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0 '1- 6 Ou / "', 1,250,000 Units Advanced Tobacco Products Consisting of 1,250,000 Shares of Common Sto and Warrants to Purchase 625,000 , Shares of Common Stock ,iC'v'6711=~ l,;:D [Jtcit'.R: E C n •; C C Inch;,~~~ 29 i964 OFFICE UF dFi LIC_1 i I Oi. - A~ REPORT SEP.~,' A11 of the Units offered hereby are being sold by the Company. Each Unit consists of one share of Common Stock and one 'Warrant to purchase one-half share of Common Stock. The shares of Common Stock and Warrants constituting the Units will not be separately transferable until August 21, 1984 (90 days after this offering), or such earlier date as may be determined by the Company with the consent of the Representative of the Underwriters. See "Description of Units." Even multiples of Warrants may be exercised to purchase shares of Common Stock at an initial exercise price of $7.00 per whole share, subject to adjustment in certain events. Each registered holder of Warrants may exercise his Warrants in whole or in part, at any time after the date the Warrants become separately transferable until May 31, 1986, except that under certain circumstances the expiration date may be accelerated by the Company. See "Description of Warrants." Prior to this offering, there has been .no market for any of the Company's securities. See "Underwriting" for information relating to the factors that were considered in determining the initial public offering price. THESE SECURITIES INVOLVE A HIGH DEGREE OF RISK AND PURCHASERS MAY SUSTAIN A LOSS OF THEIR TOTAL INVESTMENT. SEE "RISK FACTORS." ~ . THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. Per Unit ...................................................................... Total(3) ........................................................................ Price to Public $6.50 $8,125,000 Underwriting Discount(I ) $.5525 $690,625 J Proceeds to Company(2) $5.9475 $7,434,375 (1) See "Underwriting" for information concerning indemnification of the Underwriters and Unit purchase warrants to be sold to the Representative of the Underwriters. (2) Before deducting estimated expenses of $300,000 payable by the Company. (3) The Company has granted to the Underwriters an option to purchase up to an additional 187,500 Units to cover over-allotments. If all such Units are purchased, the Total Price to Public, Underwriting Discount and Proceeds to Company will be $9,343,750, $794,219 and $8,549,531, respectively. See "•Underwriting." This prospectus also covers 4,692,122 shares of Common Stock to be issued in connection with an acquisition. See "The Company." The Units are offered by the several Underwriters when, as and if delivered to and accepted by the Underwriters and subject to certain other conditions, including their right to reject orders in whole or in part. It is expected that delivery of the Units will be made against payment therefor in Dallas, Texas on or about May 31, 1984. Schneider, Bernet & Hickman, Inc. May 23, 1984 0 0 r I

r 'I'he Smokeless Cigarette and the packages in Nhich it %%ill be sold. free-flow mouthpiece Cross-section %ieN of the Smokeless Cigarette. The Company intends to furnish its shareholders and holders of Warrants. after the close ofcach fiscal \,ear. an annual report containing audited financial statements. In addition. the Company intends to furnish its shareholders and holders of Warrants quarterly reports containing unaudited financial information. 1\ CO\\ECFIO\ W1Ttl 'fHIS OFFERI\G,'I'HE: l:\DE:RWR1'I'ERS N1A1' OVk:R-A1.1.0T OR E:FFECf TRA\SACI'1O\S WHICH STABILIZE OR \lal\'1'AI\ THE MARKET PRICE OF THE l:\fTS,COMMO\ STOCK AND NVARRA\TS.aT a LEVELABOVETHA'I'WHICH MIGHT OTHERWISE PREVAIL I\ THE OPEN MARKET. SUCH STABIL17_IN'G, IF COMME\CE:D, MA1 BE DISCO\TI\LED AT A\1' TIME. i

PROSPECTUS SUMMARY The following summary is qualifred in its entirety by the detailed information and financial statements appearing elsewhere in this Prospectus. THE COMPANY ' Advanced Tobacco Products, Inc. has developed a patented smokeless tobacco product (the "Smokeless Cigarette") which has the appearance and feel and provides a sensation similar to a conventional cigarette, but which delivers nicotine satisfaction to the user by inhalation of nicotine vapor in a manner not requiring the combustion of tobacco. The Company believes that the Smokeless Cigarette delivers an amount of nicotine per inhalation within a range of amounts received per inhalation from conventional cigarettes and contains flavorings similar to those commonly used in conventional cigarettes. Because the use of the Smokeless Cigarette does not involve the combustion of tobacco, the user inhales none of the carbon monoxide or tars produced by tobacco combustion which the United States Surgeon General has determined may cause cancer and increase the risk of heart disease. In addition, the Smokeless Cigarette does not expose the user or others to smoke and the related odor associated with the use of conventional cigarettes and, as a result, may be enjoyed where conventional cigarette smoking is prohibited or is socially unacceptable. The Company intends to market the Smokeless Cigarette as a pleasurable nicotine product and not as a product intended to discourage or reduce smoking or to have therapeutic benefits. The Company believes most users of the Smokeless Cigarette will be smokers of conventional cigarettes who wish to reduce their health concerns or who wish to enjoy the inhalation ofni_cotine in stt;oking restricted environments. During the past five years the Company's activities have included product development, clinical and consumer testing, and the development of promotional and advertising plans. The Company intends to finance its initial product marketing, including television advertising, and commercial scale production with the proceeds of this offering. THE OFFERING Securities Oftered ..................... 1,250,000 Units (the "Units"), each consisting of one share of Common Stock and one Warrant to purchase one-half share of Common Stock. Even multiples of Warrants may be exercised to purchase shares of Common Stock at a price of $7.00 per whole share, commencing on August 21, 1984, and expiring on May 31, 1986, unless such date is ~ accelerated by the Company under certain terms and oonditions.(1) Common Stock Outstanding After Offering ........................ 6,987,600 shares.(1) Use of Proceeds ....................... Approximately 53,100,000 to finance advertising and promotional costs; $1,500,000 to finance the purchase of manufacturing equipment; 5700,000 to finance the production of inventory necessary to commence commercial scale operations; 5350,000 to finance leasehold improvements; $250,000 to finance market research; $700,000 to finance other anticipated operating expenses prior to commencement of commercial scale operations; and the balance for additions to working capital. See "Use of Proceeds." Risk Factors ............................ The Units offered hereby involve a high degree of risk and substantial dilution. See "Risk Factors" and "Dilution." NASDAQ Symbols .................. Units: ATPIU; Warrants: ATPIW; Common Stock: ATPI (1) Excludes 625,000 shares of Common Stock issuable upon exercise of the Warrants, 187,500 shares of Common Stock which may be sold pursuant to the Underwriters' over-allotment option to purchase 187,500 Units and up to 93,750 shares issuable upon the exercise of Warrants included in such Units, and 150,000 shares of Common Stock issuable upon exercise of Unit purchase warrants to be purchased by the Representative of the Underwriters and upon the exercise of Warrants included in the Units covered by such warrants. 3

SELECTED FINANCIAL INFORMATION THE COMPANY AND PRO FORMA - THE COMPANY AND NCC GROUP, LTD. COMBINED Drcember 31 March 31, 1984 , 1983 Historictl Historical Pro Forvu Combined(1) As Adjusted(Ix2) Balance Sheet Data: Working capital .......................................... S 2,125 S 127,461 S 195,598 57,329,973 Total assets ................................................. 29,668 279,734 703,691 7,838,066 Total liabilities ............ ..................... .•...••••• 16,284 57,496 32,978 32,978 Total shareholders' equity .......................... 13,384 222,238 670,713 7,805,088 August, 1982 (Date of Lcepdon of NCC) to December 31, Yeu Ended December 31, 'Ibree Months Ended Mvch 31, 1982 1983(3) 1983 1984 Operating Data(3): Advanced Tobacco Products, Inc.: Revenues - interest ................................ $ S 2,762 Total expenses ......................................... 16,000 13,908 Net loss .................................................... S(16,000) S 1( 1,146) Net Ioss*per share ..................................... ' R.04) 01 ) Pro Forma Combined - Advanced Tobacco Products, Inc. and NCC Group, Ltd. Revenues - interest ............. ................... 17;117 28,459 7,177 3,946 Total expenses ......................................... 178,598 263,173 37,842 70,473 Net loss .................................................... S 161 481) S 2( 34,714) S 3( 0,665) S 6( 6,527) Net loss per share ..................................... S(.OS) K. 01 ) (1) Assumes the purchase by the Company of the assets, subject to the liabilities of NCC Group, Ltd. and the issuance by the Company of 4,669,692 net shares of Common Stock in connection therewith. See "The Company" and "Management - Certain Transactions." (2) Gives effect to the sale of the Units offered hereby (exclusive of the 187,500 Units subject to the Underwriters' over-allotment option). Gives effect to the immediate application of the net proceeds of the offering to working capital, but does not give effect to the application of such proceeds over the twelve-month period commencing with the closing of the offering as described under "Use of Prooeeds." (3) Includes only the operations of the Company from April, 1983 (date of inception) through December 31, 1983. This Prospectus assumes the purchase by the Company of the assets, subject to the liabilities, ojNCC Group, Ltd., and the issuance by the Company oj4',669.692 net shares oJCommon Stock in connection thereK,ith. i - .n ~ 4 ° 0

THE COMPANY Advanced Tobacco Products, Inc. has developed and obtained United States and foreign patents relating to a smokeless tobacco product (the "Smokeless Cigarette") which has the appearance and feel and provides a sensation similar to a conventional cigarette, but which delivers nicotine satisfaction to the user through inhalation of nicotine vapor derived from a small amount of a nicotine mixture contained within the product. Because the nicotine inhaled from the Smokeless Cigarette is not derived from the combustion of tobacco as is the case with a conventional cigarette, the user inhales none of the carbon monoxide or tars produced by tobacco combustion which the United States Surgeon General has determined may cause cancer and increase the risk of heart disease. In addition, use of the Smokeless Cigarette does not expose the user or others to the smoke and the related odor associated with the use of conventional cigarettes and, as a result, may be enjoyed where conventional cigarette smoking is prohibited or is socially unacceptable. The Company intends to market the Smokeless Cigarette as a pleasutable nicotine product and not as a product intended to discourage or reduce smoking or to have therapeutic benefits. The Company believes that the Smokeless Cigarette delivers an amount of nicotine per inhalation within a range of amounts delivered per inhalation from many conventional combustible cigarettes. The Company's belief is based upon clinical testing of subjects after use of Smokeless Cigarettes and conventional cigarettes and the Company's analysis of Federal Trade Commission reports regarding approximately 200 varieties of conventional cigarettes. The clinical studies upon which the Company's belief is based were performed by individual physicians and clinical researchers who at the time of their studies were independent of the Company. The Company believes, however, that the nicotine delivery of the Smokeless Cigarette and of conventional cigarettes varies substantially among individual users due to differing smoking or nicotine inhalation habits. The Company believes that most users of the Smokeless Cigarette will be smokers of conventional cigarettes who wish to reduce their health concerns or who wish to enjoy nicotine in restricted smoking environments or when others may be offended by conventional cigarette smoke and odor. According to an independent study, in 1982 approximately 56 million Americans smoked 633 billion conventional cigarettes purchased at retail for $23.4 billion. Many of these smokers' use of combustible cigarettes has been restricted in certain public areas and business and commercial environments by local ordinances adopted under smoking restriction laws currently in effect in a majority of states, many of which laws have been recently enacted. EGC Associates, Inc., an independent market research firm retained by the Company, has completed a study of consumer acceptance of the Smokeless Cigarette involving shopping mall intercept interviews in Los Angeles, Chicago, San Antonio, Oklahoma City and Columbus, Ohio. Of the 550 cigarette smokers interviewed after sampling the Smokeless Cigarette, 44% indicated they would be "very likely" to purchase the Smokeless Cigarette on a trial basis if it were available, 30% indicated they would be "somewhat likely" to do so, and 26% indicated that it was "not too likely" that they would purchase the Smokeless Cigarette on a trial basis. Of those interviewed, 12% indicated they would be willing to pay more for "a day's worth" of the Smokeless Cigarette than for a pack of conventional cigarettes, 46% indicated they would pay the same amount, 41 % indicated they would pay slightly less than such amount, and 5% did not know what they would pay. The study attempted to measure only the initial interest of consumers in the Smokeless Cigarette and may not be indicative of a level of sustained acceptance of the Smokeless Cigarette in the markets tested or in other markets. The Company has commenced the development of its advertising and promotion plan with the assistance of an advertising and promotion firm. During 1984 the Company intends to continue consumer testing in order further to develop its advertising and promotion program. The Company intends to commence the introduction of its Smokeless Cigarettes to the retail market in selected major Texas cities approximately twelve months after this offering and to expand its market throughout the United States and selected foreign countries on a region by region basis consistent with its production and marketing capacity and the results of its initial marketing. The Company has obtained a commitment for the completion of its initial manufacturing facility prior to the final quarter of 1984. The Company has also obtained commitments from suppliers to provide conventional cigarette manufacturing equipment modified to manufacture Smokeless Cigarettes. 5

Development of the Smokeless Cigarette was commenced in 1977 by Mr. J. P. Ray, President of the Company. During 1978 and 1979 medical tests were performed regarding the nicotine delivered by the Smokeless Cigarette. In 1978 Mr. Ray applied for a United States patent and a number of foreign patents intended to cover the technology underlying the Smokeless Cigarette. A United States patent relating to the Smokeless Cigarette was issued on August 18, 1981 and seven foreign patents were subsequently issued (eight additional foreign patents are pending). I The Company was formed in April, 1983, under the name S. A. Vend, Inc., which was changed to Advanced_Tobacco Products, Inc. in January, 1984. On September 19, 1983, the Company entered into an agreement with NCC Group, Ltd., a partnership formed by Mr. Ray in August, 1982 to finance the development and testing of the Smokeless Cigarette, under which the Company will acquire the technology relating to the Smokeless Cigarette and other nicotine products and the United States and foreign patents and patent applications relating to such technology. Unless the context requires otherwise, all references in this Prospectus to the "Company" include NCC Group, Ltd., Mr. Ray and other owners of the patents and technology to be acquired by the Company through NCC Group, Ltd. The Company's principal offices and facilities are located at 2929 Mossrock, Suite 130, San Antonio, Texas 78230, and its telephone number is (512) 340-5892. RISK FACTORS The Units offered hereby are speculative and involve a high degree of risk. In analyzing this offering, prospective investors should carefully consider, among others, the mattors set forth below. The order in which such risks are discussed is not necessarily indicative of their relative significance. l.- Potential FDA Regnlitiod; Otber Governniental'Regulation and Taxationp' General. The Company believes that its Smokeless Cigarette currently is not subject to significant state or federal governmental regulation or taxation. The Company's belief, however, is based upon the opinion ;c ,~of its counsel Matthews & Braiiscomb, San Antonio, Texas, and itsspecial Food and Drug Administ.ration~ ~• ("FDA")oounsel 8urdiri &Galkins,ngton; D.C•.-(tb the extent such opinions relate to matters within the jurisdiction of or relating to the FDA), generally to the effect summarized below and in "Business - Governmental Regulation and Taxation." Such opinions are not binding on a court of law or the FDA, however, and are based upon such counsels' interpretation of several significant statutes and regulations, discussed briefly below, which do not specifically include or exclude the Smokeless Cigarette as a regulated or specially taxed product. The Company has not sought any ruling or determination under any such statutes or regulations, however, and, to the Company's knowledge, no court or governmental agency has ruled on the applicability of any such statutes or regulations to the Smokeless Cigarette. Specifically, the Company has not sought an advisory opinion from the FDA as to the "drug" or "new drug" status of the Smokeless Cigarette, even though such an opinion might be obtained if the Company were to submit to the FDA certain information relating to the Smokeless Cigarette and the Company's marketing plans. The Company has not sought such an opinion because the Company does not believe such an opinion is necessary for the reasons set forth below under "FDA Regulation", because such an opinion, even if granted, may be amended or revoked by the FDA at any time after it has been issued, and because the Company believes that obtaining such an opinion would involve unnecessary time and expense (even though the time and expense associated with a later assertion of jurisdiction by the FDA would likely be significantly greater than that associated with seeking such an opinion). Therefore, there can be no assurance that the Company's manufacturing and marke.ting of its product will not be materially delayed or otherwise materially burdened by governmental regulation or taxation. Such delays or other burdens could result from the amendment of current laws and regulations or the enactment of new regulatory or taxation schemes as well as interpretations of current statutes and regulations in the specific context of the Smokeless Cigarette. FDA Regulation. The FDA has refused to assert jurisdiction over conventional cigarettes as customarily marketed by maintaining the position that the Federal Food, Drug and Cosmetic Act (the "FDC Act") generally does not apply to cigarettes containing nicotine or nicotine separately. The FDA's position was affirmed in 1980 by the United States Court of Appeals for the District of Columbia Circuit 6

