<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED FEBRUARY 28, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0-08718
CITADEL TECHNOLOGY, INC.
(formerly Citadel Computer Systems Incorporated)
(NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)
DELAWARE 75-2432011
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
3811 TURTLE CREEK BLVD., SUITE 770, DALLAS, TX 75219-4421
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(214) 520-9292
ISSUER'S TELEPHONE NUMBER
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT: NONE
SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE
(TITLE OF CLASS)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or
for such shorter period the Registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.
Yes [ ] No [X]
Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B is not contained in this form, and no disclosure will be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference to such filing requirements incorporated by reference
in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [ ]
State issuer's revenues for its most recent fiscal year............. $ 4,439,608
As of August 9, 1999, the average bid and ask price of the Company's common
stock was $1.98 per share. The aggregate market value of the voting and
non-voting common stock held by non-affiliates of the Company was $47,178,378 as
of August 9, 1999.
As of August 9, 1999, there were 43,357,748 shares of common stock, $.01 par
value per share, outstanding.
Transitional Small Business Disclosure Format. Yes [ ] No [X]
<PAGE> 2
CITADEL TECHNOLOGY, INC.
FORM 10-KSB
ANNUAL REPORT
FOR THE FISCAL YEAR ENDED
FEBRUARY 28, 1999
Table of Contents
<TABLE>
<S> <C> <C>
PART I
Item 1. Description of Business ................................................................... 1
Item 2. Description of Property ................................................................... 21
Item 3. Legal Proceedings ......................................................................... 21
Item 4. Submission of Matters to a Vote of Security Holders ....................................... 22
PART II
Item 5. Market for Common Equity and Related Stockholder Matters .................................. 23
Item 6. Management's Discussion and Analysis ...................................................... 24
Item 7. Consolidated Financial Statements ......................................................... 27
Item 8. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure ............................................................................. 28
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section
16(a) of Exchange Act ............................................................. 28
Item 10. Executive Compensation .................................................................... 31
Item 11. Security Ownership of Certain Beneficial Owners and Management ............................ 34
Item 12. Certain Relationships and Related Transactions ............................................ 36
PART IV
Item 13. Exhibits, Financial Statement Schedules and Reports on Form 8-K ........................... 38
</TABLE>
<PAGE> 3
PART I
ITEM 1. DESCRIPTION OF BUSINESS
The discussion in this Report on Form 10-KSB contains forward-looking statements
that involve known and unknown risks and uncertainties. The statements contained
in this Report that are not purely historical are forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, including
statements regarding the Company's expectations, beliefs, intentions or
strategies regarding the future. In this Report, the words "anticipates",
"believes", "expects", "estimates", "intends", "future", and similar expressions
identify forward-looking statements. All forward-looking statements included in
this document are based on information available to the Company on the date
hereof, and the Company assumes no obligation to update any such forward-looking
statements. The Company's actual results could differ materially from those
discussed herein. Factors that could cause or contribute to such differences
include, but are not limited to, those discussed elsewhere in this Report under
the heading "CERTAIN FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS" as well
as those discussed elsewhere in this Report, and the risks discussed in the
Company's Securities and Exchange Commission filings.
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"). Our 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 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.
In January 1999, Citadel announced the formation of its Internet subsidiary,
How2HQ.com, Inc. ("How2HQ.com"), to implement Citadel's Internet and e-commerce
strategies. Citadel also previously announced that it will distribute 750,000
shares of How2HQ.com's common stock to Citadel's shareholders upon compliance
with the Securities and Exchange Commission (SEC) requirements applicable to
Citadel and its subsidiary in connection with the proposed spinoff. How2HQ.com
will initially offer How2 Headquarters (How2HQ) and four initial channels
(How2Work, How2Play, How2Shop&Save and How2Home), as well as provide on-line
tutorials, "how to" information and a complete range of Internet and e-commerce
solutions, from award-winning web site design, to back end integration and
rebate and product fulfillment services.
The Company is the successor to a Delaware corporation (the "Old Company") that
was formed and began operations in June 1992. References in this Report to
"Citadel" or the "Company" shall include Citadel and the Old Company unless the
context requires otherwise.
The Company maintains its principal executive offices at 3811 Turtle Creek
Blvd., Suite 770, 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.
