<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 25, 1998.
REGISTRATION NO. 333-65089
===============================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------
FORM SB-2/A
REGISTRATION STATEMENT UNDER
THE SECURITIES ACT OF 1933
AMENDMENT NO. 1
---------------------------
CITADEL TECHNOLOGY, INC.
(Name of small business issuer in its charter)
<TABLE>
<CAPTION>
<S> <C> <C>
DELAWARE 7372 75-2432011
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification No.)
3811 TURTLE CREEK BOULEVARD STEVEN B. SOLOMON
SUITE 600 CHIEF EXECUTIVE OFFICER
DALLAS, TEXAS 75219-4421 3811 TURTLE CREEK BOULEVARD, SUITE 600
(214) 520-9292 DALLAS, TEXAS 75219-4421
(Address and telephone number of principal (214) 520-9292
executive offices) (Name, address and telephone number of agent for service)
</TABLE>
---------------------------
COPIES TO:
David A. Wood, Esq.
Wood, Exall & Bonnet, L.L.P.
12222 Merit Drive, Suite 880
Dallas, Texas 75251
(972) 991-8510
---------------------------
APPROXIMATE DATE OF PROPOSED SALE TO THE PUBLIC: AS SOON AS PRACTICABLE AFTER
THE EFFECTIVE DATE OF THIS REGISTRATION STATEMENT.
IF THIS FORM IS FILED TO REGISTER ADDITIONAL SECURITIES FOR AN OFFERING
PURSUANT TO RULE 462(b) UNDER THE SECURITIES ACT, PLEASE CHECK THE FOLLOWING
BOX AND LIST THE SECURITIES ACT REGISTRATION STATEMENT NUMBER OF THE EARLIER
EFFECTIVE REGISTRATION STATEMENT FOR THE SAME OFFERING. [ ]
IF THIS FORM IS A POST-EFFECTIVE AMENDMENT FILED PURSUANT TO RULE 462(c) UNDER
THE SECURITIES ACT, CHECK THE FOLLOWING BOX AND LIST THE SECURITIES ACT
REGISTRATION STATEMENT NUMBER OF THE EARLIER EFFECTIVE REGISTRATION STATEMENT
FOR THE SAME OFFERING. [ ]
IF ANY OF THE SECURITIES BEING REGISTERED ON THIS FORM ARE TO BE OFFERED ON A
DELAYED OR CONTINUOUS BASIS PURSUANT TO RULE 415 UNDER THE SECURITIES ACT OF
1933, OTHER THAN SECURITIES OFFERED ONLY IN CONNECTION WITH DIVIDEND OR
INTEREST REINVESTMENT PLANS, CHECK THE FOLLOWING BOX. [X]
IF DELIVERY OF THE PROSPECTUS IS EXPECTED TO BE MADE PURSUANT TO RULE 434,
PLEASE CHECK THE FOLLOWING BOX. [ ]
--------------------------
<TABLE>
<CAPTION>
CALCULATION OF REGISTRATION FEE
- -------------------------------------------------------------------------------------------------------------------------
PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AMOUNT TO OFFERING PRICE AGGREGATE AMOUNT OF
SECURITIES TO BE REGISTERED BE REGISTERED (1) PER SHARE (2) OFFERING PRICE (2) REGISTRATION FEE (2)
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock, $.01 par value 6,792,544 $ .75 $ 5,094,408 $ 1,873.90
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Includes 5,268,135 shares of Common Stock, par value $0.01 per share, of the
Registrant ("Common Stock"), issuable upon exercise of warrants and options held
by certain Selling Stockholders and 900,000 shares of Common Stock issuable upon
conversion of shares of preferred stock held by certain Selling Stockholders and
624,409 shares held by certain Selling Stockholders.
(2) Estimated solely for purposes of calculating the registration fee. The
additional $177.68 of the registration fee is calculated in accordance with Rule
457(a)and(c), based upon the average of the bid and asked prices of the
Registrant's Common Stock reported by the OTC Bulletin Board on November 19,
1998 with respect to the additional 803,060 shares being registered pursuant to
this amendment. The Registrant paid on September 30, 1998 the amount of
$1,696.22 based on the then current number of shares (5,989,484) and market
price ($.96).
-------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THIS REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(a), MAY DETERMINE.
===============================================================================
<PAGE> 2
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
SUBJECT TO COMPLETION, DATED NOVEMBER 25, 1998
PROSPECTUS
CITADEL TECHNOLOGY, INC.
RESALE OF 6,792,544 SHARES OF COMMON STOCK
This Prospectus relates to the offer and sale (the "Offering") from time to
time by certain persons or entities (the "Selling Stockholders") of up to
6,792,544 shares (the "Shares") of common stock, $0.01 par value per share (the
"Common Stock"), of Citadel Technology, Inc., a Delaware corporation (the
"Company"). The Company is not offering any shares of Common Stock under this
Prospectus and will not receive any of the proceeds from the resale of the
Shares by the Selling Stockholders. This Prospectus relates to the following
securities: (i) 5,168,135 Shares issuable upon exercise of outstanding warrants
and options held by certain Selling Stockholders (the "Warrants" and the
"Options" respectively); (ii) 900,000 Shares issuable upon conversion of shares
of convertible preferred stock of the Company held by certain Selling
Stockholders (the "Preferred Stock") and (iii) 724,409 Shares of Common Stock
held by certain Selling Stockholders. The Warrants, Options and Preferred Stock
are sometimes collectively referred to in this Prospectus as the "Convertible
Securities." See "Description of Securities." The Company would receive
estimated net proceeds of approximately $3,178,381 if all of the Warrants and
Options are exercised by the holders thereof. See "Use of Proceeds."
The Selling Stockholders may offer and sell the Shares from time to time in
transactions in the over-the-counter market, in negotiated transactions, or by a
combination of these methods, at the then prevailing market prices or prices
related to such market prices. The Selling Stockholders may effect these
transactions by selling the Shares to or through broker-dealers, who may receive
compensation in the form of discounts or commissions from the Selling
Stockholders or from the purchasers of the Shares for whom the broker-dealers
may act as agent or to whom they may sell as principal, or both. See "Plan of
Distribution." The Selling Stockholders also may sell such Shares from time to
time pursuant to Rule 144 under the Securities Act of 1933, as amended (the
"Securities Act").
No offered shares of Common Stock may be sold by the Selling Stockholders
without the availability of a current Prospectus or Prospectus Supplement. To
the extent required, the number of securities to be sold, the respective
purchase price and public offering price, the name of any agent, dealer or
underwriter and any applicable commissions or discounts with respect to a
particular offer will be set forth in and accompanied by a Prospectus
Supplement. See "Plan of Distribution."
The Common Stock is quoted on the Over-The-Counter Bulletin Board System
under the symbol "CITN." On November 19, 1998, the closing bid and asked price
of the Common Stock on the OTC Bulletin Board were $.74 and $.76 per share,
respectively.
THE SECURITIES OFFERED HEREBY ARE SPECULATIVE AND INVOLVE A HIGH DEGREE OF
RISK AND SUBSTANTIAL DILUTION AND SHOULD BE CONSIDERED ONLY BY INVESTORS WHO CAN
AFFORD THE LOSS OF THEIR ENTIRE INVESTMENT. SEE "RISK FACTORS" COMMENCING ON
PAGE 9 OF THIS PROSPECTUS.
<PAGE> 3
The Company will bear all of the expenses (other than selling commissions
and fees and expenses of counsel or other advisors to the Selling Stockholders)
in connection with the registration and sale of the Shares. The Company has also
agreed to indemnify certain of the Selling Stockholders against certain
liabilities, including liabilities under the Securities Act. The total expenses
to be paid by the Company in connection with the Offering are estimated to be
$65,000. See "Selling Stockholders" and "Plan of Distribution."
Any agents, dealers or underwriters that participate with the Selling
Stockholders in the distribution of the shares of Common Stock may be deemed to
be "underwriters" within the meaning of the Securities Act, and any commissions
received by them and any profits on the resale of the Selling Stockholders'
shares, may be deemed to be underwriting commissions or discounts under the
Securities Act. Under applicable rules and regulations promulgated under the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), including
without limitation Regulation M, any person engaged in a distribution of
securities may not simultaneously engage in market-making activities with
respect to such securities for a period beginning on the later of five business
days, or such other period as may be required by Regulation M, prior to the
determination of the offering price or such time that a person becomes engaged
in the distribution and ending when the distribution is completed (for a selling
security holder) or when any other person's participation has been distributed.
In addition to, and without limiting the foregoing, each of the Selling
Stockholders and any other person participating in a distribution will be
subject to the applicable provisions of the Exchange Act and the rules and
regulations thereunder, including, without limitation, Regulation M, which
provisions may limit the timing of purchases and sales of any of the Securities
by each of the Selling Stockholders or any such other person. All of the
foregoing may affect the marketability of the securities.
THE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
The date of this Prospectus is November 25, 1998
<PAGE> 4
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements made in this Prospectus that are not historical are
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995, Section 27A of the Securities Act and Section 21E
of the Exchange Act. The words "estimate," "project," "intend," "expect,"
"believe," and similar expressions are intended to identify forward-looking
statements, and all statements other than statements of historical facts
included in this Prospectus, including without limitation, statements under
"Risk Factors," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business" regarding the Company's financial
position, business strategy and plans and objectives of management of the
Company for future operations, are forward-looking statements, which may involve
known and unknown risks and uncertainties. Although the Company believes the
expectations reflected in the forward-looking statements are reasonable, it can
give no assurance that such expectations will prove to have been correct.
Certain important factors that could cause actual results, performances, or
achievements to differ materially from the Company's expectations include those
disclosed under "Risk Factors" and elsewhere in this Prospectus and in the
Company's reports filed from time to time with the Securities and Exchange
Commission (the "Commission"). All subsequent written and oral forward-looking
statements attributable to the Company or persons acting on its behalf are
expressly qualified in their entirety by such disclosures.
AVAILABLE INFORMATION
The Company has filed a registration statement on Form SB-2 (together with
any and all amendments and supplements, the "Registration Statement") with the
Commission under the Securities Act with respect to the offer, sale and issuance
of the Common Stock. This Prospectus does not contain all of the information set
forth in the Registration Statement and exhibits thereto, certain portions of
which have been omitted as permitted by the rules and regulations of the
Commission. The statements contained in this Prospectus as to the contents of
any contract or other document identified as exhibits in this Prospectus are not
necessarily complete, and in each instance, reference is made to a copy of such
contract or document filed as an exhibit to the Registration Statement, each
statement being qualified in any and all respects by such reference. For further
information regarding the Company and the Common Stock, reference is made to the
Registration Statement, including the exhibits and schedules thereto, which may
be inspected without charge at the principal office of the Commission located at
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549.
The Company is subject to the informational reporting requirements of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), and, in
accordance therewith, files reports, proxy statements and other information with
the Commission. Such reports, proxy statements and other information filed by
the Company may be inspected and copied at the public reference facilities of
the Commission located at Judiciary Plaza, 450 Fifth Street, N.W., Washington,
D.C. 20549, at the New York Regional Office of the Commission, 7 World Trade
Center, Suite 1300, New York, New York 10048, and at the Chicago Regional Office
of the Commission, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661.
Copies of such material can also be obtained at prescribed rates from the Public
Reference Section of the Commission at 450 Fifth Street, N.W., Washington, D.C.
20549. Such materials may also be accessed electronically on the Internet at
http://www.sec.gov.
The Company will provide without charge to each person who receives a
Prospectus or Prospectus Supplement, upon written or oral request of such
person, a copy of any information that is incorporated by reference in the
Prospectus (not including exhibits to the information that is incorporated by
reference unless the exhibits are themselves specifically incorporated by
reference). Such requests may be directed to Stockholder Relations, Citadel
Technology, Inc., 3811 Turtle Creek Boulevard, Suite 600, Dallas, Texas 75219,
telephone (214) 520-9292.
2
<PAGE> 5
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by, and must be read in
conjunction with, the more detailed information, including "Risk Factors," and
financial statements and related notes thereto, appearing elsewhere in this
Prospectus. Each prospective investor is urged to read this Prospectus and any
Prospectus Supplement in its entirety. Except as otherwise noted, all
information in this Prospectus reflects the one-for-two reverse stock split of
the Common Stock effected on May 6, 1996. See "Description of Capital Stock."
THE COMPANY
Citadel Technology, Inc. ("Citadel" or the "Company") develops and markets
security and administration software products for both computer networks and
desktop personal computers ("PCs"). Citadel's products are designed to reduce
the direct and indirect costs of computer network and desktop operations,
protect proprietary networks and information, and otherwise improve overall
office and personal productivity. Our integrated, user-friendly network products
enable network administrators to control access to network resources, automate
routine network maintenance tasks, and automatically shutdown and restart
servers and desktop PCs in the event of a network crash. Our desktop products
enable individual PC users to control access to their desktops, secure files,
and index and retrieve files stored in a variety of storage media.
Citadel's network products are designed to reduce clients' costs, improve
the accuracy of clients' information, maintain the operation of networks, secure
networks 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. Our network software products operate on operating
systems designed by Novell, Microsoft, IBM and Apple. Citadel focuses 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.
Citadel's primary software products include Crash Protection and Recovery
(CPR), NetOFF, WinShield, FolderBolt, C:\MORE!, Server Sentry, Phantom of the
Console, and Server Cam. See "Citadel Products".
The Company's strategy is to develop long-term client relationships and to
maintain a high level of client satisfaction, which the Company believes will
result in additional recurring revenues from new products and upgrades on
existing software products. The Company has focused its development efforts on
the client-server LAN and PC 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. The Company believes its products are
positioned to capitalize on this trend.
The Company's fundamental objective is to become a leading supplier of
security and administration software products for computer networks and PCs. The
Company seeks to achieve this objective through the following strategies:
o Expand Software Product Portfolio. The Company's existing product line
addresses a wide range of the security and administration needs of computer
network administrators and PC users. The Company believes a central element
of its future success will be the development of new products and
enhancements for its existing products that provide additional capabilities
and features and differentiate the Company's product line from the product
lines of competitors and potential competitors.
3
<PAGE> 6
o Continue to Expand Sales and Marketing. The Company is continuing to
implement the restructuring of its marketing and sales effort, moving from
telemarketing to distribution through the field sales, retail, distributor,
VAR, and OEM channels.
o Enter into Additional Strategic Relationships. The Company has successfully
developed strategic alliances or partnerships with other technology
companies in the past. In addition to the strategic alliance with Metamor
Worldwide, Inc. ("Metamor"), the Company has developed a close working
relationship with Iomega Corporation, which has included the Company's
C:\More! product in its Iomega-ready software program and assisted the
Company in promoting the product. The Company also works closely with
representatives of Novell, Inc. and Microsoft Corporation in the
development of its products. The Company intends to further leverage its
technology and products by entering into strategic relationships with other
technology companies, including other complementary software and hardware
providers (such as PC OEMs, server manufacturers, and removable media
storage vendors).
o Maintain Technological Leadership. The Company believes that its computer
security and administration products are more advanced than those of its
competitors. It intends to maintain its technological lead by continuing to
dedicate significant resources to its research and development efforts.
o Pursue Acquisition Opportunities. In addition to the Company's internal
product development efforts, the Company has obtained products and
technology through acquisitions. Such acquisitions can be less expensive
and more time efficient than internal development. The Company believes
that additional opportunities may arise in the future to expand its product
lines or technology base by acquiring businesses, products and technologies
that complement those of the Company although there can be no assurances in
this regard.
The Company was formerly known as Citadel Computer Systems Incorporated and
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 Prospectus to "Citadel" or the "Company" shall
include Citadel and Old Citadel unless the context requires otherwise.
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.
4
<PAGE> 7
THE OFFERING
Securities Offered 6,792,544 Shares of Common Stock, comprised
of 5,168,135 Shares issuable upon exercise by
certain Selling Stockholders of warrants and
options to purchase shares of Common Stock
issued in connection with private placements
by the Company, 900,000 Shares issuable upon
conversion of preferred stock and 724,409
Shares of Common Stock held by certain
Selling Stockholders.
Selling Stockholders The Shares offered hereby may be offered and
sold by certain Selling Stockholders, each of
whom received or will receive Shares either
in, or in connection with, private placements
by the Company. See "Selling Stockholders."
Common Stock to be Outstanding
After this Offering (1) 37,548,357 shares of Common Stock.
Use of Proceeds The Company will not receive any of the
proceeds from the sale of the Shares pursuant
to this Prospectus. The Company would receive
estimated net proceeds of up to $3,178,381
(after deducting estimated expenses of
$65,000) if the Selling Stockholders exercise
all of the Warrants and Options. The Company
currently intends to use such net proceeds,
if any, for working capital and general
corporate purposes. See "Use of Proceeds."
Risk Factors An investment in the Shares offered
hereby involves a high degree of risk and
should be made only by investors who can
afford the loss of their entire investment.
See "Risk Factors."
Trading symbol CITN
(1) Assumes conversion in full into Shares of Common Stock of the Warrants and
Preferred Stock held by the Selling Stockholders as described in "Selling
Stockholders."
5
<PAGE> 8
SUMMARY SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data set forth below have been derived
from and should be read in conjunction with the Company's more detailed
financial statements and the related notes thereto included elsewhere herein.
The financial statements for the years ended February 28, 1997 and 1998 have
been audited by Grant Thornton, LLP, independent accountants. The financial
statements for the six months ended August 31, 1997 and 1998 are unaudited. In
the opinion of management, such statements include all adjustments (consisting
only of normal recurring adjustments) necessary for a fair presentation of the
information set forth therein. The results of operations for the six months
ended August 31, 1998 are not necessarily indicative of results that may be
expected for the year ending February 28, 1999.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
AUGUST 31,
YEAR ENDED FEBRUARY 28, (UNAUDITED)
----------------------------- -----------------------------
STATEMENT OF OPERATIONS DATA: 1997 1998 1997 1998
- ----------------------------- ----------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
Net Sales $ 5,326,192 $ 1,613,326 $ 838,368 $ 2,111,513
Gross Profit 5,021,756 1,534,897 814,582 1,980,270
Selling, general and administrative
expenses 5,939,099 3,056,408 1,621,795 2,196,789
Provision for uncollectible
receivables 1,984,113 368,897 0 15,000
Research and development expense 3,336,253 161,010 217,737 251,333
Operating loss before
depreciation and amortization (6,237,709) (2,051,418) (1,024,950) (482,852)
Depreciation and amortization 942,166 1,270,708 622,328 723,917
Operating loss (7,179,875) (3,322,126) (1,647,278) (1,206,769)
Net loss before extraordinary item $(7,515,607) $(3,522,710) $(1,796,355) (1,281,254)
Net loss $(7,515,607) $(3,522,710) $(1,796,355) $ (548,186)
Net loss before extraordinary item
per share (1) $ (.56) $ (.21) $ (.12) $ (.05)
Net loss per share (1) $ (.56) $ (.21) $ (.12) $ (.02)
Number of shares used in computing
per share amount (1) 13,721,032 16,801,818 14,424,452 24,123,254
</TABLE>
<TABLE>
<CAPTION>
AUGUST 31, 1998
(UNAUDITED)
-------------------------------
FEBRUARY 28, FEBRUARY 28,
BALANCE SHEET DATA 1997 1998 ACTUAL AS ADJUSTED(2)
- ------------------ ------------ ------------ ----------- --------------
<S> <C> <C> <C> <C>
Cash and cash equivalents $ 15,100 $ 8,555 $ 1,930,876 $ 5,109,257
Total assets 10,724,093 6,163,034 9,859,086 13,037,467
Stockholders' equity 3,272,223 1,287,861 7,834,081 11,237,462
</TABLE>
(1) Excludes 6,522,544 shares of Common Stock which may be issued and sold by
the Company upon the exercise in full of the Warrants, Options and Preferred
Stock.
(2) Adjusted from actual to reflect the sale of shares of Common Stock offered
by the Selling Stockholders and the exercise of the Warrants, Options and
Preferred Stock by the Selling Stockholders and the payment of the exercise
price of the Warrants and Options to the Company and the application of the
net proceeds therefrom. See "Use of Proceeds."
6
<PAGE> 9
RISK FACTORS
In addition to the other information in this Prospectus, the following risk
factors should be carefully considered in evaluating the Company and its
business before purchasing shares of the Common Stock offered hereby. THIS
OFFERING INVOLVES SUBSTANTIAL INVESTMENT RISK AND SHARES SHOULD BE PURCHASED
ONLY BY INVESTORS WHO CAN AFFORD THE LOSS OF THEIR ENTIRE INVESTMENT. IN
EVALUATING AN INVESTMENT IN THE COMPANY AND ITS BUSINESS, PROSPECTIVE INVESTORS
SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS AS WELL AS OTHER
INFORMATION SET FORTH ELSEWHERE IN THIS PROSPECTUS.
As described under "Disclosure Regarding Forward-Looking Statements,"
certain statements made in this Prospectus are forward-looking within the
meaning of the Private Securities Litigation Reform Act of 1995. This Prospectus
contains forward-looking statements that involve known and unknown risks and
uncertainties. The Company's actual results of operations could differ
materially from those anticipated in these forward-looking statements as a
result of certain factors, including those set forth in the following Risk
Factors and elsewhere in this Prospectus.
Fluctuations in Quarterly Operating Results; Future Operating Results Uncertain.
The Company's quarterly operating results have in the past varied and may in the
future vary significantly depending on a number of factors, including the size
and timing of significant orders; increased competition; market acceptance of
new products, applications and product enhancements; changes in pricing policies
by the Company and its competitors; the ability of the Company to timely
develop, introduce and market new products, applications and product
enhancements and to control costs; the Company's success in expanding its sales
and marketing programs; technological changes in the LAN security and
administration market; the mix of sales among the Company's channels; deferrals
of customer orders in anticipation of new products, applications or product
enhancements; changes in Company strategy; personnel changes; and general
economic factors.
The Company's future revenues are difficult to predict. The Company
operates with virtually no order backlog because its software products typically
are shipped shortly after orders are received. As a result, product revenues in
any quarter are substantially dependent on orders booked and shipped. Revenues
for any future quarter are not predictable with any significant degree of
certainty. Product and software maintenance revenues are also difficult to
forecast because the LAN security and administration market is rapidly evolving
and the Company's sales cycle varies substantially from customer to customer.
Royalty and license revenues are substantially dependent upon sales by OEMs of
their products that incorporate the Company's software. Accordingly, royalty and
license revenues are subject to OEMs' product cycles, which are also difficult
to predict. Royalty and license revenues are further impacted by fluctuations in
licensing activity from quarter-to-quarter, because initial license fees
generally are non-recurring and recognized upon the signing of the license
agreement. The Company's expense levels are based, in part, on its expectations
as to future revenues. If revenue levels are below expectations, operating
results are likely to be adversely affected. Net income may be
disproportionately affected by a reduction in revenues because a proportionately
smaller amount of the Company's expenses varies with its revenues. As a result,
the Company believes that period-to-period comparisons of its results of
operations are not necessarily meaningful and should not be relied upon as
indications of future performance. Due to all of the foregoing factors, it is
possible that in future quarters, the Company's operating results may be below
the expectations of public market analysts and investors. In such event, the
price of the Company's common stock would likely be materially adversely
affected.
Need for Additional Financing. The Company currently funds its operations and
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 available funds prove to be
insufficient to fund the Company's presently anticipated operations, the Company
will be required to seek additional financing. There can be no assurance that,
if additional financing is required, it will be available on acceptable terms,
or at all. Nor can any assurances be given that current investors would be
willing to fund any additional operational requirements of the Company in the
future. Additional financing may involve substantial dilution to the interests
of the Company's then-current shareholders.
Competition. The network security and administration market is intensely
competitive, highly fragmented and characterized by rapidly changing technology
and evolving standards. Competitors vary in size and in the scope and breadth
of the products and services offered. The Company's major
7
<PAGE> 10
competitors on the Novell NetWare and Windows NT platforms include Computer
Associates, McAfee, Symantec and others, all of which have greater financial
resources than the Company. The Company also expects increased competition from
systems and network management companies, especially those that have
historically focused on the mainframe market and are broadening their focus to
include the client/server market. In addition, because there are relatively low
barriers to entry in the software market, the Company expects additional
competition from other established and emerging companies. Increased
competition is likely to result in price reductions, reduced gross margins and
loss of market share, any of which could adversely affect the Company's
business, operating results and financial condition.
Many of the Company's current and potential competitors have significantly
greater financial, technical, marketing and other resources than the Company. As
a result, they may be able to respond more quickly to new or emerging
technologies and changes in customer requirements, or to devote greater
resources to the development, promotion, sale and support of their products than
the Company. In addition, current and potential competitors have established or
may establish cooperative relationships among themselves or with third parties.
Accordingly, it is possible that new competitors or alliances among competitors
may emerge and rapidly acquire significant market share. In addition, network
operating system vendors could introduce new or upgrade existing operating
systems or environments that include security, administration and storage
management functionality offered by the Company's products, which could render
the Company's products obsolete and unmarketable. There can be no assurance that
the Company will be able to compete successfully against current or future
competitors or that competitive pressures faced by the Company will not
materially adversely affect its business, operating results and financial
condition.
Dependence on New Software Products; Rapid Technological Change. The security
and administration software market is characterized by rapid technological
change, changing customer needs, frequent new software product introductions
and evolving industry standards. The introduction of products embodying new
technologies and the emergence of new industry standards could render the
Company's existing products obsolete and unmarketable. The Company's future
success will depend upon its ability to develop and introduce new software
products (including new releases, applications and enhancements) on a timely
basis that keep pace with technological developments and emerging industry
standards and address the increasingly sophisticated needs of its customers.
There can be no assurance that the Company will be successful in developing and
marketing new products that respond to technological changes or evolving
industry standards, that the Company will not experience difficulties that
could delay or prevent the successful development, introduction and marketing
of these new products, or that its new products will adequately meet the
requirements of the marketplace and achieve market acceptance. If the Company
is unable, for technological or other reasons, to develop and introduce new
products in a timely manner in response to changing market conditions or
customer requirements, the Company's business, operating results and financial
condition will be adversely affected. The Company currently has plans to
introduce and market several potential new products and upgrades in the next
twelve months. Due to the complexity of software products and the difficulty in
gauging the engineering effort required to produce these potential new products
and upgrades, such potential new products and upgrades are subject to
significant technical risks. There can be no assurance that such potential new
products and upgrades will be introduced on a timely basis or at all. In the
past, the Company has experienced delays in the commencement of commercial
shipments of its new products and upgrades, resulting in the loss of customers
and delay or loss of product revenues. If potential new products and upgrades
are delayed or do not achieve market acceptance, the Company's business,
operating results and financial condition will be adversely affected.
Software products as complex as those offered by the Company may contain
undetected errors or failures when first introduced or as new versions are
released. The Company has in the past discovered software errors in certain of
its new products after their introduction and has experienced delays or lost
revenues during the period required to correct these errors. Although the
Company has not experienced
8
<PAGE> 11
material adverse effects resulting from any such errors to date, there can be
no assurance that, despite testing by the Company and by current and potential
customers, errors will not be found in new products after commencement of
commercial shipments, resulting in loss of or delay in market acceptance, which
could have a material adverse effect upon the Company's business, operating
results and financial condition.
Reliance on Microsoft and Novell Technology. The Company's software products
are designed for Microsoft technologies, including Windows NT and Windows 95/98,
and Novell Netware. Although the Company believes that Microsoft and Novell
technologies are and will be widely utilized by businesses in the corporate
market, no assurances can be given that these businesses will actually adopt
such technologies as anticipated or will not in the future migrate to other
computing technologies that the Company does not support. Moreover, the
Company's strategy will require that the Company's products and technology be
compatible with new developments in Microsoft and Novell technologies, and
there can be no assurances that the Company will be able to develop compatible
products.
Risk Associated With Strategy of Expanding Reseller and OEM Channels.
Historically, the Company used primarily a direct sales model, complemented
with a telesales force, for the sale of its software products. In fiscal 1998,
the Company began to expand its distribution efforts to include third party
resellers in both the United States and internationally. To increase the
Company's growth will require the Company to expand its direct sales force and
add distributors, system integrators and value added resellers (collectively,
"resellers") to market, sell, and support the Company's software products. The
Company will be increasingly dependent upon resellers for domestic and
international sales. The Company has only limited experience in marketing its
products through resellers. The expansion of the Company's distribution network
and its direct sales force will require the expenditure of substantial
resources. There can be no assurance that the Company will be able to expand
its distribution channels successfully.
Even if the Company is successful in its expansion into the distribution
channel, the Company's agreements with resellers will generally not be exclusive
and in many cases may be terminated by either party without cause. Many of the
Company's resellers will carry product lines that are competitive with those of
the Company. Therefore, there can be no assurance that these resellers will give
a high priority to the marketing of the Company's products and they may, in
fact, give a higher priority to other products, including the products of
competitors. Events or occurrences of this nature could have a material adverse
effect on the Company's business, operating results and financial condition. The
Company's results of operations could also be adversely affected by changes in
reseller inventory strategies, which could occur rapidly, and in many cases, may
not be related to end user demand. There can be no assurance that the Company
will be successful in retaining resellers or if even retained such resellers
will be successful in selling and marketing the Company's products.
In addition to the above, an integral part of the Company's sales strategy
is to increase the proportion of the Company's customers licensed through OEMs.
As with resellers, the Company has limited experience in dealing with OEMs. The
Company is investing and plans to continue to invest significant resources to
develop this channel, which could materially affect the Company's operating
performance. There can be no assurances that the Company will be successful in
its efforts to increase the revenues generated by this channel.
Management of Expanding Operations. In the event the Company experiences a
period of significant expansion of its operations such expansion could put a
significant strain upon the Company's management systems and resources. In
addition, such expansion will require the Company to hire a significant number
of employees. The Company may also need to expand the geographic scope of its
customer base and operations. This expansion could result in substantial
demands on the Company's management resources. The Company's ability to compete
effectively and to manage future expansion of
9
<PAGE> 12
its operations, if any, will require the Company to continue to improve its
financial and management controls, reporting systems and procedures on a timely
basis and expand, train and manage its employee work force. There can be no
assurance that the Company will be able to do any of these successfully. The
Company's failure to do so could have a material adverse effect upon the
Company's business, operating results and financial condition.
Dependence Upon Key Personnel. The Company's future performance also depends in
significant part upon the continued service of its key technical and senior
executive and sales management personnel, only some of whom are covered by
employment contracts. The loss of the services of one or more of the Company's
officers or other key employees could have a material adverse effect on the
Company's business, operating results and financial condition. The Company's
future success also depends on its continuing ability to attract and retain
highly qualified technical and managerial personnel. Competition for such
personnel is intense, and there can be no assurance that the Company can retain
its key technical and managerial employees or that it can attract, assimilate
or retain other highly qualified technical and managerial personnel in the
future.
Dependence on Growth in the Network Security, Administration and Storage
Management Market; General Economic and Market Conditions. Substantially all of
the Company's operating business is in the network and desktop security and
administration software market, which is still an emerging market. The Company's
future financial performance will depend in large part on continued growth in
the number of organizations adopting security and administration solutions for
their client/server and desktop environments. There can be no assurance that the
market for network and desktop security and administration will continue to
grow. If the security and administration software market fails to grow or grows
more slowly than the Company currently anticipates, the Company's business,
operating results and financial condition would be adversely affected. During
recent years, segments of the computer industry have experienced significant
economic downturns characterized by decreased product demand, production
overcapacity, price erosion, work slowdowns and layoffs. The Company's
operations may in the future experience substantial fluctuations from period to
period as a consequence of such industry patterns, general economic conditions
affecting the timing of orders from major customers, and other factors affecting
capital spending. There can be no assurance that such factors will not have a
material adverse effect on the Company's business, operating results or
financial condition.
Dependence on Proprietary Technology; Risks of Infringement. The Company depends
significantly upon proprietary technology. The Company relies on trade secrecy
laws, confidentiality agreements and contractual provisions to protect its
proprietary technology. The Company seeks to protect its software, documentation
and other written materials under trade secret and copyright laws, which afford
only limited protection. 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. Despite the Company's efforts to protect its
proprietary rights, unauthorized parties may attempt to copy aspects of the
Company's products or to obtain and use information that the Company regards as
proprietary. Policing unauthorized use of the Company's products is difficult,
and although the Company is unable to determine the extent to which piracy of
its software products exists, software piracy can be expected to be a persistent
problem. In selling its products, the Company relies primarily on "shrink wrap"
licenses that are not signed by licensees, and, therefore, such licenses may be
unenforceable under the laws of certain jurisdictions. In addition, the laws of
some foreign countries do not protect the Company's proprietary rights to as
great an extent as do the laws of the United States. There can be no assurance
that the Company's means of protecting its proprietary rights will be adequate
or that the Company's competitors will not independently develop similar
technology, 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 thereof.
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<PAGE> 13
There has also been a substantial amount of litigation in the software
industry regarding intellectual property rights. There can also 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 current or
future products, trademarks or other proprietary rights. The Company expects
that software product developers will increasingly be subject to infringement
claims as the number of products and competitors in the Company's industry
segment grows and the functionality of products in different industry segments
overlaps. Any such claims, whether initiated by the Company or others and
whether they are with or without merit, could be time-consuming, result in
costly litigation, cause product shipment delays or require the Company to enter
into royalty or licensing agreements. Such royalty or licensing agreements, if
required, may not be available on terms acceptable to the Company or at all,
which could have a material adverse effect upon the Company's business,
operating results and financial condition.
Product Liability. The Company's license agreements with its customers
typically contain provisions designed to limit the Company's exposure to
potential product liability claims. In selling its products, the Company relies
primarily on "shrink wrap" licenses that are not signed by licensees, and,
therefore, such licenses may be unenforceable under the laws of certain
jurisdictions. As a result of these and other factors, the limitation of
liability provisions contained in the Company's license agreements may not
always be effective. The Company's products can be used to secure and
administer critical operating systems within an organization, and, as a result,
the sale and support of products by the Company may entail the risk of product
liability claims. A successful product liability claim brought against the
Company could have a material adverse effect upon the Company's business,
operating results and financial condition.
Year 2000 Compliance. Many currently installed computer systems and software
products are coded to accept only two digit entries in the date code field.
These date code fields will need to accept four digit entries to distinguish
21st century dates from 20th century dates. As a result, in the near future,
computer systems and/or software used by many companies will need to be upgraded
to comply with such "Year 2000" or "Y2K" requirements. Systems that do not
properly recognize such information could generate erroneous data or cause a
system to fail. Significant uncertainty exists in the software industry
concerning the potential effects associated with such compliance. Management
does not anticipate that the Company will incur significant operating expenses
or be required to invest heavily in computer systems improvements to be Year
2000 compliant. Although the Company believes its software products are Year
2000 compliant, there can be no assurance that the Company's software products
contain all the necessary software routines and programs for the accurate
calculation, display, storage and manipulation of data involving dates. The
Company believes that the purchasing patterns of customers and potential
customers may be affected by Year 2000 issues as companies expend significant
resources to correct or patch their current software systems for Year 2000
compliance. These expenditures may result in reduced funds available to purchase
products such as those offered by the Company. The occurrence of any of the
foregoing could have a material adverse effect on the Company's business,
operating results or financial condition.