in Action on Smoking and Health v. Harris. Because of the foregoing, the Company does not believe the Smokeless Cigarette will be subject to FDA regulation. However, the FDA can assert jurisdiction over cigarettes containing nicotine, or nicotine separately, as a drug when a jurisdictional basis, such as health claims by the vendor, exists. It is therefore possible that the FDA would determine that the Smokeless Cigarette is a "drug" or "new drug" and that the Company would be unsuccessful in opposing such a determination. Should PDA regulation be imposed, introduction of the Smokeless Cigarette into the United States market could be prohibited or delayed for an indefinite period pending FDA approval, and FDA approval of the Smokeless Cigarette could be conditioned upon restrictions materially adverse to the Company's marketing efforts. If the Smokeless Cigarette is marketed in interstate commerce under such circumstances without an approved application, the Company could be in violation of the FDC Act and such violation could result in seizure of its products, irrjunctions and criminal penalties. Prohibition of Television Advertising; Federal Excise Tax. The Federal Cigarette Labeling and Advertising Act which, among other things, prohibits television advertising of and imposes labeling requirements upon conventional cigarettes, and the federal cigarette excise tax statutes, apply only to "cigarettes," which are defined as a "roll of tobacco" wrapped in certain substances. Because the Smokeless Cigarette does not contain a "roll of tobacco", but rather nicotine and other purified substances derived from tobacco, and because neither the Federal Cigarette Labeling and Advertising Act nor the federal cigarette excise tax statutes have been applied to smokeless tobacco products such as chewing tobacco or snuff, the Company believes the Smokeless Cigarette is not subject to such act or tax. Nevertheless, the Company has not requestcd a ruling or other determination regarding the applicability of such act or tax and is not aware of any controlling precedent, and it is possible that it could be successfully argued that the Smokeless Cigarette is sufficiently similar to conventional cigarettes to justify the application of such act or tax to the product. The Company believes that the use of television advertising would provide the Company with the most effective means of introducing the Smokeless Cigarette to the retail market and a substantial competitive advantage over its conventional cigarette competitors. The application of the federal ban on television advertising to the Smokeless Cigarette would increase the risk that the Smokeless Cigarette will not be successfully introduced, and, if successfully introduced, will not sucoessfully compete with conventional cigarettes and other competing products on a sustained basis. Since the federal ban on cigarette advertising commenced in 1971, the Company believes that very few new brands of conventional cigarettes have been successfully introduced, and only at a cost significantly in excess of the Company's expected financial resources. Although the application of the federal cigarette excise tax to the Smokeless Cigarette may result in less net revenue to the Company per sales unit, the Company does not believe the amount of net revenue reduction would by itself cause its operations to be unprofitable. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Certain Factors Bearing on Results of Future Operations." State Regulation. State statutes taxing cigarettes and cigars and restricting their use are also believed by the Company generally to be inapplicable because definitions of the taxed and restricted product generally refer to "a roll of tobacco for smoking" without specifying nicotine alone as the relevant substance. The Company believes that the Smokeless Cigarette will be taxed and otherwise regulated under state laws as a smokeless tobacco product, such as snuff and chewing tobacco. However, a determination that federal laws and regulations concerning conventional cigarettes are applicable to the Smokeless Cigarette would likely result in interpretations of many state conventional cigarette laws such that they would be applicable to Smokeless Cigarettes. See "Business - Governmental Regulation and Taxation." 2. Uncertain Market and Competition The Company is not aware of any previous attempt to market a product intended to provide nicotine pleasure other than conventional combustible or smokeless tobacco products such as conventional cigarettes, cigars, chewing tobacco and snuff. The Company believes that there is no market history for nicotine products which would provide a reliable basis for estimating the potential market for the Smokeless 7

Cigarette or the advertising and promotional costs required to develop such a market. Furthermore, because the Smokeless Cigarette delivers nicotine vapor to its user, the Company does not consider the Smokeless Cigarette to be similar to recently introduced cigarette substitute products such as non-tobacco combustible cigarettes or special filters designed to eliminate or reduce the use of nicotine. However, there is a risk that the Smokeless Cigarette may encounter market resistance due to a perception that it is another cigarette substitute which eliminates or reduces the user's inhalation of nicotine. The Smokeless Cigarette may also encounter resistance to the extent conventional cigarette smokers regard the inhalation of the smoke produced by tobacco combustion to be an essential part of their cigarette smoking enjoyment. In addition to the risks associated with consumer acceptance of the Smokeless Cigarette, there is a substantial competitive risk associated with the fact that the Company's resources available for promotional activities and advertising will be small when compared to the resources of most manufacturers of conventional cigarettes and other potential competitors. Consequently, there can be no assurance that the Company will be able to compete effectively with manufacturers of conventional tobacco products or with any competitive nicotine delivery products not yet developed, will be able to defend successfully its patent rights, or that the market for the Smokeless Cigarette will be substantial and within the Company's financial ability to develop. Furthermore, the Company's marketing strategy relies to a significant extent on the anticipated use of television advertising, which is prohibited under federal law as to conventional cigarettes. This law has not been interpreted in the context of the Smokeless Cigarette. See "Risk Factors - Untested Patents" and "- Governmental Regulation" and "Business - Competition." 3. Lack of Ssles and Earnings During the past five years the Company's activities have consisted of product development, clinical and consumer testing and the development of promotional and advertising plans. The Company has not yet commenced commercial scale manufacturing or retail sales of its Smokeless Cigarette. Since commencement of operations by NCC Group, Ltd. in August, 1982, through March 31, 1984, NCC Group, Ltd. had an accumulated net loss of $435,576. During the period from inception in April, 1983, through March 31, 1984, the Company had an accumulated net loss of 527,146. The Company does not anticipate that it will have significant sales or operate at a profit for at least twelve months after the date of this Prospectus. Furthermore, the Company anticipates that its operations will result in decreases in its working capital for at least 24 months after the date of this Prospectus because initial retail sales are not expected until approximately twelve months after this offering and because a significant amount of working capital is expected to be used as inventory and accounts receivable increase prior to and after the commencement of initial retail sales. The Company believes, however, that the proceeds of this offering, together with its cash on hand, will be sufficient to meet its cash needs for at least twelve months following this offering. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." 4. Untested Patents The Company currently holds one United States patent, and holds seven foreign patents and currently pending patent applications in eight other foreign countries paralleling its United States patent relating to the basic technology underlying the Smokeless Cigarette. In addition, the Company has applied for patents covering certain improvements to the Smokeless Cigarette and inventions concerning certain other nicotine related products. The Company has received an opinion from its patent counsel, Arnold, White & Durkee, Houston, Texas, to the effect that the product which it intends to market, as well as the process which it intends to use in manufacturing its product, do not infringe any known U.S. patent rights of other parties. Nevertheless, the foregoing opinion is not binding upon any court or governmental agency and none of the Company's patent rights have been litigated or subjected to judicial scrutiny. Moreover, the Company believes that many courts have been unsympathetic to the holders of patents relating to relatively simple inventions such as the Smokeless Cigarette. It is possible that if a manufacturer of a similar product could demonstrate a significant difference between its product and the Smokeless Cigarette, the Company would be unable to prevent the sale of such product. Therefore, if the Company's patent rights are tested in litigation, there can be no assurance that patent rights affording substantial competitive protection to the Company will be upheld or that such rights would prevent the marketing of competing products similar in concept and design to the Smokeless Cigarette. Furthermore, there is no assurance that the Company 8

would be able to absorb the expenses of patent litigation against any infringers if necessary to enforce the Company's rights. Nevertheless, the Company intends, to the extent of its financial resources, vigorously to defend its patent rights with respect to competing products it believes infringe upon such righu. See "Business - Patents and Trademarks." 5. Control by Officers, Directors and Current Shareboiders After completion of this offering and assuming the exercise of the Wari-ants, the officers, directors and existing shareholders of the Company, and the owners of the Smokeless Cigarette patent and related rights, will own approximately 75% of the shares of Common Stock of the Company then outstanding. Accordingly, since the Common Stock of the Company has no cumulative voting rights, such officers, directors, shareholders and owners will be in a position to elect all of the directors of the Company and to control its business policies. See "Principal Shareholders." 6. Dilution This offering involves immediate substantial dilution of the book value of the Common Stock of the Company from the offering price per Unit. See "Dilution." 7. Possible Release from Escrow and Rule 144 Sales All holders of the Common Stock other than purchasers of Units have agreed with the State Securities Commissioner of Texas to deposit into escrow an aggregate of approximately 3,000,000 of the 5,737,600 shares of the Company's Common Stock they will own after the transactions described in this Prospectus. The escrow agreement generally provides that such shares may not be released from escrow prior to the fifth anniversary of this offering, and thereafter only in aggregate annual increments of approximately 600,000 shares, unless (i) the Company's net earnings in each of any two consecutive fiscal years are at least equal to the product of 10% of the public offering price per Unit times 6,987,600 (the number of shares of Common Stock outstanding immediately after the closing of this offering), (ii) the Company's accumulated net earnings after this offering are equal to or greater than the product of 30% (increasing by 6 percentage points per year in each year after the fifth anniversary of the effective date of the Registration Statement of which this Prospectus is a part) of the public offering price per Unit times 6,987,600, (iii) the closing price per Unit or the combined closing price, as the case may be, per share of Common Stock and per Warrant if the Common Stock and Warrants are separately tradeable, for at least 90 consecutive trading days shall have been at least (a) S 13.00 (adjusted for stock splits and stock dividends) at any time on or before the fifth anniversary of the effective date of the Registration Statement of which this Prospectus is a part, or (b) 59.75 (adjusted for stock splits and stock dividends) at any time after the fifth anniversary of such effective date, or (iv) a tender offer or an offer to merge or otherwise acquire the Company's Common Stock or substantially all of its assets pursuant to which the public shareholders of the Company are entitled to receive not less than the same value per share (which must be cash if the offer is made by certain affiliates) as the existing shareholders is made by a third party and accepted by the Company or the holders of a majority of its Common Stock. In addition to the foregoing escrow agreement, all holders of the Company's securities have agreed with the Representative of the Underwriters to refrain from selling any shares of Common Stock in the public trading market except pursuant to the provisions of Rule 144 under the Securities Act applicable to "restricted securities," even though 4,692,122 of such shares issuable in connection with the acquisition of the Smokeless Cigarette patent rights are covered by the Registration Statement of which this Prospectus is a part and, absent such an agreement, the holders of such shares would generally be able to resell their shares free of such restrictions. Unless previously waived by the Representative of the Underwriters, this agreement will result in the eligibility for sales in the public market, subject in some cases to the foregoing escrow agreement, of 990,478 of the currently outstanding shares of Common Stock beginning in September, 1985, 55,000 shares beginning in January, 1986, and the balance (4,692,122 shares) two years following the completion of this offering. The availability of such shares for resale may have an adverse effect on the market price for the Company's Common Stock. The release of any of the foregoing shares from escrow and the availability of any of the foregoing shares for resale pursuant to the agreement with the Representative ofthe Underwriters may have an adverse effect on the market price for the Company's securities. 9

8. Dependence on Key Personnel The Company will be heavily dependent on the efforts of certain of its executive officers. The loss of the services of one or more of these individuals could materially adversely affect the Company. While certain of such executive officers have had experience with other consumer products and have been involved in the development of the Smokeless Cigarette, none has had experience in the packaging or manufacturing of the Smokeless Cigarette. See "Management." Futhermore, the Company's adticipated operations will require it to employ and train a significant number of additional employees. There can be no assurance that the Company will be successful in recruiting or retaining personnel of the requisite caliber or in the requisite number to enable the Company to conduct its business as proposed. See "Business - Employees." 9. Possible Products II.iability Claims Because the Smokeless Cigarette is a novel nicotine delivery product and because manufacturers of conventional cigarettes have been subjected to products liability lawsuits based on the content of conventional cigarettes, the Company may be subjected to products liability claims from persons who use the Smokeless Cigarette in the manner intended by the Company. However, the Company believes that normal use of the Smokeless Cigarette is no more harmful, if at all, than the inhalation of nicotine through the smoking of conventional cigarettes. The Smokeless Cigarette contains an amount of nicotine comparable to that contained in some brands of conventional cigarettes and less than is contained in most cigars. As is the case with conventional cigarettes and cigars, the amount of nicotine contained in a Smokeless Cigarette may be harmful if swallowed. Consequently, the Company may be subjected to products liability claims from persons who may use the Smokeless Cigarettes in ways not anticipated or intended by the Company. The packages in which the Smokeless Cigarettes will be sold will bear a warning that the Smokeless Cigarette may be harmful if swallowed. See "Business - The Smokeless Cigarettes." The Company maintains an umbrella insurance policy providing up to S 11,000,000 in coverage and intends to obtain additional excess products liability coverage of approximately S20,000,000 prior to commencing commercial operations. USE OF PROCEEDS The net proceeds from the sale of the 1,250,000 Units offered hereby are estimated to be approximately $7,100,000, excluding any proceeds from any exercise of the Underwriter's over-allotment option or from any exercise of Warrants. The following table sets forth each intended use of proceeds and the percentage of the aggregate net proceeds represented by each. Pending such uses, the net proceeds will be invested in short-term, interest-bearing obligations, such as certificates of deposit issued by banks, government obligations and money market securities. Inteoded Use of Proceeds Amount % of Aggrce.te Net Proceeds Advertising and promotional costs ................................... 53,100,000 43.7% Purchasing, modification and refurbishment of manufacturing equipment necessary to commence commercial scale operations ........................................... 1,500,000 21.1% Construction of leasehold improvements to initial manufacturing facility ..................................................... 350,000 4.9% Market research ................................................................. 250,000 3.5% Production of inventory necessary to commence commercial scale operations ........................................... 700,000 9.9% Financing of other anticipated operating expenses prior to commencement of commercial scale operations (including S335,000 for management salaries) .............. 700,000 9.9% Working capital ................................................................ 500,000 7.0% The Company anticipates that the net proceeds from this offering, together with cash on hand, will be sufficient to finance its operations for at least twelve months following the completion of this offering. 10

See "Risk Factors - Lack ofSales and Earnings" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." DIVIDEND POLICY The Company has not paid any dividends on its Common Stock and intends for the foreseeable future to follow a policy of retaining earnings, if any, for use in connection with the commencement of its operations and expansion of its business. DILUTION For purposes of the following discussion, no value has been assigned to the Warrants included in the Units being offered hereby and purchasers of the Units are considered to have paid 56.50 per share of Common Stock. At March 31, 1984, the net tangible book value of the Company's Common Stock was S 197,436, or S.034 per shm, after giving effect to the acquisition of the assets subject to the liabilities of NCC Group, Ltd. "Net tangible book value" represents the amount of the Company's tangible assets (which excludes the Company's patent rights) less the amount of its liabilities. Without giving effect to any other changes in such book value after March 31, 1984, but giving effect to the sale by the Company of the Units offered by it hereby (kss estimated expenses and underwriting discounts and commissions), the pro forma net tangible book value of the Company at March 31, 1984 would have been S 1.06 per share. This represents an immediate dilution to new investors purchasing Units in the offering of 55.44 per share from the -initial--public- ofl'crine_prisx _per _Unit,_ _as -illustrated in _the- following_ t-a_ble._ Neither_ the_ foregoing calculations nor the tables give effect to the exercise of (i) the Warrants included in the Units, or (ii) the 100,000 Unit purchase warrants to be purchased by the Representative of the Underwriters, which if exercised may result in additional dilution. Public offering price .................................................................................. 56.50 Net tangible book value before offering .................................................... S.034 Increase attributable to payments by new investors .................................. 1.026 Pro forma net tangible book value after offering ....................................... 1.06 Dilution of net tangible book value per share to new investors ................. 55.44 The following table compares the share ownership and cash contribution to the Company (including its predecessors) thcrefor by the Company's existing shareholders, including shareholders receiving shares in connection with the acquisition of the assets of NCC Group, Ltd. and the above private placement, with the share ownership and effective cash contribution to the Company therefor by persons purchasing Units in the offering described herein. Perccnt of Percent Total o f Cons{d- Shares Total Coasident3oo tradoa Purchaied Shue. Paid Pald Existing shareholders .................................. 5,737,600 82.1% $1,156,675 12.5% Purchasers in offering ................................. 1,250,000 17.9% $8,125,000 87.5% The Company's shareholders other than purchasers of the Units have agreed with the State Securities Commissioner of Texas to deposit in escrow an aggregate of 3,000,000 of such shareholders' shares, subject to release only upon the satisfaction of certain conditions. Such shareholders have also agrecd not to sell any of their shares in the public market except in compliance with the holding period, volume limitations and other requirements of Rule 144 under the Securities Act of 1933. The shares held by such shareholders would not become available for such sales until the period commencing in September, 1985 through the second anniversary of this offering. See "Risk Factors - Possible Release From Escrow and Rule 144 Sales" and "Management - Certain Transactions." Il

CAPITALIZATION The following table sets forth the actual shareholders' equity and capitalization of the Company as of March 31, 1984, on a pro forma basis as of such date giving effect to the acquisition of the net assets of NCC Group, Ltd. and as adjusted to give effect to the sale of the Units (exclusive of the 187,500 Units subject to the Underwriters' over-allotment option). Marcb 31, 1984 Outstandins Pro Forma Combined As Adjusted (Unaudited) Debt ................................................................ - - - Shareholders' equity: Preferred stock, $100.00 par value; authorized, 500,000 shares; none issued .... - - - Common stock, 5.01 par value; authorized, 30,000,000 shares; issued and outstanding, 1,067,908 shares, 5,737,600 shares pro forma and 6,987,600 shares as adjusted(1) ................. 10,679 57,376 69,876 Paid-in capital .............................................. 238,705 1,076,059 8,197,934 Deficit .......................................................... (27,146 ) (462,722) (462,722) Total shareholders' equity ........................... $222,238 S 670,713 $7,805,088 (1) Excludes 163,600 shares of Common Stock covered by outstanding options, 310,000 shares of Common Stock reserved for issuance upon exercise of options that may be granted under the Company's incentive stock option plan, and 150,000 shares of Common Stock issuable upon exercise of Unit purchase warrants to be purchased by the Representative ofthe Underwriters and upon exercise of Warrants included in the Units covered by such Unit purchase warrants. See "Management - Stock Option Plan" and "Underwriting." 12

