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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended February 28, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number: 0-08718
CITADEL COMPUTER SYSTEMS INCORPORATED
(Exact name of small business issuer 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 75219-4421
(Address of principal executive office)
(214) 520-9292
Issuer's telephone number)
Securities registered under Section 12(b) of the Act: None
Securities registered under Section 12(g) of the Act:
Common Stock, par value $.01
(Title of class)
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 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 No X
--- ---
Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B is not contained in this form, and no disclosure will be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference to such filing requirements incorporated by reference
in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [ ]
State issuer's revenues for its most recent fiscal year:.............$5,290,000
As of October 14, 1997, the average bid and ask price of the Company's stock
was $0.75 per share. The aggregate market value of the voting stock held by
non-affiliates of the Company was $9,043,718. As of October 14, 1997, there
were 18,536,902 shares of common stock, $.01 par value, outstanding.
Transitional Small Business Disclosure Format. Yes No X
--- ---
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UNLESS OTHERWISE INDICATED, SHARE AND PER SHARE INFORMATION CONTAINED IN THIS
REPORT REFLECT THE COMPANY'S ONE-FOR-FIVE REVERSE STOCK SPLIT, EFFECTIVE AS
OF DECEMBER 11, 1995, THE ONE-FOR-TWO STOCK DIVIDEND PAID ON FEBRUARY 2,
1996, AND THE ONE-FOR-TWO REVERSE STOCK SPLIT EFFECTIVE AS OF MAY 1, 1996.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
This report includes a number of forward-looking statements which reflect the
Company's current views with respect to future events and financial
performance. These forward-looking statements are subject to certain risks
and uncertainties, including those discussed below, that could cause actual
results to differ materially from historical results or those anticipated. In
this report, the words "anticipates", "believes", "expects", "estimates",
"intends", "future", and similar expressions identify forward-looking
statements. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date hereof. See
"Business Risks" on page 14 of this Report.
THE COMPANY
Citadel Computer Systems Incorporated ("Citadel" or the "Company") is a
developer and marketer of computer software products including security and
management utilities for networks and personal computers. The Company's
products are designed to secure and manage personal computers ("PCs") and
local area networks ("LANs") and enable network administrators to more
efficiently manage the networks. The market demand for the Company's
products is driven by the rapidly increasing complexity and importance of
LANs and PCs within organizations. Network administrators must manage both
the proliferation of client workstations and desktop applications and the
increasing access to mission-critical information by a growing number of PC
users. The failure to maintain the security of data and the integrity and
operations of networks can result in a significant loss of productivity and
in substantial costs for many organizations.
RECENT DEVELOPMENTS FOR THE COMPANY
Fiscal 1997 was a period of significant change for the Company. The Company
closed its Houston offices and consolidated its operations in Dallas, Texas.
The Company also incurred a reduction in force through May 1997, which
included the Company's President and Chief Executive Officer, Vice President
of Sales, Vice President of Channel Sales and several other officers. In
April 1997, the Company appointed its former Chief Operating Officer, Steven
B. Solomon, as its new President and Chief Executive Officer, and appointed
Richard L. Travis, Jr., its Chief Financial Officer, to the additional post
of Chief Operating Officer. In April 1997, the Company's former Chief
Executive Officer, George T. Sharp, agreed to terminate his employment
agreement with the Company in connection with the Company's restructuring
plans. Additionally, several key appointments were made to the finance and
sales, marketing, and engineering functions. In December 1995, Carl Banzhof
joined the Company and was appointed Vice President -Engineering. In July
1997, Mr. Marks the Company's Chief Technology Officer resigned his position
with the Company and Mr. Banzhof assumed the role of Chief Technology Officer
of the Company. The new management team began significantly restructuring the
sales and marketing departments to focus on strategic relationships and OEM
relationships rather than the telemarketing operations, and changing the
Company's research and development focus. Additionally, the Company has
focused on controlling expenses and as a result of the restructuring, the
Company estimates that operating expenses have been reduced by at least
$300,000 per month. Management believes that due to these changes, revenues
for the first nine months of fiscal 1998 will be lower than for comparable
prior periods.
In April 1997, the Company entered into an Asset Sale Agreement with Messrs.
Gertner and Sharp, two of the Company's directors (the "Purchasers"). At the
date of the agreement, the Purchasers owned approximately 31% of the
Company's outstanding Common Stock. The Company sold to the Purchasers,
$3,750,000 of trade accounts receivable and forgave indebtedness owed by the
Purchasers to the Company in the amount of $72,000. The carrying value of
the receivables at February 28, 1997, net of allowance, was $1,877,000.
Consideration received consisted of 3,900,000 shares of the Company's Common
Stock, with a market value of approximately $2,750,000, as of the date of the
transaction (for accounting purposes, the stock was valued at approximately
$1,950,000). The shares acquired represent approximately 23% of the
Company's then issued and outstanding shares and are held as treasury shares.
Pursuant to the participation interest, Citadel will retain a profits
participation interest in the Assets in the event the Purchasers collect in
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excess of $2,250,000 of the accounts receivable (after expenses of
collection), in which case the Purchasers shall pay to Citadel 50% of such
amounts collected in excess of $2,250,000. The transaction will result in no
gain or loss to the Company.
On October 6, 1997, the Company entered into a definitive purchase agreement
with CORESTAFF, Inc. ("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.
OVERVIEW
The Company's products are designed to reduce clients' costs, improve the
accuracy of clients' information, maintain the operation of the network,
secure the network from fraud or unauthorized use and generally enable the
administrator to devote more time to improving the service to the network
rather than focusing on operational details. Citadel's network software
products operate on operating systems designed by Novell, Microsoft, IBM and
Apple. Citadel's focus is on the two largest, Novell and Microsoft, whose
NetWare and Windows NT software control in excess of 70% of the market for
network operating systems.
The Company's primary products include the Citadel Network Recovery System
(NRS), NetOFF, TabWorks, Server Sentry, Phantom of the Console, Server Cam,
WinShield, FolderBolt, NightWatch and C:\More!. See "--Products." Citadel's
clients include many Fortune 2000 companies and government agencies.
Citadel's strategy is to develop long-term client relationships and to
maintain a high level of lifetime client satisfaction, which Citadel believes
will result in additional recurring revenues from new products and upgrades
on existing software products. Citadel has focused its development efforts
on the client-server LAN market due to the rapid growth of this market as
companies, government agencies and educational users shift from mainframes to
client server networks and intranets. Citadel believes its products are
positioned to capitalize on this trend.
The Company intends to achieve its strategic goals in part by entering into
strategic alliances with industry leaders. In August 1996, the Company
entered into a strategic relationship with the XSoft division of Xerox
Corporation ("Xerox"), in which the Company obtained the TabWorks products
and obtained a license to incorporate XSoft's Summarizer technology for
bundling in the Company's products. In December 1996, Microsoft announced
that it would include the Company's WinShield product in a software bundle
distributed to the K-12 education market. In June 1997, Compaq Computer
Corporation announced that it will include WinShield on certain of their
Presario personal computers sold in the education markets. In October 1997,
the Company entered into a strategic alliance with CORESTAFF with respect to
CORESTAFF's investment in Citadel and certain joint research and development,
technology, licensing and marketing activities. The Company is in
negotiations to enter into OEM relationships with other industry leaders. The
Company believes these strategic relationships will result in an increase in
market penetration, brand recognition, and sales and marketing channels.
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In February 1996, Citadel acquired Circuit Masters Software, Inc., the
developer of Server Sentry, Phantom of the Console and Server Cam. In August
1996, the Company acquired the Kent-Marsh Group, the companies that developed
WinShield, FolderBolt and NightWatch. In August 1996, the Company also
acquired the TabWorks and related product lines from the XSoft division of
Xerox, as well as all of the outstanding stock of DanaSoft Corporation
("DanaSoft"), a maker of specialized software products for Cabletron Spectrum
modules. The Company believes that further opportunities may exist to expand
its product lines by acquiring businesses, products and technologies that
complement those of the Company.
The Company is the successor to a Delaware corporation (also known as Citadel
Computer Systems Incorporated ("Old Citadel")) that was formed and began
operations in June 1992. References in this Report to "Citadel" or the
"Company" shall include Citadel and Old Citadel unless the context requires
otherwise. On February 29, 1996, a wholly-owned subsidiary of LoneStar
Hospitality Corporation, the Company's predecessor, merged with Old Citadel
(the "Merger"). This Merger has been accounted for as a reverse acquisition.
Accordingly, in discussions in this Report of previous operations and
pre-merger transactions, the Company is referred to as "LoneStar".
The Company maintains its principal executive offices at 3811 Turtle Creek
Blvd., Suite 600, Dallas, Texas 75219-4421; the telephone number of this
office is (214) 520-9292. The Company maintains a site on the World Wide Web
at http://www.citadel.com.
INDUSTRY BACKGROUND
Over the last decade, the increasing power, ease of use and low cost of
personal computers ("PCs") have resulted in extensive use of PCs by
businesses and organizations. The computing environment of many businesses
evolved from a single-vendor mainframe orientation to multi-vendor
environments with a large number of PCs and workstations. In response to
this, organizations have invested in local area networks ("LANs") and
"intranets" to realize the cost and productivity benefits of sharing
applications, files, data and peripherals (such as printers) among PC users
across a workgroup, department or entire enterprise. Client/server networks
and intranets have become dominant business computing platforms as more PCs
and workstations have become connected to networks and companies have
downsized mainframe applications to client/server architectures. As a result
of the downsizing of mainframe applications to client/server LANs and
intranets, mission critical functions are increasingly performed over
client/server networks. These functions include electronic funds transfers,
airline, hotel and rental car reservation systems, and telemarketing and
order entry functions.
Unauthorized access to, or destruction of, the mission critical information
could have adverse effects on the network or intranet users. These mission
critical functions and the continued proliferation of higher speed PCs and
workstations place increased demands for security and ease of administration
on the networks transmitting or processing the data. As a result,
client/server networks demand additional security and administrative
functions. Networks are required to provide greater security to provide
greater utility and performance to accommodate these improvements and provide
the greatest benefits to the end user. As increasing numbers of businesses
use client/server LANs and intranets, the security of data transmission,
communication and processing over the networks has become critical.
Management believes that the market for network security and administration
systems and software products has grown over the last several years due to an
increase in the use of computer networks and the vulnerability of data which
is transmitted over these networks. Remote access to proprietary corporate
information has increased substantially due to the proliferation of LANs and
WANs in corporations and institutions. With the increasing use of public and
private communications networks and the ability of different types of
computers to communicate with each other, data integrity and security have
gained increased importance.
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Unrestricted access to computer networks subjects the owner of the network to
unauthorized interception, electronic vandalism or terrorism and alteration.
The increased use of networked computers also increases risk, both by
multiplying the number of access points to valuable data and the number of
personal computers which can be utilized to obtain unauthorized information.
The Company believes that the use of computer networks such as the Internet
and corporate intranets will continue to expand and that, as reliance on
these networks grows, organizations will become more dependent on the
integrity and security of the network. Therefore, the Company believes that
protecting information on networks such as the Internet and the intranet is
likely to offer future business growth opportunities.
THE CITADEL SOLUTION
Citadel offers a family of software products that are designed to address a wide
range of network and desktop security and administration requirements. The
Company's products offer the following benefits:
BROAD INTEGRATED SOLUTION. The Company offers an integrated network and
desktop security and administration solution that provides the following
tools: automatic logoff, configuration protection, encryption,
notification of network administrators in the event of system failure
and orderly logoff that saves open files and applications.
EASE OF USE. The Company's products are designed to plug and play
within the Citadel Network Administrator so additional functions can be
added at low cost. The look and feel of the interface is designed to be
intuitive to the network or PC user and compatible with the operations
of desktop and network operating systems, including Windows, Windows NT
and NetWare.
CENTRALIZED CONTROL. From one console, a LAN administrator can
monitor, configure and change the network resources available to network
users.
COST EFFECTIVENESS. The Company believes its products can reduce the
cost of overall system support and maintenance by ensuring an orderly
backup, reducing license fees by logging off inactive users, and
reducing the personnel resources required to administer the LAN.
CITADEL STRATEGY
The Company's objective is to become one of the leading suppliers of security
and administration software products for networks and PCs. The Company seeks to
achieve this objective through the following strategies:
ESTABLISH KEY STRATEGIC RELATIONSHIPS. The Company intends to
leverage its technology and products by entering into strategic
relationships with other technology companies. In August 1996, the
Company entered into a strategic relationship with the XSoft division of
Xerox to obtain a license to incorporate XSoft's Summarizer technology
for bundling in the Company's products. In December 1996, the Company's
WinShield product was included in a Microsoft Corporation ("Microsoft")
software bundle distributed to the K-12 education market. In June 1997,
Compaq Computer Corporation announced that it will include WinShield on
certain of their Presario personal computers sold in the education
markets. In October 1997, the Company entered into a strategic alliance
with CORESTAFF with respect to CORESTAFF's investment in Citadel and
certain joint research and development, technology, licensing and
marketing activities. The Company is currently involved in ongoing
negotiations to enter into OEM relationships with other industry leaders.
The Company believes these strategic relationships will result in an
increase in market penetration, brand recognition and sales and marketing
channels.
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PROVIDE CLIENTS WITH A BROAD RANGE OF NETWORK AND PC SECURITY AND
ADMINISTRATION SOFTWARE PRODUCTS. The Company has developed a product
line designed to enhance the security of data on networks and on the
desktop and to enhance the productivity of network administrators in
managing networks or intranets. The Company's products provide a broad
array of solutions to problems faced by network administrators and are
designed to be compatible with all major network operating systems,
including NetWare and Windows NT.
MAINTAIN TECHNOLOGY LEADERSHIP. The Company intends to maintain its
high standards in the design and development of network security and
administrative software and providing products that address the security
and administration requirements of network administrators and PC users.
The Company is committed to the continued development of new and
enhanced security software products that incorporate advanced
technologies. The Company has established a research and development
team and employs highly skilled technical personnel.
EXPAND SALES AND MARKETING ACTIVITIES. The Company has recently
established an Enterprise Sales Group to target larger corporate
accounts to supplement the activities of, and to follow up on leads
generated by, the Company's inside sales force. The Company believes
that the Enterprise Sales Group will permit larger sales of Company
products to large users that can use several Citadel products. In
addition, the Company maintains a site on the World Wide Web at
http://www.citadel.com to provide information regarding the Company and
to permit users to sample the Company's products over the Internet.
EXPAND THROUGH ACQUISITIONS. In addition to the Company's internal
product development activities, the Company has in the past expanded,
and expects in the future to expand, its product line and technologies
(including a greater number of software products and applications)
through acquisitions of companies or technologies complementary to the
Company's current business. In February 1996, the Company acquired
Circuit Masters Software, Inc., the software company that developed
Server Sentry, Phantom of the Console and Server Cam. In August 1996,
the Company acquired the Kent-Marsh Group, the company that developed
WinShield, FolderBolt and NightWatch. In August 1996, the Company also
acquired the TabWorks and related product lines from the XSoft division
of Xerox, and acquired all of the outstanding stock of DanaSoft. The
Company believes that further opportunities may exist to expand its
product lines by acquiring businesses, products and technologies that
complement those of the Company.
PRODUCT DESIGN STANDARDS
STANDARDS COMPLIANCE. The Company's policy is to offer products that operate on
network and desktop operating systems that are in wide use. This provides the
Company's customers with assurance that Company products will function
effectively on their networks.
NETWORK COMPATIBILITY. The Company's products are typically compatible with
the leading network and desktop operating systems, including Novell's NetWare
and Microsoft's Windows NT network operating systems. This provides the
Company's customers with assurance that Company products will function
effectively on their networks.
EASE OF USE. The Company believes that users of its products, while concerned
that their networks are secure, do not wish to be required to take additional
actions to achieve secure status. Therefore, the Company's products are
designed to function without extensive user involvement, thus offering a high
level of ease of use.
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EASE OF ADMINISTRATION. The Company has extended its ease-of-use concept to the
central management of a secure network with a product known as the Citadel
Network Administrator, which is designed to provide central management and
security features with the ability to "plug and play" additional functions at a
low cost.
PRICE PERFORMANCE CRITERIA. The Company provides products at a price and
performance level that the Company believes offers superior network and PC
security and management options at affordable prices.
CITADEL PRODUCTS
CITADEL NETWORK RECOVERY SYSTEM. Citadel introduced its Network Recovery System
("NRS") in August 1996 to provide a network security and administrative solution
that incorporates key features of several of Citadel's products. The NRS allows
fully unattended shutdown and restart of servers and workstations in the event
of a crash or other catastrophic network event, such as a power outage. The NRS
is made up of four primary modules that perform the task of detecting fatal
server problems, recovering network servers and giving a microscopic view into
why the network server failed. The NRS is composed of the Server Sentry,
NetOFF, Phantom of the Console and Server Cam products described below. These
NRS modules work together to help the network administrator or user to keep
servers up and running by automatically recovering when servers crash. The NRS
comprehensively initiates and manages the recovery process from the first sign
of a problem through crash analysis and enables the user to reduce downtime and
have the answers to the questions that arise when the network crashes.
Citadel's NRS provides an integrated solution to help eliminate downtime and
meet service level requirements for mission-critical networks.
NETOFF. NetOFF is a network management security and utility program designed to
protect a network by shutting down unattended computers automatically when a
user leaves a computer logged on while the user is away from the terminal for a
specified length of time. Network administrators may also set a time for NetOFF
to shut down computers on the network in order to complete a clean backup. The
program ensures an orderly shut down by automatically closing all open files and
applications on the computer and saving the information. The latest release of
NetOFF, NetOFF Version 5.0, is available for Windows 95, Windows 3.1, Windows
NT, and NetWare Versions 3.11 and 4.11 operating environments. NetOFF provides
three major benefits:
ENHANCES NETWORK SECURITY. Unattended computers subject the computer and
the network to computer theft of confidential files and information.
NetOFF logs off unattended computers and helps to secure the network by
preventing unauthorized use of unattended terminals.
CONSERVES RESOURCES. Software licenses often require payment for software
running on the network. Many companies pay excess license fees for
programs that are left open on unattended computers. NetOFF may help
customers reduce costs by logging off unattended computers.
PROVIDES A CLEAN BACK-UP. To further protect corporate information,
corporations typically employ a back-up system. The back-up system is a
tape drive or other storage medium that periodically copies all of the data
stored in the network. Should a data loss occur from a power failure,
mechanical failure or other error, the lost information can be fed back
into the computer in a matter of minutes, thereby saving the company
hundreds of hours required to reenter lost data. However, the back-up
system only backs up computers that are logged off from the network. If a
computer is logged on during the process, the data from that computer can
be corrupted or omitted from the back-up tape. NetOFF eliminates these
problems by automatically logging off network client stations at a time
selected by the network administrator.
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TABWORKS. The Company acquired the TabWorks technology in August 1996 from the
XSoft division of Xerox. TabWorks was developed at the Xerox PARC Research
Laboratory in Palo Alto, California, by an advanced research team. TabWorks is
a personal document management tool for Windows 95 and 3.1 users that makes it
easier to manage documents and applications, such as spreadsheets, letters,
databases and graphics, by project, customer, function, time frame or other
methods. TabWorks automatically creates a computerized "book" that lets the
user organize and find documents and applications in a way the user determines,
using familiar organizational tools such as Notebook Tabs, a Table of Contents
and an Index. TabWorks enables the user to quickly organize and find documents
by automatically creating a Table of Contents that lists the tabbed sections and
all items in the Tab, plus an Index that lists items alphabetically and by
location. TabWorks updates the Index and Table of Contents when changes are
made to the Tabs.
For example, the user can set up a tabbed section for the "X Account" and put
the related materials, including spreadsheets, letters, reports, schedules,
databases, graphics and documents relevant to the account, together with the
related software applications, on the pages in the tabbed section. For
security, the user can lock the Tab so that the Tab is tamper proof. Later,
when the user needs to work on the Account, the user may open the TabWorks book,
using the password, and flip to the X Account tab. All applications are
immediately available.
SUMMARIZATION. The summarization technology, as used in our newly developed
C:\More! product, parses a file and automatically, through artificial
intelligence, produces a summary of its contents. The summarized form of the
document contains a definable number of key sentences along with key words that
will allow a user to easily recognize a file's content. In order to produce the
summarized form, the technology utilizes word proximity, word structure, and
advanced lexicography.
SERVER SENTRY. The Company believes Server Sentry is the first network
protection system that automatically restarts the file server in the event of a
system crash. Server Sentry automatically notifies network personnel, produces
downtime reports and captures all information available to enable the network
administrator to avoid recurrences.
PHANTOM OF THE CONSOLE. Phantom operates as a "virtual user" that automates
certain daily server tasks for network file servers, permitting network
administrators to increase LAN productivity. The software automatically executes
commands and runs programs at any set time, day or night, without the need for
an operator at the console. Phantom preserves server cache memory and improves
overall server performance by scheduling the unloading, loading and execution of
Network Loadable Modules ("NLMs") that must be unloaded for backup to proceed.
SERVER CAM. Server Cam is a software program that emulates a time-lapse video
recorder connected to the network. Server Cam captures events as they occur,
which allows network personnel to track down network intruders and vandals.
Server Sentry may also be used to re-create critical events for training
sessions.
WINSHIELD. The Company acquired the WinShield product line in connection with
its acquisition of Kent-Marsh and ADI in August 1996. WinShield is designed to
give the user the power to administer or share computing resources without
losing them. The program permits the user to control and prevent or protect the
use of diskettes, CD-ROMs and peripheral devices such as printers and to
preserve settings in the desktop appearance, configuration and initialization
files. WinShield maintains control of the Windows 95 or Windows 3.1 desktop
environment without sacrificing ease of use. The product prevents accidental or
deliberate configuration damage, protects valuable applications and controls the
use of peripherals. The program protects against piracy and unsupervised
surfing on the Internet. The user can govern access to CD-ROM or disk drives
and control the specific CDs that can be mounted. The user can simplify and
easily protect the desktop environment by shielding the use of Explorer icons
and implementing a wide variety of
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system restrictions. The user can also toggle between several setup
environments depending on the persons with whom the computer will be shared.
The WinShield product has been included in Compaq's and Microsoft's software
bundles for the education markets.
FOLDERBOLT AND FOLDERBOLT-PRO. The Company acquired the FolderBolt product line
in connection with its acquisition of Kent-Marsh and ADI in August 1996. The
product permits the user to lock entire directories and configure shared user
files.
NIGHTWATCH. The Company acquired the NightWatch product line in connection with
its acquisition of Kent-Marsh and ADI in August 1996.
C:\MORE!. C:\More! is intelligent media management software that enables
both individual and networked computer users to quickly and easily find all
of their computer directories and files, regardless of location. C:\More!
automatically scans and catalogs the data from virtually all forms of
computer media, including hard drives, as well as floppy, Iomega-TM-,
SyQuest-TM-, and Imation-TM- disks - and even CDs. C:\More! has been
endorsed and approved as an Iomega-Ready software product. The technology's
advanced file and tracking capabilities enable users to search for documents
even among removable media not inserted into the computer. Currently
designed for Windows 95 and Windows NT platforms, other platforms will
include Mac-PC and Windows 3.1 in the near future. Compatible with all
popular word processors, office product suites, and graphic formats, C:\More!
was introduced in September 1997 and will be ready for shipment in November
1997.
Additional Company products include: (1) NetConsole, which is designed to
automate input tasks at the server console so that commands can be scheduled
at an unattended server. For example, a network administrator will want all
NLMs unloaded and all users logged off. NetConsole enables the network
administrator to schedule these tasks at a time just prior to system backup;
(2) NetPurge, which automatically searches for old or unused files and moves
them to archival storage. Because disk storage on large networks is scarce,
network administrators must carefully monitor and eliminate inactive files to
free up space. NetPurge automates this function; (3) NetQ, which enables
network users to manage facility queues, such as those for printing,
archiving, or custom applications. NetQ constantly updates queuing displays
so that network administrators can manage queue assignments in real time; and
(4) NetWatch, which detects and corrects unowned network files. An unowned
file is one to which no user has been assigned. For example, if a user is
deleted from a network (because of promotion, termination or other reason),
all files previously owned by that user will be designated as "unowned" by
the network. Consequently, if an unowned file is modified by a new user,
NetWare cannot update it, and hours of modifications may be lost. NetWatch
eliminates this problem by assigning all unowned files to a supervisor ID or
other user-specified ID.
SALES AND MARKETING
To address a broad range of sales and marketing opportunities, the Company uses
a multi-channel distribution strategy that includes a combination of direct and
indirect sales and marketing.
SALES. In 1997, Citadel changed the focus of its selling efforts from a
telemarketing direct sales force to a multi-channel distribution strategy that
includes an enterprise sales group, OEM distribution arrangements, VAR and
dealer channels, direct sales channels, strategic alliances with industry
leaders, and trade shows.
The Enterprise Sales Group is a direct sales force that focuses on end users
that have, or are installing, large, sophisticated enterprise-wide networks.
These end users may place larger orders for a range of the Company's products.
The Company recently implemented a value-added reseller program and is also
exploring joint marketing and licensing arrangements with other companies.
Certain of the Company's products are currently distributed through distributors
(and indirectly, VARs, other resellers, systems integrators and retail outlets),
and the Company expects to rely increasingly on distributors to market its
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other products. There can be no assurance, however, that such distributors,
VARs, other resellers, systems integrators and retail outlets will be able to
market the Company's products effectively.
Citadel's inside sales operations meet the needs of first-time buyers or
existing customers making follow-on purchases, which typically purchase small
volumes, upgrades or special promotions. The inside sales force provides a
direct link to the end user, allowing Citadel to develop products and
services that specifically meet the needs of the network and intranet markets
and PC users.