1
<PAGE> 4
NEW PRODUCTS
In March 1999, Citadel announced WinShield Secure PC, its next generation
WinShield desktop security and configuration tool. This product will contain
powerful new Internet security features that allow Internet filtering and
blocking which will allow the administrator to specify the Internet protocols
and web sites that are available for users of the protected computer. Desktop
administrators will have the ability to assign access rights to files and
folders for all Windows 95, 98, NT and Windows 2000 systems. Other new features
WinShield Secure PC will provide are security mechanisms such as screen saver
control with network authentication, event management for automatic logoff, as
well as timed application usage. WinShield Secure PC will be available in
network or stand alone workstations.
In 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.
COMPANY AWARDS AND PRODUCT RECOGNITION
Winning on Windows -- In April 1999, Citadel announced that it was selected by
Microsoft Corp. and CMP Media (Nasdaq: CMPX) as one of the fastest growing
independent software vendors (ISVs) for Windows. Citadel was ranked as the 15th
fastest growing ISV in the first ever "Winning on Windows." The "Winning on
Windows" ranking was announced in April at an awards reception in Chicago at the
Spring Comdex/Windows World Show. The announcement of the ISV 75 marks the first
annual "Winning on Windows" awards campaign, which is designed to identify and
promote the fastest-growing Windows software companies and recognize industry
growth and innovation. Top companies were selected and ranked according to the
highest percentage revenue growth between 1997 and 1998. The research and
selection process was conducted by Austin, Texas-based researcher, Reality
Research (a wholly owned subsidiary of CMP Media).
Schools 2000 Program - In December 1998, the Company announced that it was
selected to join the Schools 2000 program created by Microsoft, MCI/Worldcom,
HP, and Dell and 15 other technology companies. The Schools 2000 Program is
designed to integrate "best-of-breed" products to create the educational
computer system of the future. It incorporates the visions of what leading
technology companies foresee as the design and configuration of network and
desktop computing in schools across the world in the 21st century. These
hand-picked technology companies will showcase their products in a collaborative
solution in schools located in Washington DC, Los Angeles, Dallas, Redmond, and
other locations around the world. Each school will provide a living showcase of
how this premier technology can be used, in the year 2000 and beyond, to enhance
the educational process the same way it enhances business productivity across
the globe.
2
<PAGE> 5
How2HQ.com, Inc. - PROPOSED SPINOFF, ACQUISITIONS AND RELATED MATTERS
In January 1999, Citadel announced that it had formed a subsidiary, How2HQ.com,
Inc. (formerly inLighten.com and shoppingwave.com), to implement Citadel's
Internet and e-commerce strategies. With an anticipated launch date on August
15, 1999, How2HQ.com will initially offer How2 Headquarters (How2HQ), How2Work,
How2Play, How2Home and How2Shop&Save, as well as provide a complete range of
Internet and e-commerce solutions, from award-winning web site design, to back
end integration and order and rebate fulfillment. Citadel received 5 million
shares of the subsidiary's common stock in consideration for cash, sharing of
resources, personnel and services. Citadel also previously announced that it
will distribute 750,000 shares of How2HQ.com common stock owned by Citadel to
Citadel's shareholders upon compliance with the Securities and Exchange
Commission (SEC) requirements applicable to Citadel and How2HQ.com in connection
with the proposed spinoff. The completion of the spinoff distribution is subject
to certain risks and uncertainties including possible delays related to
compliance with the SEC requirements, as to which there can be no assurances.
Following a four-for-one stock split in July 1999, Citadel now owns 20 million
shares of How2HQ.com common stock. See "Risk Factors -- Risks Associated with
the How2HQ.com Spinoff."
In March 1999 How2HQ.com completed the acquisition of 2-Lane Media, Inc.