SELECTED FINANCUIL INFORMATION The following tables set forth certain historical selected financial information for the Company, on a prolorma basis giving effect to thc'aoquisition of the net assets of NCC Group, Ltd., and as adjusted to give cffect to the sale of Units (exclusive of the 187,500 Units subject to the Underwriters' over-allotment option). The following selected financial information has been derived from historical audited and historical unaudited financial statements, and u.nauditod pro forma financial statements included elsewhere in this Prospectus, and should be read in conjunction therewith. The historical financial statements of the Company and NCC for the periods to December 31, 1983 have been examined by Dcloitte Haskins & Sells, certified public accountants, whose report thereon, together with such financial statements and notes thereto, appear elscwhar in this Prospectus. The following pro forma condensed operating data is not necessarily indicative of the future results of operations of the combined Company. THE COMPANY AND PRO FORMA - THE COMPANY AND NCC GROUP, LTD. COMBINED December 31, Marrb 31, 1984 1983 Pro Forma As Hktorka! H{storkal Combtoed(l) Adjusted Balance Sheet DAta: Working capital .......................................... $ 2,125 $127,461 $195,598 57,329,973 Total assets ................................................. 29,668 279,734 703,691 7,838,066 Total liabilities ........................................... 16,284 57,496 32,978 32,978 Total shareholders' equity .......................... 13,384 222,238 670,713 7,805,088 ANgust, 1982 7hrK MontW (Date of Year Ended tscepti00) LO Eaded March 31, December 31, December 31, 1982 1983(1) 1983 1981 Operating Data(1): Advanced Tobacco Product~ Inc.: Revenues - interest ................................ $ S 2,762 Total expenses ......................................... 16,000 13,908 Net loss .................................................... S(1 6,000) S(11,146) Net loss per share ..................................... M.OJ4 S(.01) Pro Forma Combined - Advancod Tobacco Products, Inc. and NCC Group, Ltd. Revenues - interest ................................ $ 17,117 $ 28,459 $ 7,177 S 3,946 Total expenses ......................................... 178,598 263,173 37,842 70,473 Net loss .................................................... S(161,481) S 234 714 S 3( 0,665) S 6( 6,527) Net loss per share ..................................... S(.OS) S-O l) (1) Includes only the operations of the Company from April, 1983 (date of inception) through December 31, 1983. 13

MANAGEMEN-I'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND R£SULT'S OF OPERATIONS Liquidity and Capital Resources During the past five years the Company's activities have consisted of product development, clinical and consumer testing and the development ofpromotional and advertising plans. Since the commencement of operations of NCC Group, Ltd. in August, 1982, through March 31, 1984, the NCC Group, Ltd. had an accumulated net loss of 5435,756. During the period from inception in April, 1983 through March 31, 1984 the Company had an accumulated net loss of 527,146. The Company has not yet commenced retail sales or commercial scale manufacturing of its Smokeless Cigarette. The Company expects to introduce the Smokeless Cigarette in Austin and San Antonio, Texas, commencing approximately one year after this offering, and in Dallas and Houston during the second year after this offering. Depending on the results of initial marketing and the Company's manufacturing, marketing and financial capacity, the Company presently anticipates that it will introduce the Smokeless Cigarette nationally in the second or third year after this offering. The Company's only source of capital to date has been the net proceeds from the sale in 1981 of 5500,000 of units of limited partnership interest in its predecessor NCC Group, Ltd., and from the sale of 55,000 shares of Common Stock in a private placement in January, 1984 for $220,000. Until the commercial introduction of its Smokeless Cigarette, the Company's only anticipated source of cash, other than income from the short term investment of its cash on hand, will be the net proceeds from the sale of the Units. Upon the completion of this offering the Company will have net cash resources of approximately $7,200,000, of which approximately S 1,850,000 will be used during the six-month period following the completion of this offering to purchase, modify and refurbish manufacturing equipment and to make leasehold improvements to its initial manufacturing facility. During the two-year period following completion of this offering the Company plans to apply approximately 54,700,000 to advertising and promotional costs and market research, but the Company's advertising and promotion expenditures could increase substantially during the second year of such two-year period if the Company commences its national expansion during such second year. Approximately 5700,000 will be required to finance the production of the Company's initial inventory of Smokeless Cigarettes believed to be necessary to commence commercial operations. As a result of the foregoing and other anticipated expenditures, the Company anticipates that approximately S 1,300,000 of the Company's cash on hand and net proceeds of this offering will be available to finance the Company's other cash expenditures until positive cash flow from operations, if any, is achieved. See "Use of Proceeds." As indicated above, the Company anticipates the initial commercial introduction of its Smokeless Cigarette and the receipt of initial revenues from operations no earlier than the first anniversary of the completion of this offering. Accordingly, the Company expects that its operations will continue to result in operating losses for at least twelve months after this offering. Furthermore, the Company anticipates that its operations will result in decreases in its working capital for at least 24 months after this offering because initial retail sales are not expected until approximately twelve months after this offering and because a significant amount of working capital is expected to be used as inventory and accounts receivable increase prior to and after the commencement of initial retail sales. Nevertheless, assuming no internally generated revenues other than income from short-term investment of available cash, and the anticipated addition of employees consistent with the Company's current business plan, the Company anticipates that its cash on hand, together with the net proceeds of this offering, will be sufficient to meet its anticipated cash requirements for at least the twelve-month period following completion of this offering. There can be no assurance, however, that the Company's actual losses will not be greater than anticipated or that its available cash will in fact be sufficient to meet its cash requirements. In any event, if the Company commences its national expansion during the second year after this offering, the Company anticipates that the costs and expenses associated with such expansion would cause its anticipated operating losses to continue and its anticipated cash requirements to exceed its available cash 14

during such second year. To the extent that the Company's available cash is insufficient, for any reason, to meet the Company's cash requirements, the Company may attempt to raise additional capital through bank borrowings, additional sales of equity or other securities, or other means, but has not made any arrangements with any third parties with respect thereto. Certain Factors Bearing on Results of Future Operations Anticipated Unit Manufacturing Costs and Revenues. The Company plans to market its Smokeless Cigarettes in packs of six, which packs are intended to have a nicotine delivery capacity sufficient to satisfy the average smoker of conventional cigarettes for an entire day, for a factory selling price of approximately 60 cents per pack. The Company believes that such price is the approximate average factory selling price for packs of 20 conventional cigarettes and that the retail price per pack of six Smokeless Cigarettes will be approximately the same as, or slightly less than, the average price per pack of 20 conventional cigarettes. The Company anticipates that the manufacturing cost, including manufacturing overhead, of the Smokeless Cigarette will be approximately 22 cents per pack of six at the commencement of commercial scale production, assuming the manufacturing of approximately 200,000 Smokeless Cigarettes per eight hour shift and one production line, decreasing to approximately 16 cents assuming the manufacturing of 800,000 Smokeless Cigarettes per eight hour shift and four production lines, which the Company anticipates will be its approximate maximum output per shift. The foregoing unit manufacturing costs do not include operating costs not directly or indirectly related to manufacturing, which costs (particularly for advertising, promotional and other marketing costs) are expected to be substantial. There can be no assurance that the demand for the Smokeless Cigarette will be sufficient to justify the manufacturing of 800,000 Smokeless Cigarettes per eight hour shift. Furthermore, there can be no assurance that the anticipated substantial marketing costs and the increased per unit manufacturing costs that could arise if demand is insufficient to justify the production ofat least 200,000 Smokeless Cigarettes per eight hour shift and one production line would not have an adverse effect on the Company's results of operations. See "Business - Manufacturing." Selling. Distribution and Marketing Costs. The Company expects to incur significant selling, distribution and marketing costs to introduce, and to expand and maintain sales of, the Smokeless Cigarette. The Company's region-by-region marketing strategy is designed to control such costs, but such costs are expected to exceed manufacturing costs for the foreseeable future. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" and "Business - Marketing and Markets." Effect ojFederal Cigarette Excise Tax. The Company believes its Smokeless Cigarette will not be subject to current federal excise taxes applicable to conventional cigarettes. See "Business - Governmental Regulation and Taxation - Taxation ofCigarettes Under the Internal Revenue Code." Because the amount of the current federal cigarette excise tax is calculated by the use of a flat tax rate per thousand cigarettes manufactured, each pack of six Smokeless Cigarettes manufactured would result in approximately 30% of the tax imposed on a pack of 20 conventional Class A cigarettes. Therefore, in the event the Smokeless Cigarettes were taxed under the Internal Revenue Code on the same basis as conventional Class A cigarettes, each pack of six Smokeless Cigarettes would bear a tax of 4.8 cents. The federal cigarette excise tax was doubled on January 1, 1983. There can be no assuranet that if the tax is determined to be applicable to the Smokeless Cigarette, the Smokeless Cigarette would not be subject to similar future increases. IS

BUSINESS Introduction The Company believes that the Surgeon General's determination that cigarette smoking is dangerous to smokers' health and the legal and social trend toward the protection of non-smokers from the effects of cigarette smoke have created a market for a product that delivers nicotine in a form and manner similar to that enjoyed by smokers of conventional cigarettes while avoiding the principal negative effects of ciprette smoking. The number of conventional cigarette smokers who will purchase and use the Smokeless Cigarette on a sustained basis, however, cannot be reliably estimated. Nevertheless, the Company believes that its profitability does not require a large percentage penetration of the conventional cigarette market .because an independent study indicates that in 1982 there were approximately 56 million American smokers smoking approximately 633 billion conventional cigarettes at a retail cost of approximately S23.4 billion (and that in 1981 more than four trillion conventional cigarettes were manufactured worldwide). Although the Surgeon General and other medical researchers have concluded that many of the products of the combustion of tobacco known popularly as "tar" (including aza-arenes, turmorigenic hydrocarbons, arsinious oxide and radioactive polonium compounds) are carcinogens, nicotine is not known to the Company to have ever been shown to be a cause ofcanoer or lung disease. In the November 17, 1983, prepublication release of the Surgeon General's report entitled The Health Consequences ofSmoking: Cardiovascular Disease ("the 1983 Surgeon General's Report"), the Surgeon General indicates that the increased risk of heart disease is even a greater hazard to smokers of conventional cigarettes than the increased risk of cancer. The 1983 Surgeon General's Report and other medical literature believed by the Company to be responsible suggest that the carbon monoxide resulting from burning tobacco may increase smokers' risk of cardiovascular disease. Although noting that use of nicotine may negatively effect the operation of the cardiovascular system, the Surgeon General indicates that the exact mechanisms whereby nicotine might influence cardiovascular events are unknown. Furthermore, the Surgeon General and many other medical commentators have not shown nicotine to be a primary contributor to the hazards of inhaling cigarette smoke and there is a significant body of scientific opinion to the effect that cigarette smokers experience pleasurable, though not therapeutic, pharmacological effects from inhaling nicotine and that these pleasurable effecu may be the primary reason many individuals continue cigarette smoking in spite of health warnings and negative social consequences. The 1983 Surgeon General's ~eport states that: "One should not ignore the proportion of the population that continues to smoke, nor should one accept unchallenged the concept of a`safe' cigarette. The main objective is to reduce the harmful constituents present in tobacco smoke. It is probable that promotion of ultra-low-yield products will not suffice, since compensatory mechanisms may be triggered by sensory needs for taste as well as for nicotine. . "A cigarette considered less harmful for cancer etiology might not reduce the risk for coronary disease. It appears to be a formidable task to develop a product that satisfies the smoker and does not increase disease risk through exposure to carbon monoxide, cyanide, nitrous oxide, or still unknown agents." The Company believes that the Smokeless Cigarette does not contain the harmful constituents referred to in the Surgeon General's Report, but responds to conventional cigarette smokers' sensory needs for taste and nicotine. However, the Smokeless Cigmtte was not tested by or on behalf of the Surgeon General and the 1983 Surgeon General's Report concluded that it is unlikely that a "safe cigarette" can be developed that will reduce the risk of cardiovascular disease. The 1983 Surgeon General's Report states the following with regard to the effect of nicotine as delivered by conventional cigarettes: "Nicotine exerts an effect on danglionic cells, producing transient excitation. The pharmacological effects are small, but are reinforced several times daily in habitual smokers. 16

The exact mechanisms whereby nicotine might influence cardiovascular events are unknown, but a lowering of the ventricular fibrillation threshold is closely related to nicotine levels." Because the Company believes that the Smokeless Cigarette delivers an amount of nicotine within a range of amounts delivered by conventional cigarettes, the Company believes that the Surgeon General's statements with regard to the effect of nicotine as delivered to conventional cigarette smokers would also be applicable in the case of the Smokeless Cigarette. The conventional cigarette industry has responded to the public's health concerns relating to cigarette smoking primarily with two general innovations: filtered cigarettes and low tar cigarettes. Most low tar and filtered cigarettes are designed to reduce the tar content of cigarette smoke in a manner which also reduces nicotine delivery. Consequently, the Surgeon General has indicated that smokers of low tar and filtered cigarettes may smoke more low tar or filtered cigarettes per day in order to maintain their accustomed daily intake of nicotine than do many smokers of other conventional cigarettes. Non-tobacco industry responses to the problems of cigarette smokers have included attempts to simulate cigarette smoking through the use of substances not including nicotine or the removal of nicotine from cigarette smoke by filtration, and alternative means of nicotine delivery such as NicoretteO, chewing gum recently introduced by Dow Chemical Company. Unlike the foregoing alternatives, the Company's product is intended to offer cigarette smokers the alternative of continuing their nicotine consumption in a manner similar to smoking conventional cigarettes, but free of other products of tobacco combustion suspected to be harmful. The Company is not aware of any currently available product which provides the conventional cigarette smoker with a means of enjoying the inhalation of nicotine in circumstances in which conventional cigarette smoking is illegal or socially unacceptable. Consequently, the Company believes that its Smokeless Cigarette is a unique ahernative for conventional cigarette smokers who desire nicotine inhalation pleasure with reduced health concerns and without negative social consequences or legal restrictions. The Company intends to market the Smokeless Cigarette as a pleasurable nicotine product and not as a product intended to deter or reduce smoking or to have therapeutic benefits. The Smokeless Cigarette The Smokeless Cigarette consists essentially of an active surface containing a nicotine solution blended with carriers, flavorants and pH buffers inserted within a small tube having the shape, weight and size of a conventional cigarette. Whed the user draws air through the Smokeless Cigarette a small amount of nicotine vapor is emitted into the air inhaled by the user. In order to appeal to the perceived preferences of the conventional cigarette smoker, the Company, has designed its Smokeless Cigarette in order to have substantially the same appearance, weight and feel, and to provide a similar sensation, as a conventional cigarette. The Smokeless Cigarette includes cigarette filter rod segments overwrapped with a paper laminate and commonly used cork-like tipping paper, and can be manufactured in standard cigarette lengths. The nicotine solution used in the Smokeless Cigarette is blended with flavorants for the purpose of approximating the flavors of leading brands of "regular," "menthol" and "light" conventional cigarettes. These flavorants are available to the Company from suppliers of flavorants to the conventional cigarette industry. The Company intends to offer the Smokeless Cigarettes in packs of six at a retail price approximately the same as, or slightly less than, a pack of twenty conventional cigarettes. Each pack of six Smokeless Cigarettes will have a nicotine delivery capacity intended to satisfy the average smoker of conventional cigarettes for an entire day. Because the nicotine delivery capacity of a Smokeless Cigarette is determined primarily by the amount of nicotine it contains, a single Smokeless Cigarette can be manufactured with the nicotine delivery capacity of several cigars or conventional cigarettes. However, because the Smokeless Cigarette is more efficient as a means of nicotine delivery than are cigars and conventional cigarettes, a Smokeless Cigarette can be manufactured to deliver an amount of nicotine equivalent to several conventional cigarettes or cigars while containing only an amount of nicotine comparable to that contained in a single cigarette of some brands of conventional cigarettes and less than is contained in most cigars. 17