MARKETING. The marketing department is responsible for assessing market
opportunities, product planning and specific sales support. In addition, the
marketing organization is actively involved in obtaining input from potential
and existing clients, product development, sales and client services and
support. As a result of this involvement, the marketing department helps to
define the scope, features and functionality of new products and product
upgrades. Citadel's marketing efforts include display advertising in
industry publications, direct mail, card deck ads and lead generation at
industry trade shows.
PRODUCT DEVELOPMENT
Citadel believes that its success will depend largely upon its ability to
enhance existing products and develop new products that meet the needs of a
rapidly evolving marketplace and increasingly sophisticated and demanding
customers. The Company intends to expand its product offerings and to
introduce new products for customers seeking additional network and PC
security and administration features. While the Company intends to primarily
develop the products internally, it may, based on timing and cost
considerations, acquire technologies or products from third parties.
Citadel recently introduced C:\More! and its Network Recovery System, and
plans to introduce upgrades for its NetOFF, Phantom of the Console, Server
Sentry, Server Cam, TabWorks and WinShield during the third and fourth
quarters of fiscal 1998. The Company also intends to introduce additional
products and upgrades to address current and future end user needs.
Schedules for the development of high technology products are inherently
difficult to predict, and there can be no assurance that Citadel will achieve
targeted initial customer shipment dates for any product.
The Company accounts for software development costs in accordance with SFAS
No. 86 issued by FASB, under which the Company is required to capitalize
software development costs after technological feasibility of a project is
established and must cease capitalizing such costs when the products derived
from the project are available for sale, lease or otherwise marketed.
Subsequently, capitalized costs are amortized on a product-by-product basis,
based on the greater of (a) the amount computed by the straight-line method
over the estimated useful life of the product or (b) the amount computed by
using the ratio that current gross revenues bear to the total of current and
anticipated future revenues. The Company evaluated the estimated net
realizable value of each software product at each balance sheet date and
records write-downs to net realizable value for any product for which the net
book value is in excess of its net realizable value. It is reasonably
possible that future events may cause a reduction in the amortization period
of software costs.
The Company anticipates that it will continue to commit substantial resources
to research and development in the future.
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CLIENT SUPPORT AND WARRANTIES
The Company's products are generally warranted to be free of defects in
materials and workmanship for 90 days. During and after the expiration of
the basic warranty period, the Company offers yearly maintenance contracts on
most of its software and basic technical support and replacement of defective
media.
MANUFACTURING AND SUPPLIERS
The Company prepares master software disks, user manuals and packaging for
certain products and out- sources production of other products. Certain of
the Company's disk duplication, as well as its product packaging, is
performed by the Company at its offices, while the other disk duplication and
product packaging and printing of user manuals and related materials is
performed to the Company's specifications by outside sources. During peak
demand, the Company may use outside sources to perform disk duplication and
product packaging services. To date, the Company has not experienced any
material difficulties or delays in manufacture through an interruption in its
own production or the production of any suppliers. Because of the generally
short cycle between order and shipment, Citadel does not believe that its
backlog as of a particular date is indicative of future sales.
CUSTOMERS
The Company's customers include many Fortune 2000 companies, and there
appears to be a strong need for the Company's products within this market
segment. There are no assurances that these companies will continue to
utilize the Company's products in the future.
Citadel believes that a necessary element of its future success will be the
retention of its customer base. Therefore, the Company is dedicated to the
highest level of customer support and satisfaction. The Company attempts to
ensure that its sales employees are committed to ensuring the highest level
of customer satisfaction. The Company encourages its sales employees who
interact with the Company's customers to take innovative approaches towards
ensuring that the customers' needs are met.
The Company's specialized information systems further facilitate the
Company's goal of total customer satisfaction by allowing the Company's
representatives to enter comments regarding customers' orders, as well as
comments regarding feedback, both positive and negative, which the customer
has given to the Company's representatives. These comments can then be
accessed by other employees, allowing them to quickly reference a particular
customer's preferences, needs and past ordering practices, among other
information.
COMPETITION
The LAN security and administration software industry is intensely
competitive and rapidly changing. The Company competes against large
companies (such as Novell, Microsoft, Cheyenne Software, Inc. and others)
that offer network and desktop security and administration software as a
segment of their businesses. The Company also competes with a large number
of small companies that offer network security and administration software as
a major portion of their product line. Some of these competitors offer
products that address multiple aspects of network and desktop security and
administration and management, while other competitors market products that
provide narrow solutions. Many of the Company's competitors have longer
operating histories and significantly greater financial, technical, sales,
marketing and other resources, as well as greater name recognition and a
larger installed customer base, than the Company. Further, many competitors
have established relationships with customers of the Company and end users of
the Company's
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products. The Company's competitors could, in the future, introduce products
with more features and lower prices than the Company's product offerings.
These companies could also bundle existing or new products with other, more
established products in order to compete with the Company.
As the LAN and PC markets develop, a number of companies with significantly
greater resources than the Company could attempt to increase their presence
in this market by acquiring or forming strategic alliances with competitors
of the Company or by introducing products specifically designed for the LAN
and PC markets. In addition, Novell or Microsoft, the dominant suppliers of
operating systems for LANs and PCs, could include, in NetWare or Windows NT
or other operating systems, functionality similar to that of the Company's
existing or future products.
The Company and its competitors generally compete on the basis of product
features and functions, product architecture, product quality, the ability of
products to run on a variety of different network and desktop operating
systems, technical support and other related services, and price/performance
features. Based on these factors, the Company believes that it has competed
effectively to date. The Company expects competition to increase, which
could result in price reductions and loss of market share for the Company.
The Company must continue to introduce new products and enhancements to its
existing products in a timely manner in order to remain competitive.
However, even if the Company introduces new and enhanced products in a timely
manner, it may not be able to compete effectively because of the
significantly larger resources available to many of its competitors. There
can be no assurance that the Company will be able to compete successfully or
that competition will not have a material adverse effect on the Company's
business.
INTELLECTUAL PROPERTY
The Company's success has been and will be dependent in part on its ability
to protect its proprietary technology. The Company relies primarily upon
trade secrecy and confidentiality agreements to establish and protect its
rights in its proprietary technology. The Company does not have any patents
or statutory copyrights on any of its proprietary technology which the
Company believes to be material to its future success, and the Company cannot
be certain that others will not develop substantially equivalent or
superseding proprietary technology. Furthermore, there can be no assurance
that any confidentiality agreements between the Company and its employees
will provide meaningful protection of the Company's proprietary information
in the event of any unauthorized use or disclosure of such proprietary
information.
There can be no assurance that the Company will not become the subject of
claims of infringement with respect to intellectual property rights
associated with the Company's products. In addition, the Company may
initiate claims or litigation against third parties for infringement of the
Company's proprietary rights or to establish the validity of the Company's
proprietary rights. Any such claims could be time consuming and could result
in costly litigation or lead the Company to enter into royalty or licensing
agreements rather than disputing the merits of such claims.
EMPLOYEES
As of February 28, 1997, the Company employed 72 individuals, including 22
in sales and marketing, 10 in product research and development, 4 in
production and operations, 10 in customer service and technical support and
20 in administration, finance and MIS. The Company believes that its ability
to recruit and retain highly skilled technical and other management personnel
will be critical to its ability to execute its business plans. None of the
Company's employees are represented by a labor union or are subject to a
collective bargaining agreement. The Company believes that its relations
with its employees are good.
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As part of the Company's restructuring, the Company, by identifying areas for
greater operational efficiencies and out-sourcing certain functions
previously performed in-house, has significantly reduced the number of its
employees. As of October 14, 1997, the Company had 24 employees (8 in sales
and marketing, 5 in product research and development, 1 in production and
operations, 3 in customer service and technical support and 7 in
administration, finance and MIS). The Company anticipates adding some
additional employees in the sales and marketing and research and development
areas as resources and need dictate.
GOVERNMENT REGULATION
Government regulation has not had a material effect on the Company's conduct of
its business to date.
SALE OF RESTAURANT ASSETS
As of March 1, 1996, LoneStar consummated the sale of its restaurants in the
Dallas, Texas area and related development rights to Miami Subs USA, Inc.
("Miami Subs"), the franchiser of the restaurants. Miami Subs also assumed
LoneStar's indebtedness of $1,500,000 to Stephens Diversified Leasing, Inc.
d/b/a Stephens Franchise Finance ("Stephens"). LoneStar received 1,325,000
shares of Miami Subs' common stock (the "Miami Subs Stock"), and Miami Subs
has filed a registration with the Securities and Exchange Commission (the
"SEC") covering the Miami Subs Stock. During the six months following the
closing, LoneStar cannot sell any of the Miami Subs Stock, except with Miami
Subs' consent, and Miami Subs has the right to acquire the Miami Subs Stock
for $2.50 per share. LoneStar will thereafter be able to sell the Miami Subs
Stock in private transactions, or in open market transactions not to exceed
240,000 shares per calendar quarter, or 20,000 shares per week. All sales by
the Company are subject to a right of first refusal by Miami Subs. Miami Subs
has assumed no liabilities of LoneStar, except for LoneStar's loan from
Stephens and certain restaurant and equipment leases. LoneStar has also
issued to Miami Subs a promissory note in the principal amount of $1,500,000.
The note is secured by the Miami Subs Stock and does not bear interest. The
maturity date of the note was extended to July 1, 1996, as a result of
LoneStar's principal payment of $50,000. The parties have operated under a
series of standstill agreements and are currently in negotiations with
respect to the Note. In June 1997, the Company tendered the stock to Miami
Subs as payment for the $1,250,000 note payable to Miami Subs. In addition,
the Company received 200,000 shares of unrestricted Miami Subs stock and the
assumption, by Miami Subs, of certain of the Company's restaurant operations
liabilities. The Company sold the shares of Miami Subs stock in fiscal 1998.
HISTORICAL BACKGROUND
Effective February 29, 1996, Old Citadel merged into LSHC Acquisition, Inc.,
a wholly owned Delaware subsidiary of LoneStar, pursuant to a Second Amended
and Restated Agreement and Plan of Merger, dated February 29, 1996 (the
"Merger Agreement"). Pursuant to the terms of the Merger Agreement, and as
adjusted for the one-for-two reverse stock split effected on May 1, 1996,
each stockholder and warrant holder of Citadel received 2.25 shares or share
equivalents of common stock, par value $.01 per share (the "Common Stock"),
of the Company for each share of Common Stock of Citadel held by such
stockholder. Former stockholders of Old Citadel now own approximately 60% of
the issued and outstanding shares of Common Stock of the Company on a fully
diluted basis. On May 1, 1996, after the effective date of the Merger, the
Company changed its name from LoneStar Hospitality Corporation to Citadel
Computer Systems Incorporated to better reflect the Merger and effected a
one-for-two reverse split.
In July 1994, pursuant to another acquisition consummated in March 1994, the
Company changed its name to LoneStar Hospitality Corporation. From March 1994
until February 1996, the Company owned and operated franchised restaurants in
the Dallas, Texas area.
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FORWARD-LOOKING INFORMATION
The statements contained in this Report that are not historical facts,
including, but not limited to, statements found in this Item 1. "Description
of Business" and in Item 6. "Management's Discussion and Analysis," are
forward-looking statements and 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: integration of acquired technology and
companies, transition of selling and distribution methods, consolidation of
operations into the Company's Dallas offices, the availability of capital on
terms acceptable to the Company, general economic conditions, competition,
the market for the network software products, software development costs and
possible future 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.
BUSINESS RISKS
UNCERTAINTY OF SUCCESS IN SOFTWARE MARKET
The future success of the Company is highly dependent on its ability to
generate significant revenue from its software product offerings. However,
the software market is characterized by rapid technological growth and
intense competition. There can be no assurance that the Company has the
resources, both financial and personnel, to effectively achieve success in
this market.
EXPANSION OF DISTRIBUTION CHANNELS
Historically, the Company used primarily a direct sales model, complemented
with a telesales force, for the sale of its software products. In fiscal
1997, the Company began to expand its distribution efforts to include third
party resellers in both the United States and internationally. The Company's
growth will require it to expand its direct sales force and add distributors
to market, sell, and support the Company's software products. The Company
will be increasingly dependent upon distributors for domestic and
international sales. The Company has only limited experience in marketing its
products through distributors. The expansion of the Company's distribution
network and its direct sales force will require the expenditure of
substantial resources which will be funded primarily through the Company's
operations. There can be no assurance that the Company will be able to expand
its distribution channels successfully.
INTENSE COMPETITION
The Company experiences intense competition from other software companies.
The Company believes that its ability to compete successfully depends on a
number of factors, including the performance, price, and functionality of its
products relative to those of its competitors. Most of the Company's
competitors are larger and have greater financial, technical, marketing,
support, and other resources than the Company. In addition, the software
industry is characterized by low barriers to entry. There can be no assurance
that the Company will be able to compete successfully in the future, or that
the competition will not have a material adverse effect on the Company's
operating results and financial condition.
NEED FOR ADDITIONAL FINANCING; GOING CONCERN MATTERS
The Company currently funds product development and the expansion of sales
and marketing activities through existing cash reserves and cash from
operations and issuances of securities. In the event that cash from
operations and other
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available funds prove to be insufficient to fund the Company's presently
anticipated operations, the Company will be required to seek additional
financing. In October 1997, the Company sold 2,500,000 shares of its Common
Stock to CORESTAFF for $750,000 and other valuable consideration. There can
be no assurance that, if additional financing is required, it will be
available on acceptable terms, or at all. Additional financing may involve
substantial dilution to the interests of the Company's then-current
shareholders. The Company's auditors have included, in their report on the
Company's consolidated financial statements, a paragraph regarding the
ability of the Company to continue as a going concern. Further reference is
made to Note C to the Company's consolidated financial statements for
additional discussion on this matter.
LEGAL PROCEEDINGS
The Company is involved in certain legal proceedings as described in "Item 3.
Legal Proceedings." While the Company intends to defend such lawsuits,
adverse decisions could have a material adverse effect on the Company.
ITEM 2. DESCRIPTION OF PROPERTY
The Company leases its office premises located at 3811 Turtle Creek Blvd.,
Suite 600, Dallas, Texas, pursuant to a lease that expires in 2001 with two
five-year renewal options. The Company believes that these facilities are
adequate for its current needs and that suitable additional or alternative
space will be available in the future on commercially reasonable terms as
needed.
The Company maintains its principal executive offices at 3811 Turtle Creek
Blvd., Suite 600, Dallas, Texas 75219-4421; the telephone number of this
office is (214) 520-9292. The Company maintains a site on the World Wide Web
at http://www.citadel.com.
ITEM 3. LEGAL PROCEEDINGS
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 and the individual director 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 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
claim. Vestcom has agreed to stay the arbitration proceeding pending a
decision on one of the Company's defenses in Texas state court. 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of the year ended February 28, 1997, no matter was
submitted to a vote of security holders, through the solicitation of proxies
or otherwise.
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ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The Company's Common Stock is currently traded on the OTC Bulletin Board
under the symbol NOFF. The following table sets forth, for the periods
indicated, the high and low bid and ask prices for the Common Stock as
reported on the OTC Bulletin Board. Such prices have been adjusted to
reflect the one-for-five reverse stock split effected in December 1995, the
one-for-two stock dividend distributed in February 1996, and the one-for-two
reverse stock split effected on May 1, 1996. The quotations reflect
inter-dealer prices, without retail mark-up, mark-down or commission and may
not represent actual transactions. The Common Stock was traded under the
symbol LSHO from December 15, 1995, to May 3, 1996, and under the symbol LSHC
prior to December 15, 1995.
FISCAL YEAR Bid Ask
--- ----
High Low High Low
---- --- ---- ---
1996
----
1st Quarter 2.50 .84 9.26 4.16
2nd Quarter 5.00 .84 8.34 4.16
3rd Quarter 4.58 .75 8.33 2.80
4th Quarter 3.88 .50 4.38 2.41
1997
----
1st Quarter 18.38 3.50 19.00 4.00
2nd Quarter 13.75 3.00 14.00 3.50
3rd Quarter 4.63 1.13 4.75 1.19
4th Quarter 1.88 .84 1.94 .91
Holders of Common Stock are entitled to dividends when, as and if declared by
the Board of Directors out of funds legally available therefor. The Company
has never paid cash dividends on its Common Stock, and management intends,
for the immediate future, to retain any earnings for the operation and
expansion of the Company's business. Any future determination regarding the
payment of dividends will depend upon results of operations, capital
requirements, the financial condition of the Company and such other factors
that the Board of Directors of the Company may consider. If the Company
issues preferred stock, the Board of Directors will have the right to
establish the rights, designations and preferences thereof, including
preferences as to payment of dividends and liquidation proceeds.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS
The following discussion should be read in conjunction with the financial
statements and notes thereto found elsewhere herein, as well as the
disclosure relating to forward-looking statements set forth in Item 1.
Business--Forward-Looking Information. On February 29, 1996, a wholly-owned
subsidiary of the Company merged with Citadel Computer Systems Incorporated
(the "Merger"). See "Historical Background" in Item 1 of this Report. The
Merger has been accounted for as a reverse acquisition. Accordingly, except
where noted otherwise, the discussion herein relates to the results of
operations and liquidity of Citadel, rather than of the pre-Merger operations
of the Company.
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RESULTS OF OPERATIONS
YEAR ENDED FEBRUARY 28, 1997, AS COMPARED WITH YEAR ENDED DECEMBER 31, 1995
During the fiscal year ended February 28, 1997, the Company had net sales of
$5,326,192, an increase of $3,371,353, or 172%, over net sales of $1,954,839
during the fiscal year ended December 31, 1995. The Company realized
additional sales as a result of increased market awareness of its NetOFF,
Server Sentry and Phantom of the Console products, as well as the addition of
new vertical marketing channels and an increase in its sales and marketing
efforts through the expansion of the Company's sales and marketing
department.
During the fiscal 1997, the Company has also increased its efforts to enter
into OEM and joint venture relationships with strategic partners to increase
its sales channels. In December 1996, the Company's WinShield product was
selected by Microsoft for inclusion in a bundled software product targeted
for the education market. Additionally, during the second quarter of fiscal
1998, the Company signed a bundling agreement with Compaq relating to its
WinShield product. In October 1997, the Company entered into a strategic
alliance with CORESTAFF in which CORESTAFF purchased 2,500,000 shares of
Citadel's common stock and the parties agreed to certain joint research and
development, technology licensing, and marketing activities. The Company is
continuing to explore similar arrangements with other market leaders in the
technology industry and expects to finalize additional alliances in the
second and third quarters of fiscal 1998. The Company expects this channel
to represent a significant percentage of the Company's revenue in the future.
In addition, the Company has recently 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 extremely well received
internationally, and the Company expects this channel will also represent a
significant percentage of the Company's revenues in the future.
The Company introduced NetOFF 5, a 32-bit Net Ware and Windows NT product,
early in the fourth quarter of fiscal 1997 and has recently introduced its
C:\More! product and expects to launch its new Network Recovery System
product in the third quarter of fiscal 1998. The Company also is beta
testing a Windows 95 32-bit upgrade to its WinShield product line and expects
to launch additional new products and upgrades in future quarters of fiscal
1998 that will provide ease-of-use security solutions for Internet and
intranet applications on Microsoft and Novell platforms.
During the first and second quarter of fiscal year 1998, the Company, as part
of its restructuring, changed from its mainly telemarketing and trade-show
model to a more traditional VAR, reseller, OEM and joint venture model.
While the Company believes the newly adopted strategies will better position
the Company for the future and will eventually result in increased sales, the
Company believes that its sales for at least the first two quarters of fiscal
1998 were below the corresponding level of sales for fiscal 1997.
The costs and expenses incurred in connection with producing the Company's
products were $304,436 during the fiscal year ended February 28, 1997, an
increase of $176,853, or approximately 139%, from costs of sales of $127,583
incurred in the previous fiscal year. As a percentage of net sales, costs of
sales decreased in the fiscal year ended February 28, 1997, to 5.7% from 6.5%
in the prior period. The decreases in cost of sales, on a percentage basis,
was primarily the result of greater efficiencies from the higher level of
sales and the company bringing the fulfillment of orders during the year
in-house versus out-sourcing these services as it had done in the past. The
Company, as part of its restructuring, has recently started to out-source a
significant portion of its order fulfillment. Therefore, the Company would
expect that these expenses may increase, as a percentage of sales, in future
periods. However, as an increasing percentage of the Company's sales are
sold through strategic alliances, electronic commerce, site licensing, etc.,
the actual impact of this on the Company's operating performance is expected
to be minimal.
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Selling, general and administrative expenses for the fiscal year ended
February 28, 1997, were $5,939,099, an increase of $4,423,965, or 292%, over
selling, general and administrative expenses during the prior fiscal year.
Such expenses increased primarily due to the Company's growth, which included
the addition of key management and implementation of corporate
infrastructure; the hiring of sales and marketing, development, and
administrative personnel; trade show and marketing expenses; the introduction
of new products and the establishment of the enterprise and VAR and sales
groups; expenses related to its status as a publicly traded company; its
continued efforts to expand its product offerings; and the expansion and
consolidation of its offices. While, as part of the plan of restructuring
mentioned earlier, the Company expects selling, general and administrative
expenses to decrease during the first three quarters of fiscal year 1998.
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.
Provision for uncollectible accounts increased $1,174,325, or 145%, from
$809,788 to $1,984,113 for fiscal years ended December 31, 1995 and February
28, 1997, respectively. The Company generally delivers its products to
customers on a 30-day trial basis following receipt of a signed trial
agreement from customers. The Company only recognizes revenue if the product
has not been returned within the 30 days in accordance with the terms and
conditions of the trial agreement. Numerous disagreements have arisen
between the Company and its customers regarding the customer's obligation to
pay for products delivered. As a result, a significant portion of the
Company's sales have not been collected as of February 28, 1997.
The Company believes these agreements are legally binding contracts and
intends to continue to pursue the collection thereof. However, the Company
has provided an allowance for returns and doubtful accounts of $2,500,000 as
of February 28, 1997 to cover the potential for uncollectible accounts.
Effective April 1997, the Company modified its sales methods and agreements,
which the Company believes will significantly reduce potential conflicts with
its customers and should result in a higher rate of collection. As a result
of this change, the Company expects sales to decrease for at least the first
nine months of its fiscal year 1998 and expects sales for the fourth quarter
to be at or above prior years' levels.
Depreciation and amortization expense increased to $942,166 in the fiscal
year ended February 28, 1997, from $153,224, or an increase of 515% over the
fiscal year ended December 31, 1995. This increase is due to the acquisition
of certain companies and products during the fiscal year.
Research and development expenses charged to operations for the year ended
February 28, 1997 were $3,336,523 compared to $136,355 for the year ended
December 31, 1995, or an increase of $3,200,168. During fiscal year ended
February 28, 1997, and in connection with certain acquisitions, the Company
wrote-off approximately $3,268,040 of purchased in-process research and
development costs that had not reached the working model stage and for which
there was no alternative use. For fiscal year 1997, the Company capitalized
$456,976 in software development costs which will be amortized over the
estimated useful lives of the underlying products. As mentioned earlier, the
Company introduced NetOFF 5, a Windows NT 32-bit product, early in the fourth
quarter of fiscal 1997 and launched its C:\More! product in September 1997
and expects to launch its Network Recovery System product in October 1997.
The Company 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.
During the fiscal year ended February 28, 1997, the Company had a net loss on
sales of marketable securities of $451,280. This resulted from a $1,000,000
charge related to the write-down of the Miami Subs Stock pursuant to the sale
of the restaurants, offset by a $548,720 gain on the sale of certain
marketable securities during the year.
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LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents at February 28, 1997 were $15,100.
Cash flows from operations were a negative $6,706,035 for the fiscal year ended
February 28, 1997, compared to negative $1,165,990 for the fiscal year ended
December 31, 1995. The increase was due principally to the increased net loss
of the Company for the year and the increase in receivables related to the
increased sales.
Cash used in investing activities was $1,562,464 in the fiscal year ended
February 28, 1997, compared to $156,255 in the prior year. This increase was
due to the acquisition of businesses and software and an increase in capital
expenditures related to the expansion and development of the Company's
infrastructure.
Cash flows provided by financing activities were $8,158,034 in the fiscal year
ended February 28, 1997, compared to $1,376,067 in the fiscal year ended
December 31, 1995. This increase was due primarily to the proceeds from the
sale of the Company's common stock, preferred stock, equity notes and proceeds
from the issuance of debt, less repayments.
In fiscal 1997, the Company announced a share repurchase program whereby the
Company is authorized to repurchase up to 500,000 shares of its outstanding
Common Stock in the open market through February 1998. During the year ended
February 28, 1997, the Company repurchased approximately 85,000 shares for an
aggregate purchase price of approximately $209,787.
As a result of the aforementioned factors, cash and cash equivalents decreased
by $110,465 in the fiscal year ended February 28, 1997.
The Company has recently completed a restructuring which the Company expects
has resulted in operating expenses being reduced by at least $300,000 per
month. 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 the 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
2,500,000 shares of Citadel Common Stock. While the Company has been
successful in the past in raising additional capital when needed, there can
be no assurance, however, that the Company will be successful in raising
capital in the future. The Company is continuing to look for other sources
of capital.
On March 11, 1997, the Company had an initial closing with respect to $1,000,000
which is part of a private placement of up to $1,500,000 of 5% Redeemable
Convertible Notes due February 2000 (before fees and expenses). The Notes were
sold to certain offshore accredited investors pursuant to Section 4(2) of the
Securities Act of 1933, as amended, and Regulation S. The Company used the
proceeds to retire certain outstanding indebtedness and for working capital.
