or suspending the use of any preliminary prospectus or the Prospectus, or any amendment or supplement thereto, or the institution of proceedings for that purpose, (iii) of the issuance by the Commission or by any state securities commission of any proceedings for the suspension of the qualification of any of the Securities for offering or sale in any jurisdiction or of the initiation, or the threatening, of any proceeding for that purpose, (iv) of the receipt of any comments from the Commission; and (v) of any request by the Commission for any amendment to the Registration Statement or any amendment or supplement to the Prospectus or for additional information. If the Commission or any state securities commission shall enter a stop order or suspend such qualification at any time, the Company will use its best efforts to obtain promptly the lifting of such order. (c) The Company shall file the Prospectus (in form and substance satisfactory to the Underwriter) in accordance with the requirements of the Act. 12 (d) The Company will give the Underwriter notice of its intention to file or prepare any amendment to the Registration Statement (including any post- effective amendment) or any amendment or supplement to the Prospectus (including any revised prospectus which the Company proposes for use by the Underwriter in connection with the offering of the Securities which differs from the corresponding prospectus on file at the Commission at the time the Registration Statement becomes effective, whether or not such revised prospectus is required to be filed pursuant to Rule 424(b) of the Regulations), and will furnish the Underwriter with copies of any such amendment or supplement a reasonable amount of time prior to such proposed filing or use, as the case may be, and will not file any such amendment or supplement to which the Underwriter or Singer Zamansky, LLP ("Underwriter's Counsel") shall reasonably object. (e) The Company shall endeavor in good faith, in cooperation with the Underwriter, at or prior to the time the Registration Statement becomes effective, to qualify the Securities for offering and sale under the securities laws of such jurisdictions as the Underwriter may reasonably designate to permit the sales and dealings therein for as long as may be necessary to complete the distribution, and shall make such applications, file such documents and furnish such information as may be required for such purpose; provided, however, the Company shall not be required to qualify as a foreign corporation or become subject to service of process in any such jurisdiction. In each jurisdiction where such qualification shall be effected, the Company will, unless the Underwriter agrees that such action is not at the time necessary or advisable, use all reasonable efforts to file and make such statements or reports at such times as are required by the laws of such jurisdiction to continue such qualification. (f) During the time when a prospectus is required to be delivered under the Act, the Company shall use all reasonable efforts to comply with all requirements imposed upon it by the Act, as now and hereafter amended, and by the Regulations, as from time to time in force, so far as necessary to permit the continuance of sales of or dealings in the Securities in accordance with the provisions hereof and the Prospectus, or any amendments or supplements thereto. If at any time when a prospectus relating to the Securities is required to be delivered under the Act, any event shall have occurred as a result of which, in the opinion of counsel for the Company or Underwriter's Counsel, the Prospectus, as then amended or supplemented, includes an untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading, or if it is necessary at any time to amend or supplement the Prospectus to comply with the Act, the Company will notify the Underwriter promptly and prepare and file with the Commission an appropriate amendment or supplement in accordance with Section 10 of the Act, each such amendment or supplement to be satisfactory to Underwriter's Counsel, and the Company will furnish to the Underwriter copies of such amendment or supplement as soon as available and in such quantities as the Underwriter may request. (g) As soon as practicable, but in any event not later than 45 days after the end of the 12-month period beginning on the day after the end of the fiscal quarter of the Company during which the effective date of the Registration Statement occurs (90 days in the event that the end of such fiscal quarter is the end of the Company's fiscal year), the Company shall make generally available to its security holders, in the manner specified in Rule 158(b) of the Regulations, and to 13 the Underwriter, an earnings statement which will be in the detail required by, and will otherwise comply with, the provisions of Section 1l(a) of the Act and Rule 158(a) of the Regulations, which statement need not be audited unless required by the Act, covering a period of at least twelve (12) consecutive months after the effective date of the Registration Statement. (h) During a period of five (5) years after the date hereof, until and including the like day and month in 2002, the Company will furnish to its stockholders, as soon as practicable, annual reports (including consolidated financial statements of the Company and its consolidated subsidiaries audited by independent public accountants) and will make available to its stockholders consolidated unaudited quarterly reports (except for the last quarter of each fiscal year) of earnings of the Company and its consolidated subsidiaries, and will deliver to the Underwriter: (i) concurrently with furnishing such quarterly reports to its stockholders, a consolidated statement of income of the Company and its consolidated subsidiaries for each quarter in the form furnished to the Company's stockholders; (ii) concurrently with furnishing such annual reports to its stockholders, a consolidated balance sheet of the Company and its consolidated subsidiaries as at the end of the preceding fiscal year, together with statements of consolidated operations, stockholders' equity, and cash flows of the Company and its consolidated subsidiaries for such fiscal year, accompanied by a copy of the report thereon of independent certified public accountants; (iii) as soon as they are available, copies of all other reports (financial or other) mailed to stockholders; (iv) as soon as they are available, copies of all reports and financial statements furnished to or filed with the Commission, Nasdaq or any securities exchange; (v) every press release and every material news item or article of interest to the financial community in respect of the Company or its affairs which was released or prepared by or on behalf of the Company; and (vi) any additional information of a public nature concerning the Company and its businesses which the Underwriter may reasonably request. During such five-year period, the foregoing financial statements will be accompanied by similar financial statements for any significant subsidiary which is not consolidated. (i) The Company will maintain a transfer agent (the "Transfer Agent") and, if necessary under the jurisdiction of incorporation of the Company, a registrar (which may be the same entity as the transfer agent) for the Securities and the Underwriter's Warrants. (j) The Company will furnish to the Underwriter, without charge, at such place as the Underwriter may designate, copies of each preliminary prospectus, the Registration Statement, the Prospectus and any pre-effective or post-effective amendments thereto (two of which copies will be signed and will include all financial statements and exhibits), in each case as soon as available 14 and in such quantities as the Underwriter may reasonably request. (k) On or before the effective date of the Registration Statement, the Company shall provide the Underwriter with true copies of duly executed Lock-up Agreements. On or before the Closing Date, the Company shall deliver instructions to the Transfer Agent authorizing it to place appropriate stop transfer orders on the Company's ledgers. (1) The Company shall use its best efforts to cause its officers, directors, stockholders or affiliates (within the meaning of the Regulations) not to take, directly or indirectly, any action designed to, or which might in the future reasonably be expected to cause or result in, unlawful stabilization or manipulation of the price of any securities of the Company. (m) The Company shall apply the net proceeds from the sale of the Securities substantially in the manner, and subject to the conditions, set forth under "Use of Proceeds" in the Prospectus. (n) After the effective date of the Registration Statement, the Company shall timely file all such reports, forms or other documents as may be required (including, but not limited to, a Form SR as may be required pursuant to Rule 463 under the Act) from time to time, under the Act, the Exchange Act, and the Regulations, and all such reports, forms and documents filed will comply as to form and substance with the applicable requirements under the Act, the Exchange Act, and the Regulations. (o) The Company shall use its best efforts to cause the Securities to be quoted on the Nasdaq SmallCap Market and the Boston Stock Exchange, or such regional stock exchange as the Company and Monroe mutually agree, and for a period of two (2) years from the date hereof shall use its best efforts to maintain the quotation of the Securities to the extent outstanding. (p) For the first 30 days following the closing date, the Company shall provide the Underwriter DTC transfer sheets as the Underwriter may request. For a period of two (2) years from the Closing Date, the Company shall furnish to the Underwriter, at the Company's sole expense, monthly DTC transfer sheets relating to the Common Stock and Warrants. (q) For a period of five (5) years after the effective date of the Registration Statement, the Company shall, at the Company's sole expense, take all reasonable and appropriate actions to qualify the Common Stock and Warrants in all jurisdictions of the United States which do not require the Company to qualify as a foreign corporation or to file a general consent to service of process in order to permit secondary sales of such securities pursuant to the Blue Sky laws of those jurisdictions. (r) The Company (i) prior to the effective date of the Registration Statement has filed a Form 8-A with the Commission providing for the registration of the Common Stock and Warrants under the Exchange Act and (ii) as soon as practicable but later than the effective date will use its best efforts to take all necessary and appropriate actions to be included in Standard and Poor's Corporation Descriptions or Moody's OTC Manual and to continue such inclusion for a period of not less than five (5) years (or, if sooner, the date on which the Common Stock and Warrants are 15 listed on the New York Stock Exchange, American Stock Exchange, or Nasdaq National Market). (s) The Company agrees that for a period of twelve (12) months following the effective date of the Registration Statement it will not, without the prior written consent of Monroe, offer, issue, sell, contract to sell, grant any option for the sale of or otherwise dispose of any Common Stock or securities convertible into Common Stock, except for the issuance of shares of Common Stock registered under the Act pursuant to the Registration Statement, or except pursuant to incentive or benefit plans approved by the Board of Directors of the Company, pursuant to options or warrants outstanding on the Closing Date, or in connection with acquisitions of companies, products or technologies. The Company also agrees not to file any Registration Statement, including on Form S- 8 or such comparable form without the consent of the Underwriter. (t) Until the completion of the distribution of the Securities in connection with the initial public offering of the Securities, the Company shall not without the prior written consent of Monroe or Underwriter's Counsel, issue, directly or indirectly, any press release or other communication or hold any press conference with respect to the Company or its activities or the offering contemplated hereby, other than trade releases issued in the ordinary course of the Company's business consistent with past practices. (u) For a period equal to the lesser of (i) five (5) years from the date hereof, and (ii) the sale to the public of the Underwriter's Securities (or the shares of Common Stock issuable upon exercise of the Underwriter's Securities), the Company will not take any action or actions which may prevent or disqualify the Company's use of an appropriate form for the registration under the Act of the Underwriter's Securities (or the shares of Common Stock issuable upon exercise of the Underwriter's Securities). (v) The Company agrees that it shall use its best efforts, which shall include, but shall not be limited to, the solicitation of proxies, to elect one (1) designee designated by Monroe to the Company's Board of Directors for a period of three (3) years following the Closing Date, provided that such designee is reasonably acceptable to the Company and that such director may be excluded from consideration of certain confidential matters which, in the good faith judgment of a majority of the other directors, make such director's presence not appropriate. (w) The Company agrees that within forty-five (45) days after the Closing Date it shall retain a public relations firm which is reasonably acceptable to Monroe. Provided that such public relations firm performs in a commercially reasonable and satisfactory manner, the Company shall keep such public relations firm and any replacement for a total period of two (2) years from the Closing Date. Any replacement public relations firm shall be retained only with the consent of Monroe, which shall not be unreasonably withheld. (x) The Company agrees that any and all future transactions between the Company and any of its officers, directors, principal stockholders and the affiliates of the foregoing persons will be on terms no less favorable to the Company than could reasonably be obtained in arm's length transactions with independent third parties, and that any such transactions also be approved by a majority of the Company's outside independent directors disinterested in the transaction. 16 (y) The Company shall prepare and deliver, at the Company's sole expense, to Monroe within the one hundred and twenty (120) day period after the later of the effective date of the Registration Statement and the latest Option Closing Date, as the case may be, one bound volume each containing all correspondence with regulatory officials, agreements, documents and all other materials in connection with the offering to which such Registration Statement relates as requested by the Underwriter's Counsel. 5. Payment of Expenses ------------------- (a) The Company hereby agrees to pay on each of the Closing Date and each Option Closing Date (to the extent not previously paid) all expenses and fees (other than fees of Underwriter's Counsel, except as provided in (iv) below of this Section 5) incident to the performance of the obligations of the Company under this Agreement, the Warrant Agreement, and the Underwriter's Warrant Agreement, including, without limitation: (i) the fees and expenses of accountants and counsel for the Company; (ii) all costs and expenses incurred in connection with the preparation, duplication, printing, filing, delivery and mailing (including the payment of postage with respect thereto) of the Registration Statement and the Prospectus and any amendments and supplements thereto and the duplication, mailing (including the payment of postage with respect thereto) and delivery of this Agreement, the Warrant Agreement, the Agreement Among Underwriter, the Selected Dealers Agreements, the Powers of Attorney, and related documents, including the cost of all copies thereof and of the preliminary prospectuses and of the Prospectus and any amendments thereof or supplements thereto supplied to the Underwriter and such dealers as the Underwriter may request, in quantities as hereinabove stated; (iii) the printing, engraving, issuance and delivery of the certificates representing the Securities; (iv) the qualification of the Securities under state or foreign securities or "Blue Sky" laws and determination of the status of such securities under legal investment laws, including the costs of word processing and mailing the "Preliminary Blue Sky Memorandum," the "Supplemental Blue Sky Memorandum" and "Legal Investments Survey," if any, and reasonable disbursements and fees of counsel in connection therewith; (v) advertising costs and expenses, including but not limited to the costs and expenses incurred by the Company and the Underwriter in connection with the "road show," information meetings and presentations, bound volumes and prospectus memorabilia and reasonable "tombstone" advertisement expenses; (vi) experts; (vii) the fees and expenses of the transfer agent and registrar; (viii) the fees payable to the Commission and the NASD, (ix) issue and transfer taxes, if any; and (x) the fees and expenses incurred in connection with the listing of the Securities on the Nasdaq SmallCap Market and any other market or exchange. (b) If this Agreement is terminated by the Underwriter in accordance with the provisions of Section 6, Section 10(a) or Section 11, the Company shall reimburse and indemnify the Underwriter for all of its actual out-of-pocket expenses on an accountable basis, including the fees and disbursements of Underwriter's Counsel, less any amounts already paid pursuant to Section 5(c) hereof provided that Monroe shall notify the Company of any single expense or any series of similar expenses which in the aggregate exceed $5,000 (provided further that such notice requirement shall not apply to Monroe's actual out-of- pocket legal expenses). (c) The Company further agrees that, in addition to the expenses payable pursuant to subsection (a) of this Section 5, it will pay to the Underwriter on the Closing Date by certified or 17 bank cashier's check or, at the election of the Underwriter, by deduction from the proceeds of the offering contemplated herein a non-accountable expense allowance equal to three percent (3%) of the gross proceeds received by the Company from the sale of the Firm Securities, at least $50,000 of which has been paid to date. In the event the Underwriter elects to exercise the over-allotment option described in Section 2(b) hereof, the Company further agrees to pay to the Underwriter on each Option Closing Date (by certified or bank cashier's check or, at the Underwriter's election, by deduction from the proceeds of the offering) a non-accountable expense allowance equal to three percent (3%) of the gross proceeds received by the Company from the sale of the Option Securities. 6. Conditions of the Underwriter's Obligations. The obligations of the ------------------------------------------- Underwriter hereunder shall be subject to the continuing accuracy of the representations and warranties of the Company herein as of the date hereof and as of the Closing Date and each Option Closing Date, if any, as if they had been made on and as of the Closing Date or each Option Closing Date, as the case may be; the accuracy on and as of the Closing Date or Option Closing Date, if any, of the statements of officers of the Company made pursuant to the provisions hereof; and the performance by the Company on and as of the Closing Date and each Option Closing Date, if any, of its covenants and obligations hereunder and to the following further conditions: (a) The Registration Statement shall have become effective not later than 5:00 p.m., New York City time, on the date prior to the date of this Agreement or such later date and time as shall be consented to in writing by the Underwriter, and, at the Closing Date and each Option Closing Date, if any, no stop order suspending the effectiveness of the Registration Statement shall have been issued and no proceedings for that purpose shall have been instituted or shall be pending or threatened by the Commission and any request on the part of the Commission for additional information shall have been complied with to the reasonable satisfaction of Underwriter's Counsel. If the Company has elected to rely upon Rule 430A of the Regulations, the price of the Units and any price- related information previously omitted from the effective Registration Statement pursuant to such Rule 430A shall have been transmitted to the Commission for filing pursuant to Rule 424(b) of the Regulations within the prescribed time period, and prior to the Closing Date the Company shall have provided evidence satisfactory to the Underwriter of such timely filing, or a post-effective amendment providing such information shall have been promptly filed and declared effective in accordance with the requirements of Rule 430A of the Regulations. (b) The Underwriter shall not have advised the Company that the Registration Statement, or any amendment thereto, contains an untrue statement of fact which, in the Underwriter's reasonable opinion, is material, or omits to state a fact which, in the Underwriter's reasonable opinion, is material and is required to be stated therein or is necessary to make the statements therein not misleading, or that the Prospectus, or any supplement thereto, contains an untrue statement of fact which, in the Underwriter's reasonable opinion, is material, or omits to state a fact which, in the Underwriter's reasonable opinion, is material and is required to be stated therein or is necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. (c) On or prior to the Closing Date, the Underwriter shall have received from Underwriter's Counsel such opinion or opinions with respect to the organization of the Company, the validity of the Securities, the Registration Statement, the Prospectus and other related matters 18 as the Underwriter may reasonably request and Underwriter's Counsel shall have received from the Company such papers and information as they request to enable them to pass upon such matters. (d) At the Closing Date, the Underwriter shall have received the favorable opinion of Fenwick & West LLP ("Fenwick & West"), counsel to the Company, dated the Closing Date, addressed to the Underwriter and in form and substance satisfactory to Underwriter's Counsel, to the effect that: (i) the Company (A) has been duly organized and is validly existing as a corporation in good standing under the laws of its jurisdiction of incorporation, (B) is duly qualified and licensed and in good standing as a foreign corporation in each jurisdiction in which its ownership or leasing of any properties or the character of its operations requires such qualification or licensing, except where the failure to be so qualified or licensed would not have a material adverse effect on the Company's business and (C) to such counsel's knowledge, has all requisite corporate power and authority and has obtained any and all necessary authorizations, approvals, orders, licenses, certificates, franchises and permits of and from all governmental or regulatory officials and bodies (including, without limitation, those having jurisdiction over environmental or similar matters), to own or lease its properties and conduct its business as described in the Prospectus. (ii) except as described in the Prospectus and except for A&R Technology, a currently inactive subsidiary organized in the former Soviet Union which, to such counsel's knowledge, does not currently engage in any substantial activities, to such counsel's knowledge, the Company does not own an interest in any corporation, limited liability company, partnership, joint venture, trust or other business entity; (iii) to such counsel's knowledge, the Company has a duly authorized, issued and outstanding capitalization as set forth in the Prospectus, and any amendment or supplement thereto, under "Capitalization" and "Description of Capital Stock," and to the knowledge of such counsel, the Company is not a party to or bound by any instrument, agreement or other arrangement providing for it to issue any capital stock, rights, warrants, options or other securities, except for this Agreement, the Warrant Agreement, the Underwriter's Warrant Agreement, and as described in the Prospectus. The Securities and all other securities issued or issuable by the Company which will be outstanding after the Closing Date conform in all material respects to the statements with respect thereto contained in the Registration Statement and the Prospectus. All issued and outstanding securities of the Company have been duly authorized and validly issued and are fully paid and non assessable; and none of such securities were issued in violation of any preemptive rights in the Company's Articles of 19 Incorporation, the Company's By-laws, the agreements and instruments identified in such counsel's opinion as having been reviewed for purposes of the opinion or other preemptive rights known to such counsel of any holders of any security of the Company. The Securities to be sold by the Company hereunder, under the Warrant Agreement, and under the Underwriter's Warrant Agreement are not and will not be subject to any preemptive rights in the Company's Articles of Incorporation, the Company's By-laws, the agreements and instruments identified in such counsel's opinion as having been reviewed for purposes of the opinion or any other preemptive or similar rights of any stockholder known to such counsel, have been duly authorized and, when issued, paid for and delivered in accordance with their terms, will be validly issued, fully paid and non assessable and will conform in all material respects to the description thereof contained in the Prospectus; all corporate action required to be taken for the authorization, issue and sale of the Securities has been duly and validly taken; and the certificates representing the Securities are in due and proper form. The Underwriter's Warrants and Warrants constitute valid, binding and enforceable obligations of the Company to issue and sell, upon exercise thereof and payment therefore, the number and type of securities of the Company called for thereby (except as such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other laws of general application relating to or affecting enforcement of creditors' rights and the application of equitable principles in any action, legal or equitable, and except as rights to indemnity or contribution may be limited by applicable law). Upon the issuance and delivery pursuant to this Agreement of the Securities to be sold by the Company, the Company will convey, against payment therefore as provided herein, to the Underwriter and the Underwriter, respectively, good and