(www.2lm.com), the recipient of more than 65 major interactive industry awards
for interactive/multimedia communications. 2-Lane Media offers web site and
e-commerce design services for a diverse client roster that spans the worldwide
Fortune 1000. 2-Lane Media's mission has been to utilize the vast potential of
multimedia technologies and the Internet to help companies effectively
communicate information. The 2-Lane Media team was one of the first to open a
new multimedia marketing medium to the film industry by creating Interactive
Press Kits for upcoming feature films. 2-Lane Media also pioneered the use of
Macromedia's new interactive Shockwave plug-in, featuring the technology in
sites for several major motion pictures. 2-Lane's client list reads like a
"Who's Who" of industry leaders including Nestle, Disney, Transamerica, Golden
Books, Rockwell International Corp. and Tenet Healthcare. 2-Lane Media has also
recently signed several new e-commerce accounts including Prolong, a leading
manufacturer of car-care products best known for its effective infomercials, and
Pacific Sunwear, the largest national retailer of active and beachwear for teens
and twentysomethings. Both projects revolve around creating lifestyle-
appropriate communities that integrate with an on-line shopping environment. The
purchase price for 2-Lane Media consisted of 300,000 shares of How2HQ.com common
stock and options to purchase an additional 50,000 shares. The 300,000 shares
are convertible at the option of the holders into a maximum of 500,000 shares of
Citadel common stock in the event the How2HQ.com shares do not become publicly
traded by March 2000.
In addition, in May 1999 How2HQ.com completed the acquisition of The Forward
Companies ("Forward"), a leading product rebate and promotional fulfillment
operation that offers its high-tech and blue chip clients end-to-end solutions
for designing, implementing and fulfilling merchandise and consumer rebate
programs. In addition to processing rebates for modems, printers, scanners and
dozens of popular software programs, Forward handles fulfillment assignments for
e-commerce, high technology and other companies. Forward leases a 67,000 square
feet state-of-the-art facility in Coppell, Texas (near the Dallas/Fort Worth
International Airport). Forward's client list includes numerous high tech
companies, including Microsoft, 3Com, Hewlett-Packard, Canon, UMax, Cross
Computing, and Diamond Multimedia, as well as other leading companies such as
Quaker State, Alcon Surgical, and Southwestern Bell. The terms of the
transaction included a cash payment of $8 million and 550,000 shares of
How2HQ.com common stock with a guaranteed floor of $10 per share for a period
ending upon effectiveness of an initial public offering. How2HQ.com also granted
to the shareholders of the Forward Companies warrants to purchase an additional
200,000 shares at $10 per share, in the event certain earnout provisions are
met.
In August 1999, How2HQ.com completed the acquisition of certain assets from
Broadcast Production Group, Inc. ("BPG") used in multimedia production and
content conversion (to convert traditional media formats into web-enabled
content). In addition, How2HQ.com retained certain members of the BPG management
team as employees of How2HQ.com. The purchase price consisted of $500,000 in
cash and 200,000 shares of How2HQ.com common stock. In connection with the
acquisition, How2HQ.com agreed to issue addition shares to the shareholders of
BPG (based on the average closing price over the 30 days following then current
trading prices) in the event the common stock does not trade at or above $10 in
the thirty days following an initial public offering by How2HQ.com.
3
<PAGE> 6
OTHER RECENT DEVELOPMENTS
In January 1999, Citadel announced that Washington Mutual, Inc. (NYSE: WM), the
sixth largest bank in the US, deployed a WinShield and NetOFF suite to secure
their networks and desktops. IBM Global Services, Inc. (NYSE: IBM) selected
Citadel to provide computer security for Washington Mutual. Citadel issued an
enterprise site license to Washington Mutual, for the WinShield and NetOFF
security suite, with an order in excess of $1 million. Citadel's security
solution was chosen over a number of competitive products evaluated by IBM
Global Services because it combined features and services designed to meet the
customer's needs. The combination of NetOFF and WinShield provided Washington
Mutual with the availability to lock down desktop configuration settings, secure
unattended workstations, control access to applications and directories, prevent
the use of unauthorized CDs, and prevent the unauthorized renaming and deleting
of folders and files.
In November 1998, the Company appointed Citadata, Inc. as its exclusive reseller
and distributor for the Mexican market.
In June 1998, a Dallas based private investment fund affiliated with Michael
Ruff, a director of the Company, acquired 2 million shares of Citadel common
stock for $2.5 million. In May 1998, Metamor Worldwide, a major shareholder of
the Company and an affiliate of a Citadel director, acquired 2,000 shares of
Series D Convertible Preferred Stock for proceeds to the Company of $2,000,000.
In June 1999, Metamor converted its preferred stock and $238,082 of accrued
dividends into 2,081,937 shares of Citadel common stock.