The agreement contains certain conversion restrictions as to the percentage of
Notes that may be converted and when such conversions may be made. The
principal amounts of the Notes may be converted, at the holders option, into
Common Stock of the Company at an exercise price between 80% and 75% of the
average bid price for the five trading days prior to the date of conversion,
depending on the date of conversion. No conversions are allowed prior to 41
days from the date of closing. The Company had previously announced its
intention to raise approximately $3 million from a
19
<PAGE>
private placement during its fourth quarter. To date, an aggregate of
$1,000,000 of the notes, as disclosed above, were sold in the private
placement. The Company determined to postpone the sale of the remaining
amounts, but may consider other financing alternatives in the future.
On April 11, 1997, the Board of Directors of the Company authorized the
redemption of all or a portion of its Redeemable Convertible Notes due in the
year 2000 and Series B Convertible Preferred Stock upon notice of conversion.
The Board has initially authorized up to $1.5 million for redemption in
amounts, and at times, depending on market conditions.
The Company also completed a private placement of $500,000 of 8% Redeemable
Convertible Notes as of April 11, 1997, due April 11, 2000. The notes were
sold to certain offshore accredited investors pursuant to Section 4(2) of the
Securities Act of 1933, as amended, and Regulation S. The Company used the
proceeds to retire certain outstanding indebtedness and for working capital.
The agreement contains certain redemption provisions which allow the Company
to redeem all or a portion of the Notes at a certain premium, depending on
the date of redemption. The principal amounts of the Notes may be converted,
after 45 days and at the holders option, into Common Stock of the Company at
an exercise price of 75% of the average bid price for the five trading days
prior to the date of conversion.
On June 9, 1997, the Company had a closing with respect to $1,125,000 of 8%
Redeemable Convertible Notes due June 9, 2000 (before fees and expenses).
The Notes were sold to certain offshore accredited investors pursuant to
Section 4(2) of the Securities Act of 1933, as amended, and Regulation S.
The Company used the proceeds to retire certain Convertible Notes and for
working capital. The agreement contains certain redemption provisions which
allow the Company to redeem all or a portion of the Notes at a certain
premium, depending on the date of redemption. The principal amounts of the
Notes may be converted, after 45 days and at the holders option, into Common
Stock of the Company at an exercise price of 75% of the average bid price for
the five trading days prior to the date of conversion. In connection with
this transaction, the Company's Chairman of the Board pledged stock of
Worldwide PetroMoly, Inc. to secure up to $500,000 of the indebtedness.
See the Independent Auditors Report and Note C to the Notes to Financial
Statements to this Report regarding the continued existence of the Company as
a going concern.
INFLATION
Inflation did not have a material effect on the Company's results during the
periods discussed.
ACCOUNTING STANDARDS NOT ADOPTED
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share." SFAS
No. 128 is not expected to have a material effect on the computation of loss
per share.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income,"
which establishes standards for reporting and display of comprehensive income
and its components, as defined. SFAS No. 130 requires that all items that
must be recognized under accounting standards as components of comprehensive
income be reported in a financial statement displayed with the same
prominence as other financial statements. Adoption of SFAS No. 130 is not
expected to have a material effect on the Company's financial statements.
In addition, in June 1997, the FASB issued SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information," which requires public
enterprises to report certain financial and descriptive information about
operating segments, as defined, in annual financial statements and selected
information
20
<PAGE>
in condensed financial statements for interim periods issued to shareholders,
if practical. The effect of SFAS No. 131 on disclosures in the Company's
financial statements has not been determined.
All of the aforementioned accounting standards are effective for years beginning
after December 15, 1997.
ITEM 7. FINANCIAL STATEMENTS
The Financial Statements for the fiscal year ended February 28, 1997, are found
following the signature page of this Report.
ITEM 8. CHANGES IN, AND DISAGREEMENTS WITH, ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL MATTERS
There has been no change in the principal accountant of the Company during the
Company's two most recent fiscal years.
Grant Thornton LLP is the Company's principal accountant. Old Citadel's former
principal accountant was BDO Seidman, LLP. BDO Seidman, LLP had audited the
financial statements of Old Citadel for the fiscal year ended December 31, 1994.
PART II
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934
DIRECTORS AND EXECUTIVE OFFICERS
The following table contains information about the Company's directors and
executive officers. The Company expects that these persons will serve as
directors until the next annual meeting or until their respective successors
are duly elected and qualified. There is currently one vacancy on the Board
of Directors.
NAME AGE POSITION
- ---- --- --------
Gilbert Gertner 73 Chairman of the Board
George T. Sharp 54 Vice Chairman and Director
Steven B. Solomon 32 President, Chief Executive Officer, Secretary
and Director
Richard L. Travis, Jr. 41 Chief Financial Officer and Chief Operating
Officer
Stuart B. Marks 33 Former Chief Technology Officer
Carl E. Banzhof 30 Chief Technology Officer
Victor K. Kiam, II 72 Director
Mark Rogers 34 Director
Chris A. Economou 41 Director
Axel Sawallich 53 Director
21
<PAGE>
GILBERT GERTNER has been Chairman of the Company since February 29, 1996, and
was chairman of Old Citadel from its inception in July 1992 until the Merger.
From 1990 to 1995, Mr. Gertner was president of Gertner Investments, an
investment firm specializing in identifying, capitalizing and developing
high-tech companies. Mr. Gertner served as a director of Microtel
International, Inc. (formerly known as CXR Telecom Corp.) from 1986 to 1994,
and as a director of Data Systems and Software, Inc. (formerly known as
Defense Software and Systems, Inc.) from 1991 to 1994. Mr. Gertner also
serves as chairman of the board of directors of Worldwide PetroMoly, Inc., a
public company involved in the manufacturing and marketing of synthetic
petroleum products.
GEORGE T. SHARP, Vice Chairman of the Company since May 1997, had served as
President, Chief Executive Officer and a director of the Company from
February 29, 1996, through April 25, 1997, and was president of Old Citadel
from its inception in June 1992. Prior to founding Citadel, Mr. Sharp was
president of Matrix Systems Incorporated, which developed software programs
that provided accounting systems, contact management systems and reporting
systems to independent insurance companies nationwide.
STEVEN B. SOLOMON has been the President and Chief Executive Officer since
May 1997 and served as Chief Operating Officer, Secretary and a director of
the Company from February 29, 1996, through April 25, 1997. He was the
president and a director of LoneStar from its inception in February 1992
until February 1996 and chairman of the Board of Directors from December 1994
until February 1996. Mr. Solomon also served as developer and executive
producer of SportsWaves!, a division of LoneStar that produced syndicated
television programs covering the National Football League and collegiate and
professional sports. From November 1991 to September 1992, Mr. Solomon served
as vice president of corporate development for Europa Cruises Corporation. He
also served as a business advisor and as a development and corporate finance
consultant. From May 1990 to November 1991, Mr. Solomon served as president
of Solomon Associates, a firm which offered consulting services relating to
investments and acquisitions in the shipping industry and venture capital
projects.
RICHARD L. TRAVIS, JR., Chief Operating Officer and Chief Financial Officer,
joined Citadel in December 1996 and has almost 20 years of financial
experience in the manufacturing, financial services, real estate,
construction and telecommunications industries. Mr. Travis served for ten
years as executive vice president and chief financial officer of Texwood
Industries, Inc., a manufacturing and distribution company. Prior to joining
Texwood Industries, Inc., Mr. Travis was senior audit manager from 1983 to
1986 at Grant Thornton LLP, an accounting firm providing audit, tax and
management consulting services, where he managed the firm's Dallas Savings
and Loan practice. Mr. Travis received a B.S./B.B.A. with honors in
Accounting from Florida Atlantic University in 1977, and he earned his
Certified Public Accountant designation in 1978.
STUART B. MARKS, former Chief Technology Officer, joined Citadel in November
1994. Mr. Marks has more than 17 years of experience designing and
developing application software for commercial and entertainment markets,
including political, real estate, construction, education and financial
markets. He has extensive experience in systems integration and is the
author of Citadel's most recent upgrade of NetOFF. Mr. Marks was president
of Marcor, Inc., a software development and consulting group he founded in
1985, until it was acquired by Citadel in November 1994. Mr. Marks resigned
his position with the Company effective July 1997.
CARL E. BANZHOF, present Chief Technology Officer, former Vice President
- -Development of Network Products, joined the Company in February 1996 in
connection with the Company's acquisition of Circuit Masters Software, Inc.
Mr. Banzhof has more than 15 years of experience in the software industry,
including designing, developing and marketing software products; building
software development teams and organizations and managing products in Network
Management and PC DESKTOP markets. He was the founding partner of Circuit
Masters Software, Inc., a software company which developed and marketed
22
<PAGE>
network management utilities for Novell NetWare environments, where he served
as vice president of software engineering from 1992 to 1995. Prior to
joining Circuit Masters Software, Inc., Mr. Banzhof was lead software
developer from 1988 to 1992 at Fluor Daniel Engineering, a software
development and worldwide engineering company. He also served as a software
developer for Micro Computer Business Systems from 1986 to 1987 and for
Southwest Manufacturing from 1983 to 1986.
KENNETH JOHNSEN was elected to the board in October 1997. Mr. Johnsen is
President of Information Technology Services Group of CORESTAFF and an
Executive Vice President of CORESTAFF, one of the largest providers of
information technology and staffing services in the U.S. Prior to his
employment with CORESTAFF in May 1997, Mr. Johnsen worked with IBM for 22
years, as president of worldwide commercial operations for its personal
computer business and as general manager for IBM's Hong Kong operations from
1991 to 1993.
VICTOR K. KIAM, II was elected to the Board of Directors in July 1996. Mr.
Kiam is chairman of Remington Products, L.L.C., a manufacturer, distributor
and marketer of electrical shavers and other consumer products based in
Bridgeport, Connecticut. Mr. Kiam also serves on the boards of directors of
several other consumer product companies.
MARK ROGERS was elected to the Board of Directors in July 1996. Mr. Rogers
manages NFT Ventures, Inc., the venture capital fund established by Ray
Noorda, the founder of Novell, Inc. Through NFT, Mr. Rogers works with
several computer software companies in Silicon Valley, Texas and Utah,
ranging from start-up phase through sale of the company. Mr. Rogers also
serves on the boards of directors of several other high technology firms.
CHRIS A. ECONOMOU was elected to the Board of Directors of the Company on
February 29, 1996, and has been a director of LoneStar since June 1993. He
has been engaged in the private practice of law in Fort Lauderdale, Florida,
in the areas of real estate, business and corporate law for more than ten
years. He served as executive vice president, secretary, general counsel and
director of Miami Subs Corporation from August 1992 until June 1994. He is
also a director of Z-Communications, Inc., a privately-held electronic parts
manufacturer.
DR. AXEL SAWALLICH has been a director of the Company since February 1996 and
a director of LoneStar since March 1993. Dr. Sawallich is in the business of
providing investment advisory services in Vienna, Austria. Since 1993, Dr.
Sawallich has been the managing partner of Global Invest, an investment firm
located in Vienna, Austria, since 1994. From 1991 until 1994, he was
employed by SERCO Investment Counseling Corporation, an investment firm
located in Vienna, and was its executive director from 1992 until 1993. From
November 1989 to November 1990, Dr. Sawallich was the general manager and
director of the Vienna, Austria, regional branch of Allegmeine Sparkasse Bank
AG, Linz, a banking firm. From May 1985 to November 1989, Dr. Sawallich was
with Bank fur Arbeit und Wirtschaft AG, a Vienna, Austria banking firm,
serving as the deputy head of the credit department until 1986 and as the
executive vice president of the Bank's Bureau for Commercial Customers,
thereafter. Dr. Sawallich received a Doctor of Law from the University of
Vienna.
There are no family relationships among any of the directors or executive
officers of the Company.
BOARD COMMITTEES AND MEETINGS
During the fiscal year ended February 28, 1997, the Board of Directors held
two meetings and took action by unanimous consent on one occasion. Each
director attended at least 75% of the number of meetings of the Company's
Board of Directors and committees on which he served.
Following the Merger, the Board of Directors established an executive
committee consisting of Messrs. Gertner, Sharp and Solomon. During the
fiscal year ended February 28, 1997, the executive committee held
three meetings and took action by unanimous consent on eight occasions.
23
<PAGE>
COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
that the Company's officers, directors and persons who own more than ten
percent (10%) of a registered class of the Company's equity securities file
reports of ownership and changes in ownership with the Securities and
Exchange Commission (the "SEC"). Officers, directors and greater than ten
percent (10%) shareholders are required by SEC regulations to furnish the
Company with copies of all Section 16(a) forms they file. Based solely on
its review of the copies of such forms received by it, or written
representations from certain reporting persons that no Form 5s were required
for those persons, the Company believes that during the fiscal year ended
February 28, 1997, Mr. Solomon filed Form 4s late. Such Form 4s related to
grants to, or extensions of, exercise periods or reductions in exercise
prices of options held by such persons.
ITEM 10. EXECUTIVE COMPENSATION
The total compensation for the three fiscal years ended February 28, 1997,
for George T. Sharp, the Company's former Chief Executive Officer; Steven B.
Solomon, the Company's current Chief Executive Officer (and the chief
executive officer of LoneStar prior to the Merger); Stuart B. Marks, the
Company's former Chief Technology Officer; and Carl E. Banzhof, the Company's
present Chief Technology Officer (the "Named Executive Officers"), is set
forth below in the following Summary Compensation Table. No other person
received cash compensation in excess of $100,000 during the fiscal year ended
February 28, 1997.
SUMMARY COMPENSATION TABLE
Fiscal Annual Compensation All Other
Name and Position Year Salary Bonus Compensation
----------------- ---- ------ ----- ------------
George T. Sharp, 1997 150,000 42,727 11,400 /1/
Vice Chairman 1996* 20,833 0 0
1995 81,947 45,433 0
Steven B. Solomon, 1997 120,000 66,496 18,846 /1/
President, Chief 1996+ 110,000 0 13,150 /2/
Executive Officer 1995 91,923 0 23,900 /3/
and Secretary
Stuart B. Marks, 1997 108,330 1,000 0
Former Chief 1996 83,162 0 0
Technolog Officer 1995 34,664 /4/ 0 0
Carl E. Banzhof, 1997 103,228 1,000 0
Present Chief 1996 15,600 /5/ 0 0
Technology 1995 0 0 0
Officer
___________________________
* Transition period
+ April 1, 1995 - February 29, 1996
24
<PAGE>
/1/ Mr. Sharp received a car allowance of $950 per month during fiscal year
ended February 28, 1997. Mr. Solomon received a car allowance of $950 per
month and life and disability insurance during fiscal year ended February 28,
1997.
/2/ Mr. Solomon received a car allowance of $650 per month through June 1995
and $950 per month after July 1, 1995, life insurance and disability
insurance during the fiscal year ended February 29, 1996.
/3/ Mr. Solomon received a car allowance of $650 per month during the fiscal
year ended March 31, 1995. He also received approximately $15,000 in
connection with his efforts to raise capital during that fiscal year and
disability insurance.
/4/ Mr. Marks started to work for the Company in November 1994. Mr. Marks
resigned his employment with the Company effective July 1997.
/5/ Mr. Banzhof started to work for the Company in December 1996.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
During the fiscal year ended February 28, 1997, no options were granted to
the Named Executive Officers.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR
VALUES
The following table describes, for each of the Named Executive Officers,
options exercised and the potential values for their unexercised in-the-money
options at February 28, 1997:
<TABLE>
Value of
Number of Unexercised
Unexercised Options/ Options/SARs at
Shares Value SARs at FY-End(#) FY-End ($)
Acquired on Realized Exercisable/ Excercisable/
Name Exercise (#) ($) Unexercisable Unexercisable
- -------------------- ------------- -------- ------------------- --------------
<S> <C> <C> <C>
George T. Sharp 0 0 1,125,000 / 0 457,031 / 0
George T. Sharp 0 0 337,500 / 0 5,484 / 0
Steven B. Solomon 0 0 1,584,461 / 0 25,593 / 0
Stuart B. Marks 0 0 33,345 / 0 542 / 0
</TABLE>
COMPENSATION OF DIRECTORS
Directors are not compensated for any services provided as directors but are
reimbursed reasonable expenses incurred in connection with attendance at
meetings of the Board or committees.
EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT ARRANGEMENTS
In March 1996, the Board of Directors approved employment agreements between
the Company and Messrs. Sharp and Solomon and a consulting agreement between
the Company and Mr. Gertner. In April 1997, in connection with the discharge
of a certain indebtedness due the Company by GGS Investment Company (see also
"Certain Relationships and Related Transactions"), Mr. Sharp agreed to the
termination of his
25
<PAGE>
employment agreement. The following is a brief description of Mr. Sharp's
prior contract, Mr. Gertner's consulting agreement and Mr. Solomon's
employment agreement.
Mr. Sharp's employment agreement, dated December 1, 1995, had an initial term
through November 30, 2000, with automatic renewals annually unless otherwise
extended or terminated in writing. Mr. Sharp's employment agreement provided
for an annual base salary and permitted bonuses at the discretion of the
Board. The base salary was $150,000 during the first year of the agreement,
$165,000 during the second year, $181,500 during the third year, $199,644
during the fourth year and $219,600 during the fifth year. If Mr. Sharp was
unable to perform his duties during the term because of personal injury,
disability or illness, the Company was required to pay his salary during the
full term of the agreement. In consideration of certain intellectual
property that Mr. Sharp contributed to the Company in the past, the Company
could not terminate his employment for any reason during the initial
five-year term of the agreement. If, however, the Company elected to
terminate the employment agreement for any reason during the initial
five-year term, the balance of the base salary during the balance of that
initial term would be accelerated and payable immediately. This contract was
terminated in April 1997.
Mr. Gertner's consulting agreement, dated December 1, 1995, has an initial
term expiring November 30, 2000, with automatic renewals annually unless
terminated in writing or otherwise extended. Mr. Gertner's consulting
agreement provides for an annual compensation, with additional compensation
at the discretion of the Board. The compensation was $120,000 during the
first year of the consulting agreement, $132,000 during the second year and
$144,000 during remaining three years of the consulting agreement. If Mr.
Gertner's consulting contract is terminated, other than for death or
disability, he shall be entitled to any unpaid compensation and additional
compensation, and any options to purchase Company securities exercisable
during the term of the consulting agreement would become immediately
exercisable.
Mr. Solomon's employment agreement is dated as of March 1, 1996, and its
initial term expires on February 28, 2001. The agreement will be
automatically renewed annually unless terminated in writing or otherwise
extended. Mr. Solomon's employment agreement provides for an annual base
salary and permits the award of bonuses at the discretion of the Board. The
base salary is $120,000 during the first year of the employment agreement and
will be $132,000 during the second year and $144,000 during the remaining
three years of the employment agreement. If Mr. Solomon is terminated other
than for cause, he will be entitled to a severance payment equal to the
greater of the remaining payments due under the employment agreement or any
extension thereof, discounted at 6%, or 24 months' base salary in effect at
the time of such termination.
The Company shall provide life insurance in the amount of $1,000,000 on the
life of Mr. Solomon, in addition to key man life insurance policy on Mr.
Solomon maintained by the Company for its benefit. The Company also provides
disability insurance for Mr. Solomon. The Company shall provide Mr. Solomon
with an automobile allowance of $950 per month and automobile liability
insurance.
REPRICING OF OPTIONS
In June 1995, the board of directors of LoneStar approved the reduction in
the exercise price of several outstanding options and warrants from their
existing exercise prices to $.33-1/3 per share. Among the options with
respect to which exercise prices were lowered were certain options held by
directors or former directors of LoneStar and included an option to purchase
9,461 shares of Common Stock held by each of Mr. Solomon and three other
persons. See Item 12. "Certain Relationships and Related Transactions." In
its action, the LoneStar board reduced the exercise price from $3.98 per
share to $.33-1/3 per share for the period from June 27, 1995, until October
15, 1995, at which time the exercise price reverted to $3.98 per share.
26
<PAGE>
The LoneStar board approved the reduction for two principal reasons. First,
the board wished to provide its investors, including members of the LoneStar
board, with an opportunity to bring their basis in their investment in
LoneStar to a level that was closer to the then-current market price of
LoneStar's common stock. Second, the LoneStar board wanted to encourage
these persons to increase their investment in LoneStar at a time when
additional funds were needed in connection with the operation and growth of
LoneStar's business. Mr. Solomon elected not to exercise the aforementioned
option at the reduced exercise price.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following information is submitted as of October 14, 1997, with respect
to the Company's voting securities owned beneficially by each person known by
the Company owning more than five percent (5%) of the Common Stock of the
Company (the only class of voting securities now outstanding) and by all
directors and executive officers of the Company, individually and as a group.
Unless otherwise indicated, the number of shares and percentage of ownership
of Common Stock for each of the named stockholders assumes that shares of
Common Stock that the stockholder may acquire within 60 days of the Record
Date are outstanding. As of October 14, 1997, the Company had 18,536,902
shares of Common Stock outstanding.
APPROXIMATE
NAME AND ADDRESS NUMBER OF SHARES PERCENT OF CLASS
- ---------------- ---------------- ----------------
Gilbert Gertner 2,744,000 /1/ 13.6%
1300 Post Oak Blvd., 9th Floor
Houston, Texas 77056
George T. Sharp 1,762,500 /1/ 8.8%
1300 Post Oak Blvd., 9th Floor
Houston, Texas 77056
Steven B. Solomon 3,803,000 /2/ 18.5%
3811 Turtle Creek Blvd., Suite 600
Dallas, Texas 75219-4421
Richard L. Travis, Jr. 671,500 /3/ 3.5%
3811 Turtle Creek Blvd., Suite 600
Dallas, Texas 75219-4421
Carl Banzhof 233,151 /4/ 1.3%
3811 Turtle Creek Blvd., Suite 600
Dallas, Texas 75219-4421
Chris A. Economou 274,400 /5/ 1.5%
150 North Federal Highway, Suite 210
Fort Lauderdale, Florida 33301
Kenneth Johnsen 0 *
CORESTAFF, Inc.
4400 Post Oak Parkway
Suite 2000
Houston, Texas 77027
Victor K. Kiam, II 472,500 /6/ 2.5%
RPI Corporation
350 Fifth Avenue, Suite 5408
New York, New York 10018
27
<PAGE>
Mark Rogers 200,000 /7/ 1.1%
NFT Ventures, Inc.
751 Laurel Street, No. 119
San Carlos, California 94070
Axel Sawallich 269,461 /8/ 1.4%
Rudolfplatz 10
A-1080 Vienna, Austria
CORESTAFF, Inc. 4,500,000 /9/ 21.9%
4400 Post Oak Parkway
Suite 2000
Houston, Texas 77027
All officers and directors as a group
(10 persons): 10,430,512 /10/ 41.8%
- ---------------
*Less than one percent.
/1/ Includes 1,462,500 shares presently issuable pursuant to an option to
purchase Common Stock. The number of shares held by Mr. Gertner also
includes warrants to purchase 150,000 shares held by Worldwide PetroMoly,
Inc., a company controlled by Mr. Gertner.
/2/ Includes 2,075,000 shares presently issuable pursuant to options to
purchase Common Stock.
/3/ Includes 650,000 shares presently issuable pursuant to options to purchase
Common Stock.
/4/ Includes 50,000 shares presently issuable pursuant to options to purchase
Common Stock.
/5/ Includes 100,000 shares presently issuable pursuant to options to
purchase Common Stock.
/6/ Includes 262,500 shares presently issuable pursuant to options to purchase
Common Stock.
/7/ Includes 200,000 shares presently issuable pursuant to options to purchase
Common Stock.
/8/ Includes 112,500 shares held by Dr. Sawallich as trustee, over which he has
voting and dispositive power and 50,000 shares presently issuable pursuant to
options to purchase Common Stock.
/9/ Includes 2,000,000 shares presently issuable pursuant to warrants to
purchase Common Stock owned by CORESTAFF and 2,500,000 shares owned by
CORESTAFF.
/10/ Includes all shares presently issuable pursuant to presently exercisable
options held by Messrs. Gertner, Sharp, Banzhof, Solomon, Travis, Kiam,
Rogers, Economou, and Sawallich.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In connection with a $1,125,000, 8% Redeemable Convertible Note offering
dated June 9, 1997, the Company's Chairman of the Board pledged stock of a
company controlled by him to secure the repayment of up to $500,000 of this
indebtedness.
In April 1997, the Company entered into an Asset Sale Agreement with Messrs.
Gertner and Sharp, two of the Company's directors (the "Purchasers"). At the
date of the agreement, the Purchasers owned approximately 31% of the
Company's outstanding Common Stock. The Company sold to the Purchasers,
$3,750,000 of trade accounts receivable and forgave indebtedness owed by the
Purchasers to the Company in the amount of $72,000. The carrying value of
the receivables at February 28, 1997, net of allowance, was $1,877,000.
Consideration received consisted of 3,900,000 shares of the Company's Common
Stock, with a market value of approximately $2,750,000, as of the date of the
transaction (for accounting purposes, the stock was valued at approximately
$1,950,000). The shares acquired represent approximately 23% of the
Company's then issued and outstanding shares and are held as treasury shares.
Pursuant to the participation interest, Citadel will retain a profits
participation interest in the Assets in the event the Purchasers collect in
excess of $2,250,000 of the accounts receivable (after expenses of
28
<PAGE>
collection), in which case the Purchasers shall pay to Citadel 50% of such
amounts collected in excess of $2,250,000. The transaction will result in no
gain or loss to the Company.
At various times during the year ended February 28, 1997, Messrs. Gertner,
Sharp and Solomon, or their affiliates, personally guaranteed or pledged
securities to secure the repayment of various obligations of the Company,
including the personal guarantees of Messrs. Gertner and Sharp and the pledge
by Messrs. Gertner and Solomon of stock to secure the repayment of certain
loans. At various times during the year ended February 28, 1997, Messrs.