marketable title to the Securities free and clear of all liens and other encumbrances; (iv) if applicable, filing of all pricing information has been timely made in the appropriate form under Rule 430A, and based solely upon the oral advice of the Staff of the Commission, the Registration Statement is effective under the Act and no stop order suspending the use of any preliminary prospectus, the Registration Statement or Prospectus or any part of any thereof or suspending the effectiveness of the Registration Statement has been issued and no proceedings for that purpose have been instituted or are pending or, to such counsel's knowledge, threatened or contemplated under the Act; (v) each of any preliminary prospectus, the Registration Statement, and the Prospectus and any amendments or supplements thereto (other 20 than the financial statements and other financial and statistical data included therein as to which no opinion need be rendered) comply as to form in all material respects with the requirements of the Act and the Regulations. Such counsel shall state that such counsel has participated in conferences with officers and other Underwriter of the Company and the Underwriter and Underwriter of the independent public accountants for the Company, at which conferences the contents of any preliminary prospectus, the Registration Statement, the Prospectus, and any amendments or supplements thereto were discussed, and, although such counsel is not passing upon and does not assume any responsibility for the accuracy, completeness or fairness of the statements contained in the Preliminary Prospectus, the Registration Statement and Prospectus, and any amendments or supplements thereto, on the basis of the foregoing, no facts have come to the attention of such counsel which lead them to believe that either the Registration Statement or any amendment thereto, at the time such Registration Statement or amendment became effective or the Preliminary Prospectus or Prospectus or amendment or supplement thereto as of the date of such opinion contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading (it being understood that such counsel need express no opinion with respect to the financial statements and schedules and other financial and statistical data included in the Preliminary Prospectus, the Registration Statement or Prospectus, and any amendments or supplements thereto); (vi) to such counsel's knowledge, (A) there are no agreements, contracts or other documents required by the Act to be described in the Registration Statement and the Prospectus and filed- as exhibits to the Registration Statement other than those described in the Registration Statement and the Prospectus and filed as exhibits thereto; (B) the descriptions in the Registration Statement and the Prospectus and any supplement or amendment thereto of contracts and other agreements to which the Company is a party that are expressly referred to in the Registration Statement and the Prospectus, are accurate in all material respects; (C) there is not pending and the Company has received no oral or written notice of any action, arbitration, suit, proceeding, litigation, governmental or other proceeding against the Company (including, without limitation, those having jurisdiction over environmental or similar matters), domestic or foreign, which (x) is required by the Regulations to be disclosed in the Registration Statement which is not so disclosed (and such proceedings as are summarized in the Registration Statement are accurately summarized in all material respects), (y) questions the validity of the capital stock of the Company or this Agreement, the Warrant Agreement, or the 21 Underwriter's Warrant Agreement, or of any action taken or to be taken by the Company pursuant to or in connection with any of the foregoing; and (D) there is not pending and the Company has received no oral or written notice of any action, suit or proceeding against the Company before any court or arbitrator or governmental body, agency or official in which there is a reasonable possibility of an adverse decision which may result in a material adverse change in the Business, which could reasonably be expected to materially adversely affect the present or prospective ability of the Company to perform its obligations under this Agreement, the Warrant Agreement or the Underwriter's Warrant Agreement, or which in any manner draws into question the validity or enforceability of this Agreement, the Warrant Agreement or the Underwriter's Warrant Agreement; (vii) the Company has the corporate power and authority to enter into each of this Agreement, the Warrant Agreement, and the Underwriter's Warrant Agreement and to consummate the transactions provided for therein; and each of this Agreement, the Warrant Agreement, and the Underwriter's Warrant Agreement has been duly authorized, executed and delivered by the Company. Each of this Agreement, the Warrant Agreement, and the Underwriter's Warrant Agreement, assuming due authorization, execution and delivery by each other party thereto, constitutes a legal, valid and binding obligation of the Company enforceable against the Company in accordance with its terms (except as the enforceability thereof may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other laws of general application relating to or affecting enforcement of creditors' rights and the application of equitable principles in any action, legal or equitable, except as rights to indemnity or contribution may be limited by applicable law). To such counsel's knowledge, none of the Company's execution, delivery or performance of this Agreement, the Warrant Agreement, and the Underwriter's Warrant Agreement, the consummation by the Company of the transactions contemplated herein or therein, or the conduct of the Company's business as described in the Registration Statement, the Prospectus, and any amendments or supplements thereto conflicts with or results in any material breach or violation of any of the terms or provisions of, or constitutes a material default under, or results in the creation or imposition of any material lien, charge, claim, encumbrance, pledge, security interest, defect or other restriction or equity of any kind whatsoever upon, any property or assets (tangible or intangible) of the Company pursuant to the terms of (A) the articles of incorporation or by-laws of the Company, as amended, (B) any license, contract, indenture, mortgage, deed of trust, voting trust agreement, stockholders' agreement, note, loan or credit agreement or any other agreement or instrument known to such counsel, to which the 22 Company is a party or by which it is bound, or (C) any federal, state or local statute, rule or regulation known to such counsel to be applicable to the Company or any judgment, decree or order known to such counsel of any arbitrator, court, regulatory body or administrative agency or other governmental agency or body (including, without limitation, those having jurisdiction over environmental or similar matters), domestic or foreign, having jurisdiction over the Company or any of its activities or properties, in each case where such conflict, breach, violation or default would have a material adverse effect on the Company's business; (viii) the certificates evidencing the Securities as described in the Registration Statement comply in all material respects with the descriptions set forth therein, and comply with the California Corporation Code, as in effect on the date hereof; each Warrant will be exercisable for one share of the Common Stock of the Company, respectively, and at the prices provided for in the Warrant Agreement; (ix) no consent, approval, authorization or order, and no filing with, any court, regulatory body, government agency or other body (other than such as may be required under Blue Sky laws, as to which no opinion need be rendered or under federal securities laws, as to which no opinion need be rendered pursuant to this subsection (viii)) is required in connection with the issuance of the Securities pursuant to the Prospectus and the Registration Statement, the performance of this Agreement, the Warrant Agreement, and the Underwriter's Warrant Agreement, and the transactions contemplated hereby and thereby; (x) to such counsel's knowledge, the properties of the Company conform in all material respects to the description thereof contained in the Registration Statement and the Prospectus; (xi) to the knowledge of such counsel, and except as disclosed in the Registration Statement and the Prospectus, (A) the Company is not in material breach of, or in material default under, any term or provision of any license, contract, agreement, indenture, mortgage, installment sale agreement, deed of trust, lease, voting trust agreement, stockholders' agreement, note, loan or credit agreement or any other agreement or instrument evidencing an obligation for borrowed money, or other agreement or instrument to which the Company is a party or by which the Company is bound or to which the property or assets (tangible or intangible) of the Company is subject, in each case where such breach or default would have a material adverse effect on the business of the Company, and (B) the Company is not in material violation of any term or provision of its 23 articles of incorporation or by-laws, as amended, or in material violation of any franchise, license, permit, judgment, decree, order, statute, rule or regulation known to such counsel to be applicable to the Company, in each case where such breach, default or violation would have a material adverse effect on the Company's business; (xii) the statements in the Prospectus under "Dividend Policy," "Description of Capital Stock," and "Shares Eligible for Future Sale" have been reviewed by such counsel, and insofar as they refer to statements of law, descriptions of statutes, licenses, rules or regulations or legal conclusions, are correct in all material respects; (xiii) the Units, Common Stock and Warrants have been accepted for quotation on the Nasdaq SmallCap Market; (xiv) to such counsel's knowledge and based upon a review of the outstanding securities and the contracts furnished to such counsel by the Company, except as disclosed in the Registration Statement and Prospectus, no person, corporation, trust, partnership, association or other entity has the right to include and/or register any securities of the Company in the Registration Statement, require the Company to file any registration statement or, if filed, to include any security in such registration statement; and (xv) assuming the authority and capacity of, and due execution by the parties thereto other than the Company, each Lock-up Agreement is a legal, valid and binding obligation of the party thereto, enforceable against the party and any subsequent holder of the securities subject thereto in accordance with its terms (except as such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other laws of general application relating to or affecting enforcement of creditors' rights and the application of equitable principles in any action, legal or equitable, and except as rights to indemnity or contribution may be limited by applicable law). In rendering such opinion, such counsel (A) need not express any opinion as to matters involving the application of laws other than the laws, rules and regulations of the United States (with such exceptions and limitations as are set forth in such counsel's opinion) and the laws, rules and regulations of the State of California; and (B) as to matters of fact, to the extent they deem proper, on certificates and written statements of responsible officers of the Company and certificates or other written statements of officers of departments of various jurisdictions having custody of documents respecting the corporate existence or good standing of the Company, provided that copies of any such statements or certificates shall be delivered to Underwriter's Counsel if requested. At each Option Closing Date, if any, the Underwriter shall have received the favorable opinion of Fenwick & West, counsel to the Company, dated the Option Closing Date, addressed to 24 the Underwriter and in form and substance satisfactory to Underwriter's Counsel confirming as of such Option Closing Date the statements made by Fenwick & West in its opinion delivered on the Closing Date. (e) On or prior to each of the Closing Date and the Option Closing Date, if any, Underwriter's Counsel shall have been furnished such documents, certificates and opinions as they may reasonably require for the purpose of enabling them to review or pass upon the matters referred to in subsection (c) of this Section 6, or in order to evidence the accuracy, completeness or satisfaction of any of the representations, warranties or conditions of the Company or herein contained. (f) Prior to each of the Closing Date and each Option Closing Date, if any: (i) there shall have been no material adverse change nor development involving a prospective material adverse change in the condition, financial or otherwise, prospects, stockholders' equity or the business activities of the Company, whether or not in the ordinary course of business, from the latest dates as of which such condition is set forth in the Registration Statement and Prospectus; (ii) except as disclosed in the Registration Statement or the Prospectus, there shall have been no transaction, not in the ordinary course of business, entered into by the Company, from the latest date as of which the financial condition of the Company is set forth in the Registration Statement and Prospectus which is adverse to the Company; (iii) the Company shall not be in default under any provision of any instrument relating to any outstanding indebtedness which default has not been waived; (iv) except as disclosed in the Registration Statement or the Prospectus, the Company shall not have issued any securities (other than the Securities) or declared or paid any dividend or made any distribution in respect of its capital stock of any class and there has not been any change in the capital stock, or any material increase in the debt (long or short term) or liabilities or obligations of the Company (contingent or otherwise) except for the issuance of the Option Securities, the Underwriter's Warrants, and shares of Common Stock issued upon the exercise of currently outstanding warrants or options, or options and warrants granted in the ordinary course of business consistent with prior practice; (v) no material amount of the assets of the Company shall have been pledged or mortgaged, except as set forth in the Registration Statement and Prospectus; (vi) there shall not have been pending and the Company shall not have received oral or written notice of any action, suit or proceeding, at law or in equity, (or circumstances giving rise to same) against the Company, or affecting any of its respective properties or businesses before or by any court or federal, state or foreign commission, board or other administrative agency wherein an unfavorable decision, ruling or finding may materially adversely affect the Business of the Company except as set forth in the Registration Statement and Prospectus; and (vii) no stop order shall have been issued under the Act and no proceedings therefore shall have been initiated, threatened or contemplated by the Commission. (g) At each of the Closing Date and each Option Closing Date, if any, the Underwriter shall have received a certificate of the Company signed on behalf of the Company by the principal executive officer of the Company, dated the Closing Date or Option Closing Date, as the case may be, to the effect that such executive has carefully examined the Registration Statement, the Prospectus and this Agreement, and that: (i) The representations and warranties of the Company in this Agreement are true and correct, as if made on and as of the Closing Date or the 25 Option Closing Date, as the case may be, and the Company has complied with all agreements and covenants and satisfied all conditions contained in this Agreement on its part to be performed or satisfied at or prior to such Closing Date or Option Closing Date, as the case may be; (ii) No stop order suspending the effectiveness of the Registration Statement or any part thereof has been issued, and no proceedings for that purpose have been instituted or are pending or, to the best of such person's knowledge after due inquiry, are contemplated or threatened under the Act; (iii) The Registration Statement and the Prospectus and, if any, each amendment and each supplement thereto, contain all statements and information required by the Act to be included therein, and none of the Registration Statement, the Prospectus nor any amendment or supplement thereto includes any untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein not misleading and neither the Preliminary Prospectus or any supplement, as of their respective dates, thereto included any untrue statement of a material fact or omitted to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading; and (iv) Subsequent to the respective dates as of which information is given in the Registration Statement and the Prospectus, and except as described in or specifically contemplated by the Registration Statement and Prospectus: (a) the Company has not incurred up to and including the Closing Date or the OptionClosing Date, as the case may be, other than in the ordinary course of its business, any material liabilities or obligations, direct or contingent; (b) the Company has not paid or declared any dividends or other distributions on its capital stock; (c) the Company has not entered into any transactions not in the ordinary course of business; (d) there has not been any change in the capital stock as described in the Registration Statement and Prospectus or material increase in long-term debt or any increase in the short-term borrowings (other than any increase in the short term borrowings in the ordinary course of business) of the Company; (e) the Company has not sustained any material loss or damage to its property or assets, whether or not insured; (f) there is not pending, and the Company has received no oral or written notice of, any litigation (or circumstances giving rise to same) against the Company or any affiliated party of any of the foregoing which is required to be set forth in an amended or supplemented Prospectus which has not been set forth; and (g) there has occurred no event required to be set 26 forth in an amended or supplemented Prospectus which has not been set forth. References to the Registration Statement and the Prospectus in this subsection (g) are to such documents as amended and supplemented at the date of such certificate. (h) By the Closing Date, the Underwriter will have received clearance from the NASD as to the amount of compensation allowable or payable to the Underwriter. (i) At the time this Agreement is executed, the Underwriter shall have received a letter, dated such date, addressed to the Underwriter in form and substance satisfactory in all respects (including the non-material nature of the changes or decreases, if any, referred to in clause (iii) below) to the Underwriter and Underwriter's Counsel, from Grant Thornton: (i) confirming that they are independent certified public accountants with respect to the Company within the meaning of the Act and the applicable Rules and Regulations; (ii) stating that it is their opinion that the financial statements of the Company included in the Registration Statement comply as to form in all material respects with the applicable accounting requirements of the Act and the Regulations thereunder and that the Underwriter may rely upon the opinion of Grant Thornton with respect to the financial statements and supporting schedules included in the Registration Statement; (iii) stating that, on the basis of a limited review which included a reading of the latest available unaudited interim financial statements of the Company (with an indication of the date of the latest available unaudited interim financial statements), a reading of the latest available minutes of the stockholders and board of directors and the various committees of the board of directors of the Company, consultations with officers and other employees of the Company responsible for financial and accounting matters and other specified procedures and inquiries, nothing has come to their attention which would lead them to believe that: (A) the unaudited financial statements of the Company included in the Registration Statement, if any, do not comply as to form in all material respects with the applicable accounting requirements of the Act and the Regulations or are not fairly presented in conformity with generally accepted accounting principles applied on a basis substantially consistent with that of the audited financial statements of the Company included in the Registration Statement; or (B) at a specified date not more than five (5) days prior to the effective date of the Registration Statement, there has been any change in the capital stock or material increase in long-term debt of the Company, or any material decrease in the 27 stockholders' equity or net current assets or net assets of the Company as compared with amounts shown in the most recent balance sheet included in the Registration Statement, other than as set forth in or contemplated by the Registration Statement, or, if there was any change or decrease, setting forth the amount of such change or decrease. (iv) stating that they have compared specific dollar amounts, numbers of shares, percentages of revenues and earnings, statements and other financial information pertaining to the Company set forth in the Prospectus in each case to the extent that such amounts, numbers, percentages, statements and information may be derived from the general accounting records, including work sheets, of the Company and excluding any questions requiring an interpretation by legal counsel, with the results obtained from the application of specified readings, inquiries and other appropriate procedures (which procedures do not constitute an examination in accordance with generally accepted auditing standards) set forth in the letter and found them to be in agreement; and (v) statements as to such other material matters incident to the transaction contemplated hereby as the Underwriter may reasonably request. (j) At the Closing Date and each Option Closing Date, if any, the Underwriter shall have received from Grant Thornton a letter, dated as of the Closing Date or the Option Closing Date, as the case may be, to the effect that they reaffirm that statements made in the letter furnished pursuant to Subsection (i) of this Section 6, except that the specified date referred to shall be a date not more than five (5) days prior to the Closing Date or the Option Closing Date, as the case may be, and, if the Company has elected to rely on Rule 430A of the Rules and Regulations, to the further effect that they have carried out procedures as specified in clause (iv) of Subsection (i) of this Section 6 with respect to certain amounts, percentages and financial information as specified by the Underwriter and deemed to be a part of the Registration Statement pursuant to Rule 430A(b) and have found such amounts, percentages and financial information to be in agreement with the records specified in such clause (iv). (k) On each of Closing Date and Option Closing Date, if any, there shall have been duly tendered to the Underwriter for the several Underwriter's accounts the appropriate number of Securities. (1) No order suspending the sale of the Securities in any jurisdiction designated by the Underwriter pursuant to subsection (e) of Section 4 hereof shall have been issued on either the Closing Date or the Option Closing Date, if any, and no proceedings for that purpose shall have been instituted or shall be contemplated. (m) On or before the Closing Date, the Company shall have executed and delivered to the Underwriter, (i) the Underwriter's Warrant Agreement, substantially in the form filed 28 as Exhibit 4.02, to the Registration Statement, in final form and substance satisfactory to the Underwriter, and (ii) the Underwriter's Warrants in suet denominations and to such designees as shall have been provided to the Company. (n) On or before the Closing Date, the Common Stock shall have been duly approved for quotation on the Nasdaq SmallCap Market. (o) On or before the Effective Date, the Company will be listed with standard and Poor's or such other comparable services acceptable to the Underwriter. (p) On or before the Closing Date, there shall have been delivered to the Underwriter all of the Lock-up Agreements in final form and substance satisfactory to Underwriter's Counsel. (q) At the Closing Date, the Underwriter shall have received the opinion of Fenwick & West, dated the Closing Date, addressed to the Underwriter, concerning certain intellectual property matters, in substantially the form previously presented to the Underwriter. If any condition to the Underwriter's obligations hereunder to be fulfilled prior to or at the Closing Date or the relevant Option Closing Date, as the case may be, is not so fulfilled, the Underwriter may terminate this Agreement or, if the Underwriter so elects, it may waive any such conditions which have not been fulfilled or extend the time for their fulfillment. 