<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB/A
AMENDMENT NO. 1
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended November 30, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from________ to ________
Commission file number: 0-08718
CITADEL TECHNOLOGY, INC.
(Exact name of small business issuer
as specified in its charter)
DELAWARE 75-2432011
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3811 TURTLE CREEK BLVD., SUITE 600, DALLAS, TX 75219
(Address of principal executive offices)
(214) 520-9292
(Issuer's telephone number)
----------------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
Check whether the issuer (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for
such shorter period the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.
Yes X No
--- ---
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date.
Common Stock, par value $.01 18,942,902
----------
Outstanding at January 14, 1998
Transitional Small Business Disclosure Format Yes [ ] No [X]
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The Financial Statements of the Company are found after the signature
page.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
The statements contained in this Report that are not historical
facts, including, but not limited to, statements found in this Item 2 -
"Management's Discussion and Analysis," are forward-looking statements and,
as such, involve a number of risks and uncertainties. The actual results of
the future events described in such forward-looking statements in this Report
could differ materially from those stated in such forward-looking statements.
Among the factors that could cause actual results to differ materially are:
general economic conditions; competition; the market for network and desktop
software products; seasonality of product sales; the Company's capital
requirements and the uncertainty of additional funding; the Company's
inconsistent revenues and the uncertainty of future profitability; costs and
risks related to integration of acquisitions; uncertainties related to new
product development and market acceptance of new products developed; costs,
expenses and delays related to the implementation of new sales strategies;
software development costs; litigation; as well as the risks and
uncertainties discussed in this Report, including, without limitation, the
portions referenced above, and the uncertainties set forth from time to time
in the Company's other public reports and filings and public statements.
RECENT DEVELOPMENTS
PRODUCTS: The Company's C:\MORE! product, a file management utility,
was recently featured by IOMEGA at Comdex and was a cover
story in their online magazine. Crash Protection and
Recovery (CPR) was also featured at the Comdex trade show in
the Novell booth. The interest in both products at the show
and subsequent thereto has been outstanding. Both these
products have been featured in several local and national
reviews targeted at technology professionals and consumers.
The Company has also recently completed development on its
Winshield 95 product and plans to introduce a Winshield
NT/Network version during the first quarter of fiscal 1999.
This release will substantially increase the potential
customer base for the Winshield product. In addition, the
Company plans to introduce upgrades for its Enterprise
products including support for the NT platform for: CPR,
Phantom of the Console, Server Sentry, Server Cam and
Tabworks products during the fourth quarter of fiscal 1998
and first quarter of fiscal 1999. The Company expects to
launch additional new products and upgrades in future
quarters of fiscal 1999 that will provide ease-of-use
security for Internet and intranet applications on Microsoft
and Novell platforms.
SALES &
MARKETING: With the introduction of new products, a revised sales model
and the launch of the Company's authorized reseller program,
the Company will leverage a broad range of sales and
marketing opportunities that will target direct and indirect
customers. In fiscal year 1998, the Company changed the
focus of its selling efforts from a telemarketing/direct
sales strategy to a multi-channel sales strategy that
includes an enterprise sales group, tele-marketing group,
channel group, OEM/Vendor relations group and a VAR
recruitment and management group. The channel group has
successfully penetrated several retail accounts and
continues to broaden its reach. Each of these sales groups
have exposure to software
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buyers and end users and will provide valuable feedback
that will help determine new product features and direction.
PR activities have increased substantially with the release
of the new products and continues to provide the Company
with additional exposure.
OPERATIONS: The Company has recently filled two key management
positions. Bennett Klein joined the Company as Vice
President of Business Development and Jack Doxey joined the
Company as Vice President of Sales and Marketing. Klein
joins the Company from Iomega, where he was part of the
original marketing team that brought Zip and Jaz removable
storage to the mass market. He has over 15 years experience
in marketing management with several technology companies,
including Cheyenne Software and IBM. Doxey's software sales
and marketing experience includes over 10 years of extensive
work with retail and value-added resellers in the
distribution channel, including Attachmate, MicroHelp, DCA,
Technology Advancement Corporation and MindShare Associates.