Although the Company believes the software and hardware it uses internally
comply with Year 2000 requirements and is not aware of any material operational
issues or costs associated with preparing its internally used software and
hardware for the Year 2000, there can be no assurances that the Company will not
experience serious, unanticipated negative consequences and/or material costs
caused by undetected errors or defects in the technology used in its internal
systems. The occurrence of any of the foregoing could have a material adverse
effect on the Company's business, operating results or financial condition.
Possible Volatility of Stock Price. The trading price of the Company's common
stock has been subject to wide fluctuations throughout its history. The trading
price of the Company's common stock could be
11
<PAGE> 14
subject to wide fluctuations in the future in response to quarterly variations
in operating results, announcements of technological innovations or new
products, applications or product enhancements by the Company or its
competitors, changes in financial estimates by securities analysts and other
events or factors. In addition, the stock market has experienced volatility
that has particularly affected the market prices of equity securities of many
high technology companies and that often has been unrelated to the operating
performance of such companies. These broad market fluctuations may adversely
affect the market price of the Company's common stock.
Legal Proceedings. The Company is involved in certain legal proceedings as
described in "Legal Proceedings." While the Company intends to defend such
lawsuits, adverse decisions or settlements, and the costs of defending such
suits, could have a material adverse effect on the Company.
Impact of Acquisitions; Possible Acquisitions. A significant percentage of the
Company's revenues has been attributable to acquisitions. There can be no
assurance that the Company will be able to integrate successfully the companies
and technologies that it has acquired or may acquire in the future. The Company
has pursued in the past, and may continue to pursue in the future, strategic
acquisitions as part of its business strategy. While the Company has no
understandings, commitments or agreements with respect to any acquisition,
acquisition opportunities may become available in the future. Acquisitions would
require investment of operational and financial resources and could require
integration of dissimilar operations, assimilation of new employees, diversion
of management resources, increases in administrative costs and additional costs
associated with debt or equity financing and may result in increased goodwill,
intangible assets and amortization expense. There is no assurance that any
future acquisition by the Company would not have an adverse effect on the
Company's results of operations or would not result in dilution to existing
stockholders, including those purchasing Shares in this Offering. See "Business
- -- Business Strategy."
Risk of Product Returns. As is typical of the computer software industry, the
Company incurs expenses as a result of the return of products by customers. Such
returns may result from defective goods, inadequate performance relative to
customer expectations, distributor shipping errors and other causes which are
outside the Company's control. Although the Company's distributors have specific
return policies that enable the distributors to return certain types of goods
for credit, to the extent that the Company's customers return products which are
not accepted for return by the distributor of such products, the Company will be
forced to bear the cost of such returns. Any significant increase in the rate of
product returns could have a material adverse effect on the Company's financial
position and operating results. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Business Interruption. The Company believes that its success to date has been,
and future results of operations will be, dependent in large part upon its
ability to provide prompt and efficient service to its customers. As a result,
a substantial disruption of the Company's day-to-day operations (due to a
number of possible causes, including earthquake, riot, fire or a material
failure of the Company's telephone or power service) could have a material
adverse effect upon the Company. In addition, the Company's success is largely
dependent on the accuracy, quality and utilization of the information
12
<PAGE> 15
generated by its specialized information systems. Although the Company has
never experienced any significant disruptions, a substantial interruption in
these systems or in the Company's telephone communications systems could have a
material adverse effect on the Company's business. See "Business."
Discretionary Use of Proceeds. The Company currently intends to use any
proceeds of the exercise of the Warrants or Options underlying the shares in
this offering for working capital and general corporate purposes. There can be
no assurances that any of the holders of the Warrants or Options will choose to
exercise their Warrants or Options, and there can therefore be no assurances
that the Company will receive any proceeds from the exercise of such Warrants
or Options. In the event the holders of Warrants or Options do exercise the
Warrants or Options, the Company's management will have broad discretion with
respect to the expenditure of the proceeds of any such exercises. See "Use of
Proceeds."
Strategic Alliances. The development of alliances with selected software
companies that complement the Company's market and sales direction is an
element in the Company's marketing strategy. These alliances typically involve
joint marketing agreements and the inclusion of the Company's products in the
product line of the strategic partner. To date, the Company has entered into
bundling agreements with companies including, among others, Microsoft, Iomega,
Compaq and Novell. There can be no assurance, however, of increased revenues as
a result of these bundling agreements or any other such alliance.
Control by Management and Existing Stockholders. Prior to this offering, the
present directors, executive officers and principal stockholders of the Company
and their affiliates, in the aggregate, beneficially own approximately 53.5% of
the outstanding Common Stock. Upon consummation of this offering and assuming
exercise of the Warrants in full, the present directors, executive officers and
principal stockholders of the Company and their affiliates will, in the
aggregate, beneficially own approximately 45.5% of the outstanding Common
Stock. These stockholders, acting together, may have the ability to control the
election of the Company's directors and most other stockholders' actions and,
as a result, direct the Company's affairs and business. Such concentration may
have the effect of delaying or preventing a change of control of the Company.
See "Principal Stockholders."
No Dividends. It is the current policy of the Company that it will retain
earnings, if any, for continued expansion of its operations and other corporate
purposes and that it will not pay any cash dividends on its Common Stock in the
foreseeable future. The payment of cash dividends by the Company may be limited
by certain of the Company's preferred stock and credit facilities. Future
borrowings or preferred stock may contain similar restrictions. See "Dividend
Policy."
Potential Effect of Anti-Takeover Provisions. The Company's Board of Directors
has the authority to issue up to 1,000,000 shares of Preferred Stock and to
determine the price, rights, preferences, qualifications, limitations and
restrictions, including voting rights, of those shares without any further vote
or action by the stockholders. The rights of the holder of Common Stock will be
subject to, and may be adversely affected by, the rights of the holders of any
Preferred Stock that may be issued in the future. The issuance of Preferred
Stock could have the effect of delaying or preventing a change of control.
Further, Section 203 of the General Corporation Law of Delaware prohibits the
Company from engaging in certain business combinations with interested
stockholders. These provisions may have the effect of delaying or preventing a
change in control of the Company without action by the stockholders, and
therefore could adversely affect the price of the Common Stock and, to the
extent tender offers for shares of the Company's Common Stock are discouraged
or prevented by these provisions, may reduce the likelihood that investors
could receive a premium for their shares of Common Stock. See "Description of
Capital Stock."
Possible Dilution Due to Issuance of Additional Common Stock; Market Overhang.
As of November 18, 1998, the Company had outstanding 31,173,713 shares of
Common Stock (35,338,326 issued, less
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<PAGE> 16
treasury shares of 4,164,613), approximately 80,000 and 650,0000 shares of
Common Stock were issuable upon the conversion of the Series B and Series C
Preferred Stock, respectively (assuming conversion based on the closing bid
price as of November 14, 1998); approximately 2,225,000 shares of Common Stock
were issuable upon the conversion of Series D Preferred Stock; approximately
9,250,000 shares of Common Stock were issuable upon the exercise of outstanding
warrants issued by the Company, and approximately 5,750,000 shares of Common
Stock were issuable upon the exercise of outstanding options issued by the
Company. The conversion of Series B, Series C, and Series D Preferred Stock, or
additional Preferred Stock, if any, or the exercise of options and warrants,
including the Warrants, as well as the sale by the Company of additional
securities or rights to purchase such securities, would likely have an adverse
or dilutive effect on the market value of the Common Stock, including the shares
of Common Stock being offered hereby. The Series B, Series C, and Series D
Preferred Stock, and the Company's outstanding convertible debentures or notes
(in the outstanding principal and interest amount of $1,020,000 as of November
14, 1998) may be converted into shares of Common Stock at a discount to the
market price of the Common Stock on the particular date of conversion. As of
November 14, 1998, such convertible preferred stock, debentures and notes would
be convertible into 4,740,000 shares of Common Stock, of which 900,000 shares of
Common Stock are covered by this Prospectus. Furthermore, the Company may
conduct additional offerings of its Common Stock or securities convertible into
Common Stock. As a result, the voting power of each holder of Common Stock may
be diluted by the issuance of additional shares of Common Stock. Also, the book
value per share of Common Stock may be reduced upon the exercise of outstanding
options or warrants or the conversion of convertible securities such as the
Preferred Stock, depending upon the exercise price of the options or warrants
and the conversion ratio of the Preferred Stock, and the book value per share of
Common Stock, at the time of such exercise or conversion.
Furthermore, the prevailing market price for the Common Stock may be
materially and adversely affected by the addition of a substantial number of
shares of Common Stock, including the Shares offered hereby, into the market or
by the registration under the Securities Act of such additional shares. In
addition, the prospect of future sales of shares of Common Stock issuable upon
the exercise of outstanding warrants, options and convertible securities may
have a depressive effect upon the market price of the Common Stock, as such
warrants and options would be more likely to be exercised at a time when the
price of the Common Stock is in excess of the applicable exercise price.
Shares Eligible for Sale. As of November 18, 1998, the Company had outstanding
31,173,713 shares of Common Stock, of which approximately 22,000,000 shares are
freely transferable without restriction or further registration under the
Securities Act. Of the shares which are freely transferable, approximately
12,650,000 are owned by affiliates and are subject to the volume limitations of
Rule 144. Under Rule 144, as amended, if certain conditions are met, persons who
are affiliates of the Company and persons who satisfy a one year "holding
period" may sell within any three month period a number of shares which does not
exceed the greater of one percent of the total number of shares outstanding or
the average weekly trading volume of such shares during the four calendar weeks
prior to such sale. After a two year holding period is satisfied, persons who
are not "Affiliates" of the Company are permitted to sell such shares without
regard to these volume restrictions. "Affiliates" of the Company consist of all
officers and directors of the Company and all holders of ten percent (10%) or
more of the outstanding shares of Common Stock.
Sales of substantial amounts of Common Stock in the public market following
the offering made hereby could have a materially adverse effect on the market
price of the Common Stock. See "Description of Capital Stock" and "Shares
Eligible for Future Sale."
Authorization and Issuance of Preferred Stock. The Company's Board of Directors
is authorized to issue up to 1,000,000 shares of Preferred Stock. The Board of
Directors has the power to establish the
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<PAGE> 17
dividend rates, liquidation preferences, voting rights, redemption and
conversion terms and privileges with respect to any series of Preferred Stock.
The issuance of any shares of Preferred Stock having rights superior to those
of the Common Stock may result in a decrease in the value or market price of
the Common Stock. Holders of Preferred Stock may have the right to receive
dividends, certain preferences in liquidation and conversion rights. Issuances
of Preferred Stock could under certain circumstances have the effect of
delaying, deferring or preventing a change in control of the Company without
further vote or action by the stockholders and may adversely affect the voting
and other rights of the holders of Common Stock.
USE OF PROCEEDS
The Company will not receive any of the proceeds from the sale of the
Shares offered by the Selling Stockholders. If all Warrants to purchase the
shares of Common Stock offered in this offering were exercised, the Company
would receive aggregate net proceeds of approximately $3,178,381, after
deducting estimated expenses of $65,000.
The proceeds from the sale of the shares of Common Stock offered hereby are
solely for the accounts of the Selling Stockholders. Accordingly, the Company
will receive none of the proceeds from sales thereof. The shares offered hereby
are owned directly by Selling Stockholders or are issuable upon exercise of
Warrants or conversion of the Preferred Stock held by the Selling Stockholders.
Included in this Prospectus are 6,792,544 Shares underlying the Convertible
Securities. If all Warrants to purchase the shares of Common Stock offered in
this offering were exercised, the Company would receive aggregate net proceeds
of approximately $3,178,381, after deducting estimated expenses of $65,000. The
net proceeds the exercise of Warrants, if any, will be used for sales and
marketing and research and development expenditures, and other working capital
and general corporate purposes. The Company may also use all or a portion of the
net proceeds for the acquisition of businesses, products and technologies that
are complementary to those of the Company. While the Company from time to time
has engaged, and expects to continue to engage, in preliminary discussions with
other business entities with regard to the possibility of such acquisitions, as
of the date hereof no such discussions have resulted in any pending definitive
acquisition agreement. No assurances can be given that the Company will be able
to reach a definitive agreement on or consummate any such acquisition. The
foregoing represents the Company's current best estimate of its use of the net
proceeds of the exercise of the Warrants to purchase the Shares offered hereby,
if any, based upon its present plans, the state of its business operations and
current conditions in the computer software industry. The Company reserves the
right to change the use of the net proceeds if unanticipated developments in the
Company's business, business opportunities, or changes in economic, regulatory
or competitive conditions, make shifts in the allocations of proceeds necessary
or desirable. Pending any uses, the Company intends to invest the net proceeds
from such exercises in short-term, interest bearing securities or accounts.
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<PAGE> 18
SELLING STOCKHOLDERS
This Prospectus relates to the offer and sale by the following Selling
Stockholders of the Shares. Although the Company would receive the net proceeds
from the exercise of the Warrants, it will not receive any additional proceeds
from the sale by any of the following Selling Stockholders of the Shares. To the
best of the Company's knowledge, none of the Selling Stockholders has any plan,
arrangement, understanding, agreement, commitment or intention to sell their
securities. See "Plan of Distribution." Except as otherwise indicated below,
none of the following individuals or entities has held any position or office
within the Company nor has had any other material relationship with the Company
in the past three years, other than in connection with the transactions pursuant
to which the Selling Stockholders acquired the Warrants or Preferred Stock. The
following table sets forth certain information about the Selling Stockholders
for whom the Company is registering Shares for resale to the public.
<TABLE>
<CAPTION>
NUMBER OF PERCENT
SHARES NUMBER OF NUMBER OF BENEFICIALLY
OWNED SHARES BEING SHARES OWNED OWNED
PRIOR TO REGISTERED AFTER AFTER
NAME OFFERING FOR RESALE OFFERING(1) OFFERING(2)
---- --------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
SHARES UNDERLYING JANSSEN MEYERS WARRANTS
Janssen Meyers Associates LP 727,809 727,809 0 *
Gary Brustein 84,452 84,452 0 *
Mark Fisher 42,226 42,226 0 *
David Gerstenhaber 84,375 84,375 0 *
Stuart and Paula Graff 168,904 168,904 0 *
Lawrence Horowitz 168,904 168,904 0 *
J. Mitchell Hull 168,904 168,904 0 *
Victor K. Kiam II (3) 744,452 84,452 660,000 1.7%
Jack Nagel 42,226 42,226 0 *
Daniel B. Najor 84,452 84,452 0 *
Joseph Perri 337,808 337,808 0 *
Darren Perman and Ruby Yuan 168,904 168,904 0 *
Gerald and Nessa Perman 168,904 168,904 0 *
Michael Pizitz 84,452 84,452 0 *
Richard Pizitz 84,452 84,452 0 *
Claudia Rouhana 42,226 42,226 0 *
William Rouhana 42,226 42,226 0 *
Neal K. Semel 168,904 168,904 0 *
Ken Sitomer 42,226 42,226 0 *
Neal Weissman 84,452 84,452 0 *
K. Eicheman 225,000 225,000 0 *
---------- --------- --------- ----
Total Shares Underlying
Janssen Meyers Warrants 3,766,260 3,106,260 660,000 1.7%
---------- --------- --------- ----
SHARES UNDERLYING OLD CITADEL WARRANTS
Applied Quantitative Solutions 135,000 135,000 0 *
David Davis 60,750 60,750 0 *
Michael Ferguson 270,000 270,000 0 *
Caren Rae Gertner (4) 22,500 22,500 0 *
Hans Mayer 112,500 112,500 0 *
Wayne Pence Jr. 56,250 56,250 0 *
Jeffrey Ross 22,500 22,500 0 *
Gary Rudolph 56,250 56,250 0 *
Larry Sachnowitz 168,750 168,750 0 *
Gordon and Sara Scheele 20,250 20,250 0 *
Jack Simpson 28,125 28,125 0 *
Roger Trandell 56,250 56,250 0 *
Peter Weih 56,250 56,250 0 *
---------- --------- --------- ----
Total Shares Underlying
Old Citadel Warrants 1,065,375 1,065,375 0 *
---------- --------- --------- ----
OTHER SHARES UNDERLYING WARRANTS AND OPTIONS
Worldwide PetroMoly, Inc. (5) 3,373,375 150,000 3,223,375 8.2%
Bill Solomon 250,000 250,000 0 *
Charles B. Krusen 100,000 100,000 0 *
Lakeshore International Ltd. 50,000 50,000 0 *
Tom Oxley 2,000,000 250,000 1,750,000 4.6%
McGinn Smith 20,000 20,000 0 *
Edward Coppola 100,000 100,000 0 *
Spiga Limited 25,000 25,000 0 *
John Winter Smith 5,000 5,000 0 *
Delta Capital Partners 25,000 25,000 0 *
Larry Sachnowitz 10,000 10,000 0 *
Cavior Organization, Inc. 11,500 11,500 0 *
---------- --------- --------- ----
Total Other Shares Underlying
Warrants 5,969,875 996,500 4,973,375 12.8%
---------- --------- --------- ----
Total Shares Underlying Warrants 10,801,510 5,168,135 5,633,375 14.5%
---------- --------- --------- ----
PREFERRED STOCK
Edward Coppola (6) 250,000 250,000 0 *
Lakeshore International Ltd. (7) 650,000 650,000 0 *
---------- --------- --------- ----
Total Preferred Stock 900,000 900,000 0 *
---------- --------- --------- ----
COMMON STOCK
Lakeshore International Ltd. 147,900 147,900 0 *
Precision Capital Investors Limited
Partnership I 56,509 56,509 0 *
Bennett Klein (8) 258,329 100,000 158,329 *
Vance Nesbitt 220,000 220,000 0 *
Conant Whittenburg French & Schachter 200,000 200,000 0 *
---------- --------- --------- ----
Total Common Stock 882,738 724,409 158,329 *
---------- --------- --------- ----
TOTAL 12,584,248 6,792,544 5,791,704 14.5%
========== ========= ========= ====
</TABLE>
16
<PAGE> 19
(1) Assumes no sales are effected by the Selling Stockholders other than
pursuant to this Registration Statement.
(2) Assumes the sale of all Shares being registered pursuant to this
Registration Statement.
(3) Mr. Kiam is Chairman of the Board of Directors of the Company.
(4) Caren Rae Gertner is the daughter of Mr. Gil Gertner, a director of the
Company.
(5) Mr. Gil Gertner, a director of the Company, is Chairman of the Board of
Worldwide PetroMoly, Inc. ("PetroMoly"). Includes 1,462,500 shares presently
issuable pursuant to options to purchase Common Stock held by Mr. Gertner. The
number of shares held by Mr. Gertner also includes warrants to purchase 150,000
shares held by Worldwide PetroMoly, Inc. ("PetroMoly"), a company controlled by
Mr. Gertner, and 732,375 shares standing in PetroMoly's name pursuant to a
pledge by Steven B. Solomon, which shares Messrs. Gertner and Sharp agreed to
cause PetroMoly to return to Mr. Solomon but which have not been returned. See
"Certain Relationships and Transactions." Does not include 2,500,000 shares for
Mr. Gertner that he has agreed to transfer to the Company in exchange for
certain accounts receivable of the Company. See "Certain Relationships and
Transactions." Mr. Gertner has filed an affidavit of lost certificates with the
transfer agent relating to these shares. However, these shares have not yet been
canceled by the transfer agent because Mr. Gertner had not provided the transfer
agent with the necessary bond or indemnification. These shares have been
excluded from the number of shares outstanding.
(6) Consist of shares of Common Stock issuable upon the exercise of Series D
Preferred Stock at a conversion price of $1.075 per share.
(7) Consist of shares of Common Stock issuable upon the exercise of Series C
Preferred Stock at a conversion ratio based on 75% of the five day average
closing bid price of Company's Common Stock ($.60 per share).
(8) Includes 108,329 shares presently issuable to Mr. Klein (the Company's Vice
President - Business Development) pursuant to options exercisable within the
next 60 days.
* Represents less than one percent.
Warrants to purchase 3,106,260 of the Shares being offered for resale by
the Selling Stockholders were acquired in connection with a private placement by
the Company's predecessor in December 1995 (the "Janssen Meyers Private
Placement"). Warrants to purchase 1,065,375 of the Shares being offered for
resale by the Selling Stockholders were acquired upon conversion of certain
notes issued in a private placement by the Company's predecessor
in 1995 (the "Old Citadel Private Placement").
In connection with the issuance of the Warrants to certain Selling
Stockholders, the Company agreed to file and use its best efforts to cause to be
declared effective the Registration Statement of which this Prospectus is a
part. The Company has also agreed to use its best efforts to keep the
Registration Statement effective until the earliest of (A) February 28, 2001
(five years after date of the Company's initial public offering), or (B) such
time as all of the shares have been sold, or (C) such date as all of the shares
may be sold under Rule 144. The Company has agreed to indemnify the Selling
Stockholders and each underwriter, if any, and each person who controls any such
underwriter or person, against certain expenses, claims, losses, damages and
liabilities (or action in respect thereof). The Company has agreed to pay the
expenses of registering the shares under the Securities Act, including
registration and filing fees, blue sky expenses, printing expenses, accounting
fees, administrative expenses and its own counsel fees.
PLAN OF DISTRIBUTION
The Company is registering the Shares on behalf of the Selling
Stockholders, which term includes donees and pledgees selling Shares received
from a named Selling Stockholder after the date of this Prospectus. All costs,
expenses and fees in connection with the registration of the Shares offered
hereby
17
<PAGE> 20
to the sale of Shares will be borne by the Company. Brokerage commissions and
similar selling expenses, if any, attributable to the sale of Shares will be
borne by the Selling Stockholders. Sales of Shares may be effected by Selling
Stockholders from time to time in one or more types of transactions (which may
include block transactions) in the over-the-counter market, in negotiated
transactions, through put or call options transactions relating to the Shares,
through short sales of Shares, or a combination of such methods of sale, at
market prices prevailing at the time of sale, or at negotiated prices. Such
transactions may or may not involve brokers or dealers. The Company is not
aware of any agreements, understandings or arrangements with any underwriters
or broker-dealers regarding the sale of the securities, nor is the Company
aware of an underwriter or coordinating broker acting in connection with the
proposed sale of Shares by the Selling Stockholders.
The Selling Stockholders may effect such transactions by selling Shares
directly to purchasers or to or through broker-dealers, which may act as agents
or principals. Such broker-dealers may receive compensation in the form of
discounts, concessions, or commissions from the Selling Stockholders and/or the
purchasers of Shares for whom such broker-dealers may act as agents or to whom
they sell as principal, or both (which compensation as to a particular
broker-dealer might be in excess of customary commissions).
The Selling Stockholders and any broker-dealers that act in connection with
the sale of Shares might be deemed to be "underwriters" within the meaning of
Section 2(11) of the Securities Act, and any commissions received by such
broker-dealers and any profit on the resale of the Shares sold by them while
acting as principals might be deemed to be underwriting discounts or commissions
under the Securities Act. The Company has agreed to indemnify each Selling
Stockholder against certain liabilities, including liabilities arising under the
Securities Act. The Selling Stockholders may agree to indemnify any agent,
dealer or broker-dealer that participates in transactions involving sales of the
Shares against certain liabilities, including liabilities arising under the
Securities Act. Because Selling Stockholders may be deemed to be "underwriters"
within the meaning of Section 2(11) of the Securities Act, the Selling
Stockholders will be subject to the prospectus delivery requirements of the
Securities Act. The Company has informed the Selling Stockholders that the
anti-manipulative provisions of Regulation M promulgated under the Exchange Act
may apply to their sales in the market.
Selling Stockholders also may resell all or a portion of the Shares in open
market transactions in reliance upon Rule 144 under the Securities Act, provided
they meet the criteria and conform to the requirements of such Rule.
Upon the Company being notified by a Selling Stockholder that any material
arrangement has been entered into with a broker-dealer for the sale of Shares
through a block trade, special offering, exchange distribution or secondary
distribution or a purchase by a broker or dealer, a supplement to this
prospectus will be filed, if required, pursuant to Rule 424(b) under the Act,
disclosing (i) the name of each such selling Stockholder and of the
participating broker-dealer(s), (ii) the number of shares involved, (iii) the
price at which such shares were sold, (iv) the commissions paid or discounts or
concessions allowed to such broker-dealer(s), where applicable, (v) that such
broker-dealer(s) did not conduct any investigation to verify the information set
out or incorporated by reference in this Prospectus and (vi) other facts
material to the transaction. In addition, upon the Company being notified by a
Selling Stockholder that a donee or pledgee intends to sell more than 500
shares, a supplement to this prospectus will be filed.
18
<PAGE> 21
MARKET PRICES OF COMMON STOCK AND DIVIDEND POLICY
The Company's Common Stock is currently traded on the OTC Bulletin Board
under the symbol CITN. 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-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 NOFF from May 4,
1996 to March 26, 1998.
<TABLE>
<CAPTION>
FISCAL YEAR BID ASK
- ----------- ----------------- -----------------
QUARTER HIGH LOW HIGH LOW
------- ----- ---- ----- ----
<S> <C> <C> <C> <C>
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
1998
1st Quarter .88 .25 .97 .28
2nd Quarter .69 .15 .75 .17
3rd Quarter .90 .39 .93 .41
4th Quarter .55 .18 .59 .22
1999
1st Quarter 1.94 .35 1.97 .35
2nd Quarter 2.15 .80 2.25 .85
3rd Quarter
(through 11/16/98) 1.05 .40 1.09 .47
</TABLE>
On November 19, 1998, the last reported sale price of the Company's Common
Stock on the over-the-counter bulletin board was $.76 per share. On November 19,
1998, the Company had approximately 4,200 stockholders of record of the
Company's Common Stock.
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. The Company has issued preferred stock,
which entitles the holders thereof to preferences as to payment of dividends and
liquidation proceeds.
19
<PAGE> 22
CAPITALIZATION
The following table sets forth (i) the actual capitalization of the Company
as of August 31, 1998 (ii) the pro forma capitalization of the Company as of
August 31, 1998, assuming the exercise of the Warrants, after deducting the
estimated offering expenses payable by the Company in connection with the sale
of Shares by the Selling Stockholders, and the application of the net proceeds
from the exercise of the Warrants as set forth in "Use of Proceeds." The
information set forth below should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the financial statements and the related notes thereto included elsewhere in
this Prospectus. See "Use of Proceeds."
<TABLE>
<CAPTION>
August 31, 1998
(UNAUDITED)
-----------------------------
ACTUAL AS ADJUSTED
(1)
------------ ------------
<S> <C> <C>
Short-term debt
Notes payable $ 323,955 $ 323,955
Current portion of long-term debt 347,781 257,691
Long-term debt 74,910 --
------------ ------------
Total debt 746,646 581,646
------------ ------------
Stockholders' Equity
Preferred stock, par value $.01,; 1,000,000 shares
authorized; 6,553 issued and outstanding 67 21
Common stock, par value $.01; 60,000,000 shares
authorized; 32,040,426 issued and outstanding 320,404 385,629
Equity Notes 944,000 944,000
Additional paid-in-capital 23,196,241 26,534,443
Accumulated deficit (14,126,392) (14,126,392)
Treasury stock, at cost (4,164,613 shares) (2,500,239) (2,500,239)
------------ ------------
Total stockholders' equity 7,834,081 11,237,462
------------ ------------
Total Capitalization $ 8,580,727 $ 11,819,108
============ ============
</TABLE>
(1) Adjusted from actual to reflect the sale of 6,792,544 shares of Common Stock
offered by the Selling Stockholders and the exercise of the Warrants and
Options and Preferred Stock by the Selling Stockholders and the payment of
the exercise price of the Warrants and Options to the Company and the
application of the net proceeds therefrom. See "Use of Proceeds."
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the financial
statements and notes found elsewhere herein, as well as the disclosure relating
to forward-looking statements set forth in "Description of Business--Certain
Factors That May Affect Future Operating Results."
OVERVIEW
Citadel Technology, Inc. ("Citadel" or the "Company"), formerly Citadel
Computer Systems Incorporated, develops and markets security and administration
software products for both computer networks and desktop personal computers
("PCs"). Its integrated, easy-to-use products enable network administrators to
control access to network resources, automate routine network maintenance tasks,
and automatically shutdown and restart servers and desktop PCs in the event of a
network crash. The Company's products also enable individual PC users to control
access to their desktops, secure files, and
20
<PAGE> 23
automatically shutdown and restart servers and desktop PCs in the event of a
network crash. The Company's products also enable individual PC users to
control access to their desktops, secure files, and index and retrieve files
stored in a variety of storage media. The Company's products are designed to
reduce the direct and indirect costs of computer network operations, protect
proprietary networks and information, and otherwise improve overall office
productivity.
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.
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.
RESULTS OF OPERATIONS
THREE MONTHS AND SIX MONTHS ENDED AUGUST 31, 1998 COMPARED WITH THREE MONTHS
AND SIX MONTHS ENDED AUGUST 31, 1997
During the three months ended August 31, 1998, the Company had net sales of
$1,077,318, an increase of $731,224 or 211.3% over net sales of $346,094 for the
three months ended August 31, 1997. During the six months ended August 31, 1998,
the Company had net sales of $2,111,513, an increase of $1,273,145, or 151.9%
over net sales of $838,368 for the six months ended August 31, 1997. The Company
attributes the sales increase to increased industry recognition of its products
and the recent partnering relationship with System Plan in Japan and its
bundling arrangements with Microsoft and Compaq.
The costs and expenses incurred in connection with producing the Company's
products increased from $14,375, or 4.2% of net sales for the three months
ended August 31, 1997, to $60,912, or 5.7% for the three months ended August
31, 1998. The costs and expenses incurred in connection with producing the
Company's products increased from $23,786, or 2.8% of net sales for the six
months ended August 31, 1997, to $131,243, or 6.2% for the six months ended
August 31, 1998. The percentage increase in cost of sales for the quarter and
for the year to date over the same periods last year can be attributed to a
change in the product sales mix to lower priced products sold on an individual
unit basis and the establishment of a reserve for product returns. Both factors
can be attributed to the Company's entry into the retail sales channel, which
the Company was not engaged in during the same periods last year. In addition,
and partly due to its entry into the retail channel, the Company completely
updated its packaging and collateral pieces to give all its products a common
look. This also tended to increase the Company's cost of sales on a per unit
basis. The impact of the aforementioned was offset, to some degree, by the
increase in the Company's bundling revenues over the same periods last year,
which tended to reduce the cost of sales on a percentage basis. The reduction
in costs and expenses as a percentage of revenues in the current quarter over
the previous quarter can be attributed to the increase in bundling revenues as
a percentage of total revenues in this quarter over the previous quarter.
Research and development costs charged to expense for the three months ended
August 31, 1998 were $146,609 versus $67,215 for the same period last year, or
an increase of $79,394 or 118.1%. Research and development costs charged to
expense for the six months ended August 31, 1998 were $251,333 versus $217,737
for the same period last year, or an increase of $33,596 or 15.4%. The Company
capitalized software development costs of approximately $247,000 and $745,000
for the three and six months ended August 31, 1998, respectively, versus
approximately $135,000 and $281,000 for the three and six months ended August
31, 1997, respectively. The increase in costs capitalized relates primarily to
development work being performed by Metamor Software Solutions during the
periods. The Company launched its WinShield NT and Network products during the
first quarter of fiscal 1999 and its FolderBolt 95 and CPR for Netware products
during the second quarter. The Company expects to launch its Citadel Secure
Desktop product and other new products and upgrades during the third and fourth
quarters of fiscal 1999 that will provide ease-of-use security solutions for
Internet and intranet applications on Microsoft and Novell platforms.
Selling and marketing expense increased $655,144, or 215.7% from $303,760 for
the three months ended August 31, 1997 to $958,904 for the three months ended
August 31, 1998. For the six months ended August 31, 1998 selling and marketing
expenses were $1,430,298, compared to $611,387 for the comparable period last
year, or an increase of $818,911, or 133.9%. As a percentage of sales, selling
and marketing expenses increased from 87.8% to 89.0% for the quarter and
decreased from 72.9% to 67.7%, for the six months ended August 31, 1997 and
1998, respectively. During the quarter ended August 31, 1988, the Company
allocated considerable resources to marketing and the expansion of its inside
and outside sales departments. The Company expects that it will continue to
allocate additional resources to selling and marketing expenses in the future.
Therefore, the Company would expect that in the future these expenses will
continue to increase on a dollar basis, but to the extent sales increase these
expenses can be expected to decrease as a percentage of sales.
General and administrative expenses were $426,570 for the three months ended
August 31, 1997, compared to $426,152 for the three months ended August 31,
1998. General and administrative expenses for the six months decreased $228,917,
or 22.7%, from $1,010,408 to $781,491 for the six months ended May 31, 1997 and
1998, respectively. This resulted primarily from the Company's restructuring and
cost control programs implemented during the previous fiscal year. As a
percentage of sales these expenses decreased for the quarter from 123.3% in 1997
to 39.6% in 1998, and from 120.5% to 37.0%, for the six months ended August 31,
1997 and 1998, respectively. The Company would expect that as revenues increase
these expenses will continue to decrease as a percentage of sales.
Depreciation and amortization expense increased $23,339 or 6.7%, to $371,491
from $348,152 for the three months ended August 31, 1998 and 1997, respectively.
For the six months, depreciation and amortization expense increased $101,589, or
16.3%, from $622,328 to $723,917 for the periods ended August 31, 1997 and 1998,
respectively. This increase resulted from the commencement of amortization on
certain capitalized research and development costs relating to products that
became available for sale during the periods.
Interest expense for the three months ended August 31, 1998 was $30,847
compared to $29,502 for the three months ended August 31, 1997. For the six
months ended August 31, 1998, interest expense increased $31,323, from $50,728
for the six months ended August 31, 1997, to $82,051, or 61.7%. This resulted
primarily from the Company having more interest bearing debt outstanding during
the period when compared to the same period last year.
As a result of the foregoing the Company reported a net loss before
extraordinary items of $910,031 for the three months ended August 31, 1998,
compared to a net loss of $935,236 for the same period last year. For the six
months ended August 31, 1998, the Company reported a net loss before
extraordinary items of $1,281,254, compared to a net loss of $1,796,355, for the
same period last year.