7. Indemnification. --------------- (a) The Company agrees to indemnify and hold harmless each of the Underwriter (for purposes of this Section 7 "Underwriter" shall include the officers, directors, partners, employees, agents and counsel of the Underwriter, including specifically each person who may be substituted for an Underwriter as provided in Section 11 hereof), and each person, if any, who controls the Underwriter ("controlling person") within the meaning of Section 15 of the Act or Section 20(a) of the Exchange Act, from and against any and all-loss, liability, claim, damage, and expense whatsoever (including, but not limited to, reasonable attorneys' fees and any and all reasonable expense whatsoever incurred in investigating, preparing or defending against any litigation, commenced or threatened, or any claim whatsoever and any and all amounts paid in settlement of any claim or litigation provided that the indemnified persons may not agree to any such settlement without the prior written consent of the Company), as and when incurred, arising out of, based upon or in connection with: (i) any untrue statement or alleged untrue statement of a material fact contained (A) in any preliminary prospectus, the Registration Statement or the Prospectus (as from time to time amended and supplemented), or (B) in any application or other document or communication (in this Section 7 collectively called "application") executed by or on behalf of the Company or based upon written information furnished by or on behalf of the Company in any jurisdiction in order to qualify the Securities under the securities laws thereof or filed with the Commission, any state securities commission or agency, The Nasdaq Stock Market, Inc. or any securities exchange; or any omission or alleged omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading (in the case of the Prospectus, in the light of the circumstances under which they were made), unless such statement or omission was 29 made in reliance upon and in conformity with written information furnished to the Company with respect to any Underwriter by or on behalf of such Underwriter expressly for use in any preliminary prospectus, the Registration Statement or Prospectus, or any amendment thereof or supplement thereto, or in any application, as the case may be; or (ii) any breach of any representation, warranty, covenant or agreement of the Company contained in this Agreement. The indemnity agreement in this subsection (a) shall be in addition to any liability which the Company may have at common law or otherwise. (b) The Underwriter agrees to indemnify and hold harmless the Company, each of its directors, employees, agents, each of its officers who has signed the Registration Statement, counsel to the Company, and each other person, if any, who controls the Company, within the meaning of the Act, to the same extent as the foregoing indemnity from the Company to the Underwriter but only with respect to statements or omissions, if any, made in any preliminary prospectus, the Registration Statement or Prospectus or any amendment thereof or supplement thereto or in any application made in reliance upon, and in strict conformity with, written information furnished to the Company with respect to the Underwriter by the Underwriter expressly for use in such preliminary prospectus, the Registration Statement or Prospectus or any amendment thereof or supplement thereto or in any such application. The Company acknowledges that the statements with respect to the public offering of the Securities set forth under the heading "Underwriting" and the stabilization legend in the Prospectus have been furnished by the Underwriter expressly for use therein and constitute the only information furnished in writing by or on behalf of the Underwriter for inclusion in the Prospectus. (c) Promptly after receipt by an indemnified party under this Section 7 of notice of the commencement of any action, suit or proceeding, such indemnified party shall, if a claim in respect thereof is to be made against one or more indemnifying parties under this Section 7, notify each party against whom indemnification is to be sought in writing of the commencement thereof (but the failure to so notify an indemnifying party shall not relieve it from any liability which it may have otherwise or which it may have under this Section 7, except to the extent that it has been prejudiced in any material respect by such failure). In case any such action is brought against any indemnified party, and it notifies an indemnifying party or parties of the commencement thereof, the indemnifying party or parties will be entitled to participate therein, and to the extent it may elect by written notice delivered to the indemnified party promptly after receiving the aforesaid notice from such indemnified party, to assume the defense thereof with counsel reasonably satisfactory to such indemnified party. Notwithstanding the foregoing, the indemnified party or parties shall have the right to employ its or their own counsel in any such case, but the fees and expenses of such counsel shall be at the expense of such indemnified party or parties unless: (i) the employment of such counsel shall have been authorized in writing by the indemnifying parties in connection with the defense of such action at the expense of the indemnifying party; (ii) the indemnifying parties shall not have employed counsel reasonably satisfactory to such indemnified party to have charge of the defense of such action within a reasonable time after notice of commencement of the action; or (iii) such indemnified party or parties shall have been advised in writing by counsel that a conflict of interest exists between the indemnifying party and the indemnified parties making representation of such parties by the same counsel inappropriate (in which case the indemnifying parties shall not have the right to direct the defense of such action on behalf of the indemnified party or parties) in any of which events the reasonable fees and expenses of one additional counsel shall be borne by the 30 indemnifying parties. In no event shall the indemnifying parties be liable for fees and expenses of more than one counsel (in addition to any local counsel) separate from their own counsel for all indemnified parties in connection with any one action or separate but similar or related actions in the same jurisdiction arising out of the same general allegations or circumstances. Anything in this Section 7 to the contrary notwithstanding, an indemnifying party shall not be liable for any settlement of any claim or action effected without its written consent provided, however, that such consent was not unreasonably withheld. (d) In order to provide for just and equitable contribution in any case in which: (i) an indemnified party makes claim for indemnification pursuant to this Section 7, but it is judicially determined (by the entry of a final judgment or decree by a court of competent jurisdiction and the expiration of time to appeal or the denial of the last right of appeal) that such indemnification may not be enforced in such case notwithstanding the fact that the express provisions of this Section 7 provide for indemnification in such case; or (ii) contribution under the Act may be required on the part of any indemnified party, then each indemnifying party shall contribute to the amount paid as a result of such losses, claims, damages, expenses or liabilities (or actions in respect thereof), (A) in such proportion as is appropriate to reflect the relative benefits received by each of the contributing parties, on the one hand, and the party to be indemnified on the other hand, from the offering of the Securities, or (B) if the allocation provided by clause (A) above is not permitted by applicable law, in such proportion as is appropriate to reflect not only the relative benefits referred to in clause (i) above but also the relative fault of each of the contributing parties, on the one hand, and the party to be indemnified on the other hand in connection with the statements or omissions that resulted in such losses, claims, damages, expenses or liabilities, as well as any other relevant equitable considerations. In any case where the Company is a contributing party and the Underwriter is the indemnified party, the relative benefits received by the Company on the one hand, and the Underwriter, on the other, shall be deemed to be in the same proportion as the total net proceeds from the offering of the Securities (before deducting expenses other than underwriting discounts and commissions) bear to the total underwriting discounts received by the Underwriter hereunder, in each case as set forth in the table on the Cover Page of the Prospectus. Relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company or by the Underwriter, and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such untrue statement or omission. The amount paid or payable by an indemnified party as a result of the losses, claims, damages, expenses or liabilities (or actions in respect thereof) referred to above in this subdivision (d) shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action or claim. Notwithstanding the provisions of this subdivision (d) the Underwriter shall not be required to contribute any amount in excess of the underwriting discount applicable to the Securities purchased by the Underwriter hereunder. No person guilty of fraudulent misrepresentation (within the meaning of Section 12(f) of the Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. For purposes of this Section 7, each person, if any, who controls the Company within the meaning of the Act, each officer of the Company who has signed the Registration Statement, and each director of the Company shall have the same rights to contribution as the Company, subject in each case to this subparagraph (d). Any party entitled to contribution will, promptly after receipt of notice of commencement of any action, suit or proceeding against such party in respect to which a claim for contribution may be 31 made against another party or parties under this subparagraph (d), notify such party or parties from whom contribution may be sought, but the omission so to notify such party or parties shall not relieve the party or parties from whom contribution may be sought from any obligation it or they may have hereunder or otherwise than under this subparagraph (d), or to the extent that such party or parties were not adversely affected by such omission. The contribution agreement set forth above shall be in addition to any liabilities which any indemnifying party may have at common law or otherwise. 8. Representations and Agreements to Survive Delivery. All -------------------------------------------------- representations, warranties and agreements contained in this Agreement or contained in certificates of officers of the Company submitted pursuant hereto, shall be deemed to be representations, warranties and agreements of the Company at the Closing Date and the Option Closing Date, as the case may be, and such representations, warranties and agreements of the Company and the respective indemnity and contribution agreements contained in Section 7 hereof shall remain operative and in full force and effect regardless of any investigation made by or on behalf of the Underwriter, the Company, any controlling person of either the Underwriter or the Company, and shall survive termination of this Agreement or the issuance and delivery of the Securities to the Underwriter, as the case may be. 9. Effective Date. This Agreement shall become effective at 5:00 p.m., -------------- New York City time, on the date hereof. For purposes of this Section 9, the Securities to be purchased hereunder shall be deemed to have been so released upon the earlier of dispatch by the Underwriter of telegrams to securities dealers releasing such shares for offering or the release by the Underwriter for publication of the first newspaper advertisement which is subsequently published relating to the Securities. 10. Termination. ----------- (a) Subject to subsection (b) of this Section 10, the Underwriter shall have the right to terminate this Agreement, if between the date of this Agreement and the Closing Date or the Option Closing Date, as the case may be: (i) if any domestic or international event or act or occurrence has materially disrupted, or in the Underwriter's reasonable opinion will in the immediate future have a material and adverse effect on the securities markets generally; or (ii) any material adverse change in the financial markets shall have occurred; or (iii) if trading on the New York Stock Exchange, the American Stock Exchange, or in the over-the-counter market shall have been suspended, or minimum or maximum prices for trading shall have been fixed, or maximum ranges for prices for securities shall have been required on the over-the-counter market by the NASD or by order of the Commission or any other government authority having jurisdiction; or (iv) if the United States shall have become involved in a war or major hostilities, or if there shall have been an escalation in an existing war or major hostilities or a national emergency shall have been declared in the United States; or (v) if a banking moratorium has been declared by a state or federal authority; or (vi) if the Company shall have sustained a loss material to the Company by fire, flood, accident, hurricane, earthquake, theft, sabotage or other calamity or malicious act which, whether or not such loss shall have been insured, will, in the Underwriter's opinion, make it inadvisable to proceed with the delivery of the Securities; or (viii) if there shall have occurred either of the following which in the Underwriter's good faith judgment would make it inadvisable to proceed with the offering, sale and/or delivery of the Securities, (X) a material adverse change in the prospects or conditions of the 32 Company, or (Y) a material adverse change in the general market, political or economic conditions, in the United States or elsewhere, in each case in this clause (Y) having a material and adverse effect on the securities markets generally. (b) If this Agreement is terminated by the Underwriter in accordance with any of the provisions of Section 6, Section l0(a) or Section 11, the Company shall promptly reimburse and indemnify the Underwriter pursuant to Section 5(b) hereof. Notwithstanding any contrary provision contained in this Agreement, any election hereunder or any termination of this Agreement (including, without limitation, pursuant to Sections 6, 10, 11 and 12 hereof), and whether or not this Agreement is otherwise carried out, the provisions of Section 5 and Section 7 shall not be in any way affected by such election or termination or failure to carry out the terms of this Agreement or any part hereof. 11. Default by the Company. If the Company shall fail at the Closing Date ---------------------- or any Option Closing Date, as applicable, to sell and deliver the number of Securities which it is obligated to sell hereunder on such date, then this Agreement shall terminate (or, if such default shall occur with respect to any Option Securities to be purchased on an Option Closing Date, the Underwriter may at the Underwriter's option, by notice from the Underwriter to the Company, terminate the Underwriter's obligation to purchase Option Securities from the Company on such date) without any liability on the part of any non-defaulting party other than pursuant to Section 5, Section 7 and Section 10 hereof. No action taken pursuant to this Section shall relieve the Company from liability, if any, in respect of such default. 12. Notices. All notices and communications hereunder, except as herein ------- otherwise specifically provided, shall be in writing and shall be deemed to have been duly given if mailed or transmitted by any standard form of telecommunication. Notices to the Underwriter shall be directed to the Underwriter, Monroe Parker Securities, Inc., 2500 Weschester Avenue, Purchase NY 10577, Attention: Stephen Drescher, with a copy, which shall not constitute notice, to Singer Zamansky, LLP, 40 Exchange Place, New York, NY 10005, Attention: Gregory Sichenzia, Esq. Notices to the Company shall be directed to Isonics Corporation, 4010 Moorpark Avenue, Suite 119, San Jose, California 95117, Attention: James E. Alexander, with a copy, which shall not constitute notice, to Fenwick & West LLP, Two Palo Alto Square, Palo Alto, California 94306, Attention: C. Kevin Kelso, Esq. 13. Parties. This Agreement shall inure solely to the benefit of and ------- shall be binding upon the Underwriter, the Company and the controlling persons, directors and officers referred to in Section 7 hereof and their respective successors, legal Underwriter and assigns, and no other person shall have or be construed to have any legal or equitable right, remedy or claim under or in respect of or by virtue of this Agreement or any provisions herein contained. No purchaser of Securities from any Underwriter shall be deemed to be a successor by reason merely of such purchase. 14. Construction. This Agreement shall be governed by and construed ------------ and enforced in accordance with the laws of the State of New York without giving effect to the choice of law or conflict of laws principles. 15. Counterparts. This Agreement may be executed in any number of ------------ counterparts, each of which shall be deemed to be an original, and all of which taken together shall be deemed to be one 33 and the same instrument. 16. Entire Agreement: Amendments. This Agreement, the Warrant ---------------------------- Agreement, and the Underwriter's Warrant Agreement constitute the entire agreement of the parties hereto and supersede all prior written or oral agreements, understandings and negotiations with respect to the-subject matter hereof. This Agreement may not be amended except in a writing, signed by the Underwriter and the Company If the foregoing correctly sets forth the understanding between the Underwriter and the Company, please so indicate in the space provided below for that purpose, whereupon this letter shall constitute a binding agreement among us. Very truly yours, ISONICS CORPORATION By:_________________________ Name: Boris Rubizbevsky Title: Vice-Chairman CONFIRMED AND ACCEPTED AS OF THE DATE FIRSTABOVE WRITTEN: MONROE PARKER SECURITIES, INC. By:_________________________ Name: Stephen Drescher Title: Director of Corporate Finance 34 EX-3.01 3 AMENDED AND RESTATED ARTICLE OF INCORPORATION EXHIBIT 3.01 AMENDED AND RESTATED ARTICLES OF INCORPORATION OF ISONICS CORPORATION James E. Alexander and Paul J. Catuna certify that: 1. They are the President and Chief Executive Officer and the Secretary, respectively of Isonics Corporation, a California Corporation. 2. The Articles of Incorporation of this corporation are amended and restated to read as set forth in Annex "A" hereto. --------- 3. The foregoing amendment and restatement of the Articles of Incorporation has been duly approved by the board of directors. 4. The foregoing amendment and restatement of the Articles of Incorporation has been duly approved by the required vote of shareholders in accordance with Sections 902 and 903 of the California Corporations Code. The total number of outstanding shares entitled to vote thereon is 1,516,756 shares of Common Stock, There are no shares of the corporation's authorized Preferred Stock issued or outstanding. The number of shares voting in favor of the amendment and restatement equaled or exceeded the vote required. The percentage vote required was more than fifty percent (50%) of the outstanding shares of Common Stock. We further declare under penalty of perjury under the laws of the State of California that the matters set forth in this certificate are true and correct of our knowledge. Dated: August ___, 1997 ---------------------------------------- James E. Alexander President and Chief Executive Officer ---------------------------------------- Paul J. Catuna, Secretary ANNEX "A" AMENDED AND RESTATED ARTICLES OF INCORPORATION OF ISONICS CORPORATION ARTICLE I The name of this corporation is: Isonics Corporation. ARTICLE II The purpose of this corporation is to engage in any lawful act or activity for which a corporation may be organized under the General Corporation Law of California other than the banking business, the trust company business or the practice of a profession permitted to be incorporated by the California Corporations Code. ARTICLE III The aggregate number of shares of capital stock which this corporation shall be authorized to issue is Thirty Million (30,000,000), which shall consist of: (a) Twenty Million (20,000,000) shares which shall be designated as Common Stock; and (b) Ten Million (10,000,000) shares which shall be designated as Preferred Stock. Upon the filing of these articles, each issued and outstanding share of Common Stock shall be split into three (3) shares of Common Stock. ARTICLE IV The shares of this corporation's Preferred Stock may be issued from time to time in one or more series as the Board of Directors may from time to time determine. The Board of Directors is authorized to determine and alter the rights, preferences, privileges and restrictions granted to, or imposed upon, any wholly unissued series of Preferred Stock, and to fix the number of shares of any series of Preferred Stock and the designation of any such series of Preferred Stock. The Board of Directors, within the limits and restrictions stated in any resolution or resolution of the Board of Directors originally fixing the number of shares constituting any series, may increase or decrease (but not below the number of shares of such series then outstanding) the number of shares of any series prior to or subsequent to the issuance of shares of that series. ARTICLE V 5.1 Liability of Directors. The liability of directors of the ---------------------- corporation for monetary damages shall be eliminated to the fullest extent permissible under California Law. 5.2 Indemnification. The corporation is authorized to provide --------------- indemnification of agents (as defined in Section 317 of the California Corporations Code) through Bylaw provisions, agreements with agents, votes of shareholders or disinterested directors, or otherwise, to the fullest extent permissible under California law. 5.3 Amendment, Modification. Any amendment, repeal or modification ----------------------- of any provision of this Article V shall not adversely affect any right or protection of an agent of this corporation existing at the time of such amendment, repeal or modification. EX-4.02 4 FORM OF UNDERWRITER'S WARRANT AGREEMENT EXHIBIT 4.02 ________________________________ ISONICS CORPORATION AND MONROE PARKER SECURITIES, INC. UNDERWRITER'S WARRANT AGREEMENT DATED AS OF_____________, 1997 ________________________________ UNDERWRITER'S WARRANT AGREEMENT dated as of _____________, 1997, between ISONICS CORPORATION, a California corporation (the "Company"), and MONROE PARKER SECURITIES, INC. and its assignees or designees (each hereinafter collectively referred to variously as "Holders" or the "Underwriter"). W I T N E S S E T H : ------------------- WHEREAS, the Underwriter has agreed pursuant to the underwriting agreement (the "Underwriting Agreement") dated as of the date hereof and entered into between the Company and the Underwriter therein (the "Underwriter") in connection with the Company's proposed public offering of 700,000 units ("Units") at a public offering price of $7.00 per Unit, consisting of 1,400,000 shares of Common Stock which have been given a value for purposes of this agreement of $3.40 per share as (hereinafter defined) and 1,400,000 redeemable warrants (the "Redeemable Warrants") which have been given a value for purposes of this agreement of $.10 per warrant to purchase one (1) share of Common Stock at an exercise price of $4.00 per share (the "Public Offering"). WHEREAS, pursuant to the Underwriting Agreement, the Company proposes to issue warrants (the "Underwriter's Warrants") to the Underwriter to purchase up to an aggregate of 140,000 shares of Common Stock of the Company and/or 140,000 Redeemable Warrants. WHEREAS, the Underwriter's Warrants to be issued pursuant to this Agreement will be issued on the Closing Date (as such term is defined in the Underwriting Agreement) by the Company to the Underwriter in consideration for, and as part of the Underwriters' compensation in connection with, the Underwriter acting as the underwriter pursuant to the Underwriting Agreement. NOW, THEREFORE, in consideration of the premises, the payment by the Underwriter to the Company of an aggregate of _______ dollars ($140.00), the agreements herein set forth and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows: 1. Grant. The Underwriter is hereby granted the right to purchase, at ------ any time one year after the Effective Date of the Registration Statement until 5:30 p.m., New York time, on September ___, 2002 (five years from the Effective Date of the Registration Statement), at which time the Underwriter's Warrants expire, up to an aggregate of 140,000 shares of Common Stock, no par value (the "Common Stock"), and/or 140,000 Redeemable Warrants at an initial exercise price (subject to adjustment as provided in Section 11 hereof) of $5.61 per share of ------- Common Stock (165% of the initial public offering price per share and $.165 per Redeemable Warrant (165% of the initial public offering price per Redeemable Warrant, (collectively, the "Exercise Price"). The Redeemable Warrant is exercisable to purchase one additional share of Common Stock at an initial exercise of $4.00 (from one year after the Effective Date of the Registration Statement until September __, 5:30 p.m. New York time, 2001 (four years from the Effective Date of the Registration Statement), at which time the Redeemable Warrants shall expire. The shares of Common Stock and the Redeemable Warrants issuable upon exercise of the Underwriter's Warrants are in all respects 2 identical to the shares of Common Stock and the Redeemable Warrants being purchased by the Underwriters for resale to the public pursuant to the terms and provisions of the Underwriting Agreement. The shares of Common Stock and the Redeemable Warrants issuable upon exercise of the Underwriter's Warrants are sometimes hereinafter referred to collectively as the "Securities." 2. Underwriter's Warrant Certificates. The Underwriter's Warrant ---------------------------------- Certificates (the "Warrant Certificates") delivered and to be delivered pursuant to this Agreement shall be in the form set forth in Exhibit A, attached hereto and made a part hereof, with such appropriate insertions, omissions, substitutions, and other variations as required or permitted by this Agreement. 3. Registration of Warrant. The Underwriter's Warrants shall be numbered ----------------------- and shall be registered on the books of the Company when issued. The Underwriter's Warrants and securities underlying such warrant shall be registered on the Company's registration statement for the initial Public Offering of its securities. 4. Exercise of Underwriter's Warrants. ----------------------------------- The Underwriter's Warrants initially are exercisable at an aggregate Exercise Price (subject to adjustment as provided in Section 11 hereof) of $5.61 ------- per share of Common Stock and $.165 per Redeemable Warrant as set forth in Section 8 hereof payable by certified or official bank check in New York - ------- Clearing House funds. Upon surrender of a Underwriter's Warrant Certificate with the annexed Form of Election to Purchase duly executed, together with payment of the Exercise Price for the Securities purchased at the Company's principal offices in California presently located at 4010 Moorpark Avenue, Suite 119, San Jose, California 95117, the registered holder of an Underwriter's Warrant Certificate ("Holder" or "Holders") shall be entitled to receive a certificate or certificates for the shares of Common Stock and/or Redeemable Warrants so purchased. The purchase rights represented by each Underwriter's Warrant Certificate are exercisable at the option of the Holder thereof, in whole or in part (but not as to fractional shares of Common Stock and/or Redeemable Warrants underlying the Underwriter's Warrants). Underwriter's Warrants may be exercised to purchase all or part of the shares of Common Stock together with an equal or unequal number of the Redeemable Warrants represented thereby. In the case of the purchase of less than all of the shares of Common Stock and/or Redeemable Warrants purchasable under any Underwriter's Warrant Certificate, the Company shall cancel said Underwriter's Warrant Certificate upon the surrender thereof and shall execute and deliver a new Underwriter's Warrant Certificate of like tenor for the balance of the shares of Common Stock and/or Redeemable Warrants purchasable thereunder. 