The Company expccts initially to manufacture the Smokeless Cigarette in a form such that each normal •'puf}r" on a Smokeless Cigarette will deliver an amount of vaporized nicotine, which the Company believes • is within a range of amounts of nicotine delivered by a normal puff on many conventional cigarettes. See "The Company." Nicotine is an alkaloid with two properties not found among commonly~used alkaloids, such as, for example, caffeine, quinine, and codeine, which enable the Smokeless Cigarette to deliver nicotine to its user in substantially the same form and quantity per inhalation as many conventional cigarettes without the nceessity for tobacco combustion. First, the quantity of nicotine required to produce the effect on the nervous system to which most cigarette smokers are accustomed is small relative to the amounts of other alkaloids regularly consumed by typical users. This characteristic is important because nicotine is a toxic substance and, if consumed in a manner different than inhalation of the amount delivered by conventional cigarettes or through the Smokeless Cigarette, can be highly dangerous. See "Risk Factors - Possible Products Liability Claims." Second, nicotine when extracted from tobacco and properly distilled is a colorless, transparent liquid which vaporizes easily. Market and Marketing The Company believes that most users of the Smokeless Cigarette will be current smokers of conventional cigarettes who wish to reduce their health concerns or to enjoy nicotine in environments where smoking is forbidden or when others may be offended by conventional cigarette smoke and odor. According to an independent study, in 1982 approximately 56 million Americans smoked 633 billion conventional cigarettes purchased at retail for 523.4 billion, and in 1981 more than 4 trillion conventional cigarettes were manufactured world wide. The Company intends to market the Smokeless Cigarette initially in Austin and San Antonio, Texas beginning no earlier than the first anniversary of the completion of the public offering, and in Dallas and Houston during the second year after this offering, and to expand its market throughout the United States and selected foreign countries thereafter on a region by region basis based on and subject to the results of initial marketing and the Company's manufacturing, marketing and financing capacity. The Company anticipates two significant marketing advantages not enjoyed by its conventional cigarette competitors. Fim, the Company anticipates the availability of television advertising of its Smokeless Cigarettes which the Company believes is the most cost-effective means of mass consumer advertising. Second, the Company believes that the introduction of its Smokeless Cigarette will require less promotion and advertising than is the case'with the introduction of new conventional cigarette brands or smokeless tobacco products because the Smokeless Cigarette is a novel form of nicotine delivery and therefore more likely to benefit from consumer curiosity and word-of-mouth publicity. The Company believes that such publicity is likely to occur due to the continuing publicity regarding the health risks of smoking and legal restrictions on smoking in public places, publicity surrounding the recent introduction by Dow Chemical Company of its NicoretteO' nicotine chewing gum, and publicity normally associated with newly introduced novel consumer products. The Company's strategy of region by region introduction of the Smokeless Cigarette is intended to help control its advertising and promotional cost by allowing the Company to concentrate its initial advertising in a single region in order to initiate its anticipated word-of-mouth advantage. However, there can be no assurance that the Company's anticipation of the availability of television advertising and of consumer curiosity regarding the Smokeless Cigarette will be accurate or that any such initial curiosity will result in positive word-of-mouth publicity. The amount of advertising and promotional activity to be financed by the net proceeds of this offering is far less than that normally necessary for a successful nationwide introduction of a new conventional cigarette brand or smokeless tobacco product. See "Risk Factors - Potential FDA Regulation; Other Governmental Regulation and Taxation," "Management's Discussion and Analysis - Selling, Distribution and Marketing Costs" and "Business - Governmental Regulation and Taxation - The Federal Cigarette Labeling and Advertising Act." 18

The Company plans to introduce its Smokeless Cigarette through a regional multi-media advertising program emphasizing television advertising, but also including magazine, newspaper and outdoor billboard advertising. To the extent that television advertising is not available to the Company, the Company intends to rely primarily on such latter forms of advertising. This program has been developed by the Company with the assistance of its advertising agency, The Richards Group, Inc. of Dallas. The Company's strategy will be to distribute its Smokeless Cigarettes through the same retail outlets through which conventional cigarettes are sold. The Company anticipates selling directly to supermarkets through food brokers and to drug stores and tobacco wholesalers through manufacturers representatives. The Company expects that tobacco wholesalers will re-distribute the Smokeless Cigarettes to restaurants, newsstands and other retailers of tobacco products. No commitments or other arrang.ements have been made with any such distributors because the Company believes that it is customary in introducing new consumer products for the manufacturer to arrange distribution relationships approximately three months prior to the commercial introduction of the product and to arrange retail relationships when commercial quantities of the product are in warehouse inventory. The Company does not anticipate any significant delays or difficulties in establishing satisfactory distribution relationships because the Company believes, based on management's experience with the introduction of other consumer products, that demand by food brokers and tobacco wholesalers for new consumer products is sufficient to facilitate the wholesale and retail distribution of the anticipated quantities of the Smokeless Cigarette. The Company intends to market its Smokeless Cigarette under the trademark "FAVOR" which the Company believes signifies the benefits of the Smokeless Cigarette to its user and to others who would otherwise be subjected to tobacco smoke had the user not chosen a Smokeless Cigarette. See "Business - Patents and Trademarks." Competition The Company believes that its principal competitors will be manufacturers of conventional cigarettes, most, if not all, of which have financial, promotional, advertising, manufacturing and other resources substantially in excess of the Company's. The Company's ability to finance promotional activities is small when compared with such large and experienced competitors. However, because the Smokeless Cigarette is a novel concept in the delivery of nicotine satisfaction, the Company believes that the promotional and advertising costs required to introduce its product will be substantially less than the costs normally incurred in the introduction of a conventional cigarette brand into the highly competitive conventional cigarette market. The Company believes the use of television advertising would also provide the Company with a competitive advantage over conventional cigarette manufacturers who are prohibited by the Federal Cigarette Labeling and Advertising Act from advertising conventional cigarette products on television. Further, since the Company anticipates that the direct manufacturing costs of a pack of Smokeless Cigarettes will be no greater than a pack of conventional cigarettes with less nicotine delivery capacity, the Company anticipates that it will be able to offer a substantial cost per unit advantage to the consumer, if necessary for competitive purposes, because of the heavy tax component of the retail price of conventional cigarettes. The Company intends, however, initially to sell packs of six Smokeless Cigarettes at approximately the same factory price as most packs of 20 conventional cigarettes. See "Risk Factors - Uncertain Market and Competition" and "- Potential FDA Regulation; Other Governmental Regulation and Taxation," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business Markets and Marketing." In addition to other factors, the Company anticipates that it will enjoy a direct manufacturing cost advantage over manufacturers of conventional cigarettes because the Company's manufacturing equipment will be less complicated, resulting in a smaller percentage of skilled labor among manufacturing personnel and because costly handling and storage of tobacco will not be required. The Company believes that the Smokeless Cigarette is competitive with conventional cigarettes because the Smokeless Cigarette can often be used in situations in which smoking conventional cigarettes is undesirable or prohibited. In addition, although the Company does not claim that the Smokeless Cigarette possesses any therapeutic benefits, the public may perceive the Smokeless Cigarette to be less harmful than conventional cigarettes. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business - Markets and Marketing," "- Manufacturing." 19

In addition to manufacturers of conventional cigarettes, the Company will be competing with manufacturers of conventional smokeless tobacco products such as chewing tobacco and snuff, and of alternative nicotine delivery products such as Dow Chemical Company's Nicorette' nicotine chewing gum, many, if not all, of which also have financial, promotional, advertising, manufacturing and other resources far greater than those of the Company. The Company may also experience substantial competition from manufacturers of future nicotine delivery products similar to the Smokeless Cigarette unless the Company is able successfully to assert patent infringement actions with respect to such products. See "Risk Factors - Untested Patent Protection" and "Business - Patents and Trademarks." Manufacturing While the Smokeless Cigarette resembles a conventional cigarette, it consists of two filter rods of a type commonly used by manufacturers of filter tipped conventional cigarettes, wrapped with a paper laminate and commonly used tipping paper. One of the filter rods constitutes the part of the Smokeless Cigarette into which the nicotine is introduced and the other rod is the tip which is placed in the user's mouth. The Smokeless Cigarette can be manufactured by modified versions of machines in common use by manufacturers of filter tipped conventional cigarettes. The manufacture of the Smokeless Cigarette will involve substantially the same steps as the manufacture of conventional filter tipped cigarettes except that the difficult tasks of dealing with thin cigarette paper and maintaining proper packed tobacco density will not be involved. The two types of filter rods used in the product will be fed into a combiner machine which will cut the filter rods into desired lengths and wrap them in alternating order with a laminated paper. The combiner will then cut the alternating filter rod assembly into lengths constituting two cigarettes each. These double length assemblies will then be fed into a tipping machine which will wrap commonly available tipping paper around the center of each assembly and then cut it at the center point, resulting in two tipped Smokeless Cigarettes. • The Smokeless Cigarettes will then be injected with a small amount of a nicotine solution by the use of a needle load injector commonly used by the felt-tip pen industry. Nicotine solution in volumes sufficient to meet the Company's foreseeable needs is available from a number of sources outside of the conventional cigarette and smokeless tobacco product industry. The finished Smokeless Cigarettes will then be fed into packing and wrapping machines commonly used in the conventional cigarette industry. The Company has obtained a commitment from a supplier to provide, modify and refurbish four dual rod combiners at a price of $50,000 each ($200,000 total), four tipping machines at $25,000 each (S 100,000 total), four packers at S 150,000 each (5600,000 total), four wrappers at S27,500 each (S 110,000 total) and four needle load injectors at 530,000 each (S 120,000 total). The Company believes that these t::achines,x,ilt, ,, ., ~~.,;~ir.~.,.~.,;~ir.~i....r.it.with four man>~ctt~ing lines with a combined sustained manufacturing capability of approximately one million Smokeless Cigarettes per eight-hour shift. Operation of these four manufacturing lines will require approximately 7,500 square feet of floor space and approximately 30 production personnel per shift. The Company has obtained a commitment for the lease of a 20,000 square foot facility, on a 40 acre tract, to be constructed in the San Antonio metropolitan area in which to establish its initial four line manufacturing facility. The lease will provide for a three year initial term and two successive five year renewal terms, at a rental rate of 5.93 per square foot (depending on final construction costs) plus cost of living adjustments during the renewal terms. The Company's cost analysis indicates that its manufacturing cost of a pack of six Smokeless Cigarettes with a nicotine delivery capacity approximately equivalent to a twenty cigarette pack of conventional cigarettes will be approximately 16 cents, assuming the manufacturing of 800,000 Smokeless Cigarettes per eight hour shift using the manufacturing equipment described above. The Company anticipates that its maximum output per eight hour shift in its contemplated manufacturing facility will be approximately 800,000 Smokeless Cigarettes There can be no assurance that the demand for the Smokeless Cigarette will be sufficient to justify the manufacturing of 800,000 Smokeless Cigarettes per shift and the Company anticipates that its unit manufacturing costs will be higher at lower levels of production. See "Management's Discussion and Analysis of Financial Condition and Results of Operation - Certain Factors Bearing on Results of Operations." 20

Patents and Tradem.irks The Company is the owner of United States Patent No. 4,284,089, which issued on August 18, 1981, and will expire on August 18, 1998. This patent relates to the technology underlying the Smokeless Cigarette. The Company has been advised by its patent counsel that the product which it intends to market, as well as the process which it intends to use in manufacturing its product, do not infringe any known existing patent rights of other parties. See "Risk Factors - Untested Patents." Three additional United States patent applications have been filed in the ordinary course of the Company's research and development activities with regard to nicotine delivery. The Company cannot predict whether any particular patent applied for will be granted. The Company is also the owner of patents issued by seven foreign countries and currently pending patent applications in eight foreign countries paralleling its United States patent. The Company intends to seek additional foreign patents in selected countries paralleling currently pending United States patent applications. The Company is not able to determine at this time whether its patents or those which may eventually issue from pending applications will secure long term competitive advantages for the Company. None of the Company's patent rights have been litigated or subjected to judicial scrutiny and the Company believes that many courts have been unsympathetic to the holders of patents relating to relatively simple inventions such as the Smokeless Cigarette in patent infringement actions seeking to assert such patents. Therefore, if the Company's patent rights are tested in litigation, there caa be no assurance that patent rights affording substantial competitive protection to the Company will be upheld or that such rights would prevent the marketing of competing products similar in eoncept to the Smokeless Cigarette. Therefore it is possible that if a competitor could demonstrate a significant difference between the form of a competing product or the related manufacturing process and the Smokeless Cigarette, the Company would not be able to prevent the competitor from marketing such a product. The Company intends vigorously to defend its patent rights against infringement by competitors, but the Company's limitod resources may make it difficult or impossible to sustain any such defenses, however meritorious. See "Risk Factors - Untested Patents." The Company has filed with the United States Patent and Trademark Office an application to register the trademark "FAVOR" for use in connection with its Smokeless Cigarette. Governmental Regulation snd Taucation General ~ Governmental regulation and taxation of tobacco products, including cigarettes, generally consists of the television advertising prohibitions and labeling requirements of the Federal Cigarette Labeling and Advertising Act and similar state statutes or regulations, and foderal and state cigarette excise taxes. The Company believes that its Smokeless Cigarette is not subject to significant state or federal governmental regulation or taxation. The Company's belief, however, is based upon the opinion of its counsel, Matthews & Branscomb, San Antonio, Texas, and, to the extent such opinions relate to matters within the jurisdiction of or relating to the FDA, its special FDA counsel Burditt & Calkins, Washington, D.C., generally to the effect summarizod below and in "Risk Factors - Potential FDA Regulation; Other Governmental Regulation and Taxation." Such opinions are based primarily upon such counsels' literal interpretation of several significant statutes and regulations applicable to certain tobacco products, but which do not specifically include or exclude the Smokeless Cigarette as a regulated or specially taxed product. Such opinions are not binding upon any court or governmental agency and the Company has not sought any ruling or determination, nor is it aware of any controlling precedents under any such statutes or regulations. FDA Cigarette Regulation . Although tobacco products are not specifically excluded from the provisions of the Federal Food, Drug and Cosmetic Act (the "FDC Act"), the Food and Drug Administration (the "FDA") has refused to assert jurisdiction over conventional cigarettes by maintaining the position that the FDC Act does not apply to cigarettes containing nicotine or nicotine separately.'The FDA's position was affirmed in 1980 by the United States Court of Appeals for the District of Columbia Circuit in Action on Smoking and Health v. Harris. It is management of the Company's belief that the FDA's position with regard to tobacco products 21

has been modified only when a manufacturcr of a tobacco product claims that its product is therapeutically or medicinally beneficial as well as pleasurable or when the users of the product intend therapeutic or medicinal efiam. The Company does not claim any therapeutic or medicinal effects from the use of the Smokeless Cigarette nor does it intend to market the Smokeless Cigarette claiming any such effects. The Company does believe that use of the Smokeless Cigarette, unlike the use of conventional cigarettes, will not increase the user's risk of lung disease or cancer because the Smokeless Cigarette does not contain any of the ingredients that the Surgeon General has concluded increase such risksr but the Company does not believe that use of the Smokeless Cigarette will reduce the user's risk of lung disease or cancer or have a therapeutic or medicinal effect on any user suffering such a condition. See "Business - Introduction." Nevertheless, users of the Smokeless Cigarette may believe the Smokeless Cigarette has therapeutic or medicinal effects which could increase the risk that the FDA could take the position that the Smokeless Cigarette is subject to the FDC Act, and, in any event, the FDA may determine, based on statements by the Company or any other relevant evidence, that the Smokeless Cigarette is subject to FDA approval and regulation. The term "drug," as defined in the FDC Act, includes "articles (other than food) intended to affect the structure or any function of the body.... ." Although cigarettes and the nicotine delivered thereby do affect certain body functions, in 1953 the United States Court of Appeals for the Second Circuit in F. T.C. v. Ligett & Myers Tobacco Co., construed the Federal Trade Commission Act, which employs an identical definition of "drug," so as to exclude conventional cigarettes from such definition. In reaching this conclusion, the court relied upon the legislative history of the FDC Act and administrative interpretation of the Federal Trade Commission Act. The court noted that while cigarettes and the nicotine delivered thereby might be deemed to have a "soothing" effect on the body, it was doubtful that Congress intended for every substance which produces a soothing effect to be considered a "drug" for regulatory purposes. Because of the foregoing, the Company does not believe the Smokeless Cigarette will be subject to FDA regulation. However, there is a possibility that the FDA could consider the Smokeless Cigarette to be a"drag" under the FDC Act, and while the Company would vigorously oppose and appeal such a determination, it is possible that the Company would be unsuccessful in its opposition and appeal. Under the FDC Act, a "new drug" must be the subject of an approved new drug application in order to move lawfully in interstate commerce. The Company has not filed a notice of claimed investigational exemption for a new drug or a new drug application for the Smokeless Cigarette. Should FDA regulation be imposed, introduction of the Smokeless Cigarette into the United States market could be delayed for an indefinite period pending testing by the Company to demonstrate the safety and effectiveness of the product. In addition, should FDA regulation be imposed,,the Company may fail to obtain the FDA approval that would be needed to conduct appropriate tests or the Company may otherwise fail to obtain approval of a new drug application. Any FDA approval of the Smokeless Cigarette could be conditioned upon restrictions, such as a requirement that a prescription be obtained for each purchase of Smokeless Cigarettes, materially adverse to the Company's marketing efforts. If the Smokeless Cigarette is marketed in interstate commerce under such circumstances without an approved application, the Company could be in violation of the FDC Act and such violation could result in seizure of the product, injunctions and criminal penalties. FDA Smoking Deterrent Regulation The most recently published FDA action regarding conventional cigarettes has been its proposal in 1982 of rules on Smoking Deterrent Drug Products. The proposed rules would establish conditions under which over-the-counter smoking deterrent products would generally be recognized as safe and effective and not misbranded. These rules do not purport to regulate nicotine, but are intended to regulate those products which claim to deter or reduce smoking. If these proposed rules become effective and if the Smokeless Cigarette were advertised or marketed as a product to reduce or deter smoking, the Company would be required to conform to the labeling and testing requirements ofthese rules as finally adopted. The Company intends, however, to market the Smokeless Cigarette as a pleasurable nicotine product and not as a product intended to reduce or deter smoking. Therefore, the Company does not believe that the Smokeless Cigarette would be subject to the FDA's proposed rules. Nevertheless, the Smokeless Cigarette may be deemed to be subject to the proposed rules because of user perceptions of the effect of the product. 22