Other marketing positions have been filled and the marketing
department now creates all marketing materials internally.
The Company has started its initial staffing of the internal
sales group and VAR management group and expects to continue
to grow the sales and marketing departments in future
quarters.
RESULTS OF OPERATIONS
During the three months ended November 30, 1997, the Company had net
sales of $269,344, a decrease of $1,231,926 or 82.1% from net sales of
$1,501,270 for the three months ended November 30, 1996. During the nine
months ended November 30, 1997, the Company had net sales of $1,107,712, a
decrease of $3,282,496, or 74.8% from net sales of $4,390,208 for the nine
months ended November 30, 1996.
During the first three quarters of this fiscal year, the Company was
integrally involved with completing its corporate plan of restructuring,
which included the consolidation of its Houston operations into its Dallas
location; the elimination of outside sales offices; the outsourcing of
certain functions previously performed in-house; the reduction of its
workforce by approximately 70%; the identification of areas for greater
operational efficiencies to enable the Company to significantly reduce its
overhead and administrative expenses; and development and implementation of
new sales and marketing strategies. The new sales and marketing strategies
focus the Company's efforts more toward the traditional VAR, reseller, OEM
and joint venture model and less towards the Company's historical
telemarketing and trade-show model. The Company believes these changes
attributed to its sales decrease during these quarters and believes that
sales will continue to be below last years numbers through the end of the
current fiscal year. The Company does believe, however, that these newly
adopted strategies will better position the Company for strong future growth
and anticipates revenues for fiscal year 1999 to be significantly above
fiscal year 1998.
The Company, during the past nine months, has entered into strategic
alliances with several market leaders in the industry and expects to continue
to explore similar arrangements in the future. The Company recently signed a
strategic alliance with CORESTAFF, Inc. ("CORESTAFF"), whereby both companies
have agreed to cross-sell each other's products, with the Company being the
exclusive distributor of CORESTAFF's "First Step" software program, a
peer-to-peer system that enables users to easily access multiple systems
requiring different user codes. In addition, the alliance provides that
CORESTAFF's Software Services Unit, Millennium, with a development staff of
over 150, will provide development support to the Company. The Company's
OEM/Vendor relationship currently includes partnerships or relationships with
Microsoft, IOMEGA, Novell and Compaq. These relationships not only give the
Company another channel of distribution, but also endorsements that are used
by the Enterprise group to add credibility to the Company's products. In the
coming year the Company will continue to partner-up with other market leaders
in the industry.
During the fourth quarter, the Company started shipments of its IOMEGA
endorsed C:\MORE! product and its Winshield 95 product to various retail and
VAR channels. The initial response on both these products has been
outstanding and the Company expects both products to represent a significant
portion of its revenue in fiscal 1999. In
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addition, the Company is currently in BETA testing on its Crash Protection
Recovery ("CPR"), Winshield NT and Winshield Enterprise ( a network version
of its Winshield 95 product) products and expects a full release of these
products during the first quarter of fiscal 1999. The Company expects to
launch additional new products and upgrades in future quarters of fiscal 1999
that will provide ease-of-use security for Internet and intranet applications
on Microsoft and Novell platforms.
The costs and expenses incurred in connection with producing the
Company's products decreased from $91,224, or 6.1% of net sales for the
three months ended November 30, 1996, to $11,469, or 4.3% for the three
months ended November 30, 1997. The costs and expenses incurred in connection
with producing the Company's products decreased from $246,413, or 5.6% of net
sales for the nine months ended November 30, 1996, to $35,255, or 3.2% for
the nine months ended November 30, 1997. On an overall basis, these expenses
have decreased, as a percentage of sales, as a result of the Company
performing a large portion of its order fulfillment in-house versus
outsourcing this service as it had done during the previous fiscal year. In
addition, as an increasing percentage of the Company's sales are made through
strategic alliances, electronic commerce, site licensing, or other channels,
the costs and expenses incurred in connection with producing the Company's
products will continue to decrease as a percentage of sales. During the
second and third quarters, as part of the Company's restructuring, the
Company outsourced a large percentage of its order fulfillment services.