In May 1998, the Company appointed System Plan as its exclusive reseller and
distributor for the Japanese market.
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.
4
<PAGE> 7
The Company's primary products include NetOFF, WinShield, FolderBolt, and
WinShield Secure PC. See "Citadel Products". The Company's clients and OEM
partners ("original equipment manufacturers" that bundle our software with their
product offerings) include many Fortune 2000 companies, government and
educational agencies and individual PC users.
THE COMPANY 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 has
successfully developed strategic alliances or partnerships with other technology
companies in the past. 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).
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,
5
<PAGE> 8
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 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
6
<PAGE> 9
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, Optimize Products for Leading Technologies. The Company's
major products are easy to install and are fully compatible with the major
network and desktop operating systems, including Windows NT, NetWare, and
Windows 3.1, 95 and 98. The intuitive look and feel of the products'
graphical user interface ("GUI") enhances their usability.
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 administrate networks.
CITADEL PRODUCTS
NetOFF. NetOFF is designed to protect a network by shutting down unattended
client PCs automatically after a specified period of inactivity. 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.
7
<PAGE> 10
WinShield. WinShield is designed to address the problems that arise when users
share desktop PCs in work environments such as schools, libraries, government
offices, and resource centers such as Kinkos 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 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 95, 98 and NT. A WinShield network
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.
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, 98 and NT.
8
<PAGE> 11
WinShield Secure PC ("Secure PC"). This product is expected to be released in
beta during the second quarter of fiscal year 2000. The Company believes that
Secure PC will create one of the most secure Windows desktop PC operating
environments available. Secure PC 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, idle logoff (utilizing NetOFF technology), desktop configuration
(utilizing WinShield technology), file and folder encryption (using FolderBolt
technology), Internet monitoring and blocking features, and a customizable GUI
shell.
In addition, the Company has the following products: Server Sentry, Server Cam,
Phantom of the Console, C:\More! and Crash Protection and Recovery System (CPR).
SALES AND MARKETING
With the introduction of new products, recruitment of senior software sales
personnel, and a revised sales model, the Company seeks to leverage a broad
range of sales and marketing opportunities that will target direct and indirect
corporate, education and retail customers.
Sales
To address a broad range of sales and marketing opportunities, in fiscal 1998
the Company 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.
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 direct
9
<PAGE> 12
from the Company, depending on their business model.
The Company continues to work with a limited number of international
resellers. In fiscal 1999, the Company entered into relationships with
distributors in Japan and Mexico that the Company believes may enable the
Company to penetrate these 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 OEM Sales. The Company has entered into arrangements with OEMs that focus
on creating bundled solutions to permit customers to purchase total desktop
applications incorporating Citadel software. These partners include Compaq,
IBM, Microsoft, Hewlett-Packard and Dell, which resell our products with
their hardware, software and networking solutions.
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 Microsoft and
Novell, joint marketing with retailers, and Internet advertising. The Company's
product awareness advertising is combined with public relations campaigns and
advertisements targeted at resellers and vertical markets.
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 approach
PC OEMs, disk drive manufacturers, server manufacturers, and removable storage
media vendors regarding potential business partnerships. The Company's existing
strategic relationships with Novell, Compaq and Microsoft provide the Company
with (i) 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.
10
<PAGE> 13
PRODUCT DEVELOPMENT
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.
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 ("accounting for the costs of computer software to be sold, leased or
otherwise marketed") issued by FASB. Under this pronouncement, the Company is
required to capitalize software development costs after technological
feasibility of a project is established and must cease capitalizing such costs
when the products derived from the project are available for sale, lease or
otherwise marketed. After which, capitalized costs are amortized on a
product-by-product basis, based on the greater of (a) the amount computed by the
straight-line method over the estimated useful life of the product or (b) the
amount computed by using the ratio that current gross revenues bear to the total
of current and anticipated future revenues. The Company evaluated the estimated
net realizable value of each software product at each balance sheet date and
records write-downs to net realizable value for any product for which the net
book value is in excess of its net realizable value. For a discussion of certain
write-downs taken in fiscal 1999, see "Management's Discussion and Analysis."
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
11
<PAGE> 14
opportunities. Once a product design has been finalized, the actual final
development work is either performed in-house or by third party contractors,
depending on project scope and resource schedules.