Taxation ojCrgarettes Under the Internal Revenue Code The Internal Revenue Code of 1954, as amended (the "Code"), and the regulations promulgated thereunder by the Bureau of Alcohol, Tobacco and Firearms (the "BATF") generally deal with the taxation of the manufacture and sale of cigarettes and cigars. Smoking tobacco, chewing tobacco and snuff are excluded from taxation by definitions contained in the Code and by specific BATF regulation. The Code and BATF regulation definition of a "cigarette" includes-a product which is a "roll of tobacco" wrapped in paper or other substanoes. Because the Smokeless Cigarette contains a nicotinesolution instead of a "roll of tobacco," the Company believes that it is not a "cigarette" as defined by the Code and BATF regulations. In a ruling (ATF Ruling 78-2) attempting to clarify the definition of"cigarette" under the Code and BATF Regulations, the BATF held that "a cigarette-style smoking product which contains no tobacco, tobacco-derived component or resin, nicotine or nicotine derivative is not a cigarette... ." Although the quoted language could indicate that the BATF considers any cigarette-style smoking product which contains nicotine to be a"cigarette" for such purposes, the BATF has not indicated by published action known to the Company whether in its view a cigarette-style nicotine product like the Smokeless Cigarette which is not smoked would be a "cigarette" as defined in the Code or BATF regulations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Factors Bearing on Results of Future Operations" for a discussion of the anticipated effect of the application of current federal cigarette excise taxes to the Smokeless Cigarette. The Federal Cigarette Labeling and Advertising Act The labeling requirements and television advertising prohibitions of the Federal Cigarette Labeling and Advertising Act (the "Advertising Act") apply only to'cigarettes. The definition of "cigarette" under the Advertising Act is identical to the "roll of tobacco" definition of "cigarette" used in the Code and the BATF regulations. The Federal Trade Commission, the federal agency through which the Advertising Act is enforced, has not expressly ruled on the question of whether a cigarette-style product which contains a tobacco derived component such as nicotine would be a"cigarette" as defined in the Advertising Act. Again, because the Smokeless Cigarette contains a nicotine solution instead of a "roll of tobacco" and in the Company's opinion does not give rise to the health concerns addressed by the Advertising Act, the Company believes that the Smokeless Cigarette is not a "cigarette" as defined by the Advertising Act. However, because the Smokeless Cigarette has the appearance of a conventional cigarette and contains nicotine, there can be no assurance that the FTC would concur with the Company's position. See "Risk Factors - Potential FDA Regulation; Other Governmental Regulation and Taxation," and "- Prohibition of Television Advertising; Federal Excise Tax" for discussions of the adverse effects of the application of the Advertising Act to the Smokeless Cigarette. The Federal Hazardous Substances Act The Federal Hasardous Substanoes Act~tfie'°Substances Act"yprovides the Consumer-Product Safety Commission ("CPSC") with the authority to regulate the labeling, packaging, manufacturing and sale of products determined by the CPSC to be "hazardous substanets" within the meaning of the Substances Act and the regulations promulgated thereunder. The Substances Act specifically excludes "tobacco and tobacco products" from its scope. To the Company's knowledge, the CPSC has not ruled on the question of whether nicotine or the Smokeless Cigarette is a"tobaceo product" under the Substances Act. The Company believes that because the nicotine used in the Smokeless Cigarette is derived entirely from tobacco, the Smokeless Cigarette is a"tobaeco product" not regulated under the Substances Act. State Regulation and Taxation State regulation of tobacco products generally consists of taxing laws and regulations and the regulation of the use of tobacco products, primarily cigars and cigarettes. Although most states tax all tobacco products, cigarettes and cigars are generally taxed at the highest rate. State statutes taxing cigarettes and cigars are believed by the Company to be generally inapplicable to Smokeless Cigarettes because definitions of the taxed product generally include "a roll of tobacco for smoking," without specifying 0 0 0 r Io

nicotine alone as the relevant substance. However, to the Company's knowledge no state or municipal taxing authority has interpreted any such law or regulation in the specific context of the Smokeless Cigarette. The Company believes that the Smokeless Cigarette will be generally subject to state and municipal taxation as a smokeless tobacco product such as chewing tobacco and snuff. \ The use of tobacco smoking products is primarily regulated by state statutqs and municipal ordinances prohibiting public smoking. The prohibitions in these state statutes and municipal ordinances generally proscribe "smoking tobacco" irt certain public places. The Company believes that the state and municipal prohibitions are generally inapplicable to the use of its Smokeless Cigarettes because such use does not involve "smoking." However, to the Company's knowledge no prohibition on public smoking has been interpreted in the specific context of the Smokeless Cigarettes. Many states have enacted hazardous substance laws similar to the federal Substances Act. To the Company's knowledge these laws have not generally been enforced against tobacco or tobacco products, even when tobacco products are not specifically excluded as hazardous substances as is the case under the federal Substances Act. Texas, the state in which the Company intends to initially manufacture and market the Smokeless Cigarette, has a hazardous substance law similar to the federal Substances Act, and which to the Company's knowledge has not been applied to tobacco or tobacco products. Unlike the Substances Act, however, there is no specific Texas statutory exclusion of tobacco or tobacco products. No Texas court or agency has interpreted Texas' hazardous substance law in the specific context of the Smokeless Cigarette. There -can therefore be no as;ura,-rce-that-T-exas-or any-otlier state--will-consider-the-Smokeles.s-Cigarette a tobacco product. Properties or leased following the closing of this offering. The Company owns no substantial tangible property, but will hold the patent rights now held by NCC Group, Ltd. and other technology owners upon consummation of this offering. See "The Company." See "Business - Manufacturing" for a description of manufacturing equipment and facilities to be acquired Employees As of March 31, 1984, except for one clerical employee and five prototype assembly personnel, the Company's staff oonsisted enti ly of management, including its Chairman and Chief Executive Officer, President and Chief OperatinOfficer, Vice Chairman and Chief Marketing Officer, Vice President - Administration and Vice President - Technology. See "Management - Executive Officers and Directors." After the completion of this offering and prior to the anticipated first introduction of the Smokeless Cigarette into the retail market, the Company anticipates hiring an additional four managerial personnel, including a Vice President - Operations, Vice President - Advertising and Promotion, Vice President - Sales, and Vice President - Finance, approximately 15 administrative employees, approximately 22 sales, research and development and manufacturing employees and approximately 30 hourly wage manufacturing, shipping and maintenance employees per shift. Researcb and Development The Company conducts an ongoing research and development program pursuant to which it intends to improve its manufacturing processes and products and develop additional tobacco-related products. 24

MANAGEMENT Executive Officers and Directors The following table sets forth the names, ages and positions of the executive officers and directors of the Company. N.me AQe Posltioo Gerald R. Mazur J. Philip Ray 64 49 Chairman of the Board of Directors, Chief Executive Officer, Treasurer and Director President, Chief Operating Officer, and Director Edmund G. Vimond, Jr. 48 Vice Chairman of the Board of Directors, Chief Ira D. Hill James D. Simonsen Jack R. Crosby Edward C. Gardere Stan Richards 49 43 56 51 51 Marketing Officer and Director Vice President - Technology Vice President - Administration, Secretary Director Director Director M r. Mazur, along with Mr. Ray, was a founder and director of Datapoint Corporation of San Antonio, Texas, a manufacturer of electronic data processing systems, and was employed by Datapoint Corporation in various capacities from 1968 to 1971, including Chairman of its Board of Directors and Chief Executive Officer. Since 1971, Mr. Mazur has been an investor in and sponsor of various real estate and oil and gas enterprises and has participated as a partner in an independent insurance brokerage firm. Mr. Ray is the founder and general partner of NCC Group, Ltd. and since 1977 has been engaged in research and development activities relating to the Smokeless Cigarette and other nicotine products. Mr. Ray was a founder and director of Datapoint Corporation and served as its President and Chief Operating Officer from 1968 to 1973. From. 1973 until 1977, Mr. Ray was engaged in electronic data processing research and development. .Prior to organizing Datapoint Corporation in 1968, Mr. Ray was Program Manager of the Dynatronics Division of General Dynamics Corporation, Manager of Engineering for International Data Systems Corporation, and Project Engineer for Texas Instruments, Inc. Mr. Vimond was President and Chief Executive Officer of R. J. Reynolds Tobacco International, Inc., from 1980 to 1982. In 1978 and 1979 Mr, Vimond was Group Vice President of American Cyanamid Corporation with responsibility for the marketing of household products, toiletries and fine fragrances, including products sold under the brand names "Pine-Sol," "Breck," "Old Spice," "Nina Ricci," "Pierre Cardin" and "Cie." From 1970 to 1977, Mr. Vimond was employed primarily in consumer products marketing executive positions by various subsidiaries of Johnson & Johnson, Inc., including Personal Products Company of which he was President in 1976 and 1977. Personal Products Company manufactures and sells feminine hygiene products under the brand names "Modess," "Stayfree" and "Carefree." Since 1982 Mr. Vimond has been a principal in Lemont Consulting Group, a marketing and management consulting firm in New York City. Dr. Hill was Vice President, Technology,.of International Flavors & Fragrances, Inc. from 1979 through 1983, responsible for, among other matters, research and development of fragrance concentrates for use in plastics. From 1974 to 1979, Dr. Hill was Research and Development Vice President of 25

International Flavors & Fragrances, Inc. From 1970 to 1974 Dr. Hill served as Manager, Research and Development, Environmental Planning, of Monsanto Industrial Chemicals Co. Mr. Simonsen was Vice President - Human Relations of Datapoint Corporation from February, 1978 until December, 1983. From 1970 until February, 1978 Mr. Simonsen was Director of Industrial \ Relations of Datapoint Corporation. Mr. Crosby is a founder of Prime Cable Corporation and Telesystems International Corporation, operators of cable television systems in the United States and Switzerland, respectively. Mr. Crosby is also a founder and Chairman of the Board of Directors of Rust Investment Corporation and the managing general partner of Rust Capital, Ltd., a privately owned small business investment company, and is a general partner of Rust Ventures, Ltd., a venture capital limited partnership. Mr. Crosby also serves on the boards of directors of Texas American Bancshares Corporation (a bank holding company), Orion Pictures Corp. (an entertainment company), Buckhorn, Inc. (a conglomerate), and Evergreen Capital Corp. (a venture capital firm), Mr. Crosby has been active in the cable television and venture capital business through the activities described above and in other enterprises for more than the past five years. Mr. Gardere, a director of the Company since December, 1983, has been Chairman of the Board of Directors and Chief Executive Officer of Schneider, Bernet & Hickman, Inc., the Representative of the Underwriters, for more than the last five years. Mr. Richards, a director of the Company since December, 1983, has been President and Chief Executive Officer of The Richards Group, Inc., an advertising firm of which he is the founder, for more than the last five years. Directors are elected by the Company's shareholders for a term which continues until the next annual meeting of the Company's shareholders or until their respective successors are duly elected and qualified. The Company's officers are elected by the Board of Directors of the Company and hold office until their respective successors are duly elected and qualified. The outside directors receive S500 per meeting, plus reimbursement of travel expenses. Remuneration None of the officers or directors have received cash remuneration from the Company aggregating 560,000 or at a rate which would aggregate 560,000 on an annual basis except for Mr. Ray who has received a consultation fee at a rate of 560,000 per year from NCC Group, Ltd. since its inception in August of 1982. The following table sets forth certain information concerning the remuneration which the Company anticipates will be paid to or accrued for the account of certain executive officers of the Company and to all such executives as a group for services to the Company in all capacities during the 12 month period following the completion of this offering. It is anticipated that such remuneration will be paid out of a portion of the proceeds of the offering. See "Use of Proceeds.". Name of Individual or Identity of Group Cap&city Casb Remuneration Gerald R. Mazur Chairman of the Board and Chief Executive S 100,000 J. P. Ray Officer and Treasurer President and Chief Operating Officer 100,000 Edmund G. Vimond, Jr. Vice Chairman of the Board and Chief 60,000 Marketing Officer 26

Name of lodi.idual or ldeotit) of Group Cap-in CaA Remuneration James D. Simonsen(l) Vice President - Administration, 50,000 Ira D. Hill(2) Secretary Vice President - Technology ~ 23,000 All such officers as a group (5 persons) 5335,000 (1) The Company's agreement with Mr. Simonsen requires his services full time except to the extent his time is reasonably required for establishment by him of an executive search firm which will provide the Company with executive search services on a direct expense reimbursement only basis. See "Management - Certain Transactions." (2) The Company's agreement with Dr. Hill does not require his services full time, but provides that he must devote so much of his time to the Company's business as may be reasonably necessary to carry out the specific assignments given him by the Company's President or Board of Directors and recognizes that he may spend in excess of 50% of his professional time on other business not competitive with the Company's nicotine product business. The Company employs Gerald R. Mazur, J. P. Ray, Edmund G. Vimond, Jr., Ira D. Hill and James D. Simonsen under employment agreements expiring in 1987. These agreements provide that these employees of the Company shall receive the annual salaries indicated in the above cash remuneration table as well as certain employee benefits. These agreements are terminable without cause by the Company upon the payment of three months' salary by the Company and contain confidentiality and non-competition provisions. Incentive Stock Option Plans On January 5, 1984, the Company's Board of Directors and shareholders adopted the Advanced Tobacco Products, Inc. 1984 Incentive Stock Option Plan (the "ATP Plan"), which authorizes the granting of stock options covering a maximum of 310,000 shares of Common Stock to officers and key management employees of the Company. The Board of Dinoctors.may grant options to eligible participants upon such terms as the Board of Directors may determine in its sole discretion, so long as consistent with the terms and purposes of the ATP Plan. Members of the Board of Directors are eligible to participate in the ATP Plan provided they are employees and do not participate in the decision or vote of the Board of Directors concerning the grant, purchase price, or other terms of any option of which they are a recipient. Under the ATP Plan, the exercise price per share cannot be less than 100% (or 11096 in the case of options granted to holders of 10% or more of the then outstanding Common Stock) of the fair market value of the Company's Common Stock as determined by the Board of Directors on, and the exercise period for the option cannot exceed ten years from, the date the option is granted. An option granted under the ATP Plan may be exercised only after one year of continued employment by the Company immediately following the date of grant of the option. Upon the first annual anniversary of the date of grant, options shall be exercisable with respect to 25% of the underlying shares and thereafter options may become exercisable with respect to no more than 25% of the underlying shares per year. Options granted under the ATP Plan are not transferable except by will or the laws of descent or distribution and are exercisable only if the optionee, unless retired, deceased or disabled, is employed by the Company at the time of exercise. On May 22, 1984, the Company granted a four year option to purchase 15,000 shares of Common Stock at an exercise price of $6.00 per share to Gerald K. Hofer in connection with his employment as the Company's comptroller. No other stock options have been granted under the ATP Plan. In April, 1983, the Company adopted its S. A. Vend, Inc. 1983 Incentive Stock Option Plan (the "S. A. Vend Plan"). The terms of the S. A. Vend Plan are substantially the same as the ATP Plan except that options may be granted by the Board of Directors of the Company under the S. A. Vend Plan without restriction as to time of exercise and may be exercised within 90 days following termination of employment 27

by the Company without cause. In April, 1983, Mr. Mazur was granted an option under the S. A. Vend Plan to purchase 887,250 shares of Common Stock at an excrcise price of 5.03 per share. Mr. Mazur exercised his option in whole in September, 1983. Five-year options under the S. A. Vend Plan have been granted to three other employees, Messrs. Vimond and Simonsen and Dr. Hill. Mr. Vimond's option covers 93.600 shares at an exercise price of 5.025 per share, and is exercisable as to 46,800 shares after August 1, 1984 and as to the balance after August I, 1985. Dr. Hill's option covers 30,000 shares at an exercise price of 53.25 per share, and is exercisable as to 15,000 shares after November 18, 1984 and as to the balance after November 18, 1985. Mr. Simonsen was granted an option on December 27, 1983 to purchase 25,000 shares at an exercise price of 53.50 per share, which is exercisable as to 12,500 shares after December 27, 1984 and as to the balance after December 27, 1985. Mr. Simonsen was, granted an option covering an additional 15,000 shares on January 6, 1984, at an exercise price of 54.00 per share, which option is exercisable as to 7,500 shares after January 6, 1985 and as to the balance after January 6, 1986. The S.A. Vend Plan has been terminated except as to outstanding options. The ATP Plan and the S. A. Vend Plan are not "qualified plans" within the meaning of Section 401 of the lnternal Revenue Code of 1954, as amended (the "Code"). The options granted under such plans may qualify as "incentive stock options" if the options and the optionee meet the requirements of Section 422A of the Code or may not be qualified if they fail to meet such requirements. Certain Transactions On September 19, 1983, the Company entered into an agreement with NCC Group, Ltd. (the "Acquisition Agreement ) under which the Company obtained the right to acquire all of the assets of NCC Group, Ltd., including the technology, patents and patent applications of NCC Group, Ltd. related to the Smokeless Cigarette and certain other nicotine related products. NCC Group, Ltd., formed in August, 1982 with aggregate capital contributions of 5505,051, obtained an option (the "Technology Option") to acquire the technology, patents and patent applications related to the Smokeless Cigarette held by J. P. Ray and certain other holders of such technology. The holders of such technology purchased their interests for an aggregate of approximately 5400,000 from 1978 through 1982. Simultaneously with the completion of this offering the Technology Option is being exercised by NCC Group, Ltd. and the Acquisition Agreement is being consummated, resulting in the Company's ownership of all of the technology, patents and patent applications related to the Smokeless Cigarette and other nicotine products developed by NCC Group, Ltd. Upon consummation of the Acquisition Agreement and exercise of the Technology Option and the liquidation of NCC Group, Ltd., Mr. Ray will receive 2,168,042 shares of Common Stock, Gerald R. Mazur, Chairman of the Board of Directors, Chief Executive Officer and a director of the Company, and trusts and custodianships for the benefit of members of his family will hold 941,689 shares of Common Stock, Rust Capital, Ltd., a venture capital investment partnership of which Jack R. Crosby, a director of the Company, is a partner, will receive 375,853 shares of Common Stock, and the other prior holders of the Smokeless Cigarette technology and patents and partners in NCC Group, Ltd. will receive an aggregate of 1,184,108 shares of Common Stock. All of the foregoing persons have agreed with the State Securities Commissioner of Texas to deposit a portion of their shares in escrow and have further agreed not to resell any of their shares in the public market except pursuant to the provisions of Rule 144. See "Risk Factors - Possible Release From Escrow and Rule 144 Sales" and "Dilution." ' The Company has entered into an agreement with The Richards Group, Inc. under which the Richards Group, Inc. will provide advertising and promotional services to the Company at rates and under terms considered by the Company to be reasonable and standard in the advertising industry and at least as favorable as could be obtained from unaffiliated parties. Stan Richards, a director of the Company, is the founder, President, Chief Executive Officer and principal owner of The Richards Group, Inc. 28