Therefore, these expenses increased, as a percentage of sales, over the first
quarter of this fiscal year, but still remain below prior years' numbers.
This is in part due to the fact, as mentioned earlier, that as the percentage
of the Company's sales that are sold through strategic alliances, electronic
commerce, site licensing, or other channels increases, the costs and expenses
incurred in connection with producing the Company's products, as a percentage
of sales, will decrease. Due to volume and quality control related
considerations, the Company recently resumed performing a large portion of
its order fulfilment services in-house. The Company may, in the future
however, as volume or resources dictate, determine it to be in its best
interest to once again out-source these service. In addition, a change in
the Company's sales mix, as a percentage, to its lower priced retail
products, will result in these expenses, as a percentage of sales, to
increase. Therefore, these expenses may be expected to increase in future
periods, as a percentage of sales.
Selling, general and administrative expenses for the three months ended
November 30, 1997, were $1,115,225, a decrease of $809,329, or 42.5%, over
selling, general and administrative expenses of $1,924,554 for the three
months ended November 30, 1996. Selling, general and administrative expenses
for the nine months ended November 30, 1997, were $2,900,778, a decrease of
$2,225,475, or 43.4%, over selling, general and administrative expenses of
$5,126,253 for the nine months ended November 30, 1996. Such expenses
decreased primarily due to the Company's savings as a result of its
reorganization, a decrease in the provision for uncollectible accounts and a
decrease in the Company's trade-show activities as a result of the change in
the Company's sales approach. These decreases were offset by start-up and
marketing expenses associated with its new sales approach and new product
introductions, the addition of new sales and marketing executives, and its
continued efforts to expand its product offerings. The Company expects as
revenues increase, it will allocate additional resources to selling and
marketing activities. Thus these expenses may be expected to increase in
future periods; however, as a percentage of sales these expenses should
remain relatively constant. The Company did, during the quarter, provide an
addition of $250,000 to its reserve for uncollectible accounts, relating to
prior year's uncollected sales. The Company anticipates that, as a
continued part of its restructuring and as relating to these sales, it may
take a similar charge in the fourth quarter of this fiscal year.
Research and development costs charged to expense for the three months
ended November 30, 1997, were $28,183 versus $0 for the same period last
year. Research and development costs charged to expense for the nine months
ended November 30, 1997 were $82,162 versus $4,007,792 for the same period
last year, or a decrease of $3,925,630 or 97.9%. Research and development
costs for the nine months ended November 30, 1996 included approximately
$3,959,000 of research and development costs written off by the Company in
connection with certain acquisitions and the purchase of technology from
Xerox. In addition, as a result of the development activity on two of the
Company's new products (C:\MORE! and CPR), the Company capitalized research
and development costs of approximately $75,000 and $372,000 for the three and
nine months ended November 30, 1997, respectively, versus approximately
$170,000 and $330,000 for the three and nine months ended November 30, 1996,
respectively. The Company expects to continue to increase development staff
and expects to launch additional new products and upgrades in the fourth
quarter of fiscal 1998 and in future periods that will provide for ease of
security
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solutions for Internet and intranet applications on Microsoft and Novell
platforms. During the quarter, the Company entered into a software
development agreement with Millennium Computer Corporation ("Millennium"), a
software development division of CORESTAFF, whereby the Company will
out-source certain development activities to Millennium. The Company
believes that its relationship with Millennium could represent, to the
Company, a significant strategic advantage over other competitors in the
industry. The Company believes that this alliance will significantly
increase the speed and quality in which the Company is able to introduce new
products and upgrades to existing products to the marketplace and it will
enable the Company to stay on the cutting edge of technology.