During the three months and six months ended August 31, 1998, the Company
recognized gains on the settlement of debts of $205,847 and $733,068,
respectively. These gains related primarily to the restructuring of a certain
note payable to Inxight, a division of Xerox and the settlement of certain
accrued obligations. In connection with the Inxight transaction, Inxight agreed
to reduce a certain note and accrued interest due from the Company by $520,816.
In exchange the Company agreed to a shorter maturity on the note and the
issuance of 250,000 shares of the Company's common stock to Inxight (valued at
$92,500 as of the date of the transaction). The value of the stock has been
treated as a reduction in the gain associated with the transaction.
As a result of the aforementioned, for the three months ended August 31, 1998,
the Company reported a net loss of $704,184, and a net loss of $548,186 for the
six months then ended, compared to a net loss of approximately $935,236 and
$1,796,355 for the respective comparable periods last year.
21
<PAGE> 24
YEAR ENDED FEBRUARY 28, 1998 COMPARED WITH YEAR ENDED FEBRUARY 28, 1997
During the fiscal year ended February 28, 1998, the Company had net sales
of $1,613,326, a decrease of $3,712,866, or 69.7%, over net sales of $5,326,192
during the fiscal year ended February 28, 1997. The Company realized this
reduction in sales as a result of the restructuring of its operations, and the
reduction in its workforce. The Company during the year changed from its mainly
telemarketing and trade show sales model to a more traditional VAR, reseller,
OEM and joint venture sales model. While the Company believes the newly adopted
sales strategies have better positioned the Company for the future and expects
increased sales in fiscal 1999, the revenues for fiscal 1998 were adversely
affected by the restructuring and new sales strategy.
During fiscal 1998, the Company increased its efforts to enter into OEM and
joint venture relationships with strategic partners to increase its sales
channels. 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 Metamor in which
Metamor purchased 2,500,000 shares of the Company's common stock and the parties
agreed to certain joint research and development, technology licensing, and
marketing activities. In February 1998, the Company's WinShield product was the
"Spotlight of the Month" product on Microsoft's educational software website. In
addition, the Company started to market its products internationally through the
establishment of distribution relationships in the UK and Japan. The Company is
continuing to explore similar arrangements with other market leaders in the
technology industry and the Company expects these channels will represent a
significant percentage of the Company's revenues in the future.
The costs and expenses incurred in connection with producing the Company's
products were $78,429 during the fiscal year ended February 28, 1998, a decrease
of $226,007, or approximately 74.2%, from costs of sales of $304,436 incurred in
the previous fiscal year. This resulted primarily from the reduction in sales.
As a percentage of net sales, costs of sales decreased in the fiscal year ended
February 28, 1998, to 4.9% from 5.7% in the prior period. The decrease in cost
of sales, on a percentage basis, was primarily the result of greater operational
and order procurement efficiencies relating to the fulfillment of customer
orders during the year.
Selling general and administrative expenses for the fiscal year ended
February 28, 1998, were $3,056,408, a decrease of $2,882,691, or 48.5%, over
selling, general and administrative expenses of $5,939,099 during the prior
fiscal year. Such expenses decreased primarily due to the Company's
restructuring, which included significantly reducing its workforce, the
consolidation of all operational, production and sales offices into its Dallas
location, the identification of areas for operational efficiencies and the
corresponding reduction in the associated operational expenses. While selling,
general and administrative expenses decreased during 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.
22
<PAGE> 25
Provision for uncollectable accounts decreased from $1,984,113 for the
fiscal year ending February 28, 1997 to $368,897 for fiscal year 1998, or a
decrease of $1,615,216, or 81.4%. Under the Company's previous telemarketing
sales model, the Company generally delivered its products to customers on a
30-day trial basis following receipt of a signed trial agreement. The Company
only recognized revenue if the product had not been returned within the 30 days
in accordance with the terms and conditions of the trial agreement. Numerous
disagreements arose between the Company and its customers regarding the
customer's obligation to pay for products delivered. The Company believes these
agreements are legally binding contracts and intends to continue to pursue the
collection thereof. However, the Company provided an allowance for returns and
doubtful accounts of $2,500,000 and $681,000 as of February 28, 1997 and 1998,
respectively, to cover the potential for uncollectable accounts. Due to trouble
encountered by the Company with this sales model, the Company, during fiscal
1998, changed its sales model to a more traditional VAR, reseller, OEM and joint
venture model. As a result of this change, the Company conflicts with its
customers have been substantially reduced and collections have been
significantly improved.
Depreciation and amortization expense increased to $1,270,708 in the fiscal
year ended February 28, 1998, from $942,166, or an increase of 34.9% over the
fiscal year ended February 28, 1997. This increase is due to the commencement of
amortization on certain capitalized software development costs relating to
products that became available for sale. Management expects that these expenses
will continue to increase in the quarters to come as additional products reach a
salable state.
Research and development expenses charged to operations for the year ended
February 28, 1998 were $161,010 compared to $3,336,253 for the year ended
February 28, 1997, or a decrease of $3,175,243 or 95.2%. During fiscal year
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. The Company did not incur a similar expense in fiscal 1998. The
Company capitalized $568,963 and $457,321 in software development costs for
fiscal years 1998 and 1997, respectively. These costs will be amortized over the
estimated useful lives of the underlying products.
During the fiscal year ended February 28, 1998, the Company had a net loss
on sales of marketable securities of $199,672 versus $451,280 for the fiscal
year ended February 28, 1997. The loss for the fiscal year 1998 resulted from
the ultimate disposal of the Miami Subs stock. The loss for fiscal year 1997
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.
LIQUIDITY AND CAPITAL RESOURCES
FOR THE SIX MONTHS ENDED AUGUST 31, 1998
23
<PAGE> 26
The Company's cash and cash equivalents at August 31, 1998 were $1,930,876.
Cash flows from operations were a negative $2,934,447 for the six months ended
August 31, 1998, compared to negative $667,047 for the six months ended August
31, 1997. The increase in the negative cash flow from operations resulted
primarily from an increase in Company's receivables due to an increase in the
Company's sales sold with extended payment terms, an increase in other assets
which related primarily to expenditures for various marketing and advertising
programs and a decrease in accounts payable and accrued expenses. The
aforementioned negative impacts were offset in part by a decrease in the
Company's net loss for the period.
Cash used in investing activities was approximately $769,919 for the six months
ended August 31, 1998, compared to approximately $252,846 for the same period
last year. This increase resulted primarily from the increase in development
expenses relating to development activities on new products and product
upgrades.
Cash flows provided by financing activities were $5,653,687 for the six months
ended August 31, 1998, compared to $940,944 for the six months ended August 31,
1997. This increase was due primarily to more capital being raised during this
period compared to the same period last year.
As a result of the aforementioned factors, cash and cash equivalents increased
by $1,922,321 for the six months ended August 31, 1998 versus an increase of
$21,101 for the same period last year.
YEAR ENDED FEBRUARY 28, 1998 COMPARED WITH YEAR ENDED FEBRUARY 28, 1997
The Company's cash and cash equivalents at February 28, 1998 were $8,555.
Cash flows from operations were a negative $2,661,326 for the fiscal year
ended February 28, 1998, compared to negative $6,706,035 for the fiscal year
ended February 28, 1997. The decrease was due principally to the decreased net
loss of the Company for the year as a result of the Company's restructuring
efforts.
Cash used in investing activities was $4,780 in the fiscal year ended
February 28, 1998, compared to $1,562,464 in the prior year. This decrease was
primarily due to a decrease in capital expenditures and a decrease in the
acquisitions of businesses and software.
Cash flows provided by financing activities were $2,659,561 in the fiscal
year ended February 28, 1998, compared to $8,158,034 in the fiscal year ended
February 28, 1997. This decrease was due primarily to fewer funds being raised
this year as compared to last year through equity note and preferred stock
issuances. However, the Company does expect that it may require additional
funding in the future.
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In March 1996, in connection with the sale of its restaurants owned by the
Company's predecessor to Miami Subs USA, Inc. ("Miami Subs"), the Company
received 1,325,000 shares of Miami Subs common stock and Miami Subs assumed
certain restaurant indebtedness. The Company issued a nonrecourse, non-interest
bearing, promissory note to Miami Subs with a remaining principal amount of
$1,250,000, secured by a pledge of the aforementioned 1,325,000 shares of Miami
Subs common stock owned by the Company. The Company determined that it could not
recover its investment in the Miami Subs stock and through a charge to earnings
of $1,000,000 wrote down the investment during the quarter ended May 31, 1996,
to its market value as of July 19, 1996. Subsequent to May 31, 1996, the Company
through a charge to equity further wrote down the investment in the Miami Subs
stock to the carrying value of the debt. In June 1997, the Company tendered the
stock to Miami Subs as payment in full of the $1,250,000 debt owed by the
Company to Miami Subs. In addition, to settle certain disputes between the
Company and Miami Subs, Miami Subs issued to the Company 200,000 shares of Miami
Subs common stock and agreed to assume additional indebtedness related the
Company's former restaurant operations. The Company sold the shares for
approximately $156,000 and used the proceeds for working capital.
In January 1998, the Company received a loan in the amount of $350,000 from
an individual. The loan bore interest at a rate of 5% per annum and was payable
in full on or before January 1999. In connection with the loan, the Company
issued warrants to purchase 200,000 shares of common stock. Subsequent to the
end of the Company's 1998 fiscal year, this debt was converted into shares of
the Company's Common Stock. See "Recent Sales of Unregistered Securities."
As a result of the aforementioned factors, cash and cash equivalents
decreased by $6,545 in the fiscal year ended February 28, 1998.
INFLATION
Inflation did not have a material effect on the Company's results during
the periods discussed.
ACCOUNTING STANDARDS NOT ADOPTED
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 June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information," and supersedes FASB issued SFAS No. 14,
"Financial Reporting for Segments of a Business Enterprise. SFAS No. 131
requires public enterprises to report certain financial and descriptive
information about operating segments, as defined, in annual financial statements
and selected information in condensed financial statements for interim periods
issued to shareholders, if practical. SFAS No. 131 is not expected to have a
material impact on the financial condition or results of operations of the
Company.
Both the aforementioned accounting standards are effective for years
beginning after December 15, 1997.
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In October 1997, the Accounting Standards Executive Committee ("AcSec")
issued Statement of Position 97-2, Software Revenue Recognition ("SOP 97-2"),
which delineates the accounting for software product and maintenance revenues.
SOP 97-2 supersedes the Accounting Standards Executive Committee Statement of
Position 91-1, Software Revenue Recognition. In March 1998, AcSec issued SOP
98-4 "Deferral of Effective Date of a Provision of SOP 97-2, Software Revenue
Recognition," in which certain provisions of SOP 97-2 have been deferred for one
year. SOP 97-2 and 98-4 are effective for transaction entered into after March
31, 1998. The Company is evaluating the requirements of SOP 97-2 and 98-4, and
the effects, if any, on the Company's current revenue recognition policies.
BUSINESS
THE COMPANY
Citadel Technology, Inc. ("Citadel" or the "Company"), formerly Citadel
Computer Systems Incorporated, develops and markets security and administration
software products for both computer networks and desktop personal computers
("PCs"). Its integrated, easy-to-use network products enable network
administrators to control access to network resources, automate routine network
maintenance tasks, and automatically shutdown and restart servers and desktop
PCs in the event of a network crash. The Company's desktop products also enable
individual PC users to control access to their desktops, secure files, and index
and retrieve files stored in a variety of storage media. The Company's products
are designed to reduce the direct and indirect costs of computer network
operations, protect proprietary networks and information, and otherwise improve
overall productivity for home, office, and school PC's.
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.
RECENT DEVELOPMENTS FOR THE COMPANY
Management
Fiscal 1998 was a period of restructuring and transition for the Company.
The Company consolidated all its operations into its Dallas location,
significantly reduced its workforce, completely revamped its sales and marketing
strategies, and restructured many of the operational aspects of the Company. In
April 1997, the Company's former president and chief executive officer resigned
and agreed to the termination of his employment contract in connection with the
Company's restructuring. Additionally, several other key members of the
Company's management team resigned, including its former Vice President of
Sales, Vice President of Channel Sales, Chief Technology Officer, and several
other of its officers. 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 July 1997, Mr. Carl Banzhof, the Company's
Vice President of Engineering, assumed the role of Chief Technology Officer of
the Company. In January 1998, Bennett Klein, formerly of Iomega, joined the
Company as Vice President of Business Development. In addition, Jack Doxey
joined the Company as Vice President of Marketing in August 1998, Alex London,
as Vice President of Sales in July 1998, and Stephen Hill, as Vice President of
Channel Sales in June 1998. Besides the restructuring efforts, the new
management team began developing strategic and OEM relationships with industry
market leaders. As a result of the foregoing, while the Company's sales for the
current year were adversely affected, management believes that the Company is
well positioned today to move forward.
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Products
In November 1997, the Company introduced C:\More!, a product that enables
users to index, locate, and retrieve their files from a wide range of different
storage media. C:\More! has received a favorable initial response in the market.
Iomega, the developer of the highly successful ZIP and JAZ drives, has included
C:\More! in its Iomega-ready software program and has assisted the Company in
promoting the product. Among other things, Iomega has featured C:\More! on its
web site, invited the Company to present C:\More! at the Iomega booth at the
fall 1997 Comdex show, and authorized the Company to use images of the ZIP and
JAZ drives in the packaging for C:\More!.
In January 1998, the Company introduced WinShield 95/NT, the Company's
solution for desktop users who want to protect their PC system from unauthorized
modification or access. WinShield was the Spotlight Product for February 1998 on
Microsoft's educational software web site. Sales of WinShield are currently
gaining momentum in the VAR, distribution and corporate channels.
The Company has secured retail distribution for its C:\More!, WinShield and
Folderbolt products in key retail outlets such as Office Depot, Office Max, Best
Buy, Computer City, Micro Center, and CompUSA., and is currently working with
other retail outlets.
Metamor Transactions
On October 6, 1997, the Company entered into a formal strategic alliance
with Metamor Worldwide, Inc. (formerly CORESTAFF, Inc.) (NASDAQ:MMWW), a leading
provider of information technology and staffing services with annual revenues in
excess of $1.0 billion. The alliance includes the following elements:
o In October 1997, Metamor purchased 2.5 million shares of the Company's
common stock for $750,000 in cash and other valuable consideration, and was
also granted warrants to purchase an additional 1 million shares at $4.00
per share and another 1 million shares at $5.00 per share.
o An executive vice president of Metamor, who also serves as the president of
Metamor's information technology services division, joined the Company's
board of directors in October 1997.
o Metamor agreed to provide software development support to the Company,
including support through its subsidiary, Metamor Software Solutions
("MSS"), which employs more than 200 software programmers. As a result of
this support, the Company believes that it will be able to introduce new
products and upgrades to existing products and otherwise react to changes
in customer needs and the market more quickly than in the past.
o The Company and Metamor will cross-sell each other's products. The Company
will be the exclusive distributor of Metamor's "First Step" software
program, a peer-to-peer system that enables users to easily access multiple
systems requiring different user codes.
o In May 1998, Metamor invested an additional $2 million in the Company, by
purchasing 2,000 shares of the Company's convertible preferred stock.
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Other Recent Developments
On February 26, 1998, the stockholders of the Company approved the
amendment of the Company's Certificate of Incorporation to change the Company's
name to Citadel Technology, Inc.
In March 1998, the Company in association with Guildsoft Limited opened an
office in Devon, England to distribute the Company's products in UK and Europe.
In May 1998, the Company appointed System Plan as its exclusive reseller
and distributor for the Japanese market.
In June 1998, a Dallas based private investment fund acquired 2 million
shares of Citadel stock for $ 2.5 million and an additional 1 million shares for
$1.5 million.
OVERVIEW
The Company's network products are designed to: reduce clients' costs,
improve the accuracy of clients' information, maintain the operation of
networks, secure networks 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. The Company's network software
products operate on operating systems designed by Novell, Microsoft, IBM and
Apple. The Company'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 desktop products are designed to enable
individual PC users to control access to their desktops, secure files, and index
and retrieve files stored in a variety of storage media.
The Company's primary products include the Crash Protection and Recovery
(CPR), C:\MORE!, NetOFF, Server Sentry, Phantom of the Console, Server Cam,
WinShield, and FolderBolt. See "Citadel Products". The Company's clients include
many Fortune 2000 companies and government and educational agencies and
individual PC users.
CITADEL STRATEGY
The Company's strategy is to develop long-term client relationships and to
maintain a high level of lifetime client satisfaction, which the Company
believes will result in additional recurring revenues from new products and
upgrades on existing software products. The Company has focused its development
efforts on the client-server LAN and PC 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. The Company believes its
products are positioned to capitalize on this trend.
The Company's fundamental objective is to become a leading supplier of
security and administration software products for computer networks and PCs. The
Company seeks to achieve this objective through the following strategies:
o Expand Software Product Portfolio. The Company's existing product line
addresses a wide range of the security and administration needs of computer
network administrators and PC users. The Company believes a central element
of its future success will be the development of new products and
enhancements for its existing products that provide additional capabilities
and features and differentiate the Company's product line from the product
lines of competitors and potential competitors.
o Continue to Expand Sales and Marketing. The Company is continuing to
implement the restructuring of its marketing and sales effort, moving from
telemarketing to distribution through the retail, distributor, VAR, and OEM
channels.
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o Enter into Additional Strategic Relationships. The Company has successfully
developed strategic alliances or partnerships with other technology
companies in the past. In addition to the strategic alliance with Metamor,
the Company has developed a close working relationship with Iomega, which
has included the Company's C:\More! product in its Iomega-ready software
program and assisted the Company in promoting the product. The Company also
works closely with representatives of Novell and Microsoft in the
development of its products. The Company intends to further leverage its
technology and products by entering into strategic relationships with other
technology companies, including other complementary software and hardware
providers (such as PC OEMs, server manufacturers, and removable media
storage vendors).
o Maintain Technological Leadership. The Company believes that its computer
security and administration products are more advanced than those of its
competitors. It intends to maintain its technological lead by continuing to
dedicate significant resources to its research and development efforts.
o Pursue Acquisition Opportunities. In addition to the Company's internal
product development efforts, the Company has had success in acquiring
products and technology. Such acquisitions can be less expensive and more
time efficient than internal development. The Company believes that
additional opportunities may arise in the future to expand its product
lines or technology base by acquiring businesses, products and technologies
that complement those of the Company.
INDUSTRY BACKGROUND
Network Security and Administration. Largely as a result of the increasing
power, ease of use, and low cost of PCs, many businesses and other organizations
have shifted from a centralized mainframe computer platform, usually procured
from a single vendor, to a distributed multiple-PC networked platform, the
elements of which are procured from a variety of vendors. These organizations
have invested heavily in client-server networks, "intranets," and other
distributed computing networks to realize the cost and productivity benefits of
sharing applications, files, data, and printers and other peripherals among PC
users across a work group, department or entire enterprise. As a result of the
migration of mainframe applications to network servers, mission critical
functions are increasingly performed over such distributed networks. These
functions include e-mail; electronic funds transfer; reservation entry for
airlines, hotels and rental car companies; and telemarketing and order entry.
The use of complex, heterogeneous distributed networks linking multiple
host servers and client PCs creates substantial risk. Unauthorized interception,
alteration, and theft of proprietary information, as well as electronic
vandalism or terrorism aimed at disrupting network operations, can have major
adverse effects on the organizations that own, operate, and/or use those
distributed networks. This risk grows every day because of the deployment of
more capable PCs, growth in the number of network access points, enhancements in
the ability of different types of computers to communicate with one another, and
expansion in the number of public and private communications networks used to
support distributed computing environments. As a result of these developments,
protecting distributed networks and the information transmitted over those
networks is an increasingly important and difficult task.
Another challenge facing organizations that depend on distributed computing
networks is network administration. In many cases because of budgetary or other
constraints, organizations are hard pressed to address the network
administration needs that arise as their networks grow in size and complexity.
Some organizations outsource some or all network administration tasks to a
service bureau or VAR. Some smaller organizations have no formally trained
network administrator available on a daily basis. Organizations without a
substantial (and usually expensive) in-house network administration effort are
vulnerable to network disruptions. Such disruptions can reduce top-line revenue
by preventing
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the entry of order information and delaying transaction processing, reducing
internal productivity by idling network users, alienating customers by
interfering with customer service functions, and increasing overall workplace
tension.
The Company believes that corporate and institutional use of distributed
computing networks will continue to expand and that, as reliance on these
networks deepens, organizations will become increasingly more concerned about
(i) protecting the integrity and security of these networks, (ii) reducing the
incidence of network disruptions, and (iii) reducing the expense of network
administration. The Company, therefore, believes that demand for more powerful
and more cost effective network security and administration tools will grow
substantially over the next several years.
PC Security and Administration. Even in a distributed computing
environment, many users prefer to maintain all or a substantial portion of their
important "stuff" (e.g., business and personal files) on their desktop hard
drive or other desktop storage media (i.e., diskettes, Zip drives, etc.).
Desktop computer storage continues to grow and new systems provide on average
more than 5 GB of storage for each user's data, e-mail, and Internet downloads.
Storage of large amounts of information at the desktop level increases the
risk of security breaches by inviting unauthorized access, viewing and copying
of confidential information, and access to network information during the many
times a user is away from his or her desk, including lunch breaks or meetings.
Moreover, organizations are moving to expand sharing of desktop PCs by
employees, particularly in functions that require 24-hour service. Shared PCs
are found often in service bureaus, call center operations, government and
education agencies, libraries, and the home. Protecting an individual user's
data and PC settings and configuration is critical, especially in a shared PC
environment.
THE CITADEL SOLUTION
The Company's current line of software products addresses computer security
and administration problems at both the network and desktop levels. Key features
of the Company's products include:
o Integrated Product Capabilities. The Company's integrated security and
administration solution enables a network administrator from a single
console to automatically shutdown and restart in an orderly manner servers
and desktop units in the event of a network crash, control access to
network resources, log off inactive desktop users and save all desktop work
in progress, and automate routine network maintenance tasks.
o PC Configuration Protection. The Company's solution also enables individual
PC users, particularly those who share a desktop unit with a co-worker or
other students, to protect their PC configurations and data.
o Enhanced Customer Productivity. The Company's products are designed to
improve overall office productivity, particularly by reducing the direct
and indirect costs of network operations by reducing (i) the personnel
resources required to administer the network, (ii) the disruption
(including data loss) caused by network crashes, (iii) software license
fees charged to inactive users, and (iv) unauthorized use of network and
desktop resources.
o Ease of Use, Optimized Products for Leading Technologies. The Company's
products are easy for a customer to install and are fully compatible with
the major network and desktop operating systems, including Windows NT,
NetWare, and Windows 3.1 and 95. The intuitive look and feel of the
products' graphical user interface ("GUI") enhances their usability.
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o Modular Product Design. The Company's programs can be added on a
plug-and-play basis to the Citadel Network Administrator - a centralized
program manager included with all Citadel network products. This modularity
provides a migration path for network administrators. As their network
security and administration needs become more complex, they can utilize
more of the Company's products and operate them all through an existing,
familiar program manager.
o 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 networks.
CITADEL PRODUCTS
NetOFF. NetOFF is designed to protect a network by shutting down unattended
client PCs automatically after a specified period of inactivity or at a
designated time. Network administrators may also use NetOFF to shut down such
PCs to complete a clean backup. The product ensures an orderly shutdown by
automatically closing all open files and applications on the PC and saving the
information. NetOFF is available for the Windows NT and NetWare platforms and
supports Windows 3.1, 95, 98 and NT desktop PCs. The benefits of NetOFF include:
o Enhancing Overall Computer Security - Unattended desktop PCs subject the
network and PC to a heightened risk of data theft. NetOFF protects
confidential files and information by loading a password protected
screensaver and logging off the unattended PCs, thus shutting off access to
PC hard drives and the network.
o Facilitating Clean Back-Ups - To protect important information, almost
every company employs a back-up system. The back-up system is a magnetic
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 restored in
a relatively short time, saving the company the time and effort necessary
to attempt to reconstruct lost data and files. The back-up system, however,
backs up only closed files. If a PC is logged on during the process, data
in open files can be corrupted or omitted from the back-up tape. NetOFF
eliminates these problems by automatically logging off network client
stations at a time pre-selected by the network administrator.
o Conserving Resources - Software license fees are often based on the number
of actual users of the licensed product. Many companies pay excess license
fees for programs that are left open on unattended computers. NetOFF helps
customers reduce costs by logging off unattended PCs.
FolderBolt. FolderBolt provides desktop users, particularly users in a shared
desktop PC environment, such as education, with several tools to protect
proprietary information. Users can protect groups of directories, individual
directories, or files by designating them as locked or read-only protected or as
a secure drop box. Optional data encryption adds another layer of security
against more sophisticated intruders. Users are able to send self-extracting
encrypted e-mails within the company or across the Internet. FolderBolt is
available for Windows 3.1, 95 and 98 and Macintosh. A Windows 95 version of
FolderBolt was released in September 1998, and an NT version is expected to be
released in the fourth quarter of fiscal 1999.
WinShield. WinShield is designed to address the problems that arise when users
share desktop PCs in work environments such as schools, libraries, home,
government offices, and resource centers such as Kinko's and AlphaGraphics. The
product enables a network administrator (or in a smaller office, individual
users) to establish different profiles for different users that can only be
modified by the administrator. These profiles include desktop appearance,
configuration, and initialization, as well as restrictions on
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user access to various PC and network resources (including hard drives,
diskettes, CD-ROMs, printers, Internet access, etc.). The same desktop PC can
then toggle between several user profiles.
WinShield prevents deliberate or accidental configuration changes that can
disrupt use of a desktop PC, abuse of PC or network resources (such as
unauthorized Internet surfing or installation of unauthorized software), and
interception or alteration of proprietary information. The user can govern
access to CD-ROM or disk drives and control the specific CDs that can be used.
WinShield is currently available for Windows 3.1, 95 and 98. A Windows NT
version and a server-controlled version was released in June 1998. The product
has been included in Compaq's and Microsoft's software bundles for the
educational market and has been a feature product of the month on Microsoft's
website and is sold through Best Buy, Office Max and other retail outlets.
Crash Protection and Recovery System ("CPR"). CPR for NetWare 3.X and higher
operating systems was released in April 1998. The Company expects to release its
Windows NT version of CPR during the fourth quarter of fiscal year 1999. CPR
enables the fully unattended shutdown and restart of servers and desktop PCs in
the event of a computer network crash or other catastrophic event, such as a
power outage. CPR is an integrated package combining four of the Company's
products - NetOFF, Server Sentry, Phantom of the Console, and Server Cam. These
modules operate under a centralized program manager - Citadel Network
Administrator. Together, the modules (i) detect fatal server problems, (ii) shut
down the servers and logoff individual desktop PCs in an orderly manner, (iii)
keep a record of the network disruption for later analysis, and (iv)
automatically restart the server. CPR initiates and manages the network recovery
process in a comprehensive manner - from the first sign of a problem through
crash analysis - and thus enables the administrator user to reduce downtime and
determine what caused the network to crash. CPR minimizes network downtime and
the attendant problems of a network crash, such as data loss.
Server Sentry. The Company believes Server Sentry is the first network
protection product that automatically restarts the network server in the event
of a crash. Server Sentry automatically notifies network personnel, produces
downtime reports, and captures information to enable the network administrator
to avoid recurrences. Server Sentry is available for NetWare 3.x and higher. A
Windows NT version is being developed with an expected release date in the
fourth quarter of fiscal year 1999.
Phantom of the Console. Phantom operates as a "virtual administrator,"
automating specified daily server tasks for network file servers, thus
permitting network administrators to increase LAN productivity. The product
automatically executes commands and runs programs at any set time, day or night,
without the need for an administrator at the console. Phantom preserves server
cache memory and improves overall server performance by scheduling the
unloading, loading, and execution of network loadable modules. Phantom is
available for NetWare 3.x and higher. A Windows NT and 95 version is being
developed with an expected release in the fourth quarter of fiscal year 1999.
Server Cam. Server Cam emulates a time-lapse video recorder connected to the
network server console. Server Cam captures events as they occur, which helps
network personnel to recreate and investigate the events leading to a crash.
Server Cam is available for NetWare 3.x and higher.
C:\More! C:\More!, which began shipping in January 1998, enables both
individual and networked computer users to quickly and easily locate all of
their computer files. The proliferation of storage alternatives, such as higher
capacity hard drives that can store gigabytes of information and high capacity
removable media such as ZIP, JAZ, Syquest and others, combined with dramatic
growth in the
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complexity and size of files to be stored as the use of graphics and other
storage-intensive capabilities grows, has led to users finding it more and more
difficult to find and access stored information.
Using advanced summarization technology licensed from the PARC
Laboratory-based Inxight Software division of Xerox, C:\More! automatically
scans and catalogs files from virtually all forms of computer storage media,
including hard drives; floppy, Iomega(TM), SyQuest(TM), and Imation(TM) disks;
and even CD-ROMs. It automatically creates and updates keywords, summaries, and
thumbnail images (for graphics files) and generates an index that the user can
later search when trying to locate and retrieve a particular file, even a file
stored on removable media not currently inserted in the drive. Text searches can
be conducted without opening files, and graphics files can be identified quickly
via thumbnail viewer. C:\More! also enables users to easily move many files from
different physical sources at one time onto a ZIP or other high capacity
removable medium to take home, take on the road, or share with others.
C:\More! provides cataloging assistance that has been available in the past only
to high-end users in the digital photography and desktop publishing industries
in products like Cantos and Extensis. The Company believes that C:\More!
provides much greater file/information capability than file-management utilities
from Symantec, Corel, and Claris, which only minimally enhance functions built
into Windows and other operating systems and applications. C:\More! has been
endorsed and approved as an Iomega-ready software product. C:\More! is currently
available for Windows NT and 95 and is sold through Best Buy, Office Max and
other retail outlets.
Citadel Secure Desktop ("CSD"). Expected to begin beta testing during the fourth
quarter of fiscal year 1999, CSD is being jointly developed by the Company and
Millennium. Combining technologies from both companies, the Company believes
that CSD will create the most secure Windows desktop PC operating environment
commercially available. CSD will be positioned and marketed to large
corporations running large heterogeneous networks combining mainframes,
minicomputers, LAN/WAN servers, and desktop client PCs. Key features will
include single sign-on, idle logoff (utilizing NetOFF technology), desktop
configuration (utilizing WinShield technology), file and folder encryption
(using FolderBolt technology), and a customizable GUI shell.
Other Citadel Products. Additional Company products include: (1) Tabworks, a
personal document management tool for computers using Windows 95 and 3.1
operating systems; (2) NetConsole, which is designed to automate input tasks at
the server console so that commands can be scheduled at an unattended server;
(3) NetPurge, which automatically searches for old or unused files and moves
them to archival storage; (4) NetQ, which enables network users to manage
facility queues, such as those for printing, archiving, or custom applications;
and (5) NetWatch, which detects and corrects unowned network files.
SALES AND MARKETING
With the introduction of new products, recruitment of senior software sales
personnel, and a revised sales model, the Company intends to leverage a broad
range of sales and marketing opportunities that will target direct and indirect
customers.
Sales
To address a broad range of sales and marketing opportunities, the Company,
in fiscal 1998, changed the focus of its selling efforts from a telemarketing
direct sales force to a multi-channel distribution strategy. The Company's
multi-channel sales strategy includes an enterprise sales group, OEM
distribution arrangements, VAR and dealer channels, direct sales channels,
strategic alliances with industry leaders, and trade shows.
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o Enterprise Sales Group and VARs. This direct sales group is responsible for
end users owning or operating large, sophisticated enterprise networks,
including corporations and educational institutions. These end users place
orders primarily for the Company's products and have a sales cycle from two
to six months depending on the size of the network and the resources they
have available for testing.
In addition to managing the Company's relationship with these end users,
the Enterprise Sales Group is responsible for recruiting and managing VARs
nationwide. Each sales person is responsible for developing relationships
with VARs and end users in their geographic territory. VARs and other
resellers broaden the Company's exposure to corporate and educational
accounts. VARs can purchase the Company's products through wholesale
distributors or directly from the Company, depending on their business
model. In January 1998, the Company's VAR authorization program was
launched. As of the end of November 15, 1998, the Company had approximately
70 VARs recruited.
The Company continues to work with a limited number of international
resellers for WinShield, C:\More!, NetOFF, Server Sentry, and Phantom of
the Console. In 1998, the Company entered into relationships with
distributors in the UK and Japan, that will enable the Company to penetrate
the UK, France, Germany, Spain, Italy and Japan markets.
o Direct Sales Group. This group, which is primarily composed of in-house
telemarketers, focuses on qualifying leads for the Enterprise Sales Group.
This function includes cold calls and follow-up calls from marketing events
and trade shows. The group does the majority of the prospecting and
qualifying of large deals, thus allowing the Enterprise Sales Group to
focus on closing the sale. The Direct Sales Group also closes sales on
small deals and inbound calls.
o Channel Group. This group focuses on retail accounts and on the wholesale
distributors, such as Ingram Micro and Tech Data, through which both VARs
and retail accounts source products. The group is also responsible for
sales and marketing events that are implemented in national retail chains
such as CompUSA. By leveraging the retail channel, the Company believes it
can effectively build brand recognition for the Citadel name and enhance
the market profile of its entire software product portfolio.
The Company currently has C:\More! WinShield, Folderbolt and
WinShield/Folderbolt Security Suite stocked in Office Depot, CompUSA,
Computer City, Micro Center, and Best Buy and is negotiating with office
super stores, mall chains, and other retail accounts. The Company is also
implementing indirect training programs with the sales representatives in
retail storefronts. These programs are managed via direct mail to store
locations from the Company's corporate office.
Marketing
The marketing department provides each of the sales groups with the tools
necessary to develop leads, inform prospective customers, and close sales. The
Company's marketing activities include direct mail to VARs and other resellers
as well as educational and corporate buyers, public relations via product
reviews, industry trade shows with trade show partners such as Iomega and
Novell, joint marketing with retailers, and Internet advertising. The Company's
product awareness advertising is combined with an aggressive public relations
campaign and advertisements targeted at resellers and vertical markets.
Since the Company has undergone significant changes through both acquisitions
and product updates, it was necessary during fiscal 1998 to develop new user
interfaces, packaging, literature, and collateral materials for each product.
These materials now give the Company's products a common look and feel
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<PAGE> 37
that serves to easily identify the Company's products at all levels, including
retail, reseller, and end user. This common look and feel also helps to raise
the Company's profile in the software industry and expand product cross-selling
opportunities. The marketing group also gathers specific information from
customers and sales representatives that is used to assess future market
opportunities and plan future products.
Business Development
The business development team's mission is to (i) increase market awareness of
the Company and (ii) identify additional channels and vehicles through which to
market the Company's products.