Edward C. Gardere, a director of the Company, is the Chairman of the Board Executive Officer of Schneider, Bernet & Hickman, Inc., the Represent8tive-b January, 1984, the Company sold 55,000 shares of Common Stock at a purchasep to twelve purchasers pursuant to a private placement. Certain affiliates of Schneid purchased 38,750 of such sharrs, including Mr. Gardere who purchased 6,25p may be sold until January, 1985 and thereafter may be sold only pursuant to Rule 144 or anu... from the registration requirements of the Securities Act of 1933. As a result, none of such shares i,.-, sold in the public market without registration until January, 1986, and then only subject to the volume limitations and other requirements of Rule 144. A portibn of such shares will be deposited in escrow pursuant to an agreement with the State Securities Commissioner of Texas. See "Risk Factors - Possible Rule 144 Sales." Under the Company's employment agreement with James D. Simonsen, its Vice President - Administration and Secretary, Mr. Simonsen may devote the time reasonably necessary to establish an executive search firm, so long as such firm will provide its services to the Company free of charge except for the reimbursement of direct costs. Transactions between the Company and its officers, directors, principal shareholders or affiliates of any of them will be on terms no less favorable than could be obtained from unaffiliated third parties. PRINCIPAL SHAREHOLDERS The following table sets forth information with respect to Common Stock ownership as of March 31, 1984, of the Company's directors, its officers and directors as a group and the beneficial owners of more than five percent of the outstanding Common Stock. Except as indicated below, the Company believes that each beneficial owner has sole investment and voting power with respect to the shares shown. Before Offerine(ix2) After OfferinQ(2) Name and Addreu of Numlxt Percent Numbei Percent BeoeGrial t7wner of Shares of C4ss of Shares of Class J. P. Ray ....................... .............................. 2,168,042 37.8% 2,168,042 31.0% 2929 Mossrock ~ Suite 130 San Antonio, Texas 78230 Gerald R. Mazu.r(3) ..................................... 586,994 10.20 586,994 8.4~0 One Riverwalk Place Suite 402 San Antonio, Texas 78205 Jack R. Crosby(4) ........................................ 375,853 6.6% 450,853 6.5% 1300 Norwood Tower Austin, Texas 78701 Officers and directors as a group (5 personsx3X4) .......................................... 3,147,023 54.9% 3,222,023 46.1% (1) Gives effect to the issuance of 4,669,692 net shares incident to the Company's acquisition of the assets of NCC Group, Ltd. (2) Excludes 163,600 shares of Common Stock covered by outstanding options granted, and an additional 310,000 shares of Common Stock reserved for issuance, under the Company's executive stock option nlans. 625.000 shares issuable upon exercise of the Warrants included in the Units offered hereby, up to 187,500 Units subject to the Underwriters' over-allotment option, and 150,000 shares issuable upon 29

exercise of Unit purchase warrants, and warrants included in Units underlying such warrants, to be purchased by the Representative of the Underwriters. See "Management - Stock Option Plan" and "- Certain Transactions" and "Underwriting." (3) Excludes 354,695 shares held by various trusts created by, and custodians appointed by, Mr. Mazur for the benefit of his children and grandchildren. , (4) Includes 375,853 shares held by a limited partnership of which Mr. Crosby is a partner and 75,000 shares included in 75,000 Units Mr. Crosby intends to purchase in this offering, but excludes 37,500 shares underlying the Warrants included in such Units. The shares included in such Units and underlying such Warrants will not be subject to the restrictions on transferability imposed on the Company's existing shareholders and described under "Risk Factors - Possible Release From Escrow and Rule 144 Sales" because Mr. Crosby did not own any shares of Common Stock directly prior to the offering. DESCRIPTION OF UNITS Each Unit offered hereby consists of one share of Common Stock and one Warrant. Each Warrant will entitle the holder to purchase one-half share of Common Stock of the Company. A share of Common Stock and the accompanying Warrant constituting a Unit will not be separately transferable prior to the Separation Date, which is August 21, 1984 (90 days after this offering), or such earlier date as may be designated by the Company, with the consent of the Representative of the Underwriters. Prior to the Separation Date, each Unit will be transferable only as a whole and any transfer of the shares of Common Stock offered as part of such Unit will constitute a transfer of the holder's interest in the Warrant included in such Unit. Each certificate representing shares of Common Stock of the Company and each certificate representing Warrants issued prior to the Separation Date to purchasers of Units will bear a legend to the foregoing effect. DESCRIPTION OF WARRANTS The Warrants will be issued in registered form pursuant to the terms of a Warrant Agreement to be dated as of May 23, 1984 (the "Warrant Agreement"), between the Company and Frost National Bank, as Warrant Agent. Prior to the Separation Date, the Warrants may not be exercised and the certificates evidencing the Warrants and shares of Common Stock constituting the Units may not be separated or transferred separately. The Representative has advised the Company that it expects that the Warrants and the Common Stock will be traded separately after the Separation Date. The following statements are summaries of certain provisions of the Warrant Agreement, copies of which may be examined at the principal corporate trust offices of the Warrant Agent and a copy of which is filed as an exhibit to the Registration Statement. The following statements are subject to the detailed provisions of the Warrant Agreement. Rights to Purchase Shares of Common Stock Each Warrant will entitle the registered holder to purchase from the Company one-half share of Common Stock at the exercise price set forth on the cover page of this Prospectus during the period commencing from the Separation Date and through the close of business on May 31, 1986, or such later date as the Company may determine in its sole discretion upon giving at least six months prior notice to the Warrant Agent and any stock exchanges on which the Warrants may be listed (the "Expiration Date"), except that, under the circumstances described below, the Expiration Date may be accelerated by the Company. The Warrants may only be exercised by the registered holders thereof in even multiples of Warrants. The exercise price, the number of shares of Common Stock purchasable upon exercise, and the number of Warrants are subject to adjustment as described below. Each holder of Warrants may exercise any or all such Warrants by surrendering the certificates evidencing such Warrants, with the form of election to purchase on the reverse side of such certificate properly completed and executed, together with payment of the exercise price to the Warrant Agent at its 30

office maintained for that purpose. Such office will initially be the principal corporate trust office of the Warrant Agent in San Antonio, Texas. The exercise price will be payable in cash in United States dollars or by certified or official bank check payable in United States dollars to the order of the Company. No adjustments as to dividends with respect to the shares of Common Stock of the Company will be made upon any exercise of Warrants. If less than all of the Warrants evidenced by a Warrant certificate are exercised, a new certificate will be issued for the remaining number of Warrants. Certificates evidencing the Warrants may be exchanged for new certificates of different denominations by presenting the Warrant certificates at the office of the Warrant Agent. The Company is not required to issue fractional Warrants upon adjustment, or fractional shares of Common Stock of the Company upon exercise, of the Warrants. In lieu of fractional shares, there will be paid to the holder of the Warrants at the time of any exercise an amount in cash equal to the same fraction of the current market value (as defined) of a share of Common Stock. Warrantholders do not have any voting or any other rights of shareholders of the Company and are not entitled to dividends, until the Warrants are exercised. Warrants will not be exercisable by a Warrantholder if (a) the shares of Common Stock issuable upon exercise of such Warrants have not been registered under the securities or blue sky laws of the state of residence of such holder or (b) a current prospectus meeting the requirements of the laws of such state cannot be lawfully delivered by or on behalf of the Company. Pursuant to the terms of the Warrant Agreement, the Company has agreed to use reasonable efforts to register such shares in all states and to maintain a current prospectus relating thereto. Acceleration of Expiration Date The Company may at its option accelerate the Expiration Date by giving notice to the Warrant Agent, if the Common Stock shall have had a closing bid price of not less than 200% of the then current Warrant exercise price per whole share of Common Stock for a period of 30 consecutive trading days ending not more than ten calendar days immediately prior to the date of such notice. Notice of the acceleration will be mailed to all Warrantholders and publicized in The Wall Street Journal at least 30 days, but no more than 60 days, before the. date to which the Expiration Date has been accelerated. ; Adjustments The exercise price and the number and kind of shares of Common Stock of the Company or other securities purchasable upon exercise of any Warrants and the number of Warrants are subject to adjustment upon the occurrence of certain events, including: the issuance of shares of Common Stock or other stock of the Company as a dividend or distribution on shares of Common Stock of the Company to the holders of all of its outstanding shares of Common Stock; subdivisions, combinations, or certain reclassifications of shares of Common Stock of the Company; the issuance to holders of shares of Common Stock of the Company generally of rights, options, or warrants (expiring within 45 days after the record date for determining stockholders entitled to. receive them) to subscribe for shares of Common Stock of the Company at less than 95% of the current market price (as defined); or the distribution to the holders of shares of Common Stock of the Company generally of evidences of indebtedness or assets (excluding cash dividends and distributions payable out of unrestricted surplus in accordance with Texas law or earned surplus and dividends or other distributions payable in Common Stock or other stock of the Company) or rights, options, or warrants to subscribe for securities of the Company other than those mentioned above. No adjustment in the exercise price will be required to be made with respect to the warrants until cumulative adjustments amount to one percent or more of the.exercise price; however, any such adjustment not required to be made will be carried forward and taken into account in any subsequent adjustment. In the event of any capital reorganization, certain reclassifications of the shares of Common Stock of the Company, any consolidation or merger involving the Compar)y (other than a consolidation or merger 31

which does not result in any reclassification or change in the outstanding shares of Common Stock), or sale of the properties and assets of the Company as, or substantially as, an entirety to any other corporation, each Warrant would thereupon become exercisable only for the number of shares of stock or other securities, assets, or cash to which a holder of the number of shares of Common Stock of the Company purchasable (at the time of such reorganization, reclassification, consolidation, merger, or sale) upon exercise of such Warrant would have been entitled upon such reorganization, reclassification, consolidation, merger, or sale. In the case of a cash merger of the Company into another corporation or any other cash transaction of the type mentioned above, the effect of these provisions would be that the holder of a Warrant would thereafter be limited to exercising such Warrant at the exercise price in effect at such time for the amount of cash per share that a Warrantholder would have received had such holder exercised such Warrant and received shares of Common Stock of the Company immediately prior to the effective date of such cash merger or transaction. Depending upon the terms of such cash merger or transaction, the aggregate amount of cash so received could be more or less than the exercise price of the Warrant. Modification of the Warrant Agreement The Warrant Agreement contains provisions permitting the Company and the Warrant Agent without the consent of any Warrantholder to supplement or amend the Warrant Agreement in order to cure any ambiguity, to correct or supplement any provision contained therein which may be defective or inconsistent with any other provisions therein, or to make any other provisions in regard to matters or questions arising thereunder which the Company and the Warrant Agent may deem necessary or desirable and which does not adversely affect the interests of the Warrantholders. CERTAIN INCOME TAX CONSIDERATIONS The following summary of federal income tax considerations is only a general discussion and the consequences to each investor will depend upon his circumstances. Consequently, each prospective investor is urged to consult his own tax advisor with specific reference to his particular circumstances. It is not practical to discuss al1 of the federal income tax consequences relating to the purchase, ownership, and disposition of a Unit. The following discussion relates to those issues which are likely to be among the most important to prospective investors and is based upon currently applicable laws, regulations, cases, and rulings, all as presently interpreted. The federal income tax considerations relevant to an investment in a Unit depend in part on the income tax situation of each particular investor. The discussion below is directed to individual taxpayers who are citizens of the United States. Foreign investors, corporations (including corporations which are subject to special rules such as subchapter S corporations or insurance companies), tax-exempt trusts, other trusts, and estates are cautioned to consult their tax advisors before investing in a Unit. In addition, this summary is limited to investors who will hold the Units, the shares of Common Stock, the Warrants, and any shares of Common Stock obtained upon exercise or automatic conversion of Warrants as "capital assets" (generally, property held for investment rather than primarily for sale to customers in the ordinary course of a trade or business) for federal income tax purposes. To determine tax basis for federal income tax purposes, the purchase price of a Unit will be allocated between the shares of Common Stock and the Warrants comprising the Unit in the proportion that the fair market value of each bcars to the sum of their fair market values. No gain or loss will be recognized by a holder of a Warrant upon the acquisition of shares of Common Stock of the Company by exercising the Warrant. However, short-term capital gain or loss, in some cases ordinary income, will be recognized to the extent that a holder receives cash in lieu of fractional shares. The holder's tax basis for shares of Common Stock of the Company received upon exercise of a Warrant 32

will equal the sum of the holder's tax basis in the Warrant plus the exercise price. The holding period for such shares of Common Stock will commence when the Warrant is exercised for purposes of determining whether a subsequent sale or exchange of the shares of Common Stock gives rise to long- or short-term gain or loss. The sale of a Warrant will result in recognition of capital gain or loss to the holder measured by the difference between the amount realized and the holder's tax basis in the Warrant. Such gain or loss will be long-term if the Warrant has been held for more than one year (or the long-term holding period in effect at the time of sale, if other than one year). Adjustments of the exercise price (and possibly adjustments to the number of shares of Common Stock of the Company purchasable upon the exercise of Warrants) could, upon the occurrence of certain distributions to holders of shares of Common Stock of the Company (which distributions are not currently contemplated by the Company), result in~constructive distributions to the holders of the Warrants which could be taxable as dividends under Section 305 of the Internal Revenue Code of 1954, as amended. DESCRIPTION OF CAPITAL STOCK The Company is authorized to issue 30,000,000 shares of Common Stock, 5.01 par value, and 500,000 shares of preferred stock, $ 100 par value. No preferred stock is outstanding and no series of preferrad stock has been fixed. All outstanding shares of Common Stock are, and the shares offered hereby upon issuance and sale will be, duly authorized, validly issued, fully paid and nonassessable. Holders of Common Stock are entitled to one vote per share on all matters submitted to a vote of shareholders, and the vote of the holders of a majority of the shares represented at a meeting at which a quorum is present will be the act of the shareholders' meeting unless the vote of a greater number is required by law or the Company's articles of incorporation. Cumulative voting in the election of directors is not permitted, and the holders of a majority of the Company's voting securities can therefore elect all members of the Board of Directors. See "Principal Shareholders." Holders of Common Stock have no preemptive rights to purchase or subscribe for securities of the Company, and the Common Stock is not convertible into any other securities or subject to redemption. Subject to the rights of holders of the Company's outstanding preferred stock, if any, the holders of Common Stock are entitled to receive such dividends as may be declared by the Board of Directors out of funds legally available therefor and, upon dissolution or liquidation, to share ratably in any assets of the Company remaining after satisfaction of its liabilities. The articles of incorporation of the Company provide that its Board of Directors may issue up to 500,000 shares of the preferred stock from time to time, in one or more series, in such amounts as the Board of Directors may determine without further action of the Company's shareholders. In determining to issue such shares of preferred stock, the Board of Directors is empowered to fix, among other things, the voting power, designations, preferenees, rights and restrictions of such preferred stock. In the event of any future issuance thereof, the specific attributes of such shares of preferred stock will be those which, in the judgment of the Board of Directors, are appropriate to the conditions and circumstances under which the shares are issued. The Company has no present intention to issue any shares of preferred stock. Frost National Bank, San Antonio, Texas, is the transfer agent and registrar for the Common Stock. I INDIM 33 u, 0 0 ~ ~