5. Issuance of Certificates. Upon the exercise of the Underwriter's ------------------------ Warrant, the issuance of certificates for shares of Common Stock and/or Redeemable Warrants or other securities, properties or rights underlying such Underwriter's Warrant shall be made forthwith (and in any event within five (5) business days thereafter) without charge to the holder thereof including, without limitation, any tax which may be payable in respect of the issuance thereof, and such certificates shall (subject to the provisions of Sections 7 --------- and 9 hereof) be issued in the name of, or in such names as may be directed by, the Holder thereof; provided, however, that the Company shall not be required to pay any tax which may be payable in respect of any transfer involved in the issuance and delivery 3 of any such certificates in a name other than that of the Holder and the Company shall not be required to issue or deliver such certificates unless or until the person or persons requesting the issuance thereof shall have paid to the Company the amount of such tax or shall have established to the satisfaction of the Company that such tax has been paid. The Underwriter's Warrant Certificates and the certificates representing the shares of Common Stock and/or Redeemable Warrants or other securities, property or rights issued upon exercise of the Underwriter's Warrant shall be executed on behalf of the Company by the manual or facsimile signature of the then present President or any Vice President of the Company under its corporate seal reproduced thereon, attested to by the manual or facsimile signature of the then present Secretary or any Assistant Secretary of the Company. Underwriter's Warrant Certificates shall be dated the date of execution by the Company upon initial issuance, division, exchange, substitution or transfer. 6. Transfer of Underwriter's Warrant. The Underwriter's Warrant shall be --------------------------------- transferable in the first year only to officers, directors and principals of the Underwriter, only on the books of the Company maintained at its principal office, where its principal office may then be located, upon delivery thereof duly endorsed by the Holder or by its duly authorized attorney or underwriter accompanied by proper evidence of succession, assignment or authority to transfer. Upon any registration transfer, the Company shall execute and deliver the new Underwriter's Warrant to the person entitled thereto. 7. Restriction On Transfer of Underwriter's Warrant. The Holder of a ------------------------------------------------ Underwriter's Warrant Certificate, by its acceptance thereof, covenants and agrees that the Underwriter's Warrant is being acquired as an investment and not with a view to the distribution thereof, and that the Underwriter's Warrant may not be sold, transferred, assigned, hypothecated or otherwise disposed of, in whole or in part, for the term of the Underwriter's Warrant, except to officers or partners of the Underwriters, or by operation of law. 8. Exercise Price. --------------- 8.1 Initial and Adjusted Exercise Price. Except as otherwise ------------------------------------ provided in Section 11 hereof, the initial exercise price of each Underwriter's Warrant shall be $5.61 per share of Common Stock (165% of the initial public offering price per share of Common Stock) and $.165 per Redeemable Warrant (165% of the initial public offering price per Redeemable Warrant). The adjusted exercise price shall be the price which shall result from time to time from any and all adjustments of the initial exercise price in accordance with the provisions of Section 11 hereof. Any transfer of a Underwriter's Warrant shall ------- constitute an automatic transfer and assignment of the registration rights set forth in Section 9 hereof with respect to the Securities or other securities, ------- properties or rights underlying the Underwriter's Warrants. 8.2 Exercise Price. The term "Exercise Price" herein shall mean the -------------- initial exercise price or the adjusted exercise price, depending upon the context or unless otherwise specified. 4 9. Registration Rights. ------------------- 9.1 Registration Under the Securities Act of 1933. Each --------------------------------------------- Underwriter's Warrant Certificate and each certificate representing shares of Common Stock and/or Redeemable Warrants and any of the other securities issuable upon exercise of the Underwriter's Warrant (collectively, the "Warrant Shares") shall bear the following legend unless (i) such Underwriter's Warrant or Warrant Shares are distributed to the public or sold to the underwriters for distribution to the public pursuant to Section 9 hereof or otherwise pursuant to ------- a registration statement filed under the Securities Act of 1933, as amended (the "Act"), or (ii) the Company has received an opinion of counsel, in form and substance reasonably satisfactory to counsel for the Company, that such legend is unnecessary for any such certificate: THE UNDERWRITER'S WARRANT REPRESENTED BY THIS CERTIFICATE AND THE OTHER SECURITIES ISSUABLE UPON EXERCISE THEREOF MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO (i) AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933, (ii) TO THE EXTENT APPLICABLE, RULE 144 UNDER SUCH ACT (OR ANY SIMILAR RULE UNDER SUCH ACT RELATING TO THE DISPOSITION OF SECURITIES), OR (iii) AN OPINION OF COUNSEL, IF SUCH OPINION SHALL BE REASONABLY SATISFACTORY TO COUNSEL FOR THE ISSUER, THAT AN EXEMPTION FROM REGISTRATION UNDER SUCH ACT IS AVAILABLE. THE TRANSFER OR EXCHANGE OF THE UNDERWRITER'S WARRANT REPRESENTED BY THE CERTIFICATE IS RESTRICTED IN ACCORDANCE WITH THE UNDERWRITER'S WARRANT AGREEMENT REFERRED TO HEREIN. 9.2 Automatic and Piggyback Registration. The Underwriter's Warrant ------------------------------------- and all securities underlying the Underwriter's Warrant shall be registered on the registration statement for the Company's initial Public Offering of securities. In the event a new registration statement is required to effect valid registration of the Underwriter's Warrant and the securities thereunder, then if, at any time commencing after the effective date of the Registration Statement and expiring five (5) years thereafter, the Company proposes to register any of its securities under the Act (other than in connection with a merger or pursuant to Form S-4 or Form S-8) it will give written notice by registered mail, at least twenty (20) days prior to the filing of each such registration statement, to the Holders of the Underwriter's Warrants and/or the Warrant Shares of its intention to do so. If any of the Holders of the Underwriter's Warrants and/or Warrant Shares notify the Company within ten (10) days after mailing of any such notice of its or their desire to include any such securities in such proposed registration statement, the Company shall afford such Holders of the Underwriter's Warrants and/or Warrant Shares the opportunity to have any such Underwriter's Warrants and/or Warrant Shares registered under such registration statement. In the event that the managing underwriter for said offering advises the Company in writing that in its opinion the number of 5 securities requested to be included in such registration exceeds the number which can be sold in such offering without causing a diminution in the offering price or otherwise adversely affecting the offering, the Company will include in such registration (a) first, the securities the Company proposes to sell, (b) ----- second, the securities held by the entities, if any, that made the demand for - ------ registration, (c) third, the Underwriter's Warrants and/or Warrant Shares ----- requested to be included in such registration which in the opinion of such underwriter can be sold, pro rata, among all proposed selling shareholders. Notwithstanding the provisions of this Section 9.2, the Company shall have ------- the right at any time after it shall have given written notice pursuant to this Section 9.2 (irrespective of whether a written request for inclusion of any such - ------- securities shall have been made) to elect not to file any such proposed registration statement or to withdraw the same after the filing but prior to the effective date thereof. 9.3 Demand Registration. -------------------- (a) At any time commencing one (1) year after the effective date of the Registration Statement and expiring five (5) years from the effective date of the Registration Statement, the Holders of the Underwriter's Warrants and/or Warrant Shares representing a "Majority" (as hereinafter defined) of the Underwriter's Warrants and/or Warrant Shares shall have the right (which right is in addition to the registration rights under Section 9.2 ------- hereof), exercisable by written notice to the Company, to have the Company prepare and file with the Securities and Exchange Commission (the "Commission"), on one occasion, a registration statement and such other documents, including a prospectus, as may be necessary in the opinion of both counsel for the Company and counsel for the Holders, in order to comply with the provisions of the Act, so as to permit a public offering and sale by such Holders and any other Holders of the Underwriter's Warrant and/or Warrant Shares who notify the Company within fifteen (15) days after the Company mails notice of such request pursuant to Section 9.3(b) hereof (collectively, the "Requesting Holders") of their - ------- respective Warrant Shares for the earlier of (i) nine (9) consecutive months or (ii) until the sale of all of the Warrant Shares requested to be registered by the Requesting Holders. (b) The Company covenants and agrees to give written notice of any registration request under this Section 9.3 by any Holder or Holders ------- representing a Majority of the Underwriter's Warrants and/or Warrant Shares to all other registered Holders of the Underwriter's Warrants and the Warrant Shares within ten (10) days from the date of the receipt of any such registration request. (c) Intentionally omitted. (d) Notwithstanding anything to the contrary contained herein, if the Company shall not have filed a registration statement for the Warrant Shares within the time period specified in Section 9.4(a) hereof pursuant to the ------- written notice specified in Section 9.3(a) of the Holders of a Majority of the ------- Underwriter's Warrants and/or Warrant Shares, the Company, at its option, may repurchase (i) any and all Warrant Shares at the higher of the Market Price (as defined in Section 9.3(e)) per share of Common Stock on (e) the date of the notice sent ------- pursuant to Section 9.3(a) or (y) the expiration of the period specified in ------- Section 9.4(a) and (ii) any and all Underwriter's Warrants at such Market Price - ------- less the exercise price of such Underwriter's Warrant. Such repurchase shall be in immediately available funds and shall close within two (2) days after the later of (i) the expiration of the period specified in Section 9.4(a) or (ii) the delivery of the written notice of election specified in this Section 9.3(d). ------- (e) Definition of Market Price. As used herein, the phrase -------------------------- "Market Price" at any date shall be deemed to be the last reported sale price, or, in case no such reported sale takes place on such day, the average of the last reported sale prices for the last three (3) trading days, in either case as officially reported by the principal securities exchange on which the shares of Common Stock and/or Redeemable Warrants or Common Stock is listed or admitted to trading, or, if the shares of Common Stock and/or Redeemable Warrants or Common Stock is not listed or admitted to trading on any national securities exchange, the average closing sale price as furnished by the NASD through The Nasdaq Stock Market, Inc. ("Nasdaq") or similar organization if Nasdaq is no longer reporting such information, or if the shares of Common Stock and/or Redeemable Warrants or Common Stock is not quoted on Nasdaq as determined in good faith by resolution of the Board of Directors of the Company, based on the best information available to it. 9.4 Covenants of the Company With Respect to Registration. In ----------------------------------------------------- connection with any registration under Sections 9.2 or 9.3 hereof, the Company -------- covenants and agrees as follows: (a) The Company shall use its best efforts to file a registration statement within ninety (90) days of receipt of any demand therefor, and to have any registration statements declared effective at the earliest possible time, and shall furnish each Holder desiring to sell Warrant Shares such number of prospectuses as shall reasonably be requested. The Company shall keep its registration statement for its initial Public Offering effective for so long as the Underwriter may reasonably request; provided however, this obligation of the Company shall terminate upon the earlier of the expiration of the Warrants or until such Warrants are fully exercised. (b) The Company shall pay all costs, fees and expenses in connection with all registration statements filed pursuant to Sections 9.2 and -------- 9.3(a) hereof including, without limitation, the Company's legal and accounting fees, printing expenses, blue sky fees and expenses. The Holder(s) will pay all costs, fees and expenses (including those of the Company) in connection with the registration statement filed pursuant to Section 9.3(c). ------- (c) The Company will use its commercially reasonable efforts to take all necessary action which may be required in qualifying or registering the Warrant Shares included in a registration statement for offering and sale under the securities or blue sky laws of such states as reasonably are requested by the Holder(s), provided that the Company shall not be obligated to execute or file any general consent to service of process or to qualify as a foreign corporation to do business under the laws of any such jurisdiction. 7 (d) The Company shall indemnify the Holder(s) of the Warrant Shares to be sold pursuant to any registration statement and each person, if any, who controls such Holders within the meaning of Section 15 of the Act or Section 20(a) of the Securities Exchange Act of 1934, as amended ("Exchange Act"), against all loss, claim, damage, expense or liability (including all expenses reasonably incurred in investigating, preparing or defending against any claim whatsoever) to which any of them may become subject under the Act, the Exchange Act or otherwise, arising from such registration statement but only to the same extent and with the same effect as the provisions pursuant to which the Company has agreed to indemnify each of the Underwriters contained in Section 7 of the Underwriting Agreement. (e) The Holder(s) of the Warrant Shares to be sold pursuant to a registration statement, and their successors and assigns, shall severally, and not jointly, indemnify the Company, its officers and directors and each person, if any, who controls the Company within the meaning of Section 15 of the Act or Section 20(a) of the Exchange Act, against all loss, claim, damage or expense or liability (including all expenses reasonably incurred in investigating, preparing or defending against any claim whatsoever) to which they may become subject under the Act, the Exchange Act or otherwise, arising from information furnished by or on behalf of such Holders, or their successors or assigns, for specific inclusion in such registration statement to the same extent and with the same effect as the provisions contained in Section 7 of the Underwriting ------- Agreement pursuant to which the Underwriters have agreed to indemnify the Company. (f) Nothing contained in this Agreement shall be construed as requiring the Holder(s) to exercise their Underwriter's Warrant prior to the initial filing of any registration statement or the effectiveness thereof. (g) The Company shall not permit the inclusion of any securities other than the Warrant Shares to be included in any registration statement filed pursuant to Section 9.3 hereof, or permit any other registration statement ------- (other than a registration statement on Form S-4 or S-8) to be or remain effective during a ninety (90) day period following the effectiveness of a registration statement filed pursuant to Section 9.3 hereof, without the prior ------- written consent of National or as otherwise required by the terms of any existing registration rights granted prior to the date of this Agreement by the Company to the holders of any of the Company's securities. (h) The Company shall furnish to each Holder participating in the offering and to each underwriter, if any, a signed counterpart, addressed to such Holder or underwriter, of (i) an opinion of counsel to the Company, dated the effective date of such registration statement (and, if such registration includes an underwritten public offering, an opinion dated the date of the closing under the underwriting agreement), and (ii) a "cold comfort" letter dated the effective date of such registration statement (and, if such registration includes an underwritten public offering, a letter dated the date of the closing under the underwriting agreement) signed by the independent public accountants who have issued a report on the Company's financial statements included in such registration statement, in each case covering substantially the same matters with respect to such registration statement (and the prospectus included therein) and, in the case of such accountants' letter, with respect to events subsequent to the date of such financial statements, as are customarily 8 covered in opinions of issuer's counsel and in accountants' letters delivered to underwriters in underwritten public offerings of securities. (i) The Company shall as soon as practicable after the effective date of the registration statement, and in any event within fifteen (15) months thereafter, make "generally available to its security holders" (within the meaning of Rule 158 under the Act) an earnings statement (which need not be audited) complying with Section 11(a) of the Act and covering a period of at ------- least twelve (12) consecutive months beginning after the effective date of the registration statement. (j) The Company shall enter into an underwriting agreement with the managing underwriters selected for such underwriting by Holders holding a Majority of the Warrant Shares requested to be included in such underwriting, which may be the Underwriter. Such agreement shall be satisfactory in form and substance to the Company, each Holder and such managing underwriters, and shall contain such representations, warranties and covenants by the Company and such other terms as are customarily contained in agreements of that type used by the managing underwriter. The Holders shall be parties to any underwriting agreement relating to an underwritten sale of their Warrant Shares and may, at their option, require that any or all the representations, warranties and covenants of the Company to or for the benefit of such underwriters shall also be made to and for the benefit of such Holders. Such Holders shall not be required to make any representations or warranties to or agreements with the Company or the underwriters except as they may relate to such Holders and their intended methods of distribution. (k) For purposes of this Agreement, the term "Majority" in reference to the Underwriter's Warrants or Warrant Shares, shall mean in excess of fifty percent (50%) of the then outstanding Underwriter's Warrants or Warrant Shares that (i) are not held by the Company, an affiliate, officer, creditor, employee or agent thereof or any of their respective affiliates, members of their family, persons acting as nominees or in conjunction therewith or (ii) have not been resold to the public pursuant to a registration statement filed with the Commission under the Act. 10. Obligations of Holders. It shall be a condition precedent to the ----------------------- obligations of the Company to take any action pursuant to Section 9 hereof that ------- each of the selling Holders shall: (a) Furnish to the Company such information regarding themselves, the Warrant Shares held by them, the intended method of sale or other disposition of such securities, the identity of and compensation to be paid to any underwriters proposed to be employed in connection with such sale or other disposition, and such other information as may reasonably be required to effect the registration of their Warrant Shares. (b) Notify the Company, at any time when a prospectus relating to the Warrant Shares covered by a registration statement is required to be delivered under the Act, of the happening of any event with respect to such selling Holder as a result of which the prospectus included in such registration statement, as then in effect, includes an untrue statement of a material 9 fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances then existing. 11. Adjustments to Exercise Price and Number of Securities. The Exercise ------------------------------------------------------ Price in effect at any time and the number and kind of securities purchased upon the exercise of the Underwriter's Warrant shall be subject to adjustment from time to time only upon the happening of the following events: 11.1 Stock Dividend. Subdivision and Combination. In case the Company -------------------------------------------- shall (i) declare a dividend or make a distribution on its outstanding shares of Common Stock in shares of Common Stock, (ii) subdivide or reclassify its outstanding shares of Common Stock into a greater number of shares, or (iii) combine or reclassify its outstanding shares of Common Stock into a smaller number of shares, the Exercise Price in effect at the time of the record date for such dividend or distribution or of the effective date of such subdivision, combination or reclassification shall be adjusted so that it shall equal the price determined by multiplying the Exercise Price by a fraction, the denominator of which shall be the number of shares of Common Stock outstanding after giving effect to such action, and the numerator of which shall be the number of shares of Common Stock outstanding immediately prior to such action. Such adjustment shall be made successively whenever any event listed above shall occur. 11.2 Adjustment in Number of Securities. Upon each adjustment of the ----------------------------------- Exercise Price pursuant to the provisions of this Section 11, the number of ------- Warrant Shares issuable upon the exercise at the adjusted Exercise Price of each Underwriter's Warrant shall be adjusted to the nearest number of whole shares of Common Stock by multiplying a number equal to the Exercise Price in effect immediately prior to such adjustment by the number of Warrant Shares issuable upon exercise of the Underwriter's Warrant immediately prior to such adjustment and dividing the product so obtained by the adjusted Exercise Price. 11.3 Definition of Common Stock. For the purpose of this Agreement, -------------------------- the term "Common Stock" shall mean (i) the class of stock designated as Common Stock in the Articles of Incorporation of the Company as amended as of the date hereof, or (ii) any other class of stock resulting from successive changes or reclassifications of such Common Stock consisting solely of changes in par value, or from par value to no par value, or from no par value to par value. 11.4 Merger or Consolidation. In case of any consolidation of the ------------------------ Company with, or merger of the Company into, another corporation (other than a consolidation or merger which does not result in any reclassification or change of the outstanding Common Stock), the corporation formed by such consolidation or merger shall execute and deliver to the Holder a supplemental warrant agreement providing that the Holder of each Underwriter's Warrant then outstanding or to be outstanding shall have the right thereafter (until the expiration of such Underwriter's Warrant) to receive, upon exercise of such Underwriter's Warrant, the kind and amount of shares of stock and other securities and property receivable upon such consolidation or merger by a holder of the number of shares of Common Stock for which such Underwriter's Warrant might have been exercised immediately prior to such consolidation, merger, sale or transfer. Such supplemental warrant 10 agreement shall provide for adjustments which shall be identical to the adjustments provided in Section 11. The above provision of this subsection shall similarly apply to successive consolidations or mergers. 11.5 No Adjustment of Exercise Price in Certain Cases. No adjustment ------------------------------------------------- of the Exercise Price shall be made: (a) Upon the issuance or sale of the Underwriter's Warrant or the Warrant Shares: (b) Upon the issuance or sale of Common Stock (or any other security convertible, exercisable, or exchangeable into shares of Common Stock) upon the direct or indirect conversion, exercise, or exchange of any options, rights, warrants, or other securities or indebtedness of the Company outstanding as of the date of this Agreement or granted pursuant to any stock option plan of the Company in existence as of the date of this Agreement, pursuant to the terms thereof; or (c) If the amount of said adjustment shall be less than two cents ($.02) per share, provided, however, that in such case any adjustment that would otherwise be required then to be made shall be carried forward and shall be made at the time of and together with the next subsequent adjustment which, together with any adjustment so carried forward, shall amount to at least two cents ($.02) per Underwriter's Warrant. 