CLIENT SUPPORT AND WARRANTIES
The Company believes that retention of customers is a key element of its
success. Therefore, the Company is dedicated to 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 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.
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
users. There are no assurances that these companies or institutions 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, Network Associates, 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.
12
<PAGE> 15
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.
The Company also expects that competition may increase as a result of 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.
13
<PAGE> 16
INTELLECTUAL PROPERTY RIGHTS
The Company regards certain features of its internal operations, software and
documentation as its intellectual property. The Company 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 August 4, 1999, the Company had approximately 42 employees, including 21
in sales and marketing, eight in product research and development, two in
production and operations, four in customer service and
14
<PAGE> 17
technical support, two in business development, and five in administration,
finance and MIS. The Company's Internet subsidiary also employs more than 150
persons, which includes former employees of 2-Lane Media and the Forward
Companies as well as management. 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.
GOVERNMENT REGULATION
Government regulation has not had a material effect on the Company's conduct of
its business to date.
CERTAIN FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
Investing in our common stock involves a high degree of risk. Any of the
following risks could materially adversely affect our business, operating
results and financial condition and could result in a complete loss of your
investment.
In addition to the other information in this Report, the following factors
should be considered carefully in evaluating the Company and its business. This
disclosure is for the purpose of qualifying for the "safe harbor" provisions of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. It contains factors which could
cause results to differ materially from such forward-looking statements. These
factors are in addition to any other cautionary statements, written or oral,
which may be made or referred to in connection with any such forward-looking
statement.
The following matters, among other things, may have a material adverse effect on
the business, financial condition, liquidity, results of operations or
prospects, financial or otherwise, of the Company. Reference to these factors in
the context of a forward-looking statement or statements shall be deemed to be a
statement that any one or more of the following factors may cause actual results
to differ materially from those in such forward-looking statement or statements.
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
15
<PAGE> 18
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; delays in software and purchases as a result of customers' uncertainty
as to the effect of the Y2K problem; 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 some future quarter
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.
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 competitors on the Novell NetWare and
Windows NT platforms include Computer Associates, Network General, 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 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 adversely affect its business, operating results
and financial condition.
Risks Associated with How2HQ.com Spinoff
In January 1999, Citadel announced the formation of How2HQ.com, Inc. (formerly
inLighten.com, inc. and shoppingwave.com, inc.), to implement Citadel's Internet
and e-commerce strategies. Citadel also previously announced that it intends to
16
<PAGE> 19
distribute 750,000 shares of How2HQ.com common stock to Citadel's shareholders
upon compliance with the Securities and Exchange Commission (SEC) requirements
applicable to Citadel and How2HQ.com in connection with the proposed spinoff.
Compliance with SEC requirements and state law requirements could delay or
prevent the completion of the spinoff. There can be no assurances that Citadel
will be able to effect the distribution of the shares of How2HQ.com to Citadel
shareholders on a timely basis or at all.
In addition, Citadel has agreed to convert the shares of How2HQ.com common stock
issued in connection with the acquisition of 2-Lane Media by How2HQ.com into up
to 500,000 Citadel shares at the option of the 2-Lane Media shareholders in the
event How2HQ.com does not become publicly traded by March 2000. Pursuant to the
terms of the subscription agreements between How2HQ.com and certain of its
stockholders, Citadel may be required to issue up to 414,000 shares of Citadel
common stock based on a conversion price of $3.75 per share (above the fair
market value on the dates of issuance) in the event How2HQ.com does not become
publicly traded by February 2000. These provisions could have the effect of
diluting Citadel's stockholders if the market price for Citadel's stock is above
that price at the time of conversion.
Risks Associated with Past and Future Acquisitions
Citadel and How2HQ.com have from time to time pursued a strategy for the
acquisition of assets or stock of companies or technologies to enhance their
product lines and services, and may continue this strategy in the future.