Gertner, Sharp and Solomon, or their affiliates, advanced funds to Citadel to
fund various short-term obligations of Citadel. See Item 6. "Management's
Discussion and Analysis."
In December 1996, Worldwide PetroMoly, Inc., a company controlled by Mr.
Gertner, Chairman of the Board of the Company, made a loan to Citadel in the
original principal amount of $500,000. In connection with the loan, Citadel
granted warrants to purchase 150,000 shares of Citadel Common Stock at an
exercise price of $2.00 per share (the exercise price was reduced to $.59 per
share in connection with Mr. Gertner's assumption of this indebtedness in
connection with the discharge of a certain GGS joint venture note due the
Company as discussed below). The loan was secured by a pledge of 732,375
shares of Citadel Common Stock owned by Mr. Solomon, a director and officer
of the Company. The loan bears interest at ten percent (10%) per annum and
had a one-month term. The Company made a payment of $250,000 in March 1997,
and Mr. Gertner and Mr. Sharp agreed to assume the balance of the remaining
indebtedness pursuant to the discharge of the joint venture's indebtedness
due the Company, as detailed below. Although Messrs. Gertner and Sharp
agreed to assume the Citadel note, obtain the release of Citadel and the
return of Mr. Solomon's shares, Worldwide PetroMoly has not yet signed a
release or returned the shares.
In November 1996, the Company made a one-year, $625,000, 8% loan to GGS
Investment Company ("GGS"), a joint venture owned by Mr. Gertner, Chairman of
the Board of the Company, Mr. Sharp, former Chief Executive Officer of the
Company and Steven B. Solomon, former Chief Operating Officer of the Company,
who were also directors and owned an aggregate of approximately 6,800,000
shares of the Company's outstanding Common Stock, at that time. The purpose
of the joint venture was to invest in securities for short-term profits. The
loan agreement provided that interest would be waived for the first six
months in consideration of 100% of the net profits, during that period, being
paid to the Company. The loan was guaranteed by each of the officers, and
the guaranty was secured by a pledge of 754,000 shares of the Company's
Common Stock, valued at approximately $1,282,000 as of the date of the
transaction.
The joint venture was not profitable, and the loan was discharged subsequent
to February 28, 1997 in the following manner: Mr. Solomon forgave $78,000 of
accrued compensation due him, Mr. Gertner and Mr. Sharp assumed debt of
approximately $275,000 (including accrued interest) due to a company
controlled by him, Mr. Sharp received a credit against the loan of $200,000
as consideration for agreeing to terminate his noncancellable employment
contract, and approximately $72,000 was forgiven in connection with the Asset
Sale Agreement discussed above.
In February 1996, LoneStar issued to Chris A. Economou, Steven R. Leipsner,
David S. Lundeen and James E. Bradshaw, each being a member of the Board of
Directors, as then constituted, options to acquire 25,000 shares of Common
Stock at $3.50 per share until May 31, 1996.
During the fiscal year ended February 29, 1996, Axel Sawallich, a director of
the Company, received options to purchase 75,000 shares of Common Stock as
compensation for his assistance in the placement of securities to investors in
Europe.
29
<PAGE>
Chris A. Economou, a director of the Company, provided legal services to
LoneStar. During the fiscal year ended February 29, 1996, Mr. Economou agreed
to receive 105,500 shares of Common Stock in lieu of $35,000 as legal fees for
legal services performed for the Company.
Lawrence E. Steinberg, a director of LoneStar until February 29, 1996, is of
counsel to Jenkens & Gilchrist, a Professional Corporation, a Dallas law firm
that performs legal services for LoneStar. During the year ended February 29,
1996, LoneStar had incurred legal fees totaling $418,784 to Jenkens & Gilchrist.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBITS
2.1 Second Amended and Restated Plan of Merger, dated February 29, 1996,
by and between LoneStar Hospitality Corporation, LSHC Acquisition, Inc. and
Citadel Computer Systems Incorporated (without exhibits). (incorporated by
reference to Exhibit 2.1 of the Company's Current Report on Form 8-K dated
February 29, 1996)
2.2 Purchase and Sale Agreement, dated March 1, 1996, by and between
LoneStar Hospitality Corporation, LS Holding Corp. and Miami Subs USA, Inc.
(without exhibits). (incorporated by reference to Exhibit 2.2 of the
Company's Current Report on Form 8-K dated February 29, 1996)
2.3 Technology Transfer Agreement, by and between LoneStar Hospitality
Corporation and Circuit Masters Software, Inc., dated February 29, 1996
(without exhibits). (incorporated by reference to Exhibit 2.3 of the
Company's Current Report on Form 8-K dated February 29, 1996)
2.4 Technology Transfer Agreement, by and between Citadel Computer Systems
Incorporated and Bill Mulvany, dated February 29, 1996 (without exhibits).
(incorporated by reference to Exhibit 2.4 of the Company's Current Report on
Form 8-K dated February 29, 1996)
2.5 Technology Transfer Agreement, by and between Citadel Computer Systems
Incorporated and Kim Marie Newman, dated February 29, 1996 (without
exhibits). (incorporated by reference to Exhibit 2.5 of the Company's Current
Report on Form 8-K dated February 29, 1996)
2.6 Agreement, by and between Citadel Computer Systems, Inc.; Circuit
Masters Software, Inc.; Patrick William Mulvany and Kim Marie Newman, dated
May 16, 1996, but effective as of February 29, 1996. (incorporated by
reference to Exhibit 2.6 of the Current Report on Form 8-K/A filed with the
Securities and Exchange Commission on June 10, 1996)
3.1 Certificate of Incorporation. (incorporated by reference to the
Registration Statement on Form S-1, File No. 33-25462, for Apollo Resources,
Inc., on November 10, 1988, and declared effective January 4, 1989)
3.2 Certificate of Amendment to Certificate of Incorporation filed with
the Delaware Secretary of State on June 4, 1990. (incorporated by reference
to Exhibit 3.2 of the Company's Annual Report on Form 10-KSB for the fiscal
year ended February 29, 1996)
3.3 Bylaws. (incorporated by reference to the Registration Statement on
Form S-1, File No. 33-25462, filed with the Securities and Exchange
Commission on November 10, 1988)
30
<PAGE>
3.4 Certificate of Amendment to Certificate of Incorporation filed with
the Delaware Secretary of State on October 15, 1991. (incorporated by
reference to the Company's Annual Report on Form 10-K SB for the year ended
December 31, 1991)
3.5 Certificate of Amendment to Certificate of Incorporation filed with
the Delaware Secretary of State on July 20, 1994. (incorporated by reference
to the Company's Quarterly Report on Form 10-QSB for the quarter ended June
30, 1994)
3.6 Certificate of Amendment to Certificate of Incorporation filed with
the Delaware Secretary of State on December 11, 1995. (incorporated by
reference to the Company's Quarterly Report on Form 10-QSB for the quarter
ended December 31, 1995)
3.7 Certificate of Amendment to Certificate of Incorporation filed with
the Delaware Secretary of State on May 1, 1996. (incorporated by reference to
Exhibit 3.7 of the Company's Annual Report on Form 10-KSB for the fiscal year
ended February 29, 1996)
3.8 Certificate of Designations of Series A Preferred Stock. (incorporated
by reference to Exhibit 4 of the Company's Quarterly Report on Form 10-QSB
for the fiscal quarter ended May 31, 1996)
3.9 Certificate of Designations of Series B Preferred Stock. (incorporated
by reference to Exhibit 4.2 of the Company's Quarterly Report on Form 10-QSB
for the fiscal quarter ended August 31, 1996)
10.1 Employment Agreement dated December 1, 1995, by and between Citadel
Computer Systems Incorporated and George Sharp. (incorporated by reference to
Exhibit 10.3 of the Company's Annual Report on Form 10-KSB for the fiscal
year ended February 29, 1996)
10.2 Consulting Agreement dated December 1, 1995, by and between Citadel
Computer Systems Incorporated and Gilbert Gertner. (incorporated by reference
to Exhibit 10.4 of the Company's Annual Report on Form 10-KSB for the fiscal
year ended February 29, 1996)
10.3 Employment Agreement dated March 1, 1996, by and between Citadel
Computer Systems Incorporated and Steven B. Solomon. (incorporated by
reference to Exhibit 10.5 of the Company's Annual Report on Form 10-KSB for
the fiscal year ended February 29, 1996)
10.4 Stock Purchase Agreement, dated August 16, 1996, among Citadel
Computer Systems Incorporated, Kent-Marsh Ltd., Inc., Bob Wesolek and Vance
Nesbitt. (incorporated by reference to Exhibit 2.1 of the Company's Current
Report on Form 8-K filed September 3, 1996)
10.5 Stock Purchase Agreement, dated August 16, 1996, among Citadel
Computer Systems Incorporated, Astonishing Developments, Inc., Bob Wesolek
and Vance Nesbitt. (incorporated by reference to Exhibit 2.2 of the Company's
Current Report on Form 8-K filed September 3, 1996)
10.6 Agreement, dated April 11, 1997, among Citadel, George Sharp and Gil
Gertner. (incorporated by reference to Exhibit 99.1 of the Company's Current
Report on Form 8-K filed April 11, 1997)
10.7 Form of Offshore Securities Subscription Agreement, Convertible Notes,
Warrants and Registration Rights Agreement between Citadel Computer Systems
Incorporated and First Bermuda Securities Limited. (incorporated by reference
to Exhibits 99.1 through 99.4 of the Company's Current Report on Form 8-K
filed March 26, 1997)
31
<PAGE>
10.8 Form of Offshore Securities Subscription Agreement, Convertible Notes,
Warrants and Registration Rights Agreement between Citadel Computer Systems
Incorporated and Willora Company Ltd. (incorporated by reference to Exhibits
99.1 through 99.4 of the Company's Current Report on Form 8-K filed April 28,
1997)
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
October 6, 1997.
*10.11 Warrant to Purchase Common Stock of Citadel issued to
Worldwide PetroMoly Inc.
*21 Subsidiaries of the Company.
*23.1 Consent of Grant Thornton LLP.
*27 Financial Data Schedule.
- -----------------
* Filed as part of the Form 10-KSB for fiscal year ended February 28, 1997.
REPORTS ON FORM 8-K
The Company filed no Current Reports on Form 8-K for the fourth quarter of
the fiscal year ended February 28, 1997.
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
/s/ Steven B. Solomon
- ---------------------------------------
Steven B. Solomon
President and Chief Executive Officer
Dated: October 16, 1997
32
<PAGE>
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the Registrant and in the capacities and on
the dates indicated:
Name and Title Date
- -------------- ----
- ------------------------------------- October 16, 1997
Gilbert Gertner
Chairman of the Board of Directors
/s/ George T. Sharp
- ------------------------------------- October 16, 1997
George T. Sharp
Vice Chairman and Director
/s/ Steven B. Solomon
- ------------------------------------- October 16, 1997
Steven B. Solomon
President, Chief Executive Officer, Secretary and
Director (Principal Executive Officer)
/s/ Richard L. Travis, Jr.
- ------------------------------------- October 16, 1997
Richard L. Travis, Jr.
Chief Financial Officer and Chief Operating Officer
(Principal Accounting Officer)
/s/ Victor K. Kiam, II
- ------------------------------------- October 16, 1997
Victor K. Kiam, II
Director
- ------------------------------------- October 16, 1997
Mark Rogers
Director
/s/ Chris A. Economou
- ------------------------------------- October 16, 1997
Chris A. Economou
Director
/s/ Dr. Axel Sawallich
- ------------------------------------- October 16, 1997
Dr. Axel Sawallich
Director
- ------------------------------------ October 16, 1997
Ken Johnsen
Director
33
<PAGE>
INDEX TO FINANCIAL STATEMENTS
Report of Independent Certified Public Accountants F-2
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-5
Consolidated Statement of Stockholders' Equity (Deficit) F-6
Consolidated Statements of Cash Flows F-7
Notes to Consolidated Financial Statements F-8
F-1
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Citadel Computer Systems, Incorporated
We have audited the accompanying consolidated balance sheets of Citadel
Computer Systems, Incorporated as of February 28, 1997, February 29, 1996 and
December 31, 1995 and the related consolidated statements of operations,
stockholders' equity (deficit), and cash flows for the year ended February
28, 1997, the two months ended February 29, 1996 and the year ended December
31, 1995. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe our audits provide a reasonable
basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Citadel
Computer Systems, Incorporated as of February 28, 1997, February 29, 1996 and
December 31, 1995, and the consolidated results of their operations and their
consolidated cash flows for the year ended February 28, 1997, the two months
ended February 29, 1996 and the year ended December 31, 1995, in conformity
with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. As discussed in Note C to the financial
statements, the Company had a net loss of $7,515,607 for the year ended
February 29, 1997, losses have continued through June 30, 1997, and the
Company does not have adequate cash to support its operations. Management's
plans with regard to these matters are discussed in Note C. These matters
raise substantial doubt about the Company's ability to continue as a going
concern. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
GRANT THORNTON LLP
Dallas, Texas
August 29, 1997 (except for the last
paragraph of Note Q,
as to which the date is
October 6, 1997)
F-2
<PAGE>
CITADEL COMPUTER SYSTEMS, INCORPORATED
CONSOLIDATED BALANCE SHEETS
<TABLE>
February 28, February 29,
ASSETS 1997 1996
----------- -----------
<S> <C> <C>
CURRENT ASSETS
Cash $ 15,100 $ 125,565
Accounts receivable, less allowance for returns and
doubtful accounts of $625,000 and $325,000 727,422 484,336
Notes receivable from related parties 870,000 -
Marketable securities available for sale 1,250,000 -
Assets under contract of sale - 2,605,772
Other 57,106 82,405
----------- ----------
Total current assets 2,919,628 3,298,078
ACCOUNTS RECEIVABLE - NONCURRENT, less allowance
for returns and doubtful accounts of $1,875,000 1,875,000 -
PROPERTY AND EQUIPMENT, NET 696,459 110,327
PURCHASED SOFTWARE, NET OF ACCUMULATED
AMORTIZATION OF $854,000 AND $188,000 4,396,398 2,622,000
CAPITALIZED SOFTWARE DEVELOPMENT COSTS,
NET OF ACCUMULATED AMORTIZATION OF $19,000 AT
FEBRUARY 28, 1997 573,388 135,412
OTHER ASSETS 263,220 249,046
----------- ----------
$10,724,093 $6,414,863
----------- ----------
----------- ----------
</TABLE>
F-3
<PAGE>
CITADEL COMPUTER SYSTEMS, INCORPORATED
CONSOLIDATED BALANCE SHEETS - CONTINUED
<TABLE>
February 28, February 29,
LIABILITIES AND STOCKHOLDERS' EQUITY 1997 1996
----------- -----------
<S> <C> <C>
CURRENT LIABILITIES
Cash overdraft $ 167,256 $ -
Current maturities of long-term debt 804,141 -
Notes payable 2,456,087 4,034,214
Accounts payable and accrued expenses 2,253,481 2,030,800
----------- ----------
Total current liabilities 5,680,965 6,065,014
LONG-TERM LIABILITIES
Debt, less current maturities 1,770,905 -
Accounts payable - 34,360
----------- ----------
Total long-term liabilities 1,770,905 34,360
----------- ----------
Total liabilities 7,451,870 6,099,374
COMMITMENTS AND CONTINGENCIES - -
STOCKHOLDERS' EQUITY
Common stock, $.01 par value per share; authorized,
30,000,000 shares; issued, 16,501,980 shares
in 1997 and 11,509,126 shares in 1996 165,020 115,091
Preferred stock, $.01 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 300,000 -
Additional paid-in capital 13,370,627 2,405,144
Accumulated deficit (9,854,067) (2,204,746)
Unrealized loss on securities available for sale (355,772) -
Treasury stock, at cost (264,613 shares) (353,590) -
----------- ----------
Total stockholders' equity 3,272,223 315,489
----------- ----------
$10,724,093 $6,414,863
----------- ----------
----------- ----------
</TABLE>
The accompanying notes are an integral part of these statements.
F-4
<PAGE>
CITADEL COMPUTER SYSTEMS, INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
Two months
Year ended ended Year ended
February 28, February 29, December 31,
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
REVENUES
Sales $ 5,824,553 $ 301,781 $ 2,562,530
Less returns for allowances 498,361 34,703 607,691
----------- ---------- -----------
Net sales 5,326,192 267,078 1,954,839
COST OF SALES 304,436 24,308 127,583
----------- ---------- -----------
Gross profit 5,021,756 242,770 1,827,256
OPERATING EXPENSES
Selling, general and administrative expenses 5,939,099 507,325 1,515,134
Provision for uncollectible receivables 1,984,113 76,398 809,788
Depreciation and amortization 942,166 29,199 153,224
Research and development expense 3,336,253 32,842 136,355
----------- ---------- -----------
12,201,631 645,764 2,614,501
----------- ---------- -----------
Operating loss (7,179,875) (402,994) (787,245)
OTHER INCOME (EXPENSE)
Interest expense (253,557) (31,579) (250,525)
Write-down of marketable securities (1,000,000) - -
Gain on sales of marketable securities 548,720 - -
Other 369,105 45,036 (71,878)
----------- ---------- -----------
(335,732) 13,457 (322,403)
----------- ---------- -----------
NET LOSS $(7,515,607) $ (389,537) $(1,109,648)
----------- ---------- -----------
----------- ---------- -----------
Loss per share $(.56) $(.06) $(.17)
----- ----- -----
----- ----- -----
Weighted average shares outstanding 13,721,032 6,750,000 6,570,284
----------- ---------- -----------
----------- ---------- -----------
</TABLE>
The accompanying notes are an integral part of these statements.
F-5
<PAGE>
CITADEL COMPUTER SYSTEMS, INCORPORATED
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
Unrealized
loss on
Common stock securities Additional
----------------- Preferred Equity available paid-in Accumulated Treasury
Shares Amount stock notes for sale capital deficit stock Total
---------- ------- ------- ------ ----------- ---------- ----------- -------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1,
1995 2,895 $ 29 $ - $ - $ - $ 825,485 $ (705,561) $ - $ 119,953
Issuance of common
stock 105 1 - - - 55,519 - - 55,520
1,000-for-1 stock split,
effective in the form
of a stock dividend 2,997,000 29,970 - - - (29,970) - - -
Net loss - - - - - - (1,109,648) - (1,109,648)
---------- -------- ------ ----------- ----------- ----------- ----------- -------- ------------
Balance at December 31,
1995 3,000,000 30,000 - - - 851,034 (1,815,209) - (934,175)
Recapitalization of
Citadel Computer
Systems, Incorporated
and merger with
LoneStar Hospitality
Corp. 8,138,756 81,388 - - - (442,187) - - (360,799)
Acquisition of business 370,370 3,703 - - - 1,996,297 - - 2,000,000
Net loss - - - - - - (389,537) - (389,537)
---------- -------- ------ ----------- ----------- ----------- ----------- -------- ------------
Balance at February 29,
1996 11,509,126 115,091 - - - 2,405,144 (2,204,746) - 315,489
Exercise of stock options
and warrants 240,282 $ 2,403 $ - $ - $ - $ 639,259 $ - $ - $ 641,662
Sale of preferred stock -
3,490 shares, net of
issuance costs of
$565,118 - - 35 - - 2,924,847 - - 2,924,882
Sale of equity notes,
net of issuance costs
of $527,434 - - - 4,550,000 - (527,434) - - 4,022,566
Conversions to common
stock 3,633,623 36,337 (30) (4,250,000) - 4,213,693 - - -
Payment of dividends
Preferred stock 75,296 753 - - - 54,225 (54,978) - -
Equity notes 45,947 459 - - - 78,277 (78,736) - -
Notes payable converted
to warrants - - - - - 734,000 - - 734,000
Stock options issued for
services - - - - - 70,040 - - 70,040
Sale of common stock, net
of issuance costs of
$87,059 357,706 3,577 - - - 845,775 - - 849,352
Unrealized loss on
securities available
for sale - - - - (355,772) - - - (355,772)
Purchase of treasury
stock - 84,613 shares - - - - - - - (209,787) (209,787)
Sale of subsidiary for
common stock -
180,000 shares - - - - - - - (143,803) (143,803)
Acquisition of businesses 640,000 6,400 - - - 1,932,801 - - 1,939,201
Net loss - - - - - - (7,515,607) - (7,515,607)
---------- -------- ------ ----------- --------- ----------- ----------- --------- ------------
Balance at February 28,
1997 16,501,980 $165,020 $ 5 $ 300,000 $(355,772) $13,370,627 $(9,854,067) $(353,590) $ 3,272,223
---------- -------- ------ ----------- --------- ----------- ----------- --------- ------------
---------- -------- ------ ----------- --------- ----------- ----------- --------- ------------
</TABLE>
The accompanying notes are an integral part of these statements.
F-6
<PAGE>
CITADEL COMPUTER SYSTEMS, INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Two months
Year ended ended Year ended
February 28, February 29, December 31,
1997 1996 1995
----------- ----------- ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(7,515,607) $ (389,537) $(1,109,648)
Adjustments to reconcile net loss to net cash used
by operating activities
Acquisition of in-process research and development 3,268,040 - -
Write-down of available for sale securities 1,000,000 - -
Depreciation and amortization 942,166 29,199 153,224
Stock and options issued for services 70,040 - 5,520
Gain on sale of securities (548,720) - -
Loss on disposal of asset - - 47,900
Provision for losses on accounts receivable
and sales returns 2,482,474 132,802 410,314
Changes in operating assets and liabilities
Accounts receivable (4,489,829) (165,122) (706,725)
Other receivables (870,000) 5,998 (83,002)
Other current assets 48,400 (53,850) (139,299)
Software development costs (457,321) - -
Cash overdraft 167,256 - (6,272)
Accounts payable and accrued expenses (442,733) 97,353 261,998
Other assets (360,201) - -
----------- ----------- -----------
NET CASH USED BY OPERATING ACTIVITIES (6,706,035) (343,157) (1,165,990)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of available for sale securities (7,032,397) - -
Sales of available for sale securities 7,581,117 - -
Capital expenditures (763,824) (100,998) (158,355)
Proceeds from sale of assets - - 2,100
Acquisition of businesses and software (1,347,360) (200,000) -
----------- ----------- -----------
NET CASH USED BY INVESTING ACTIVITIES (1,562,464) (300,998) (156,255)
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on notes payable $(1,439,127) $ (227,107) $ (742,000)
Proceeds from notes payable - 943,005 1,850,595
Net proceeds from factor - - 267,472
Proceeds from long-term debt 1,583,522 - -
Repayments on long-term debt (215,036) - -
Proceeds from sale of preferred stock 2,924,882 - -
Proceeds from sale of equity notes 4,022,566 - -
Proceeds from sale of common stock 1,491,014 - -
Purchase of treasury stock (209,787) - -
----------- ----------- -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 8,158,034 715,898 1,376,067
----------- ----------- -----------
Net increase (decrease) in cash (110,465) 71,743 53,822
Cash at beginning of the period 125,565 53,822 -
----------- ----------- -----------
Cash at end of the period $ 15,100 $ 125,565 $ 53,822
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these statements.
F-7
<PAGE>
CITADEL COMPUTER SYSTEMS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
February 28, 1997, February 29, 1996 and December 31, 1995
NOTE A - BASIS OF PRESENTATION
Effective February 29, 1996, Citadel Computer Systems, Incorporated (the
Company), successor to Citadel Computer Systems, Incorporated, a
Delaware corporation (Old Citadel), merged with LSHC Acquisition, Inc.,
a wholly-owned subsidiary of LoneStar Hospitality Corporation
(LoneStar). Pursuant to the terms of the merger agreement, each
stockholder of the Company received 2.25 shares of LoneStar common stock
for each share of the Company's common stock.
Immediately after the merger, the stockholders of Old Citadel owned
approximately 60% of the outstanding common stock of the Company.
Therefore, the merger has been accounted for as a reverse merger,
whereby Old Citadel is deemed to have acquired LoneStar.
As discussed in Note N, LoneStar entered into an agreement in
February 1996 to sell substantially all of its assets and
operations in exchange for common stock of Miami Subs USA, Inc.
The sale was consummated on March 1, 1996, and LoneStar is no
longer an operating company.
As a result of the merger, (i) stockholders' equity of the Company
was decreased by $360,799, which represents the stockholders'
deficit of LoneStar at the date of the merger, and (ii) the Company
has been "recapitalized" to reflect the outstanding shares of
LoneStar, the legal acquiror.
NOTE B - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS
The Company develops and markets, throughout the United States,
computer network management, security and utility software. To
date, the Company's activities have primarily been limited to
marketing and selling software products directly to end users
through telemarketing and trade shows. Effective April 1997, the
Company changed its sales and marketing approach to focus more on
establishing key business relationships with value-added resellers, other
resellers, original equipment manufacturers, and joint venture partners
as the preferred method for the distribution of its products.
CHANGE OF NAME
On May 6, 1996, LoneStar changed its name to Citadel Computer
Systems, Incorporated.
F-8
<PAGE>
CITADEL COMPUTER SYSTEMS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1997, February 29, 1996 and December 31, 1995
NOTE B - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES - CONTINUED
USE OF ESTIMATES
In preparing financial statements in conformity with generally
accepted accounting principles, management is required to make
estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and
liabilities at the date of the financial statements, and the
reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
REVENUE RECOGNITION
The Company generally delivers its products to customers on a thirty
(30) day trial basis following receipt of a signed trial agreement
from the customer. The Company only recognizes revenue if the
product has not been returned within 30 days in accordance with the
terms and conditions of the trial agreement. Numerous
disagreements have arisen between the Company and its customers
regarding the customer's obligation to pay for the products
delivered. As a result, a significant portion of the Company's
sales have not been collected as of February 28, 1997.