12. Exchange and Replacement of Underwriter's Warrant Certificates. Each --------------------------------------------------------------- Underwriter's Warrant Certificate is exchangeable, without expense, upon the surrender thereof by the registered Holder at the principal executive office of the Company for a new Underwriter's Warrant Certificate of like tenor and date representing in the aggregate the right to purchase the same number of Warrant Shares in such denominations as shall be designated by the Holder thereof at the time of such surrender. Upon receipt by the Company of evidence reasonably satisfactory to it of the loss, theft, destruction or mutilation of any Underwriter's Warrant Certificate, and, in case of loss, theft or destruction, of indemnity or security reasonably satisfactory to it and reimbursement to the Company of all reasonable expenses incidental thereto, and upon surrender and cancellation of the Underwriter's Warrant, if mutilated, the Company will make and deliver a new Warrant Certificate of like tenor, in lieu thereof. 13. Elimination of Fractional Interests. The Company shall not be ------------------------------------ required to issue certificates representing fractions of shares of Common Stock upon the exercise of the Underwriter's Warrant, nor shall it be required to issue scrip or pay cash in lieu of fractional interests, it being the intent of the parties that all fractional interests shall be eliminated by rounding any fraction up to the nearest whole number of shares of Common Stock or other securities, properties or rights. 14. Reservation and Listing of Securities. The Company shall at all times ------------------------------------- reserve and keep available out of its authorized shares of Common Stock, solely for the purpose of issuance upon 11 the exercise of the Underwriter's Warrant and the Redeemable Warrant, such number of shares of Common Stock or other securities, properties or rights as shall be issuable upon the exercise thereof. Every transfer agent ("Transfer Agent") for the Common Stock and other securities of the Company issuable upon the exercise of the Underwriter's Warrant will be irrevocably authorized and directed at all times to reserve such number of authorized shares of Common Stock and other securities as shall be requisite for such purpose. The Company will keep a cow of this Agreement on file with every Transfer Agent for the Common Stock and other securities of the Company issuable upon the exercise of the Underwriter's Warrant. The Company will supply every such Transfer Agent with duly executed stock and other certificates, as appropriate, for such purpose. The Company covenants and agrees that, upon exercise of the Underwriter's Warrant and payment of the Exercise Price therefor, all shares of Common Stock and other securities issuable upon such exercise shall be duly and validly issued, fully paid, non-assessable and not subject to the preemptive rights of any stockholder. As long as the Underwriter's Warrant shall be outstanding, the Company shall use its best efforts to cause all shares of Common Stock issuable upon the exercise of the Underwriter's Warrant to be listed (subject to official notice of issuance) on all securities exchanges on which the Common Stock issued to the public in connection herewith may then be listed and/or quoted on Nasdaq SmallCap Market. 15. Notices to Underwriter's Warrant Holders. Nothing contained in this ----------------------------------------- Agreement shall be construed as conferring upon the Holders the right to vote or to consent or to receive notice as a stockholder in respect of any meetings of stockholders for the election of directors or any other matter, or as having any rights whatsoever as a stockholder of the Company. If, however, at any time prior to the expiration of the Underwriter's Warrants and their exercise, any of the following events shall occur: (a) the Company shall take a record of the holders of its shares of Common Stock for the purpose of entitling them to receive a dividend or distribution payable otherwise than in cash, or a cash dividend or distribution payable otherwise than out of current or retained earnings, as indicated by the accounting treatment of such dividend or distribution on the books of the Company; or (b) the Company shall offer to all the holders of its Common Stock any additional shares of capital stock of the Company or securities convertible into or exchangeable for shares of capital stock of the Company, or any option, right or warrant to subscribe therefor; or (c) a dissolution, liquidation or winding up of the Company (other than in connection with a consolidation or merger) or a sale of all or substantially all of its property, assets and business as an entirety shall be proposed; then in any one or more of said events, the Company shall give written notice of such event at least fifteen (15) days prior to the date fixed as a record date or the date of closing the transfer books for the determination of the stockholders entitled to such dividend, distribution, convertible or exchangeable securities or subscription rights, or entitled to vote on such proposed dissolution, liquidation, winding up or sale. Such notice shall specify such record date or the date of closing the transfer books, as the case may be. Failure to give such notice or any defect therein shall not affect the validity of any action taken in connection with the declaration or payment of any such dividend, or the issuance of any convertible or exchangeable securities, or subscription rights, options or warrants, or any proposed dissolution, liquidation, winding up or sale. 16. Redeemable Warrants. -------------------- The form of the certificate representing the Redeemable Warrants (and the form of election to purchase shares of Common Stock upon the exercise of the Redeemable Warrants and the form of assignment printed on the reverse thereof) shall be substantially as set forth in Exhibit "A" to the Warrant Agreement dated as of the date hereof by and among the Company, the Underwriter and Continental Stock Transfer & Trust Company, as warrant agent (the "Redeemable Warrant Agreement"). Each Redeemable Warrant issuable upon exercise of the Underwriter's Warrants shall evidence the right to initially purchase a fully paid and non-assessable share of Common Stock at an initial purchase price of $5.61 from one year after the Effective Date of the Registration Statement until 5:30 p.m. New York time on __________, 2001 (four (4) years from the Effective Date of the Registration Statement) at which time the Redeemable Warrants, unless the exercise period has been extended, shall expire. The exercise price of the Redeemable Warrants and the number of shares of Common Stock issuable upon the exercise of the Redeemable Warrants are subject to adjustment, whether or not the Underwriter's Warrants have been exercised and the Redeemable Warrants have been issued, in the manner and upon the occurrence of the events set forth in Section 8 of the Redeemable Warrant Agreement, which is hereby incorporated by reference and made a part hereof as if set forth in its entirety herein. Subject to the provisions of this Agreement and upon issuance of the Redeemable Warrants underlying the Underwriter's Warrants, each registered holder of such Redeemable Warrant shall have the right to purchase from the Company (and the Company shall issue to such registered holders) up to the number of fully paid and non-assessable shares of Common Stock (subject to adjustment as provided herein and in the Redeemable Warrant Agreement), free and clear of all preemptive rights of stockholders, provided that such registered holder complies with the terms governing exercise of the Redeemable Warrant set forth in the Redeemable Warrant Agreement, and pays the applicable exercise price, determined in accordance with the terms of the Redeemable Warrant Agreement. Upon exercise of the Redeemable Warrants, the Company shall forthwith issue to the registered holder of any such Redeemable Warrant in his name or in such name as may be directed by him, certificates for the number of shares of Common Stock so purchased. Except as otherwise provided in this Agreement, the Redeemable Warrants underlying the Underwriter's Warrants shall be governed in all respects by the terms of the Redeemable Warrant Agreement. The Redeemable Warrants shall be transferable in the manner provided in the Redeemable Warrant Agreement, and upon any such transfer, a new Redeemable Warrant Certificate shall be issued promptly to the transferee. The Company covenants to, and agrees with, the Holder(s) that without the prior written consent of the Holder(s), which will not be unreasonably withheld, the Redeemable Warrant Agreement will not be modified, amended, canceled, altered or superseded, and that the Company will send to each Holder, irrespective of whether or not the Underwriter's Warrants have been exercised, any and all notices required by the Redeemable Warrant Agreement to be sent to holders of the Redeemable Warrants. 13 17. Notices. All notices, requests, consents and other communications ------- hereunder shall be in writing and shall be deemed to have been duly made and sent when delivered, or mailed by registered or certified mail, return receipt requested: (a) if to the registered Holder of the Underwriter's Warrant, to the address of such Holder as shown on the books of the Company; or (b) if to the Company, to the address set forth in Section 4 hereof or to such other address as the Company may designate by notice to the Holders. 18. Supplements: Amendments: Entire Agreement. This Agreement (including ------------------------------------------ the Underwriting Agreement to the extent portions thereof are referred to herein) contains the entire understanding between the parties hereto with respect to the subject matter hereof and may not be modified or amended except by a writing duly signed by the party against whom enforcement of the modification or amendment is sought. The Company and the Underwriter may from time to time supplement or amend this Agreement without the approval of any Holders of Underwriter's Warrant Certificates (other than the Underwriter) in order to cure any ambiguity, to correct or supplement any provision contained herein which may be defective or inconsistent with any provisions herein, or to make any other provisions in regard to matters or questions arising hereunder which the Company and the Underwriter may deem necessary or desirable and which the Company and the Underwriter deem shall not adversely affect the interests of the Holders of Underwriter's Warrant Certificates. 19. Successors. All of the covenants and provisions of this Agreement ----------- shall be binding upon and inure to the benefit of the Company, the Holders and their respective successors and assigns hereunder. 20. Survival of Representations and Warranties. All statements in any ------------------------------------------ schedule, exhibit or certificate or other instrument delivered by or on behalf of the parties hereto, or in connection with the transactions contemplated by this Agreement, shall be deemed to be representations and warranties hereunder. Notwithstanding any investigations made by or on behalf of the parties to this Agreement, all representations, warranties and agreements made by the parties to this Agreement or pursuant hereto shall survive. 21. Governing Law. This Agreement and each Underwriter's Warrant ------------- Certificate issued hereunder shall be deemed to be a contract made under the laws of the State of New York and for all purposes shall be construed in accordance with the laws of said State without giving effect to the rules of said State governing the conflicts of laws. 22. Severability. If any provision of this Agreement shall be held to be ------------ invalid or unenforceable, such invalidity or unenforceability shall not affect any other provision of this Agreement. 14 23. Captions. The caption headings of the Sections of this Agreement are --------- for convenience of reference only and are not intended, nor should they be construed as, a part of this Agreement and shall be given no substantive effect. 24. Benefits of this Agreement. Nothing in this Agreement shall be -------------------------- construed to give to any person or corporation other than the Company and the Underwriter and any other registered Holder(s) of the Underwriter's Warrant Certificates or Warrant Shares any legal or equitable right, remedy or claim under this Agreement; and this Agreement shall be for the sole and exclusive benefit of the Company and the Underwriters and any other Holder(s) of the Underwriter's Warrant Certificates or Warrant Shares. 25. Counterparts. This Agreement may be executed in any number of ------------ counterparts and each of such counterparts shall for all purposes be deemed to be an original, and such counterparts shall together constitute but one and the same instrument. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed, as of the day and year first above written. ATTEST: ISONICS CORPORATION _________________ Name: ________________________ Secretary Title: ________________________ MONROE PARKER SECURITIES, INC. By: ________________________ Name: Stephen Drescher Title: Director of Corporate Finance 15 EXHIBIT A [FORM OF UNDERWRITER'S WARRANT CERTIFICATE] THE UNDERWRITER'S WARRANT REPRESENTED BY THIS CERTIFICATE AND THE OTHER SECURITIES ISSUABLE UPON EXERCISE THEREOF MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO (i) AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933, (ii) TO THE EXTENT APPLICABLE, RULE 144 UNDER SUCH ACT (OR ANY SIMILAR RULE UNDER SUCH ACT RELATING TO THE DISPOSITION OF SECURITIES), OR (iii) AN OPINION OF COUNSEL, IF SUCH OPINION SHALL BE REASONABLY SATISFACTORY TO COUNSEL FOR THE ISSUER, THAT AN EXEMPTION FROM REGISTRATION UNDER SUCH ACT IS AVAILABLE. THE TRANSFER OR EXCHANGE OF THE UNDERWRITER'S WARRANT REPRESENTED BY THIS CERTIFICATE IS RESTRICTED IN ACCORDANCE WITH THE WARRANT AGREEMENT REFERRED TO HEREIN. EXERCISABLE ON OR BEFORE 5:30 P.M., NEW YORK TIME, ___________, 2002 Underwriter's Warrant No.________ Shares of Common Stock and/or Redeemable Warrants WARRANT CERTIFICATE This Warrant Certificate certifies that ________, or registered assigns, is the registered holder of Warrants to purchase initially, at any time commencing one year after ____________, 1997 until 5:30 p.m., New York time on _____________, 2002 ("Expiration Date"), up to _______ shares of Common Stock and/or ___________ Redeemable Warrants (each to acquire one share of the Company's Common Stock at the initial exercise price, subject to adjustment of $4.00 per share) of Isonics Corporation, a California corporation (the "Company") at the initial exercise price, subject to adjustment in certain events, of $5.61 per share of Common Stock and $.165 per Redeemable Warrant (165% of the initial public offering price per Warrant) (the "Exercise Price") upon surrender of this Underwriter's Warrant Certificate and payment of the Exercise Price at an office or agency of the Company, but subject to the conditions set forth herein and in the Underwriter's Warrant Agreement dated as of __________, 1997 among the Company, and Monroe Parker Securities, Inc. (the "Warrant Agreement"). Payment of the Exercise Price shall be made by certified or official bank check in New York Clearing House funds payable to the order of the Company. No Warrant may be exercised after 5:30 p.m., New York time, on the Expiration Date, at which time all Underwriter's Warrants evidenced hereby, unless exercised prior thereto, shall thereafter be void. The Underwriter's Warrants evidenced by this Warrant Certificate are part of a duly authorized issue of Underwriter's Warrants issued pursuant to the Warrant Agreement, which Warrant Agreement is hereby incorporated by reference in and made a part of this instrument and is hereby referred to for a description of the rights, limitation of rights, obligations, duties and immunities thereunder of the Company and the holders (the words "holders" or "holder" meaning the registered holders or registered holder) of the Underwriter's Warrant. The Warrant Agreement provides that upon the occurrence of certain events the Exercise Price and the type and/or number of the Company's securities issuable thereupon may, subject to certain conditions, be adjusted. In such event, the Company will, at the request of the holder, issue a new Warrant Certificate evidencing the adjustment in the Exercise Price and the number and/or type of securities issuable upon the exercise of the Underwriter's Warrants; provided, however, that the failure of the Company to issue such new Warrant Certificates shall not in any way change, alter, or otherwise impair, the rights of the holder as set forth in the Warrant Agreement. Upon due presentment for registration of transfer of this Warrant Certificate at an office or agency of the Company, a new Warrant Certificate or Warrant Certificates of like tenor and evidencing in the aggregate a like number of Underwriter's Warrants shall be issued to the transferee(s) in exchange for this Warrant Certificate, subject to the limitations provided herein and in the Warrant Agreement, without any charge except for any tax or other governmental charge imposed in connection with such transfer. Upon the exercise of less than all of the Underwriter's Warrant evidenced by this Certificate, the Company shall forthwith issue to the holder hereof a new Warrant Certificate representing such numbered unexercised Underwriter's Warrants. The Company may deem and treat the registered holder(s) hereof as the absolute owner(s) of this Warrant Certificate (notwithstanding any notation of ownership or other writing hereon made by anyone), for the purpose of any exercise hereof, and of any distribution to the holder(s) hereof, and for all other purposes, and the Company shall not be affected by-any notice to the contrary. All terms used in this Warrant Certificate which are defined in the Warrant Agreement shall have the meanings assigned to them in the Warrant Agreement. EXH. A-2 This Warrant Certificate does not entitle any holder thereof to any of the rights of a shareholder of the Company. IN WITNESS WHEREOF, the Company has caused this Warrant Certificate to be duly executed under its corporate seal. Dated as of ________ __, 1997. ATTEST: ISONICS CORPORATION _________________ Name: ______________________ Secretary Title: ______________________ EXH. A-3 [FORM OF ELECTION TO PURCHASE PURSUANT TO SECTION 4] The undersigned hereby irrevocably elects to exercise the right, represented by this Warrant Certificate, to purchase _____ shares of Common Stock and/or _____ Redeemable Warrants and herewith tenders in payment for such securities a certified or official bank check payable in New York Clearing House Funds to the order of Isonics Corporation (the "Company") in the amount of $______, all in accordance with the terms of Section 4 of the Underwriter's Warrant Agreement dated as of _________, 1997 among the Company and Monroe Parker Securities, Inc. The undersigned requests that a certificate for such securities be registered in the name of ________________________, whose address is ___________________________and that such certificate be delivered to__________________________, whose address is __________________, and if said number of shares shall not be all the shares purchasable hereunder, that a new Warrant Certificate for the balance of the shares purchasable under the within Warrant Certificate be registered in the name of the undersigned warrant holder or his assignee as below indicated and delivered in the address stated below. Dated: ______________________ ____________________________________________ (Signature must conform in all respects to the name of the holder as specified on the face of the Warrant Certificate.) Address:____________________________________ ____________________________________ ____________________________________________ (Insert Social Security or Other Identifying Number of Holder) Signature Guaranteed:___________________________________________________________ (Signature must be guaranteed by a bank savings and loan association, stockbroker, or credit union with membership in an approved signature guaranty Medallion Program pursuant to Securities Exchange Act Rule 17Ad-15.) EXH. A-4 [FORM OF ASSIGNMENT] (To be executed by the registered holder if such holder desires to transfer the Warrant Certificate.) FOR VALUE RECEIVED, ______________________ hereby sells, assigns and transfers unto [NAME OF TRANSFEREE] this Warrant Certificate, together with all right, title and interest therein, and does hereby irrevocably constitute and appoint _____________________ Attorney, to transfer the within Warrant Certificate on the books of the within-named Company, with full power of substitution. Dated: ______________________ ____________________________________________ (Signature must conform in all respects to the name of the holder as specified on the face of the Warrant Certificate.) Address:____________________________________ ____________________________________ ____________________________________________ (Insert Social Security or Other Identifying Number of Holder) Signature Guaranteed:___________________________________________________________ (Signature must be guaranteed by a bank savings and loan association, stockbroker, or credit union with membership in an approved signature guaranty Medallion Program pursuant to Securities Exchange Act Rule 17Ad-15.) EXH. A-5 EX-4.03 5 FORM OF WARRANT AGREEMENT EXHIBIT 4.03 ISONICS CORPORATION AND CONTINENTAL STOCK TRANSFER & TRUST COMPANY AND MONROE PARKER SECURITIES, INC. WARRANT AGREEMENT Dated as of _______, 1997 WARRANT AGREEMENT THIS WARRANT AGREEMENT (this "Agreement"), dated this day of _________ 1997, by and among ISONICS CORPORATION, a California corporation (the "Company"), CONTINENTAL STOCK TRANSFER & TRUST COMPANY, as Warrant Agent (the "Warrant Agent"), and MONROE PARKER SECURITIES, INC. (the "Underwriter"), and each of their successors and assigns. W I T N E S S E T H: WHEREAS, in connection with (i) the Company's underwritten initial public offering pursuant to a registration statement on Form SB-2 of 700,000 Units consisting of 1,400,000 shares of Common Stock (as defined in Section 1), and 1,400,000 redeemable common stock purchase warrants (the "Warrants"), each warrant entitling the holder thereof to purchase one additional share of Common Stock; (ii) the over-allotment option to purchase up to an additional 105,000 Units (consisting of 210,000 shares of Common Stock and 210,000 Warrants) (the "Over-allotment Option"); and (iii) the sale to the Underwriter of warrants (the "Underwriter's Warrants") to purchase up to 140,000 shares of Common Stock and/or 140,000 Warrants, the Company will issue up to 1,750,000 Warrants (subject to adjustment as provided herein and in the Underwriter's Warrant Agreement); and WHEREAS, the Company desires to provide for the issuance of certificates representing the Warrants; and WHEREAS, the Company desires the Warrant Agent to act on behalf of the Company, and the Warrant Agent is willing to so act, in connection with the issuance, registration, transfer, exchange and redemption of the Warrants, the issuance of certificates representing the Warrants, the exercise of the Warrants and the rights of the holders thereof. NOW, THEREFORE, in consideration of the premises and the mutual agreements hereinafter set forth and for the purpose of defining the terms and provisions of the Warrants and the certificates representing the Warrants and the respective rights and obligations thereunder of the Company, the Underwriter, the holders of certificates representing the Warrants and the Warrant Agent, the parties hereto agree as follows: 1. Definitions. As used herein, the following terms shall have the ------------ following meanings, unless the context shall otherwise require: (a) "Act" shall mean the Securities Act of 1933, as amended. (b) "Common Stock" shall have the meaning assigned to it in Section 8(h) hereof. (c) "Commission" shall mean the Securities and Exchange Commission. 