Depreciation and amortization expense increased to $302,620 for the
three months ended November 30, 1997, from $257,915, or an increase of 17.3%
over the prior period. Depreciation and amortization expense increased to
$924,948 for the nine months ended November 30, 1997, from $598,420, or 54.6%
over the same period last year. The increases resulted from depreciation
and amortization of certain acquisitions and products in these periods that
were not present in the same period last year and the commencement of
amortization on certain capitalized research and development costs relating
to products that are available for sale.
Interest expense for the three and nine months ended November 30, 1997,
was $13,617 and $64,345, respectively, versus $113,420 and $292,329 for the
same periods last year. The decrease resulted from the Company having less
interest bearing indebtedness in place this fiscal year compared to last
fiscal year.
During the three months ended November 30, 1996, the Company had a
net gain on security transactions of $786,895 and a net loss of $451,280 for
the nine months ended November 30, 1996, versus no security transactions for
the three months ended November 30, 1997 and a net loss on security
transactions of $199,672 for the nine months then ended. The security loss
for the nine months ended November 30, 1997, related to the realization of
$355,772 of previously unrealized security losses, net of security gains of
$156,100. Both these transactions related to the settlement and liquidation
of the Miami Subs stock discussed in the Company's Form 10-KSB for the fiscal
year ended February 28, 1997.
As a result of the aforementioned, the Company for the three and nine
months ended November 30, 1997, reported a net loss of $1,196,246 and
$2,992,601, respectively, compared to a net profit of $111,895 for the three
months ended November 30, 1996 and a net loss of $5,846,133 for the nine
months ended November 30, 1996.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents at November 30, 1997 were
$160,500.
Cash flows from operations were a negative $1,779,366 for the nine
months ended November 30, 1997, compared to negative $4,990,232 for the nine
months ended November 30, 1996. The decrease was due principally to a
decrease in the net loss of the Company due to factors previously discussed
in this Report and an increase in the Company's accounts payable and accrued
expenses due to the Company's limited cash resources.
Cash used in investing activities was $351,481 for the nine months ended
November 30, 1997, compared to $1,713,114 for the same period last year.
This decrease resulted from a decrease in net securities and business
purchases and a decrease in capital expenditures, offset by an increase in
capitalized costs associated with the development of the Company's software
products.
Cash flows provided by financing activities were $2,276,247 for the nine
months ended November 30, 1997, compared to $6,824,934 for the nine months
ended November 30, 1996. This decrease was due primarily to less capital
being raised during this period compared to the same period last year and
less debt financing.
As a result of the aforementioned factors, cash and cash equivalents
increased by $145,400 for the six months ended November 30, 1997 versus an
increase of $121,588 for the same period last year.
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As previously discussed, the Company has completed a plan of
restructuring which has reduced the Company's overhead considerably. In
addition, the Company is continuing to work with various vendors and lenders
to restructure payables and debt that is currently owed. However, even if
the Company is successful with these endeavors, the Company does not believe
that the current funds available will be sufficient to fund the Company's
operations through the end of its current fiscal year. As a result, the
Company is seeking additional capital to fund its operations for fiscal year
1999, after which the Company believes its operations will be
self-sufficient. In October 1997, the Company received cash proceeds of
$750,000 and other valuable consideration from CORESTAFF in connection with
the sale of 2.5 million shares of the Company's common stock. The Company
also during the quarter completed a $500,000 Regulation D Series C preferred
stock offering. In addition, the Company has entered into arrangement with
Hoak Breedlove Wesneski & Co., a Dallas based investment banking firm, to
work with the Company. While the Company has been successful, in the past,
in raising capital when needed, no assurances can be made that the Company
will be successful in raising any such capital in the future; and that if
successful, such will not result in a dilution to existing shareholders.