How2HQ.com recently acquired 2-Lane Media, Inc. and the Forward Companies, and
How2HQ.com has entered into a letter of intent to acquire certain assets of
Broadcast Production Group, Inc., which letter of intent is subject to customary
conditions, including the negotiation and closing of a definitive purchase
agreement. Future acquisitions could result in potentially dilutive issuances of
equity securities, the incurrence of debt and contingent liabilities and
amortization expenses related to goodwill and other intangible assets, which
could materially adversely affect our results of operations. Any such
acquisitions would be accompanied by the risks commonly encountered in such
transactions, including the difficulty of assimilating the technology,
operations and personnel of the acquired companies, the potential disruption of
our ongoing business, additional expenses associated with amortization of
acquired intangible assets, the maintenance of uniform standards, controls,
procedures and policies, and the potential unknown liabilities associated with
acquired businesses, including litigation and tax liabilities relating to the
acquired businesses or arising from the acquisitions. There can be no assurance
that we will be able to identify candidates suitable for acquisition or that we
will be able to consummate desired acquisitions on acceptable terms or that we
will be successful in integrating the acquired companies. If realized, any of
these risks could have a material and adverse effect upon our business, results
of operations and financial condition.
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, financial 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
17
<PAGE> 20
affected. Due to the complexity of software products and the difficulty in
gauging the engineering effort required to produce these potential new products
and upgrades, potential new products and upgrades are subject to significant
technical risks. There can be no assurance that 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 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.
The recent trend toward server-based applications in networks and applications
distributed over the Internet could have a material adverse effect on sales of
the Company's products. Future technology or market changes may cause certain of
the Company's products to become obsolete more quickly than expected. The use of
a Web browser, running on either a PC or network computer, to access
client/server systems is emerging as an alternative to traditional desktop
access through operating systems that are resident on personal computers. If the
functionality associated with this type of system access reduce the need for the
Company's products, the Company's future net revenues and operating results
could be materially adversely affected.
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, if the Company's products and technology are not compatible
with new developments in Microsoft and Novell technologies, as to which there
can be no assurances, the Company's business, results of operations and
financial condition could be materially and adversely affected.
Risk Associated With 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. The Company uses 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, and 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.
18
<PAGE> 21
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. There
can be no assurances that the Company will be successful in its efforts to
increase the revenues generated by this channel.
International Operations; Risks Associated with International Sales
The Company has recently entered into affiliations in Japan and Mexico. While
the Company has taken steps to minimize the financial exposure of such ventures,
there can be no assurances that its products will be successful overseas and
that these ventures will not have an adverse impact on the financial condition
of the Company. In addition, in order to successfully expand international sales
significant management attention and financial resources could be required and
could have an adverse effect on the Company's operating margins. In addition,
the Company relies significantly on its distributors and other resellers in
international sales efforts, that are not employees of the Company and do not
offer the Company's products exclusively, and there can be no assurance that
they will continue to market the Company's products. Additional risks inherent
in the Company's international business activities generally include unexpected
changes in regulatory requirements, fluctuations in the values of currencies,
tariffs and other trade barriers, costs to localize products, lack of acceptance
of localized products, if any, in foreign countries, longer accounts receivable
payment cycles, difficulties in managing international operations, potentially
adverse tax consequences including restrictions on the repatriation of earnings,
and the burdens of complying with a wide variety of foreign laws. There can be
no assurance that such factors will not have a material adverse effect on the
Company's future international sales and, consequently, the Company's business,
operating results and financial condition.
Risk of Accounting Treatment
The Company has received requests from the staff of the Securities and Exchange
Commission for additional information regarding the accounting for certain of
its acquisitions, including questions relating to the write-off of associated
in-process research and development costs and other matters. While the Company
has responded to these requests, the Company cannot determine at this time the
effect, if any, that the outcome of this matter will have on its reported
financial position or results of operations. However, should the staff of the
Securities and Exchange Commission require the Company to retroactively record
any adjustments, the effect could have a material adverse impact on the future
trading price of the Company's common stock.
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 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.
19
<PAGE> 22
Dependence on Growth in the Network Storage Management Market; General Economic
and Market Conditions
Substantially all of Citadel's historical 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 and
software industry have experienced significant economic downturns characterized
by decreased product demand, production overcapacity, price erosion, work
slowdowns and layoffs. The Company's operations have in the past and 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.
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.