The Company believes that these agreements are legally binding
contracts and intends to continue to pursue the collection thereof.
The Company has, however, provided an allowance for returns and
doubtful accounts of $2,500,000 as of February 28, 1997 to cover
potential uncollectible accounts.
Effective April 1997, the Company modified its sales methods and
agreements, which the Company believes will significantly reduce
potential conflicts with its customers and should result in a
higher rate of collection. As a result of this change, the Company
expects sales to decrease for at least the first two quarters of
its fiscal year ending February 28, 1998.
PROPERTY, EQUIPMENT AND DEPRECIATION
Property and equipment are stated at cost. Depreciation is provided
using the straight-line method over estimated useful lives of the
assets.
SOFTWARE COSTS
Purchased software is recorded at cost and is amortized by the
straight-line method over five years.
The Company capitalizes software development costs when
technological feasibility has been established. Software
development costs not qualifying for capitalization are expensed as
research and development costs. Research and development expense
totaled $3,336,253 , $32,842, and $136,355 for the year ended
February 28, 1997, the two months ended February 29, 1996 and the
year ended December 31, 1995,
F-9
<PAGE>
CITADEL COMPUTER SYSTEMS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1997, February 29, 1996 and December 31, 1995
NOTE B - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES - CONTINUED
respectively. Included in fiscal 1997 expense is $3,268,040
representing amounts written off in connection with the
acquisitions referred to in Notes F and G. Capitalized costs are
amortized on a product-by-product basis, based on the greater
amount computed by using (a) the ratio that current gross revenue
for a product bears to the total of current and anticipated future
gross revenues for that product, or (b) straight-line amortization
using useful lives ranging from 3 to 7 years. The Company
evaluates the estimated net realizable value of each software
product at each balance sheet date and records write-downs to net
realizable value for any products for which the net book value is
in excess of net realizable value.
It is reasonably possible that future events could cause a reduction
in the amortization period of software costs.
STOCK-BASED COMPENSATION
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("Statement No. 123") is effective for
the year ended February 28, 1997. Statement No. 123 establishes a
fair value based method of accounting for employee stock options,
but permits continued application of the accounting method
prescribed by Accounting Principles Board Opinion No. 25 ("Opinion
25"), "Accounting for Stock Issued to Employees." Entities that
continue to apply the provisions of Opinion 25 are required to make
pro forma disclosures of net income and earnings per share as if
the fair value based method of accounting had been applied. Refer
to Note L.
INVESTMENT SECURITIES
The Company classifies investments as available for sale.
Securities classified as available for sale are reported at fair
value, with unrealized gains and losses excluded from earnings and
reported as a separate component of stockholders' equity.
Permanent declines in value are reported in the statements of
operations.
Realized gains and losses for securities classified as available for
sale are reported in earnings in year of sale.
RECLASSIFICATIONS
Certain amounts for 1996 and 1995 have been reclassified to conform
to the 1997 presentation.
LOSS PER SHARE
The computation of loss per share is based upon the weighted average
number of outstanding common shares during the periods. The
weighted average number of shares outstanding in 1995 was
calculated by giving retroactive effect to the 1,000-for-1 stock
split of Old Citadel shares, the shares issued in the merger of Old
Citadel and LoneStar, and the 1-for-2 reverse stock split in May
1996 (Note L). No effect has been
F-10
<PAGE>
CITADEL COMPUTER SYSTEMS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1997, February 29, 1996 and December 31, 1995
NOTE B - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES - CONTINUED
given to stock options, warrants and conversion rights of
noteholders and preferred stockholders, because the effect of
assumed exercises or conversions is anti-dilutive.
NOTE C - GOING CONCERN MATTERS
OVERVIEW
The accompanying financial statements of the Company have been
presented on the basis that the Company is a going concern, which
contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. The Company reported
a net loss of $7,515,607 for the year ended February 28, 1997 and
net losses of $389,537 and $1,109,648 for the two months ended
February 29, 1996 and the year ended December 31, 1995,
respectively. Additionally, at February 28, 1997, the Company has
a working capital deficit of $2,761,337 and funds used in operations
were $6,706,035 for the year then ended. Through June 30, 1997,
the Company has continued to incur losses, and the Company does not
have adequate cash to support its operations.
CURRENT DEVELOPMENTS
The Company, in April 1997, commenced an aggressive restructuring
program and put in place budgetary controls covering all areas of
its operations. As part of this program, the Company consolidated
its Houston operations into its Dallas location; eliminated its
outside sales offices; reduced its workforce by 70%; significantly
reduced its overhead, marketing and general and administrative
expenses; and changed its overall sales strategy. The Company
estimates that the aforementioned items have reduced operating
expenses by a minimum of $300,000 per month. In addition, the
Company is working with various vendors and lenders to restructure
payables and debt that are currently owed.
The Company has shifted its sales strategy from its traditional
telemarketing approach to a concentration on resellers and value
added resellers, original equipment manufacturers and joint venture
partners. The Company anticipates that, due to the change in sales
strategy, fiscal year 1998 sales will be below prior year levels
for at least the first two quarters. However, it expects that
sales under the new strategy will be collected within the Company's
normal terms of 30 days and thus the resulting impact on the
Company's cash flow should be minimal. However, no assurances can
be provided that the resulting sales volume will be below prior
year's levels for only the first two quarters, that the sales under
the new strategy be collected in 30 days or, as such, the resulting
impact of the new strategy on the Company's cash flow will be
minimal.
F-11
<PAGE>
CITADEL COMPUTER SYSTEMS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1997, February 29, 1996 and December 31, 1995
NOTE C - GOING CONCERN MATTERS - CONTINUED
The Company has recently signed several strategic alliances with
some of the leading companies in the technology industry and
expects to finalize additional alliances during the second and
third quarters of its current fiscal year. The Company anticipates
sales through these alliances will represent a significant
percentage of the Company's revenue in the future. However, the
Company can provide no assurance that significant revenues will be
generated from these new alliances.
The Company has released, and expects to release, new products and
improved versions of current products. The Company anticipates
that the potential revenue stream from these products could be
quite substantial. However, the Company can provide no assurances
that significant revenues will be generated from these products.
OVERALL
While management continues to explore further ways to cut its
operating costs, form new strategic alliances and introduce new
products, the Company's continued existence will be dependent upon
its ability to raise additional capital. The Company believes that
it will be successful in raising additional capital through private
placement offerings or other means (Note Q). Historically, the
Company has been successful in raising funds from outside sources.
However, there can be no assurances the Company will be successful
in the future.
All of the above matters raise substantial doubt about the Company's
ability to continue as a going concern. The accompanying financial
statements do not include any adjustments that might result from
the outcome of these uncertainties.
NOTE D - MARKETABLE SECURITIES
The Company received 1,325,000 shares of Miami Subs U.S.A., Inc.
(Miami Subs) common stock valued at $2,567,187 as consideration for
the sale of its restaurants on March 1, 1996 (Note M). Based on
events occurring after the sale of the restaurants, the Company
concluded that it could no longer recover the carrying value of the
Miami Subs stock and wrote the investment down by a charge to
earnings of $1,000,000. At February 28, 1997, a valuation
allowance of $355,772 has been made by a charge to stockholders'
equity. In June 1997, the Company tendered the stock to Miami Subs
as payment for the $1,250,000 note payable to Miami Subs (Note I).
F-12
<PAGE>
CITADEL COMPUTER SYSTEMS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1997, February 29, 1996 and December 31, 1995
NOTE E - PROPERTY AND EQUIPMENT
Major classes of property and equipment and their estimated useful
lives are as follows:
February 28, February 29,
Lives 1997 1996
---------- ----------- ------------
Furniture 5-10 years $ 228,433 $ 24,158
Office equipment 3-7 years 132,205 48,661
Leasehold improvements Lease term 15,000 -
Computer equipment 3-7 years 547,900 76,377
--------- ---------
923,538 149,196
Less accumulated depreciation (227,079) (38,869)
--------- ---------
Net property and equipment $ 696,459 $110,327
--------- ---------
--------- ---------
NOTE F - ACQUISITIONS
Effective February 29, 1996, the Company acquired substantially all
of the assets of Circuit Masters Software, Inc. (Circuit Masters)
in a transaction accounted for as a purchase. Consideration
consisted of 370,370 shares of common stock valued at $2,000,000,
cash of approximately $200,000 and assumption of certain
liabilities of approximately $50,000.
In August 1996, the Company acquired Kent Marsh Ltd., Inc. and
Astonishing Developments, Inc. (the ADI Group), which develops
security software for stand alone personal computers, for a total
consideration of approximately $2,200,000, consisting of 360,000
shares of common stock valued at $1,200,000 (subject to sales
restrictions for two years), $600,000 in cash and $400,000 in
short-term notes.
In August 1996, the Company acquired Danasoft, Inc. which develops
and markets software for Internet and Intranet applications, for a
total consideration of $294,000, consisting of 100,000 shares of
common stock valued at $264,000 and $30,000 in cash.
In August 1996, the Company acquired MicroVault Corporation, a data
security software provider, for a total consideration of $550,000,
consisting of 180,000 shares of common stock valued at $475,000 and
$75,000 in cash. There was a disagreement between the parties and,
in February 1997, the Company sold MicroVault Corporation back to
its former owner for the 180,000 shares of stock.
Each acquisition has been accounted for by the purchase method. In
connection with the acquisition of the ADI Group and MicroVault
Corporation, the Company wrote off approximately $1,711,000 of
purchased research and development technology that had not reached
the working model stage and for which there is not an alternate
use.
F-13
<PAGE>
CITADEL COMPUTER SYSTEMS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1997, February 29, 1996 and December 31, 1995
NOTE F - ACQUISITIONS - CONTINUED
The following unaudited pro forma summary of results of operations gives
effect to the acquisitions of Circuit Masters and the ADI Group (the effect
of the acquisition of Danasoft, Inc. was not material) as though the
acquisitions had been made as of the beginning of the previous fiscal year
(January 1, 1995):
Two months
Year ended ended Year ended
February 28, February 29, December 31,
1997 1996 1995
------------- ------------ ------------
Revenues $ 5,732,406 $ 406,744 $ 3,410,580
Net loss (6,479,902) (454,360) (3,273,504)
Net loss per share (.47) (.06) (.47)
The fiscal 1997 pro forma data excludes the write-off of $1,236,000 (.09
per share) of purchased research and development related to the ADI Group
acquisition. Such write-off has been included in the fiscal 1995 data and
was equal to $.19 per share.
The unaudited pro forma summary results of operations are not necessarily
indicative of results of operations that would have occurred had the
transactions taken place as of January 1, 1995 or of the future results of
operations of the combined businesses.
NOTE G - PURCHASE OF SOFTWARE
On August 29, 1996, the Company acquired certain technologies from Xerox
Corporation (Xerox) for a total consideration of $1,957,000, consisting of
a note payable of $1,350,000 ($1,207,000 after discounting for imputed
interest, and to be reduced by $100,000 if paid within one year) and cash
of $750,000. In addition, royalties of up to $1,250,000 will be payable to
Xerox based upon future sales. The total consideration was allocated
between purchased software ($400,000) and in-process research and
development costs ($1,557,000), which was written off at the date of
purchase.
In connection with the acquisitions of the ADI Group, and Danasoft, Inc.
(Note F), the Company acquired software valued at approximately $1,406,000
and $177,000, respectively.
NOTE H - FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments consist of cash, marketable securities,
notes receivable, accounts receivable, accounts and notes payable, and
long-term debt. Marketable securities are carried at fair value. The
Company estimates the fair value of long-term debt approximates its carrying
value. The other instruments' carrying values approximate fair value because
of their short-term maturities.
F-14
<PAGE>
CITADEL COMPUTER SYSTEMS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1997, February 29, 1996 and December 31, 1995
NOTE I - NOTES PAYABLE
Notes payable consist of the following:
<TABLE>
February 28, February 29,
1997 1996
------------ ------------
<S> <C> <C>
Unsecured notes payable to individuals, including $430,000
in 1997 and $141,488 in 1996 to related parties, due at
various dates in 1997, bearing interest at rates ranging
from 0% to 10%; weighted average interest rate is
approximately 4.0% (1) $ 722,500 $1,624,493
Note payable to factor, collateralized by receivables - 267,472
Note payable to officer, non-interest bearing and due upon
demand 36,809 117,722
Note payable to commercial finance company; note was replaced
in March 1996 by a note to Miami Subs USA, Inc. (2) 1,250,000 1,467,039
Notes payable to individuals, bearing interest at 12%, due
July 1996 (3) - 557,488
Note payable to a corporation, bearing interest at 10%,
past due (4) 250,000 -
Note payable to bank, bearing interest at 11.50%, past due 150,000 -
Note payable to a commercial finance company, bearing interest
at 11.5%, due April, 1997 20,555 -
Other notes payable 26,223 -
---------- -----------
$2,456,087 $4,034,214
---------- -----------
---------- -----------
</TABLE>
(1) Certain of these notes have warrants to purchase common stock. The
aggregate number of such warrants at February 28, 1997 is 365,625 with
an exercise price of $.89 per share.
(2) Note is noninterest bearing and was due in July 1996. Note was liquidated
in June 1997 by transferring collateral to Miami Subs USA, Inc. (Note D).
(3) These notes had warrants to purchase 105,000 shares of common stock at
$2.00 per share.
(4) Payee is controlled by the Company's Chairman of the Board. Note is
collateralized by pledge of Company shares owned by an officer of the
Company. See Note N regarding assumption of the note by the Chairman
of the Board in April 1997. In connection with the loan, the Company
granted warrants to purchase 150,000 shares of common stock at an exercise
price of $2.00 per share (the exercise price was reduced to $.59 in
connection with the discharge of the GGS loan discussed in Note N).
F-15
<PAGE>
CITADEL COMPUTER SYSTEMS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1997, February 29, 1996 and December 31, 1995
NOTE J - LONG-TERM DEBT
<TABLE>
February 28, February 29,
1997 1996
------------ ------------
<S> <C> <C>
Redeemable convertible notes, interest at 5% payable
in common stock, due in March 2000 (1) $1,000,000 $ -
Note payable to Xerox Corporation, non-interest bearing,
due September 1998, interest imputed at 10% (net of
discount of $143,440) 1,075,918 -
Note payable to a bank, payable $4,063 per month plus
interest at 10.5%, through August 2000 178,693 -
Capital lease obligations, payable in varying monthly
installments through 2001, collateralized by the
related equipment and guaranteed by certain officers
of the Company 374,434 -
---------- -------
2,629,045 -
Less amounts representing interest on capital lease
obligations, imputed at rates ranging from 7.02%
to 23.78% (53,999) -
---------- -------
2,575,046 -
Less current maturities 804,141 -
---------- -------
$1,770,905 $ -
---------- -------
---------- -------
</TABLE>
(1) These notes are convertible into common stock at the lesser of $1.50
per share or a percentage, which ranges from 75 to 80% of the average
market price for the five days preceding conversion. The notes are
payable, at the option of the Company, in cash or common stock. However,
in the event of a transfer of 50% of the voting rights of the common stock,
the note holder can demand payment in cash for unconverted notes at 125% of
the principal amount.
Aggregate maturities of long-term debt for the five years following
February 28, 1997, are as follows:
Year ending
February 28,
------------
1998 $ 804,141
1999 611,744
2000 143,805
2001 1,014,133
2002 1,223
----------
$2,575,046
----------
----------
F-16
<PAGE>
CITADEL COMPUTER SYSTEMS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1997, February 29, 1996 and December 31, 1995
NOTE K - INCOME TAXES
Following is a reconciliation of the Company's income tax provision with
the amount of tax computed at the statutory rate:
<TABLE>
Two months
Year ended ended Year ended
February 28, February 29, December 31,
1997 1996 1995
------------ ------------- ------------
<S> <C> <C> <C>
Tax benefit at statutory rate $ 2,555,000 $ 133,000 $ 377,000
Write-off of purchased research and development (582,000) - -
Change in valuation allowance, net of amounts
that relate to acquired business ($219,000) and
unrealized losses on securities available for
sale ($121,000) in 1997 (2,005,000) (132,000) (375,000)
Other 32,000 (1,000) (2,000)
------------ ---------- -----------
$ - $ - $ -
------------ ---------- -----------
------------ ---------- -----------
Significant components of deferred income tax assets and liabilities are as
follows:
February 28, February 29, December 31,
1997 1996 1995
------------- ------------- -------------
Deferred tax assets
Net operating loss carryovers $ 1,560,000 $ 634,000 $ 368,000
Accounts receivable 923,000 111,000 168,000
Marketable securities 461,000 - -
Property and equipment 32,000 - -
Accounts payable and accrued
expenses 103,000 - -
Other 11,000 - 77,000
------------ ---------- ----------
3,090,000 745,000 613,000
Valuation allowance (3,090,000) (745,000) (613,000)
------------ ---------- ----------
Net deferred tax asset $ - $ - $ -
------------ ---------- ----------
------------ ---------- ----------
</TABLE>
The Company has net operating loss carryovers of approximately $4,500,000,
at February 28, 1997. The net operating loss carryover, which is subject
to annual limitations as prescribed by the Internal Revenue Code, is
available to offset future taxable income through 2012.
F-17
<PAGE>
CITADEL COMPUTER SYSTEMS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1997, February 29, 1996 and December 31, 1995
NOTE L - STOCKHOLDERS' EQUITY
PREFERRED STOCK
The Company's outstanding Series B preferred stock is convertible at the
option of the holder into shares of common stock at 83% of the average
market price of the common stock for the five days preceding conversion.
Each share of preferred stock has a conversion value of $1,000. Any shares
outstanding at September 24, 1998 will be automatically converted.
Dividends accrue at 5% and are payable in common stock.
EQUITY NOTES
During fiscal 1997, the Company issued $4,550,000 of equity notes. These
notes are unsecured and are convertible into common stock at 80% of the
average market price of the common stock for the five days preceding
conversion. Notes outstanding at maturity (July 1997) are automatically
converted into common stock. Interest at 8% is payable only in common
stock. At February 28, 1997, $4,250,000 of the notes had been converted.
The outstanding balance of $300,000 is classified on the balance sheet as a
component of stockholders' equity.
STOCK OPTIONS AND WARRANTS
The Company has issued stock options to directors, employees, and others.
Options are granted at no less than fair value at date of grant, as
determined by the board of directors. Generally, the options vest over no
more than one year. Following is a summary of option transactions for the
periods beginning January 1, 1995:
Weighted
average
exercise
Shares price
--------- ---------
Outstanding at January 1, 1995 - $ -
Granted 4,887,500 0.81
--------- -------
Outstanding at December 31, 1995 4,887,500 0.81
Options of LoneStar outstanding at
date of merger 249,378 3.94
--------- -------
Outstanding at February 29, 1996 5,136,878 0.96
Granted 1,602,000 5.24
Exercised (153,499) 2.74
Expired or canceled (662,694) 2.84
--------- -------
Outstanding at February 28, 1997 5,922,685 $ 1.86
--------- -------
--------- -------
F-18
<PAGE>
CITADEL COMPUTER SYSTEMS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1997, February 29, 1996 and December 31, 1995
NOTE L - STOCKHOLDERS' EQUITY - CONTINUED
Weighted
average
exercise
Shares price
--------- --------
Exercisable at February 28, 1997 5,054,685 $1.16
Exercisable at February 29, 1996 5,136,878 .96
Weighted-average fair value of
options granted during the year
ended February 28, 1997 $1.77
-----
-----
The following table summarizes information about stock options at
February 28, 1997:
<TABLE>
Outstanding Exercisable
------------------------------------- -------------------
Weighted
average
remaining Weighted Weighted
contractual average average
Range of life exercise exercise
exercise prices Shares (in years) price Shares price
--------------- ------ ---------- -------- ------ --------
<S> <C> <C> <C> <C> <C>
$ .50 - .89 4.631,845 2.81 $ .79 4,591,845 $ .79
1.50 - 1.75 165,000 5.60 1.61 75,000 1.75
3.50 - 3.93 197,840 3.68 3.59 187,840 3.59
5.00 10,000 4.42 5.00 - N/A
6.00 118,000 2.75 6.00 - N/A
7.00 800,000 5.08 7.00 200,000 7.00
--------- ----- --------- -----
5,922,685 $1.86 5,054,685 $1.16
--------- ----- --------- -----
--------- ----- --------- -----
</TABLE>
F-19
<PAGE>
CITADEL COMPUTER SYSTEMS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1997, February 29, 1996 and December 31, 1995
NOTE L - STOCKHOLDERS' EQUITY - CONTINUED
The Company has adopted the disclosure provisions of Statement No. 123, as
discussed in Note B, and continues to apply Opinion 25 for stock options
granted to employees. If the Company had recognized compensation expense
based upon the fair value at the grant date for options granted to
employees during the year ended February 28, 1997, the two months ended
February 29, 1996 and the year ended December 31, 1995, the effect on net
loss and loss per share would have been as follows:
Two months
Year ended ended Year ended
February 28, February 29, December 31,
1997 1996 1995
------------- ------------ ------------
Net loss
As reported (7,515,607) (389,537) (1,109,648)
Pro forma (9,539,474) (425,486) (1,132,497)
Loss per common share
As reported (.56) (.06) (.17)
Pro forma (.70) (.06) (.17)
The fair value of these options was estimated at the date of grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions: expected volatility of 145-185%; risk-free interest rate of
6-6.5%; no dividend yield; and expected lives of 1-4 years.
The pro forma amounts presented are not representative of the amounts that
will be disclosed in the future because they do not take into effect pro
forma expenses related to grants before 1995.
F-20
<PAGE>
CITADEL COMPUTER SYSTEMS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1997, February 29, 1996 and December 31, 1995
NOTE L - STOCKHOLDERS' EQUITY - CONTINUED
In connection with the issuance of debt, the Company has issued warrants to
purchase common stock. The following summarizes the warrant transactions
for 1995 and 1996:
Shares Exercise Price
------ --------------
Outstanding at January 1, 1995 - $ -
Issued 3,395,250 .44 - 1.78
--------- -------------
Outstanding at December 31, 1995 3,395,250 .44 - 1.78
Warrants of LoneStar outstanding at
date of merger 105,000 2.00
--------- -------------
Outstanding at February 29, 1996 3,500,250 .44 - 2.00
Issued 540,822 1.25 - 4.00
Exercised (167,721) .89 - 3.50
Expired (38,362) 3.50
--------- -------------
Outstanding at February 28, 1997 3,834,989 $ .89 - 4.00
--------- -------------
--------- -------------
In connection with the Merger, all outstanding options and warrants to
purchase shares of Old Citadel became options and warrants to purchase
shares of the Company's common stock.
Substantially all warrants are exercisable at February 28, 1997.
REVERSE STOCK SPLIT
The Board of Directors approved a 1-for-2 reverse stock split in May 1996.
All share data in the financial statements and notes has been adjusted to
reflect the split.
F-21
<PAGE>
CITADEL COMPUTER SYSTEMS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1997, February 29, 1996 and December 31, 1995
NOTE M - SALE OF ASSETS BY LONESTAR
On March 1, 1996, LoneStar consummated the sale of its restaurants and
related development rights to Miami Subs USA, Inc. (Miami Subs), the
franchiser of the restaurants, pursuant to an agreement entered into in
February 1996. These assets are carried on the balance sheet at February
29, 1996 as assets under contract of sale and are stated at contract price.
LoneStar received 1,325,000 shares of Miami Subs' common stock (the Miami
Subs Stock), which was valued at $2,605,772 as consideration for the sale.
LoneStar is permitted to sell the Miami Subs Stock in private transactions,
or in open market transactions not to exceed 240,000 shares per calendar
quarter, or 20,000 shares per week. All sales are subject to a right of
first refusal by Miami Subs at $2.50 per share. Miami Subs has assumed
certain indebtedness of LoneStar (Note I), and LoneStar issued to Miami
Subs a nonrecourse note in the principal amount of $1,467,039 which is
secured by the Miami Subs Stock.
NOTE N - RELATED PARTY TRANSACTIONS
JOINT VENTURE
In November 1996, the Company made a one-year, $625,000, 8% loan to GGS
Investment Company (GGS), a joint venture owned by Gilbert Gertner,
Chairman of the Board of the Company, George Sharp, Chief Executive Officer
of the Company and Steven B. Solomon, Chief Operation Officer of the
Company, who were also directors and owned approximately 46% of the
Company's outstanding common stock at that time. The purpose of the joint
venture was to invest in securities for short-term profits. The loan
agreement provided that interest would be waived for the first six
months in consideration of 100% of the net profits, during that period,
being paid to the Company.
The loan was guaranteed by each of the officers, and the guaranty was
secured by the pledge of a total of 754,000 shares of the Company's common
stock, valued at approximately $1,282,000 as of the date of the
transaction.
The joint venture was not profitable, and the loan was discharged by GGS
subsequent to February 28, 1997 in the following manner: Mr. Solomon
forgave $78,000 due from the Company to him; Mr. Gertner assumed debt of
the Company to a corporation controlled by Mr. Gertner in the principal
amount of $250,000 plus accrued interest of approximately $25,000;
Mr. Sharp received a credit against the loan of $200,000 as consideration
for agreeing to terminate his noncancellable employee contract aggregating
approximately $700,000 through November 2000; and $72,000 of the loan was
forgiven in connection with the asset sale agreement discussed below.
F-22
<PAGE>
CITADEL COMPUTER SYSTEMS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1997, February 29, 1996 and December 31, 1995
NOTE N - RELATED PARTY TRANSACTIONS - CONTINUED
ASSET SALE AGREEMENT
In April 1997, the Company entered into an asset sale agreement with its
Chief Executive Officer and its Chairman of the Board (the Purchasers)
jointly. At the date of the agreement, the Purchasers owned approximately
31% of the Company's outstanding common stock at that date. The Company
sold to the Purchasers, $3,750,000 of trade accounts receivable and forgave
indebtedness owed by the Purchasers to the Company in the amount of
$72,000. The carrying value of the receivables at February 28, 1997, net
of allowance, was $1,875,000. Consideration received consisted of
3,900,000 shares of the Company's common stock with a market value of
approximately $2,750,000 as of the date of the transaction. For accounting
purposes, the Company has valued the shares at approximately $1,950,000.