PART II. OTHER INFORMATION
Except as listed below, all information required by Part II is omitted
because the items are inapplicable or the answer is negative.
ITEM 1. LEGAL PROCEEDINGS
A former employee of the Company's predecessor filed a lawsuit against
the Company and one of its officers and directors alleging that the Company
and/or the individual owe the plaintiff additional stock options and seeking
damages in excess of $2,600,000. The Company and the individual believe such
claims are without merit and intend to vigorously defend against the claim
and are considering filing counterclaims. The Company has filed an answer in
the case, styled HEREDIA V. CITADEL, ET AL., in the 298th Court of Dallas
County, Texas.
One current and one former employee of the Company have filed a lawsuit
against the Company demanding payment of a promissory note issued in
connection with the acquisition of Kent-Marsh and ADI and seeking damages in
excess of $400,000. The Company believes it has defenses to payment under
the note. The Company is currently involved in negotiations with respect to
the settlement of the case. In the event the settlement negotiations are
unsuccessful, the Company intends to vigorously defend against the lawsuit.
The Company has filed an answer in the case, styled NESBITT & WESOLEK V.
CITADEL, in the 193rd District Court of Dallas County, Texas. The Company
has reached a settlement with the former employee. The remaining suit seeks
damages in excess of $240,000.
The Company is involved in an arbitration proceeding with Vestcom, a
group that claims it is entitled to compensation and a finder's fee for
introducing the Company to a third party. The Company believes it has
defenses to such arbitration claim. The Company intends to vigorously defend
against the claim.
Five former employees of the Company filed a lawsuit against the Company
and one current and one former officer and director alleging that the Company
and/or the individuals owe the plaintiffs stock options in lieu of certain
amounts claimed to be due to them for salary, bonus or override compensation,
and seeking damages, attorney's fees, pre- and post-judgment interest, and
costs allegedly in excess of $4,000,000. The Company and the individuals
believe such claims are without merit and intend to vigorously defend against
the claims. The lawsuit was filed October 27, 1997 and is styled Marks,
Marks, Ranshaw, Colquitt & Lauratis v. Citadel Computer Systems, Inc., et
al., in the 189th Judicial District Court of Harris County, Texas.
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 2. CHANGES IN SECURITIES
The Company during the quarter, pursuant to Regulation D, issued 5,000
shares of convertible Series C preferred stock to Lakeshore International,
Ltd. McGinn, Smith & Co., Inc. served as the placement agent for the
issuance. These shares are convertible, at the option of the holder, after a
4 month lock-up period, into shares of common stock of the Company, at
conversion rates ranging from between 70% to 80% of the average market price
of the common stock for five days preceding conversion, depending on the date
of conversion. Each share of preferred stock has a conversion value of $100
and warrants for five years to purchase 10 shares of common stock, of the
Company, at a price of $1.00 per share. Dividends accrue at 8% and are
payable, at the option of the Company, in cash or common stock at the time of
conversion.
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ITEM 5. OTHER INFORMATION
On October 6, 1997, the Company entered into a definitive purchase
agreement with CORESTAFF whereby CORESTAFF purchased 2.5 million shares of
the Company's Common Stock for $750,000 and other valuable consideration with
warrants to purchase an additional 2 million shares (1 million at $4.00 per
share and 1 million at $5.00 per share). As part of the agreement, CORESTAFF
will provide development support for the Company, and each Company will
cross-sell each others products, with Citadel being the exclusive distributor
of CORESTAFF's "First Step" software program, a peer-to-peer system that
enables users to easily access multiple systems requiring different user
codes. CORESTAFF is one of the largest providers of information technology
and staffing services in the U.S. CORESTAFF's development division,
Millennium Computer Corporation, has in excess of 100 programmers and will
provide development support services to the Company, as needed.