2 (d) "Corporate Office" shall mean the office of the Warrant Agent (or its successor) at which at any particular time its business in , shall be administered, which office is located on the date hereof c/o Continental Stock Transfer & Trust Company, 2 Broadway, 19th Floor, New York, NY 10004. (e) "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended. (f) "Exercise Date" shall mean, subject to the provisions of Section 5(b) hereof, as to any Warrant, the date on which the Warrant Agent shall have received both (i) the Warrant Certificate representing such Warrant, with the exercise form thereon duly executed by the Registered Holder hereof or his attorney duly authorized in writing; and (ii) payment in cash or by official bank or certified check made payable to the Warrant Agent for the account of the Company, of the amount in lawful money of the United States of America equal to the applicable Purchase Price (as hereinafter defined) in good funds. (g) "Exercise Price" shall mean, subject to modification and adjustment as provided in Section 8, $4.00 per share and further subject to the Company's right, in its sole discretion, to decrease the Exercise Price for a period of not less than thirty (30) days on not less than thirty (30) days' prior written notice to the Registered Holders and Monroe Parker Securities, Inc. (h) "Initial Warrant Exercise Date" shall mean one year after the Effective Date of the Prospectus. (i) "Initial Warrant Redemption Date" shall mean eighteen (18) months following the Effective Date of the Prospectus. (j) "Market Price" shall mean (i) if the Common Stock is listed, or admitted to unlisted trading privileges on a national securities exchange, or is traded on the Nasdaq National Market or Nasdaq, the last reported sale price on the date of the event to which such Market Price relates, or, if no such reported sale takes place on such date, then the average of the last reported sales prices for the last three (3) trading days, in each case as officially reported by the principal securities exchange on which the Common Stock is listed or admitted to unlisted trading privileges or by the Nasdaq National Market or Nasdaq, or (ii) if the Common Stock is not listed or admitted to unlisted trading privileges on any national securities exchange, or traded on the Nasdaq National Market or Nasdaq, but is traded in the over-the-counter market, then the average of the last reported bid and asked prices of the Common Stock reported by the National Quotation Bureau, Inc. on the last business day prior to the date of the event to which such Market Price relates, and if no such reported sale takes place on such date, then the average of the last sales prices so reported for the last three (3) trading days on which such price is reported immediately preceding the date to which such Market Price relates; or (iii) if the Common Stock is neither listed, nor admitted to unlisted trading privileges on the National Securities Exchange, nor traded on the Nasdaq National Market or Nasdaq, nor traded in the over-the-counter market, then the amount, not less that the book value thereof as of the end of the most recently completed fiscal quarter of the Company ending prior 3 to the date to which such Market Price relates, as determined in good faith (using customary valuation methods) by the Board of Directors of the Company, which determination shall be evidenced by a resolution of the Board of Directors and based on the best information available to it. (k) "NASD" shall mean the National Association of Securities Dealers, Inc. (1) "Nasdaq" shall mean the Nasdaq SmallCap Market. (m) "Redemption Date" shall mean the date (which may not occur before the Initial Warrant Redemption Date) fixed for the redemption of the Warrants in accordance with the terms hereof. (n) "Redemption Price" shall mean the price at which the Company may, at its option, redeem the Warrants, in accordance with the terms hereof, which price shall be $.10 per Warrant, subject to adjustment from time to time pursuant to the provisions of Section 9 hereof. (o) "Registered Holder" shall mean each person in whose name a Warrant Certificate representing any of the Warrants shall be registered on the books maintained by the Warrant Agent pursuant to Section 6. (p) "Underwriter's Warrant Agreement" shall mean the agreement dated as of _, 1997 between the Company and the Underwriter relating to and governing the terms and provisions of the Underwriter's Warrants. (q) "Transfer Agent" shall mean Continental Stock Transfer & Trust Company, or its authorized successor. (r) "Underwriting Agreement" shall mean the underwriting agreement dated as of _, 1997 between the Company and the underwriters listed therein relating to the Offering. (s) "Warrant Certificate" shall mean a certificate representing one or more of the Warrants substantially in the form annexed hereto as Exhibit A. (t) "Warrant Expiration Date" shall mean, unless the Warrants are redeemed as provided in Section 9 hereof prior to such date, 5:00 p.m. (New York time), on _______ (four (4) years from the date of the Prospectus), or the Redemption Date as defined herein, whichever date is earlier; provided that if such date shall in the State of New York be a holiday or a day on which banks located in the State of New York are authorized to close, then 5:00 p.m. (New York time) on the next following day which, in the State of New York, is neither a holiday nor a day on which such banks are authorized to close. Upon five business days' prior written notice to the Registered Holders, the Company shall have the right to extend the Warrant Expiration Date. 4 2. Warrants and Issuance of Warrant Certificates. --------------------------------------------- (a) Each Warrant shall initially entitle the Registered Holder of the Warrant Certificate representing such Warrant to purchase at the Exercise Price therefor from the Initial Warrant Exercise Date until the Warrant Expiration Date one share of Common Stock upon the exercise thereof in accordance with the terms hereof, subject to modification and adjustment as provided in Section 8. (b) Upon execution of this Agreement, Warrant Certificates representing the number of Warrants sold pursuant to the Underwriting Agreement (subject to modification and adjustment as provided in Section 8) shall be executed by the Company and delivered to the Warrant Agent. (c) Upon exercise of the Underwriter's Warrants as provided therein, Warrant Certificates representing all or a portion of 140,000 Warrants to purchase up to an aggregate of 140,000 shares of Common Stock (subject to modification and adjustment as provided in Section 8 hereof and in the Underwriter's Warrant Agreement), shall be countersigned, issued and delivered by the Warrant Agent upon written order of the Company signed by its Chairman of the Board, Chief Executive Officer, President or a Vice President and by its Chief Financial Officer, Treasurer or an Assistant Treasurer or its Secretary or an Assistant Secretary. (d) From time to time, up to the Warrant Expiration Date, the Warrant Agent shall countersign and deliver Warrant Certificates in required denominations of one or whole number multiples thereof to the person entitled thereto in connection with any transfer or exchange permitted under this Agreement. Except as provided herein, no Warrant Certificates shall be issued except Warrant Certificates initially issued hereunder and those issued on or after the Initial Warrant Exercise Date, upon the exercise of fewer than all Warrants held by the exercising Registered Holder, (ii) Warrant Certificates issued upon any transfer or exchange of Warrants, (iii) Warrant Certificates issued in replacement of lost, stolen, destroyed or mutilated Warrant Certificates pursuant to Section 7, (iv) Warrant Certificates issued pursuant to the Underwriter's Warrant Agreement; and (v) at the option of the Company, Warrant Certificates in such form as may be approved by its Board of Directors, to reflect any adjustment or change in the Exercise Price, the number of shares of Common Stock purchasable upon exercise of the Warrants or the Redemption Price therefor made pursuant to Section 8 hereof. 3. Form and Execution of Warrant Certificates. ------------------------------------------- (a) The Warrant Certificates shall be substantially in the form annexed hereto as Exhibit A (the provisions of which are hereby incorporated herein) and may have such letters, numbers or other marks of identification or designation and such legends, summaries or endorsements printed, lithographed or engraved thereon as the Company may deem appropriate and as are not inconsistent with the provisions of this Agreement, or as may be required to comply with any law or with any rule or regulation made pursuant thereto or with any rule or regulation of any stock exchange on which the Warrants may be listed, or to conform to usage. The Warrant 5 Certificates shall be dated the date of issuance thereof (whether upon initial issuance, transfer, exchange or in lieu of mutilated, lost, stolen or destroyed Warrant Certificates) and issued in registered form. Warrants shall be numbered serially with the letter "W" on the Warrants. (b) Warrant Certificates shall be executed on behalf of the Company by its Chairman of the Board, Chief Executive Officer, President or any Vice President and by its Chief Financial Officer, Treasurer or an Assistant Treasurer or its Secretary or an Assistant Secretary, by manual signatures or by facsimile signatures printed thereon, and shall have imprinted thereon a facsimile of the Company's seal. Warrant Certificates shall be manually countersigned by the Warrant Agent and shall not be valid for any purpose unless so countersigned. In case any officer of the Company who shall have signed any of the Warrant Certificates shall cease to be such officer of the Company after the date of signature but before the date of issuance of the Warrant Certificates or before countersignature by the Warrant Agent and issuance and delivery thereof, such Warrant Certificates, nevertheless, may be countersigned by the Warrant Agent, issued and delivered with the same force and effect as though the person who signed such Warrant Certificates had not ceased to be such officer of the Company. After countersignature by the Warrant Agent, Warrant Certificates shall be delivered by the Warrant Agent to the Registered Holder promptly and without further action by the Company, except as otherwise provided by Section 4(a) hereof. 4. Exercise. --------- (a) Warrants in denominations of one or whole number multiples thereof may be exercised by the Registered Holder thereof commencing at any time on or after the Initial Warrant Exercise Date, but not after the Warrant Expiration Date, upon the terms and subject to the conditions set forth herein and in the applicable Warrant Certificate. Warrants may be exercised by their holders or redeemed by the Company as follows: Exercise of Warrants shall be accomplished upon surrender of the Warrant Certificate evidencing such Warrants, with the Subscription Form on the reverse side thereof duly filled in and executed, to the Warrant Agent at its business office, together with payment to the Warrant Agent of the Exercise Price (as of the date of such surrender) of the Warrants then being exercised and an amount equal to any applicable transfer tax and, if requested by the Company, any other taxes or governmental charges which the Company may be required by law to collect in respect of such exercise. Payment of the Exercise Price and other amounts may be made by wire transfer of good funds, or by certified or bank cashier's check, payable in lawful money of the United States of America to the order of the Warrant Agent, who shall in turn make prompt payment to the Company. No adjustment shall be made for any cash dividends, whether paid or declared, on any securities issuable upon exercise of a Warrant. A Warrant shall be deemed to have been exercised immediately prior to the close of business on the Exercise Date and upon exercise thereof, the person entitled to receive the securities deliverable upon such exercise shall be treated for all purposes as the holder of the securities issuable thereby as of the close of business on the Exercise Date. If Warrants in denominations other than whole number multiples thereof shall be exercised at one time by the same Registered Holder, the number of full shares of Common Stock which shall be issuable upon exercise thereof shall be computed on the basis of the aggregate number of full shares of Common Stock issuable upon such exercise. As soon as practicable on or after the Exercise Date and in any event within five business days after such date, 6 if one or more Warrants have been exercised in the manner described in this subsection (a), the Warrant Agent on behalf of the Company shall cause to be issued to the person or persons entitled to receive the same a Common Stock certificate or certificates for the shares of Common Stock deliverable upon such exercise, and the Warrant Agent shall deliver the same to the person or persons entitled thereto. Upon the exercise of any one or more Warrants, the Warrant Agent shall promptly notify the Company in writing of such fact and of the number of securities delivered upon such exercise and, subject to subsection (b) below, shall cause payment in cash or by check made payable to the order of the Company, equal to the Exercise Price of such Warrants, to be deposited promptly in the Company's bank account or paid directly to the Company, as specified by the Company. (b) The Company shall engage the Underwriter as a Warrant solicitation agent, and, at any time upon the valid exercise of any Warrants after one year from the date hereof, excluding any Warrant (i) exercise at a time when the Exercise Price exceeds the Market Price, (ii) held in a discretionary account; or (iii) exercised in an unsolicited transaction, the Company shall instruct the Warrant Agent to, and the Warrant Agent shall, on a daily basis, within two (2) business days after such exercise, notify the Underwriter of the exercise of any such Warrants and shall, on a weekly basis (subject to collection of funds constituting the tendered Exercise Price, but in no event later than five (5) business days after the last day of the calendar week in which such funds were tendered), remit to the Underwriter an amount equal to five percent (5%) of the Exercise Price of such Warrants then being exercised unless the Underwriter shall have notified the Warrant Agent that the payment of such amount with respect to such Warrant is violative of the General Rules and Regulations promulgated under the Exchange Act, or the rules and regulations of the Nasdaq Stock Market, Inc. or any of its markets or quotation systems on which the Company's securities are quoted or applicable state securities or "blue sky" laws, or the Warrants are those underlying the Underwriter's Warrants in which event, the Warrant Agent shall have to pay such amount to the Company; provided, that, the Warrant Agent shall not be obligated -------- to pay any amounts pursuant to this Section 4(b) during any week that such amounts payable are less than $1,000 and the Warrant Agent's obligation to make such payments shall be suspended until the amount payable aggregates $1,000, and provided further, that, in any event, any such payment (regardless of amount) shall be made not less frequently than monthly. Notwithstanding the foregoing, the Underwriter shall be entitled to receive the commission contemplated by this Section 4(b) as Warrant solicitation agent only if: (i) the Underwriter has provided actual services in connection with the solicitation of the exercise of a Warrant by a Registered Holder; and (ii) the Registered Holder exercising a Warrant affirmatively designates in writing on the Subscription Form on the reverse side of the Warrant Certificate that the exercise of such Registered Holder's Warrant was solicited by the Underwriter. (c) The Company shall not be required to issue fractional shares on the exercise of Warrants. Warrants may be exercised only in such multiples as are required to permit the issuance by the Company of one or more whole shares. If one or more Warrants shall be presented for exercise in full at the same time by the same Registered Holder, the number of whole shares which shall be issuable upon such exercise thereof shall be computed on the basis of the aggregate number of shares purchasable on exercise of the Warrants presented. If any fraction of a share would, except for the provisions provided herein, be issuable on the exercise of any Warrant (or specified 7 portion thereof), the Company shall pay an amount in cash equal to such fraction multiplied by the then current Market Price of a share of Common Stock. 5. Reservation of Shares: Listing: Payment of Taxes: etc. ------------------------------------------------------ (a) The Company covenants that it will at all times reserve and keep available out of its authorized Common Stock, solely for the purpose of issue upon exercise of Warrants, such number of shares of Common Stock as shall then be issuable upon the exercise of all outstanding Warrants. The Company covenants that all shares of Common Stock which shall be issuable upon exercise of the Warrants shall, at the time of delivery thereof, be validly issued, fully paid and nonassessable and free from all preemptive or similar rights, taxes, liens and charges with respect to the issue thereof, and that upon issuance such shares shall be listed on each securities exchange, if any, on which the other shares of outstanding Common Stock of the Company are then listed. (b) The Company covenants that if any securities to be reserved for the purpose of exercise of Warrants hereunder require registration with, or approval of, any governmental authority under any federal securities law before such securities may be validly issued or delivered upon such exercise, then the Company will file a registration statement under the federal securities laws or a post-effective amendment covering such securities, use its best efforts to cause the same to become effective and to keep such registration statement current on or after the Initial Warrant Exercise Date and while any of the Warrants are outstanding and deliver a prospectus which complies with Section 10(a)(3) of the Act to the Registered Holder exercising the Warrant (except, if in the opinion of counsel to the Company, such registration is not required under the federal securities laws or if the Company receives a letter from the staff of the Commission stating that it would not take any enforcement action if such registration is not effected; provided, however, that (i) if at the time of exercise of any Warrants the Company does not have in place an effective registration statement or is otherwise, in the good faith determination of the Board of Directors of the Company, precluded by applicable laws from issuing the underlying shares of Common Stock, the Company may, in lieu of issuance of the shares of Common Stock, elect to redeem the Warrants duly surrendered for exercise for a price per Warrant equal to the difference between the Market Price of the securities for which such Warrant is exercisable on the date of such submission and the Exercise Price of such Warrants, and in the event of such redemption, the Company will pay to the holder of such Warrants the above- described redemption price in cash within ten (10) business days after receipt of notice from the Warrant Agent that such Warrants have been submitted for exercise; and (ii) if the Market Price of the Common Stock is less than the Exercise Price, then the Company need not take such actions to file a registration statement (or a post-effective amendment to a registration statement) with respect to the issuance of Common Stock upon exercise of the Warrants until such time as the Company has been subject to the requirements of Section 12 or 15(d) of the Exchange Act for a period of at least twelve calendar months immediately preceding the filing of the registration statement). The Company will use its best efforts to obtain appropriate approvals or registrations under state "blue sky" securities laws with respect to any such securities. However, Warrants may not be exercised by, or shares of Common Stock issued to, any Registered Holder in any state in which such exercise or issuance would be unlawful. 8 (c) The Company shall pay all documentary, stamp or similar taxes and other governmental charges that may be imposed with respect to the issuance of Warrants, or the issuance or delivery of any shares of Common Stock upon exercise of the Warrants; provided, however, that if shares of Common Stock are to be delivered in a name other than the name of the Registered Holder of the Warrant Certificate representing any Warrant being exercised, then no such delivery shall be made unless the person requesting the same has paid to the Warrant Agent the amount of transfer taxes or charges incident thereto, if any; provided, however, that the Company shall not be required (i) to pay any tax which may be payable in respect of any transfer involved in the transfer and delivery of Warrant Certificates; or (ii) to issue or deliver any certificate for shares of Common Stock or other securities upon the exercise of any Warrant Certificate until any such tax shall have been paid, all such tax being payable by the holder of such Warrant Certificate at the time of surrender. (d) The Warrant Agent is hereby irrevocably authorized as the Transfer Agent to requisition from time to time certificates representing shares of Common Stock or other securities required to be issued upon exercise of the Warrants, and the Company will comply with all such requisitions. 6. Exchange and Registration of Transfer. ------------------------------------- (a) Warrant Certificates may be exchanged for other Warrant Certificates representing an equal aggregate number of Warrants of the same class or may be transferred in whole or in part. Warrant Certificates to be exchanged shall be surrendered to the Warrant Agent at its Corporate Office, and, promptly following satisfaction of the terms and provisions hereof, the Company shall execute and the Warrant Agent shall countersign, issue and deliver in exchange therefor the Warrant Certificate or Certificates which the Registered Holder making the exchange shall be entitled to receive. (b) The Warrant Agent shall keep, at its office, books in which, subject to such reasonable regulations as it may prescribe, it shall register Warrant Certificates and the transfer thereof in accordance with customary practice. Upon due presentment for registration of transfer of any Warrant Certificate at such office, the Company shall execute and the Warrant Agent shall issue and deliver to the transferee or transferees a new Warrant Certificate or Certificates representing an equal aggregate number of Warrants of the same class. (c) With respect to all Warrant Certificates presented for registration of transfer, or for exchange or exercise, the Subscription Form on the reverse thereof shall be duly endorsed or be accompanied by a written instrument or instruments of transfer and subscription, in form satisfactory to the Company and the Warrant Agent, duly executed by the Registered Holder thereof or his attorney-in-fact duly authorized in writing. (d) A service charge may be imposed on the Registered Holder by the Warrant Agent for any exchange or registration of transfer of Warrant Certificates. In addition, the Company may require payment by such holder of a sum sufficient to cover any tax or other 9 governmental charge that may be imposed in connection therewith. (e) All Warrant Certificates surrendered for exercise or for exchange in case of mutilated Warrant Certificates shall be promptly canceled by the Warrant Agent and thereafter retained by the Warrant Agent until termination of this Agreement. (f) Prior to due presentment for registration of transfer thereof, the Company and the Warrant Agent may deem and treat the Registered Holder of any Warrant Certificate as the absolute owner thereof and of each Warrant represented thereby (notwithstanding any notations of ownership or writing thereon made by anyone other than a duly authorized officer of the Company or the Warrant Agent) for all purposes and shall not be affected by any notice to the contrary. 7. Loss or Mutilation. Upon receipt by the Company and the Warrant ------------------- Agent of evidence satisfactory to them of the ownership of and the loss, theft, destruction or mutilation of any Warrant Certificate and (in the case of loss, theft or destruction) of indemnity satisfactory to them, and (in case of mutilation) upon surrender and cancellation thereof, the Company shall execute and the Warrant Agent shall (in the absence of notice to the Company and/or the Warrant Agent that a new Warrant Certificate has been acquired by a bona fide ----------- purchaser) countersign and deliver to the Registered Holder in lieu thereof a new Warrant Certificate of like tenor representing an equal aggregate number of Warrants. Applicants for substitute Warrant Certificates shall also comply with such other reasonable regulations and pay such other reasonable charges as the Warrant Agent may prescribe. 8. Adjustments of Number and Kind of Shares Purchasable and Exercise ----------------------------------------------------------------- Price. The number and kind of securities or other property purchasable upon - ------- exercise of a Warrant shall be subject to adjustment from time to time upon the occurrence, after the date hereof, of any of the following events: (a) Dividends. Stock Splits. Reverse Splits. Etc. In case the --------------------------------------------- Company shall (i) pay a dividend in, or make a distribution of, shares of Common Stock or of capital stock convertible into Common Stock on its outstanding Common Stock, (ii) subdivide its outstanding shares of Common Stock into a greater number of such shares; or (iii) combine its outstanding shares of Common Stock into a smaller number of such shares, the total number of shares of Common Stock purchasable upon the exercise of each Warrant outstanding immediately prior thereto shall be adjusted so that the Registered Holder of any Warrant Certificate thereafter surrendered for exercise shall be entitled to receive, at the same aggregate Exercise Price, the number of shares of Common Stock which such holder would have owned or have been entitled to receive immediately following the happening of any of the events described above had such Warrant been exercised in full immediately prior to the occurrence of such event. Any adjustment made pursuant to this subsection shall, in the case of a stock dividend or distribution, become effective as of the record date therefor and, in the case of a subdivision or combination, be made as of the effective date thereof. If, as a result of an adjustment made pursuant to this subsection, the Registered Holder of any Warrant Certificate thereafter surrendered for exercise shall become entitled to receive shares of two or more 10 classes of capital stock of the Company, the Board of Directors of the Company (whose determination shall be conclusive and shall be evidenced by a Board resolution filed with the Warrant Agent) shall determine the allocation of the Exercise Price among shares of such classes of capital stock. (b) No Change in Aggregate Exercise Price. In the event of any -------------------------------------- adjustment of the total number of shares of Common Stock purchasable upon the exercise of Warrants pursuant to subsection (a) above, the aggregate Exercise Price of each such Warrant shall remain unchanged, but the number of shares of capital stock obtainable on exercise of each such Warrant shall be adjusted as provided in subsection (a) above. (c) Reorganization or Reclassification. In the event of a capital ----------------------------------- reorganization or a reclassification of the Common Stock (except as provided in subsection (a) above or subsection (e) below), each Registered Holder of a Warrant, upon exercise of such Warrant, shall be entitled to receive at the same aggregate Exercise Price, in substitution for the Common Stock to which such Registered Holder would have become entitled upon exercise immediately prior to such reorganization or reclassification, the shares or other securities or property of the Company (or cash) that he would have been entitled to receive upon such reorganization or reclassification if such Warrant had been exercised immediately prior thereto; and in any such case, appropriate provision (as determined by the Board of Directors of the Company, whose determination shall be conclusive and shall be evidenced by a certified Board resolution filed with the Warrant Agent) shall be made for the application of this Section 8 with respect to the rights and interests thereafter of the Registered Holders of all then outstanding Warrants (including but not limited to the allocation of the Exercise Price among shares of classes of capital stock), to the end that this Section 8 (including the adjustments of the number of shares of Common Stock or other securities purchasable and the Exercise Price thereof) shall thereafter be reflected, as nearly as reasonably practicable, in all subsequent exercises of the Warrants for any shares or securities or other property (or cash) thereafter deliverable upon the exercise of the Warrants. (d) Certificate of Adjustment. Whenever the number of shares of -------------------------- Common Stock or other securities purchasable upon exercise of a Warrant is adjusted as provided in this Section 8, the Company will promptly file with the Warrant Agent a certificate signed by a Chairman or Vice-Chairman of the Board or the President or a Vice President of the Company and by the Chief Financial Officer, Treasurer or an Assistant Treasurer or the Secretary or an Assistant Secretary of the Company setting forth the number and kind of