UNDERWRTI`ING Subject to the terms and conditions contained in the Underwriting Agreement, the Company has agreed to sell, and the Underwriters named below, for whom Schneider, Bernet & Hickman, Inc. is acting as Representative, have severally agreed to purchase the number of Units set forth opposite their respective names: I Uodcrwriter Number of Units Schneider, Bernet & Hickman, Inc ...................................................................... 500,000 William Blair & Company .................................................................................. 30,000 First Affiliated Securities, Inc . ............................................................................. 30,000 First Albany Corporation .................................................................................... 30,000 First Southwest Company ................................................................................... 30,000 J. J. B. Hilliard, W. L. Lyons, Inc . ....................................................................... 30,000 Howard, Weil, Labouisse, Friedrichs Incorporated ............................................. 30,000 Interstate Securities Corporation ......................................................................... 30,000 Laidlaw Adams & Peck Inc . ............................................................................... 30,000 ...... Morgar-,-Kee~gan &-£ortt any. Inc, <..,,._,................................................. - 30,000 The Ohio Company .....................::...................................................................... 30,000 Piper, Jaffray & Hopwood Incorporated ............................................................. 30,000 Rauscher Pierce Refsnes, Inc . ............................................................................. 30,000 Raymond. James & Associates, Inc . ................................................................... 30,000 Rodman & Renshaw, Inc. ................................................................................... 30,000 Rotan Mosle Inc . ................................................................................................ 30, 000 R. Rowland & Co., Incorporated ........................................................................ 30,000 Seidler Amdec Securities Inc . .............................................................................. 30,000 Wheat, First Securities, Inc . ................................................................................ 30,000 Woodman Kirkpatrick & Gilbreath .................................................................... 30,000 ....................................... Carolina Securities Corporation .................................... 15,000 D. A. Davidson & Co. InfDrporated ................................................................... 15,000 R. G. Dickinson & Co. ....................................:.................................................. 15,000 First Equity Corporation of Florida .................................................................... 15,000 Frederick & Company, Inc . ................................................................................ 15,000 Hariifen, Imhoff Inc . ............................ ............................................................... 15,000 Institutional Equity Corporation.......................................................................... 15,000 Manley, Bennett, McDonald & Co. ............................:....................................... 15,000 Roney & Co . .......................................................:............................................ ... 15,000 Sou thwest Sectui ti es, I nc . .................................................................................... 15,000 Sterling, Grace & Co., Inc . .................................................................................. 15,000 Weber, Hall, Sale & Associates, Inc . ................................................................... 15,000 Total .................................................................................................... ............. 1,250,000 The Company is obligated to sell and the Underwriters must purchase all of the Units offered hereby if any are purchased. Terms of Sale The Underwriters propose initially to offer the Units to the public at the initial offering price set forth on the cover page of this Prospectus and to certain dealers at such price less a concession of not more than 5.32 per Unit. The Underwriters may allow, and such dealers may reallow, a concession of not more than 5.25 per Unit on sales to other dealers. After the initial public offering, the public offering price, concession and reallowanocs may be changed by the Representative of the Underwriters. 34

There has been no previous public market for the Units, the Warrants or the Common Stock. The initial public offering price of the Units and the exercise price of the Warrants will be determined by negotiations between the Company and the Representative of the Underwriters. Factors that will be considered in determining such prices will include, among other things, the market potential for the Company's products, the Company's earnings potential, an assessment of th; Company's management, general conditions of the securities markets at the time of the offering, demand for similar securities of other issuers and other factors. The Units are offered by the Underwriters subject to receipt and acceptance by them, to their right to reject any order in whole or in part, to the approval of certain legal matters by counsel and to certain other conditions. It is expectcd that dclivery of the Units will be made against payment therefor in Dallas, Texas on or about May 31, 1984. Over-Allotment Option The Company has granted to the Underwriters an option, exercisable within 30 days after the date of this Prospectus, to purchase up to an additional 187,500 Units to cover over-allotments, if any, at the initial public offering price less the underwriting discount set forth on the cover page of this Prospectus. After the commencement of this offering, the Underwriters may confirm sales of Units subject to the over-allotment option. As a result, the Underwriters could have a short position equal to or in excess of the number of Units issuable upon exercise of the option. If the market price of the Units were to rise during the term of the option, the Underwriters will be protected from risk of loss on the Units subject to the ovcr-allotment option through their ability to cover any short position by purchases of the necessary Units at the offering price less the underwriting discount. If the Underwriters purchase any of the 187,500 additional Units, each of the Underwriters will have a firm commitment, subject to certain conditions, to purchase approximately the same percentage thereof which the number of Units to be purchased by it as shown in the foregoing table bears to 187,500. Any purchase of Units pursuant to the over-allotment option will result in the realization by the Underwriters of additional underwriting compensation to the extent of the underwriting discount applicable to such Units. Unit Purchase WarTants The Company has agreed, tor a price of $100 and in further consideration of obtaining competent investment banking scrvioes, to ketl to Schneider, Bernet & Hickman, Inc., the Representative of the Underwriters, concurrently with the purchase by the Underwriters of the Units being offered hereby, five year Unit purchase warrants covering an aggregate of 100,000 Units. All shares of Common Stock issuable upon the exercise of the Warrants underlying the Units subject to such warrants will be issuable out of the authorized but unissued shares of Common Stock of the Company. Such Warrants may be exercised as to all or any lesser number of Units covered thereby commencing twelve months after the date of this Prospectus and are non-transferrable except to (i) successors to the Representative in merger or consolidation; (ii) purchasers of substantially all of the Representative's assets; and (iii) officer-shareholders of the Representative or shareholders or partners of its transferees in the event of liquidation or dissolution. The warrants contain provisions which require, under certain circumstances, the Comparfy to register the Units underlying such warrants and the shares of Common Stock underlying the Warrants constituting a part of such Units for resale to the public at its sole cost and expense. The exercise price of the warrants is equal to 120% of the initial public offering price. The exercise price and the number of Units issuable upon exercise of the warrants are subject to adjustment in order to protect the holders thereof against dilution in certain events. For the life of the Unit purchase warrants, the holders thereof are given an opportunity to benefit from a rise in the market price of the Units, the Company's Common Stock and the Warrants with a resulting 35

dilution in the interests of other sbareholders: Holders of such warrants might be expected to exercise them at a time when the Company would, in all likelihood, be able to obtain any needed capital by a new offering of securities on terms more favorable than those provided by the warrants. Other Matters ' The Company has agreed to indemnify the several Underwriters against certain liabilities, including liabilities under the Securities Act of 1933, as amended. The shareholders of the Company (other than purchasers of Units), have agreed to refrain from selling any shares of the Company's Common Stock in the public market for a period of two years after the dates of their purchases without the prior written consent of the Representative of the Underwriters. See "Risk Factors - Possible Release From Escrow and Rule 144 Sales." The Underwriters do not intend to confirm sales to any accounts over which they exercise discretionary authority. Edward C. Gardere, Chairman of the Board of Directors and Chief Executive Officer of the Representative, is a director of the Company. See "Management." Joe B. Kercheville, a Senior Vice President and director of Rotan Mosle Inc. is a limited partner of NCC Group, Ltd. and holder of patent rights relating to the Smokeless Cigarette and in such capacities will receive 47,109 shares of the Company's Common Stock in connection with the Company's acquisition of the assets of NCC Group, Ltd. LEGAL MATTERS Certain legal matters in connection with the validity of the securities offered hereby and regulations and tax statutes applicable to the Company's business will be passed upon for the Company by Matthews & Branscomb, San Antonio, Texas. Certain legal matters within the jurisdiction of or relating to the FDA will be passed upon for the Company by Burditt & Calkins, Washington, D.C. Jackson, Walker, Winstead, Cantwell & Miller, Dallas, Texas is acting as counsel for the Underwriters in connection with certain legal matters relating to the securities offered hereby. Matthews & Branscomb and certain of its members will own 276,655 shares of Common Stock after giving effect to the offering and the acquisition of the assets of NCC Group, Ltd. as a result of their acceptance of shares and technology interests in partial payment for legal services rendered prior to the offering and their purchase of technology interests. EXPERTS The historical financial statements of the Company and NCC for the periods to December 31, 1983 included in this prospectus and in the registration statement have been examined by Deloitte Haskins & Sells, independent public accountants, as stated in their opinions appearing herein, and have been so included in reliance upon such opinions given upon the authority of that firm as experts in accounting and auditing. ADDITIONAL INFORMATION The Company has filed with the Securities and Exchange Commission, Washington, D.C., a Registration Statement under the Securities Act of 1933 with respect to the Common Stock offered hereby. This Prospectus does not contain all the information set forth in the Registration Statement, certain portions of which have been omitted pursuant to the rules and regulations of the Commission. Such information is available for inspection at the principal office of the Commission in Washington, D.C. Copies of the material contained in the Registration Statement may be obtained from the Commission upon payment of the fees prescribed by its rules and regulations. 36

ADVANCED TOBACCO PRODUCTS, INC. AND NCC GROUP, LTD. (Development Stage Enterprises) INDEX TO FINANCIAL STATEMENTS Pro Forma Combined - Advanced Tobacco Products, Inc. and NCC Group, Ltd. (Unaudited): Pro Forma Condensed Combined Balance Sheet at March 31, 1984 ....................................... F-1 Pro Forma Condensed Combined Statements of Loss for the period from August, 1982 (date of inception) to December 31, 1982, for the year ended December 31, 1983, for the three months ended March 31, 1984, and for the period from August, 1982 (date of inception) to March 31, 1984 ................................................................................................... F-2 Notes to Pro Forma Condensed Combined Financial Statements ............................................. F-3 Advanced Tobacco Products, Inc.: Opinion of Independent Public Accountants ............................................................................. F-4 Balance Sheets at December 31, 1983 and March 31, 1984 (Unaudited) ................................. F-5 Statements of Loss for the period from April, 1983 (date of inception) to December 31, 1983, for the three months ended March 31, 1984 (Unaudited), and for the period from April, 1983 (date of inception) to March 31, 1984 (Unaudited) .............................................. F-6 Statements of Changes in Shareholders' Equity for the period from April, 1983 (date of inception) to December 31, 1983 and for the three months ended March 31, 1984 (Unaudited) ................................................................................................... F-7 Statements of Changes in Financial Position for the period from April, 1983 (date of inception) to December 31, 1983, for the three months ended March 31, 1984 (Unaudited), and for the period from April, 1983 (date of inoeption) to March 31, 1984 (Unaudited) ................................................................................................... F-8 Notes to Financial Statements ................................................................................................... F-9 NCC Group, Ltd.: Opinion of Independent Public Accountants ............................................................................. F-11 Balance Sheets at December 31, 1982 and 1983 and March 31, 1984 (Unaudited) ................. F-12 Statements of loss for the period from August, 1982 (date of inception) to December 31, 1982, for the year ended December 31, 1983, for the period from August, 1982 (date of inception) to December 31,, 1983, for the three months ended March 31, 1983 and 1984 (Unaudited), and for the period from August, 1982 (date of inception) to March 31, 1984 (Unaudited) ................................................................................................... F-13 Statements of Changes in Partners' Capital for the period from August, 1982 (date of inception) to December 31, 1982, for the year ended December 31, 1983, and for the three months ended March 31, 1984 (Unaudited) ................................................................... F-14 Statements of Changes in Financial Position for the period from August, 1982 (date of inception) to December 31, 1982, for the year ended December 31, 1983, for the period from August, 1982 (date of inception) to December 31, 1983, for the three months ended March 31, 1983 and 1984 (Unaudited), and for the period from August, 1982 (date of inception) to March 31, 1984 (Unaudited) .........................................:.................................... F-15 Notes to Financial Statements ................................................................................................... F-16 37

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ADVANCED TOBACCO PRODUCTS, INC. AND NCC GROUP, LTD. (Development StW EaterprLsea) PRO FORMA CONDENSED COMBINED BALINCE SHEET (U.a.dlted). The following pro forma condensed combined balance sheet combines balance sheets of Advancxd Tobacco Products, Inc. ("ATPI") and NCC Group, Ltd. (a Limited Partnership) ("NCC"), at March 31, 1984, under the assumptions set forth in the accompanying notes. The acquisition of the assets of NCC is being accounted for as a reorganization of interests under common control. See Note I of Notes to Pro Forma Condensed Combined Financial Statements. The pro forma condensed combined balance sheet should be read in conjunction with the separate financial statements and notes thereto of ATPI and NCC included elsewhere herein. The pro forma condensed combined balance sheet is not necessarily indicative of the financial position of the combined company as it may be in the future. Marc! 31, 1984 Pro Forna Pro Forma ATPi NCC Adjustmeots Notes Combloed \ Current Assets: Cash ....................................................... S 176,925 S 43,619 S S 220,544 Receivable from ATPI ........................... 50,217 (50,217) (2) Prepaid insurance .............:...................... 8,032 8,032 Total current assets ................................ 184,957 93,836 (50,217) 228,576 Organization costs .................................. 10,975 10,975 Public offering eosts ................................ 83,302 83,302 Deposits .................................................. 1,338 1,338 Equipment .............................................. 500 ~ 500 Patents .................................................... 379,000 (1) 379,000 TOTALASSETS ............................................. 5279,734 S 95,174 S 328,783 S 703,691 Current Ilabllities: Payable to NCC ...................................... S 50,217 S S(50,217) (2) S Accrued expenses ................... 7,279 25,699 32,978 ................. 57,496 25,699 5_ ( 0,217) 32,978 Total current liabiGties....... Equity: Partners' capital ...................................... 505,051 (505,051) (1) Common stock ........................................ 10,679 46,697 (1) 57,376 Paid-in capital ........................................ 238,705 837,354 (1) 1,076,059 2) Deficit ..................................................... (27,14 6) (435,57 6) (462,72 Total equity ......................................... 222,238 69,475 379,000 670,713 TOTAL LIABILITIES AND EQUIIY ................. 5279,734 S 95,174 S 328,783 S 703,691 F-I

ADVANCED TOBACCO PRODUCIS, INC. AND NCC GROUP, LTD. (Devdopuxet Stage Eaterpriscs) PRO FORMA QONDENSED COMBiNIED STATF.MEN'i5 OF L06.S (U..altt.d) The following pro forma oondensod combined statements of loss combine the operations of Advanced Tobacco Products, Inc. ("ATPI") and NCC Group, Ltd. (a Limited Partnership) ("NCC") for the period from August, 1982 (date of inccption) to December 31, 1982, for the year ended December 31, 1983, for the three months ended March 31, 1983 and 1984, and for the period from August, 1982 (date of inception) to March 31, 1984. The pro forma combined statements of loss have been prepared under the assumptions set forth in the Notes to Pro Forma Combined Financial Statements. These statements should be read in conjunction with separate financial statements and notes thereto of ATPI and NCC, included elsewhere herein. The pro forma combined statements of loss are not necessarily indicative of the results of operations of the combined company as it may be in the future. AaRsest, 1982 (Date of Lceptioo) to December Year Eoded 1982(3) December 31, 1983(3) 1983(3) August, 1982 (Date of TLree Moot6s IDttPtlOO Ee6ed Much 31, of NCC) to Mares 31, 1984(3) 1984(3) Pro Forma Pro Forma Pro Forms NCC ATPI NCC Combioed. NCC ATPI NCC Combined Combined REVENUES - Interest ................... $ 17,117 $ S 28,459 $ 28,459 S 7,177 S 2,762 $ 1,184 S 3,946 $ 49,522 EX PE NS.FS: Research and development ....... 111,903 149,900 149,900 31,945 37,987 37,987 299,790 General and administrative ...... 29,147 16,000 65,137 81,137 13.908 9,196 23,104 133,388 Legal fees .................................. 37,548 32,136 32,136 5,897 9,382 9,382 79,066 Total ..................................... 178,598 16,000 247,173 263,173 37,842 13,908 56,565 70,473 512.244 Net Loss ............................. ^16l 481 16 000 215~ 8,714) 1(234,714 ) 30 665 1 l 146 • 53 381 6~S 6,527) 462 722 Weighted average number of shares of common stock outstanding ................................. 447,959 4,669,692 5,117,651 1,055,820 4,669,692 5,725,512 5,099,525 Net loss per shue of common stock ........................................... ~ S(.04) $(.05) $(.01) $(.01) S(.09) F•2 tr ~ w a

ADVANCED TOBACCO PRODUCTS, INC. AND NCC GROUP, LTD. (Development Stage Enterprises) NOTES TO PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS (UNAUDITED) 1. Under the terms of the NCC partnership agreement, the partnership has the exclusive option to acquire the rights and patents to the nicotine vapor delivery system (the noncombustible cigarette) that are currently held by the technology holders in exchange for interests in the partnership. The pro forma adjustments give effect to this aoquisition of rights and patents as of March 31, 1984 at the historical cost basis (5379,000) of the technology holders in exchange for 4,222,910 shares of common stock, the acquisition of NCC limited partners' interest in exchange for 469,212 shares of common stock, and the contribution by certain shareholders of 22,430 shares of common stock to the Company in order to meet certain limitations established under the terms of the acquisition. 2. Elimination of intercompany accounts between combined companies. 3. The pro forma condensed combined statements of loss combine the operations of NCC since inception (August, 1982) and ATPI since inception (April, 1983). Pro forma shares presented in the accompanying statements and used in the computation of pro forma net loss per share are the sum of the weighted average number of shares of ATPI common stock outstanding during the period since inception (April, 1983) to December 31,1983 and the three months ended March 31, 1984 and the shares to be issued to give effect to the acquisition of rights and patents, the NCC limited partners' interest, and the contribution by certain shareholders of common stock to ATPI. / F-3

OPINION OF INDEPENDENT PUBLIC ACCOUNTANTS Advanced Tobacco Products, Inc.: We have examined the balance sheet of Advanced Tobacco Products, Inc. (a development stage enterprise) as of December 31, 1983 and the related statements of loss, changes in shareholders' equity, and changes in financial position for the period from April, 1983 (date of inoeption) to December 31, 1983. Our examination was made in accordance with generally accepted auditing standards and, accordingly, included such tests of the accounting records and such other auditing procedures as we considered necessary in the circumstances. In our opinion, such financial statements present fairly the financial position of Advanced Tobacco Products, Inc. at December 31, 1983 and the results of its operations and changes in its financial position for the period from April, 1983 (date of inception) to December 31, 1983, in conformity with generally accepted accounting principles. DEWITTE HASKINS & SELLS San Antonio, Texas April 12, 1984 / F-4