Business development has the lead in implementing the Company's plan to
systematically approach all PC OEMs, disk drive manufacturers, server
manufacturers, and removable storage media vendors regarding potential business
partnerships. The Company's existing strategic relationships with Novell,
Microsoft, Compaq and Iomega provide the Company with (i) valuable insight into
future developments in network and desktop operating systems and other
technologies, (ii) a higher market profile as the Company is invited to promote
and demonstrate its products at key industry trade shows and conferences, (iii)
access to top resellers in the Company's target market, and (iv) expanded
cross-selling opportunities. The Company's business development team expects to
derive similar benefits from new business partnerships.
PRODUCT DEVELOPMENT
The Company 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 or through its affiliation with Metamor, it may, based on
timing and cost considerations, acquire technologies or products from third
parties.
The Company's product development efforts are built around its analysis of
market opportunities. That analysis includes a review of existing or potential
competition by the developers of the key operating systems or other third-party
vendors. After an opportunity is identified, the business development team with
sales and marketing team input, prepares a Product Requirements Document ("PRD")
outlining the market opportunity and the product features needed to address it.
In developing new products, the Company strives to meet the following standards
in product development:
o Standards Compliance and Network Compatibility. The Company's products
comply with industry standards and are designed to be compatible with the
leading network and desktop PC operating systems, including Novell's
NetWare and Microsoft's Windows NT. To that end, the Company's products are
currently developed using Microsoft Visual C++ and Novell toolkits.
o Ease of Use. The Company's products are designed to function without
extensive and continual user involvement. The aim is to simplify, not
complicate, the user's work environment.
o Ease of Administration. The Company has extended its ease-of-use concept to
network administration with 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.
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o Cost Effectiveness. The Company provides products at a price and
performance level that the Company believes offer superior network and PC
security and administration options at affordable prices.
Schedules for the development of high technology products are inherently
difficult to predict, and there can be no assurance that the Company will
achieve targeted initial customer shipment dates for any of its products, or at
all.
The Company accounts for software development costs in accordance with SFAS No.
86 issued by FASB. Under this pronouncement the Company is required to
capitalize software development costs after technological feasibility of a
product is established and must cease capitalizing such costs when the product
is available for sale, lease or otherwise marketed. Capitalized costs are then
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 maintains a core software development staff at its corporate office
to maintain existing code bases and define the Company's approach in developing
new technologies and products to meet market opportunities. Once a product
design has been finalized, the actual final development work is either performed
in-house or outsourced to Metamor's software development operation, depending on
project scope and resource schedules. The Company anticipates that it will
continue to commit substantial resources to research and development in the
future.
The Company recently introduced C:\More!, WinShield NT and WinShield Network and
is in the beta testing on CPR-NT and FolderBolt for Windows 95 and NT. The
Company is currently in development on its Citadel Secure Desktop product.
Planned releases on all three products are scheduled for the third and fourth
quarters of the Company's 1999 fiscal year and in fiscal 2000. The Company also
intends, with its resources and the resources available to the Company from
Metamor, to introduce additional products and upgrades to existing products that
continue to address current and future end user needs.
CLIENT SUPPORT AND WARRANTIES
The Company believes that retention of customers is a key element of its future
success. Therefore, the Company is dedicated to the highest level of customer
support and satisfaction. The Company encourages its sales employees in their
interaction with a customer to be flexible and innovative to ensure that the
customer's needs are met. The Company's specialized information systems also
further the Company's customer service goals. They enable the Company's
employees to enter comments regarding a customer's order, as well as comments
regarding feedback, both positive and negative, from the customer. 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.
The Company's products are generally warranted to be free of defects in
materials and workmanship for 90 days. The Company offers yearly maintenance
contracts on most of its software and basic technical support and replacement
of defective media.
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<PAGE> 39
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, the Company 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 educational
markets, and there appears to be a strong need for the Company's products within
these market segments. There are no assurances that these companies will
continue to utilize the Company's products in the future.
COMPETITION
The security and administration software industry is intensely competitive and
rapidly changing. The Company competes against large companies (such as
Microsoft, Novell, Computer Associates, McAfee, Symantec and others) that offer
network and desktop PC security and administration software as a segment of
their businesses. The Company also competes with a large number of small
companies that offer security and administration software for networks and
desktop PCs as a 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 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.
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 its products are
well positioned in the market and that it has targeted promising niche
opportunities.
An example of such strategic niche targeting is the Company's CPR product. Most
software developers have focused on high-level network management and disaster
recovery (i.e., backup and restore) products. On the high-end of network
management, IBM, Computer Associates, and Hewlett-Packard fight for market
share. Their products focus on managing the installation, setup, and day-to-day
operations of large heterogeneous networks. On the lower end, companies like
Intel, Seagate, Symantec, and McAfee have products that focus on data backup
and recovery, software distribution and metering, auditing, anti-virus and PC
system repair. CPR targets a need that to date has not been addressed --
unattended detection, evaluation, and resolution of network server problems and
failures. Although some of CPR's features can be found in other network
products, those products require manual intervention by network administrators,
rather than 24 hour a day automatic supervision of the network.
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Many of the Company's current and potential competitors have significantly
greater financial, technical, marketing and other resources than the Company.
As a result, they may be able to respond more quickly to new or emerging
technologies and changes in customer requirements, or to devote greater
resources to the development, promotion, sale and support of their products
than the Company. The Company also expects that competition will increase as a
result of future software industry consolidations, which have occurred in the
past. In addition, current and potential competitors have established or may
establish cooperative relationships among themselves or with third parties.
Accordingly, it is possible that new competitors or alliances among competitors
may emerge and rapidly acquire significant market share. In addition, network
and desktop PC operating system vendors could introduce new or upgrade existing
operating systems or environments that include security and administration
functionality offered by the Company's products, which could render the
Company's products obsolete and unmarketable. There can be no assurance that
the Company will be able to compete successfully against current or future
competitors or that competitive pressures faced by the Company will not
materially adversely affect its business, operating results and financial
conditions.
INTELLECTUAL PROPERTY
Purchased and Internally Developed Proprietary Technology.
During the course of calendar year 1996, the Company acquired several products
(generally through the purchase of other companies) with the aim of using the
base proprietary technology within each product to create a new class of
utility software. These product acquisitions included:
o Server Sentry
o Phantom of the Console
o Server CAM
o WinShield
o FolderBolt
In addition to these acquisitions, the Company also acquired licenses for other
important technologies which are embedded in C:\More!, the Company's solution
for cataloging and file retrieval in a multiple storage media.
C:\More! also incorporates a Company-developed robust search and retrieval
engine that ultimately will be available for use by other application
developers. The engine will allow developers to access cataloged information
directly from the Microsoft Office products as well as prevalent programming
languages such as C/C++, Visual Basic, and Java.
The Company's networking products are based upon proprietary technologies that
provide a core set of common user interface objects and libraries. This core
set is known as the Citadel Administrator Framework ("CAF"). CAF enables the
Company to produce new products or conform new acquisitions for the Windows
32-bit environment in a fraction of the time normally spent developing user
interfaces. For example, a product that needs to include network features can
be compiled in such a way that the simple inclusion of a single Windows dynamic
link library will allow it to communicate within heterogeneous network
environments such as Novell NetWare and Microsoft Windows NT.
The Company has developed proprietary technology and expertise to manage
crashes on Novell or NT servers. To automate the response to these events, the
Company has developed the Citadel Server Crash Applications Programming
Interface ("API"). This API enables Server Sentry to intercept and document
many of the common causes behind server crashes and delay or even prevent the
crashes from occurring in the first place.
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The core of NetOFF is the Company's proprietary Citadel Workstation Shutdown
Technology ("CWST"). CWST automatically shuts down and saves all work in
progress on a PC. CWST can be modified by the user to shut down new
applications, or the user can rely on CWST's built-in advanced application
identification capability.
To assist in its automation efforts, the Company has developed a portable
scripting language and execution tool that can run on Microsoft NT Server, NT
Workstation, Windows 95, Windows 98, and Novell NetWare servers. This technology
is currently the basis for Phantom of the Console. The scripting language can
also be launched by other applications and programming languages installed on
the same computer.
The Company is well prepared to develop new products as encryption becomes an
increasingly used tool in providing security in the distributed computing
environment. The Company's dynamic modular approach to encryption applications
supports its own proprietary encryption algorithms as well as other encryption
methods available in the marketplace. Where secure access is a concern,
WinShield contains proprietary components such as the WinShield Extensible
Platform, which allows users to specify additional features not found in
WinShield as initially installed, such as blocking a specific menu from within
a specific application.
Intellectual Property Rights.
The Company regards certain features of its internal operations, software and
documentation as its 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 a combination of copyright, trademarks, trade
secret laws, confidentiality agreements and other measures 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 November 18, 1998, the Company had 46 employees: 26 in sales and
marketing, 5 in product research and development, 3 in production and
operations, 5 in customer service and technical support and 7 in administration,
finance and MIS. The Company anticipates adding additional employees in sales,
marketing, and research and development as needs and resources dictate. The
Company's future success depends in significant part upon the continued service
of its key technical and senior management personnel and its continuing ability
to attract and retain highly qualified technical and managerial personnel.
Competition for such personnel is intense, and there can be no assurance that
the Company can retain its key technical and managerial employees or that it can
attract, assimilate or retain other highly qualified technical and managerial
personnel in the future. None of the Company's employees are represented by a
labor union. The Company has not experienced any work stoppages and considers
its relations with its employees to be good.
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GOVERNMENT REGULATION
Government regulation has not had a material effect on the Company's conduct of
its business to date.
LITIGATION
A former employee of LoneStar Hospitality Corporation (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, were obligated to pay the exercise price for certain
stock options, and breached a purported agreement to register certain stock held
by the plaintiff. The plaintiff is seeking damages of approximately $2,300,000,
plus attorneys' fees, pre- and post-judgment interest and costs of the lawsuit.
The Company and the individual believe such claims are without merit and intend
to vigorously defend against the claims and are considering filing
counter-claims. The Company has filed an answer in the case, styled Heredia v.
Citadel, et. al., in the 298th Court of Dallas County, Texas. In September 1998
the plaintiff amended his complaint to allege securities fraud claims and to
seek punitive damages. The trial was postponed in September 1998 until late 1998
or early 1999.
Two former employees of the Company have lawsuits pending against the Company
demanding payment of a promissory note issued in connection with the acquisition
of Kent-Marsh and Astonishing Developments, Inc. and are seeking damages in
excess of $400,000. The Company reached a settlement with one of the employees
under the terms of a promissory note and agreed judgment. The court severed the
claims of the remaining party, who amended his claims to include amounts
allegedly owing under an employment agreement (total of revised damages in
excess of $475,000). The Company recently settled this lawsuit in consideration
for $140,000 payable over seven months commencing December 1998, plus 220,000
shares of Common Stock which are included in this offering. The Company also
entered an agreed judgment in the amount of $294,000 which may be filed by the
plaintiff in the event of default by the Company in its payment obligations or
if the plaintiff realizes less than agreed amounts on the sale of the shares.
The case was styled Nesbitt & Wesolek v. Citadel, in the 193rd District Court
of Dallas County, Texas.
On January 7, 1998, the Company's former Houston landlord filed a lawsuit
against the Company, styled Lehndorff Four Oaks Place Joint Venture v. Citadel,
in the 11th Judicial District Court of Harris County, Texas, alleging that the
Company breached a certain lease covering the Company's former Houston office
space. The suit seeks damages to date of approximately $180,000, plus
attorney's fees, pre- and post-judgment interest and court costs. The Company
believes that it has viable defenses against such a claim and is in the process
of filing a counter-suit against the plaintiff.
The Company and its president are involved in an arbitration proceeding, styled
Vestcom Ltd. v. Citadel Computer Systems Incorporated before the American
Arbitration Association in Los Angeles, California. Vestcom claims it is
entitled to compensation and a finder's fee for introducing the Company to a
third party and is seeking damages of $100,000 in shares of the Company's
Common Stock plus 50% of additional consideration paid by the Company to such a
third party. The Company and its president believe they have defenses to such
claim. Vestcom agreed to stay the arbitration proceeding pending a decision on
one of the Company's defenses in Texas state court. The case is styled Citadel
Computer Systems Incorporated and Steven B. Solomon v. Vestcom, Ltd., in the
193rd Judicial District Court in Dallas County, Texas. In June 1998, the Texas
state court made an oral ruling in favor of the Company and its president that
the purported agreement was a forgery. In the event the court issues a written
opinion in accordance with its oral ruling, the arbitration proceedings should
be permanently enjoined. The Company intends to vigorously defend against the
claim.
In September 1998, the Company settled a lawsuit styled Marks, Marks, Ranshaw,
Colquit & Lauratis v. Citadel Computer Systems Incorporated, et al., in the
189th Judicial Court of Harris County, Texas for $25,000 cash plus the
extension of the plaintiffs' options to purchase 207,088 shares of Common Stock
and the Company's agreement to register the shares underlying these options. The
lawsuit was filed by former employees who alleged that the company and/or the
individual defendants owed the plaintiff's damages, attorney's fees, pre- and
post judgment interest and costs allegedly in excess or $4,000,000.
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In August 1998, Janssen Meyers Associates, L.P. ("JM") filed a lawsuit against
the Company. The suit alleges that the Company owes the plaintiffs fees in the
amount of approximately $16,750,000 plus interest and attorney's fees in
connection with services allegedly performed by JM in respect of the merger
between LoneStar and Old Citadel and related matters. The Company believes such
claims are without merit and intends to vigorously defend against the claims.
The lawsuit, styled Janssen Meyers Associates, L.P. v. Citadel Technology,
Inc., was filed in the Supreme Court of the State of New York, County of New
York. The Company has removed the case to federal court in the Southern District
of New York.
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. Adverse judgements,
settlements, or costs in defending such suits could have a material adverse
effect on the Company's financial condition and results of operations.
The Company and the Company's senior management are, and may in the future be,
involved in other suits and actions incidental to the Company's business. The
Company does not believe that the resolution of any of the other current suits
or actions will result in any material adverse effect on the financial condition
or operations of the Company.
FACILITIES
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.
Citadel's facilities are located in Dallas, Texas, where the Company leases
approximately 14,500 square feet. The Company occupies such premises under a
lease that expires in 2002. The Company believes that suitable space will be
available in such locations as required. See Note J to the Company's
Consolidated Financial Statements.
MANAGEMENT
DIRECTORS
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 elected and qualified.
<TABLE>
<CAPTION>
NAME AGE POSITION WITH CITADEL DIRECTOR SINCE
- ---- --- --------------------- --------------
<S> <C> <C> <C>
Victor Kiam, II 72 Chairman of the Board 1996
Steven Solomon 34 President, Chief Executive Officer,
and Assistant Secretary 1992
Mark Rogers 39 Director 1996
Kenneth Johnsen 44 Director 1997
Chris A. Economou 43 Director 1993
Axel Sawallich 54 Director 1993
Michael Ruff 22 Director 1998
Gilbert Gertner 74 Director 1992
</TABLE>
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VICTOR KIAM, II has served as a director of the Company since July 1996 and has
served as Chairman of the Company since January 1998. 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, and has served in various managerial capacities at Remington since
1979. From 1988 to 1992, Mr. Kiam was Chairman of the New England Patriots
Football Team. Mr. Kiam also serves on the boards of directors of several other
consumer product companies (including Cirrus Air Technologies, Inc., a
manufacturer and distributor of products for travelers), has written several
books, sits on the boards of numerous charitable, sales and civic
organizations, and has received many awards for his marketing expertise.
STEVEN SOLOMON has served as the President and Chief Executive Officer of the
Company since May 1997, and as a director of the Company or its predecessors
since February 1992. From February 1996 through April 1997, Mr. Solomon served
as Chief Operating Officer of the Company. He was the president and a director
of LoneStar Hospitality Corp. ("LoneStar"), a predecessor of the Company that
owned and operated six Miami Subs franchised restaurants in Dallas and Houston,
Texas, from its inception in February 1992 until its merger with the Company
(the "Merger") in February 1996 and was chairman of the Board of Directors of
LoneStar from December 1994 until February 1996. During his tenure at LoneStar,
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 other collegiate and professional sports.
MARK ROGERS has served as a director of the Company since July 1996. Since
1989, Mr. Rogers has managed NFT Ventures, Inc., a venture capital fund
established by Ray Noorda, the founder of Novell, Inc. In connection with his
position at NFT Ventures, Mr. Rogers advises several computer software
companies in Silicon Valley, Texas and Utah, with respect to various strategic
and developmental matters. Mr. Rogers also serves on the boards of directors of
several other high-tech companies.
KENNETH JOHNSEN has served as a director of the Company since October 1997. Mr.
Johnsen is president of Metamor Solutions, the information technology services
division of Metamor Worldwide, Inc. (formerly CORESTAFF, Inc.) ("Metamor"), and
is an executive vice president and director of Metamor, one of the largest
providers of information technology and staffing services in the U.S. From 1975
until joining Metamor in May 1997, Mr. Johnsen was employed with IBM Corporation
in various managerial capacities, including Vice President of Worldwide
Commercial Operations for IBM PC Company from January 1997 to May 1997, Vice
President, Business Services and Business Development for ISSC, IBM's
outsourcing subsidiary, from January 1994 to December 1996 and General Manager
of IBM China/Hong Kong from September 1991 to December 1993. The Company and
Steven B. Solomon are parties to an agreement to use their best efforts to
nominate and elect a representative designated by Metamor to the Company's Board
of Directors at all annual or special stockholder meetings at which directors
are being elected until such time as Metamor is the beneficial owner of less
than two percent (2%) of the Company's then outstanding stock.
CHRIS A. ECONOMOU has served as a director of the Company since February 1996,
and was a director of LoneStar from June 1993 until the Merger. He has been
engaged in the private practice of law in Fort Lauderdale, Florida, primarily in
the transactional and corporate areas since 1988. He served as executive vice
president, secretary and general counsel of Miami Subs Corporation from August
1992 until June 1994 and director from 1989 to 1994.
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DR. AXEL SAWALLICH has served as a director of the Company since February 1996
and was a director of LoneStar from March 1993 until the Merger. Since January
1997, Dr. Sawallich has been chief investment consultant for LIFEPLAN
Investments, Vienna, Austria. Since 1993, he has been the managing partner of
Global Invest, an investment firm located in Vienna, Austria. From 1991 until
1994, he also was a consultant for Serco Investment Counseling Corporation.
From 1989 to 1990, Dr. Sawallich was the general manager and director of the
Vienna regional branch of Allgemeine Sparkasse Bank AG. From May 1985 to
November 1989, Dr. Sawallich was with Bank fuer Arbeit und Wirtschaft AG,
Vienna, 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 has also been acting as an independent, publicly
certified, investment advisor since 1993.
MICHAEL RUFF has served as a director of the Company since July 1998. Mr. Ruff
has served as chairman of the board of directors of Texas Central Bank, N.A.,
since February 1998, and as a member of the board of directors of the bank
since December 1995. Mr. Ruff has served as president of Lennox Properties
Inc., a real estate development company specializing in single and multi family
developments in Dallas, Colorado Springs and Atlanta, since June 1997 and as
vice president since June 1995. Mr. Ruff is president of Icarus Investments,
Inc. (formerly ALR, Inc.), a non-diversified hedge fund specializing in public
securities investments. Prior to his appointment as President of Icarus in
August 1996, he served as vice president since August 1994. Mr. Ruff received
his degree in economics from Rice University.
GILBERT GERTNER has served as a director of the Company since February 1996 and
served as Chairman of the Company from February 1996 until January 1998, and
was chairman of Citadel's predecessor ("Old Citadel") from its inception in
July 1992 until the Merger. Since 1992, Mr. Gertner has been a principal and
the president of Gertner Investments, an investment firm specializing in
capitalizing and assisting management in the development of high-tech
companies. Mr. Gertner serves as a director of CXR Telecom Corp. 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.
There are no family relationships among any of the directors or executive
officers of the Company. See "Certain Relationships and Related Transactions"
for a description of transactions between the Company and its directors,
executive officers or their affiliates.
EXECUTIVE OFFICERS
The following sets forth certain information regarding other significant
employees of, and consultants to, the Company:
<TABLE>
<CAPTION>
NAME AGE POSITION WITH CITADEL
- ---- --- ---------------------
<S> <C> <C>
Steven B. Solomon 34 President, Chief Executive Officer,
Assistant Secretary and Director
Richard L. Travis, Jr. 42 Chief Financial Officer, Chief Operating
Officer and Secretary
Carl E. Banzhof 33 Chief Technology Officer
Bennett Klein 43 Vice President of Business Development
Jack Doxey 32 Vice President of Marketing
Alex London 52 Vice President of Sales
</TABLE>
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Information concerning the business experience of Mr. Solomon is provided under
the caption "Directors" above. Set forth below is information concerning the
business experience of the other executive officers of the Company.
RICHARD L. TRAVIS, JR. has served as Chief Financial Officer since he joined
the Company in December 1996, as Chief Operating Officer since April 1997, and
as Secretary since January 1998. He has approximately 20 years of financial
experience in the manufacturing, financial services, real estate, construction
and telecommunications industries. Prior to joining Citadel, 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.
CARL E. BANZHOF has served as Chief Technology Officer since July 1997, prior
to which he served as Vice President - Development of Network Products since
joining the Company in February 1996. 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 and vice president of software engineering
from 1992 to 1995 of Circuit Masters Software, Inc., a software company which
developed and marketed network management utilities for Novell NetWare
environments, and was acquired by the Company in February 1996. 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.
BENNETT KLEIN has served as Vice President of Business Development since
January 1998. Prior to joining the Company, Mr. Klein was employed at Iomega
Corporation, where he was part of the original marketing team that successfully
brought the JAZ and ZIP removable storage media to the mass market. He has
approximately 15 years experience in OEM development and sales and marketing,
including experience with such industry leaders as Cheyenne Software, where he
was product line manager helping to market their premier network storage
management product line, and IBM, where he focused on sales and marketing of
mass storage, network management, telecommunications, telephony and optical
storage solutions.
JACK W. DOXEY served as Vice President of Sales and Marketing from November 1997
until May 1998. Mr. Doxey rejoined the Company in August 1998 as its Vice
President of Marketing. Mr. Doxey has 10 years experience in the field of
software sales and marketing including extensive work in the retail and VAR
channels of distribution. From November 1996, until October 1997 he served as
Vice President of Sales and Marketing for Visual Applications, a privately held
software manufacturer based in Kansas City, Missouri. From March 1995 until
November 1996, Mr. Doxey served as an independent sales and marketing consultant
to software and hardware manufacturers including: Attachmate, MicroHelp, Eicon
Technologies, Penumbra, and smaller start-up manufacturers. From September 1994
until March 1995, he helped found MindShare Associates, an out-source marketing
company for software and hardware manufacturers, where he served as a Vice
President. From July 1993 until September 1994, he managed the retail channel
marketing efforts for DCA in Alpharetta, Georgia. From August 1989 until July
1993, he served as a regional manager for Technology Advancement Corporation, an
out-source marketing firm in Utah, where he established regional operations in
the Southeast, Southern California, and London, England.
44
<PAGE> 47
ALEX LONDON has served as Vice President of Sales since joining the Company in
August 1998. Mr. London has over 15 years experience in the software sales in
companies of all sizes, from start-ups to large publicly held companies. From
1997 to 1998, Mr. London served as a sales manager for Digital Equipment Corp.
From 1995 to 1997, he served as a sales manager for Simpact Inc., a specialized
protocol software and tools company. In 1994, Mr. London served as education
market manager for Cisco Systems, Inc. From 1990 to 1993, he served as vice
president of sales for Network Management Services, a network services company.
BOARD OF DIRECTORS
The Board of Directors of the Company is composed of eight directors.
All directors hold office until the next annual meeting of stockholders or until
their successors are elected and qualified. Subject to the terms of their
employment agreements, if any, officers serve at the discretion of the Board of
Directors.
DIRECTORS' COMPENSATION
The Company's directors do not receive cash compensation for
attendance at Board of Directors or committee meetings, but may be reimbursed
for certain expenses in connection with attendance at Board and committee
meetings.
45
<PAGE> 48
COMPENSATION OF EXECUTIVE OFFICERS
The total compensation for the three fiscal years ended February 28, 1998, for
George Sharp, the Company's former Chief Executive Officer; Steven Solomon, the
Company's current Chief Executive Officer (and the chief executive officer of
LoneStar prior to the Merger); Richard Travis, the Company's Chief Operating
and Financial Officer; and Carl Banzhof, the Company's 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
$100,000 during the fiscal year ended February 28, 1998.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
NUMBER OF
RESTRICTED UNDERLYING ALL OTHER
FISCAL SALARY BONUS STOCK AWARD SHARES COMPENSATION
NAME AND POSITION (S) YEAR ($) ($) ($) (#) ($)
-------------------- ------ ------- ------- ----------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C>
George Sharp 1998 0 0 0 0 200,000 /1/
former Vice Chairman 1997 150,000 42,727 0 0 11,400 /1/
and President 1996 * 20,833 0 0 0 0
---- ------- ------- ------ ------ ------
Steve Solomon
President, Chief 1998 135,000 104,000 /2/ 0 0 19,742 /2/
Executive Officer 1997 120,000 66,496 0 0 18,846 /2/
and Asst. Sect'y 1996 + 110,000 0 0 0 13,150 /2/
---- ------- ------- ------ ------ ------
Richard Travis
Chief Operating 1998 130,000 10,000 20,000 /3/ 70,000 /3/ 14,952 /3/
and Financial 1997 29,791 /3/ 0 0 2,650 /3/
Officer and Sect'y 1996 0 0 0 0 0
---- ------- ------- ------ ------ ------
Carl Banzhof 1998 100,625 500 0 0 0
Chief Technology 1997 103,228 1,000 0 0 0
Officer 1996 15,600 /4/ 0 0 0 0
---- ------- ------- ------ ------ ------
</TABLE>
* Transition period
+ April 1, 1995 - February 29, 1996
/1/ Mr. Sharp received $200,000 as consideration for agreeing to terminate his
noncancellable employment contract. This amount was applied against amounts due
the Company from a certain joint venture in which Mr. Sharp was a partner - see
"Employment and Termination of Employment Arrangements" and "Certain
Relationships and Related Transactions." Mr. Sharp received a car allowance of
$950 per month during the fiscal years 1997 and 1998 (through April 1997). Mr.
Sharp ended his employment with the Company as part of the Company's
restructuring in April 1997.
/2/ In connection with a discharge of a certain indebtedness, Mr. Solomon
forgave $79,000 in accrued compensation due him - see "Certain Relationships
and Related Transactions." Mr. Solomon received a car allowance of $950 per
month and life and disability insurance during fiscal years 1997 and 1998. Mr.
Solomon received a car allowance of $650 per month from March 1, 1995 through
June 30, 1995 and $950 per month after July 1, 1995, and life and disability
insurance during the fiscal year ended February 29, 1996.
/3/ Mr. Travis received a car allowance of $950 per month for fiscal years 1997
(December through February 1997) and 1998. In connection with Mr. Travis's
employment agreement Mr. Travis can elect to receive Company stock in-lieu of
certain stipulated raises based on the closing bid price of the Company's
Common Stock as of such date. Mr. Travis so elected this option during the
fiscal year ended February 28, 1998, and in connection therewith received
70,000 shares of the Company's common stock. Mr. Travis commenced employment
with the Company in December 1996.
/4/ Mr. Banzhof started to work for the Company in December 1995.
46
<PAGE> 49
OPTION GRANTS DURING 1998 FISCAL YEAR
The following table contains information concerning stock option grants made to
each of the Named Officers for the fiscal year ended February 28, 1998. No
stock appreciation rights were granted to these individuals during such year.
Mr. Sharp did not receive any stock option grants during the year and as such
has not been included in the table.
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE VALUE
AT ASSUMED ANNUAL RATES OF
STOCK PRICE APPRECIATION
INDIVIDUAL GRANTS /1/ FOR OPTION TERM /2/
- ------------------------------------------------- ---------------------------
NUMBER OF PERCENT OF
SECURITIES TOTAL OPTIONS/
UNDERLYING SARS GRANTED EXERCISE OR
OPTIONS/SARS TO EMPLOYEES BASE PRICE EXPIRATION
NAME GRANTED (#) IN FISCAL YEAR ($ / sh) DATE 5% ($) 10% ($)
---- ------------ --------------- ----------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Steven Solomon 1,000,000 17.5% .25 7/15/07 $ 157,224 $ 398,436
1,000,000 17.5% .25 7/15/07 157,224 398,436
- -------------- ------------ --------------- ----------- ------- --------- ---------
Richard Travis 650,000 11.4% .20 7/15/07 $ 81,756 $ 207,187
500,000 8.7% .35 6/01/07 110,057 278,905
- -------------- ------------ --------------- ----------- ------- --------- ---------
Carl Banzhof 100,000 4.0% .25 7/15/07 $ 15,722 $ 39,844
- -------------- ------------ --------------- ----------- ------- --------- ---------
</TABLE>
/1/ The options disclosed in the table were granted on July 16, 1997, with the
exception of Mr. Travis's 500,000 options which were granted on June 1, 1997.
The exercise price for each option may be paid in cash, in shares of common
stock valued at fair market value on the exercise date or through a cashless
exercise procedure involving a same-day sale of purchased shares. The Company
may also finance the option exercise by loaning the optionee sufficient funds
to pay the exercise price for the purchased shares. Of Mr. Solomon's and Mr.
Travis's options, 1,000,000 and 650,000 respectively, were fully vested as of
the date of grant, and options for 1,000,000 and 500,000 options, respectively,
were granted in connection with their employment agreements. These options vest
at 250,000 and 125,000 shares per year, respectively, commencing July 15, 1998
and June 1, 1998, respectively. Mr. Banzhof's options vested as follows: 50,000
on the date of grant, with the remaining 50,000 vesting on July 16, 1998.
/2/ The 5% and 10% assumed annual rates of compounded stock price appreciation
are mandated by rules of the Securities and Exchange Commission. There can be
no assurance provided to any executive officer or any other holder of the
Company's securities that the actual stock price appreciation over the life of
the options will be at the assumed 5% and/or 10% levels or at any other defined
levels. Unless the market of the Common Stock appreciates over the option term,
no value will be realized from the option grants made to the executive
officers.
47
<PAGE> 50
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES
The following table describes, for each of the Named Officers, options
exercised and the potential values for their unexercised in-the-money options at
February 28, 1998 (the Company issued no SARs during the year):
<TABLE>
<CAPTION>
NUMBER OF
SECURITIES VALUE OF
UNDERLYING UNEXERCISABLE IN-
UNEXERCISED THE-MONEY OPTIONS/
OPTIONS/SARS AT SARS AT FISCAL
FISCAL YEAR END YEAR END
($) ($) /2/
===================== =====================
SHARES VALUE
ACQUIRED ON REALIZED EXERCISABLE/ EXERCISABLE/
NAME EXERCISE (#) ($) /1/ UNEXERCISABLE UNEXERCISABLE
- --------------- ------------ --------- --------------------- ---------------------
<S> <C> <C> <C> <C>
George Sharp 0 0 1,462,500 / 0 $ 0 / 0
- --------------- ------------ --------- --------------------- ---------------------
Steven Solomon 400,000 $ 68,000 2,175,000 / 1,000,000 $ 304,500 / 140,000
- --------------- ------------ --------- --------------------- ---------------------
Richard Travis 50,000 20,000 600,000 / 500,000 $ 114,000 / 20,000
- --------------- ------------ --------- --------------------- ---------------------
Carl Banzhof 0 0 50,000 / 50,000 $ 7,000 / 7,000
- --------------- ------------ --------- --------------------- ---------------------
</TABLE>
/1/ Based on the market price at the date exercised less the exercise price
payable for each share.
/2/ Based on the fair market value of the Company's Common Stock at February 28,
1998 of $.39 per share less the exercise price payable for each share.
REPRICING OF OPTIONS
<TABLE>
<CAPTION>
SECURITIES LENGTH OF
UNDERLYING MARKET PRICE EXERCISE ORIGINAL OPTION
NUMBER OF OF STOCK AT PRICE AT TERM REMAINING
OPTIONS/SARS TIME OF TIME OF NEW AT DATE OF
REPRICED OR REPRICING OR REPRICING OR EXERCISE REPRICING
NAME DATE AMENDED (#) AMENDMENT AMENDMENT ($) PRICE ($) AMENDMENT
- ------------------- ------- ------------ ------------- ------------- --------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Steven Solomon -
President and Chief
Executive Officer 7/15/97 1,575,000 $.20 $.89 $.25 3 1/2 years
- ------------------- ------- ------------ ------------- ------------- --------- ---------------
Mark Rogers -
Director 7/15/97 400,000 $.20 $.89 $.40 3 1/2 years
- ------------------- ------- ------------ ------------- ------------- --------- ---------------
Victor Kiam -
Chairman 7/15/97 400,000 $.20 $.89 $.40 3 1/2 years
- ------------------- ------- ------------ ------------- ------------- --------- ---------------
Gil Gertner -
Director 7/15/97 1,000,000 $.20 $.89 $.40 2 1/2 years
- ------------------- ------- ------------ ------------- ------------- --------- ---------------
</TABLE>
In July 1997, following a significant decline in the market price of the
Company's stock, the board of directors of Citadel approved the reduction in the
exercise price of several outstanding options and warrants, held by certain
members of the board and employees, from their existing exercise price to either
$.25 per share (for employees) or $.40 per share (for directors).
The board approved the reduction in order to encourage these persons to
increase their investment in Citadel at a time when additional funds were needed
in connection with the operation and growth of the Company's business and to
enhance the Company's ability to retain the services of such individuals by
reducing the exercise price of the options closer to the then current market
price of the Company's common stock. Mr. Solomon and Mr. Kiam elected to
exercise options to purchase 400,000 shares and 200,000 shares, respectively.
The board approved the reduction in the exercise price of 1,000,000 options held
by Mr. Gertner, former chairman of the board, from $.89 to $.40 per share, at
the same time, in consideration of Mr. Gertner agreeing to forgive his
consulting contract - see "Employment and Termination of Employment
Arrangements" and "Certain Relationships and Related Transactions."
48
<PAGE> 51
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"), Messrs. Gertner and
Sharp agreed to the termination of their employment and consulting agreements.
The Company renegotiated Mr. Solomon's employment agreement as of July 15, 1997,
and entered into an employment agreement with Mr. Travis and Mr. Klein as of
June 1, 1997 and January 5, 1998, respectively. Each agreement provides for an
annual base salary and bonus to be awarded at the discretion of the Board. In
addition, each agreement provides for the payment of certain benefits in the
event of termination other than for cause and certain life and disability
benefits.