securities or other property purchasable upon exercise of a Warrant, as so adjusted, stating that such adjustments in the number or kind of shares or other securities or property conform to the requirements of this Section 8, and setting forth a brief statement of the facts accounting for such adjustments. Promptly after receipt of such certificate, the Company, or the Warrant Agent at the Company's request, will deliver, by first-class mail, postage pre-paid, a brief summary thereof (to be supplied by the Company) to all Registered Holders of the outstanding Warrant Certificates; provided, however, that failure to file or to give any notice required under this subsection, or any defect therein, shall not affect the legality or validity of any such adjustments under this Section 8; and provided, further, that, where appropriate, such notice may be given in advance and included as part of the notice required to be given pursuant to Section 12 11 hereof. (e) Merger or Consolidation. In case of any consolidation of the ------------------------ Company with, or merger of the Company into another corporation (other than a consolidation or merger which does not result in any reclassification or change of the outstanding Common Stock) or in case of any sale or conveyance to another corporation of the property of the Company as an entirety or substantially as an entirety in a transaction involving as an element thereof the distribution of the consideration received by the Company therefrom, the corporation formed by such consolidation or merger or the corporation which shall have acquired such assets, as the case may be, shall execute and deliver to the Warrant Agent a supplemental warrant agreement provided that the Registered Holder of each Warrant then outstanding shall have the right thereafter (until the expiration of such Warrant) to receive, upon exercise of such Warrant, solely the kind and amount of shares of stock and other securities and property (or cash) receivable upon such consolidation, merger sale or transfer by a holder of the number of shares of Common Stock of the Company for which such Warrant could have been exercised immediately prior to such consolidation, merger, sale or transfer. Such supplemental warrant agreement shall provide for adjustments which shall be as nearly equivalent as may be practicable to the adjustments provided in this Section 8. The above provision of this Subsection 8(f) shall similarly apply to successive consolidations, mergers, sales or transfers. (f) Effect of Adjustments on Warrant Certificates. Irrespective ---------------------------------------------- of any adjustments in the number or kind of shares issuable upon exercise of Warrants, Warrant Certificates theretofore or thereafter issued may continue to express the same price and number and kind of shares as are stated in the Warrant Certificates initially issuable pursuant to this Warrant Agreement. (g) Assistance of Accounting Firm in Making Computations. The ----------------------------------------------------- Company may retain a firm of independent public accountants of recognized standing, which may be the accountants regularly retained by the Company, selected by the Board of Directors of the Company or the Executive Committee of said Board, and not disapproved by the Warrant Agent, to make any computation required under this Section 8, and a certificate signed by such firm shall, in the absence of fraud or gross negligence, be conclusive evidence of the correctness of any computation made under this Section. (h) "Common Stock". The term "Common Stock" shall mean (i) the --------------- class of stock designated as Common Stock in the Certificate of Incorporation of the Company, as amended, at the date of this Agreement; or (ii) any other class of stock resulting from successive changes or reclassifications of such Common Stock consisting solely of changes in par value, or from par value to no par value, or from no par value to par value. In the event that at any time as a result of an adjustment made pursuant to this Section 8, the Registered Holder of any Warrant thereafter surrendered for exercise shall become entitled to receive any shares of capital stock of the Company other than shares of Common Stock, thereafter the number of such other shares obtainable upon exercise of any Warrant shall be subject to adjustment from time to time in a manner and on terms as nearly equivalent as practicable to the provisions with respect to the Common Stock contained in this Section 8, and all other provisions of this Agreement, with respect to the Common Stock, shall apply on like terms to any such other shares. 12 9. Redemption. ----------- (a) Commencing on the Initial Warrant Redemption Date, the Company may, on thirty (30) days' prior written notice, redeem all, but not less than all, the Warrants at ten cents ($.10) per Warrant, provided, however, that before any such call for redemption of Warrants can take place, the last closing sale price for the Common Stock as reported by Nasdaq, (or the last closing sale price, if the Common Stock is then traded on the Nasdaq National Market or on a national securities exchange) shall have equaled or exceeded $8.50 per share (250% of the initial public offering price per share of Common Stock which assumes, for purposes of this Agreement that the initial public offering price per share of Common Stock is $3.40 per share) (subject to adjustment in the event of any stock splits or other similar events as provided in Section 8 hereof) for at least twenty (20) consecutive trading days ending on the third day prior to the date on which the notice contemplated by (b) and (c) below is given. (b) In case the Company shall exercise its right to redeem all of the Warrants, it shall give or cause to be given notice to the Registered Holders of the Warrants by mailing to such Registered Holders a notice of redemption, first-class mail, postage pre-paid, at their last address as shall appear on the records of the Warrant Agent. Any notice mailed in the manner provide herein shall be conclusively presumed to have been duly given whether or not the Registered Holder receives such notice. Not less than five (5) business days prior to the mailing to the Registered Holders of the notice of redemption, the Company shall deliver or cause to be delivered to the Underwriter a similar notice telephonically and confirmed in writing, and if the Underwriter is engaged as the Warrant solicitation agent, the Company shall also cause to be delivered to the Underwriter a list of the Registered Holders (including their respective addresses and number of Warrants beneficially owned) to whom such notice of redemption has been or will be given. (c) The notice of redemption shall specify (i) the redemption price, (ii) the Redemption Date, which shall in no event be less than thirty (30) days after the date of mailing of such notice, (iii) the place where the Warrant Certificate shall be delivered and the redemption price shall be paid, (iv) that the Underwriter shall receive the commission contemplated by Section 4(b) hereof; and (v) that the right to exercise the Warrant shall terminate at 5:00 p.m. (New York time) on the business day immediately preceding the date fixed for redemption. No failure to mail such notice nor any defect therein or in the mailing thereof shall affect the validity of the proceedings for such redemption except as to a holder (a) to whom notice was not mailed; or (b) whose notice was defective. An affidavit of the Warrant Agent or the Secretary or Assistant Secretary of the Company that notice of redemption has been mailed shall, in the absence of fraud, be prima facie evidence of the facts stated therein. (d) Any right to exercise a Warrant shall terminate at 5:00 p.m. (New York time) on the business day immediately preceding the Redemption Date. The redemption price payable to the Registered Holders shall be mailed to such persons at their addresses of record. (e) If the Underwriter acts as the Warrant solicitation agent for the Company, the Company shall indemnify the Underwriter and each person, if any, who controls the 13 Underwriter within the meaning of Section 15 of the Act or Section 20(a) of the Exchange Act against all loss, claim, damage, expense or liability (including all expenses reasonably incurred in investigating preparing or defending against any claim whatsoever) to which any of them may become subject under the Act, the Exchange Act or otherwise, arising from the registration statement or prospectus referred to in Section 5(b) hereof to the same extent and with the same effect (including the provisions regarding contribution) as the provisions pursuant to which the Company has agreed to indemnify the Underwriter contained in Section 7 of the Underwriting Agreement. (f) Five business days prior to the Redemption Date, the Company shall furnish to the Underwriter, as the Warrant solicitation agent, (i) an opinion of counsel to the Company, dated such date and addressed to the Underwriter; and (ii) a "cold comfort" letter dated such date addressed to the Underwriter, signed by the independent public accountants who have issued a report on the Company's financial statements included in such registration statement, or if different, the Company's regular outside accountants at such time, in each case covering substantially the same matters with respect to such registration statement (and the prospectus included therein) and, in the case of such accountants' letter, with respect to events subsequent to the date of such financial statements, as are customarily covered in opinions of issuer's counsel and in accountants' letters delivered to underwriters in underwritten public offerings of securities. (g) On and after the date fixed for redemption, the Registered Holders shall have no rights with respect to the Warrants except to receive the $.10 per Warrant upon surrender of their Warrant Certificates. 10. Concerning the Warrant Agent. ---------------------------- (a) The Warrant Agent acts hereunder as agent and in a ministerial capacity for the Company and the Underwriter, and its duties shall be determined solely by the provisions hereof. The Warrant Agent shall not, by issuing and delivering Warrant Certificates or by any other act hereunder, be deemed to make any representations as to the validity or value or authorization of the Warrant Certificates (except its countersignature thereof) or the Warrants represented thereby or of any securities or other property delivered upon exercise of any Warrant or whether any stock issued upon exercise of any Warrant is fully paid and nonassessable. (b) The Warrant Agent shall not at any time be under any duty or responsibility to any holder of Warrant Certificates to make or cause to be made any adjustment of the Exercise Price or the Redemption Price provided in this Agreement, or to determine whether any fact exists which may require any such adjustments, or with respect to the nature or extent of any such adjustments, when made, or with respect to the method employed in making the same (except with respect to the exercise of Warrant Certificates after actual notice of any adjustment of the Exercise Price). The Warrant Agent shall not (i) be liable for any recital or statement of fact contained herein or for any action taken, suffered or omitted by it in reliance on any Warrant Certificate or other document or instrument believed by it in good faith to be genuine and to have been signed or presented by the proper party or parties (except its countersignature on the Warrant Certificates and such statements or recitals as describe the Warrant Agent or action taken or to be 14 taken by it); (ii) be responsible for any failure on the part of the Company to comply with any of its covenants and obligations contained in this Agreement or in any Warrant Certificate; or (iii) be liable for any act or omission in connection with this Agreement except for its own negligence, bad faith or willful misconduct. (c) The Warrant Agent may at any time consult with counsel satisfactory to it (who may be counsel for the Company or for the Underwriter) and shall incur no liability or responsibility for any action taken, suffered or omitted by it in good faith in accordance with the opinion or advice of such counsel. (d) Any notice, statement, instruction, request, direction, order or demand of the Company shall be sufficiently evidenced by an instrument signed by the Chairman of the Board of Directors, Chief Executive Officer, Chief Financial Officer, President or any Vice President (unless other evidence in respect thereof is herein specifically prescribed). The Warrant Agent shall not be liable for any action taken, suffered or omitted by it in accordance with such notice, statement, instruction, request, direction, order or demand reasonably believed by it to be genuine. (e) The Company agrees to pay the Warrant Agent reasonable compensation for its services hereunder and to reimburse it for its reasonable expenses hereunder; the Company further agrees to indemnify the Warrant Agent and save it harmless from and against any and all losses, expenses and liabilities, including judgments, costs and counsel fees, for anything done or omitted by the Warrant Agent in the execution of its duties and powers hereunder except losses, expenses and liabilities arising as a result of the Warrant - ------- Agent's negligence, bad faith or willful conduct. (f) The Warrant Agent may resign its duties and be discharged from all further duties and liabilities hereunder (except liabilities resulting as a result of the Warrant Agent's own gross negligence or willful misconduct), after giving thirty (30) days' prior written notice to the Company. At least fifteen (15) days prior to the date such resignation is to become effective, the Warrant Agent shall cause a copy of such notice of resignation to be mailed to the Registered Holder of each Warrant Certificate at the Company's expense. Upon such resignation, or any inability of the Warrant Agent to act as such hereunder, the Company shall appoint in writing a new warrant agent. If the Company shall fail to make such appointment within a period of fifteen (15) days after it has been notified in writing of such resignation by the resigning Warrant Agent, then the Registered Holder of any Warrant Certificate may apply to any court of competent jurisdiction for the appointment of a new warrant agent. Any new warrant agent, whether appointed by the Company or by such a court, shall be a bank or trust company having a capital and surplus, as shown by its last published report to its stockholders, of not less than $10,000,000 or a stock transfer company. After acceptance in writing of such appointment by the new warrant agent is received by the Company, such new warrant agent shall be vested with the same powers, rights, duties and responsibilities as if it had been originally named herein as the Warrant Agent, without any further assurance, conveyance, act or deed; but if for any reason it shall be necessary or expedient to execute and deliver any further assurance, conveyance, act or deed, the same shall be done at the expense of the Company and shall be legally and validly executed and delivered by the resigning Warrant Agent. 15 Not later than the effective date of any such appointment the Company shall file notice thereof with the resigning Warrant Agent and shall forthwith cause a copy of such notice to be mailed to the Registered Holder of each Warrant Certificate. (g) Any corporation into which the Warrant Agent or any new warrant agent may be converted or merged, any corporation resulting from any consolidation to which the Warrant Agent or any new warrant agent shall be a party, or any corporation succeeding to the corporate trust business of the Warrant Agent or any new warrant agent shall be a successor warrant agent under this Agreement without any further act, provided that such corporation is eligible for appointment as successor to the Warrant Agent under the provisions of the preceding paragraph. Any such successor warrant agent shall promptly cause notice of its succession as warrant agent to be mailed to the Company and to the Registered Holders of each Warrant Certificate. (h) The Warrant Agent, its subsidiaries and affiliates, and any of its or their officers or directors, may buy and hold or sell Warrants or other securities of the Company and otherwise deal with the Company in the same manner and to the same extent and with like effect as though it were not Warrant Agent. Nothing herein shall preclude the Warrant Agent from acting in any other capacity for the Company or for any other legal entity. (i) The Warrant Agent shall retain for a period of two (2) years from the date of exercise, any Warrant Certificate received by it upon such exercise. (j) The Warrant Agent shall account promptly to the Company with respect to Warrants exercised and concurrently pay to the Company all moneys received by the Warrant Agent for the purchase of securities or other property through-the exercise of such Warrants. 11. Modification of Agreement. ------------------------- The Warrant Agent and the Company may by supplemental agreement make any changes or corrections in this Agreement (i) that they shall deem appropriate to cure any ambiguity or to correct any defective or inconsistent provision or manifest mistake or error herein contained; or (ii) that they may deem necessary or desirable and which shall not adversely affect the interests of the holders of Warrant Certificates; provided, however, that this Agreement shall not otherwise be modified, supplemented or altered in any respect except with the consent in writing of the Registered Holders representing not less than 66-2/3% of the Warrants then outstanding; provided, further, that no change in the number or nature of the securities purchasable upon the exercise of any Warrant, or to increase the Exercise Price therefor or to accelerate the Warrant Expiration Date shall be made without the consent in writing of the Registered Holder of the Warrant Certificate representing such Warrant, other than such changes as are presenting specifically prescribed by this Agreement as originally executed. In addition, this Agreement may not be modified, amended or supplemented without the prior written consent of the Underwriter, other than to cure any ambiguity or to correct any provision which is inconsistent with any other provision of this Agreement or to make any such change that is necessary or desirable and which shall not adversely affect the interests of the Underwriter and except as may be required by law. 16 12. Notices. -------- All notices, requests, consents and other communications hereunder shall be in writing and shall be deemed to have been made when delivered or mailed first- class registered or certified mail, postage prepaid, as follows: if to the Registered Holder of a Warrant Certificate, at the last address of such holder as shown on the registry books maintained by the Warrant Agent; if to the Company at 4010 Moorpark Ave., Suite 119, San Jose, California 95113 Attention: CEO, or at such other address as may have been furnished to the Warrant Agent in writing by the Company; and if to the Warrant Agent, at 2 Broadway, 19th Floor, New York, NY 10004. Copies of any notice delivered pursuant to this Agreement shall also be delivered to Monroe Parker Securities, Inc., 2500 Westchester Avenue, Purchase, New York 10577, Attention: General Counsel, or at such other address as any such party may have been furnished to the Company and the Warrant Agent in writing. 13. Governing Law. ------------- This Agreement shall be governed by and construed in accordance with the laws of the state of New York without reference to conflicts of laws or choice of law principles. 14. Binding Effect. --------------- This Agreement shall be binding upon and inure to the benefit of the Company, the Underwriter, the Warrant Agent and their respective successors and assigns and the Registered Holders from time to time of Warrant Certificates or any of them. Nothing in this Agreement is intended or shall be construed to confer upon any other person any right, remedy or claim, in equity or at law, or to impose upon any other person any duty, liability or obligation. 15. Termination. ----------- This Agreement shall terminate at the close of business on the Expiration Date of all of the Warrants or such earlier date upon which all Warrants have been exercised or redeemed, except that the Warrant Agent shall account to the Company for all Warrants outstanding and all cash held by it and the provisions of Section 10 hereof shall survive such termination. 16. Counterparts. ------------- This Agreement may be executed in several counterparts each of which shall be an original, but all of which taken together shall constitute a single instrument. 17. Holders of Warrants Not Deemed Shareholders. No holder of a -------------------------------------------- Warrant, as such, shall be entitled to vote, receive dividends or be deemed the holder of Common Stock or any other securities of the Company which may at any time be issuable on the exercise of the Warrants represented thereby for any purpose whatever, nor shall anything contained herein or in any Warrant Certificate be construed to confer upon any holder of a Warrant, as such, any of the rights of a 17 shareholder of the Company or any right to vote for the election of directors or upon any matter submitted to shareholders at any meeting thereof, or to give or withhold consent to any corporate action (whether upon any recapitalization, issuance of stock, reclassification of stock, change of par value or change of stock to no par value, consolidation, merger, conveyance or otherwise), or to receive notice of meetings or other actions affecting shareholders, or to receive dividend or subscription rights, or otherwise, until such Warrant shall have been exercised in accordance with the provisions hereof, including the receipt by the Company of the Exercise Price and any other amounts payable upon such exercise to the Warrant Agent. 18. Benefits of this Agreement. Nothing in this Agreement or in the --------------------------- Warrant Certificates shall be construed to give to any person or corporation other than the Company, the Underwriter, the Warrant Agent, and their respective successors and assigns hereunder and the Registered Holders of the Warrant Certificates any legal or equitable right, remedy or claim under this Agreement; but this Agreement shall be for the sole and exclusive benefit of the Company, the Underwriter, the Warrant Agent, their respective successors and assigns hereunder and the Registered Holders of the Warrant Certificates. 18 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed as of the first date first above written. ATTEST: ISONICS CORPORATION By:____________________________ By:___________________________ Name: _________________________ Name: James E. Alexander Title: ________________________ Title: President and Chief Executive Officer ATTEST: CONTINENTAL STOCK TRANSFER & TRUST COMPANY, as Warrant Agent By:____________________________ By:___________________________ Name: _________________________ Name: ________________________ Title: ________________________ Title: _______________________ MONROE PARKER SECURITIES, INC. By:___________________________ Name: Stephen Drescher Title: Director Corporate Finance 19 Exhibit A No. W______ VOID AFTER _________, 2001 WARRANTS REDEEMABLE WARRANT CERTIFICATE TO PURCHASE ONE SHARE OF COMMON STOCK ISONICS CORPORATION CUSIP # 464895 11 9 ---------- THIS CERTIFIES THAT, FOR VALUE RECEIVED or its registered assigns (the "Registered Holder") is the owner of the number of Redeemable Warrants (the "Warrants") specified above. Each Warrant initially entitles the Registered Holder to purchase, subject to the terms and conditions set forth in this Certificate and the Warrant Agreement (as hereinafter defined), one fully paid and nonassessable share of Common Stock, no par value per share, of Isonics Corporation, a California corporation (the "Company"), at any time commencing one year after the date of the Prospectus (the "Initial Warrant Exercise Date"), and the earlier to occur of the Expiration Date (as hereinafter defined) and the Redemption Date (as hereinafter defined) upon the presentation and surrender of this Warrant Certificate with the Subscription Form on the reverse hereof duly executed, at the corporate office of Continental Stock Transfer & Trust Company, as Warrant Agent, or its successor (the "Warrant Agent"), accompanied by payment of $4.00 per share, subject to adjustment (the "Exercise Price"), in lawful money of the United States of America in cash or by check made payable to the Warrant Agent for the account of the Company. This Warrant Certificate and each Warrant represented hereby are issued pursuant to and are subject in all respects to the terms and conditions set forth in the Warrant Agreement (the "Warrant Agreement"), dated September __, 1997, by and between the Company, Monroe Parker Securities, Inc. (the "Underwriter") and the Warrant Agent. In the event of certain contingencies provided for in the Warrant Agreement, the Exercise Price and the number of shares of Common Stock subject to purchase upon the exercise of each Warrant represented hereby are subject to modification or adjustment. Each Warrant represented hereby is exercisable at the option of the Registered Holder, but no fractional interests will be issued. In the case of the exercise of less than all the Warrants represented hereby, the Company shall cancel this Warrant Certificate upon the surrender hereof EXH. A-1 and shall execute and deliver a new Warrant Certificate or Warrant Certificates of like tenor, which the Warrant Agent shall countersign, for the balance of such Warrants. The term "Expiration Date" shall mean 5:00 p.m. (New York time) on (i) the date which is three (3) years after the Initial Warrant Exercise Date; or (ii) the date fixed for redemption hereof, whichever date is earlier. If each such date shall in the State of New York be a holiday or a day on which the banks are authorized to close, then the Expiration Date shall mean 5:00 p.m. (New York time) the next following day which in the State of New York is neither a holiday nor a day on which banks are authorized to close. The Company shall not be obligated to deliver any securities pursuant to the exercise of this Warrant unless a registration statement under the Securities Act of 1933, as amended (the "Act"), with respect to such securities is effective or an exemption thereunder is available. The Company has covenanted and agreed that it will file a registration statement under the Federal securities laws, use its best efforts to cause the same to become effective, use its best efforts to keep such registration statement current, if required under the