ADVANCED TOBACCO PRODUCTS, INC. (A Development Stage Enterprise) BALANCE SHEETS ASSETS December 31, M.rch 31, 1983 1981 (Uoaudited) CURRENT ASSETS: Cash held in money market fund ................................................................. S $176,925 Cash held in demand deposit account ......................................................... 18,409 Prepaid insurance ......................................................................................... 8,032 Total current assets .................................................................................. 18,409 184,957 ORGANIZATION oOSrs(4) .................................................................................. 10,975 10,975 PUBLIC OFFERING COSTS(4) .............................................................................. 284 83,302 OFFICE EQUIPMENT .......................................................................................... 500 TOTAL ................................................................................................... $29,668 $279,734 LIABILITIES AND SHAREHOLDERS' EQUITY(2)(6) CURRPNT LIABILmES: Payable to NCC ........................................................................................... $ 16,284 $ 50,217 Accrued expenses ......................................................................................... 7,279 Total current liabilities ............................................................................. 16,284 57,496 SHAREHOLDERS' EQUITY: Common stock - authorized 30,000,000 shares of 5.01 par value, outstanding 1,012,908 shares in 1983 and 1,067,908 in 1984 ................. 10,129 10,679 Additional paid-in capital ...t ....................................................................... 19,255 238,705 Deficit .................................................................................................... ...... (16, ~) (27,146 Total shareholders' equity ........................................................................ 13,384 222,238 TOTAL ................................................................................................... S 29,668 $279,734 See notes to financial statements. F-S

ADVANCED TOBACCO PRODUCTS, INC. (A Development Stage Enterprise) STATEMEIYfS OF LOSS April, 1983 (Date of Inception) to December 31. 1983 ' Three Months Ended March 31, 1984 April, 1983 (Date of Inception) to March 31, 1994 ((Unaudited) (Unaudited) REVENUES - Interest .............................................................. S $ 2,762 S 2,762 ExPENSES: General and administrative ................................................. 16,000 13,908 29,908 Total ..................................................................................... 16,000 13,908 29,908 Net loss ............................................................................. $ 1~ 6,000) $(11,146) S(27,14 6) Net Loss Per Share of Common Stock(S) ............................... R.04) 1.01) 5_) S.~0 Weighted Average Number of Shares of Common Stock Outstanding(5) ....................................................................... 447,959 1,055,820 _ 605,552 See notes to financial statements. / F-6

ADVANCED TOBACCO PRODUCTS, INC. (A Development Stage Enterprise) STATEMENTS OF CHANGES IN SHAttEHOLDERS' EQUtTY Coaiawa Stock Addltioa.l PaW-u ' Notes Ssara Amonct Capital Detk[t To41 BALANCE, Ap;ui, 1983 .................. Issuance of Common Stock ........ Net loss ...................................... BALANCE, DECEmBER 31, 1983 ...... Issuance of common stock.......... Net loss for three months ended March 31, 1984 .............. BALANCE, MARCH 31, 1984 (Unaudited) .................................. / S $ $ S (2X6) 1,012,908 10,129 19,255 29,384 16 000) (16, 000) 1,012,908 10,129 19,255 16,000 13,384 (6) 55,000 550 219,450 220,000 11 146 (11,146 ) 1,067,908 $10,67 9 5238,705 S 27 146) 5222,238 See notes to financial statements. F-7

ADVANCED TOBACCO PRODUCTS, INC. (A Development Stage Enterprise) STATEMF.fYi'S OF CHANGES IN FINANCIAL POSmON April, 1483 (Date of Inceptbo) to December 31, 1983 , T3ree Mootha F.oded March 31, 1984 April, 1983 (Date of locepBoa) to Much 31, 1481 SOURCE OF WORKING CAPJTAL - (Uo.udited) (Uoaudlted) lssuance of common stock ................................................... S 29,384 5220,000 5249,384 USE OF WORKING CAPITAL: Net loss from operations ...................................................... 16,000 11,146 27,146 Addition of other assets and office equipment .................... 11,259 83,518 94,777 Total uses of working capital ............................................ 27,259 94,664 121,923 Increase in working capital ...................................................... S 2,125 S125,33 6 S 127,461 CHANGES IN COMPONENTS OF WORKING CAPITAL: Increase (decrease) in current assets: Cash ................................................................................. S 18,409 S 158,516 $176,925 Prepaid insurance .............................................................. 8,032 8,032 Increase in Current Liabilities: Payable to NCC ................................................................ (16,284) (33,933) (50,217) Accrued expenses ............................................................. (7,279) (7,279) Increase in working capital ...................................................... S 2,125 S125,33 6 $127,461 See notes to financial statements. / F-8

ADVANCED TOBACCO PRODUCTS, INC. (A Development Stage Enterprise) NOTES TO FQVANCIAL SCATEMENTS (latur.oadom as o(Marct 31, 1984 a.d for tb taree e.oeths tbea esded is un.udlted) 1. Organization Advanced Tobacco Products, Inc., ("ATPI") was formed in April, 1983 under the name S. A. Vend, Inc. The Company's name was changed to Advanced Tobacco Products, Inc. in January, 1984. The Company is in the development stage and is engaged in the development of a smokeless cigarette. 2. Common Stock ui,d Incentive Stock Option Plans In April, 1983, 39,000 shares of common stock were sold to an organizing shareholder for $ 1,000. In September, 1983, 887,250 shares of common stock were sold to an officer for 526,162 under the terms of an Incentive Stock Option Plan. In September, 1983, 86,658 shares were issued to the Company's legal counsel in exchange for the value (52,222) of legal services rendered. On April 19, 1983, the Board of Directors of S.A. Vend, Inc. approved an Incentive Stock Option Plan under which options to purchase 1,050,850 shares of common stock have been granted. Options to purchase 887,250 shares were exercised during the year at about $.03 a share. Options to purchase 93,600 shares at 5.025 a share, 30,000 shares at 53.25 a share, 25,000 shares at $3.50 a share, and 15,000 shares at $4.00 are outstanding. In January, 1984, the Company's Board of Directors approved an ATPI Incentive Stock Option Plan under which a maximum of 310,000 shares of common stock have been reserved. No stock options have been granted under this Plan. 3. Option to Acquire Assets of NCC Group, Ltd. On September 19, 1983, ATPI was granted an option from NCC Group, Ltd. ("NCC") to acquire on or before December 31, 1984 all of the assets of NCC, including the rights and patents to the noncombustible cigarette, in exchange for capital stock of ATPI. The exercise of the option is contingent upon ATPI obtaining at least $5,000,000 in gross cash proceeds from the sale of its equity securities to new investors simultaneously with the exercise of the option. Exercise of the option is also contingent upon (1) ATPI meeting certain net worth requirements, (2) there being only one class of ATPI capital stock then outstanding, and (3) there being no outstanding or conditional rights to acquire any capital stock of ATPI other than those specifically noted in the Agreement to Raise Capital and Acquire Technology. The option provides that immediately after the sale of ATPI's equity securities to new investors, the current shareholders, NCC, and the individuals with incentive stock options outstanding, will hold no more than specified percentages of ATPI's outstanding shares. In order to meet these limitations, the current shareholders may have to contribute some of their ATPI shares to the Company. 4. Organization and Public Offering Costs Organization costs consist of attorney's fees paid to one of the shareholders. Amortization of the costs will commence upon completion of the sale of capital stock to the new investors. Costs related to the sale of ATPI's equity securities (See Note 3) have been capitalized as public offering costs and will be offset against proceeds from the sale when received. 5. Loss Per Share Net loss per share of common stock is computed by dividing net loss for the period by the weighted average number of shares of common stock outstanding after giving retroactive effect to a stock split (See Note 6). F-9

ADVANCED 'POBACCO PRODUCTS, INC. (A Development Stage Eaterprise) NOTES TO FWAfVC1AL S?A7EMEK[S (Coadsred) (LafonmKo..m of March 31, 1964 ad tor t4 tkr.e .o.tlu t4s ea6e1 is roaudlted) 6. Subsequent Events ' In January, 1984, the Board of Directors and shareholders authorized: (1) an increase in the authorized common, stock.to 30,000,000 shares and a change in the par value to 5.01 a share, (2) a 39-for-I stock split, and (3) the future issuance of 500,000 sharrs of S 100 par value preferred stock which may be divided and issued in any series. Shareholders' equity at December 31, 1983 and March 31, 1984 and the number of shares approved, granted, and purchased under the Company's Incentive Stock Option Plans have been retroactively adjusted to reflect this stock split. In January, 1984, 55,00d shares of common stock were issued for $220,000 ($4.00 per share) in a private placement. F-10

OPINION OF INDEPENDENT PUBLIC ACCOUhTANTS The Partners of NCC Group, Ltd. (a Limited Partnership): We have examined the balance sheets of NCC Group, Ltd. (a Limited Partnership and a development stage enterprise) as of December 31, 1982 and 1983 and the related statements of loss, changes in partners' capital, and changes in financial position for the period from August, 1982 (date of inception) to December 31, 1982, for the year ended December 31, 1983, and for the period from August, 1982 (date of inception) to Dedcmber 31, 1983. Our examinations were made in accordance with generally accepted auditing standards and, accordingly, included such tests of the accounting records and such other auditing procedures as we considered necessary in the circumstances. In our opinion, such financial statements present fairly the financial position of NCC Group, Ltd. at December 31, 1982 and 1983 and the results of its operations, the changes in its partners' capital, and the changes in its financial position for the period from August, 1982 (date of inception) to December 31, 1982, for the year ended December 31, 1983, and for the period from August, 1982 (date of inception) to December 31, 1983, in conformity with generally accepted accounting principles applied on a consistent basis. DELAITiE HASKINS & SELLS San Antonio, Texas April 12, 1984 F•II

NCC GROUP, LTD. (A Ltmited Partnership and a Development Stage Enterprise) STATEMENT'S OF CHANCES IN PARTNERS' CAPITAL General Partner IJmited Partners Partners' capital contributions at inception(l) ................................................. S 5,051 S 500,000 Net loss for the five months ended December 31, 1982 .................................. (1,615) 1_ ( 59,866) BALANCE, DECEMBER 31, 1982 ........................................................................ 3,436 340,134 Net loss for year ended December 31, 1983 ................................................... (2,187) 216 527) BALANCE, DECEMBER 31, 1983 ........................................................................ 1,249 123,607 Net loss for the three months ended March 31, 1984 ..................................... (554) 54 827) BALANCE, March 31, 1984 (Unaudited) ........................................................... S 695 S 68,780 See notes to financial statements. / F-14

NCC GROUP, LTD. (A Limited Partnership and a Devesopment Stage Enterprise) STATEMENi'S OF CHANGFS IN FINANCIAL POSITION SOURCE OF WORKING CAPITAL - Partners' capital contributions ........... USE OF WORKING CAPITAL: Net loss from operations .................... Increase in deposits ............................ Total uses of working capital ......... Increase (decrease) in working capital.... CHANGES IN COMPONENTS OF WORKING CAPITAL: Increase (decrease) in current assets: Certificates of deposit ..................... Cash held in money-market fund ... Cash held in demand deposit account ......................................... Receivable from ATPI .................... Interest receivable .......................... Increase in current liabilities - Accrued expenses ........................... Increase (decrease) in working capital.... ruree Moatlu Esded Marc6 31, 1982 19~83 1983 1983 Dec..ber 31, D.u>oeer 31, Deocebet 31, Asust. 1982 AuQutt, 19E2 (Date o( Yw (Ikte of I.ceptiow) to E.ded l.ceptloa) to AuRust. 1982 (Date of loception) to March 31. 1984 1984 (Unaudited) (Uaaudlted) $505,051 $ SS05,051 S S 5505,051 161,481 218,714 380,195 30,665 55,381 435,576 1,338 1,338 1,338 162,819 218,714 381,533 30,665 55,381 436,914 5342,232 S (218,714) S 123,518 S(30,665) S 5( 5,381) S 68,137 5320,000 S(320,000) S 104,436 104,436 S(124,795) S S 97,950 (88,816) 15,620 28,040 10,696 38,736 16,284 16,284 7,596 (7,596) (9,628) (10,737) 27,999 33,933 50,217 (7,596) (13, 404) (22,534 ) 3( 5,938) 13,404 10,239 (25,69 9) $342,232 S 218 714 $123 ,518 11L ,665) S 5( 5,381) $ 68,137 See notes to financial statements. F-IS

NCC GROUP, LTD. (A Limited Partnership and a Development Stage Enterprise) tVOTES TO FiNANC1AL STATEMENTS (1Jonrtiom as of March 31, 1%4 ad tor the 71ree Mootbs Esded March 31, 1983 ud 1984 i. Uaa.dited) 1. General The Partnership was formed in August, 1982 as a limited partnership under the Texas Uniform Limited Partnership Act. The partnership was initially capitalized by the limited partners' contributions totalling 5500,000 and the general partner's contribution of 55,051. The limited partners currently share in any profits or losses in approximately the same percentages as their capital contributions. The partnership is in the development stage and was organized for the purpose of acquiring all of the rights and patents to the niootine vapor delivery system invented by Mr. J. P. Ray, the general partner. The partners' capital contributions were to be used primarily to develop the noncombustible cigarette into a commercially marketable product. Under the terms of the partnership agreement, the partnership has the exclusive option to acquire the rights and patents in exchange for interests in the partnership constituting 90 percent of the equity of the partnership. Subsequent to the exercise of the option, the limited partners will own 10 percent of the partnership and the owners (including the general partner) of the rights and patents (the "technology holders") will own 90 percent of the partnership, which 90 percent will have been received by the technology holders in exchange for all of the rights and patents to the technology invented by Mr. Ray. (See Note 5) 2. Significant Aecountiag Policies General - The financial statements have been prepared on the accrual basis of accounting. Income Taxes - No provision has been made in the financial statements for federal income tax as all profits (losses) flow to the partners. 3. Certificates of Deposit The balance consisted of the following at December 31, 1982: t,terea / Rate Matnrlty Date Amomt 11.65 % ..................................................... February, 1983 5200,000 10.00 % ..................................................... February, 1983 100,000 7.975% ..................................................... January,.1983 20,000 Total ....................................................... $320,000 4. Related Party Transactions Certain payments have been made to the technology holders, the general partner, and a limited partner. Payments were primarily for research and development, legal, and general and administrative services, as follows: A.avs4 1982 Yeu August, 1982 71ree Months August, 1982 (Date of Eaded (Date of Ended (Date of teeeptioo) to Decem- Isceptioa) to March 31. Isception) to Dectmber 31, t+er 31, Deee.nber 31, March 31, 1982 1983 1983 1983 19" 1984 - - - (Unaudited) (Unaudited) Rescarch and development .... $41,500 584,000 S 125,500 S 16,000 521,000 S 146,500 Legal ...................................... 23,561 15,098 38,659 1,650 40,309 General and administrative .... 3,447 14,690 18,137 2.250 7,668 25,805 F-16

NCC GROUP, LTD. (A Limited Partnership and a Development Stage Enterprise) NOTES TO FINANCIAL SfA'IFMEIYTS (Continued) (1aformatioa as of MarcL 31, 198&t ud for the itiree Mooths Eoded March 31, 1983 aud 198( is Usaodited) 5. Option , On September 19, 1983, NCC granted to Advanced Tobacco Products, Inc. (formerly S. A. Vend, Inc.) an option to acquire on or before December 31, 1984 all of the assets of NCC, including the rights and patents to the noncumbustible cigarette in exchange for capital stock of Advanced Tobacco Products, Inc. ("ATPI"). The exercise of the option is contingent upon ATPI obtaining at least S 5,000,000 in gross cash proceeds from the sale of its equity securities to new investors simultaneously with the exercise of the option. Exercise of the option is also contingent upon (1) ATPI meeting certain net worth requirements, (2) there being only one class of ATPI capital stock then outstanding, and (3) there being no outstanding or conditional rights to aoquire any capital stock of ATPI other than those specifically noted in the Agreement to Raise Capital and Acquire Technology. The option provides that, immediately after the sale of ATPI's equity securities to new investors, the current shareholders, NCC, and the individual with incentive stock options outstanding wiD hold no more than specified percentages of ATPI's outstanding shares. In order to meet these I'imitations, the current shareholders may have to contribute some of their ATPI shares to the Company. F-17 "

Until August 21, 1984 (90 days after the date hereof), all dealers effecting transactions in the securities offered hereby, whether or not participating in the distribution, may be required to deliver a current prospectus with respect to such securities to any purchaser thereof prior to or concurrent with the receipt of the confirmation of the sale of those securities. This is in addition to the obligation of the dealers to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions. TABLE OF CONTENTS Page Prospectus Summary ....................................... 3 The Company .................................................. 5 Risk Factors ..................................................... 6 Use of Proceeds ............................................... 10 Dividend Policy ............................................... 11 Di l ution ........................................................... 1 1 Capitalization .................................................. 12 Selected Financial Information ........................ 13 Management's Discussion and Analysis of Financial Condition and Results of Operations ...................................................... 14 Business ........................................................... 16 Management ................................................... 25 Principal Shareholders ..................................... 29 Description of Units ........................................ 30 Description of Warrants .................................. 30 Certain Income Tax ConsideratioT ................ 32 Description of Capital Stock ........................... 33 Underwriting ................................................... 34 Legal Matters .................................................. 36 Experts ............................................................ 36 Additional Information .................................... 36 Index to Financial Statements ......................... 37 1,250,000 Units Advanced Tobacco Products, Inc. Consisting of 1,250,000 Shares of Common Stock and Warrants to Purchase 625,000 Shares of Common Stock PROSPECTUS May 23, 1984 No person has been authorized to give any information or to make any representations other than those contained in this prospectus. Any information or representations not herein contained, if given or made, must not be relied upon as having been authorized. This Prospectus does not constitute an offering or solicitation with respect to these securities in any Schneider, Bernet & Hickman, Inc. jurisdiction in which such offer or solicitation would be unlawful. The delivery of this Prospectus shall not, under any circumstances, create any implication that there has been no change in the affairs of the Company since the date hereof.