In July 1997, the Company and Mr. Solomon amended Mr. Solomon's employment
agreement. The Company entered into employment agreements with Mr. Travis and
Mr. Klein as of June 1, 1997 and January 5, 1998, respectively. Mr. Travis's
agreement provides for an initial annual base salary of $130,000 and bonuses to
be awarded at the discretion of the Board. Mr. Klein's agreement provides for an
annual base salary of $135,000 and bonuses to be awarded at the discretion of
the Board. In addition, each agreement provides for the payment of certain
benefits in the event of termination other than for cause and certain life and
disability benefits.
Mr. Solomon's employment agreement has an initial term that expires in
February 2002. It 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 of at least the amount of
the prior year's bonus at the discretion of the Board. The base salary was
$132,000 during the first five months of the employment agreement; $144,000
during the first full year; and $168,000 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 twenty four 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
lives of Messrs. Solomon and Travis, in addition to any key man life insurance
policy on Mr. Solomon maintained by the Company for its benefit. The Company is
to provide disability insurance for Mr. Solomon and Mr. Travis. The Company
shall provide each of Messrs. Travis and Solomon with an automobile allowance of
$950 per month and automobile liability insurance.
COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT
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"). Such persons 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 all filing requirements required by section 16 (a) for
fiscal 1998 applicable to such persons were complied with, except Messrs. Kiam
and Johnsen filed a Form 5 late (such Form 5s related to grants to, or
reductions in the exercise price of, options) and Messrs. Sawallich and Solomon
each filed one Form 4 late. Mr. Sawallich's Form 4 related to the sale of
securities and Mr. Solomon's related to the purchase of securities and each were
subsequently filed.
49
<PAGE> 52
LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS
The Company's Bylaws provide that the Company will indemnify its directors
and officers and may indemnify its employees and other agents to the fullest
extent permitted by law. The Company believes that indemnification under its
Bylaws covers at least negligence and gross negligence by indemnified parties,
and permits the Company to advance litigation expenses in the case of
stockholder derivative actions or other actions, against an undertaking by the
indemnified party to repay such advances if it is ultimately determined that the
indemnified party is not entitled to indemnification. The Company has in place
liability insurance for its officers and directors.
In addition, the Company's Certificate of Incorporation provides that,
pursuant to Delaware law, its directors shall not be liable for monetary damages
for breach of the directors' fiduciary duty as a director to the Company and its
stockholders. This provision in the Certificate of Incorporation does not
eliminate the directors' fiduciary duty, and in appropriate circumstances
equitable remedies such as injunctive or other forms of non-monetary relief will
remain available under Delaware law. In addition, each director will continue to
be subject to liability for breach of the director's duty of loyalty to the
Company for acts or omissions not in good faith or involving intentional
misconduct, for knowing violations of law, for actions leading to improper
personal benefit to the director, and for payment of dividends or approval of
stock repurchases or redemptions that are unlawful under Delaware law. The
provision also does not affect a director's responsibilities under any other
law, such as the federal securities laws or state or federal environmental laws.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers or persons controlling the
Company pursuant to the foregoing provisions, the Company has been informed that
in the opinion of the Securities and Exchange Commission, such indemnification
is against public policy as expressed in the Act and is therefore unenforceable.
The Company believes that its Certificate of Incorporation and Bylaw provisions
and indemnification agreements are necessary to attract and retain qualified
persons as directors and officers.
CERTAIN TRANSACTIONS
On August 11, 1998, the Company entered into a transaction with a
shareholder of the Company whereby the Company granted the shareholder certain
options to purchase shares of Common Stock of the Company and reduced the
exercise price on certain other options in consideration of the shareholder
assuming certain indebtedness of the Company. The transaction resulted in no
gain or loss to the Company. As of August 31, 1998, the Company has a
receivable from this individual in the amount of $325,000, which is secured by
750,000 shares of the Company's Common Stock.
The Company contracted with Metamor Software Solutions, a division of
Metamor, to provide various development services for the Company. The Company
incurred $112,629 in expenses related to these services during the fiscal year
ended February 28, 1998 and approximately $745,000 for the six months ended
August 31, 1998. Kenneth Johnsen, one of the Company's directors, is executive
vice president of Metamor. On October 6, 1997, the Company entered into a
Purchase Agreement with Metamor wherein Metamor purchased 2,500,000 shares of
Common Stock for $750,000, together with other valuable consideration. Pursuant
to the Agreement, Metamor received warrants to purchase 1,000,000 shares of the
Common Stock of Citadel at a purchase price of $4.00 per share and to purchase
1,000,000 shares of the Common Stock of Citadel at a purchase price of $5.00
per share for a ten-year term. On May 15, 1998, the Company and Metamor entered
into a Stock Purchase Agreement (the "Stock Purchase Agreement") pursuant to
which Metamor purchased 2,000 shares of Citadel's 11% Series D Convertible
Redeemable Preferred Stock for proceeds of $2,000,000. The preferred shares are
convertible into Common Stock of the Company at the election of the holder at a
conversion price equal to 150% of the twenty day average of the closing bid
price of the Company's Common Stock prior to the closing of the purchase ($1.07
per share). The preferred shares will automatically convert into shares of
Common Stock upon (i) the closing of an underwritten public offering that
values the Company at a minimum equity value of $20,000,000 with proceeds to
the Company of a minimum of $10,000,000 before expenses, or (ii) the date at
which the Company's Common Stock maintains a closing bid price that is 100%
greater than the conversion price for at least
50
<PAGE> 53
20 consecutive days. Beginning one year from the date of closing, the Company
may redeem all or part of the unconverted preferred shares based on a redemption
price equal to 120% of the issuance price if redeemed prior to two years after
the closing, 115% of the issuance price if redeemed prior to three years after
the closing, or 100% of the issuance price if redeemed prior to four years after
the closing.
On May 26, 1998, the Company and Icarus Investments I, Ltd. ("Icarus")
entered into a Stock Purchase Agreement pursuant to which Icarus purchased
2,000,000 shares of Citadel's Common Stock for proceeds of $2,500,000. Michael
Ruff, a director of the Company, is an affiliate of Icarus. In connection with
the transaction, the Company issued warrants to purchase 500,000 shares of the
Company's Common Stock at $4.00 per share and 500,000 at $5.00 per share. On
June 30, 1998, the Company and Icarus entered into a Stock Purchase Agreement
pursuant to which Icarus purchased 1,000,000 shares of Citadel's Common Stock
for proceeds of $1,500,000. In connection with the transaction, the Company
issued warrants to purchase 250,000 shares of the Company's Common Stock at
$2.00 per share and 500,000 at $3.00 per share.
In connection with a $1,125,000 8% redeemable convertible note offering
dated June 9, 1997, the Company's former chairman pledged stock of a company
controlled by him to secure the repayment of up to $500,000 of this
indebtedness. In connection with this pledge, the Company paid Mr. Gertner a fee
of $25,000. On February 15, 1998 the Company restructured this indebtedness and
in connection therewith Mr. Gertner's collateral was released.
In April 1997, the Company entered into an Asset Sale Agreement with
Messrs. Gertner and Sharp, two of the Company's directors at the time(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 $155,000 ($72,000 related to
the discharge of joint venture indebtedness discussed below). The carrying value
of the receivables at February 28, 1997, net of allowance, was $1,992,000.
Pursuant to the participation interest retained by the Company, 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 collection), in which case the Purchasers shall pay to Citadel 50%
of such amounts collected in excess of $2,250,000. Consideration received from
the Purchasers included 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 $2,147,500). The
shares acquired represented approximately 23% of the Company's then issued and
outstanding shares and are deemed treasury shares. The Company has not yet
canceled the shares from the Purchasers because the certificates had been lost
by the Purchasers, who have submitted lost stock affidavits to the Company's
transfer agent but have not paid the indemnity bond to effect the cancellation.
The transaction resulted in no gain or loss to the Company.
At various times during the year ended February 28, 1998, Messrs. Solomon
and Travis advanced funds to the Company to fund various short-term obligations
of the Company.
During the year ended February 28, 1998, the Company lent approximately
$122,000 to its Chief Executive Officer.
During the fiscal year ended February 28, 1998, the Company incurred legal
fees in the amount of $69,800 to Wood, Exall and Bonnet, L.L.P. David Wood, an
officer of one of the partners of such firm and former General Counsel of
Citadel, is the brother-in-law of Steven Solomon, Chief Executive Officer of the
Company. The Company has granted options to purchase up to 200,000 shares of
Common Stock to Mr. Wood.
51
<PAGE> 54
In December 1996, Worldwide PetroMoly, Inc., a company controlled by Mr.
Gertner, loaned Citadel the original principal amount of $500,000. In connection
with the loan, Citadel granted warrants to purchase 150,000 shares of its 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 the GGS joint venture note due the Company
discussed below). The loan was secured by a pledge of 732,375 shares of Citadel
Common Stock owned by Mr. Solomon. 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 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, Mr. Sharp, and
Mr. Solomon, who were 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 in April
1997 in the following manner: Mr. Solomon forgave $79,000 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 Mr.
Gertner, 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.
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 certain obligations of the Company. At
various times during the year, Messrs. Gertner and Solomon advanced funds to the
Company to fund various short-term obligations.
52
<PAGE> 55
PRINCIPAL STOCKHOLDERS
As of November 18, 1998, there were issued and outstanding shares of Common
Stock. There is no other class of voting security of the Company issued or
outstanding.
The following table sets forth the number of shares of the Company's Common
Stock beneficially owned, as of November 18, 1998, by (i) each person known to
the Company to own more than 5% of the Common Stock of the Company (the only
class of voting securities now outstanding), (ii) each of the nominees for
director, (iii) each executive officer named in the Summary Compensation Table
(the "Named Officers") and (iv) all nominees, Named Officers and other executive
officers as a group. Unless otherwise indicated, the number of shares and
percentage of ownership of Common Stock for each of the stockholders set forth
below assumes that shares of Common Stock that the stockholder may acquire
within sixty days of the date hereof are outstanding. Except as otherwise
indicated, all shares are owned directly and the owner has the sole voting and
investment power with respect thereto.
<TABLE>
<CAPTION>
NUMBER OF APPROXIMATE
NAME AND ADDRESS SHARES OWNED PERCENT OF CLASS
- --------------------------------------- ------------ ----------------
<S> <C> <C>
Carl Banzhof
3811 Turtle Creek Blvd., Suite 600
Dallas, Texas 75219 159,701 /1/ .5%
- --------------------------------------- ------------ ----------------
Jack Doxey
3811 Turtle Creek Blvd., Suite 600
Dallas, Texas 75219 82,770 /2/ .3%
- --------------------------------------- ------------ ----------------
Chris A. Economou
150 North Federal Highway, Suite 210
Fort Lauderdale, Florida 33301 474,400 /3/ 1.5%
- --------------------------------------- ------------ ----------------
Gilbert Gertner
1300 Post Oak Blvd., Suite 1985
Houston, Texas 77056 3,373,375 /4/ 10.3%
- --------------------------------------- ------------ ----------------
Kenneth Johnsen
Metamor Worldwide, Inc.
4400 Post Oak Parkway, Suite 200
Houston, Texas 77027 6,457,995 /5/ 18.4%
- --------------------------------------- ------------ ----------------
Icarus Investments I, Ltd.
8144 Walnut Hill Lane, Suite 172
Dallas, Texas 75231 4,750,000 /6/ 16.0%
- --------------------------------------- ------------ ----------------
Victor Kiam, II
RPI Corporation
350 Fifth Avenue, Suite 5408
New York, New York 10018 744,452 /7/ 2.3%
- --------------------------------------- ------------ ----------------
Bennett Klein
3811 Turtle Creek Blvd., Suite 600
Dallas, Texas 75219 258,329 /8/ .8%
- --------------------------------------- ------------ ----------------
Metamor Worldwide, Inc.
4400 Post Oak Parkway, Suite 210
Houston, Texas 77027 6,360,465 /5/ 18.2%
- --------------------------------------- ------------ ----------------
Thomas Oxley
2727 South Ocean Blvd., Apt. 803
Highland Beach, Florida 33487 2,000,000 /9/ 6.4%
- --------------------------------------- ------------ ----------------
Mark Rogers
NFT Ventures, Inc.
751 Laurel Street, No.19
San Carlos, California 94070 401,500 /10/ 1.3%
- --------------------------------------- ------------ ----------------
Michael Ruff
Icarus Investments I, Ltd.
8144 Walnut Hill Lane, Suite 172
Dallas, Texas 75231 4,880,000 /6/ 14.8%
- --------------------------------------- ------------ ----------------
Dr. Axel Sawallich
Beatrixgasse 3
A-1030 Vienna, Austria 137,144 /11/ .4%
- --------------------------------------- ------------ ----------------
Steven Solomon
3811 Turtle Creek Blvd., Suite 600
Dallas, Texas 75219 4,354,124 /12/ 14.0%
- --------------------------------------- ------------ ----------------
Richard Travis
3811 Turtle Creek Blvd., Suite 600
Dallas, Texas 75219 869,000 2.8%
- --------------------------------------- ------------ ----------------
All officers and directors
as a group (12 persons): 21,460,385 /13/ 53.5%
- --------------------------------------- ------------ ----------------
</TABLE>
53
<PAGE> 56
/1/ Includes 100,000 shares presently issuable pursuant to options to purchase
Common Stock and 2,000 shares owned by his spouse.
/2/ Includes 77,770 shares presently issuable pursuant to options to purchase
shares of Common Stock.
/3/ Includes 300,000 shares presently issuable pursuant to options to purchase
Common Stock.
/4/ Includes 1,462,500 shares presently issuable pursuant to options to purchase
Common Stock held by Mr. Gertner. The number of shares held by Mr. Gertner also
includes warrants to purchase 150,000 shares held by Worldwide PetroMoly, Inc.
("PetroMoly"), a company controlled by Mr. Gertner, and 732,375 shares standing
in PetroMoly's name pursuant to a pledge by Steven B. Solomon, which shares
Messrs. Gertner and Sharp agreed to cause PetroMoly to return to Mr. Solomon but
which have not been returned. See "Certain Relationships and Transactions." Does
not include 2,500,000 shares for Mr. Gertner that he has agreed to transfer to
the Company in exchange for certain accounts receivable of the Company. See
"Certain Relationships and Transactions." Mr. Gertner has filed an affidavit of
lost certificates with the transfer agent relating to these shares. However,
these shares have not yet been canceled by the transfer agent as Mr. Gertner had
not provided the transfer agent with the necessary bond or indemnification.
These shares have been excluded from the number of shares outstanding.
/5/ Includes 2,000,000 shares presently issuable pursuant to warrants to
purchase Common Stock owned by Metamor Worldwide, Inc. ("Metamor"), 2,500,000
shares owned by Metamor, and 1,860,465 shares of Common Stock issuable on
conversion of Series D Preferred Stock owned by Metamor. Mr. Johnsen's shares
include the Metamor shares and 50,000 shares presently issuable pursuant to
options to purchase Common Stock and 25,300 shares owned by Mr. Johnsen. Mr.
Johnsen is an executive officer of Metamor and disclaims beneficial ownership of
such shares and warrants owned by Metamor.
/6/ Includes 1,750,000 shares presently issuable pursuant to warrants to
purchase Common Stock owned by Icarus Investments I, Ltd. ("Icarus"). Based
solely on the Schedule 13G/A (Amendment No. 1) filed with the Securities and
Exchange Commission ("SEC") on July 10, 1998 with respect to the Company's
Common Stock owned by Icarus. According to the 13G/A (Amendment No. 1), Icarus
may be deemed to own beneficially 3,000,000 shares of Common Stock, acquired for
investment purposes. Mr. Ruff's shares include the Icarus shares and 130,000
shares owned by Mr. Ruff, individually.
/7/ Includes 200,000 shares presently issuable pursuant to options to purchase
Common Stock and 84,452 shares presently issuable pursuant to warrants to
purchase Common Stock and includes warrants to purchase 250,000 shares held by
RPI, Inc., a company owned and controlled by Mr. Kiam.
/8/ Includes 108,329 shares presently issuable pursuant to options to purchase
Common Stock.
/9/ Includes 250,000 shares presently issuable pursuant to warrants to purchase
Common Stock. Based solely on information contained in the Schedule 13G/A
(Amendment No. 3) filed with the Securities and Exchange Commission ("SEC") on
July 10, 1998 with respect to the Company's Common Stock owned by Mr. Oxley.
According to the Schedule 13G/A (Amendment No. 3), Mr. Oxley may be deemed to
own beneficially 2,000,000 shares of Common Stock, acquired solely for
investment purposes. Mr. Oxley has sole voting and dispositive power as to all
such shares.
/10/ Includes 400,000 shares presently issuable pursuant to options to purchase
Common Stock.
/11/ Includes 12,144 shares held by Dr. Sawallich as trustee, over which he has
voting and dispositive power and 125,000 shares presently issuable pursuant to
options to purchase Common Stock.
/12/ Includes 732,375 shares that have been pledged by Mr. Solomon
to Worldwide PetroMoly, Inc., a company controlled by Gilbert Gertner. Although
Messrs. Gertner and Sharp agreed to cause Worldwide PetroMoly to return the
732,375 shares, such shares have not yet been returned to Mr. Solomon. See
"Certain Relationships and Transactions."
/13/ Includes 8,918,516 shares presently issuable pursuant to presently
exercisable options or warrants held by Messrs. Banzhof, Doxey, Economou,
Gertner, Johnsen, Kiam, Klein, Rogers, Ruff, and Sawallich, or their affiliates
and 1,860,465 shares of Common Stock issuable on the conversion of Preferred
Stock owned by Metamor.
54
<PAGE> 57
DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company consists of 60,000,000 shares
of Common Stock, $.01 par value per share, and 1,000,000 shares of Preferred
Stock, $.01 par value per share.
COMMON STOCK
There were 31,173,713 shares of Common Stock outstanding and held of record
by approximately 4,230 stockholders as of November 18, 1998. There will be
37,548,357 shares of Common Stock outstanding after giving effect to the
conversion of the Convertible Securities underlying the shares of Common Stock
offered hereby.
Holders of Common Stock are entitled to one vote per share on all matters
to be voted upon by the stockholders. Because the shares of Common Stock do not
have cumulative voting rights, the holders of more than 50 percent of the shares
voting for the election of directors can elect all the directors if they choose
to do so and, in such event, the holders of the remaining shares will not be
able to elect any person to the Board of Directors. Subject to preferences that
may be applicable to the holders of outstanding shares of Preferred Stock, if
any, the holders of Common Stock are entitled to receive ratably such dividends,
if any, as may be declared from time to time by the Board of Directors out of
funds legally available therefor. See "Dividend Policy." In the event of
liquidation, dissolution or winding-up of the Company, and subject to the prior
distribution rights of the holders of outstanding shares of Preferred Stock, if
any, the holders of shares of Common Stock shall be entitled to receive pro rata
all the remaining assets of the Company available for distribution to its
stockholders. The Common Stock has no preemptive or conversion rights or other
subscription rights. There are no redemption or sinking fund provisions
applicable to the Common Stock. All outstanding shares of Common Stock are fully
paid and nonassessable, and the Shares to be issued pursuant to this Offering
shall be fully paid and nonassessable, assuming compliance with the exercise
provisions of the Convertible Securities.
The Board of Directors is authorized to issue additional shares of Common
Stock, not to exceed the amount authorized by the Company's Certificate of
Incorporation, and to issue options and warrants for the purchase of such
shares, on such terms and conditions and for such consideration as the Board may
deem appropriate without further stockholder action. The above description
concerning the Common Stock of the Company does not purport to be complete.
Reference is made to the Company's Certificate of Incorporation and By-laws
which are available for inspection upon proper notice at the Company's offices,
as well as to the applicable statutes of the State of Delaware for a more
complete description concerning the rights and liabilities of stockholders.
PREFERRED STOCK
As of November 19, 1998, 50 shares of Series B Convertible Preferred Stock
(the "Series B Stock") were outstanding. The Series B Stock is entitled to
liquidation and dividend preferences over the Common Stock and is convertible
into shares of Common Stock at an exercise price equal to 83% of the average
closing bid price of the Common Stock for the five trading days preceding the
date of conversion. As of November 19, 1998, 3,500 shares of Series C Preferred
Stock (the "Series C Stock") were outstanding. The Series C Stock is entitled to
liquidation and dividend preferences over the Common Stock and is convertible
into shares of Common Stock at an exercise price equal to 70 - 75% of the
average closing bid price of the Common Stock for the five trading days
preceding the date of conversion. As of November 19, 1998, 2,253 shares of
Series D Convertible Preferred Stock (the "Series D Stock") were outstanding.
The Series D Stock is entitled to liquidation and dividend preferences over the
Common Stock and is convertible into shares of Common Stock at an exercise price
equal to $1.075 per share.
55
<PAGE> 58
The Board of Directors has the authority, without further action by the
stockholders, to issue up to an additional 994,197 additional shares of
Preferred Stock in one or more series and to fix the rights, preferences and
privileges thereof, including dividend rates and preferences, conversion rights,
voting rights, terms of redemption, redemption prices, liquidation preferences
and the number of shares constituting any series or the designation of such
series, without further vote or action by the stockholders. Although it
presently has no intention to do so, the Board of Directors, without stockholder
approval, could issue Preferred Stock with voting and conversion rights which
could adversely affect the voting power of the holders of Common Stock. The
issuance of Preferred Stock may also have the effect of delaying or preventing a
change of control of the Company.
DELAWARE LAW AND CERTAIN CHARTER PROVISIONS
The Company is subject to the provisions of Section 203 of the Delaware
General Corporation law and anti-takeover law. In general, the statute prohibits
a publicly held Delaware corporation from engaging in a "business combination"
with an "interested stockholder" for a period of three years after the date of
the transaction in which the person became an interested stockholder, unless
either (I) prior to the date at which the person becomes an interested
stockholder, the Board of Directors approves such transaction or business
combination, (ii) the stockholder acquires more than 85% of the outstanding
voting stock of the corporation (excluding shares held by directors who are
officers or held in certain employee stock plan) upon consummation of such
transaction, or (iii) the business combination is approved by the Board of
Directors and by two-thirds of the outstanding voting stock of the corporation
(excluding shares held by the interested stockholder) at a meeting of
stockholders (and not by written consent). A "business combination" includes a
merger, asset sale or other transaction resulting in a financial benefit to such
interested stockholder. For purposes of Section 203, "interested stockholder" is
a person who, together with affiliates and associates, owns (or within three
years prior, did own) 15% or more of the corporation's voting stock.
The Company's Certificate of Incorporation includes a provision that allows
the Board of Directors to issue Preferred Stock in one or more series with such
voting rights and other provisions as the Board of Directors may determine. This
provision may be deemed to have a potential anti-takeover effect and the
issuance of Preferred Stock in accordance with such provisions may delay or
prevent a change of control of the Company. See "Preferred Stock."
REGISTRATION RIGHTS
The holders of approximately 13,500,000 shares of Common Stock (the
"Registrable Securities"), or certain of their transferees, will be entitled to
certain rights with respect to the registration of such shares for sale under
the Securities Act. Such holders may request that the Company file a
registration statement under the Securities Act with respect to such Common
Stock, after which the Company must use its best efforts to effect such
registration, subject to certain conditions. The Registration Statement was
filed as a result of the demand of certain of such Holders. Holders of such
registration rights may have two requests for registration until such time as
the Company qualifies for registration of the offer and sale of its securities
on Form S-3 under the Securities Act. After such qualification, such Holders may
make an unlimited number of requests for registration of such shares on Form
S-3, subject to the limitation that the Company will not be obligated to effect
a registration more than once during any year and then only with respect to
shares with an aggregate market value of greater than $1,000,000. Finally, if
the Company proposes to register any of its securities for sale under the
Securities Act (with certain exceptions), either for its own account or the
account of other shareholders, holders of Registrable Securities are entitled to
"piggyback" onto the Company's registration by requesting inclusion of their
Registrable Securities in the registration. However, the underwriters of any
offering which includes Registrable Securities retain the right to limit the
number of shares to be included in the offering. These registration rights will
expire as to any holder when such holder has
56
<PAGE> 59
disposed of all of its Registrable Securities. In general, the Company is
required to bear the expenses of all requested registrations, provided that
holders participating in the registration are required to bear their pro rata
share of underwriting discounts and commissions.
STOCK TRANSFER AGENT AND REGISTRAR
The stock transfer agent and registrar for the Company's Common Stock is
American Securities Transfer, Inc., 938 Quail Street, Suite 101, Lakewood,
Colorado 80215-5513.
SHARES ELIGIBLE FOR FUTURE SALE
Future sales of substantial amounts of Common Stock in the public market
could adversely affect prevailing market prices and adversely affect the
Company's ability to raise additional capital in the capital markets at a time
and price favorable to the Company.
Upon completion of this Offering, the Company will have approximately
37,548,357 shares of Common Stock outstanding. Of these shares, the 6,792,544
Shares offered hereby will be freely tradeable without restriction or further
registration under the Securities Act of 1933, as amended (the "Securities
Act"), unless they are purchased by "affiliates" of the Company as that term is
defined under Rule 144 adopted under the Securities Act. Approximately
12,650,000 shares are "restricted securities" as defined in Rule 144
("Restricted Shares"), available for immediate resale in the public market,
subject to restrictions of Rule 144. In general, under Rule 144 as currently in
effect, any person (or persons whose shares are aggregated) who has beneficially
owned Restricted Shares for at least one year is entitled to sell, within any
three-month period, a number of shares that does not exceed the greater of 1% of
the then outstanding shares of the Company's Common Stock or the average weekly
trading volume during the four calendar weeks preceding such sale. Sales under
Rule 144 are also subject to certain requirements as to the manner of sale,
notice and availability of current public information about the Company. A
person who is not an affiliate, has not been an affiliate within three months
prior to the sale and has beneficially owned the Restricted Shares for at least
two years is entitled to sell such shares under Rule 144(k) without regard to
any of the limitations described above.
As of November 19, 1998, approximately 15,000,000 shares of Common Stock
were reserved for issuance under the Company's options and warrants, including
approximately 14,500,000 shares of Common Stock underlying outstanding options
and warrants which have been registered pursuant to registration statements,
including the 5,168,135 shares offered hereby. The resale of shares issued under
such options or warrants by non-affiliates in the public market would be
permitted without restriction under the Securities Act.
LEGAL MATTERS
The validity of the Shares offered hereby will be passed upon for the
Company by Wood, Exall & Bonnet, L.L.P., Dallas, Texas. David Wood, an officer
of one of the partners of such firm and former General Counsel of Citadel, is
the brother-in-law of Steven Solomon, Chief Executive Officer of the Company.
The Company has granted options to purchase up to 200,000 shares of its Common
Stock to Mr. Wood.
EXPERTS
The consolidated financial statements of Citadel Technology, Inc. as of
February 28, 1998 and 1997, and for the years then ended have been included in
the registration statement in reliance upon the report of Grant Thornton, LLP,
independent auditors, given upon their authority as experts in accounting and
auditing.
57
<PAGE> 60
CITADEL TECHNOLOGY, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Audited Annual Financial Statements
Report of Independent Accountants dated June 17, 1998............................. F-2
Consolidated Balance Sheets as of February 28, 1998 and 1997...................... F-3
Consolidated Statements of Operations for the years ended
February 28, 1998 and 1997..................................................... F-5
Consolidated Statements of Stockholders' Equity for the years ended
February 28, 1998 and 1997..................................................... F-6
Consolidated Statements of Cash Flows for the years ended
February 28, 1998 and 1997..................................................... F-8
Notes to Consolidated Financial Statements........................................ F-10
Quarterly Consolidated Financial Statements
Consolidated Balance Sheets as of August 31, 1998 (unaudited) and
February 28, 1998 (audited).................................................... F-26
Consolidated Statements of Operations for the six months ended
August 31, 1998 and 1997 (unaudited)........................................... F-28
Consolidated Statements of Cash Flows for the six months ended
August 31, 1998 and 1997 (unaudited)........................................... F-29
Notes to Consolidated Financial Statements........................................ F-30
</TABLE>
F-1
<PAGE> 61
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Citadel Technology, Inc.
We have audited the accompanying consolidated balance sheets of Citadel
Technology, Inc. as of February 28, 1998 and 1997, and the related consolidated
statements of operations, stockholders' equity, and cash flows for the years
then ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe 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
Technology, Inc. as of February 28, 1998 and 1997, and the consolidated results
of its operations and its consolidated cash flows for each of the years then
ended, in conformity with generally accepted accounting principles.
GRANT THORNTON LLP
/s/ GRANT THORNTON LLP
- ----------------------
Dallas, Texas
June 17, 1998
F-2
<PAGE> 62
CITADEL TECHNOLOGY, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
February 28,
------------
ASSETS 1998 1997
----------- ------------
<S> <C> <C>
CURRENT ASSETS
Cash $ 8,555 $ 15,100
Accounts receivable, less allowance for returns and
doubtful accounts of $681,000 and $625,000 435,615 727,422
Notes receivable from related parties 376,487 870,000
Marketable securities available for sale -- 1,250,000
Other 129,493 57,106
----------- ------------
Total current assets 950,150 2,919,628
ACCOUNTS RECEIVABLE - NONCURRENT, less allowance for returns
and doubtful accounts of $1,875,000 in 1997 -- 1,875,000
PROPERTY AND EQUIPMENT, NET 387,923 696,459
PURCHASED SOFTWARE, net of accumulated amortization of
$1,788,000 and $854,000 3,462,879 4,396,398
CAPITALIZED SOFTWARE DEVELOPMENT COSTS,
net of accumulated amortization of $150,000 and $19,000 1,011,432 573,388
OTHER ASSETS 350,650 263,220
----------- ------------
$ 6,163,034 $ 10,724,093
=========== ============
</TABLE>
The accompanying notes are an integral part of these statements.
F-3
<PAGE> 63
CITADEL TECHNOLOGY, INC.
CONSOLIDATED BALANCE SHEETS - CONTINUED
<TABLE>
<CAPTION>
February 28,
------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY 1998 1997
----------- ------------
<S> <C> <C>
CURRENT LIABILITIES
Cash overdraft $ 10,249 $ 167,256
Current maturities of long-term debt 1,270,565 804,141
Notes payable 842,174 2,456,087
Accounts payable and accrued expenses 2,274,141 2,253,481
----------- ------------
Total current liabilities 4,397,129 5,680,965
LONG-TERM LIABILITIES
Debt, less current maturities 478,044 1,770,905
----------- ------------
Total liabilities 4,875,173 7,451,870
COMMITMENTS AND CONTINGENCIES -- --
STOCKHOLDERS' EQUITY
Common stock, $.01 par value per share; authorized, 60,000,000 shares;
issued and outstanding, 25,881,328 shares in 1998 and 16,501,980
shares in 1997 258,813 165,020
Preferred stock, $.01 par value per share; authorized, 1,000,000 shares;
issued and outstanding
Series B convertible, 50 shares in 1998 and 545 shares in 1997
(liquidation value $50,000 and $545,000) 1 5
Series C convertible, 5,000 shares in 1998 (liquidation value
$500,000) 50 --
Equity notes 944,000 300,000
Additional paid-in capital 16,158,442 13,370,627
Accumulated deficit (13,573,206) (9,854,067)
Unrealized loss on securities available for sale -- (355,772)
Treasury stock, at cost (4,164,613 shares in 1998 and
264,613 shares in 1997) (2,500,239) (353,590)
----------- ------------
Total stockholders' equity 1,287,861 3,272,223
----------- ------------
$ 6,163,034 $ 10,724,093
=========== ============
</TABLE>
The accompanying notes are an integral part of these statements.