Act, while any of the Warrants are outstanding, and deliver a prospectus which complies with Section 10(a)(3) of the Act to the Registered Holder exercising this Warrant; provided however, that (i) if at the time of exercise of any of the Warrants, the Company does not have in place an effective registration statement or is otherwise, in the good faith determination of the Board of Directors of the-Company, precluded by applicable laws from issuing the shares of Common Stock issuable upon such exercise, the Company may, in lieu of issuance of those shares, elect to redeem the Warrants duly surrendered for exercise for a price per Warrant equal to the difference between the Market Price (as defined below) of a share of Common Stock on the date of such submission and the Exercise Price, and in the event of such redemption, the Company will pay to the Registered Holder the above-described redemption price in cash within ten (10) business days after receipt of notice from the Warrant Agent that such Warrants have been submitted for exercise; and (ii) if the Market Price of the Common Stock is less than the Exercise Price, then the Company need not take such actions to file a registration statement (or a post- effective amendment to a registration statement) with respect to the issuance of Common Stock upon exercise of the Warrants until such time as the Company has been subject to the requirements of Section 12 or 15(d) of the Securities Exchange Act of 1934, as amended, for a period of at least twelve calendar months immediately preceding the filing of the registration statement. This Warrant shall not be exercisable by a Registered Holder in any state where such exercise would be unlawful. The term "Market Price" shall mean (i) the last reported sale price on the date of the event to which such market price relates, or, in case no such reported sale takes place on such day, the average of the last reported sales prices for the last three (3) trading days before such date, in either case as officially reported by the principal securities exchange on which the Common Stock is listed or admitted to trading or by the Nasdaq National Market or the Nasdaq SmallCap Market, (ii) if the Common Stock is not listed or admitted to trading on any national securities exchange or quoted by Nasdaq National Market or the Nasdaq SmallCap Market, the average closing bid price as furnished by the Nasdaq Quotation Bureau, Inc. or similar organization if the Nasdaq Quotation Bureau, Inc. is no longer reporting such information, or (iii) if the Common Stock is neither admitted to trading on a national securities exchange nor quoted on the Nasdaq National Market nor the Nasdaq EXH. A-2 SmallCap Market, nor quoted by over-the-counter trading, then as determined in good faith (using customary valuation methods) by the Board of Directors of the Company which determination shall be evidenced by a resolution of the Board of Directors and based on the best information available to it. This Warrant Certificate is exchangeable, upon the surrender hereof by the Registered Holder at the corporate office of the Warrant Agent, for a new Warrant Certificate or Warrant Certificates of like tenor representing an equal aggregate number of Warrants, each of such new Warrant Certificates to represent such number of Warrants as shall be designated by such Registered Holder at the time of such surrender. Upon due presentment and payment of any tax or other charge imposed in connection therewith or incident thereto, for registration of transfer of this Warrant Certificate at such office, a new Warrant Certificate or Warrant Certificates representing an equal aggregate number of Warrants will be issued to the transferee in exchange therefor, subject to the limitations provided in the Warrant Agreement. Prior to the exercise of any Warrant represented hereby, the Registered Holder shall not be entitled to any rights of a shareholder of the Company, including, without limitation, the right to vote or to receive dividends or other distributions, and shall not be entitled to receive any notice of any proceedings of the Company, except as provided in the Warrant Agreement. Subject to the provisions of the Warrant Agreement, this Warrant may be redeemed at the option of the Company, at a redemption price of $.10 per Warrant, at any time eighteen (18) months after the date of the Prospectus, provided that the last closing sale price for the Common Stock as reported by the Nasdaq SmallCap Market, if the Common Stock is then traded on the Nasdaq SmallCap Market (or the last closing sale price, if the Common Stock is then traded on the Nasdaq National Market or a national securities exchange), shall have equaled or exceeded $8.50 (250% of the initial public offering price) per share for at least twenty (20) consecutive trading days ending on the third day prior to the date on which the Notice of Redemption, as defined below, is given (subject to adjustment in the event of any stock splits or other similar events). Notice of redemption (the "Notice of Redemption") shall be given not later than the thirtieth (30th) day before the date fixed for redemption, or as provided in the Warrant Agreement. On and after the date fixed for redemption, the Registered Holder shall have no rights with respect to the Warrants except to receive the $.10 per Warrant upon surrender of this Warrant Certificate. Upon certain circumstances, the Underwriter may be entitled to receive an aggregate of five percent (5%) of the Exercise Price of the Warrants represented hereby. Prior to due presentment for registration of transfer hereof, the Company and the Warrant Agent may deem and treat the Registered Holder as the absolute owner hereof and of each Warrant represented hereby (notwithstanding any notations of ownership or writing hereon made by anyone other than a duly authorized officer of the Company or the Warrant Agent) for all purposes and the Company's right so to treat the Registered Holder shall not be affected by any notice to the contrary, except as provided in the Warrant Agreement. EXH. A-3 This Warrant Certificate shall be governed by and construed in accordance with the laws of the State of California without reference to conflict of laws or choice of law principles. This Warrant Certificate is not valid unless countersigned by the Warrant Agent. IN WITNESS WHEREOF, the Company has caused this Warrant Certificate to be duly executed, manually or in facsimile, by two of its officers "thereunto duly authorized and a facsimile of its corporate seal to be imprinted hereon. Dated: [SEAL] ISONICS CORPORATION By:___________________________ Name: James E. Alexander Title: President and Chief Executive Officer By:___________________________ Name: Paul J. Catuna Title: Secretary COUNTERSIGNED: _____________________ as Warrant Agent By: Authorized Officer EXH. A-4 SUBSCRIPTION FORM To Be Executed by the Registered Holder in Order to Exercise Warrants The undersigned Registered Holder hereby irrevocably elects to exercise Warrants represented by this Warrant Certificate, and to purchase the securities issuable upon the exercise of such Warrants, and requests that certificates for such securities shall be issued in the name of PLEASE INSERT SOCIAL SECURITY OR OTHER IDENTIFYING NUMBER _______________________________ _______________________________ _______________________________ (please print or type name and address) and be delivered to _______________________________ _______________________________ _______________________________ (please print or type name and address) and if such number of Warrants shall not be all the Warrants evidenced by this Warrant Certificate, that a new Warrant Certificate for the balance of such Warrants be registered in the name of, and delivered to, the Registered Holder at the address stated below. EXH. A-5 ASSIGNMENT To Be Executed by the Registered Holder in Order to Assign Warrants FOR VALUE RECEIVED, __________________ hereby sells, assigns and transfers unto PLEASE INSERT SOCIAL SECURITY OR OTHER IDENTIFYING NUMBER _________________________________ _________________________________ _________________________________ _________________________________ (please print or type name and address) ________________________________________________________________ of the Warrants represented by this Warrant Certificate, and hereby irrevocably constitutes and appoints ____________________________________Attorney to transfer this Warrant Certificate on the books of the Company, with full power of substitution in the premises. Dated: ______________ __________________________________ Signature Guaranteed __________________________________ THE SIGNATURE TO THE ASSIGNMENT OR THE SUBSCRIPTION FORM MUST CORRESPOND TO THE NAME AS WRITTEN UPON THE FACE OF THIS WARRANT CERTIFICATE IN EVERY PARTICULAR, WITHOUT ALTERATION OR ENLARGEMENT OR ANY CHANGE WHATSOEVER. THE SIGNATURE(S) MUST BE GUARANTEED BY AN ELIGIBLE GUARANTOR INSTITUTION (BANKS, STOCKBROKERS, SAVINGS AND LOAN ASSOCIATIONS AND CREDIT UNIONS WITH MEMBERSHIP IN AN APPROVED SIGNATURE GUARANTEE MEDALLION PROGRAM), PURSUANT TO S.E.C. RULE 17Ad-15. EXH. A-6 EX-4.04 6 SPECIMEN WARRANT CERTIFICATE Exhibit 4.04 No. W______ VOID AFTER _________, 2001 WARRANTS REDEEMABLE WARRANT CERTIFICATE TO PURCHASE ONE SHARE OF COMMON STOCK ISONICS CORPORATION CUSIP # 464895 11 9 ---------- THIS CERTIFIES THAT, FOR VALUE RECEIVED or its registered assigns (the "Registered Holder") is the owner of the number of Redeemable Warrants (the "Warrants") specified above. Each Warrant initially entitles the Registered Holder to purchase, subject to the terms and conditions set forth in this Certificate and the Warrant Agreement (as hereinafter defined), one fully paid and nonassessable share of Common Stock, no par value per share, of Isonics Corporation, a California corporation (the "Company"), at any time commencing one year after the date of the Prospectus (the "Initial Warrant Exercise Date"), and the earlier to occur of the Expiration Date (as hereinafter defined) and the Redemption Date (as hereinafter defined) upon the presentation and surrender of this Warrant Certificate with the Subscription Form on the reverse hereof duly executed, at the corporate office of Continental Stock Transfer & Trust Company, as Warrant Agent, or its successor (the "Warrant Agent"), accompanied by payment of $4.00 per share, subject to adjustment (the "Exercise Price"), in lawful money of the United States of America in cash or by check made payable to the Warrant Agent for the account of the Company. This Warrant Certificate and each Warrant represented hereby are issued pursuant to and are subject in all respects to the terms and conditions set forth in the Warrant Agreement (the "Warrant Agreement"), dated September __, 1997, by and between the Company and Monroe Parker Securities, Inc. (the "Underwriter") and the Warrant Agent. In the event of certain contingencies provided for in the Warrant Agreement, the Exercise Price and the number of shares of Common Stock subject to purchase upon the exercise of each Warrant represented hereby are subject to modification or adjustment. Each Warrant represented hereby is exercisable at the option of the Registered Holder, but no fractional interests will be issued. In the case of the exercise of less than all the Warrants represented hereby, the Company shall cancel this Warrant Certificate upon the surrender hereof EXH. A-1 and shall execute and deliver a new Warrant Certificate or Warrant Certificates of like tenor, which the Warrant Agent shall countersign, for the balance of such Warrants. The term "Expiration Date" shall mean 5:00 p.m. (New York time) on (i) the date which is three (3) years after the Initial Warrant Exercise Date; or (ii) the date fixed for redemption hereof, whichever date is earlier. If each such date shall in the State of New York be a holiday or a day on which the banks are authorized to close, then the Expiration Date shall mean 5:00 p.m. (New York time) the next following day which in the State of New York is neither a holiday nor a day on which banks are authorized to close. The Company shall not be obligated to deliver any securities pursuant to the exercise of this Warrant unless a registration statement under the Securities Act of 1933, as amended (the "Act"), with respect to such securities is effective or an exemption thereunder is available. The Company has covenanted and agreed that it will file a registration statement under the Federal securities laws, use its best efforts to cause the same to become effective, use its best efforts to keep such registration statement current, if required under the Act, while any of the Warrants are outstanding, and deliver a prospectus which complies with Section 10(a)(3) of the Act to the Registered Holder exercising this Warrant; provided however, that (i) if at the time of exercise of any of the Warrants, the Company does not have in place an effective registration statement or is otherwise, in the good faith determination of the Board of Directors of the-Company, precluded by applicable laws from issuing the shares of Common Stock issuable upon such exercise, the Company may, in lieu of issuance of those shares, elect to redeem the Warrants duly surrendered for exercise for a price per Warrant equal to the difference between the Market Price (as defined below) of a share of Common Stock on the date of such submission and the Exercise Price, and in the event of such redemption, the Company will pay to the Registered Holder the above-described redemption price in cash within ten (10) business days after receipt of notice from the Warrant Agent that such Warrants have been submitted for exercise; and (ii) if the Market Price of the Common Stock is less than the Exercise Price, then the Company need not take such actions to file a registration statement (or a post- effective amendment to a registration statement) with respect to the issuance of Common Stock upon exercise of the Warrants until such time as the Company has been subject to the requirements of Section 12 or 15(d) of the Securities Exchange Act of 1934, as amended, for a period of at least twelve calendar months immediately preceding the filing of the registration statement. This Warrant shall not be exercisable by a Registered Holder in any state where such exercise would be unlawful. The term "Market Price" shall mean (i) the last reported sale price on the date of the event to which such market price relates, or, in case no such reported sale takes place on such day, the average of the last reported sales prices for the last three (3) trading days before such date, in either case as officially reported by the principal securities exchange on which the Common Stock is listed or admitted to trading or by the Nasdaq National Market or the Nasdaq SmallCap Market, (ii) if the Common Stock is not listed or admitted to trading on any national securities exchange or quoted by Nasdaq National Market or the Nasdaq SmallCap Market, the average closing bid price as furnished by the Nasdaq Quotation Bureau, Inc. or similar organization if the Nasdaq Quotation Bureau, Inc. is no longer reporting such information, or (iii) if the Common Stock is neither admitted to trading on a national securities exchange nor quoted on the Nasdaq National Market nor the Nasdaq EXH. A-2 SmallCap Market, nor quoted by over-the-counter trading, then as determined in good faith (using customary valuation methods) by the Board of Directors of the Company which determination shall be evidenced by a resolution of the Board of Directors and based on the best information available to it. This Warrant Certificate is exchangeable, upon the surrender hereof by the Registered Holder at the corporate office of the Warrant Agent, for a new Warrant Certificate or Warrant Certificates of like tenor representing an equal aggregate number of Warrants, each of such new Warrant Certificates to represent such number of Warrants as shall be designated by such Registered Holder at the time of such surrender. Upon due presentment and payment of any tax or other charge imposed in connection therewith or incident thereto, for registration of transfer of this Warrant Certificate at such office, a new Warrant Certificate or Warrant Certificates representing an equal aggregate number of Warrants will be issued to the transferee in exchange therefor, subject to the limitations provided in the Warrant Agreement. Prior to the exercise of any Warrant represented hereby, the Registered Holder shall not be entitled to any rights of a shareholder of the Company, including, without limitation, the right to vote or to receive dividends or other distributions, and shall not be entitled to receive any notice of any proceedings of the Company, except as provided in the Warrant Agreement. Subject to the provisions of the Warrant Agreement, this Warrant may be redeemed at the option of the Company, at a redemption price of $.10 per Warrant, at any time eighteen (18) months after the date of the Prospectus, provided that the last closing sale price for the Common Stock as reported by the Nasdaq SmallCap Market, if the Common Stock is then traded on the Nasdaq SmallCap Market (or the last closing sale price, if the Common Stock is then traded on the Nasdaq National Market or a national securities exchange), shall have equaled or exceeded $8.50 (250% of the initial public offering price) per share for at least twenty (20) consecutive trading days ending on the third day prior to the date on which the Notice of Redemption, as defined below, is given (subject to adjustment in the event of any stock splits or other similar events). Notice of redemption (the "Notice of Redemption") shall be given not later than the thirtieth (30th) day before the date fixed for redemption, or as provided in the Warrant Agreement. On and after the date fixed for redemption, the Registered Holder shall have no rights with respect to the Warrants except to receive the $.10 per Warrant upon surrender of this Warrant Certificate. Upon certain circumstances, the Underwriter may be entitled to receive an aggregate of five percent (5%) of the Exercise Price of the Warrants represented hereby. Prior to due presentment for registration of transfer hereof, the Company and the Warrant Agent may deem and treat the Registered Holder as the absolute owner hereof and of each Warrant represented hereby (notwithstanding any notations of ownership or writing hereon made by anyone other than a duly authorized officer of the Company or the Warrant Agent) for all purposes and the Company's right so to treat the Registered Holder shall not be affected by any notice to the contrary, except as provided in the Warrant Agreement. EXH. A-3 This Warrant Certificate shall be governed by and construed in accordance with the laws of the State of California without reference to conflict of laws or choice of law principles. This Warrant Certificate is not valid unless countersigned by the Warrant Agent. IN WITNESS WHEREOF, the Company has caused this Warrant Certificate to be duly executed, manually or in facsimile, by two of its officers "thereunto duly authorized and a facsimile of its corporate seal to be imprinted hereon. Dated: [SEAL] ISONICS CORPORATION By:___________________________ Name: James E. Alexander Title: President and Chief Executive Officer By:___________________________ Name: Paul J. Catuna Title: Secretary COUNTERSIGNED: _____________________ as Warrant Agent By: Authorized Officer EXH. A-4 SUBSCRIPTION FORM To Be Executed by the Registered Holder in Order to Exercise Warrants The undersigned Registered Holder hereby irrevocably elects to exercise Warrants represented by this Warrant Certificate, and to purchase the securities issuable upon the exercise of such Warrants, and requests that certificates for such securities shall be issued in the name of PLEASE INSERT SOCIAL SECURITY OR OTHER IDENTIFYING NUMBER _______________________________ _______________________________ _______________________________ (please print or type name and address) and be delivered to _______________________________ _______________________________ _______________________________ (please print or type name and address) and if such number of Warrants shall not be all the Warrants evidenced by this Warrant Certificate, that a new Warrant Certificate for the balance of such Warrants be registered in the name of, and delivered to, the Registered Holder at the address stated below. EXH. A-5 ASSIGNMENT To Be Executed by the Registered Holder in Order to Assign Warrants FOR VALUE RECEIVED, __________________ hereby sells, assigns and transfers unto PLEASE INSERT SOCIAL SECURITY OR OTHER IDENTIFYING NUMBER _________________________________ _________________________________ _________________________________ _________________________________ (please print or type name and address) ________________________________________________________________ of the Warrants represented by this Warrant Certificate, and hereby irrevocably constitutes and appoints ____________________________________Attorney to transfer this Warrant Certificate on the books of the Company, with full power of substitution in the premises. Dated: ______________ __________________________________ Signature Guaranteed __________________________________ THE SIGNATURE TO THE ASSIGNMENT OR THE SUBSCRIPTION FORM MUST CORRESPOND TO THE NAME AS WRITTEN UPON THE FACE OF THIS WARRANT CERTIFICATE IN EVERY PARTICULAR, WITHOUT ALTERATION OR ENLARGEMENT OR ANY CHANGE WHATSOEVER. THE SIGNATURE(S) MUST BE GUARANTEED BY AN ELIGIBLE GUARANTOR INSTITUTION (BANKS, STOCKBROKERS, SAVINGS AND LOAN ASSOCIATIONS AND CREDIT UNIONS WITH MEMBERSHIP IN AN APPROVED SIGNATURE GUARANTEE MEDALLION PROGRAM), PURSUANT TO S.E.C. RULE 17Ad-15. EXH. A-6 EX-5.01 7 OPINION OF FENWICK & WEST LLP [LETTERHEAD OF FENWICK & WEST LLP] EXHIBIT 5.01 August 15, 1997 Isonics Corporation 4010 Moorpark Avenue, Suite 119 San Jose, California 95117 Re: Isonics Corporation ------------------- Ladies and Gentlemen: At your request, we have examined the Registration Statement on Form SB-2 filed with the Securities and Exchange Commission (the "SEC"), File no. 333- 13289, as amended (the "Registration Statement"), in connection with registration under the Securities Act of 1993, as amended, of (1) up to 700,000 Units (the "Units"), each Unit consisting of two shares of your Common Stock and two Class A Redeemable Common Stock Purchase Warrants, (2) up to 1,400,000 shares of your Common Stock (the "Firm Shares"), (3) up to 1,400,000 Class A Redeemable Common Stock Purchase Warrants (the "Firm Warrants"), (4) up to 1,400,000 shares issuable upon exercise of the Firm Warrants, (5) up to 105,000 Units issuable upon exercise of the Underwriter's over-allotment option (the "Over-Allotment Option"), (6) up to 210,000 shares of Common Stock (the "Option Shares") issuable upon exercise of the Over-Allotment option, (7) up to 210,000 Class A Redeemable Common Stock Purchase Warrants (the "Option Warrants"), (8) up to 210,000 shares issuable upon exercise of the Option Warrants, issuable upon exercise of the Over-Allotment Option, (9) up to 210,000 shares of Common Stock issuable upon exercise of the Option Warrants, (10) up to 140,000 Underwriter's Warrants, each Underwriter's Warrant exercisable to acquire one share of Common Stock and one Class A Redeemable Common Stock Purchase Warrant (the "Underlying Warrant") to acquire one share of Common Stock, (11) up to 140,000 shares of Common Stock issuable upon exercise of the Underwriter's Warrants, (12) up to 140,000 Class A Redeemable Common Stock Purchase Warrants issuable upon exercise of the Underwriter's Warrants, and (13) up to 140,000 shares of Common Stock that are issuable upon exercise of the Underlying Warrants. All of the foregoing securities will be referred to collectively as the "Securities." As your counsel, we have examined the proceedings taken by you in connection with the issuance by you of the Securities that may be issued and sold by you as described in the Registration Statement. It is our opinion that the Securities to be issued and sold by you pursuant to the Registration Statement, when issued, sold and paid for in the manner referred to in the Registration Statement, will be legally issued, fully paid and nonassessable. We consent to the use of this opinion as an exhibit to the Registration Statement and further consent to all references to us in the Registration Statement, and the Prospectus constituting a part thereof and any amendments thereto which have been approved by us. Very truly yours, /s/Fenwick & West LLP ----------------------------- Fenwick & West LLP EX-11.01 8 COMPUTATION OF PER SHARE EARNINGS EXHIBIT 11.01 ISONICS CORPORATION STATEMENTS REGARDING CALCULATION OF NET INCOME (LOSS) PER COMMON SHARE (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
PRO FORMA ---------- YEAR ENDED APRIL 30, YEAR ENDED -------------- APRIL 30, 1996 1997 1997 ------ ------- ---------- Net Income (Loss)................................... $ 281 $(1,363) $(1,363) Interest on nonconvertible promissory notes......... -- -- 315 ------ ------- ------- Net Income (Loss)................................... $ 281 $(1,363) $(1,048) ====== ======= ======= Weighted Average Common Stock Outstanding........... 3,570 4,113 4,113 Dilutive Effect of Preferred Stock.................. 235 -- 141 Pro forma shares issued for repayment of debt....... -- -- 399 Dilutive effect of stock options and warrants granted approximately twelve months preceding the offering, calculated using the treasury stock method at $3.50 per share.......................... 2,144 1,777 1,777 ------ ------- ------- Shares Used in Computing Per Share Information...... 5,949 5,890 6,430 ====== ======= ======= Net Income (Loss) Per Share......................... $ .05 $ (.23) $ (.16) ====== ======= =======
EX-23.02 9 CONSENT OF GRANT THORNTON LLP EXHIBIT 23.02 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS We have issued our report dated August 13, 1997, accompanying the financial statements of Isonics Corporation contained in this Registration Statement and Prospectus. We consent to the use of the aforementioned report in this Registration Statement and Prospectus, and to the use of our name as it appears under the caption "Experts." Grant Thornton LLP San Jose, California August 15, 1997 EX-27.01 10 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM BALANCE SHEETS AND STATEMENTS OF OPERATIONS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS 12-MOS APR-30-1996 APR-30-1997 MAY-01-1995 MAY-01-1996 APR-30-1996 APR-30-1997 116 28 0 0 35 4 0 0 1,006 1,539 1,281 1,585 81 70 10 27 1,788 2,684 1,342 2,026 452 1,671 0 0 125 0 78 1,129 0 (343) 1,788 2,684 5,567 4,539 5,567 4,539 3,835 3,616 3,835 3,616 1,210 1,838 0 0 66 395 456 (1,310) 175 53 281 (1,363) 0 0 0 0 0 0 281 (1,363) .05 (.23) .05 (.23)
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