The agreement provides that the Company will also receive 50% of the
proceeds in excess of $2,250,000 from collection of the receivables. The
transaction will result in no gain or loss.
NOTE O - COMMITMENTS AND CONTINGENCIES
The Company leases office space under noncancellable operating lease
agreements expiring at various dates through 2002. Future minimum lease
payments under these leases at February 28, 1997, were as follows:
Year ending
February 28,
-----------
1998 $ 305,000
1999 324,000
2000 330,000
2001 301,000
2002 303,000
----------
Total $1,563,000
----------
Excluded from the above are future minimum lease obligations totaling
approximately $1,353,000 on former office space in two buildings that has
been vacated by the Company. The Company is presently in default on both
leases and is negotiating with both landlords for a release from its
obligations thereunder. The Company has provided a reserve of $195,000 as
of February 28, 1997, to cover its estimated costs relating to termination
of the leases.
Rental expense totaled approximately $352,000 for the year ended February
28, 1997, $7,600 for the period ended February 29, 1996 and $54,000 for the
year ended December 31, 1995.
F-23
<PAGE>
CITADEL COMPUTER SYSTEMS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1997, February 29, 1996 and December 31, 1995
NOTE O - COMMITMENTS AND CONTINGENCIES - CONTINUED
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.
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 claim.
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.
At February 28, 1997, the Company has employment agreements with two of its
officers and a consulting agreement with its Chairman. These agreements
expire in 2000 to 2001 and, with respect to one officer, become accelerated
in the event of death or termination. As discussed in Note O, one of the
employment agreements was terminated subsequent to February 28, 1997.
NOTE P - SUPPLEMENTAL CASH FLOW INFORMATION
<TABLE>
Two months
Year ended ended Year ended
February 28, February 29, December 31,
1997 1996 1995
------------ ------------ -------------
<S> <C> <C> <C>
Supplemental disclosures of cash flow information:
Cash paid during the year for interest $ 239,508 $ - $234,212
Non-cash investing and financing transactions:
Issuance of common stock in exchange for certain
assets - - 50,000
Notes payable converted to warrants 734,000 - -
Payment of stock dividends (133,714) - -
Conversions to common stock 4,213,693 - -
Acquisition of software and in-process research
and development for notes payable 1,206,560 - -
</TABLE>
F-24
<PAGE>
CITADEL COMPUTER SYSTEMS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1997, February 29, 1996 and December 31, 1995
NOTE P - SUPPLEMENTAL CASH FLOW INFORMATION - CONTINUED
<TABLE>
Two months
Year ended ended Year ended
February 28, February 29, December 31,
1997 1996 1995
------------ ------------ -------------
<S> <C> <C> <C>
Merger with LoneStar Hospitality Corporation,
accounted for as a reverse acquisition:
Assets acquired
Assets under contract of sale $ - $ 2,605,772 $ -
Other assets - 401,650 -
Liabilities assumed
Notes payable - (2,142,249) -
Accounts payable - (1,225,972) -
------------ ------------ -----------
Excess of liabilities assumed over assets
acquired $ - $ (360,799) $ -
------------ ------------ -----------
------------ ------------ -----------
Acquisition of businesses:
In-process research and development acquired $ 1,711,480 $ - $ -
Assets acquired 2,051,135 2,250,000 -
Liabilities assumed (1,226,054) (50,000) -
Common stock issued (1,939,201) (2,000,000) -
------------ ------------ -----------
Cash paid, net $ 597,360 $ 200,000 $ -
------------ ------------ -----------
------------ ------------ -----------
</TABLE>
NOTE Q - SUBSEQUENT EVENTS
In March 1997, the Company sold $1,000,000 of 5% redeemable convertible
notes due February 2000. The notes were sold to offshore accredited
investors pursuant to Section 4(2) of the Securities Act of 1933, as
amended, and Regulation S. The Company used the proceeds to retire certain
outstanding indebtedness and for working capital.
The Company, in April 1997, completed a private placement of $500,000 of 8%
convertible redeemable debentures which mature on April 11, 2000. The
Company used the proceeds to retire certain outstanding indebtedness and
for working capital.
F-25
<PAGE>
CITADEL COMPUTER SYSTEMS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1997, February 29, 1996 and December 31, 1995
NOTE Q - SUBSEQUENT EVENTS - CONTINUED
In June 1997, the Company sold $1,125,000 of 8% redeemable convertible
notes due June 9, 2000. The notes were sold to offshore accredited
investors pursuant to Section 4(2) of the Securities Act of 1933, as
amended, and Regulation S. The Company used the proceeds to retire certain
convertible notes and for working capital.
On October 6, 1997, the Company consummated a purchase agreement with
CORESTAFF, whereby CORESTAFF purchased 2.5 million shares of the Company's
common stock for $750,000 and other non-monetary consideration and received
Warrants to purchase an additional 2 million shares of stock at $4 to $5
per share. CORESTAFF is one of the largest providers of information
technology and staffing services in the U.S. As part of the agreement,
CORESTAFF will provide development support for the Company. In addition,
Citadel will become 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.
NOTE R - FOURTH QUARTER ADJUSTMENTS
In the fourth quarter of 1997, adjustments were recorded to reflect the
following:
Income
(expense)
----------
Reallocation of purchased research and development
costs relating to the acquisitions described in Note F $ 446,900
Increase in allowance for doubtful accounts (732,800)
Adjustment of interest expense 133,800
---------
Increase in net loss $(152,100)
---------
---------
F-26
<PAGE>
- --------------------------------------------------------------------------------
PURCHASE AGREEMENT
between
CORESTAFF, INC.
and
CITADEL TECHNOLOGY, INC
Dated September 22, 1997
- --------------------------------------------------------------------------------
<PAGE>
TABLE OF CONTENTS
Page
----
ARTICLE I AUTHORIZATION AND CLOSING. . . . . . . . . . . . . . . . . . . . . . 1
1.1 Authorization of the Stock . . . . . . . . . . . . . . . . . . . . . 1
1.2 Purchase and Sale of the Stock . . . . . . . . . . . . . . . . . . . 1
1.3 The Closing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
ARTICLE II CONDITIONS OF CORESTAFF'S OBLIGATION AT THE CLOSING . . . . . . . . 1
2.1 Representations and Warranties, Covenants. . . . . . . . . . . . . . 1
2.2 Certificate of Incorporation . . . . . . . . . . . . . . . . . . . . 2
2.3 First Step Software License Agreement. . . . . . . . . . . . . . . . 2
2.4 Development Services Agreement . . . . . . . . . . . . . . . . . . . 2
2.5 Citadel Products Sales Agreement . . . . . . . . . . . . . . . . . . 3
2.6 Registration Agreement . . . . . . . . . . . . . . . . . . . . . . . 3
2.7 Option Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . 3
2.8 Closing Documents. . . . . . . . . . . . . . . . . . . . . . . . . . 3
2.9 Fees and Expenses. . . . . . . . . . . . . . . . . . . . . . . . . . 4
2.10 Compliance with Applicable Laws. . . . . . . . . . . . . . . . . . . 4
2.10 Waiver . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
ARTICLE III COVENANTS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
3.1 Financial Statements and Other Information . . . . . . . . . . . . . 4
3.2 Inspection of Property . . . . . . . . . . . . . . . . . . . . . . . 6
3.3 Restrictions . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
3.4 Affirmative Covenants. . . . . . . . . . . . . . . . . . . . . . . . 7
3.5 Current Public Information . . . . . . . . . . . . . . . . . . . . . 8
3.6 Public Disclosures . . . . . . . . . . . . . . . . . . . . . . . . . 8
3.7 Election of Director . . . . . . . . . . . . . . . . . . . . . . . . 9
ARTICLE IV TRANSFER OF RESTRICTED SECURITIES . . . . . . . . . . . . . . . . . 9
4.1 Transfer of Restricted Securities. . . . . . . . . . . . . . . . . . 9
ARTICLE V REPRESENTATIONS AND WARRANTIES OF THE COMPANY. . . . . . . . . . . .10
5.1 Organization and Corporate Power . . . . . . . . . . . . . . . . . .10
5.2 Capital Stock and Related Matters. . . . . . . . . . . . . . . . . .10
5.3 Subsidiaries; Investments. . . . . . . . . . . . . . . . . . . . . .11
5.4 Authorization; No Breach . . . . . . . . . . . . . . . . . . . . . .11
5.5 Financial Statements . . . . . . . . . . . . . . . . . . . . . . . .11
5.6 Tax Matters. . . . . . . . . . . . . . . . . . . . . . . . . . . . .12
-i-
<PAGE>
5.7 Litigation, etc. . . . . . . . . . . . . . . . . . . . . . . . . . .12
5.8 Brokerage. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13
5.9 Governmental Consent, etc. . . . . . . . . . . . . . . . . . . . . .13
5.10 ERISA. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13
5.11 Compliance with Laws . . . . . . . . . . . . . . . . . . . . . . . .13
5.12 Compliance with Securities Laws. . . . . . . . . . . . . . . . . . .13
5.13 Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14
5.13 Closing Date . . . . . . . . . . . . . . . . . . . . . . . . . . . .14
ARTICLE VI DEFINITIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . .14
ARTICLE VII MISCELLANEOUS. . . . . . . . . . . . . . . . . . . . . . . . . . .16
7.1 Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16
7.2 Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16
7.3 CORESTAFF's Investment Representations . . . . . . . . . . . . . . .16
7.4 Consent to Amendments. . . . . . . . . . . . . . . . . . . . . . . .17
7.5 Survival of Representation and Warranties. . . . . . . . . . . . . .17
7.6 Successors and Assigns . . . . . . . . . . . . . . . . . . . . . . .17
7.7 Generally Accepted Accounting Principles . . . . . . . . . . . . . .17
7.8 Severability . . . . . . . . . . . . . . . . . . . . . . . . . . . .17
7.9 Counterparts . . . . . . . . . . . . . . . . . . . . . . . . . . . .18
7.10 Descriptive Headings; Interpretation . . . . . . . . . . . . . . . .18
7.11 Governing Law. . . . . . . . . . . . . . . . . . . . . . . . . . . .18
7.12 Notices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18
7.13 Arbitration. . . . . . . . . . . . . . . . . . . . . . . . . . . . .19
-ii-
<PAGE>
LIST OF EXHIBITS
Exhibit A Certificate of Incorporation
Exhibit B Form of First Step Software License Agreement
Exhibit C Form of Development Services Agreement
Exhibit D Form of Citadel Product Sales Agreement
Exhibit E Registration Agreement
Exhibit F Option Agreement
LIST OF SCHEDULES
- -----------------
Schedule 5.5(a) Financial Statements
Schedule 5.5(b) Contracts
Schedule 5.7 Litigation
Schedule 5.8 Brokerage
Schedule 5.10 Benefit Plans
-iii-
<PAGE>
PURCHASE AGREEMENT
------------------
CITADEL TECHNOLOGY, INC.
THIS AGREEMENT is made as of _________, 1997, between CITADEL
TECHNOLOGY, INC., a _________corporation (the "Company"), and CORESTAFF,
INC., a Delaware corporation ("CORESTAFF"). Except as otherwise indicated
herein, capitalized terms used herein are defined in SECTION 6 hereof.
The parties hereto agree as follows:
ARTICLE I
AUTHORIZATION AND CLOSING
-------------------------
1.1 AUTHORIZATION OF THE STOCK. The Company shall authorize the
issuance and sale to CORESTAFF of up to 2,500,000 shares (the "Stock") of its
Common Stock, par value $.01 per share (the "Common Stock").
1.2 PURCHASE AND SALE OF THE STOCK. At the Closing (as defined in
SECTION 1.3 below), the Company shall sell to CORESTAFF and, subject to the
terms and conditions set forth herein, CORESTAFF shall purchase from the
Company, 2,500,000 shares of Common Stock at a price of $.30 per share.
1.3 THE CLOSING. The closing of the purchase and sale of the Stock to
be purchased pursuant to SECTION 1.2 (the "Closing") shall take place at the
offices of CORESTAFF, Inc., 5 Post Oak Road, Suite 1100, Houston, Texas 77027
at 10:00 a.m. on September __, 1997 or at such other place or on such other
date as may be mutually agreeable to the Company and CORESTAFF. At the
Closing, the Company shall deliver to CORESTAFF stock certificates evidencing
the Stock to be purchased by CORESTAFF, registered in CORESTAFF's name, upon
payment of the purchase price thereof by a cashier's or certified check, or
by wire transfer of immediately available funds to such account as designated
by the Company in the amount of $750,000.
ARTICLE II
CONDITIONS OF CORESTAFF'S OBLIGATION AT THE CLOSING
---------------------------------------------------
The obligation of CORESTAFF to purchase and pay for the Stock at the
Closing is subject to the satisfaction as of the Closing of the following
conditions:
2.1 REPRESENTATIONS AND WARRANTIES, COVENANTS. The representations and
warranties contained in SECTION 5 hereof shall be true and correct at and as
of the Closing as though then made, except to the extent of changes caused by
the transactions expressly
<PAGE>
contemplated herein, and the Company shall have performed in all material
respects all of the covenants required to be performed by it hereunder prior
to the Closing.
2.2 CERTIFICATE OF INCORPORATION. The Company's certificate of
incorporation (the "Certificate of Incorporation") shall be in the form set
forth as EXHIBIT A hereto, shall be in full force and effect under the laws
of Delaware as of the Closing and shall not have been amended or modified.
2.3 FIRST STEP SOFTWARE LICENSE AGREEMENT. The Company shall have
entered into an exclusive license agreement, m form and substance
substantially similar to EXHIBIT B attached hereto (the "FIRST STEP LICENSE
AGREEMENT") with CORESTAFF or its Subsidiary and the First Step License
Agreement, shall not have been amended or modified and shall be in full force
and effect as of the Closing. Pursuant to the First Step License Agreement,
(a) CORESTAFF will (i) develop the First Step Software program for Novell
only to the Company's specifications as a full turn-key package on additional
platforms necessary for marketing purposes, at no cost to the Company;
PROVIDED, HOWEVER, if the estimated cost for such development exceeds
$250,000. CORESTAFF has the option to withdraw the First Step Software as
part of this transaction; (ii) provide platform upgrades for Novell only on a
schedule to be determined by the parties and (iii) provide the Company with
an exclusive license to sell the First Step Software until March 31, 1998 and
(b) the Company will (i) represent and warrant to CORESTAFF that it is
satisfied with the form and substance of the First Step Software as currently
developed by CORESTAFF and (ii) agree that CORESTAFF's liability to the
Company under the First Step License Agreement or with respect to the First
Step Software shall be limited to the aggregate amount of royalty payments
paid to CORESTAFF by the Company. Any additional changes to the First Step
Software program will be at CORESTAFF's sole discretion. All pricing of
products and royalties payable to CORESTAFF will be mutually agreed upon and
a percentage of maintenance fees will be paid to the Company. The parties
will determine the level of the company's revenue commitments on the
exclusive license from October 1, 1997 through March 31, 1998. CORESTAFF will
provide technical support service on the First Step product at no cost to the
Company. The Company will continue to maintain all sales relationships with
existing First Step customers. In the event it is agreed that the Company
will take over existing prospects from CORESTAFF, the Company will pay an
additional royalty to CORESTAFF in an amount to be determined by both
parties. Such determination will be made upon transfer of a customer of
CORESTAFF to the Company.
2.4 DEVELOPMENT SERVICES AGREEMENT. The Company and Millennium Computer
Corporation, a Subsidiary of CORESTAFF ("MILLENNIUM") shall have entered into
a Development Services Agreement in form and substance substantially similar
to EXHIBIT C attached hereto (the "DEVELOPMENT SERVICES AGREEMENT"), and the
Development Services Agreement shall be in full force and effect as of the
Closing. Pursuant to the Development Services Agreement, Millennium will
provide development services to the Company at their standard customer rate,
less a ten percent discount. The Company will purchase from
-2-
<PAGE>
Millennium a minimum of $250,000 of development services from the Closing
through September 1, 1998.
2.5 CITADEL PRODUCTS SALES AGREEMENT. The Company and CORESTAFF shall
have entered into a Citadel Products Sales Agreement in form and substance
substantially similar to EXHIBIT D attached hereto (the "CITADEL PRODUCTS
SALES AGREEMENT"), and the Citadel Products Sales Agreement shall be in full
force and effect as of the Closing. Pursuant to the Citadel Product Sales
Agreement, CORESTAFF will sell the Company's products and will receive a
higher royalty for sales to existing customers of CORESTAFF.
2.6 REGISTRATION AGREEMENT. The Company and CORESTAFF shall have
entered into a registration agreement in form and substance substantially
similar to EXHIBIT E attached hereto (the "REGISTRATION AGREEMENT"), and the
Registration Agreement shall be in fill force and effect as of the Closing.
2.7 OPTION AGREEMENT. The Company shall have granted an Option to
CORESTAFF in the form of Option Agreement attached hereto as EXHIBIT F. The
Option will provide that CORESTAFF will have the right to purchase an
additional 2,000,000 shares of Common Stock, at an exercise price of $4 per
share for 1,000,000 shares and an exercise price of $5 per share for
1,000,000 shares.
2.8 CLOSING DOCUMENTS. The Company shall have delivered to CORESTAFF
all of the following documents;
(i) an Officer's Certificate, dated the date of the Closing,
stating that the conditions specified in SECTION 1 and SECTIONS 2.1 through
2.7, inclusive, have been fully satisfied;
(ii) certified copies of (a) the resolutions duly adopted by
the Board authorizing the execution, delivery and performance of this
Agreement, the First Step Software License Agreement, the Development
Services Agreement, the Citadel Products Sales Agreement, the Registration
Agreement, the Option Agreement and each of the other agreements
contemplated hereby (collectively, the "DOCUMENTS"), the filing of the
Certificate of Incorporation referred to in SECTION 2.2, the issuance and
sale of the Stock and the consummation of all other transactions
contemplated by this Agreement, and (b) the resolutions duly adopted by the
Company's stockholders approving the transactions contemplated hereby;
(iii) certified copies of the Certificate of Incorporation and
the Company's bylaws, each as in effect at the Closing; and
-3-
<PAGE>
(iv) such other documents relating to the transactions
contemplated by this Agreement as CORESTAFF or its counsel may reasonably
request.
2.9 FEES AND EXPENSES. The Company shall have reimbursed CORESTAFF for
the fees and expenses as provided in SECTION 7.1 hereof.
2.10 COMPLIANCE WITH APPLICABLE LAWS. The purchase of Stock by
CORESTAFF hereunder shall not be prohibited by any applicable law or
governmental regulation, shall not subject CORESTAFF to any penalty,
liability or, in CORESTAFF's sole judgment, other onerous conditions under or
pursuant to any applicable law or governmental regulation, and shall be
permitted by laws and regulations of the jurisdictions to which CORESTAFF is
subject.
2.11 WAIVER. Any condition specified in this SECTION 2 may be waived
only if such waiver is set forth in a writing executed by CORESTAFF.
ARTICLE III
COVENANTS
---------
3.1 FINANCIAL STATEMENTS AND OTHER INFORMATION. The Company shall
deliver to CORESTAFF (so long as CORESTAFF holds any Stock):
(a) as soon as available but in any event within 45 days after the
end of each quarterly accounting period in each Fiscal year, unaudited
consolidating and consolidated statements of income and cash flows of the
Company and its Subsidiaries for such quarterly period and for the period
from the beginning of the fiscal year to the end of such quarter, and
consolidating and consolidated balance sheets of the Company and its
Subsidiaries as of the end of such quarterly period, all prepared in
accordance with generally accepted accounting principles, consistently
applied, subject to the absence of footnote disclosures and to normal
year-end adjustments;
(b) as soon as available but in any event within 30 days after the
end of each month in each fiscal year, unaudited consolidating and
consolidated statements of income and cash flows of the Company and its
Subsidiaries for such month and for the period from the beginning of the
fiscal year to the end of such month, and consolidating and consolidated
balance sheets of the Company and its Subsidiaries as of the end of such
month, all prepared in accordance with generally accepted accounting
principles, consistently applied, subject to the absence of footnote
disclosures and to normal year-end adjustments;
(c) accompanying the financial statements referred to in PARAGRAPH
(a) and (b), an Officer's Certificate stating that neither the Company nor any
of its Subsidiaries is in
-4-
<PAGE>
default under any of its other material agreements or, if any such default
exists, specifying the nature and period of existence thereof and what
actions the Company and its Subsidiaries have taken and propose to take with
respect thereto;
(d) within 90 days after the end of each fiscal year,
consolidating and consolidated statements of income and cash flows of the
Company and its Subsidiaries for such fiscal year, and consolidating and
consoLidated balance sheets of the Company and its Subsidiaries as of the end
of such fiscal year, setting forth in each case comparisons to the annual
budget and to the preceding fiscal year, all prepared in accordance with
generally accepted accounting principles, consistently applied, and
accompanied by (i) with respect to the consolidated portions of such
statements (except with respect to budget data), an opinion containing no
exceptions or qualifications (except for qualifications regarding specified
contingent liabilities) of an independent accounting firm of recognized
national standing acceptable to the holders of a majority of the Investor
Common, and (ii) a copy of such firm's annual management letter to the Board;
(e) promptly upon receipt thereof, any additional reports,
management letters or other detailed information concerning significant
aspects of the Company's operations or financial affairs given to the Company
by its independent accountants (and not otherwise contained in other
materials provided hereunder);
(f) at least 30 days prior to the beginning of each fiscal year,
annual budgets prepared on a monthly basis for the Company and each of its
Subsidiaries (or regions) for such fiscal year (displaying anticipated
statements of income and cash flows), and promptly upon preparation thereof
any other significant budgets prepared by the Company and any revisions of
such annual or other budgets, and within 30 days after any monthly period in
which there is a material adverse deviation from any annual budgets, an
Officer's Certificate explaining the deviation and what actions the Company
has taken and proposes to take with respect thereto;
(g) promptly (but in any event within five business days) after
the discovery or receipt of notice of any default under any material
agreement to which it or any of its Subsidiaries is a party or any other
event or circumstance affecting the Company or any Subsidiary which is
reasonably likely to have a material adverse effect on the financial
condition, operating results, assets, operations or business prospects of the
Company or any Subsidiary (including the filing of any material litigation
against the Company or any Subsidiary or the existence of any material
dispute with any Person which involves a reasonable likelihood of such
litigation being commenced), an Officer's Certificate specifying the nature
and period of existence thereof and what actions the Company and its
Subsidiaries have taken and propose to take with respect thereto; and
(h) with reasonable promptness, such other information and
financial data concerning the Company and its Subsidiaries as any Person
entitled to receive information under this SECTION 3.1 may reasonably request.
-5-
<PAGE>
Each of the financial statements referred to in PARAGRAPHS (a) and (d) shall
be true and correct in all material respects as of the dates and for the
periods stated therein, subject in tile case of the unaudited financial
statements to changes resulting from normal year-end audit adjustments (none
of which would, alone or in the aggregate, be materially adverse to the
financial condition, operating results, assets, operations or business
prospects of the Company and its Subsidiaries taken as a whole).
Notwithstanding the foregoing, the financial statements referred to in
paragraphs (g) and (d) shall be in the form of a Form 10-Q and Form 10-K
respectively, so long as the Company remains subject to the requirements of
the Securities Exchange Act.
3.2 INSPECTION OF PROPERTY. The Company shall permit any
representatives designated by CORESTAFF (so long as CORESTAFF holds any
Stock) or any holder of at least 15% of the outstanding Stock, upon
reasonable notice and during normal business hours and such other times as
any such holder may reasonably request, to (i) visit and inspect any of the
properties of the Company and its Subsidiaries, (ii) examine the corporate
and financial records of the Company and its Subsidiaries and make copies
thereof or extracts therefrom and (iii) discuss the affairs, finances and
accounts of any such corporations with the directors, officers, key employees
and independent accountants of the Company and its Subsidiaries; provided
that the Company shall have the right to have its chief financial officer
present at any meetings with the Company's independent accountants.