F-4
<PAGE> 64
CITADEL TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Years ended February 28,
------------------------------
1998 1997
------------ ------------
<S> <C> <C>
REVENUES
Sales $ 1,638,853 $ 5,824,553
Less allowance for returns 25,527 498,361
------------ ------------
Net sales 1,613,326 5,326,192
COST OF SALES 78,429 304,436
------------ ------------
Gross profit 1,534,897 5,021,756
OPERATING EXPENSES
Selling, general and administrative expenses 3,056,408 5,939,099
Provision for uncollectible receivables 368,897 1,984,113
Depreciation and amortization 1,270,708 942,166
Research and development expense 161,010 3,336,253
------------ ------------
4,857,023 12,201,631
------------ ------------
Operating loss (3,322,126) (7,179,875)
OTHER INCOME (EXPENSE)
Interest expense (128,929) (253,557)
Write-down of marketable securities -- (1,000,000)
Gain (loss) on sales of marketable securities (199,672) 548,720
Other 128,017 369,105
------------ ------------
(200,584) (335,732)
------------ ------------
NET LOSS $ (3,522,710) $ (7,515,607)
============ ============
Loss per share $ (0.21) $ (0.56)
============ ============
Weighted average shares outstanding 16,801,818 13,721,032
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
F-5
<PAGE> 65
CITADEL TECHNOLOGY, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Unrealized
loss on
Common stock securities
-------------- Preferred Equity available
Shares Amount stock notes for sale
---------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Balance at March 1, 1996 11,509,126 $ 115,091 $ -- $ -- $ --
Exercise of stock options
and warrants 240,282 2,403 -- -- --
Sale of preferred stock -
3,490 shares, net of
issuance costs of $565,118 -- -- 35 -- --
Sale of equity notes, net of
issuance costs of $527,434 -- -- -- 4,550,000 --
Conversions to common stock 3,633,623 36,337 (30) (4,250,000) --
Payment of dividends
Preferred stock 75,296 753 -- -- --
Equity notes 45,947 459 -- -- --
Notes payable converted
to warrants -- -- -- -- --
Stock options issued for
services -- -- -- -- --
Sale of common stock, net
of issuance costs of $87,059 357,706 3,577 -- -- --
Unrealized loss on securities
available for sale -- -- -- -- (355,772)
Purchase of treasury
stock - 84,613 shares -- -- -- -- --
Sale of subsidiary for
common stock -
180,000 shares -- -- -- -- --
Acquisition of businesses 640,000 6,400 -- -- --
Net loss -- -- -- -- --
---------- ------------ ------------ ------------ ------------
Balance at February 28, 1997 16,501,980 165,020 5 300,000 (355,772)
</TABLE>
<TABLE>
<CAPTION>
Additional
paid-in Accumulated Treasury
capital deficit stock Total
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Balance at March 1, 1996 $ 2,405,144 $ (2,204,746) $ -- $ 315,489
Exercise of stock options
and warrants 639,259 -- -- 641,662
Sale of preferred stock -
3,490 shares, net of
issuance costs of $565,118 2,924,847 -- -- 2,924,882
Sale of equity notes, net of
issuance costs of $527,434 (527,434) -- -- 4,022,566
Conversions to common stock 4,213,693 -- -- --
Payment of dividends
Preferred stock 54,225 (54,978) -- --
Equity notes 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 $87,059 845,775 -- -- 849,352
Unrealized loss on securities
available for sale -- -- -- (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 1,932,801 -- -- 1,939,201
Net loss -- (7,515,607) -- (7,515,607)
------------ ------------ ------------ ------------
Balance at February 28, 1997 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> 66
CITADEL TECHNOLOGY, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY - CONTINUED
<TABLE>
<CAPTION>
Unrealized
loss on
Common stock securities
-------------- Preferred Equity available
Shares Amount stock notes for sale
---------- ------------ ------------ ------------ -----------
<S> <C> <C> <C> <C> <C>
Exercise of stock options
and warrants 1,258,100 $ 12,581 $ -- $ -- $ --
Sale of equity notes, net of
issuance costs of $182,244 -- -- -- 1,625,000 --
Sale of preferred stock -
5,000 shares, net of
issuance costs of $78,835 -- -- 50 -- --
Conversions to common stock
Debt, net of unamortized
debt issuance costs of
$38,667 2,964,093 29,641 -- -- --
Preferred stock and
equity notes 2,285,257 22,852 (4) (481,000) --
Redemption of equity notes -- -- -- (500,000) --
Payment of dividends on
equity notes 275,897 2,759 -- -- --
Common stock issued for
services 96,000 960 -- -- --
Sale of common stock 2,500,000 25,000 -- -- --
Purchase of treasury stock-
3,900,000 shares -- -- -- -- --
Change in unrealized
depreciation on securities
available for sale -- -- -- -- 355,772
Net loss -- -- -- -- --
------------ ------------ ------------ ------------ -----------
Balance at February 28, 1998 25,881,327 $ 258,813 $ 51 $ 944,000 $ --
============ ============ ============ ============ ===========
</TABLE>
<TABLE>
<CAPTION>
Additional
paid-in Accumulated Treasury
capital deficit stock Total
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Exercise of stock options
and warrants $ 376,197 $ -- $ -- $ 388,778
Sale of equity notes, net of
issuance costs of $182,244 (182,244) -- -- 1,442,756
Sale of preferred stock -
5,000 shares, net of
issuance costs of $78,835 421,115 -- -- 421,165
Conversions to common stock
Debt, net of unamortized
debt issuance costs of
$38,667 871,685 -- -- 901,326
Preferred stock and
equity notes 458,152 -- -- --
Redemption of equity notes (100,000) -- -- (600,000)
Payment of dividends on
equity notes 93,670 (96,429) -- --
Common stock issued for
services 24,240 -- -- 25,200
Sale of common stock 725,000 -- -- 750,000
Purchase of treasury stock-
3,900,000 shares -- -- (2,146,649) (2,146,649)
Change in unrealized
depreciation on securities
available for sale -- -- -- 355,772
Net loss -- (3,522,710) -- (3,522,710)
------------ ------------ ------------ ------------
Balance at February 28, 1998 $ 16,058,442 $(13,473,206) $ (2,500,239) $ 1,287,861
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
F-7
<PAGE> 67
CITADEL TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years ended February 28,
------------------------
1998 1997
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (3,522,710) $ (7,515,607)
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 1,270,708 942,166
Stock and options issued for services 25,200 70,040
Gain on sale of securities 199,672 (548,720)
Provision for losses on accounts receivable
and sales returns 368,897 2,482,474
Changes in operating assets and liabilities
Accounts receivable (280,803) (4,489,829)
Other receivables (131,487) (870,000)
Other current assets (72,387) 48,400
Software development costs (568,963) (457,321)
Cash overdraft (157,007) 167,256
Accounts payable and accrued expenses 294,984 (442,733)
Other assets (87,430) (360,201)
------------ ------------
NET CASH USED BY OPERATING ACTIVITIES (2,661,326) (6,706,035)
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 (160,880) (763,824)
Proceeds from sale of securities 156,100 --
Acquisition of businesses and software -- (1,347,360)
------------ ------------
NET CASH USED BY INVESTING ACTIVITIES (4,780) (1,562,464)
</TABLE>
The accompanying notes are an integral part of these statements.
F-8
<PAGE> 68
CITADEL TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
<TABLE>
<CAPTION>
Years ended February 28,
1998 1997
----------- ------------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on notes payable $ (628,441) $ (1,439,127)
Proceeds from notes payable 514,528 --
Proceeds from long-term debt 489,865 1,583,522
Repayments on long-term debt (119,090) (215,036)
Proceeds from sale of preferred stock 421,165 2,924,882
Proceeds from sale of equity notes 1,442,756 4,022,566
Proceeds from sale of common stock 1,138,778 1,491,014
Purchase of treasury stock -- (209,787)
Redemption of equity notes (600,000) --
----------- ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 2,659,561 8,158,034
----------- ------------
Net decrease in cash (6,545) (110,465)
Cash at beginning of the year 15,100 125,565
----------- ------------
Cash at end of the year $ 8,555 $ 15,100
=========== ============
</TABLE>
The accompanying notes are an integral part of these statements.
F-9
<PAGE> 69
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
February 28, 1998 and 1997
NOTE A - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
Nature of Business
The Company develops, markets and supports security and administration
products for both computer network and desktop personal computers. The
Company licenses the products through resellers, and directly to end-users,
in North America, Europe and Asia Pacific. The Company also licenses its
products for initial licensing fees to original equipment manufacturers
("OEM's") and receives ongoing royalties from OEMs' product sales.
During fiscal 1997, the Company primarily marketed and sold its products
directly to end-users through telemarketing and trade shows.
Change of Name
On February 26, 1998, the Company changed its name to Citadel Technology,
Inc.
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
During fiscal 1998, the Company recognized revenues when a customer's
purchase order had been received, the software had been shipped (or
electronically delivered), the remaining obligations were insignificant and
the collection of the resulting receivables was probable.
Revenues generated from products sold through traditional channels where the
right of return exist are reduced by reserves for estimated product returns.
Such reserves are based on estimates developed by management. As unused
products in these channels are exposed to rapid changes in consumer
preferences or technological obsolescence due to new operating systems or
computing products, it is reasonably possible that these estimates may
change in the future.
Revenues related to significant post-contract support agreements (generally
product maintenance agreements) are deferred and recognized over the period
of the agreements.
F-10
<PAGE> 70
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1998 and 1997
NOTE A - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES - CONTINUED
Royalty revenues are recognized as earned unless collection of such revenues
is not probable. When collection is not probable, revenues are recognized as
payments are received.
During fiscal 1997, the Company generally delivered its products to
customers on a thirty (30) day trial basis following receipt of a signed
trial agreement from the customer. The Company only recognized revenue if
the product had not been returned within 30 days in accordance with the
terms and conditions of the trial agreement. Numerous disagreements arose
between the Company and its customers regarding the customer's obligation to
pay for the products delivered. As a result, the Company provided an
allowance for returns and doubtful accounts of $681,000 and $2,500,000
during fiscal years 1998 and 1997, respectively, to cover potential
uncollectible accounts.
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 four to seven 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 $161,010 and $3,336,253 in 1998 and 1997,
respectively. Included in fiscal 1997 expense is $3,268,040 representing
amounts written off in connection with the acquisitions referred to in Notes
D. Capitalized costs are amortized using the straight-line amortization
using useful lives ranging from three to five 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
The Company accounts for stock-based employee compensation as prescribed by
Accounting Principles Board Opinion No. 25, "Accounting for Stock issued to
Employees" (Opinion No. 25) and the related interpretations. The pro forma
information required by Statement of Financial Accounting Standards No. 123,
" Accounting for Stock-Based Compensation" (Statement No. 123) is disclosed
in Note H.
F-11
<PAGE> 71
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1998 and 1997
NOTE A - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES - CONTINUED
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.
Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income", which establishes standards for reporting
and displaying comprehensive income and its components in a full set of
general-purpose financial statements and is required to be adopted by the
Company. The adoption of SFAS No. 130 is not expected to have a material
impact on the Company's financial statements.
Additionally, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information", which
establishes standards for the way that public business enterprises report
information in annual statements and interim financial reports regarding
operating segments, products and services, geographic areas and major
customers. SFAS 131 is not expected to have a material impact on the
Company's financial statements. Both the aforementioned accounting standards
are effective for years and interim periods beginning after December 15,
1997.
In October 1997 and March 1998, the Accounting Standards Executive Committee
("AcSEC") issued Statement of Position ("SOP") 97-2, "Software Revenue
Recognition" and SOP 98-4, "Deferral of the Effective Date of a Provision of
SOP 97-2, Software Revenue Recognition," respectively, which provide
guidance on applying generally accepted accounting principles in recognizing
revenue on software transactions and is effective for the Company's
transactions entered into subsequent to March 31, 1998. AcSEC is currently
deliberating the potential permanent deferral of certain provisions of SOP
97-2. The Company does not believe that the implementation of SOP 97-2 and
SOP 98-4 will have a material adverse affect on expected revenues or
earnings. However, in the event subsequent interpretations are contrary to
the Company's revenue accounting practices, the Company believes it can
change its current business practices to comply with this guidance and avoid
any material adverse affect on reported revenues and earnings. There can be
no assurance this will be the case.
F-12
<PAGE> 72
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1998 and 1997
NOTE A - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES - CONTINUED
Fair Value of Financial Instruments
The Company's financial instruments consist of cash, marketable securities,
notes receivable, accounts receivable, and accounts and notes payable.
Marketable securities are carried at fair value. The other instruments'
carrying values approximate fair value because of their short-term
maturities.
Net Income (Loss) Per Common Share
In the fourth quarter of 1998, the Company adopted the provisions of
Statement of Financial Accounting Standards No. 128, "Earnings per Share"
(SFAS No. 128). In accordance with SFAS No. 128, the Company computes income
(loss) per common share based on the weighted average number of common
shares outstanding. Income (loss) per common share - assuming dilution is
computed based on the weighted average number of common shares outstanding
plus the number of additional common shares that would have been outstanding
if dilutive potential common shares, consisting of stock options, warrants
and shares issuable upon conversion of debt, had been issued; income is
adjusted for interest on the convertible debt. Retroactive application,
which is required by SFAS No. 128, did not result in restatement of 1997 per
share data. Per share data - assuming dilution has not been presented
because the effect of potential common shares is antidilutive.
NOTE B - 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. 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 in 1997 of $1,000,000. At February 28, 1997, a valuation
allowance of $355,772 had been made by a charge to stockholders' equity. In
June 1997, the Company tendered the stock to Miami Subs as payment in full
of the $1,250,000 note payable to Miami Subs (Note E). In addition, to
settle certain disputes between the Company and Miami Subs, Miami Subs
issued to the Company 200,000 shares of Miami Subs common stock and the
Company sold the shares for approximately $156,000 and used the proceeds for
working capital.
F-13
<PAGE> 73
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1998 and 1997
NOTE C - PROPERTY AND EQUIPMENT
Major classes of property and equipment and their estimated useful lives are
as follows:
<TABLE>
<CAPTION>
February 28,
------------
Lives 1998 1997
---------- --------- ---------
<S> <C> <C> <C>
Furniture 5-10 years $ 82,978 $ 228,433
Office equipment 3-7 years 74,339 132,205
Leasehold improvements Lease term 62,184 15,000
Computer equipment 3-7 years 480,671 547,900
--------- ---------
700,172 923,538
Less accumulated depreciation (312,249) (227,079)
--------- --------
Net property and equipment $ 387,923 $ 696,459
========= =========
</TABLE>
NOTE D - ACQUISITIONS
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-14
<PAGE> 74
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1998 and 1997
NOTE D - ACQUISITIONS - CONTINUED
The following unaudited pro forma summary results of operations gives effect
to the acquisition of 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 (March 1, 1996):
<TABLE>
<CAPTION>
Year ended
February 28,
1997
------------
<S> <C>
Revenues $ 5,732,406
Net loss (6,479,902)
Net loss per share (.47)
</TABLE>
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, as such write-off has been included in the fiscal 1995 data.
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 March 1, 1996 or of the future results of
operations of the combined businesses.
NOTE E - NOTES PAYABLE
Notes payable consist of the following:
<TABLE>
<CAPTION>
February 28,
------------
1998 1997
--------- -----------
<S> <C> <C>
Unsecured notes payable to individuals, including $80,000 in 1998 and
$430,000 in 1997 to related parties, due at various dates in 1998 and
1999, bearing interest at rates ranging from 0% to 10%; weighted
average interest rate is approximately 6.1% (1) $ 652,500 $ 722,500
Note payable to officer, non-interest bearing -- 36,809
Note payable to Miami Subs USA, Inc. (2) -- 1,250,000
Note payable to a corporation, bearing interest at 10% (3) -- 250,000
Note payable to bank, bearing interest at 11.50% 102,340 150,000
Note payable to a commercial finance company, bearing interest
at 11.5% -- 20,555
Other notes payable 87,334 26,223
--------- -----------
$ 842,174 $ 2,456,087
========= ===========
</TABLE>
F-15
<PAGE> 75
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1998 and 1997
NOTE E - NOTES PAYABLE - CONTINUED
(1) Certain of these notes have warrants to purchase common stock. The
total number of warrants issued was 509,375 with an exercise price
ranging from $0.32 to $0.89 per share. A note for $350,000
outstanding at February 28, 1998, is convertible into common stock,
at $1.075 per share.
(2) Note is noninterest bearing and was liquidated in June 1997 by
transferring collateral to Miami Subs USA, Inc. (Note B).
(3) Payee is controlled by the Company's former Chairman of the Board.
Note is collateralized by pledge of Company shares owned by an
officer of the Company. See Note I regarding assumption of the note
by the former Chairman of the Board in April 1997.
NOTE F - LONG-TERM DEBT
<TABLE>
<CAPTION>
February 28,
------------
1998 1997
----------- -----------
<S> <C> <C>
Redeemable convertible notes, interest at 5% payable in common
stock, due in March 2000 (1) $ 330,000 $ 1,000,000
Note payable to Xerox Corporation, non-interest bearing, due September
1998, interest imputed at 10% (net of discount ) 995,918 1,075,918
Note payable to a bank, payable $4,063 per month plus interest at 10.5%,
through August 2000 162,781 178,693
Note payable to an individual, noninterest bearing, payable by an initial
payment of $25,000 and monthly payments of $10,000 through 1999. 259,910 --
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
----------- -----------
1,748,609 2,629,045
Less amounts representing interest on capital lease obligations, imputed
at rates ranging from 7.02% to 23.78% -- (53,999)
----------- -----------
1,748,609 2,575,046
Less current maturities 1,270,565 804,141
----------- -----------
$ 478,044 $ 1,770,905
=========== ===========
</TABLE>
F-16
<PAGE> 76
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1998 and 1997
NOTE F - LONG-TERM DEBT - CONTINUED
(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, 1998, are as follows:
<TABLE>
<CAPTION>
Year ending
February 28,
------------
<S> <C>
1999 $1,270,565
2000 123,666
2001 354,378
----------
$1,748,609
==========
</TABLE>
NOTE G - INCOME TAXES
Following is a reconciliation of the Company's income tax provision with
the amount of tax computed at the statutory rate:
<TABLE>
<CAPTION>
Years ended February 28,
------------------------
1998 1997
------------- -------------
<S> <C> <C>
Tax benefit at statutory rate $ 1,159,000 $ 2,555,000
Write-off of purchased research and development - (582,000)
Change in valuation allowance, net of amounts that relate to acquired
business ($219,000 in 1997) and unrealized losses on securities
available for sale
($121,000 in 1997) (1,136,000) (2,005,000)
Other (23,000) 32,000
------------- ------------
$ -- $ --
============= ============
</TABLE>
F-17
<PAGE> 77
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1998 and 1997
NOTE G - INCOME TAXES - CONTINUED
Significant components of deferred income tax assets and liabilities are as
follows:
<TABLE>
<CAPTION>
February 28,
------------
1998 1997
------------ -----------
<S> <C> <C>
Deferred tax assets
Net operating loss carryovers $ 3,933,000 $ 1,560,000
Accounts receivable 232,000 923,000
Marketable securities -- 461,000
Property and equipment 32,000 32,000
Accounts payable and accrued expenses 26,000 103,000
Other 3,000 11,000
------------ -----------
4,226,000 3,090,000
Valuation allowance (4,226,000) (3,090,000)
------------ -----------
Net deferred tax asset $ -- $ --
============ ===========
</TABLE>
The Company has net operating loss carryovers of approximately $11,400,000
and $4,500,000 at February 28, 1998 and 1997, respectively. 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 2013.
NOTE H - STOCKHOLDERS' EQUITY
Preferred Stock
The Company's outstanding Series B and Series C preferred stock are
convertible at the option of the holder into shares of common stock at 83%
and 70 to 80%, respectively, of the average market price of the common stock
for the five days preceding conversion subject, however, to a maximum
conversion price on the Series C preferred of $.75 per share. Each share of
Series B and Series C preferred stock has a conversion value of $1,000 and
$100, respectively. Any shares outstanding at September 24, 1998 and
November 11, 2000, respectively, will be automatically converted. Dividends
accrue at 5% and 8%, respectively, and are payable in common stock or cash.
Equity Notes
During fiscal 1998 and 1997, the Company issued $1,125,000 and $4,550,000
respectively 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 2000
and July 1997, respectively) are automatically converted into common stock.
Interest at 8% is payable only in common stock. At February 28, 1998,
$4,731,000 of the notes had been converted. The outstanding balance of
unconverted notes is classified on the balance sheet as a component of
stockholders' equity.
F-18
<PAGE> 78
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1998 and 1997
NOTE H - STOCKHOLDERS' EQUITY - CONTINUED
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 March 1, 1996:
<TABLE>
<CAPTION>
Weighted
average
exercise
Shares price
---------- --------
<S> <C> <C>
Outstanding at March 1, 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
Granted 8,611,000 0.33
Exercised (800,000) 0.28
Expired or canceled (3,936,935) 2.53
---------- --------
Outstanding at February 28, 1998 9,796,750 $ 0.41
========== ========
</TABLE>
<TABLE>
<CAPTION>
Weighted
average
exercise
Shares price
--------- --------
<S> <C> <C>
Exercisable at February 29, 1997 5,054,685 $1.16
Exercisable at February 28, 1998 7,786,750 $0.44
Weighted-average fair value of options granted during
The year ended February 28, 1997 - $1.77
Weighted-average fair value of options granted during
the year ended February 28, 1998 - $0.18
</TABLE>
F-19
<PAGE> 79
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1998 and 1997
NOTE H - STOCKHOLDERS' EQUITY - CONTINUED
In July 1997, following a significant decline in the market price of the
Company's common stock, the terms of options covering 3,375,000 shares with
exercise prices ranging from $.89 to $7.00 per share (weighted average of
$2.34 per share) were revised in order to encourage the option holders to
increase their investments in the Company at a time when additional funds
were needed in connection with the operations and growth of the Company's
business and to enhance the Company's ability to retain the services of such
individuals by reducing the exercise price of the options closer to the
then-current market levels. The exercise price was reduced to $.40 per
share. These options have been reflected as cancelled and granted in the
above summary of option transactions.
The following table summarizes information about stock options at February
28, 1998:
<TABLE>
<CAPTION>
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>
$0.20 - 0.50 8,775,250 6.10 $0.33 6,855,250 $0.26
0.51 - 1.00 935,000 3.27 0.88 845,000 0.80
1.01 - 6.00 86,500 2.40 4.21 86,500 4.21
--------- ----- --------- -----
9,796,750 $0.41 7,786,750 $0.44
========= ===== ========= =====
</TABLE>
F-20
<PAGE> 80
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1998 and 1997
NOTE H - STOCKHOLDERS' EQUITY - CONTINUED
The Company has adopted the disclosure provisions of Statement No. 123, as
discussed in Note A, 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 years ended February 28, 1998 and 1997, the effect on net loss
and loss per share would have been as follows:
<TABLE>
<CAPTION>
Years ended February 28,
---------------------------
1998 1997
--------- ---------
<S> <C> <C>
Net loss
As reported (3,522,710) (7,515,607)
Pro forma (4,197,423) (9,539,474)
Loss per common share
As reported (.21) (.56)
Pro forma (.25) (.70)
</TABLE>
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:
<TABLE>
<CAPTION>
Years ended February 28,
-------------------------
1998 1997
--------- ---------
<S> <C> <C>
Expected volatility 137-147% 145-185%
Risk-free interest rates 5.7-6.2% 6.0-6.5%
Dividend yield 0% 0%
Expected option lives 1-4 years 1-4 years
</TABLE>
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 expense related to grants before the year ended February 28, 1995.
F-21
<PAGE> 81
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1998 and 1997
NOTE H - STOCKHOLDERS' EQUITY - CONTINUED
During fiscal 1997, the Company issued warrants to purchase 540,822 shares
of common stock, principally in connection with issuance of convertible
debt. During fiscal 1998, the Company issued warrants to purchase 3,050,000
shares of common stock in connection with the sale of common stock and
312,500 shares of common stock in connection with the issuance of
convertible debt. The following summarizes the warrant transactions for 1998
and 1997:
<TABLE>
<CAPTION>
Weighted
average
Shares exercise price
--------- --------------
<S> <C> <C>
Outstanding at March 1, 1996 3,500,250 0.90
Issued 540,822 1.52
Exercised (167,721) 1.99
Expired or canceled (38,362) 3.50
--------- -----
Outstanding at February 28, 1997 3,834,989 $0.95
Issued 3,362,500 2.89
Exercised (451,437) 0.36
Expired or canceled (640,914) 1.55
--------- -----
Outstanding at February 28, 1998 6,105,138 $2.00
========= =====
</TABLE>
NOTE I - 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, former
Chairman of the Board of the Company, George Sharp, former Chief Executive
Officer of the Company and Steven B. Solomon, President and Chief Executive
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 (1) interest would be waived for the first six
months, (2) 100% of the net profits, while the loan was outstanding, would
be paid to the Company, and (3) net losses would be borne by GGS.
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.
F-22
<PAGE> 82
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1998 and 1997
NOTE I - RELATED PARTY TRANSACTIONS - CONTINUED
The joint venture was not profitable, and the loan was discharged by GGS
during fiscal 1998 in the following manner:
o Mr. Solomon forgave $78,000 due from the Company to him.
o 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.
o 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.
o $72,000 of the loan was forgiven in connection with the asset sale
agreement discussed below.
Asset Sale Agreement
In April 1997, the Company entered into an asset sale agreement with its
former Chief Executive Officer and its former 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 $155,000 ($72,000 of which related to the discharge of the joint venture
indebtedness noted earlier.) The carrying value of the receivables at
February 28, 1997, net of allowance, was $1,992,000. 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
$2,147,000. 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 resulted in no gain or loss.
Other
During the year ended February 28, 1998, the Company lent approximately
$122,000 to its Chief Executive Officer.
NOTE J - 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, 1998, were as follows:
<TABLE>
<CAPTION>
Year ending
February 28,
------------
<S> <C>
1999 $ 274,000
2000 289,000
2001 301,000
2002 303,000
----------
Total $1,167,000
==========
</TABLE>
F-23
<PAGE> 83
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1998 and 1997
NOTE J - COMMITMENTS AND CONTINGENCIES - CONTINUED
Rental expense totaled approximately $303,000 and $352,000 for the years
ended February 28, 1998 and 1997, respectively.
A former employee 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 is seeking damages of
approximately $2,300,000. The Company believes such claims are without merit
and intend to vigorously defend against the claims and are considering
filing counter-claims.
Two former employees of the Company have lawsuits pending against the
Company demanding payment of a promissory note issued in connection with the
acquisition of the ADI Group and are seeking damages in excess of $400,000.
The Company reached a settlement with one of the employees under the terms
of a promissory note and agreed judgment. The court severed the claims of
the remaining employee, who amended his claims to include amounts allegedly
owing under an employment agreement (in the amount of approximately
$168,000). The Company believes it has defenses to payment under the note
and employment agreement and intends to vigorously defend against the
lawsuit and pursue counter-claims.
On January 7, 1998, the Company's former Houston landlord filed a lawsuit
against the Company alleging that the Company breached a certain lease
covering the Company's former Houston office space. The suit seeks damages
to date of approximately $180,000, plus attorney's fees, pre and post
judgment interest and court costs. The Company believes that it has viable
defenses against such a claim and is in the process of filing a counter-suit
against the plaintiff.
The Company, and it's President, are 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, and is seeking
damages of $100,000 in shares of the Company's common stock plus 50% of
additional compensation paid by the Company to such third party. The Company
believes it has defenses to such claims. Vestcom has agreed to stay the
arbitration proceeding pending a decision on one of the Company's defenses
in Texas State Court. An oral ruling has been made by the court in favor of
the Company.
On October 12, 1997, five former employees of the Company filed a lawsuit
against the Company and one current and one former officer and director. The
suit alleges 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 seeks 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.
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 other litigation. Such litigation is not
material to the Company's consolidated financial condition or results of
operations.
At February 28, 1998, the Company has employment agreements with three of
its officers. The agreements expire in 2000 to 2002.
F-24
<PAGE> 84
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1998 and 1997
NOTE K - SUPPLEMENTAL CASH FLOW INFORMATION
<TABLE>
<CAPTION>
Years ended February 28,
------------------------
1998 1997
----------- -----------
<S> <C> <C>
Supplemental disclosures of cash flow information:
Cash paid during the year for interest $ 128,929 $ 239,508
Non-cash investing and financing transactions:
Notes payable converted to warrants -- 734,000
Payment of dividends in common stock 96,429 133,714
Conversions to common stock
Debt 901,326 --
Preferred stock and equity notes 481,004 4,213,693
Acquisition of software and in-process research
and development for notes payable -- 1,206,560
Liquidation of note payable by transfer of collateral 1,250,000 --
Sale of receivables for treasury stock 2,146,649 --
Notes receivable satisfied through debt assumptions 425,000 --
Acquisition of businesses:
In-process research and development acquired -- 1,711,480
Assets acquired -- 2,051,135
Liabilities assumed -- (1,226,054)
Common stock issued -- (1,939,201)
----------- -----------
Cash paid, net $ -- $ 597,360
=========== ===========
</TABLE>
F-25
<PAGE> 85
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CITADEL TECHNOLOGY, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
AUGUST 31, FEBRUARY 28,
ASSETS 1998 1998
---------- -----------
(unaudited)
<S> <C> <C>
CURRENT ASSETS
Cash $1,930,876 $ 8,555
Accounts receivable, less allowance for returns and
doubtful accounts of $43,000 and $681,000 1,651,622 435,615
Notes receivable from related parties 603,600 376,487
Inventory 116,706 57,512
Other 382,897 71,981
---------- ----------
Total current assets 4,685,701 950,150
PROPERTY AND EQUIPMENT, net 343,709 387,923
PURCHASED SOFTWARE, net of accumulated amortization
of $2,252,530 and $1,788,000 2,997,869 3,462,879
CAPITALIZED SOFTWARE DEVELOPMENT COSTS,
net of accumulated amortization of $312,200 and $150,000 1,593,658 1,011,432
OTHER ASSETS 238,149 350,650
---------- ----------
$9,859,086 $6,163,034
========== ==========
</TABLE>
The accompanying notes are an integral part of these statements.
F-26
<PAGE> 86
CITADEL TECHNOLOGY, INC.
CONSOLIDATED BALANCE SHEETS - CONTINUED
<TABLE>
<CAPTION>
AUGUST 31, FEBRUARY 28,
LIABILITIES AND STOCKHOLDERS' EQUITY 1998 1998
------------ ------------
(unaudited)
<S> <C> <C>
CURRENT LIABILITIES
Cash overdraft $ -- $ 10,249
Current maturities of long-term debt 347,781 1,270,565
Notes payable 323,955 842,174
Accounts payable and accrued expenses 1,278,359 2,274,141
------------ ------------
Total current liabilities 1,950,095 4,397,129
LONG-TERM LIABILITIES
Debt, less current liabilities 74,910 478,044
------------ ------------
Total liabilities 2,025,005 4,875,173
COMMITMENTS AND CONTINGENCIES -- --
STOCKHOLDERS' EQUITY
Common stock, $.01 par value per share; authorized
60,000,000 shares; issued, 32,040,426 shares
at 8/31/98 and 25,881,328 shares at 2/28/98 320,404 258,813
Preferred stock, $.01 par value per share;
authorized 1,000,000 shares; issued and outstanding
Series B convertible, 50 shares (liquidation value $50,000) 1 1
Series C convertible, 4,250 shares at 8/31/98 and 5,000 shares
at 2/28/98 (liquidation value $425,000 and $500,000) 43 50
Series D convertible, 2,253 shares (liquidation value $2,253,000) 23 --
Equity notes 944,000 944,000
Additional paid-in capital 23,196,241 16,158,442
Accumulated deficit (14,126,392) (13,573,206)
Treasury stock, at cost (4,164,613 shares) (2,500,239) (2,500,239)
------------ ------------
Total stockholders' equity 7,834,081 1,287,861
------------ ------------
$ 9,859,086 $ 6,163,034
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
F-27
<PAGE> 87
CITADEL TECHNOLOGY, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
AUGUST 31, AUGUST 31,
1998 1997 1998 1997
------------ ------------ ------------ ------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Gross sales $ 1,129,078 $ 350,070 $ 2,205,504 $ 848,138
Less returns and allowances 51,760 3,976 93,991 9,770
------------ ------------ ------------ ------------
Net sales 1,077,318 346,094 2,111,513 838,368
Cost of sales 60,912 14,375 131,243 23,786
------------ ------------ ------------ ------------
Gross profit 1,016,406 331,719 1,980,270 814,582
Operating expenses
Research and development expenses 146,609 67,215 251,333 217,737
Selling and marketing expenses 958,904 303,760 1,430,298 611,387
General and administrative expenses 426,152 426,570 781,491 1,010,408
------------ ------------ ------------ ------------
1,531,665 797,545 2,463,122 1,839,532
------------ ------------ ------------ ------------
Operating income (loss) before depreciation
and amortization (515,259) (465,826) (482,852) (1,024,950)
Depreciation and amortization expense 371,491 348,152 723,917 622,328
------------ ------------ ------------ ------------
Operating income (loss) (886,750) (813,978) (1,206,769) (1,647,278)
Other income (expense)
Interest expense (30,847) (29,502) (82,051) (50,728)
Other 7,566 107,916 7,566 101,323
Loss on marketable securities -- (199,672) -- (199,672)
------------ ------------ ------------ ------------
(23,281) (121,258) (74,485) (149,077)
------------ ------------ ------------ ------------
Net loss before extraordinary item (910,031) (935,236) (1,281,254) (1,796,355)
Extraordinary item - gain on settlement of debt 205,847 -- 733,068 --
------------ ------------ ------------ ------------
Net income (loss) $ (704,184) $ (935,236) $ (548,186) $ (1,796,355)
============ ============ ============ ============
Basic and diluted earnings (loss) per share data
Net loss before extraordinary item (0.03) (0.06) (0.05) (0.12)
Extraordinary item 0.01 -- 0.03 --
------------ ------------ ------------ ------------
Net income (loss) per share (0.03) (0.06) (0.02) (0.12)
============ ============ ============ ============
Shares used in computing earnings (loss) per share
Basic and diluted 26,256,753 14,427,452 24,123,254 14,424,452
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
F-28
<PAGE> 88
CITADEL TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Six months ended
August 31,
1998 1997
----------- -----------
(unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (548,186) $(1,796,355)
Adjustments to reconcile net loss to net cash
used by operating activities
Depreciation and amortization 723,917 622,328
Net loss on marketable securities -- 199,672
Gain on settlement of debt (733,068) --
Provision for uncollectable accounts 15,000 --
Changes in operating assets and liabilities
Accounts receivable (1,231,007) (99,851)
Notes receivable from related parties (227,113) (82,548)
Other current assets (310,916) (254,874)
Inventory (59,194) --
Bank overdraft (10,249) (22,797)
Accounts payable and accrued expenses (666,132) 771,164
Other assets 112,501 (3,786)
----------- -----------
NET CASH USED BY OPERATING ACTIVITIES (2,934,447) (667,047)
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (52,413) (128,112)
Securities transactions - net -- 156,100
Development of software (744,506) (280,834)
----------- -----------
NET CASH USED BY INVESTING ACTIVITIES (796,919) (252,846)
CASH FLOW FROM FINANCING ACTIVITIES
Net change in notes payable (118,219) (197,432)
Proceeds from sale of equity & convertible notes -- 1,075,000
Proceeds from sale of preferred stock 2,567,391 --
Proceeds from sale of common stock 3,772,015 63,426
Redemption of preferred stock (567,500) --
----------- -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 5,653,687 940,994
----------- -----------
Net increase (decrease) in cash 1,922,321 21,101
Cash at the beginning of the period 8,555 15,100
----------- -----------
Cash at the end of the period $ 1,930,876 $ 36,201
=========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
F-29
<PAGE> 89
CITADEL TECHNOLOGY, INC.
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, 1998.
The balance sheet as of February 28, 1998 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. 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, 1998 through August 31, 1998, the
Company's stockholders' equity reflected the following changes:
<TABLE>
<S> <C>
Balance at February 28, 1998 $ 1,287,861
Issuance of preferred stock, net 2,645,808
Conversion of debt to equity 442,500
Issuance of common stock, net 2,424,980
Exercise of options 25,000
Net income 155,998
-----------
Balance at May 31, 1998 6,982,147
Issuance of common stock, net 1,410,000
Redemption of preferred stock (567,500)
Conversion of debt to equity 346,003
Exercise of options 99,281
Value of options given related to assumption
of certain indebtedness 407,500
Expenses related to fund raising (139,166)
Net loss for the period (704,184)
-----------
Balance at August 31, 1998 $ 7,834,081
===========
</TABLE>
F-30
<PAGE> 90
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE C - COMMITMENTS AND CONTINGENCIES
In September 1998, the Company settled a lawsuit styled Marks, Marks, Ranshaw,
Colquitt & Lauratis v. Citadel Computer Systems Incorporated, et al., in the
189th Judicial District Court of Harris County, Texas for $25,000 in cash plus
the extension of the plaintiffs options to purchase 207,088 shares of Common
Stock and the Company agreed to register the shares underlying these options.
The lawsuit was filed by former employees who alleged that the Company and/or
the individual defendants owed the plaintiffs damages, attorney's fees, pre- and
post-judgment interest and costs allegedly in excess of $4,000,000.
In August 1998, Janssen Meyers Associates L.P. ("JM") filed a lawsuit against
the Company. The suit alleges that the Company owes the plaintiffs a fee in the
amount of $16,500,000 plus interest and attorney's fees in connection with
services allegedly performed by JM in respect of the merger between LoneStar and
Old Citadel and related matters. The Company believes such claims are without
merit and intends to vigorously defend against the claims. The lawsuit, styled
Janssen Meyers Associates, L.P. v. Citadel Technology, Inc., was filed in the
Supreme Court of the State of New York, County of New York. The Company has
removed the case to federal court in the Southern District of New York.