In connection with the purchase by CORESTAFF, CORESTAFF appointed one
member to the Company's Board of Directors. Mr. Kenneth Johnsen, President of
the Information Technology Services Group of CORESTAFF and an Executive Vice
President of CORESTAFF, was elected to the Company's board in October 1997.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a). EXHIBITS
10.10 Purchase Agreement between Citadel and CORESTAFF, Inc.,
dated September 22, 1997 (incorporated by reference to
Exhibit 10.10 of the Company's Current Report on Form 10-KSB
for the year ended February 28, 1997).
(b) REPORTS ON FORM 8-K.
On October 6,1997, the Company filed a Form 8-K with respect
to the purchase by CORESTAFF, Inc. of 2.5 million shares of
the Company's common stock and related matters.
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 TECHNOLOGY, INC.
(REGISTRANT)
Date: May 20, 1998 By: /s/ Steven B. Solomon
-----------------------------------------------
Steven B. Solomon, President and Chief Executive Officer
(Duly Authorized Signatory and Principal Executive
Officer)
By: /s/ Richard L. Travis, Jr.
-----------------------------------------------
Richard L. Travis, Jr., Chief Operating and Financial
Officer
(Duly Authorized Signatory and Principal Financial
Officer)
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PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CITADEL COMPUTER SYSTEMS INCORPORATED
8
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CITADEL COMPUTER SYSTEMS INCORPORATED
CONSOLIDATED BALANCE SHEETS
<TABLE>
NOVEMBER 30, FEBRUARY 28,
ASSETS 1997 1997
----------- ------------
<S> <C> <C>
CURRENT ASSETS
Cash $ 160,500 $ 15,100
Accounts receivable, less allowance for returns and
doubtful accounts of $705,144 and $625,000 434,687 727,422
Notes receivable from related parties 398,922 870,000
Marketable securities available for sale - 1,250,000
Other 303,425 57,106
---------- -----------
Total current assets 1,297,534 2,919,628
ACCOUNTS RECEIVABLE - NONCURRENT, less
allowance for returns and doubtful accounts
of $1,875,000 - 1,875,000
PROPERTY AND EQUIPMENT, NET 413,572 696,459
PURCHASED SOFTWARE, NET OF ACCUMULATED
AMORTIZATION OF $1,569,809 AND $854,000 3,680,591 4,396,398
CAPITALIZED SOFTWARE DEVELOPMENT COSTS,
NET OF ACCUMULATED AMORTIZATION
OF $94,375 AND $19,000 870,675 573,388
OTHER ASSETS 267,508 263,220
---------- -----------
$6,529,880 $10,724,093
---------- -----------
---------- -----------
</TABLE>
The accompanying notes are an integral part of these statements.
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CITADEL COMPUTER SYSTEMS INCORPORATED
CONSOLIDATED BALANCE SHEETS - CONTINUED
<TABLE>
NOVEMBER 30, FEBRUARY 28,
LIABILITIES AND STOCKHOLDERS' EQUITY 1997 1997
------------ ------------
<S> <C> <C>
CURRENT LIABILITIES
Cash overdraft $ 82,110 $ 167,256
Current maturities of long-term debt 847,781 804,141
Notes payable 876,700 2,456,087
Accounts payable and accrued expenses 2,317,682 2,253,481
----------- -----------
Total current liabilities 4,124,273 5,680,965
LONG-TERM LIABILITIES
Debt, less current maturities 1,335,918 1,770,905
----------- -----------
Total liabilities 5,460,191 7,451,870
COMMITMENTS AND CONTINGENCIES - -
STOCKHOLDERS' EQUITY
Common stock, $.01 par value per share; authorized
30,000,000 shares; issued, 22,968,900 shares
at 11/30/97 and 16,501,980 shares at 2/28/97 229,689 165,020
Preferred stock, $.01 par value per share;
authorized 1,000,000 shares; issued and
outstanding, 545 shares and 5 shares of Series B
convertible at 2/28/97 and 11/30/97, respectively
(liquidation value of $545,000)
and 5,000 shares of Series C convertible at 11/30/97
(liquidation value of $500,000). 50 5
Equity notes 994,000 300,000
Additional paid-in capital 15,078,739 13,370,627
Accumulated deficit (12,846,668) (9,854,067)
Unrealized loss on securities available for sale - (355,772)
Treasury stock, at cost (4,164,613 shares at 11/30/97
and 264,613 shares at 2/28/97) (2,386,121) (353,590)
----------- -----------
Total stockholders' equity 1,069,689 3,272,223
----------- -----------
$ 6,529,880 $10,724,093
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of these statements.