Reduced Demand for Products due to Changes in Customer Behavior Resulting From
Year 2000 Preparation
With the emerging requirements on Year 2000 compliance and functionality, many
enterprise customers may use their Information Technology budgets in 1999 to
focus on Year 2000 issues. In addition, our customer's Information Technology
organizations may be unwilling to deploy new software until after the Year 2000
in order to reduce the complexity of any changes in their systems required by
any actual Year 2000 failures. We believe that these factors have reduced sales
of our products in fiscal 1999 and 2000 and will have a material adverse effect
on revenues.
Year 2000 Compliance
Many currently installed computer systems and software products include
coding 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. Our computer systems and/or software will need to be
upgraded to comply with such "Year 2000" 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 problems.
The Company has conducted Year 2000 compliance reviews for current
versions of our products. The reviews include:
o Assessment;
o Implementation;
o Validation testing; and
o Contingency planning.
The Company has posted information regarding Year 2000 compliance of its
products on its web site. Although the Company has performed validation testing
to ensure our products are Year 2000 compliant and believe our software products
are Year 2000 compliant, our software products may not contain all the necessary
software routines and programs for the accurate calculation, display, storage
and manipulation of data involving dates. Failures of our software products to
contain all the necessary software routines and programs for the accurate
calculation, display, storage and manipulation of data involving dates would
seriously harm our business, operating results and financial condition.
The Company has software obtained from third parties that is incorporated
into our products, and seek assurances from vendors that licensed software is
Year 2000 compliant. Despite such testing and assurances, products incorporated
into our products may contain undetected errors of defects associated with Year
2000 date functions. Known or unknown errors or defects in our products may
result in:
o Delay or loss of revenue;
o Diversion of development resources;
o Damage to our reputation; or
o Increased service and warranty costs.
The occurrence of any of the foregoing could seriously harm our business,
operating results, or financial condition.
To the extent information is publicly available, the Company has assessed
the Year 2000 compliance status of our customers. If its current or future
customers fail to achieve Year 2000 compliance or if they divert technology
expenditures to address Year 2000 compliance problems, our business, results of
operations, or financial condition should be seriously harmed.
The Company believes the software and hardware it uses internally complies
with Year 2000 requirements. During 1998, the Company replaced or upgraded much
of our internal use hardware and software. In addition, the Company is not
aware of any material operational issues or costs associated with preparing our
internal use software and hardware for the Year 2000. However, serious,
unanticipated negative consequences, including material costs caused by
undetected errors or defects in the technology used in our internal systems may
occur. The occurrence of any of the foregoing could seriously harm our
business, operating results or financial condition.
The Company has funded its Year 2000 compliance review from operating cash
flows and has not separately accounted for these costs in the past. The Company
will incur additional amounts related to the Year 2000 compliance review
including:
o Administrative personnel to manage the review; and
o Outside contractors to provide technical advice and technical support
for our products, product engineering, and customer satisfaction.
The Company is developing contingency plans to be implemented as part of
its efforts to identify and correct Year 2000 problems. Depending on the
systems affected, these plans include:
o Accelerated replacement of affected equipment or software;
o Short to medium-term use of backup equipment and software;
o Increased work hours for our personnel or use of contract personnel
to correct (on an accelerated schedule) any Year 2000 problems that
arise or to provide manual workarounds for information systems; and
o Other similar approaches
If the Company is required to implement any of these contingency plans, it
could seriously harm our business, financial condition and operating results.
The Company's ability to achieve Year 2000 compliance and the level of
incremental costs associated therewith, could be seriously impacted by, among
other things:
o The availability and cost of programming and testing resources;
o Vendors' ability to modify proprietary software; and
o Unanticipated problems identified in the ongoing compliance review.
20
<PAGE> 23
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 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.
Need For Additional Financing
The Company currently funds product development and the expansion of sales and
marketing activities through existing cash reserves and cash from operations and
issuances of securities. In the event that cash from operations and other
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. Additional financing may
involve substantial dilution to the interests of the Company's then-current
shareholders.
Legal Proceedings
The Company is involved in certain legal proceedings as described in "Item 3.
Legal Proceedings" and from time to time, we may be subject to other legal
proceedings, including but not limited to claims that we have infringed the
intellectual property rights of others, that our products are not Year 2000
compliant or other product liability claims, or other claims incidental to our
business. 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.
ITEM 2. DESCRIPTION OF PROPERTY
The Company leases approximately 7,200 square feet as its principal executive
office premises located at 3811 Turtle Creek Blvd., