<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended August 31, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
------------ -----------
Commission file number: 0-08718
CITADEL COMPUTER SYSTEMS INCORPORATED
(Exact name of small business issuer
as specified in its charter)
DELAWARE 75-2432011
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3811 TURTLE CREEK BLVD., SUITE 600, DALLAS, TX 75219
(Address of principal executive offices)
(214) 520-9292
(Issuer's telephone number)
------------------
(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. Yes X No
--- ----
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date.
Common Stock, par value $.01 18,536,902
----------
Outstanding at October 26, 1997
Transitional Small Business Disclosure Format Yes [ ] No [X]
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The Financial Statements of the Company are found after the signature page.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
The statements contained in this Report that are not historical facts,
including, but not limited to, statements found in this Item 2 - "Management's
Discussion and Analysis," are forward-looking statements and, as such, involve a
number of risks and uncertainties. The actual results of the future events
described in such forward-looking statements in this Report could differ
materially from those stated in such forward-looking statements. Among the
factors that could cause actual results to differ materially are: general
economic conditions; competition; the market for network software products;
seasonality of product sales; the Company's capital requirements and the
uncertainty of additional funding; the Company's inconsistent revenues and the
uncertainty of future profitability; costs and risks related to integration of
acquisitions; uncertainties related to new product development and market
acceptance of new products developed; costs, expenses and delays related to the
implementation of new sales strategies; software development costs; litigation;
as well as the risks and uncertainties discussed in this Report, including,
without limitation, the portions referenced above, and the uncertainties set
forth from time to time in the Company's other public reports and filings and
public statements.
RESULTS OF OPERATIONS
During the three months ended August 31, 1997, the Company had net sales
of $346,094, a decrease of $1,416,313, or 80.4% over net sales of $1,762,407
for the three months ended August 31, 1996. During the six months ended
August 31, 1997, the Company had net sales of $838,368, a decrease of
$2,050,570, or 71.0% over net sales of $2,888,938 for the six months ended
August 31, 1996.
During the first and second quarters of this fiscal year, the Company was
integrally involved with completing its corporate plan of restructuring, which
included the consolidation of its Houston operations into its Dallas location;
the elimination of outside sales offices; the outsourcing of certain functions
previously performed in-house; the reduction of its workforce by approximately
70%; the identification of areas for greater operational efficiencies to enable
the Company to significantly reduce its overhead and administrative expenses;
and development and implementation of new sales and marketing strategies. The
new sales and marketing strategies focus the Company's efforts more toward the
traditional VAR, reseller, OEM and joint venture model and less towards the
Company's historical telemarketing and trade-show model. The Company believes
these changes attributed to its sales decrease during these quarters and
believes that sales will continue to be below last years numbers through the
third quarter. The Company does believe, however, that these newly adopted
strategies will better position the Company for future growth and anticipates
that sales for the fourth quarter will be at or above prior years' numbers.
The Company, during the past six months, has entered into strategic
alliances with many of the market leaders in the industry and expects to
continue to explore similar arrangements in the future. The Company recently
signed strategic alliance with CORESTAFF, Inc. ("CORESTAFF"), whereby both
companies have agreed to cross-sell each others products, with the Company being
the exclusive distributor of CORESTAFF's "First Step" software program, a peer-
to-peer system that enables users to easily access multiple systems requiring
different user codes. In addition,
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the alliance provides that CORESTAFF's Software Services Unit, Millennium,
with a development staff of over 100, will provide development support to
the Company. The Company has also started to market its products
internationally. While delays in specific country localization of its
products have resulted in anticipated sales being delayed into future
quarters, the Company's products are being well received internationally.
The Company expects both these channels to represent a significant percentage
of its revenues in the future.
The Company has recently introduced its IOMEGA endorsed C:\MORE!
product and expects to launch its Network Recovery System product in the
third quarter of fiscal 1998. The Company is also beta testing a Windows 95
32-bit upgrade to its Winshield product and expects to launch additional new
products and upgrades in future quarters of fiscal 1998 that will provide
ease-of-use security for Internet and intranet applications on Microsoft and
Novell platforms.
The costs and expenses incurred in connection with producing the
Company's products decreased from $108,318, or 6.2% of net sales for the
three months ended August 31, 1996, to $14,375, or 4.2% for the three months
ended August 31, 1997. The costs and expenses incurred in connection with
producing the Company's products decreased from $155,190, or 5.4% of net
sales for the six months ended August 31, 1996, to $23,786, or 2.8% for the
three months ended August 31, 1997. On an overall basis, these expenses
decreased, as a percentage of sales, as a result of the Company, during the
first quarter, performing order fulfillment in-house versus outsourcing this
service as it had done last year. In addition, as an increasing percentage of
the Company's sales are sold through strategic alliances, electronic
commerce, site licensing, etc., the costs and expenses incurred in connection
with producing the Company's products will continue to decrease as a
percentage of sales. During the second quarter, the Company, as part of its
restructuring, started to outsource its order fulfillment again. Therefore,
as the Company expected, these expenses increased, as a percentage of sales,
over the first quarter but still remain below prior years' numbers. This is
in part to the fact, as mentioned above, that as the percentage of the
Company's sales that are sold through strategic alliances, electronic
commerce, site licensing, etc. increases, the costs and expenses incurred in
connection with producing the Company's products, as a percentage of sales,
will decrease.
Selling, general and administrative expenses for the three months ended
August 31, 1997, were $781,858, a decrease of $967,109, or 55.3%, over
selling, general and administrative expenses of $1,748,967 for the three
months ended August 31, 1996. Selling, general and administrative expenses
for the six months ended August 31, 1997, were $1,785,553, a decrease of
$1,416,145, or 44.2%, over selling, general and administrative expenses of
$3,201,698 for the six months ended August 31, 1995. Such expenses decreased
primarily due to the Company's savings as a result of its reorganization, a
decrease in its provision for sales returns and allowance for doubtful
accounts and a decrease in the Company's trade-show activities as a result of
the change in the Company's sales approach, as discussed earlier. These
decreases were offset by start-up and marketing expenses associated with its
new sales approach and new product introductions, and its continued efforts
to expand its product offerings. The Company expects as revenues increase,
it will allocate additional resources to selling and marketing activities.
Thus these expenses may be expected to increase in future periods; however,
as a percentage of sales these expenses should remain relatively constant.
Research and development costs charged to expense for the three months
ended August 31, 1997 were $15,683 versus $3,959,069 for the same period last
year, or a decrease of $3,943,386 or 99.6%. Research and development costs
charged to expense for the six months ended August 31, 1997 were $53,979
versus $4,007,792 for the same period last year, or a decrease of $3,953,813
or 98.7%. Research and development costs for the three and six months ended
August 31, 1996 included approximately $3,959,000 of research and
development costs written-off by the Company in connection with certain
acquisitions and the purchase of technology from Xerox. In addition, as a
result of the development activity on two of the Company's new products
(C:\MORE and NRS), the Company capitalized research and development costs of
approximately $135,000 and approximately $281,000 for the three and six
months ended August 31, 1997, respectively, versus approximately
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$90,000 and $160,000 for the three and six months ended August 31, 1996,
respectively. The Company expects to continue to increase development staff
and expects to launch additional new products and upgrades in the future
quarters of fiscal 1998 that will provide for ease of security solutions for
Internet and intranet applications on Microsoft and Novell platforms.
Depreciation and amortization expense increased to $348,156 for the
three months ended August 31, 1997, from $175,856, or an increase of 98.0%
over the prior period. Depreciation and amortization expense increased to
$622,328 for the six months ended August 31, 1997, from $340,505, or 82.8%
over the same period last year. The increases resulted from depreciation
and amortization of certain acquisitions and products in these periods that
were not present in the same period last year and the commencement of
amortization on certain capitalized research and development costs relating
to products that are available for sale.
Interest expense for the three and six months ended August 31, 1997, was
$29,502 and $50,728, respectively, versus $144,256 and $178,909 for the same
periods last year.
As a result of the aforementioned, the Company for the three and six
months ended August 31, 1997, reported a net loss of $935,236 and $1,796,355,
respectively, compared to a net loss of $4,352,812 and $5,976,028 for the
three and six months ended August 31, 1996.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents at August 31, 1997 were $38,201.
Cash flows from operations were a negative $665,047 for the six months
ended August 31, 1997, compared to negative $2,833,895 for the six months
ended August 31, 1996. The decrease was due principally to a decrease in the
net loss of the Company due to factors previously discussed in this Report
and an increase in the Company's accounts payable and accrued expenses due to
the Company's limited cash resources.
Cash used in investing activities was $252,846 for the six months ended
August 31, 1997, compared to $3,613,944 for the same period last year. This
decrease resulted from a decrease in net securities and business purchases
and a decrease in capital expenditures, offset by an increase in capitalized
costs associated with the development of the Company's software products.
Cash flows provided by financing activities were $940,994 for the six
months ended August 31, 1997, compared to $6,916,767 for the six months ended
August 31, 1996. This decrease was due primarily to less capital being
raised during this quarter compared to the same quarter last year and less
debt financing.
As a result of the aforementioned factors, cash and cash equivalents
increased by $23,101 for the six months ended August 31, 1997 versus an
increase of $468,928 for the same period last year.
The Company has recently completed a plan of restructuring which is
expected to save the Company approximately $350,000 per month in operating
expenses. In addition, the Company is working with various vendors and
lenders to restructure payables and debt that is currently owed. However,
even if the Company is successful with these endeavors, the Company does not
believe that the current funds available will be sufficient to fund the
Company's operations through the end of its fiscal year. As a result, the
Company is seeking additional capital to fund its operations for the
remainder of the year, after which the Company believes its operations will
be self-sufficient. In October 1997, the Company received cash proceeds of
$750,000 and other valuable consideration from CORESTAFF in connection with
the sale of 2.5 million shares of the Company's common stock. In addition,
the Company is currently discussing with several investment banking firms the
possibility of raising additional capital. While the
4
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Company has been successful, in the past, in raising additional capital when
needed, no assurances can be made that the Company will be successful in
raising any such capital in the future; and that if successful, such will not
come at the expense (through dilution) of existing shareholders. The Company
is continuing to look for other sources of capital.
PART II. OTHER INFORMATION
Except as listed below, all information required by Part II is omitted
because the items are inapplicable or the answer is negative.
ITEM 1. LEGAL PROCEEDINGS
A former employee of the Company's predecessor filed a lawsuit against the
Company and one of its officers and directors alleging that the Company and/or
the individual owe the plaintiff additional stock options and seeking damages in
excess of $2,600,000. The Company and the individual believe such claims are
without merit and intend to vigorously defend against the claim and are
considering filing counterclaims. The Company has filed an answer in the case,
styled HEREDIA V. CITADEL, ET AL., in the 298th Court of Dallas County, Texas.
One current and one former employee of the Company have filed a lawsuit
against the Company demanding payment of a promissory note issued in
connection with the acquisition of Kent-Marsh and ADI and seeking damages in
excess of $400,000. The Company believes it has defenses to payment under the
note. The Company is currently involved in negotiations with respect to the
settlement of the case. In the event the settlement negotiations are
unsuccessful, the Company intends to vigorously defend against the lawsuit.
The Company has filed an answer in the case, styled NESBITT & WESOLEK V.
CITADEL, in the 193rd District Court of Dallas County, Texas. The Company
has reached a settlement with the former employee.
The Company is involved in an arbitration proceeding with Vestcom, a
group that claims it is entitled to compensation and a finder's fee for
introducing the Company to a third party. The Company believes it has
defenses to such arbitration claim. The Company intends to vigorously defend
against the claim.
At this time, the Company is unable to predict the ultimate outcome of
these suits, the costs associated with defending the claims and pursuing
counterclaims, and monetary compensation awarded, if any.
The Company is also involved in routine litigation from time to time.
Such litigation is not material to the Company's consolidated financial
condition or results of operations.
ITEM 5. OTHER INFORMATION
On October 6, 1997, the Company entered into a definitive purchase
agreement with CORESTAFF whereby CORESTAFF purchased 2.5 million shares of
the Company's Common Stock for $750,000 and other valuable consideration with
warrants to purchase an additional 2 million shares (1 million at $4.00 per
share and 1 million at $5.00 per share). As part of the agreement, CORESTAFF
will provide development support for the Company, and each Company will
cross-sell each others products, with Citadel being the exclusive distributor
of CORESTAFF's "First Step" software program, a peer-to-peer system that
enables users to easily access multiple systems requiring different user
codes. CORESTAFF is one of the largest providers of information technology
and staffing services in the U.S. CORESTAFF's development division,
Millennium Computer Corporation, has in excess of 100 programmers and will
provide development support services to the Company, as needed.
5
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In connection with the purchase by CORESTAFF, CORESTAFF appointed one
member to the Company's Board of Directors. Mr. Ken Johnsen, President of the
InformationTechnology Services Group of CORESTAFF and an Executive Vice
President of CORESTAFF, was elected to the Company's board in October 1997.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a). EXHIBITS
10.9 Form of Offshore Securities Subscription Agreement, Convertible
Notes, Warrants and Registration Rights Agreement between Citadel
Computer Systems Incorporated and Silenus Ltd. (incorporated by
reference to Exhibits 99.1 through 99.4 of the Company's Current
Report on Form 8-K filed June 24, 1997)
10.10 Purchase Agreement between Citadel and CORESTAFF, Inc., dated
September 22, 1997 (incorporated by reference to Exhibit 10.10 of
the Company's Current Report on Form 10-KSB for the year ended
February 28, 1997).
(b) REPORTS ON FORM 8-K.
On June 24, 1997, the Company filed a Form 8-K with respect to the
completion of a private placement of $1,125,000 of 8% Redeemable
Convertible Notes due June 9, 2000 (before fees and expenses).
On October 6, 1997, the Company filed a Form 8-K with respect to
the purchase by CORESTAFF, Inc. of 2.5 million shares of the
Company's common stock.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned thereunto duly authorized.
CITADEL COMPUTER SYSTEMS INCORPORATED
(REGISTRANT)
Date: November 4, 1997 By: /s/ Steven B. Solomon
---------------------------------------
Steven B. Solomon, President and Chief
Executive Officer (Duly Authorized Signatory
and Principal Executive Officer)
By: /s/ Richard L. Travis, Jr.
---------------------------------------
Richard L. Travis, Jr., Chief Operating and
Financial Officer (Duly Authorized Signatory
and Principal Financial Officer)
6
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PART 1. FINANCIAL INFORMATION - ITEM 1. FINANCIAL STATEMENTS
CITADEL COMPUTER SYSTEMS, INC.
7
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CITADEL COMPUTER SYSTEMS INCORPORATED
CONSOLIDATED BALANCE SHEETS
<TABLE>
AUGUST 31, FEBRUARY 28,
ASSETS 1997 1997
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<S> <C> <C>
CURRENT ASSETS
Cash $ 36,201 $ 15,100
Accounts receivable, less allowance for returns and
doubtful accounts of $489,958 and $625,000 770,773 727,422
Notes receivable from related parties 327,548 870,000
Marketable securities available for sale - 1,250,000
Other 311,980 57,106
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Total current assets 1,446,502 2,919,628
ACCOUNTS RECEIVABLE - NONCURRENT, less
allowance for returns and doubtful accounts
of $1,875,000 - 1,875,000
PROPERTY AND EQUIPMENT, NET 447,831 696,459
PURCHASED SOFTWARE, NET OF ACCUMULATED
AMORTIZATION OF $1,331,537 AND $854,000 3,918,863 4,396,398
CAPITALIZED SOFTWARE DEVELOPMENT COSTS,
NET OF ACCUMULATED AMORTIZATION
OF $69,250 AND $19,000 803,972 573,388
OTHER ASSETS 267,006 263,220
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$6,884,174 $10,724,093
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</TABLE>
The accompanying notes are an integral part of these statements.
8
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CITADEL COMPUTER SYSTEMS INCORPORATED
CONSOLIDATED BALANCE SHEETS - CONTINUED
<TABLE>
AUGUST 31, FEBRUARY 28,
LIABILITIES AND STOCKHOLDERS' EQUITY 1997 1997
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<S> <C> <C>
CURRENT LIABILITIES
Cash overdraft $ 144,459 $ 167,256
Current maturities of long-term debt 847,781 804,141
Notes payable 894,701 2,456,087
Accounts payable and accrued expenses 2,748,780 2,253,481
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Total current liabilities 4,635,721 5,680,965
LONG-TERM LIABILITIES
Debt, less current liabilities 1,410,918 1,770,905
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Total liabilities 6,046,639 7,451,870
COMMITMENTS AND CONTINGENCIES - -
STOCKHOLDERS' EQUITY
Common stock, $.01 par value per share; authorized
30,000,000 shares; issued, 18,857,800 shares
at 8/31/97 and 16,501,980 shares at 2/28/97 188,578 165,020
Preferred stock, $.07 par value per share;
authorized 1,000,000 shares; issued and
outstanding, 545 shares of Series B convertible
(liquidation value of $545,000) - 5
Equity notes 1,275,000 300,000
Additional paid-in capital 13,410,500 13,370,627
Accumulated deficit (11,650,422) (9,854,067)
Unrealized loss on securities available for sale - (355,772)
Treasury stock, at cost (4,164,613 shares at
8/31/97 and 264,613 shares at 2/28/97) (2,386,121) (353,590)
------------ -----------
Total stockholders' equity 837,535 3,272,223
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$ 6,884,174 $10,724,093
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</TABLE>
The accompanying notes are an integral part of these statements.
9
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CITADEL COMPUTER SYSTEMS INCORPORATED
CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
THREE MONTHS ENDED SIX MONTHS ENDED
AUGUST 31, AUGUST 31,
1997 1996 1997 1996
------------ ------------- ------------- ------------
<S> <C> <C> <C> <C>
Net sales $ 346,094 $ 1,762,407 $ 838,368 $ 2,888,938
Cost of sales 14,375 108,318 23,786 155,190
------------ ------------- ------------- ------------
Gross profit 331,719 1,654,089 814,582 2,733,748
Operating expenses
Selling, general and
administrative expenses 781,858 1,748,967 1,785,553 3,201,698
Depreciation and amortization 348,152 175,856 622,328 340,505
Research and development costs 15,687 3,959,069 53,979 4,007,792
------------ ------------- ------------- ------------
1,145,697 5,883,892 2,461,860 7,549,995
------------ ------------- ------------- ------------
Operating income (loss) (813,978) (4,229,803) 1,617,278 (4,816,247)
Other income (expense)
Interest expense (29,502) (144,256) (50,728) (178,909)
Other 107,916 259,422 101,323 257,303
Loss on marketable securities (199,672) (238,175) (199,672) (1,238,175)
------------ ------------- ------------- ------------
(121,258) (123,009) (149,077) (1,159,781)
------------ ------------- ------------- ------------
Net loss $ (935,236) $ (4,352,812) $ (1,796,355) $(5,976,028)
------------ ------------- ------------- ------------
Per share data
Net loss per share $ (0.06) $ (0.36) $ (0.12) $ (0.50)
------------ ------------- ------------- ------------
------------ ------------- ------------- ------------
Weighted average shares outstanding 14,427,452 12,030,060 14,424,452 11,888,385
------------ ------------- ------------- ------------
------------ ------------- ------------- ------------
</TABLE>
The accompanying notes are an integral part of these statements.
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CITADEL COMPUTER SYSTEMS INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
SIX MONTHS ENDED
AUGUST 31,
1997 1996
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<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (1,796,355) $ (5,976,028)
Adjustments to reconcile net loss to net cash
used by operating activities
Depreciation and amortization 622,328 338,681
Net loss on marketable securities 199,672 1,238,414
Research and development expenses acquired
with stock - 3,959,069
Changes in operating assets and liabilities
Accounts receivable (99,851) (1,367,237)
Other receivables (82,548) -
Other current assets (254,874) (172,140)
Bank overdraft (22,797) -
Accounts payable and accrued expenses 771,164 (952,686)
Other assets (3,786) 132,492
Other liabilities - (34,460)
------------- ------------
NET CASH USED BY OPERATING ACTIVITIES (667,047) (2,833,895)
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (128,112) (644,487)
Securities transactions - net 156,100 (2,238,414)
Purchase of business - (571,043)
Development of software (280,834) (160,000)
------------- ------------
NET CASH USED BY INVESTING ACTIVITIES (252,846) (3,613,944)
CASH FLOW FROM FINANCING ACTIVITIES
Net change in notes payable (197,432) (755,776)
Proceeds from sale of equity & convertible notes 1,075,000 3,223,700
Proceeds from sale of common stock 63,426 3,933,743
Proceeds from sale of debentures - 515,100
------------- ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 940,994 6,916,767
------------- ------------
Net increase (decrease) in cash 21,101 468,928
Cash at the beginning of the period 15,100 125,565
------------- ------------
Cash at the end of the period $ 36,201 $ 594,493
------------- ------------
------------- ------------
</TABLE>
The accompanying notes are an integral part of these statements.
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CITADEL COMPUTER SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - BASIS OF PRESENTATION
The financial information presented herein should be read in conjunction
with the financial statements and footnotes included in the Company's Annual
Report on Form 10-KSB for the period ended February 28, 1997. The balance
sheet as of February 28, 1997 has been derived from the audited financial
statement at that date.
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim
financial information and have been presented on the basis that the Company
is a going concern, which contemplates the realization of assets and
satisfaction of liabilities in the normal course of business. See Note C to
the Notes to Financial Statements contained in the Company's Form 10-KSB for
the year ended February 28, 1997. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management,
all adjustments considered necessary for a fair presentation, consisting of
those of a normal recurring nature, are reflected in the accompanying
financial statements.
NOTE B - STOCKHOLDERS' EQUITY
During the period from March 1, 1997 through August 31, 1997, the
Company's stockholders' equity reflected the following changes:
Balance at February 28, 1997 $3,272,223
Issuance of equity notes - net 700,000
Purchase of treasury stock (2,032,531)
Conversion of debt to equity 85,000
Expenses of offerings (141,575)
Net loss (861,119)
-----------
Balance at May 31, 1997 1,021,998
Issuance of equity notes - net 295,000
Exercise of options 80,000
Conversion of debt to equity 45,000
Expenses of offering (24,999)
Realization of unrealized loss 355,772
Net loss (935,236)
-----------
Balance at August 31, 1997 $ 837,535
-----------
-----------
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CITADEL COMPUTER SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE C - COMMITMENTS AND CONTINGENCIES
A former employee of Old LoneStar filed a lawsuit against the Company
and one of its officers and directors alleging that the Company and/or the
individual owe the plaintiff additional stock options and seeking damages of
$2,600,000. The Company believes such claims are without merit and intends
to vigorously defend against the claim.
One current and one former employee of the Company have filed a lawsuit
against the Company demanding payment of a promissory note issued in
connection with the acquisition of Kent-Marsh and ADI and seeking damages in
excess of $400,000. The Company believes it has defenses to payment under the
note. The Company is currently involved in negotiations with respect to the
settlement of the case. In the event the settlement negotiations are
unsuccessful, the Company intends to vigorously defend against the lawsuit.
The Company has filed an answer in the case, styled NESBITT & WESOLEK V.
CITADEL, in the 193rd District Court of Dallas County, Texas.
An unrelated company has filed a lawsuit against the Company and one of
its officers and directors alleging that the Company and/or the officer owe
the plaintiff a finder's fee and is seeking $100,000 of the Company's common
stock. The Company believes such claims are without merit and intends to
vigorously defend against the claims.
The Company is also involved in various legal actions arising in the
normal course of business. Management is of the opinion that their outcome
will not have a material adverse effect on the Company's financial position
or results of operations.
NOTE D - SUBSEQUENT EVENTS
On October 6, 1997, the Company entered into a definitive purchase
agreement with CORESTAFF whereby CORESTAFF purchased 2.5 million shares of
the Company's Common Stock for $750,000 and other valuable consideration with
warrants to purchase an additional 2 million shares (1 million at $4.00 per
share and 1 million at $5.00 per share). As part of the agreement, CORESTAFF
will provide development support for the Company, and each Company will
cross-sell each others products, with Citadel being the exclusive distributor
of CORESTAFF's "First Step" software program, a peer-to-peer system that
enables users to easily access multiple systems requiring different user
codes. CORESTAFF is one of the largest providers of information technology
and staffing services in the U.S. CORESTAFF's development division,
Millennium Computer Corporation, has in excess of 100 programmers and will
provide development support services to the Company, as needed.
13
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
THE FINANCIAL STATEMENTS OF CITADEL COMPUTER SYSTEMS INCORPORATED
FOR THE PERIOD ENDED AUGUST 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
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