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CITADEL COMPUTER SYSTEMS INCORPORATED
CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
THREE MONTHS ENDED NINE MONTHS ENDED
NOVEMBER 30, NOVEMBER 30,
1997 1996 1997 1996
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net sales $ 269,344 $ 1,501,270 $ 1,107,712 $ 4,390,208
Cost of sales 11,469 91,224 35,255 246,413
----------- ----------- ----------- -----------
Gross profit 257,875 1,410,046 1,072,457 4,143,795
Operating expenses
Selling, general and
administrative expenses 1,115,225 1,924,554 2,900,778 5,126,253
Depreciation and amortization 302,620 257,915 924,948 598,420
Research and development costs 28,183 - 82,162 4,007,792
----------- ----------- ----------- -----------
1,446,028 2,182,469 3,907,888 9,732,465
----------- ----------- ----------- -----------
Operating income (loss) (1,188,153) (772,423) (2,835,431) (5,588,670)
Other income (expense)
Interest expense (13,617) (113,420) (64,345) (292,329)
Other 5,524 210,843 106,847 468,146
Gain (loss) on marketable securities - 786,895 (199,672) (451,280)
----------- ----------- ----------- -----------
(8,093) 884,318 (157,170) (275,463)
----------- ----------- ----------- -----------
Net income (loss) $(1,196,246) $ 111,895 $(2,992,601) $(5,864,133)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Per share data
Net income (loss) per share $ (0.07) $ 0.01 $ (0.19) $ (0.46)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Weighted average shares outstanding 17,815,626 19,906,008 15,850,155 12,654,926
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these statements.
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CITADEL COMPUTER SYSTEMS INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
NINE MONTHS ENDED
NOVEMBER 30,
1997 1996
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(2,992,601) $(5,864,133)
Adjustments to reconcile net loss to net cash
used by operating activities
Depreciation and amortization 926,791 598,420
Net loss on marketable securities 199,672 451,519
Research and development expenses acquired
with stock - 3,959,069
Provision for uncollectible accounts 250,000 1,100,000
Changes in operating assets and liabilities
Accounts receivable (13,765) (2,749,385)
Other receivables (153,922) (1,169,295)
Other current assets (246,319) (105,852)
Bank overdraft (85,146) -
Accounts payable and accrued expenses 340,211 (914,119)
Other assets (4,287) 41,402
Other liabilities - (337,858)
------------ ------------
NET CASH USED BY OPERATING ACTIVITIES (1,779,366) (4,990,232)
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (134,919) (1,102,665)
Securities transactions - net 156,100 548,481
Purchase of business - (658,543)
Development of software (372,662) (330,073)
Purchase of treasury stock - (170,314)
------------ ------------
NET CASH USED BY INVESTING ACTIVITIES (351,481) (1,713,114)
CASH FLOW FROM FINANCING ACTIVITIES
Net change in notes payable 284,421 (1,767,509)
Proceeds from sale of stock & convertible notes 1,991,826 8,592,443
------------ ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 2,276,247 6,824,934
------------ ------------
Net increase (decrease) in cash 145,400 121,588
Cash at the beginning of the period 15,100 125,565
------------ ------------
Cash at the end of the period $ 160,500 $ 247,153
------------ ------------
------------ ------------
</TABLE>
The accompanying notes are an integral part of these statements.