3.3 RESTRICTIONS. The Company shall not without the prior written
consent of the holders of a majority of the Investor Common:
(a) directly or indirectly declare or pay any dividends or make
any distributions upon any of its equity securities, other than payments of
dividends on, or redemption payments in respect of, the Common Stock pursuant
to the Certificate of incorporation;
(b) directly or indirectly redeem, purchase or otherwise acquire,
or permit any Subsidiary to redeem, purchase or otherwise acquire, any of the
Company's equity securities (including, without limitation, warrants, options
and other rights to acquire equity securities),
(c) except as expressly contemplated by this Agreement and the
Senior Management Agreements, authorize, issue, sell or enter into any
agreement providing for the issuance (contingent or otherwise), or permit any
Subsidiary to authorize, issue, sell or enter into any agreement providing
for the issuance (contingent or otherwise) of, (i) any notes or debt
securities containing equity features (including, without limitation, any
notes or debt securities convertible into or exchangeable for equity
securities, issued in connection with the issuance of equity securities or
containing profit participation features) or (ii) any equity securities (or
any securities convertible into or exchangeable for any equity securities) or
rights to acquire any
-6-
<PAGE>
equity securities, other than the issuance of equity securities by a
Subsidiary to the Company or another Subsidiary;
(d) merge or consolidate with any Person or permit any Subsidiary
to merge or consolidate with any Person (other than a wholly owned
Subsidiary);
(e) sell, lease or otherwise dispose of, or permit any Subsidiary
to sell, lease or otherwise dispose of, more than 5 % of the consolidated
assets of the Company and its Subsidiaries (computed on the basis of book
value, determined in accordance with generally accepted accounting principles
consistently applied, or fair market value, determined by the Board in its
reasonable good faith judgment) in any transaction or series of related
transactions (other than sales of inventory in the ordinary course of
business);
(f) liquidate, dissolve or effect a recapitalization or
reorganization in any form of transaction (including, without limitation, any
reorganization into partnership form);
(g) acquire, or permit any Subsidiary to acquire, any interest in
any business (whether by a purchase of assets, purchase of stock, merger or
otherwise), or enter into any joint venture;
(h) enter into, or permit any Subsidiary to enter into, the
ownership, active management or operation of any business other than the
operation of veterinary practices and clinics;
(i) enter into, or permit any Subsidiary to enter into, any
transaction with any of its or any Subsidiary's officers, directors,
employees or Affiliates or any individual related by blood, marriage or
adoption to any such Person (a "RELATIVE") or any entity in which any such
Person or individual owns a beneficial interest (a "RELATED ENTITY"), except
for normal employment arrangements and benefit programs on reasonable terms
and except as otherwise expressly contemplated by this Agreement, the Senior
Management Agreements and the Professional Services Agreement; provided that
in no event shall any Relative or Related Entity he employed by, render
services to or receive compensation from the Company or any Subsidiary; or
(j) create, incur, assume or suffer to exist, or permit any
Subsidiary to create, incur, assume or suffer to exist, Indebtedness
exceeding the amounts approved therefor by the Board in the annual budget.
3.4 AFFIRMATIVE COVENANTS. So long as CORESTAFF holds any Stock, the
Company shall, and shall cause each Subsidiary to:
(a) comply with all applicable laws, rules and regulations of all
governmental authorities, the violation of which would reasonably be expected
to have a material
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adverse effect upon the financial condition, operating results, assets,
operations or business prospects of the Company and its Subsidiaries taken as
a whole, and pay and discharge when payable all taxes, assessments and
governmental charges (except to the extent the same are being contested in
good faith and adequate reserves therefor have been established); and
(b) enter into and maintain appropriate nondisclosure and
non-compete agreements with its key employees.
3.5 CURRENT PUBLIC INFORMATION. The Company shall file all reports
required to be filed by it under the Securities Act and the Securities
Exchange Act and the rules and regulations adopted by the Securities and
Exchange Commission thereunder and shall take such further action as any
holder or holders of Restricted Securities may reasonably request, all to the
extent required to enable such holders to sell Restricted Securities pursuant
to (i) Rule 144 adopted by the Securities and Exchange Commission under the
Securities Act (as such rule may be amended from time to time) or any similar
rule or regulation hereafter adopted by the Securities and Exchange
Commission or (ii) a registration statement on Form 5-2 or 5-3 or any similar
registration form hereafter adopted by the Securities and Exchange
Commission. Upon request, the Company shall deliver to any holder of
Restricted Securities a written statement as to whether it has complied with
such requirements.
3.6 PUBLIC DISCLOSURES. The Company shall not, nor shall it permit any
Subsidiary to, disclose CORESTAFF's name or identity as an investor in the
Company in any press release or other public announcement or in any document
or material filed with any governmental entity, without the prior written
consent of CORESTAFF, unless such disclosure is required by applicable law or
governmental regulations or by order of a court of competent jurisdiction, in
which case prior to making such disclosure the Company shall give written
notice to CORESTAFF describing in reasonable detail the proposed content of
such disclosure and shall permit CORESTAFF to review and comment upon the
form and substance of such disclosure.
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3.7 ELECTION OF DIRECTOR. The Company hereby agrees to elect one
representative designated by CORESTAFF to the Company's Board of Directors
immediately following the Closing. The Company and Steven Solomon hereby
agree to use their best efforts to nominate and elect such designee at all
annual or special stockholder meetings for which directors are being elected
until such time as CORESTAFF is the beneficial owner of less than two percent
(2)% of the Company's then outstanding Common Stock.
ARTICLE IV
TRANSFER OF RESTRICTED SECURITIES
---------------------------------
4.1 TRANSFER OF RESTRICTED SECURITIES.
(a) Restricted Securities are transferable only pursuant to (i)
public offerings registered under the Securities Act, (ii) Rule 144 or Rule
144A of the Securities and Exchange Commission (or any similar rule or rules
then in force) if such rule or rules are available and (iii) subject to the
conditions specified in PARAGRAPH (b) below, any other legally available
means of transfer.
(b) In connection with the transfer of any Restricted Securities
(other than a transfer described in subparagraph 4(i)(a) or (b) above), the
holder thereof shall deliver written notice to the Company describing in
reasonable detail the transfer or proposed transfer, together with an opinion
of Hogan & Hartson, LLP or other counsel which (to the Company's reasonable
satisfaction) is knowledgeable in securities law matters to the effect that
such transfer of Restricted Securities may be effected without registration
of such Restricted Securities under the Securities Act. In addition, if the
holder of the Restricted Securities delivers to the Company an opinion of
Hogan & Hartson, LLP or such other counsel that no subsequent transfer of
such Restricted Securities shall require registration under the Securities
Act, the Company shall promptly upon such contemplated transfer deliver new
certificates for such Restricted Securities which do not bear the Securities
Act legend set forth in SECTION 7.3. If the Company is not required to
deliver new certificates for such Restricted Securities not bearing such
legend, the holder thereof shall not transfer the same until the prospective
transferee has confirmed to the Company in writing its agreement to be bound
by the conditions contained in this paragraph and SECTION 7.3.
(c) Upon the request of CORESTAFF, the Company shall promptly
supply to CORESTAFF or its prospective transferees all information regarding
the Company required to be delivered in connection with a transfer pursuant
to Rule 144A of the Securities and Exchange Commission.
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ARTICLE V
REPRESENTATIONS AND WARRANTIES OF THE COMPANY
---------------------------------------------
As a material inducement to CORESTAFF to enter into this Agreement and
purchase the Stock, the Company hereby represents and warrants to CORESTAFF
that:
5.1 ORGANIZATION AND CORPORATE POWER. The Company is a corporation duly
organized, validly existing and in good standing under the laws of Delaware
and is qualified to do business in every jurisdiction in which the failure to
so qualify might reasonably be expected to have a material adverse effect on
the financial condition, operating results, assets, operations or business
prospects of the Company and its Subsidiaries taken as a whole. The Company
has all requisite corporate power and authority and all material licenses,
permits and authorizations necessary to own and operate its properties, to
carry on its businesses as now conducted and presently proposed to be
conducted and to carry out the transactions contemplated by this Agreement.
The copies of the Company's Certificate of Incorporation and bylaws which
have been furnished to CORESTAFF's counsel reflect all amendments made
thereto at any time prior to the date of this Agreement and are correct and
complete.
5.2 CAPITAL STOCK AND RELATED MATTERS.
(a) As of the Closing and immediately thereafter, the authorized
capital stock of the Company shall consist of __________ shares of Common
Stock, of which (i) __________ shares are issued and outstanding, __________
of which shall be reserved for issuance to CORESTAFF pursuant to the Option
Agreement, and _________ of which shall be reserved for issuance to the
executives pursuant to outstanding options (the "Outstanding Options"). As of
the Closing, the Company shall not have outstanding any stock or securities
convertible or exchangeable for any shares of its capital stock or containing
any profit participation features, nor shall it have outstanding any rights
or options to subscribe for or to purchase its capital stock or any stock or
securities convertible into or exchangeable for its capital stock or any
stock appreciation rights or phantom stock plans other than pursuant to and
as contemplated by this Agreement, the Option Agreement and the Company's
Stock Option Plan. As of the Closing, the Company shall not be subject to any
obligation (contingent or otherwise) to repurchase or otherwise acquire or
retire any shares of its capital stock or any warrants, options or other
rights to acquire its capital stock, except pursuant to this Agreement, the
Option Agreement, and the Outstanding Options. As of the Closing, all of the
outstanding shares of the Company's capital stock shall be validly issued,
hilly paid and nonassessable.
(b) There are no statutory or, to the best of the Company's
knowledge, contractual stockholders preemptive rights or rights of refusal
with respect to the issuance of the Stock hereunder, except as expressly
provided herein. Based in part on the investment representations of
CORESTAFF in SECTION 7.3 hereof, the Company has not violated any applicable
federal or state securities laws in connection with the offer, sale or
issuance of any of
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its capital stock, and the offer, sale and issuance of the Stock hereunder do
not and will not require registration under the Securities Act or any
applicable state securities laws. To the best of the Company's knowledge,
there are no agreements between the Company's stockholders with respect to
the voting or transfer of the Company's capital stock or with respect to any
other aspect of the Company's affairs, except for this Agreement.
5.3 SUBSIDIARIES; INVESTMENTS. The Company does not own or hold any
shares of stock or any other security or interest in any other Person or any
rights to acquire any such security or interest, and the Company has never
had any Subsidiary.
5.4 AUTHORIZATION; NO BREACH. The execution, delivery and performance
of this Agreement, the Documents and all other agreements contemplated hereby
to which the Company is a party and the filing of the Certificate of
Incorporation have been duly authorized by the Company. This Agreement, the
Documents, the Certificate of Incorporation and all other agreements
contemplated hereby each constitutes a valid and binding obligation of the
Company, enforceable in accordance with its terms. The execution and delivery
by the Company of this Agreement, the Documents and all other agreements
contemplated hereby to which the Company is a party, the offering, sale and
issuance of the Stock hereunder, the Certificate of Incorporation and the
fulfillment of and compliance with the respective terms hereof and thereof by
the Company do not and will not (i) conflict with or result in a breach of
the terms, conditions or provisions of, (ii) constitute a default under,
(iii) result in the creation of any lien, security interest, charge or
encumbrance upon the Company's capital stock or assets pursuant to. (iv) give
any third party the right to modify, terminate or accelerate any obligation
under, (v) result in a violation of, or (vi) require any authorization,
consent, approval, exemption or other action by or notice to any court or
administrative or governmental body pursuant to, the Certificate of
Incorporation or bylaws of the Company, or any law, statute, rule or
regulation to which the Company is subject, or any agreement, instrument,
order, judgment or decree to which the Company is a party or by which it is
bound.
5.5 FINANCIAL STATEMENTS.
(a) Attached hereto as SCHEDULE 5.5(a) are the following financial
statements (collectively the "FINANCIAL STATEMENTS") (i) audited balance
sheet and statement of income, changes in stockholder's equity, and cash flow
as of and for the fiscal years ended December 31, 1995 and 1996 (the "MOST
RECENT FISCAL YEAR END") for the Company, and (ii) an unaudited balance sheet
and statement of income, changes in stockholders' equity, and cash flow as of
and for the six months ended June 30, 1997. The Financial Statements have
been prepared in accordance with GAAP applied on a consistent basis
throughout the periods covered thereby, are correct and complete, fairly
present the financial condition of the Company as of such dates, and are
Consistent with the books and records of the Company (which books and records
are correct and complete). The Financial Statements for year ended December
31, 1996 were audited by Grant Thornton, LLP.
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The Company and its Subsidiaries do not have any material obligation or
liability (whether accrued, absolute, contingent, unliquidated or otherwise,
whether or not known to the Company or any Subsidiary, whether due or to
become due and regardless of when asserted) other than: (i) liabilities set
forth on most recent balance sheet (including any notes thereon delivered to
CORESTAFF pursuant to SECTION 3.1 hereof, (ii) liabilities and obligations
which have arisen after the date of such balance sheet in the ordinary course
of business (none of which is a material liability resulting from breach of
contract, breach of warranty, tort. infringement, claim or lawsuit) and (iii)
liabilities and obligations which have been disclosed to and approved by
CORESTAFF.
5.6 TAX MATTERS. The Company has filed all tax returns (if any) which
it is required to file under applicable laws and regulations; all such
returns are complete and correct in all material respects; the Company has
paid all taxes due and owing by it and has withheld and paid over all taxes
which it is obligated to withhold from amounts paid or owing to any employee,
stockholder, creditor or other third party; the Company has not waived any
statute of limitations with respect to taxes or agreed to any extension of
time with respect to a tax assessment or deficiency; the assessment of any
additional taxes for periods for which returns have been filed is not
expected; no foreign, federal, state or local tax audits are pending or being
conducted with respect to the Company, no information related to tax matters
has been requested by any foreign, federal, state or local taxing authority
and no notice indicating an intent to open an audit or other review has been
received by the Company from any foreign, federal, state or local taxing
authority; and there are no unresolved questions or claims concerning the
Company's tax liability. The Company has not made an election under Section
341(f) of the IRC.
5.7 LITIGATION. ETC. Except as set forth on SCHEDULE 5.7 (Litigation)
attached hereto, there are no actions, suits, proceedings, orders,
investigations or claims pending or, to the best of the Company's knowledge,
threatened against or affecting the Company (or to the best of the Company's
knowledge, pending or threatened against or affecting any of the officers,
directors or employees of the Company with respect to their businesses or
proposed business activities) at law or in equity, or before or by any
governmental department, commission, board, bureau, agency or instrumentality
(including, without limitation, any actions, suit, proceedings or
investigations with respect to the transactions contemplated by this
Agreement) which could have a material adverse effect on the financial
condition, operating results, assets, operations or business prospects of the
Company and its Subsidiaries taken as a whole; the Company is not subject to
any arbitration proceedings under collective bargaining agreements or
otherwise or, to the best of the Company's knowledge, any governmental
investigations or inquiries; and, to the best of the Company's knowledge,
there is no basis for any of the foregoing. The Company is not subject to any
judgment, order or decree of any court or other governmental agency. The
Company has not received any opinion or memorandum or legal advice from legal
counsel to the effect that it is exposed, from a legal standpoint, to any
liability or disadvantage which may be material to its business.
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5.8 BROKERAGE. Except as set forth on SCHEDULE 5.8 (Brokerage)
attached hereto, there are no claims for brokerage commissions, finders, fees
or similar compensation in connection with the transactions contemplated by
this Agreement based on any arrangement or agreement binding upon the
Company. The Company shall pay, and hold CORESTAFF harmless against, any
liability, loss or expense (including, without limitation, attorneys, fees
and out-of-pocket expenses) arising in connection with any such claim.
5.9 GOVERNMENTAL CONSENT. ETC. No permit, consent, approval or
authorization of, or declaration to or filing with, any governmental
authority is required in connection with the execution, delivery and
performance by the Company of this Agreement or the other agreements
contemplated hereby, or the consummation by the Company of any other
transactions contemplated hereby or thereby.
5.10 ERISA. Except as set forth on SCHEDULE 5.10 hereto, the Company
does not maintain or have any obligation to contribute to or any other
liability with respect to or under (including but not limited to current or
potential withdrawal liability), nor has it ever maintained or had any
obligation to contribute to or any other liability with respect to or under,
(i) any plan or arrangement whether or not terminated, which provides
medical, health, life insurance or other welfare type benefits for current or
future retired or terminated employees (except for limited continued medical
benefit coverage required to be provided under Section 4980B of the IRC or as
required under applicable state law), (ii) any "multiemployer plan" (as
defined in Section 3(37) of the Employee Retirement Income Security Act of
1974, as amended ("ERISA"), (iii) any employee plan which is a tax- qualified
"defined benefit plan" (as defined in Section 3(35) of ERISA), whether or not
terminated, (iv) any employee plan which is a tax-qualified "defined
contribution plan" (as defined in Section 3(34) of ERISA), whether or not
terminated, or (v) any other plan or arrangement providing benefits to
current or former employees, including any bonus plan, plan for deferred
compensation, employee health or other welfare benefit plan or other
arrangement, whether or not terminated. For purposes of this SECTION 5.10,
the term "Company includes all organizations under common control with the
Company pursuant to Section 414(b) or (c) of the IRC.
5.11 COMPLIANCE WITH LAWS. The Company has not violated any law or any
governmental regulation or requirement which violation would reasonably be
expected to have a material adverse effect upon the financial condition,
operating results, assets, operations or business prospects of the Company,
and the Company has not received notice of any such violation. The Company is
not subject to any clean up liability, and the Company has no reason to
believe it may become subject to any clean up liability, under any federal,
state or local environmental law, rule or regulation.
5.12 COMPLIANCE WITH SECURITIES LAWS. The Company has complied in all
material respects with all laws, rules, regulations and requirements of the
Securities Act, the Securities Exchange Act and any other Federal or state
securities laws. The Company has made
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all filings required to be made with the Securities and Exchange Commission
and all of such filings are true and correct in all material respects.
5.13 DISCLOSURE Neither this Agreement nor any of the schedules,
attachments, written statements, documents, certificates or other items
prepared or supplied to CORESTAFF by or on behalf of the Company with respect
to the transactions contemplated hereby contain any untrue statement of a
material fact or omit a material fact necessary to make each statement
contained herein or therein not misleading. There is no fact which the
Company has not disclosed to CORESTAFF in writing and of which any of its
officers, directors or executive employees is aware and which has had or
might reasonably be anticipated to have a material adverse effect upon the
existing or expected financial condition, operating results, assets, customer
or supplier relations, employee relations or business prospects of the
Company.
5.13 CLOSING DATE. The representations and warranties of the Company
contained in this SECTION 5 and elsewhere in this Agreement and all
information contained in any exhibit, schedule or attachment hereto or in any
writing delivered by, or on behalf of, the Company to CORESTAFF shall be true
and correct in all material respects on the date of the Closing as though
then made, except as affected by the transactions expressly contemplated by
this Agreement.
ARTICLE VI
DEFINITIONS
-----------
6.1 For the purposes of this Agreement, the following terms have the
meanings set forth below:
"AFFILIATE" of any particular person or entity means any other
person or entity controlling, controlled by or under common control with such
particular person or entity.
"COMMON STOCK" means the Company's common stock, par value $.01 per
share.
"INDEBTEDNESS" means all indebtedness for borrowed money (including
purchase money obligations) maturing one year or more from the date of
creation or incurrence thereof or renewable or extendible at the option of
the debtor to a date one year or more from the date of creation or incurrence
thereof, all indebtedness under revolving credit arrangements extending over
a year or more, all capitalized lease obligations and all guarantees of any
of the foregoing.
"INVESTOR COMMON" means (i) the Stock issued hereunder and (ii) any
Common Stock issued or issuable with respect to the Common Stock referred to
in clause (i) above by way of stock dividends or stock splits or in
connection with a combination of shares.
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recapitalization, merger, consolidation or other reorganization. As to any
particular shares of Investor Common, such shares shall cease to be Investor
Common when they have been (a) effectively registered under the Securities
Act and disposed of in accordance with the Registration statement covering,
them or (b) distributed to the public through a broker, dealer or market
maker pursuant to Rule 144 under the Securities Act (or any similar rule then
in force).
"INVESTOR STOCK" means the Investor Common and all shares of Common
Stock acquired pursuant to exercise of the Option Agreement.
"IRC" means the Internal Revenue Code of 1986, as amended, and any
reference to any particular IRC section shall be interpreted to include any
revision of or successor to that section regardless of how numbered or
classified.
"OFFICER'S CERTIFICATE" means a certificate signed by the Company's
president or its chief financial officer, stating that (i) the officer
signing such certificate has made or has caused to be made such
investigations as are necessary in order to permit him to verify the accuracy
of the information set forth in such certificate and (ii) to the best of such
officer's knowledge, such certificate does not misstate any material fact and
does not omit to state any fact necessary to make the certificate not
misleading.
"PERSON" means an individual, a partnership, a limited liability
company, a corporation, an association, a joint stock company, a trust, a
joint venture, an unincorporated organization and a governmental entity or
any department, agency or political subdivision thereof.
"RESTRICTED SECURITIES" means (i) the Stock issued hereunder and
pursuant to the Option Agreement and (ii) any securities issued with respect
to the securities referred to in clause (i) above by way of a stock dividend
or stock split or in connection with a combination of shares,
recapitalization, merger, consolidation or other reorganization. As to any
particular Restricted Securities, such securities shall cease to be
Restricted Securities when they have (A) been effectively registered under
the Securities Act and disposed of in accordance with the registration
statement covering them, (B)become eligible for sale pursuant to Rule 144(k)
(or any similar provision then in force) under the Securities Act or (C) been
otherwise transferred and new certificates for them not bearing the
Securities Act legend set forth in SECTION 7.3 have been delivered by the
Company in accordance with SECTION 4.1(b). Whenever any particular securities
cease to be Restricted Securities, the holder thereof shall be entitled to
receive from the Company, without expense, new securities of like tenor not
bearing a Securities Act legend of the character set forth in SECTION 7.3.
"SECURITIES ACT" means the Securities Act of 1933, as amended, or
any similar federal law then in force.
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"SECURITIES EXCHANGE ACT" means the Securities Exchange Act of
1934. as amended, or any similar federal law then in force.
"SECURITIES AND EXCHANGE COMMISSION" includes any governmental body
or agency succeeding to the functions thereof.
"SUBSIDIARY" means any corporation of which the securities having a
majority of the ordinary voting power in electing the board of directors are,
at the time as of which any determination is being made, owned by the Company
either directly or through one or more Subsidiaries.
ARTICLE VII
MISCELLANEOUS
-------------
7.1 EXPENSES. Each party agrees to bear its own expenses associated
with the transactions contemplated hereby.
7.2 REMEDIES. Each holder of Investor Stock shall have all rights and
remedies set forth in this Agreement and the Certificate of Incorporation and
all rights and remedies which such holders have been granted at any time
under any other agreement or contract and all of the rights which such
holders have under any law. Any Person having any rights under any provision
of this Agreement shall & entitled to enforce such rights specifically
(without posting a bond or other security), to recover damages by reason of
any breach of any provision of this Agreement and to exercise all other
rights granted by law.
7.3 CORESTAFF'S INVESTMENT REPRESENTATIONS. CORESTAFF hereby
represents that it is acquiring the Restricted Securities purchased hereunder
or acquired pursuant hereto for its own account with the present intention of
holding such securities for purposes of investment, and that it has no
intention of selling such securities in a public distribution in violation of
the federal securities laws or any applicable state securities laws; provided
that nothing contained herein shall prevent CORESTAFF and subsequent holders
of Restricted Securities from transferring such securities in compliance with
the provisions of ARTICLE IV hereof Each certificate for Restricted
Securities shall be imprinted with a legend in substantially the following
form:
"The securities represented by this certificate here
originally issued on ____________ and have not been
registered under the Securities Act of 1933, as amended.
The transfer of the securities represented by this
certificate is subject to the conditions specified in the
Purchase Agreement, dated as of _______________ 1997,
between the issuer (the "Company") and a certain
investor, and the Company reserves the right to refuse
the transfer of such securities
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until such conditions have been fulfilled with respect to
such transfer. A copy of such conditions shall be furnished
by the Company to the holder hereof upon written request and
without charge."
7.4 CONSENT TO AMENDMENTS. Except as otherwise expressly provided
herein, the provisions of this Agreement may be amended and the Company may
take any action herein prohibited, or omit to perform any act herein required
to be performed by it, only if the Company has obtained the written consent
of the holders of a majority of the Investor Stock. No other course of
dealing between the Company and the holder of any Stock or any delay in
exercising any fights hereunder or under the Certificate of Incorporation
shall operate as a waiver of any rights of any such holders. For purposes of
this Agreement, shares of Stock held by the Company or any Subsidiaries shall
not be deemed to be outstanding.
7.5 SURVIVAL OF REPRESENTATION AND WARRANTIES. All representations and
warranties contained herein or made in writing by any party in connection
herewith shall survive the execution and delivery of this Agreement and the
consummation of the transactions contemplated hereby, regardless of any
investigation made by CORESTAFF or on its behalf
7.6 SUCCESSORS AND ASSIGNS. Except as otherwise expressly provided
herein, all covenants and agreements contained in this Agreement by or on
behalf of any of the parties hereto shall bind and inure to the benefit of
the respective successors and assigns of the parties hereto whether so
expressed or not. In addition, and whether or not any express assignment has
been made, the provisions of this Agreement which are for CORESTAFF's benefit
as a purchaser or holder of Stock are also for the benefit of, and
enforceable by, any subsequent holder of such Stock. The rights and
obligations of CORESTAFF under this Agreement and the agreements contemplated
hereby may be assigned by CORESTAFF at any time, in whole or in part, to any
Subsidiary of CORESTAFF, or any successor thereto.
7.7 GENERALLY ACCEPTED ACCOUNTING PRINCIPLES. Where any accounting
determination or calculation is required to be made under this Agreement or
the exhibits hereto, such determination or calculation (unless otherwise
provided) shall be made in accordance with generally accepted accounting
principles, consistently applied, except that if because of a change in
generally accepted accounting principles the Company would have to alter a
previously utilized accounting method or policy in order to remain in
compliance with generally accepted accounting principles, such determination
or calculation shall continue to be made in accordance with the Company's
previous accounting methods and policies.
7.8 SEVERABILITY. Whenever possible, each provision of this Agreement
shall be interpreted in such manner as to be effective and valid under
applicable law, but if any provision of this Agreement is held to be
prohibited by or invalid under applicable law, such provision shall be
ineffective only to the extent of such prohibition or invalidity, without
invalidating, the remainder of this Agreement.
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7.9 COUNTERPARTS. This Agreement may be executed simultaneously in two
or more counterparts, any one of which need not contain the signatures of
more than one party, but all such counterparts taken together shall
constitute one and the same Agreement.
7.10 DESCRIPTIVE HEADINGS; INTERPRETATION. The descriptive headings of
this Agreement are inserted for convenience only and do not constitute a
Section of this Agreement. The use of the word "including" in this Agreement
shall be by way of example rather than by limitation.
7.11 GOVERNING LAW. The corporate law of Delaware shall govern all
issues concerning the relative rights of the Company and its stockholders.