NOTE D - CAPITAL TRANSACTIONS
On June 30, 1998, the Company and Icarus Investments I, Ltd. ("Icarus") entered
into a Stock Purchase Agreement pursuant to which Icarus purchased 1,000,000
shares of Citadel's Common Stock for proceeds of $1,500,000. Such shares were
not registered under the Securities Act, in reliance upon Section 4(2) of the
Securities Act and Rule 506 of Regulation D thereunder. In connection with the
transaction, the Company issued warrants to purchase 500,000 shares of the
Company's Common Stock at $3.00 per shares and 250,000 shares at $2.00. The
Company paid a commission of $90,000 to an individual in connection with the
transaction. No other fees were paid in connection with the sale of the shares
to Icarus.
NOTE E - RELATED PARTY TRANSACTIONS
The Company contracted with Metamor Software Solutions, a division of Metamor
Worldwide, Inc. ("Metamor") to provide various development services for the
Company. During the quarter the Company incurred approximately $246,000 in
expenses related to these services, and approximately $745,000 for the period to
date. Mr. Johnsen, one of the Company's directors, is executive vice president
of Metamor.
On August 11, 1998, the Company entered into a transaction with a shareholder
of the Company whereby the Company granted the shareholder certain options to
purchase shares of Common Stock of the Company and reduced the exercise price on
certain other options in consideration for the shareholder assuming certain
indebtedness of the Company. The transaction resulted in no gain or loss. As of
August 31, 1998, the Company has a receivable from this individual shareholder
in the amount of $325,000, which is secured by 750,000 shares of the Company's
Common Stock.
F-31
<PAGE> 91
NO DEALER, SALES REPRESENTATIVE OR ANY OTHER PERSON HAS BEEN AUTHORIZED
TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THIS
OFFERING OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE,
SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE COMPANY OR ANY UNDERWRITER. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, ANY
SECURITIES BY ANY PERSON IN ANY JURISDICTION WHERE SUCH AN OFFER OR SOLICITATION
IS NOT AUTHORIZED OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS
NOT QUALIFIED TO DO SO OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH
OFFER OR SOLICITATION. NEITHER THE DELIVER OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS
BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THAT DATE HEREOF OR THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE
HEREOF.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Disclosure Regarding Forward-Looking Statements 2
Available Information 2
Prospectus Summary 3
Risk Factors 7
Selling Stockholders 16
Plan of Distribution 17
Market Prices of Common Stock and Dividend Policy 19
Capitalization 20
Management's Discussion and Analysis of Financial
Condition and Results of Operations 20
Business 26
Management 41
Certain Transactions 50
Principal Stockholders 53
Description of Capital Stock 55
Shares Eligible for Future Sale 57
Legal Matters 57
Experts 57
Index to Financial Statements F-1
</TABLE>
Until January 3, 1999 (40 days after the effective date of this Prospectus),
all broker-dealers effecting transactions in the registered securities, whether
or not participating in this distribution, may be required to deliver a
Prospectus. This is in addition to the obligation of dealers to deliver a
Prospectus with respect to their unsold allotments or subscriptions.
6,792,544 SHARES
CITADEL TECHNOLOGY, INC.
COMMON STOCK
PROSPECTUS
November 24, 1998
<PAGE> 92
PART II
ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
The Delaware General Corporation Law authorizes a court to award, or a
corporation's board of directors to grant, indemnity to directors and officers
in terms sufficiently broad to permit such indemnification under certain
circumstances (including reimbursement for expenses incurred) arising under the
Securities Act of 1933, as amended (the "Securities Act"). The Company's
Certificate of Incorporation and Bylaws provide that the Company shall indemnify
its directors and officers to the fullest extent permitted by Delaware law and
include a provision limiting director liability to the Company or its
shareholders for monetary damages arising from certain acts or omissions in the
director's capacity as a director. In addition, the Company has the ability to
maintain insurance on behalf of its directors and executive officers to insure
them against any liability asserted against them in their capacities as
directors or officers or arising out of such status. See "Management --
Indemnification and Limitation of Liability."
Certain of the Company's registration rights agreements contain reciprocal
agreements of indemnity between the Company and certain of the Selling
Stockholders as to certain liabilities, including liabilities under the
Securities Act and in certain circumstances could provide for indemnification of
the Company's directors and officers.
Insofar as indemnification for liabilities arising under the Act may be
permitted to directors, officers and controlling persons of the small business
issuer pursuant to the foregoing provisions, or otherwise, the small business
issuer has been advised that in the opinion of the Commission such
indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable.
ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table indicates the estimated expenses to be incurred in
connection with the Offering, all of which will be paid by the Company.
<TABLE>
<CAPTION>
<S> <C>
SEC registration fee............................................... $ 1,874
Accounting fees and expenses....................................... 17,500
Legal fees and expenses............................................ 25,000
Printing and shipping.............................................. 15,000
Blue Sky fees and expenses (including counsel fees)................ 4,000
Miscellaneous expenses............................................. 1,626
-------
Total........................................................ $65,000
=======
</TABLE>
- ------------
ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES.
The following sets forth information as of September 30, 1998, regarding
all sales of unregistered securities of the Registrant during the past three
years. All such shares were exempt from registration under the Securities Act by
reason of Section 4(2) of the Securities Act, or Regulation D or Regulation S
promulgated thereunder, or Rule 701 promulgated under Section 3(b) of the
Securities Act, as transactions by an issuer not involving a public offering or
transactions relating to compensatory benefit plans and contracts relating to
compensation as provided under such Rule 701. The recipients of securities in
each such transaction represented their intentions to acquire the securities for
investment only and not with a view to or for sale in connection with any
distribution thereof, and appropriate legends were affixed to the share
certificates and warrants issued in such transactions. All recipients had
adequate access, through their relationships with the Registrant or otherwise,
to information about the Registrant.
II-1
<PAGE> 93
In December 1995, Old Citadel issued an aggregate of $610,000 of its Promissory
Notes due December 1996 to nineteen investors. Janssen Meyers, as placement
agent, received warrants to purchase up to 727,809 shares of Common Stock (after
adjustment based on antidilution provisions). The notes were issued by Old
Citadel in a private placement under Section 4(2) of the Securities Act.
In 1995, Old Citadel issued an aggregate of $730,000 of its Promissory
Notes to fifteen investors. The Notes were converted into warrants to purchase
shares of Common Stock. The notes were issued by Old Citadel in a private
placement under Section 4(2) of the Securities Act.
In June 1996, the Company issued an aggregate of $2,800,000 of its 8%
Convertible Notes due June 1997 to three investors. The notes were sold to
certain offshore accredited investors pursuant to Section 4(2) of the Securities
Act and Regulation S. The securities were convertible into shares of Common
Stock based on a conversion price at a discount to the market price at the time
of conversion.
In July 1996, the Company issued an aggregate of $1,750,000 of its 8%
Convertible Notes due July 1997 to three investors. The notes were sold to
certain offshore accredited investors pursuant to Section 4(2) of the Securities
Act and Regulation S. The securities were convertible into shares of Common
Stock based on a conversion price at a discount to the market price at the time
of conversion.
In July 1996, the Company issued an aggregate of 1,870 shares of Series A
Convertible Preferred Stock for aggregate proceeds of $1,870,000. The shares
were issued to certain offshore accredited investors pursuant to Section 4(2)
of the Securities Act and Regulation S. The securities were convertible into
shares of Common Stock based on a conversion price at a discount to the market
price at the time of conversion.
In September 1996, the Company issued an aggregate of 1,500 shares of Series B
Convertible Preferred Stock to seven investors, at a purchase price of $1,000
per share. The shares are convertible into shares of common stock at a
conversion price of 83% of the average of the closing bid price of the common
stock for the five trading days preceding the date of conversion. The shares
were issued to certain offshore accredited investors pursuant to Section 4(2) of
the Securities Act and Regulation S.
On March 11, 1997, the Company sold $1,080,000 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. For each $25,000 of notes
purchased, each investor received warrants to purchase 5,000 shares of the
common stock of the Company at $2.00 per share. The warrants have a two year
term and will vest as follows: (a) 33-1/3% vest in respect of that portion of
the note still held by the holder after the expiration of 90 days following the
closing date; (b) 33-1/3% vest in respect of that portion of the note still
held by the holder after the expiration of 135 days following the closing date;
and (c) 33-1/3% vest in respect of that portion of the note still held by the
holder after the expiration of 180 days following the closing date. First
Bermuda, as placement agent, received a commission of eight percent (8%) of the
proceeds, payable in shares of the Company's stock, and a warrant to purchase
approximately 120,000 shares of Company common stock at an exercise price of
$2.00 per share.
II-2
<PAGE> 94
In April 1997, the Company issued an aggregate of $500,000 of its 8% Convertible
Notes due April 2000 (the "Willora Notes") to Willora Company Ltd. The notes
were sold to certain offshore accredited investors pursuant to Section 4(2)
under the Securities Act and Regulation S. The notes are convertible into
shares of Common Stock based on a discount to the market price at the time of
conversion.
In May 1997, the Company issued an aggregate of $150,000 of its 10% Convertible
Notes due May 7, 2000 to Offshore Nominees Limited. The notes were sold to
certain offshore accredited investors pursuant to Section 4(2) under the
Securities Act and Regulation S. The notes are convertible into shares of Common
Stock based on a discount to the market price at the time of conversion.
In June 1997, the Company issued an aggregate of $1,125,000 ($500,000 of which
was used to redeem the Willora Notes and $125,000 was paid to the lender as a
premium) of its 8% Convertible Notes due June 2000 to Silenus Limited. The notes
were sold to certain offshore accredited investors pursuant to Section 4(2)
under the Securities Act and Regulation S. The notes are convertible into shares
of Common Stock based on a discount to the market price at the time of
conversion.
On October 6, 1997, the Company entered into a Purchase Agreement with
CORESTAFF, Inc. ("CORESTAFF") wherein CORESTAFF purchased 2,500,000 shares of
Common Stock for $750,000, together with other valuable consideration. Pursuant
to the Agreement, CORESTAFF also received warrants to purchase 1,000,000 shares
of the Common Stock of Citadel at a purchase price of $4.00 per share and to
purchase 1,000,000 shares of the Common Stock of Citadel at a purchase price of
$5.00 per share for a ten-year term. Such securities were not registered under
the Securities Act, in reliance upon Section 4(2) of the Securities Act and
Rule 506 of Regulation D thereunder. No underwriters were involved in
connection with the sale of the securities.
In November 1997, the Company, 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.
In January 1998, the Company received a loan in the amount of $400,000 from
Thomas E. Oxley. In connection with the loan, Mr. Oxley received warrants to
purchase 200,000 shares of common stock at $.32 per share (the then fair market
value of the Company's common stock at the date of the transaction). The
warrants vested immediately and expire on January 5,1999. In May 1998, Mr.
Oxley converted this debt into shares of the Company's Common Stock. Such
securities were not registered under the Securities Act, in reliance upon
Section 4(2) of the Securities Act and Rule 506 of Regulation D thereunder. No
underwriters were involved in connection with the sale of the securities.
In April 1998, the Company received a loan in the amount of $250,000 from
Edward Coppola. The loan bore interest at 10% per annum and is payable in full
on or before July 13, 1998. In connection with the loan, the Company issued
warrants to purchase 100,000 shares of the Company's Common Stock at $.50 per
share (the fair market value of the Company's Common Stock at the date of the
transaction). The warrants vest immediately and expire on April 1, 2001. Mr.
Coppola has the right to convert this debt
II-3
<PAGE> 95
into shares of the Company's Series D Convertible Redeemable Preferred Stock
(the terms of which are described below under Series D Preferred). Such
securities were not registered under the Securities Act, in reliance upon
Section 4(2) of the Securities Act and Rule 506 of Regulation D thereunder. No
underwriters were involved in connection with the sale of the securities. On May
26, 1998, Mr. Coppola converted this debt into shares of the Company's Series D
Convertible Redeemable Preferred Stock.
On April 30, 1998, the Company and Precision Capital Investors Limited
Partnership I ("Precision") entered into a Securities Purchase Agreement (the
"Purchase Agreement") pursuant to which Precision purchased shares of 6% Series
E Convertible Redeemable Preferred Stock for $500,000. The Series E Preferred
Stock was redeemed by the Company at a redemption price in cash equal to 112.5%
of the original issue price, plus accrued and unpaid dividends to the
redemption date. In connection with the transaction, the Company also issued
warrants to purchase up to 100,000 shares of the Company's common stock at
$0.75 per share (above the fair market value of the Company's common stock at
the date of the transaction), which expire on April 30, 2001. Such securities
were not registered under the Securities Act, in reliance upon.
On May 15, 1998, the Company and Metamor Worldwide, Inc. (formerly Corestaff,
Inc.) ("Metamor") entered into a Stock Purchase Agreement (the "Stock Purchase
Agreement") pursuant to which Metamor purchased 2,000 shares of Citadel's 11%
Series D Convertible Redeemable Preferred Stock for proceeds of $2,000,000. The
preferred shares are convertible into Common Stock of the Company at the
election of the holder at a conversion price equal to 150% of the twenty day
average of the closing bid price of the Company's Common Stock prior to the
closing of the purchase ($1.07 per share). The preferred shares will
automatically convert into shares of Common Stock upon (i) the closing of an
underwritten public offering that values the Company at a minimum equity value
of $20,000,000 with proceeds to the Company of a minimum of $10,000,000 before
expenses, or (ii) the date at which the Company's Common Stock maintains a
closing bid price that is 100% greater than the conversion price for at least
20 consecutive days. Such shares were not registered under the Securities Act,
in reliance upon Section 4(2) of the Securities Act and Rule 506 of Regulation
D thereunder. No underwriters were involved in connection with the sale of the
shares under the Stock Purchase Agreement. Beginning one year from the date of
closing, the Company may redeem all or part of the unconverted preferred shares
based on a redemption price equal to 120% of the issuance price if redeemed
prior to two years after the closing, 115% of the issuance price if redeemed
prior to three years after the closing, or 100% of the issuance price if
redeemed prior to four years after the closing.
On May 26, 1998, the Company and Icarus Investments I, Ltd. ("Icarus") entered
into a Stock Purchase Agreement pursuant to which Icarus purchased 2,000,000
shares of Citadel's Common Stock for proceeds of $2,500,000. Such shares were
not registered under the Securities Act, in reliance upon Section 4(2) of the
Securities Act and Rule 506 of Regulation D thereunder. In connection with the
transaction, the Company issued warrants to purchase 500,000 shares of the
Company's Common Stock at $4.00 per share and 500,000 at $5.00. No underwriters
were involved in connection with the sale of the shares under the Stock
Purchase Agreement.
On June 30, 1998, the Company and Icarus entered into a Stock Purchase
Agreement pursuant to which Icarus purchased 1,000,000 shares of Citadel's
Common Stock for proceeds of $1,500,000. In connection with the transaction,
the Company issued warrants to purchase 500,000 shares of the Company's Common
Stock at $3.00 per share and 250,000 at $2.00 per share. Such securities were
not registered
II-4
<PAGE> 96
under the Securities Act, in reliance upon Section 4(2) of the Securities Act
and Rule 506 of Regulation D thereunder. No underwriters were involved in
connection with the sale of the shares under the Stock Purchase Agreement.
II-5
<PAGE> 97
ITEMS 27. 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, 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).
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-KSB 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).
II-6
<PAGE> 98
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).
3.10 Certificate of Amendment to Certificate of Incorporation filed with the
Delaware Secretary of State on February 27, 1998 (incorporated by reference to
Exhibit 4.2 of the Company's Registration Statement on Form S-8 filed May 20,
1998, File No. 333-53131).
3.11 Certificate of Designations of Series C Preferred Stock (incorporated by
reference to Exhibit 4.6 of the Company's Registration Statement on Form S-8
filed May 20, 1998, File No. 333-53131).
3.12 Certificate of Designations of Series D Preferred Stock (incorporated by
reference to Exhibit 4.8 of the Company's Registration Statement on Form S-8
filed May 20, 1998, File No. 333-53131).
3.13 Certificate of Designations of Series E Preferred Stock (incorporated by
reference to Exhibit 4.7 of the Company's Registration Statement on Form S-8
filed May 20, 1998, File No. 333-53131).
*5.1 Opinion of Wood, Exall & Bonnet, L.L.P.
10.1 Employment Agreement dated July 15, 1997, by and between Citadel Computer
Systems Incorporated and Steven Solomon (incorporated by reference to Exhibit
10.1 to the Company's Annual Report on Form 10-KSB for the fiscal year ended
February 28, 1998).
10.2 Employment Agreement dated January 1998, by and between Citadel Computer
Systems Incorporated and Bennett Klein (incorporated by reference to Exhibit
10.2 to the Company's Annual Report on Form 10-KSB for the fiscal year ended
February 28, 1998).
10.3 Employment Agreement dated May 1, 1997, by and between Citadel Computer
Systems Incorporated and Richard L. Travis, Jr. (incorporated by reference to
Exhibit 10.10 to the Company's Annual Report on Form 10-KSB for the fiscal year
ended February 28, 1998).
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).
10.8 Form of Offshore Securities Subscription Agreement, Convertible Notes,
Warrants and Registration Rights Agreement between Citadel Computer Systems
Incorporated and Willora Company
II-7
<PAGE> 99
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 (incorporated by reference to Exhibit 10.10 to the Company's Annual Report
on Form 10-KSB for the fiscal year ended February 28, 1997).
10.11 Warrant to Purchase Common Stock of Citadel issued to Worldwide PetroMoly
Inc. (incorporated by reference to Exhibit 10.11 to the Company's Annual Report
on Form 10-KSB for the fiscal year ended February 28, 1997).
10.12 Series D Preferred Stock Purchase Agreement between Citadel and METAMOR
WORLDWIDE, Inc., dated May 15, 1998 (incorporated by reference to Exhibit 10.12
to the Company's Annual Report on Form 10-KSB for the fiscal year ended
February 28, 1998).
10.13 Stock Purchase Agreement between Citadel and Precision Capital Limited
Partnership I, dated April 30, 1998 (incorporated by reference to Exhibit 10.13
to the Company's Annual Report on Form 10-KSB for the fiscal year ended
February 28, 1998).
10.14 Stock Purchase Agreement between Citadel and Icarus Investments I, Ltd.,
dated May 27, 1998 (incorporated by reference to Exhibit 10.14 to the Company's
Annual Report on Form 10-KSB for the fiscal year ended February 28, 1998).
10.15 Stock Purchase Agreement between Citadel and Icarus, dated June 30, 1998
(incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on
Form 10-QSB for the fiscal quarter ended August 31, 1998).
10.16 Warrant to purchase shares of Common Stock issued to Icarus, dated June
30, 1998 (incorporated by reference to Exhibit 10.2 to the Company's Quarterly
Report on Form 10-QSB for the fiscal quarter ended August 31, 1998).
*10.17 Form of Warrant to purchase shares of Common Stock issued to holders of
Janssen-Meyers warrants, dated December 11, 1995.
21 Subsidiaries of the Company (incorporated by references to Exhibit 21
to the Company's Annual Report on Form 10-KSB for the fiscal year ended February
28, 1998).
*23.1 Consent of Grant Thornton LLP.
*23.2 Consent of Wood, Exall & Bonnet, L.L.P. (included in Exhibit 5.1).
**24.1 Power of Attorney (included with signature pages).
- ---------------------------------
* Filed herewith.
** Previously filed.
ITEM 28. UNDERTAKINGS.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant by the Registrant pursuant to the Company's Certificate of
Incorporation, Bylaws, Delaware law or otherwise, the Registrant has been
advised that in the opinion of the Securities and Exchange Commission, such
indemnification is against public policy as expressed in the Securities Act and
is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrant of expenses
incurred or paid by a director, officer or controlling person of the Registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the
Securities Act, the information omitted from the form of prospectus
filed as part of this Registration Statement in reliance upon Rule
430A and contained in a form of prospectus filed by the Registrant
pursuant to Rule 424(b)(1) or (4) or 497(h)
II-8
<PAGE> 100
under the Securities Act shall be deemed to be part of this
Registration Statement as of the time it was declared effective by the
Securities and Exchange Commission.
(2) For the purpose of determining any liability under the
Securities Act, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating
to the securities offered herein, and the offering of such securities
at that time shall be deemed to be the initial bona fide offering
thereof.
The undersigned Registrant hereby undertakes: (1) to file, during any period in
which offers or sales are being made, a post-effective amendment to this
Registration Statement:
(i) to include any prospectus required by Section
10(a)(3) of the Securities Act;
(ii) to reflect in the prospectus any facts or events
arising after the effective date of the registration statement
(or the most recent post-effective amendment thereof) which,
individually or in the aggregate, represent a fundamental
change in the information set forth in the Registration
Statement. Notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the total dollar
value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the
estimated maximum offering range may be reflected in the form
of prospectus filed with the Commission pursuant to Rule
424(b) if, in the aggregate, the changes in volume and price
represent no more than a 20% change in the maximum aggregate
offering price set forth in the "Calculation of Registration
Fee" table in the effective Registration Statement;
(iii) to include any material information with
respect to the plan of distribution not previously disclosed
in the Registration Statement or any material change to such
information in the registration statement;
(2) that, for the purpose of determining any liability under
the Securities Act, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof; and
(3) to remove from registration by means of a post-effective
amendment any of the securities being registered which remain unsold at
the termination of the offering.
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<PAGE> 101
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
Registrant certifies that it has reasonable grounds to believe that it meets all
the requirements for filing on Form SB-2 and has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Dallas, State of Texas, on November 25, 1998.
CITADEL TECHNOLOGY, INC.
By: /s/ STEVEN B. SOLOMON
------------------------------------
Steven B. Solomon,
Chief Executive Officer
II-10
<PAGE> 102
Pursuant to the requirements of the Securities Act of 1933, as
amended, this Registration Statement on Form SB-2 has been signed below by the
following persons on behalf of the Registrant in the capacities indicated on
the date stated.
<TABLE>
<CAPTION>
SIGNATURE CAPACITY DATE
--------- -------- ----
<S> <C> <C>
* Chairman of the Board of Directors November 25, 1998
- -----------------------------
Victor K. Kiam, II
/s/ STEVEN B. SOLOMON Chief Executive Officer, President & Director November 25, 1998
- ----------------------------- (Principal Executive Officer)
Steven B. Solomon
/s/ RICHARD L. TRAVIS, JR. Chief Financial and Operating Officer, November 25, 1998
- ----------------------------- Secretary (Principal Financial and Accounting
Richard L. Travis, Jr. Officer)
* Director November 25, 1998
- -----------------------------
Kenneth Johnsen
* Director November 25, 1998
- -----------------------------
Mark Rogers
* Director November 25, 1998
- -----------------------------
Michael A. Ruff
* Director November 25, 1998
- -----------------------------
Chris Economou
* Director November 25, 1998
- -----------------------------
Dr. Axel Sawallich
Director _________ __, 1998
- -----------------------------
Gilbert Gertner
</TABLE>
* Attorney-in-fact
By: /s/ STEVEN B. SOLOMON
-------------------------
Steven B. Solomon
II-11
<PAGE> 103
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
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, 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).
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-KSB 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).
</TABLE>
<PAGE> 104
<TABLE>
<S> <C>
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).
3.10 Certificate of Amendment to Certificate of Incorporation filed with
the Delaware Secretary of State on February 27, 1998 (incorporated by
reference to Exhibit 4.2 of the Company's Registration Statement on
Form S-8 filed May 20, 1998, File No. 333-53131).
3.11 Certificate of Designations of Series C Preferred Stock (incorporated
by reference to Exhibit 4.6 of the Company's Registration Statement on
Form S-8 filed May 20, 1998, File No. 333-53131).
3.12 Certificate of Designations of Series D Preferred Stock (incorporated
by reference to Exhibit 4.8 of the Company's Registration Statement on
Form S-8 filed May 20, 1998, File No. 333-53131).
3.13 Certificate of Designations of Series E Preferred Stock (incorporated
by reference to Exhibit 4.7 of the Company's Registration Statement on
Form S-8 filed May 20, 1998, File No. 333-53131).
*5.1 Opinion of Wood, Exall & Bonnet, L.L.P.
10.1 Employment Agreement dated July 15, 1997, by and between Citadel
Computer Systems Incorporated and Steven Solomon (incorporated by
reference to Exhibit 10.1 to the Company's Annual Report on Form
10-KSB for the fiscal year ended February 28, 1998).
10.2 Employment Agreement dated January 1998, by and between Citadel
Computer Systems Incorporated and Bennett Klein (incorporated by
reference to Exhibit 10.2 to the Company's Annual Report on Form
10-KSB for the fiscal year ended February 28, 1998).
10.3 Employment Agreement dated May 1, 1997, by and between Citadel
Computer Systems Incorporated and Richard L. Travis, Jr. (incorporated
by reference to Exhibit 10.10 to the Company's Annual Report on Form
10-KSB for the fiscal year ended February 28, 1998).
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).
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).
</TABLE>
<PAGE> 105
<TABLE>
<S> <C>
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 (incorporated by reference to Exhibit 10.10 to the Company's Annual
Report on Form 10-KSB for the fiscal year ended February 28, 1997).
10.11 Warrant to Purchase Common Stock of Citadel issued to Worldwide PetroMoly
Inc. (incorporated by reference to Exhibit 10.11 to the Company's Annual
Report on Form 10-KSB for the fiscal year ended February 28, 1997).
10.12 Series D Preferred Stock Purchase Agreement between Citadel and METAMOR
WORLDWIDE, Inc., dated May 15, 1998 (incorporated by reference to Exhibit
10.12 to the Company's Annual Report on Form 10-KSB for the fiscal year
ended February 28, 1998).
10.13 Stock Purchase Agreement between Citadel and Precision Capital Limited
Partnership I, dated April 30, 1998 (incorporated by reference to
Exhibit 10.13 to the Company's Annual Report on Form 10-KSB for the
fiscal year ended February 28, 1998).
10.14 Stock Purchase Agreement between Citadel and Icarus Investments I, Ltd.,
dated May 27, 1998 (incorporated by reference to Exhibit 10.14 to
the Company's Annual Report on Form 10-KSB for the fiscal year ended
February 28, 1998).
10.15 Stock Purchase Agreement between Citadel and Icarus, dated June 30, 1998
(incorporated by reference to Exhibit 10.1 to the Company's Quarterly
Report on Form 10-QSB for the fiscal quarter ended August 31, 1998).
10.16 Warrant to purchase shares of Common Stock issued to Icarus, dated June
30, 1998 (incorporated by reference to Exhibit 10.2 to the Company's
Quarterly Report on Form 10-QSB for the fiscal quarter ended August 31,
1998).
*10.17 Form of Warrant to purchase shares of Common Stock issued to holders of
Janssen-Meyers warrants, dated December 11, 1995.
21 Subsidiaries of the Company (incorporated by reference to Exhibit
21 to the Company's Annual Report on Form 10-KSB for the fiscal year
ended February 28, 1998).
*23.1 Consent of Grant Thornton LLP.
*23.2 Consent of Wood, Exall & Bonnet, L.L.P. (included in Exhibit 5.1).
**24.1 Power of Attorney (included with signature pages).
- -----------------
* Filed herewith.
** Previously filed.
</TABLE>
<PAGE> 1
Exhibit 5.1
Wood, Exall & Bonnet, L.L.P.
Attorneys and Counselors
12222 Merit Drive, Suite 880
Dallas, Texas 75251
Telephone (972) 991-8510
Facsimile (972) 991-9261
November 25, 1998
Citadel Technology, Inc.
3811 Turtle Creek Boulevard, Suite 600
Dallas, Texas 75219
Re: Shares of Common Stock, par value $0.01 (the "Common Stock"), of
Citadel Technology, Inc. (the "Company") to be offered and sold
pursuant to the Company's Registration Statement on Form SB-2, as filed
on September 30, 1998, as amended by Amendment No. 1 thereto, as filed
on November 25, 1998 (such amended Registration Statement, as it may be
further amended from time to time, the "Registration Statement")
Ladies & Gentlemen:
We have acted as special counsel to the Company in connection with the
registration of 6,792,544 shares of Common Stock pursuant to the Registration
Statement which were issued or reserved for issuance pursuant to private
placements, including 5,268,135 shares of Common Stock underlying warrants
granted or options issued to certain of the stockholders named in the
Registration Statement (the "Selling Stockholders"), 900,000 shares of Common
Stock issuable upon conversion of preferred stock held by certain Selling
Stockholders, and 624,409 shares of Common Stock held by certain Selling
Stockholders. Defined terms used in this opinion shall have the meanings set
forth in the Registration Statement unless the context otherwise requires.
We are members of the Bar of the State of Texas. We do not hold
ourselves out as experts on, nor do we express any opinion as to or with respect
to the applicability of, the laws of any jurisdiction other than the laws of the
State of Texas, the federal laws of the United States, and the General
Corporation Law of the State of Delaware (the "Opining Jurisdictions").
We express no opinion with respect to any of the following legal
issues: (a) state or federal securities laws or regulations; (b) fraudulent
transfer and fraudulent conveyance laws; or (c) federal and state tax laws and
regulations.
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In connection with this Opinion, we have examined the Registration
Statement and the prospectus related thereto (the "Prospectus"). In addition to
the foregoing, we have reviewed such documents and given consideration to such
matters of law and fact as we have deemed appropriate, in our professional
judgment, to render this Opinion. We have also relied, without further
independent investigation, as to certain matters of fact, on information
obtained from public officials, from officers of the Company and from other
sources believed by us to be responsible.
The assumptions, opinions and conclusions stated below are subject to:
(a) bankruptcy, insolvency, reorganization, receivership, moratorium and other
similar laws affecting the rights and remedies of creditors generally; and (b)
general principles of equity and the exercise of judicial discretion.
We have assumed, without further investigation, the following: (a) all
natural persons who are involved have sufficient legal capacity to enter into
all relevant agreements or documents (the "Agreements") relating to the issuance
of the securities registered pursuant to the Registration Statement or the
securities convertible into such securities (the "Securities"), in such capacity
as is provided thereby, and to perform the transactions contemplated by such
Agreements (collectively, the "Transactions") or to carry out their roles in the
Transactions; (b) each party to the Transactions has satisfied those legal
requirements that are applicable to it to the extent necessary to make the
Agreements to which it is a party enforceable against it; (c) each party to the
Transactions has complied with all legal requirements pertaining to its status
as such status relates to its rights to enforce the Agreements against the other
parties to the Transactions; (d) each document submitted to us for review is
accurate and complete, each such document that is an original is authentic, each
such document that is a copy conforms to an authentic original, and all
signatures on each such document are genuine; (e) each certificate issued by a
government official concerning a person or entity's property or status is
accurate, complete and authentic and all official public records (including
their proper indexing and filing) are accurate and complete; (f) the conduct of
the parties to the Transactions has complied with any requirement of good faith,
fair dealing and unconscionability; (g) the parties have acted in good faith and
without notice of any defense against the enforcement of any rights created by
the Transactions; (h) there are no agreements or understandings among the
parties, written or oral, and there is no usage of trade or course of prior
dealing among the parties that would, in either case, define, supplement or
qualify the terms of the Agreements; (i) all statutes, judicial and
administrative decisions, and rules and regulations of governmental agencies
constituting the law of the Opining Jurisdictions are generally available (i.e.,
in terms of access and distribution following publication or other release) to
lawyers practicing in the Opining Jurisdictions, and are in a format which makes
legal research reasonably feasible; (j) the constitutionality or validity of a
relevant statute, rule, regulation or agency action is not in issue unless a
reported decision in the Opining Jurisdiction has specifically addressed but not
resolved, or has established, its unconstitutionality or validity; (k) the
parties will obtain all permits and governmental approvals required in the
future, and take all actions similarly required, relevant to subsequent
consummation of the Transactions or performance of the Agreements; (l) all
parties to the Transactions will act in accordance with, and will
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<PAGE> 3
refrain from taking any action that is forbidden by, the terms and conditions of
the Agreements; and (m) the Transactions and the execution, delivery and
performance of the Agreements will not (i) breach, or result in a default under,
any existing obligation of a party to the Transactions to a contract to which
such party is a party or by which its property is bound, or (ii) breach or
otherwise violate any existing obligation of any court and administrative order,
writ, judgment or decree that names any such party and is specifically directed
to it or its property. Each assumption specifically described in this opinion is
made with the express consent and approval of the Company. However, we have not
relied on information (including certificates or other documentation) or
assumptions, otherwise appropriate in the circumstances, if we have knowledge
that the information or assumptions are false or if we have knowledge of facts
that under the circumstances would make the reliance unreasonable.
We have also assumed that (i) the shares of Common Stock when issued in
exchange for the purchase price pursuant to the exercise of Convertible
Securities will be duly issued in accordance with the terms of the applicable
Agreement, (ii) the Company will maintain an adequate number of authorized but
unissued shares and/or treasury shares of Common Stock available for issuance
to those persons who exercise Convertible Securities, (iii) the consideration
for shares of Common Stock issued pursuant to the exercise of Convertible
Securities will be actually received by the Company in accordance with the
terms of the applicable Agreement and will exceed the par value of such shares,
and (iv) the Convertibles Securities were duly granted or issued.
This opinion speaks only as of its date. We have no obligation to
advise the Company (or any third party) of changes in law or fact that occur
after the date of this opinion, even though the change may affect the legal
analysis, a legal conclusion or an informational confirmation in this opinion.
Based upon the foregoing and subject to the qualifications contained
below, we are of the opinion that when (a) the pertinent provisions of the
Securities Act of 1933, as amended, and such "blue sky" and other securities
laws as may be applicable have been complied with and (b) the Common Stock
issuable upon conversion of the Convertible Securities has been duly delivered
against payment therefor upon conversion of the Convertible Securities, all as
contemplated by the Agreements, the Common Stock owned by certain Selling
Stockholders and the Common Stock issuable upon conversion of the Convertible
Securities will be validly issued, fully paid, and nonassessable.
This opinion deals only with the specific legal issues it explicitly
addresses. Accordingly, the express opinions set forth above concerning a
particular legal issue do not address any other matters.
We consent to the filing of this opinion as an exhibit to the
Registration Statement and to references to us included in or made a part of the
Registration Statement. In giving this consent, we do not admit that we are in
the category of persons whose consent is required under Section 7 of the
Securities Act of 1933, as amended, or the rules and regulations thereunder.
Very truly yours,
Wood, Exall & Bonnet, L.L.P.
By: David Allen Wood, P.C., Partner
By: /s/ DAVID A. WOOD
-------------------------
David A. Wood, President
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<PAGE> 1
EXHIBIT 10.17
WARRANT AGREEMENT
This WARRANT AGREEMENT (the "Agreement") dated December 11, 1995, is
made by and between Citadel Computer Systems, Inc., a Delaware corporation with
an address 3811 Turtle Creek Blvd., Suite 600, Dallas, Texas 75219 (the
"Company") and _______ (the "Warrantholder")
The Company hereby agrees to issue and sell, and the Warrantholder
agrees to acquire, at a price of $.0001 per warrant, the warrants hereinafter
described (the "Warrants") to purchase ____________ shares (the "Warrant
Shares") (subject to adjustment pursuant to Section 8 hereof) of the common
stock, par value $.01 per share, of the Company (the "Common Shares"), at an
Exercise Price determined in accordance with Section 7 hereunder, which Warrants
are part of a total of warrants to purchase 650,000 Common Shares issued to
purchasers ("Holders") pursuant to a Subscription Agreement of even date here
with.
In consideration of the foregoing and for the purpose of defining the
terms and provisions of the Warrants and the respective rights and obligations
thereunder, the Company and the Warrantholder, for value received, hereby agree
as follows:
Section 1. Form of Warrant Certificates; Transferability of Warrants;
Legend on Warrant Shares.
1.1 Form of Warrant Certificate. This Warrant supersedes and replaces
the previous Warrant granted to Holder dated December 11, 1995. The Warrants
shall be evidenced by one or more Warrant certificates substantially as set
forth in Exhibit A attached hereto. The Warrant certificates shall be executed
on behalf of the Company by its Chairman of the Board, President or a Vice
President, under its corporate seal reproduced thereon, and attested by its
Secretary or an Assistant Secretary. A Warrant certificate bearing the signature
of an individual who was at any time the proper officer of the Company shall
bind the Company, notwithstanding that such individual shall have ceased to hold
such office prior to the delivery of such Warrant or did not hold such office on
the date of this Agreement. Each Warrant certificate shall be numbered and
registered on the books of the Company when it is issued, and shall be dated as
of the date of signature thereof by the Company either upon initial issuance or
upon division, exchange, substitution or transfer.
1.2 Transfer. The Warrant certificate shall be transferable only on the
books of the Company maintained at its principal office 3811 Turtle Creek Blvd.,
Dallas, Texas 75219, or wherever its principal executive offices may then be
located upon delivery thereof duly endorsed by the Warrantholder or its duly
authorized attorney or representative, or accompanied by proper evidence of
succession, assignment or authority to transfer. Upon any registration of
transfer, the Company shall execute and deliver a new Warrant certificate to the
person entitled thereto. All transfers shall be made subject to the provisions
of Section 13 hereof. In the event the Warrants or any portion thereof is
transferred, the subsequent holder thereof shall have no greater rights than
those afforded the Warrantholder hereunder
1.3 Division of Warrants. Subject to all Federal and state securities
laws, a Warrant certificate may be divided or combined, upon request to the
Company by the Warrantholder, into a certificate or certificates representing
the right to purchase the same aggregate number of Warrant Shares. Unless the
context indicates otherwise, the term "Warrantholder" shall include
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<PAGE> 2
any transferee or transferees of the Warrants pursuant to this subsection 1.3,
and the term "Warrants" shall include any and all Warrants outstanding pursuant
to this Agreement, including those evidenced by a certificate or certificates
issued upon division, exchange, substitution or transfer pursuant to this
Agreement.
1.4 Legend on Warrant Shares. Each certificate for Warrant Shares
initially issued upon exercise of the Warrant, unless at the time of exercise
such Warrant Shares are registered under the Securities Act of 1933, as amended
(the "Securities Act"), 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"),
and may not be sold, exchanged, hypothecated or transferred in any
manner in the absence of such registration or an exemption therefrom.
The Shares are subject to the terms of a certain Warrant Agreement
dated December 11, 1995 with Citadel Computer Systems, Inc., pursuant
to which they were issued."
Any certificate issued at any time in exchange or substitution for
any certificate bearing such legend (except a new certificate issued upon
completion of a public distribution pursuant to a registration statement under
the Securities Act of the Warrant Shares represented thereby) shall also bear
the above legend unless, in the opinion of counsel satisfactory to the Company,
the securities represented thereby need no longer be subject to such
restrictions
Section 2. Exchange of Warrant Certificate. Any Warrant certificate may
be exchanged for another certificate or certificates entitling the Warrantholder
to purchase a like aggregate number of Warrant Shares as the certificate or
certificates surrendered then entitled such Warrantholder to purchase. Any
Warrantholder desiring to exchange a Warrant certificate shall make such request
in writing delivered to the Company, and shall surrender, properly endorsed, the
certificate evidencing the Warrant to be so exchanged. Thereupon, the Company
shall execute and deliver to the person entitled thereto a new Warrant
Certificate as so requested.
Section 3. Term of Warrants; Exercise of Warrants
3.1 Term. Subject to the terms of this Agreement, the Warrantholder
shall have the right, at any time during the period commencing at 9:00 a.m.,
New York time, on the date hereof and ending at 5:00 p.m., New York time, on
the earlier of (i) December 11, 2005 or (ii) a date which is five (5) years
from the effective date of any public offering by the Company of its securities
(the "Termination Date"), to purchase from the Company up to the number of
fully paid and nonassessable Warrant Shares which the Warrantholder may at the
time be entitled to purchase pursuant to this Agreement, upon surrender to the
Company, at its principal office at 3811 Turtle Creek, Blvd., Suite 600, Dallas,
Texas, 75219, or wherever its principal executive offices may then be located,
of the certificate evidencing the Warrants to be exercised, together with the
purchase form on the reverse thereof duly filled in and signed, and upon
payment to the Company of the Exercise Price (as defined in and determined in
accordance with the provisions of Sections 7 and 8 hereof), for the number of
Warrant Shares in respect of which such Warrants are then exercised, but in no
event for less than 25 Warrant Shares, unless the Warrant entitled the
Warrantholder on exercise to less than 25 Warrant Shares, in which event the
Warrant can be exercised for such lesser number of Warrant Shares.
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<PAGE> 3
3.2 Exercise. Payment of the aggregate Exercise Price shall be made in
cash or by check. Upon surrender of the Warrant Certificates and payment of such
Exercise Price as aforesaid, the Company shall issue and cause to be delivered
with all reasonable dispatch to or upon the written order of the Warrantholder
and in such name or names as the Warrantholder may designate a certificate or
certificates for the number of full Warrant Shares so purchased upon the
exercise of the Warrants, together with cash, as provided in Section 9 hereof,
in respect of any fractional Warrant Shares otherwise issuable upon such
surrender. Such certificate or certificates shall be deemed to have been issued
and any person so designated to be named therein shall be deemed to have become
a holder of record of such Warrant Shares as of the date of the surrender of the
Warrant certificate and the payment of the Exercise Price, as aforesaid,
notwithstanding that the certificates representing the Warrant Shares shall not
actually have been delivered or that the stock transfer books of the Company
shall then be closed. The Warrants shall be exercisable, at the election of the
Warrantholder, either in full or from time to time in part and, in the event
that a certificate evidencing the Warrants is exercised in respect of less than
all of the Warrant Shares specified therein at any time prior to the Termination
Date, a new certificate evidencing the remaining Warrants will be issued by the
Company.
Section 4. Payment of Taxes. The Company will pay all documentary stamp
taxes, if any, attributable to the issuance of the Warrant Shares hereunder.
Section 5. Mutilated or Missing Warrant Certificate. In case the
certificate or certificates evidencing the Warrants shall be mutilated, lost,
stolen or destroyed, the Company shall, at the request of the Warrantholder,
issue and deliver in exchange and substitution for and upon cancellation of the
mutilated certificate or certificates, or in lieu of and substitution for the
certificate or certificates lost, stolen or destroyed, a new Warrant certificate
or certificates of like tenor and representing an equivalent right or interest,
but only upon receipt of evidence satisfactory to the Company of such loss,
theft or destruction of such Warrants and a bond of indemnity, if requested,
also satisfactory in form and amount, at the applicant's cost. Applicants for
such substitute Warrant certificate shall also comply with such other reasonable
requirements and pay such other reasonable charges as the Company may prescribe.
Section 6. Reservation of Warrant Shares. There has been reserved, and
the Company shall at all times keep reserved so long as all or any portion of
the Warrants remains outstanding, out of its authorized Common Shares, such
number of Warrant Shares as shall be subject to purchase under such portion of
the Warrant which remains outstanding. Every transfer agent for the Common
Shares and other securities of the Company issuable upon the exercise of the
Warrants will be irrevocably authorized and directed at all times to reserve
such number of authorized Warrant Shares and other securities as shall be
requisite for such purpose. The Company will keep a copy of this Agreement on
file with every transfer agent for the Common Shares and other securities of the
Company issuable upon the exercise of the Warrants. The Company will supply such
transfer agent with duly executed stock and other certificates for such purpose
and will provide or otherwise make available any cash which may be payable as
provided in Section 9 hereof.
Section 7. Exercise Price. The price per Share (the "Exercise Price")
at which Shares shall be purchasable upon the exercise of the Warrant shall be $
.59. The Exercise Price as determined hereunder shall be subject to further
adjustment pursuant to Section 8 hereof.
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Section 8. Adjustment of Exercise Price and Number of Warrant Shares
8.1 General. The number of Warrant Shares purchasable upon the exercise
of the Warrants and the Exercise Price shall be subject to adjustment from time
to time upon the happening of certain events, as follows:
(a) In case the Company shall (i) pay a dividend in Common
Shares or make a distribution in Common Shares, (ii) subdivide its outstanding
Common Shares, (iii) combine its outstanding Common Shares into a smaller number
of Common Shares (by way of a reverse stock split or otherwise) or (iv) issue by
reclassification of its Common Shares other securities of the Company, the
number of Warrant Shares purchasable upon exercise of the Warrants immediately
prior thereto shall be adjusted so that the Warrantholder shall be entitled to
receive the kind and number of Warrant Shares or other securities of the Company
which it would have owned or would have been entitled to receive after the
happening of any of the events described above, had the Warrants been exercised
immediately prior to the happening of such event or any record date with respect
thereto. Any adjustment made pursuant to this subsection 8.1(a) shall become
effective immediately after the effective date of such event retroactive to the
record date, if any, for such event.
(b) In case the Company shall issue rights, options, warrants
or convertible securities to all or substantially all of the holders of its
Common Shares, without any charge to such holders, entitling them to subscribe
for or purchase Common Shares at a price per share which is lower at the record
date mentioned below than the Exercise Price, the number of Warrant Shares
thereafter purchasable upon the exercise of the Warrants shall be determined by
multiplying the number of Warrant Shares theretofore purchasable upon the
exercise of the Warrants by a fraction, of which the numerator shall be the
number of Common Shares outstanding immediately prior to the issuance of such
rights, options, warrants or convertible securities plus the number of
additional Common Shares offered for subscription or purchase, and of which the
denominator shall be the number of Common Shares outstanding immediately prior
to the issuance of such rights, options, warrants or convertible securities plus
the number of Common Shares which the aggregate offering price of the total
number of Common Shares offered would purchase at the Exercise Price. Such
adjustment shall be made whenever such rights, options, warrants or convertible
securities are issued, and shall become effective immediately and retroactively
after the record date for the determination of shareholders entitled to receive
such rights, options, warrants or convertible securities.
(c) In case the Company shall distribute to all or
substantially all of the holders of its Common Shares evidences of its
indebtedness or assets (excluding cash dividends or distributions out of
earnings) or issue, to all or substantially all of such holders, without any
charge to such holders, rights, options, warrants or convertible securities
containing the right to subscribe for or purchase Common Shares (excluding those
referred to in paragraph (b) above), then in each case the number of Warrant
Shares thereafter purchasable upon the exercise of the Warrants shall be
determined by multiplying the number of Warrant Shares theretofore purchasable
upon exercise of the Warrants by a fraction, of which the numerator shall be the
Exercise Price on the date of such distribution, and of which the denominator
shall be the Exercise Price on such date minus the then fair value of the
portion of the assets or evidences of indebtedness so distributed or of such
rights, options, warrants or convertible securities applicable to one share.
Such adjustment shall be made whenever any such distribution is made and shall
be made whenever any such distribution is made and shall become effective on the
date
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of distribution retroactive to the record date for the determination of
shareholders entitled to receive such distribution.
(d) No adjustment in the number of Warrant Shares purchasable
hereunder shall be required unless such adjustment would require an increase or
decrease of at least one percent in the aggregate number of Warrant Shares then
purchasable upon the exercise of the Warrants or, if the Warrants are not then
exercisable, the number of Warrant Shares purchasable upon the exercise of the
Warrants on the first date thereafter that the Warrants become exercisable;
provided however, that any adjustments which by reason of this subsection 8.a(d)
are not required to be made immediately shall be carried forward and taken into
account in any subsequent adjustment.
(e) Whenever the number of Warrant Shares purchasable upon the
exercise of the Warrants is adjusted as herein provided in this subsection 8.1,
the Exercise Price payable upon exercise of the Warrants shall be adjusted by
multiplying such Exercise Price immediately prior to such adjustment by a
fraction, of which the numerator shall be the number of Warrant Shares
purchasable upon the exercise of the Warrant immediately prior to such
adjustment, and of which the denominator shall be the number of Warrant Shares
so purchasable immediately thereafter.
(f) To the extent not covered by paragraphs (b) or (c) hereof,
in case the Company shall sell and issue Common Shares or rights, options,
warrants or convertible securities containing the right to subscribe for or
purchase Common Shares at a price per share (determined, in the case of such
rights, options, warrants or convertible securities, by dividing (i) the total
amount received or receivable by the Company in consideration of the sale and
issuance of such rights, options, warrants or convertible securities, plus the
total consideration payable to the Company upon exercise or conversion thereof,
by (ii) the total number of shares covered by such rights, options, warrants or
convertible securities) lower than 50% of the Exercise Price in effect
immediately prior to such sale and issuance, then the Exercise Price shall be
reduced to a price (calculated to the nearest cent) determined by dividing (i)
an amount equal to the sum of (A) the number of Common Shares outstanding
immediately prior to such sale and issuance multiplied by the then existing
Exercise Price, plus (B) the consideration received by the Company upon such
sale and issuance, by (ii) the total number of Common Shares outstanding
immediately after such sale and issuance. The number of Warrant Shares
purchasable upon the exercise of the Warrants shall be that number determined by
multiplying the number of Warrant Shares issuable upon exercise immediately
prior to such adjustment by a fraction, of which the numerator is the Exercise
Price in effect immediately prior to such adjustment and the denominator is the
Exercise Price as so adjusted. For the purposes of such adjustments, the Common
Shares which the holders of any such rights, options, warrants or convertible
securities shall be entitled to subscribe for or purchase shall be deemed to be
outstanding as of the date of such sale and issuance and the consideration
received by the Company therefor shall be deemed to be the consideration
received by the Company for such rights, options, warrants or convertible
securities, plus the consideration stated in such rights, options, warrants or
convertible securities to be paid for the Common Shares covered thereby. In case
the Company shall sell and issue Common Shares or rights, options, warrants or
convertible securities containing the right to subscribe for or purchase Common
Shares for a consideration consisting, in whole or in part, of property other
than cash or its equivalent, then in determining the "price per share" of Common
Shares and the "consideration received by the Company" for purposes of the first
sentence of this paragraph (f), the Board of Directors shall determine the fair
value of said property, and
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<PAGE> 6
such determination, if reasonable and based upon the Board of Directors' good
faith business judgment, shall be binding upon the Warrantholder. There shall be
no adjustment of the Exercise Price pursuant to this paragraph (f) if the amount
of such adjustment would be less than $.01 per Warrant Share; provided, however,
that any adjustment which by reason of this provision is not required to be made
immediately shall be carried forward and taken into account in any subsequent
adjustment.
(g) Whenever the number of Warrant Shares purchasable upon the
exercise of the Warrants or the Exercise Price is adjusted as herein provided in
this subsection 8.1, the Company shall cause to be promptly mailed to the
Warrantholder in accordance with the provisions of Section 12 hereof, notice of
such adjustment or adjustments and a certificate of a firm of independent public
accountants selected by the Board of Directors of the Company (who may be the
regular accountants employed by the Company) setting forth the number of Warrant
Shares purchasable upon the exercise of the Warrants and the Exercise Price
after such adjustment, a brief statement of the facts requiring such adjustment
and the computation by which such adjustment was made.
(h) For the purpose of this subsection 8.1, the term "Common
Shares" shall mean (i) the class of shares designated as the Common Shares of
the Company at the date of this Agreement or (ii) any other class of shares
resulting from successive changes or reclassifications of such Common Shares
including changes in par value, or from par value to no par value, or from no
par value to par value. In the event that at any time, as a result of an
adjustment made pursuant to this Section 8, the Warrantholder shall become
entitled to purchase any shares of the Company other than Common Shares,
thereafter the number of such other shares so purchasable upon exercise of the
Warrants and the Exercise Price of such shares shall be subject to adjustment
from time to time in a manner and on terms as nearly equivalent as practicable
to the provisions with respect to the Shares contained in this Section 8.
(i) Upon the expiration of any rights, options, warrants or
conversion privileges referred to in this Section 8, if such shall not have been
exercised, the number of Warrant Shares purchasable upon exercise of the
Warrants and the Exercise Price, to the extent the Warrants have not then been
exercised, shall, upon such expiration, be readjusted and shall thereafter be
such as they would have been had they been originally adjusted (or had the
original adjustment not been required, as the case may be) on the basis of (A)
the fact that the only Common Shares so issued were the Common Shares, if any,
actually issued or sold upon the exercise of such privileges, options, warrants
or conversion rights and (B) the fact that such Common Shares, if any, were
issued or sold for the consideration actually received by the Company upon such
exercise plus the consideration , if any, actually received by the Company for
the issuance, sale or grant of all such rights, options, warrants or conversion
rights whether or not exercised; provided, however, that no such readjustment
shall have the effect of increasing the Exercise Price by an amount in excess of
the amount of the adjustment initially made in respect of the issuance, sale or
grant of such rights, options, warrants or convertible rights.
8.2 No Adjustment of Dividends. Except as provided in subsection 8.1,
no adjustment in respect of dividends shall be made during the term of the
Warrants or upon the exercise thereof.
8.3 No Adjustment in Certain Cases. Notwithstanding anything provision
of this Section 8, no adjustments shall be made hereunder in connection with the
issuance of Common
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<PAGE> 7
Shares or warrants or any other rights to purchase Common Shares: (a) in
connection with the exercise of options or warrants outstanding on the date
hereof; (b) in connection with the grant and/or exercise, pursuant to stock
option plans of the Company, of stock options to employees and consultants of
the Company outstanding as of the date hereof; (c) in connection with the grant
and/or exercise of stock options to non-employee directors pursuant to a
director stock option plan of the Company and (d) in connection with (i) a
private placement of the Company's securities occurring with the 180 days from
the date hereof through Janssen-Meyers Associates L.P. as placement agent or an
affiliate thereof or (ii) a public offering of the Company's securities
underwritten by Janssen-Meyers, L.P. as underwriter or an affiliate thereof.
8.4 Preservation of Purchase Rights Upon Reclassification.
Consolidation, etc. In case of any consolidation of the Company with or merger
of the Company into another corporation or in case of any sale or conveyance to
another person of the property, assets or business of the Company as an entirety
or substantially as an entirety, the Company or such successor or purchaser, as
the case may be, shall execute with the Warrantholder an agreement that the
Warrantholder shall have the right thereafter upon payment of the Exercise Price
in effect immediately prior to such action to purchase upon exercise of the
Warrants the kind and amount of shares and other securities and property which
the Warrantholder would have owned or have been entitled to receive after the
happening of such consolidation, merger, sale or conveyance had the Warrants
been exercised immediately prior to such action. In the event of a merger
described in Section 368 (a) (2) (E) of the Internal Revenue Code of 1986, as
amended, in which the Company is the surviving corporation, the right to
purchase Warrant Shares under the Warrants shall terminate on the date of such
merger and thereupon the Warrants shall become null and void but only if the
controlling corporation shall agree to substitute for the Warrants other
warrants which entitle the holders thereof to purchase, upon exercise thereof,
the kind and amount of shares and other securities and property which the
Warrantholder would have owned or had been entitled to receive had the Warrants
been exercised immediately prior to such merger. The adjustments required by
this Subsection 8.4 shall be effected in a manner which shall be as nearly
equivalent as may be practicable to the adjustments provided for elsewhere in
this Section 8. The provisions of this Subsection 8.4 shall similarly apply to
successive consolidations, mergers, sales or conveyances.
8.5 Statement on Warrant Certificate. Irrespective of any adjustments
in the Exercise Price or the number or kind of shares purchasable upon the
exercise of the Warrants, the Warrant certificate or certificates theretofore or
thereafter issued may continue to express the same price and number and kind of
shares as are stated in the Warrants initially issuable pursuant to this
Agreement
Section 9. Fractional Shares. The Company shall not be required to
issue fractional Warrant Shares on the exercise of the Warrants. If any fraction
of a Warrant Share would, except for the provisions of this Section 9, be
issuable on the exercise of the Warrants (or specified portion thereof), the
Company shall pay an amount in cash equal to the then Current Market Price
multiplied by such fraction. For purposes of this Agreement, the term "Current
Market Price" shall mean (i) if the Common Shares are traded in the
over-the-counter market and not in the NASDAQ Market System (National Market or
SmallCap) or on any national securities exchange, the average mean between the
per share closing bid and asked prices of the Common Shares on the 30
consecutive trading days immediately preceding the date in question, as reported
by NASDAQ Market System or an equivalent generally accepted reporting service,
or (ii) if the Common Shares are traded in the NASDAQ Market System (National
Market or
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SmallCap) or on a national securities exchange, the average for the 30
consecutive trading days immediately preceding the date in question of the daily
per share closing prices of the Common Shares in the NASDAQ Market System
(National Market or SmallCap) or on the principal securities exchange on which
they are listed, as the case may be. The closing price referred to in clause
(ii) above shall be the last reported sales price or, in case no such reported
sale takes place on such day, the average of the reported closing bid and asked
prices, in either case in the NASDAQ Market System (National Market or SmallCap)
or on the principal securities exchange on which the Common Shares are then
listed.
Section 10. REGISTRATION RIGHTS
10.1 Demand Registration Commencing 360 days from the date hereof and
terminating on the Termination Date, the holders of a majority of the principal
amount of the Bridge Warrants and/or Warrant Shares, shall have the right and
option to demand by written notice to the Company that the Company file on two
(2) occasions, a registration statement on Form SB-1 or Form SB-2 (or other
comparable form then in effect) and such other documents, including a
prospectus, with the Securities and Exchange Commission ("SEC") to register for
sale under the Securities Act, all of the Warrant Shares. Upon receipt of such
written request, the Company shall use its best efforts to file said
registration statement with the SEC within 60 days of such demand. In the event
that the Company shall not have obtained an order of the SEC declaring such
registration statement effective within 180 days of its filing with the SEC then
the Warrants, together with any Warrant Shares with respect to Warrants which
have previously been converted, and the Exercise Price shall be adjusted so that
the number of Warrant Shares otherwise receivable upon exercise of the Warrants
shall be increased by 25% of their original amount for each 30 day period that
the Company fails to obtain such effective order.
10.2 Piggyback Registration. If the Company shall at any time propose,
on or after 180 days from the date hereof, the registration under the Securities
Act of an offering of its debt or equity securities, the Company shall give
written notice of its intention as promptly as practicable of such proposed
registration to each and every Warrant holder or holder of Warrant Shares. The
Company shall use its best efforts to cause the registration (and the offering
if requested by the Holder) of the Warrant Shares owned by Holder (or into which
the Note is then convertible) as Holder shall request (within 10 days after the
receipt of notice) to be included, upon the same terms (including the method of
distribution), in any such offering; provided, however, that:
(a) the Company shall not be required to give notice or
include such Warrant Shares in any such registration if the proposed
registration is (A) a registration of a stock option or compensation
plan or of securities issued or issuable pursuant to any such plan of
(B) a registration of securities proposed to be issued in exchange for
securities or assets of, or in connection with a merger or
consolidation with another corporation;
(b) the Company may, without the consent of Holder, withdraw
such registration statement and abandon the proposed offering in which
Holder had requested to participate; and
(c) the registration rights set forth in this Section 10.2
shall be applicable to all Warrant Stock owned by Holder.
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10.3 Terms and Conditions. The registration rights of Holder pursuant
to this Section 10 are subject to the following terms and conditions:
(a) Holder shall provide the Company with such information
with respect to the Warrant Shares to be sold, the plans for the proposed
disposition thereof and such other information as shall, in the opinion of
counsel for the Company, be necessary to enable the Company to include in such
registration statement all material facts required to be disclosed with respect
to Holder;
(b) all expenses incurred by the Company in connection with
any registration requested under this Section will be paid by the Company. Such
expenses include, but are not limited to, printing expenses (including for such
number of registration statements, prospectuses and other filed material as
Holder shall reasonably request), "blue sky" fees and expenses and fees and
disbursements of counsel and accountants for the Company (subject, however, to
subparagraph (iv) below), except that in any such requested registration, Holder
shall pay the fees and disbursements of its counsel; and
(c) The Company will take all necessary action which may be
required in qualifying or registering the Warrant Shares included in a
registration statement, for offering and sale under the securities or blue sky
laws of such states as are requested by the holders of such securities.
(d) Once effective, the Company will be required to maintain
the effectiveness of the registration statement until the earlier of (i) the
date that all of the Warrant Shares are sold or (ii) the date that all holders
of Warrant Shares receive an opinion of counsel to the Company that all of the
Warrant Shares may be freely traded without registration under the Act, pursuant
to Rule 144 promulgated under the Act, or otherwise.
(e) The Company shall indemnify any holder of the Warrant
Shares to be sold pursuant to any registration statement and any underwriter or
person deemed to be an underwriter under the Act and each person, if any, who
controls such holder or underwriter or person deemed to be an underwriter within
the meaning of Section 15 of the Act or Section 20 (a) of the Securities
Exchange Act of 1934, as amended ("Exchange Act"), against all loss, claim,
damage, expense or liability (including all expenses reasonably incurred in
investigating, preparing or defending against any claim whatsoever) to which any
of them may become subject under the Act, the Exchange Act or otherwise, arising
from such registration statement to the same extent and with the same effect as
the provisions pursuant to which the Company has agreed to indemnify the
Placement Agent as set forth in Section 10 of the Placement Agent Agreement and
to provide for just and equitable contribution as set forth in Section 10 of the
Placement Agent Agreement.
(f) Any holder of Warrant Shares to be sold pursuant to a
registration statement, and its successors and assigns, shall severally, and not
jointly, indemnify, the Company, its officers and directors and each person, if
any, who controls the Company within the meaning of Section 15 of the Act or
Section 20 (a) of the Exchange Act, against all loss, claim, damage or expense
or liability (including all expenses reasonably incurred in investigation,
preparing or defending against any claim whatsoever) to which they may become
subject under the Act, the Exchange Act or otherwise, arising from information
furnished by or
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on behalf of such holder, or its successors or assigns, for specific inclusion
in such registration statement to the same extent and with the same effect as
the provisions pursuant to which the Underwriter has agreed to indemnify the
Company as set forth in Section 10 of the Placement Agent Agreement and to
provide for just and equitable contribution as set forth in Section 10 of the
Placement Agent Agreement.
(g) Nothing contained in this Agreement shall be construed as
requiring any holder to exercise his Warrants prior to the initial filing of any
registration statement or the effectiveness thereof.
(h) If the Company shall fail to comply with the provisions of
this Section 10, the Company shall, in addition to any other equitable or other
relief available to the holders of Warrant Shares, be liable for any or all
incidental, special and consequential damages sustained by the holders of
Warrant Shares, requesting registration of their Warrant Shares.
(i) The Company shall deliver promptly to each holder of
Warrant Shares participating in the offering in which such Holder's shares are
being registered pursuant to Section 10 hereof and requesting the correspondence
and memoranda described in this Section 10(i) and to the managing underwriter,
if any, copies of all correspondence between the Commission and the Company, its
counsel or auditors and all memoranda relating to discussions with the
Commission or its staff with respect to the registration statement and permit
each holder of Warrant Shares and underwriters to do such investigation, upon
reasonable advance notice, with respect to information contained in or omitted
from the registration statement as it deems reasonably necessary to comply with
applicable securities laws or rules of the National Association of Securities
Dealers, Inc. Such investigation shall include access to books, records and
properties and opportunities to discuss the business of the company with its
officers and independent auditors, all to such reasonable extent and at such
reasonable times and as often as any such holder of Warrant Shares or
underwriter shall reasonably request.
(j) Notwithstanding any other terms or conditions contained
herein, the holder of this Warrant or any Warrant Shares acknowledges and agrees
that for purposes of any of the registration rights contained herein such rights
shall be the same as, and adjusted to, any registration rights, granted by the
Company to any holders of securities of the Company sold pursuant to (i) the
Subscription Agreement referred to herein, (ii) any securities of the Company
sold in any offering commencing within a period of 180 days from the date hereof
through Janssen-Meyers Associates L.P. as Placement Agent and (iii) any warrants
or shares of Common Stock issued to Janssen-Meyers Associates L.P. for services
under the Placement Agent Agreement dated November 3, 1995 between the Company
and Janssen-Meyers Associates, L.P. For purposes hereof, the term "majority of
holders" shall mean the holders of Bridge Warrants, Bridge Placement Warrants,
Placement Agent Warrants and Shares, all as defined in the Placement Agent
Agreement, as a single class.
10.4 Underwriting. Holder and the Company each agree in connection with
any registration of Warrant Stock contemplated by this Section
(i) to enter into an appropriate underwriting agreement
containing terms and provisions (including reasonable provisions as to
indemnification) customary in such agreements. Holder shall indemnify
the Company and the underwriters as to information provided pursuant to
Section 10.3(a), the Company shall indemnify Holder
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as to information contained in the registration statement, and the
underwriters shall indemnify the Company and Holder as to information
provided by such underwriters;
(ii) to permit the Company, in its sole discretion, to select
the managing underwriter(s) for any registration under Section 10.1;
and
(iii) to provide Holder and its representatives with
reasonable opportunity for due diligence, if any.
Section 11. No Rights as Shareholder; Notices to Warrantholder. Nothing
contained in this Agreement or in the Warrant Certificate shall be construed as
conferring upon the Warrantholder, or its transferees, any rights as a
shareholder of the Company, including the right to vote, receive dividends,
consent or receive notices as a shareholder in respect of any meeting of
shareholders for the election of directors of the Company or any other matter.
If, however, at any time prior to the expiration of the Warrants and prior to
the exercise thereof, any of the following events shall occur
(a) any action which would require an adjustment pursuant to
Section 8.1 or 8.4; or
(b) a dissolution, liquidation or winding up of the Company
(other than in connection with a consolidation, merger or sale of its property,
assets and business as an entirety) shall be proposed; then in any one or more
of said events, the Company shall give notice in writing of such event to the
Warrantholder as provided in Section 11 hereof at least 20 days prior to the
date fixed as a record date or the date of closing the transfer books for the
determination of the shareholders entitled to any relevant dividend,
distribution, subscription rights or other rights or for the determination of
shareholders entitled to vote on such proposed dissolution, liquidation or
winding up. Such notice shall specify such record date or the date of closing
the transfer books, as the case may be.
Section 12. Notices. Any notice pursuant to this Agreement by the
Company or by the Warrantholder shall be in writing and shall be deemed to have
been duly given if delivered by hand or if mailed by certified mail, return
receipt requested, postage prepaid, addressed as follows:
(a) If to the Warrantholder - to the address as set forth in a
certain separate Stock and Warrant Purchase Agreement entered into between the
Warrantholder and the Company.
(b) If to the Company - addressed to Citadel Technology, Inc.,
3811 Turtle Creek Blvd., Suite 600, Dallas, Texas 75219. Attention: Chairman of
the Board; with a copy to Wood, Exall & Bonnet, LLP Attn: David Wood, Esq.or to
such other address as any such party may designate by notice to the other party.
Notices shall be deemed given at the time they are delivered personally or three
days after they are mailed in the manner set forth above.
(c) It is hereby agreed by the Company and the holder that
Janssen-Meyers Associates L.P. shall have the right to act as agent for the
Warrantholder to deliver any notice provided herein, including any notice
provisions required to exercise the registration rights granted in Section 10
hereof.
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Section 13. Assignment. This Agreement is binding upon and inures to
the benefit of the parties hereto and their respective heirs, successors and
permitted assigns. This Agreement cannot be assigned, amended or modified by the
parties hereto, except by written agreement executed by the parties; provided,
however, that upon 10 days' prior written notice to the Company, the
Warrantholder may assign this Agreement and its rights and obligations hereunder
to any person or entity, without the consent of the Company, provided, that the
transferee agrees to be bound by the terms of this Agreement as if such
transferee were a Warrantholder and, provided further, that the assignment is
made to an "Accredited investor" as defined by Rule 501(a) under the Securities
Act. If requested by the Company, the Warrantholder shall have furnished to the
Company an opinion of counsel reasonably satisfactory to the Company to such
effect.
Section 14. Counterparts. This Agreement may be executed in
counterparts, each of which shall be deemed an original, but all of which
together shall constitute one and the same instrument.
Section 15. Headings. The headings in this Agreement are for reference
purposes only and shall not affect in any way the meaning or interpretation of
this Agreement.
Section 16. Merger or Consolidation of the Company. The Company will
not merge or consolidate with or into any other corporation or sell all or
substantially all of its property to another person, unless the provisions of
Section 8.4 are complied with.
Section 17. Governing Law. This Agreement shall be governed by and
construed in accordance with the laws of the State of New York applicable to
contracts made and to be performed entirely within such State, without regard to
its principles of conflicts of laws.
Section 18. Severability. If any provision of this Agreement shall for
any reason be held invalid or unenforceable, such invalidity or unenforceability
shall not affect any other provision hereof and this Agreement shall be
construed as if such invalid or unenforceable provision had never been contained
herein.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
duly executed, on the day and year first above written.
Attest: CITADEL COMPUTER SYSTEMS, INC.
By: By:
------------------------------ ------------------------------
Name: Name:
---------------------------
Title: Secretary Title: President
[WARRANTHOLDER]
- ---------------------------------
Signature
- ---------------------------------
Print Name
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EXHIBIT 23.1
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We have issued our report dated June 17, 1998 accompanying the
consolidated financial statements of Citadel Technology, Inc. contained in this
Registration Statement and Prospectus. We consent to the use of the
aforementioned report in the Registration Statement and Prospectus, and to the
use of our name as it appears under the caption "Experts."
/s/ GRANT THORNTON LLP
GRANT THORNTON LLP
Dallas, Texas
November 24, 1998