12
<PAGE>
CITADEL COMPUTER SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - BASIS OF PRESENTATION
The financial information presented herein should be read in conjunction
with the financial statements and footnotes included in the Company's Annual
Report on Form 10-KSB for the period ended February 28, 1997. The balance sheet
as of February 28, 1997 has been derived from the audited financial statement at
that date.
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and have been presented on the basis that the Company is a going
concern, which contemplates the realization of assets and satisfaction of
liabilities in the normal course of business. See Note C to the Notes to
Financial Statements contained in the Company's Form 10-KSB for the year ended
February 28, 1997. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments considered
necessary for a fair presentation, consisting of those of a normal recurring
nature, are reflected in the accompanying financial statements.
NOTE B - STOCKHOLDERS' EQUITY
During the period from March 1, 1997 through November 30, 1997, the
Company's stockholders' equity reflected the following changes:
Balance at February 28, 1997 $ 3,272,223
Issuance of equity notes - net 700,000
Purchase of treasury stock (2,032,531)
Conversion of debt to equity 85,000
Expenses of offerings (141,575)
Net loss (861,119)
------------
Balance at May 31, 1997 1,021,998
Issuance of equity notes - net 295,000
Exercise of options 80,000
Conversion of debt to equity 45,000
Expenses of offering (24,999)
Realization of unrealized loss 355,772
Net loss (935,236)
------------
Balance at August 31, 1997 837,535
Exercise of options 143,400
Conversion of debt 75,000
Issuance of common stock 750,000
Issuance of preferred stock 500,000
Expenses of offering (40,000)
Net loss (1,196,246)
------------
Balance at November 30, 1997 $1,069,689
------------
------------
13
<PAGE>
CITADEL COMPUTER SYSTEMS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE C - COMMITMENTS AND CONTINGENCIES
A former employee of the Company's predecessor filed a lawsuit against
the Company and one of its officers and directors alleging that the Company
and/or the individual owe the plaintiff additional stock options and seeking
damages of $2,600,000. The Company believes such claims are without merit
and intends to vigorously defend against the claim.
One current and one former employee of the Company have filed a lawsuit
against the Company demanding payment of a promissory note issued in connection
with the acquisition of Kent-Marsh and ADI and seeking damages in excess of
$400,000. The Company believes it has defenses to payment under the note. The
Company is currently involved in negotiations with respect to the settlement of
the case. In the event the settlement negotiations are unsuccessful, the
Company intends to vigorously defend against the lawsuit. The Company has filed
an answer in the case, styled NESBITT & WESOLEK V. CITADEL, in the 193rd
District Court of Dallas County, Texas. The portion of the suit relating to the
former employee has been settled. The remaining suit seeks damages in excess of
$240,000.
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 case is currently scheduled for non-binding
arbitration.
The Company is also involved in various legal actions arising in the normal
course of business. Management is of the opinion that their outcome will not
have a material adverse effect on the Company's financial position or results of
operations.
NOTE D - PREFERRED STOCK
During the quarter the Company issued 5,000 shares of Series C preferred
stock. These shares are convertible, at the option of the holder, after a 4
month lock-up period, into shares of common stock at conversion rates ranging
between 70% to 80% of the average market price of the common stock for the five
days preceding conversion, depending on the date of conversion. Each share of
preferred stock has a conversion value of $100 and warrants for five years to
purchase ten (10) shares of common stock of the Company at a price of $1.00 per
share. Dividends accrue at 8% and are payable, at the Company's option, in cash
or common stock at the time of conversion.
NOTE E - SUBSEQUENT EVENTS
The Company recently engaged Hoak Breedlove Wesneski & Co., a Dallas based
investment banking firm, to work with the Company in procuring future
financing.
14