All other questions concerning the construction, validity and interpretation
of this Agreement and the exhibits and schedules hereto shall he governed by
and construed in accordance with the internal laws of the State of Illinois.
without giving effect to any choice of law or conflict of law provision or
rule (whether of the State of Illinois or any other jurisdiction) that would
cause the application of the laws of any jurisdiction other than the State of
Texas.
7.12 NOTICES. All notices, demands or other communications to be given
or delivered under or by reason of the provisions of this Agreement shall be
in writing and shall be deemed to have been given when delivered personally
to the recipient, sent to the recipient by reputable express courier service
(charges prepaid), 48 hours after being deposited to the recipient by United
States mail, first class, postage prepaid, or sent by facsimile. Such
notices, demands and other communications shall be sent to CORESTAFF and to
the Company at the address indicated below:
IF TO THE COMPANY:
Citadel Technology, Inc.
3811 Turtle Creek Boulevard, Suite 600
Dallas, TX 75219
Attention: Steven B. Solomon
Tel No.: (214) 520-9292
Fax No.: (214) 520-0034
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IF TO CORESTAFF:
COREStaff, Inc.
4400 Post Oak Parkway, Suite 2000
Houston, TX 77027
Attention: Kenneth R. Johnsen
Tel No.: (281) 602-3485
Fax No.: (281) 602-3430
with a copy to:
Peter T. Dameris, Esq.
COREStaff, Inc.
4400 Post Oak Parkway, Suite 1130
Houston, TX 77027
Tel No.: (281) 602-3400
Fax No.: (713) 627-1059
or to such other address or to the attention of such other person as the
recipient party has specified by prior written notice to the sending party.
7.13. ARBITRATION. THE PARTIES AGREE TO SUBMIT TO ARBITRATION, IN
ACCORDANCE WITH THESE PROVISIONS, ANY DISPUTED CLAIM OR CONTROVERSY ARISING
FROM OR RELATED TO THE ALLEGED BREACH OF THIS AGREEMENT OR ANY DISPUTED CLAIM
MADE PURSUANT TO SECTION 2.3, THE FIRST STEP LICENSE AGREEMENT OR THE FIRST
STEP SOFTWARE. THE PARTIES FURTHER AGREE THAT THE ARBITRATION PROCESS AGREED
UPON HEREIN SHALL BE THE EXCLUSIVE MEANS FOR RESOLVING ALL DISPUTES MADE
SUBJECT TO ARBITRATION HEREIN, BUT THAT NO ARBITRATOR SHALL HAVE AUTHORITY TO
EXPAND THE SCOPE OF ThESE ARBITRATION PROVISIONS. ANY ARBITRATION HEREUNDER
SHALL BE CONDUCTED UNDER THE PROCEDURES OF THE AMERICAN ARBITRATION
ASSOCIATION (AAA). EITHER PARTY MAY INVOKE ARBITRATION PROCEDURES HEREIN BY
WRITTEN NOTICE FOR ARBITRATION CONTAINING A STATEMENT OF THE MATTER TO BE
ARBITRATED. THE PARTIES SHALL THEN HAVE FOURTEEN (14) DAYS IN WHICH THEY MAY
IDENTIFY A MUTUALLY AGREEABLE, NEUTRAL ARBITRATOR. AFTER THE FOURTEEN (14)
DAY PERIOD HAS EXPIRED, THE PARTIES SHALL PREPARE AND SUBMIT TO THE AAA A
JOINT SUBMISSION, WITH EACH PARTY TO CONTRIBUTE HALF OF THE APPROPRIATE
ADMINISTRATIVE FEE. IN THE EVENT THE PARTIES CANNOT AGREE UPON A NEUTRAL
ARBITRATOR WITHIN FOURTEEN (14) DAYS AFTER WRITTEN NOTICE FOR ARBITRATION IS
RECEIVED, THEIR JOINT SUBMISSION TO THE AAA SHALL REQUEST A PANEL OF THREE
ARBITRATORS WHO ARE PRACTICING ATTORNEYS WITH PROFESSIONAL EXPERIENCE IN THE
FIELD OF CORPORATE LAW, AND THE PARTIES SHALL ATTEMPT TO SELECT AN ARBITRATOR
FROM THE PANEL ACCORDING TO AAA PROCEDURES. UNLESS OTHERWISE AGREED BY THE
PARTIES, THE ARBITRATION HEARING SHALL TAKE PLACE IN HOUSTON, TEXAS, AT A
PLACE DESIGNATED BY THE AAA. ALL ARBITRATION
-19-
<PAGE>
PROCEDURES HEREUNDER SHALL BE CONFIDENTIAL. EACH PARTY SHALL BE RESPONSIBLE
FOR ITS COSTS INCURRED IN ANY ARBITRATION. AND THE ARBITRATOR SHALL NOT HAVE
AUTHORITY TO INCLUDE ALL OR ANY PORTION OF SAID COSTS IN AN AWARD, REGARDLESS
OF WHICH PARTY PREVAILS. THE ARBITRATOR MAY INCLUDE EQUITABLE RELIEF. ANY
ARBITRATION AWARDED SHALL BE ACCOMPANIED BY A WRITTEN STATEMENT CONTAINING A
SUMMARY OF THE ISSUES IN CONTROVERSY, A DESCRIPTION OF THE AWARD, AND AN
EXPLANATION OF THE REASONS FOR THE AWARD.
IN WITNESS WHEREOF, the parties hereto have executed this Agreement on
the date first written above.
CITADEL TECHNOLOGY, INC.
By:
----------------------------------
Name:
---------------------------
Title:
---------------------------
CORESTAFF, INC.
By:
----------------------------------
Name:
---------------------------
Title:
---------------------------
For purposes of Section 3.7 hereof only:
---------------------------------------
Steven B. Solomon
-20-
<PAGE>
THE WARRANT REPRESENTED BY THIS CERTIFICATE AND THE SHARES ISSUABLE UPON
EXERCISE HEREOF HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS
AMENDED (THE "ACT"), OR ANY STATE SECURITIES LAWS AND NEITHER SUCH SECURITIES
NOR ANY INTEREST THEREIN MAY BE OFFERED, SOLD, PLEDGED, ASSIGNED OR OTHERWISE
TRANSFERRED UNLESS (1) A REGISTRATION STATEMENT WITH RESPECT THERETO IS
EFFECTIVE UNDER THE ACT AND ANY APPLICABLE STATE SECURITIES LAWS, OR (2) THE
COMPANY RECEIVES AN OPINION OF COUNSEL TO THE HOLDER OF SUCH SECURITIES,
WHICH COUNSEL AND OPINION ARE REASONABLY SATISFACTORY TO THE COMPANY, THAT
SUCH SECURITIES MAY BE OFFERED, SOLD, PLEDGED, ASSIGNED OR TRANSFERRED IN THE
MANNER CONTEMPLATED WITHOUT AN EFFECTIVE REGISTRATION STATEMENT UNDER THE ACT
OR APPLICABLE STATE SECURITIES LAWS.
THE TRANSFER OF THIS WARRANT IS
RESTRICTED AS DESCRIBED HEREIN.
CITADEL COMPUTER SYSTEMS INCORPORATED
Warrant for the Purchase of Shares of Common Stock,
par value $.01 per share
No. 1 150,000 Shares
THIS CERTIFIES that, for value received, Worldwide PetroMoly Inc. (the
"Holder"), is entitled to subscribe for and purchase from Citadel Computer
Systems Incorporated, a Delaware corporation (the "Company"), upon the terms
and conditions set forth herein, at any time or from time to time after
January 12, 1997 until 5:00 P.M. on January 12, 2000, Central time (the
"Exercise Period"), 150,000 shares of the Common Stock; at an exercise price
of $0.59 per share (the "Exercise Price"). The number of shares of Common
Stock issuable upon exercise of the Warrants (collectively, the "Warrant
Shares") and the Exercise Price may be adjusted from time to time as
hereinafter set forth.
1. EXERCISE. This Warrant may be exercised at any time during the
Exercise Period as to the whole or any lesser number of whole Warrant Shares,
by the surrender of this Warrant (with the election form at the end hereof
duly executed) to the Company at its office at 3811 Turtle Creek Boulevard,
Suite 330, Dallas, Texas 75219, or at such other place as the Company may
designate in writing, together with a check payable to the order of the
Company in an amount equal to the Exercise Price multiplied by the number of
Warrant Shares for which this Warrant is being exercised.
2. TITLE. Upon each exercise of the Holder's rights to purchase
Warrant Shares, the Holder shall be deemed to be the holder of record of the
Warrant Shares issuable upon such exercise, notwithstanding that the transfer
books of the Company shall then be closed or
1
<PAGE>
certificates representing such Warrant Shares shall not then have been
actually delivered to the Holder. As soon as practicable after each such
exercise of this Warrant, the Company shall issue and deliver to the Holder a
certificate or certificates for the Warrant Shares issuable upon such
exercise, registered in the name of the Holder or its designee. If this
Warrant should be exercised in part only, the Company shall, upon surrender
of this Warrant for cancellation, execute and deliver a new Warrant
evidencing the right of the Holder to purchase the balance of the Warrant
Shares (or portions thereof) subject to purchase hereunder.
3. TRANSFER AND RESTRICTIONS ON TRANSFER. (a) This Warrant and any
Warrants issued upon the transfer or exercise in part of this Warrant shall
be numbered and shall be registered in a Warrant Register as they are issued.
The Company shall be entitled to treat the registered holder of any Warrant
on the Warrant Register as the owner in fact thereof for all purposes. The
Company shall not be bound to recognize any equitable or other claim to or
interest in such Warrant on the part of any other person. The Company shall
not be liable for any registration or transfer of Warrants that are
registered or to be registered in the name of a fiduciary or the nominee of a
fiduciary, unless such registration or transfer is made with the Company's
actual knowledge that a fiduciary or nominee is committing a breach of trust
in requesting such registration or transfer, or with the knowledge of such
facts that its participation therein amounts to bad faith. This Warrant
shall be transferable only on the books of the Company upon delivery thereof
duly endorsed by the Holder or by his duly authorized attorney or
representative, or accompanied by proper evidence of succession, assignment,
or authority to transfer. In all cases of transfer by an attorney, executor,
administrator, guardian, or other legal representative, duly authenticated
evidence of his or its authority shall be produced. Upon any registration of
transfer, the Company shall deliver a new Warrant or Warrants to the person
entitled thereto. This Warrant may be exchanged, at the option of the Holder
thereof, for another Warrant, or other Warrants of different denominations,
of like tenor and representing in the aggregate the right to purchase a like
number of Warrant Shares (or portions thereof), upon surrender to the Company
or its duly authorized agent. The Company shall have no obligation to cause
Warrants to be transferred on its books to any person unless such transfer is
registered under the Securities Act of 1933, as amended (the "Act"), and
applicable state securities laws or unless the Company receives an opinion of
counsel to the Holder, which counsel and opinion are reasonably satisfactory
to the Company, that the Warrant may be transferred in the manner
contemplated without an effective registration statement under the Act or
applicable state securities laws.
(b) The Holder acknowledges that the Holder has been advised by the
Company that neither this Warrant nor the Warrant Shares have been registered
under the Act, that this Warrant is being or has been issued and the Warrant
Shares may be issued on the basis of the statutory exemption provided by
Section 4(2) of the Act or Regulation D promulgated thereunder, or both,
relating to transactions by an issuer not involving any public offering, and
that the Company's reliance thereon is based in part upon the representations
made by the original Holder. The Holder acknowledges that he has been
informed by the Company of, or is otherwise familiar with, the nature of the
limitations imposed by the Act and the rules and regulations thereunder on
the transfer of securities. In particular, the Holder agrees that no sale,
assignment or transfer of
2
<PAGE>
this Warrant or the Warrant Shares shall be valid or effective, and the
Company shall not be required to give any effect to any such sale, assignment
or transfer, unless (i) the sale, assignment or transfer of this Warrant or
such Warrant Shares is registered under the Act, it being understood that the
Company has no obligation or intention to so register this Warrant or the
Warrant Shares except as specifically provided herein, or (ii) this Warrant
or such Warrant Shares are sold, assigned or transferred in accordance with
all the requirements and limitations of Rule 144 under the Act, it being
understood that Rule 144 may not be available at the time of the original
issuance of this Warrant for the sale of this Warrant or the Warrant Shares
and that there can be no assurance that Rule 144 sales will be available at
any subsequent time, or (iii) such sale, assignment, or transfer is otherwise
exempt from registration under the Act.
4. ADJUSTMENT OF EXERCISE PRICE AND NUMBER OF WARRANT SHARES. If the
Company shall at any time after the date the Warrants were first issued (i)
declare a dividend on the outstanding Common Stock payable in shares of its
capital stock, (ii) subdivide the outstanding Common Stock, (iii) combine the
outstanding Common Stock into a smaller number of shares, (iv) issue any
shares of its capital stock by reclassification of the Common Stock
(including any such reclassification in connection with a consolidation or
merger in which the Company is the continuing corporation), or (v) make any
distribution of its assets to holders of its Common Stock as a liquidation or
partial liquidation dividend or by way of return of capital; then, in each
case, the Exercise Price, and the number of Warrant Shares in effect at the
time of the record date for such dividend or of the effective date of such
subdivision, combination, or reclassification, shall be proportionately
adjusted so that the Holder after such time shall be entitled to receive the
aggregate number and kind of shares which, if such Warrant had been exercised
immediately prior to such time, the Holder would have owned upon such
exercise and been entitled to receive by virtue of such dividend,
subdivision, combination, or reclassification. Such adjustment shall be made
successively whenever any event listed above shall occur.
5. MERGER. (a) In case of any consolidation with or merger of the
Company with or into another corporation (other than a merger or
consolidation in which the Company is the surviving or continuing
corporation), or in case of any sale, lease, or conveyance to another
corporation of the property and assets of any nature of the Company as an
entirety or substantially as an entirety, such successor, or such leasing or
purchasing corporation, as the case may be, shall (i) execute with the Holder
an agreement providing that the Holder shall have the right thereafter to
receive upon exercise of this Warrant solely the kind and amount of shares of
stock and other securities, property, cash, or any combination thereof
receivable upon such consolidation, merger, sale, lease, or conveyance by a
holder of the number of shares of Common Stock for which this Warrant might
have been exercised immediately prior to such consolidation, merger, sale,
lease, or conveyance and (ii) make effective provision in its certificate of
incorporation or otherwise, if necessary, to effect such agreement. Such
agreement shall provide for adjustments which shall be as nearly equivalent
as practicable to the adjustments in Section 4.
(b) In case of any reclassification or change of the shares of
Common Stock issuable upon exercise of this Warrant (other than a change in
par value or as a result of a subdivision or combination, but including any
change in the shares into two or more classes or
3
<PAGE>
series of shares), or in case of any consolidation or merger of another
corporation into the Company in which the Company is the continuing
corporation and in which there is a reclassification or change (including a
change to the right to receive cash or other property, including, without
limitation, a reverse subsidiary merger) of the shares of Common Stock (other
than a change in par value, or as a result of a subdivision or combination,
but including any change in the shares into two or more classes or series of
shares), the Holder shall have the right thereafter to receive upon exercise
of this Warrant solely the kind and amount of shares of stock and other
securities, property, cash, or any combination thereof receivable upon such
reclassification, change, consolidation, or merger by a holder of the number
of shares of Common Stock for which this Warrant might have been exercised
immediately prior to such reclassification, change, consolidation, or merger.
Thereafter, appropriate provision shall be made for adjustments which shall
be as nearly equivalent as practicable to the adjustments in Section 4.
(c) The above provisions of this Section 5 shall similarly apply to
successive reclassifications and changes of shares of Common Stock and to
successive consolidations, mergers, sales, leases, or conveyances.
6. COVENANTS OF COMPANY.
(a) The Company shall at all times reserve and keep available out
of its authorized and unissued Common Stock, solely for the purpose of
providing for the exercise of the rights to purchase all Warrant Shares
granted pursuant to the Warrants, such number of shares of Common Stock as
shall, from time to time, be sufficient therefor. The Company covenants that
all shares of Common Stock issuable upon exercise of this Warrant, upon
receipt by the Company of the full Exercise Price therefor, shall be validly
issued, fully paid, nonassessable, and free of preemptive rights.
(b) If at any time the Company shall propose to:
i) pay any dividend or make any distribution on shares of
Common Stock in shares of Common Stock or make any other distribution (other
than regularly scheduled cash dividends which are not in a greater amount per
share than the most recent such cash dividend) to all holders of Common
Stock; or
ii) issue any rights, warrants, or other securities to all
holders of Common Stock entitling them to purchase any additional shares of
Common Stock or any other rights, warrants, or other securities; or
iii) effect any reclassification or change of outstanding
shares of Common Stock, or any consolidation, merger, sale, lease, or
conveyance of property, described in Section 5; or
iv) effect any liquidation, dissolution, or winding-up of the
Company; or
4
<PAGE>
v) take any other action which would cause an adjustment to
the Exercise Price;
then, and in any one or more of such cases, the Company shall give written
notice thereof, by registered mail, postage prepaid, to the Holder at the
Holder's address as it shall appear in the Warrant Register, mailed at least
15 days prior to (i) the date as of which the holders of record of shares of
Common Stock to be entitled to receive any such dividend, distribution,
rights, warrants, or other securities are to be determined, (ii) the date on
which any such reclassification, change of outstanding shares of Common
Stock, consolidation, merger, sale, lease, conveyance of property,
liquidation, dissolution, or winding-up is expected to become effective, and
the date as of which it is expected that holders of record of shares of
Common Stock shall be entitled to exchange their shares for securities or
other property, if any, deliverable upon such reclassification, change of
outstanding shares, consolidation, merger, sale, lease, conveyance of
property, liquidation, dissolution, or winding-up, or (iii) the date of such
action which would require an adjustment to the Exercise Price.
7. EXPENSES OF EXERCISE. The issuance of any shares or other
securities upon the exercise of this Warrant, and the delivery of
certificates or other instruments representing such shares or other
securities, shall be made without charge to the Holder for any tax or other
charge in respect of such issuance. The Company shall not, however, be
required to pay any tax which may be payable in respect of any transfer
involved in the issue and delivery of any certificate in a name other than
that of the Holder and the Company shall not be required to issue or deliver
any such certificate unless and until the person or persons requesting the
issue thereof shall have paid to the Company the amount of such tax or shall
have established to the satisfaction of the Company that such tax has been
paid.
8. REGISTRATION OF WARRANT SHARES.
(a) Upon the request of the Holder, the Company shall file a
registration statement with the Commission pursuant to which the Company will
register or qualify the Registrable Securities to the extent requisite to
permit the public offering and sale of the Registrable Securities and will
use its best efforts to cause such registration statement to become effective
as promptly as practicable for one half of the Registrable Securities as of a
date six months, and for the remaining half of such Registrable Securities as
of a date nine months, following a public offering of Company shares pursuant
to a registration statement on a form other than Form S-8 or Form S-4.
Notwithstanding the foregoing, the Company shall in no event be required to
keep any such registration or qualification in effect for a period in excess
of two years from the date on which the Holders are first free to sell such
Registrable Securities.
(b) In connection with registration of securities pursuant to this
Section 8, the Holder shall pay all fees and expenses with respect to its
shares, including broker/dealer commissions, underwriting discounts, the
expenses of such underwriter, fees and disbursements of counsel of such
Holder and any stock transfer taxes incurred with respect of the Registrable
Securities of such Holder. The Company shall bear all other expenses
incurred in connection with such Registration Statement.
5
<PAGE>
9. STOP TRANSFER LEGEND. Unless registered pursuant to Act, the Warrant
Shares issued upon exercise of the Warrants shall be subject to a stop
transfer order and the certificate or certificates evidencing such Warrant
Shares shall bear the following legend:
"THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED
UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), OR ANY STATE
SECURITIES LAWS AND NEITHER SUCH SECURITIES NOR ANY INTEREST THEREIN MAY
BE OFFERED, SOLD, PLEDGED, ASSIGNED OR OTHERWISE TRANSFERRED UNLESS
(1) A REGISTRATION STATEMENT WITH RESPECT THERETO IS EFFECTIVE UNDER THE
ACT AND ANY APPLICABLE STATE SECURITIES LAWS, OR (2) THE COMPANY RECEIVES
AN OPINION OF COUNSEL TO THE HOLDER OF SUCH SECURITIES, WHICH COUNSEL AND
OPINION ARE REASONABLY SATISFACTORY TO THE COMPANY, THAT SUCH SECURITIES
MAY BE OFFERED, SOLD, PLEDGED, ASSIGNED OR TRANSFERRED IN THE MANNER
CONTEMPLATED WITHOUT AN EFFECTIVE REGISTRATION STATEMENT UNDER THE ACT
OR APPLICABLE STATE SECURITIES LAWS."
10. REPLACEMENT OF WARRANT. Upon receipt of evidence satisfactory to
the Company of the loss, theft, destruction, or mutilation of any Warrant and
(i) in the case of any such loss, theft or destruction upon delivery of
indemnity satisfactory to the Company in form and amount or, (ii) in the case
of any such mutilation upon surrender of such warrant for cancellation of the
principal office of the Company, upon reimbursement of the Company's
reasonable incidental expenses, the Company shall execute and deliver to the
Holder thereof a new Warrant of like date, tenor, and denomination.
11. NO RIGHTS AS STOCKHOLDER. The Holder of any Warrant shall not have
solely on account of such status, any rights of a stockholder of the Company,
either at law or in equity, or to any notice of meetings of stockholders or
of any other proceedings of the Company, except as provided in this Warrant.
12. CHOICE OF LAW. This Warrant has been negotiated and consummated in
the State of Texas and shall be construed in accordance with the laws of the
State of Texas applicable to contracts made and performed within such State,
without regard to principles governing conflicts of law.
13. JURISDICTION. The Company irrevocably consents to the jurisdiction
of the courts of the State of Texas and of any federal court located in such
State in connection with any action or proceeding arising out of or relating
to this Warrant, any document or instrument delivered pursuant to, in
connection with or simultaneously with this Warrant, or a breach of this
Warrant or any such document or instrument. Within 30 days after such
service, or such other time as may be mutually agreed upon in writing by the
attorneys for the parties to such action or
6
<PAGE>
proceeding, the Company shall appear to answer such summons, complaint or
other process. Should the Company so served fail to appear or answer within
such 30-day period or such extended period, as the case may be, the Company
shall be deemed in default and judgment may be entered against the Company
for the amount as demanded in any summons, complaint or other process so
served.
14. SEVERABILITY. Any provision contained in this Warrant which is
prohibited or unenforceable by law shall be ineffective to the extent of such
prohibition or unenforceability without invalidating the remaining provisions
contained in this Warrant.
15. HEADINGS. The descriptive headings of the several Sections of this
Warrant are inserted for convenience only and do not constitute part of the
Warrant.
Dated: December 12, 1996.
CITADEL COMPUTER SYSTEMS INCORPORATED
By: /s/ GEORGE SHARP
-------------------------------------
George Sharp, Chief Executive Officer
7
<PAGE>
To: Citadel Computer Systems Incorporated
3811 Turtle Creek Boulevard
Suite 330
Dallas, Texas 75219
ELECTION TO EXERCISE
The undersigned hereby exercises his or its rights to purchase
___________ Warrant Shares covered by the within Warrant and tenders payment
herewith in the amount of $___________ in accordance with the terms thereof,
and requests that certificates for such securities be issued in the name of,
and delivered to:
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
(Print Name, Address and Social Security
or Tax Identification Number)
and, if such number of Warrant Shares shall not be all the Warrant Shares
covered by the within Warrant, that a new Warrant for the balance of the
Warrant Shares covered by the within Warrant be registered in the name of,
and delivered to, the undersigned at the address stated below.
Dated:
------------------
Name:
---------------------------------------------------------------------------
(Print)
Address:
------------------------------------------------------------------------
-----------------------------------------
(Signature)
8
<PAGE>
EXHIBIT 21
The Company has the following wholly-owned Subsidiaries:
1. Kent-Marsh Ltd., Inc.
2. Astonishing Developments, Inc.
3. DanaSoft, Inc.
4. LSHC Acquisition Corp.
5. Liberty Recovery Corp.
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We have issued our report dated August 29, 1997, accompanying the
consolidated financial statements included in the Annual Report of Citadel
Computer Systems, Incorporated on Form 10-KSB as of February 28, 1997. We
hereby consent to the incorporation by reference of said report in the
Registration Statements of Citadel Computer Systems, Incorporated (formerly
LoneStar Hospitality Corporation) on Form S-8 (File No. 33-65189, No.
333-03291, and No. 333-15665 effective December 20, 1995, May 8, 1996, and
November 6, 1996, respectively).
GRANT THORNTON LLP
Dallas, Texas
October 17, 1997
<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 YEAR
ENDED FEBRUARY 28, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> FEB-28-1997
<PERIOD-START> MAR-01-1996
<PERIOD-END> FEB-28-1997
<CASH> 15,100
<SECURITIES> 1,250,000
<RECEIVABLES> 2,602,422
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 4,794,628
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 10,724,093
<CURRENT-LIABILITIES> 5,680,965
<BONDS> 1,770,905
0
5
<COMMON> 165,020
<OTHER-SE> 3,107,198
<TOTAL-LIABILITY-AND-EQUITY> 10,724,093
<SALES> 5,326,192
<TOTAL-REVENUES> 5,326,192
<CGS> 304,436
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 1,984,113
<INTEREST-EXPENSE> 253,557
<INCOME-PRETAX> (7,515,607)
<INCOME-TAX> 0
<INCOME-CONTINUING> (7,515,607)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,515,607)
<EPS-PRIMARY> (.56)
<EPS-DILUTED> 0
</TABLE>
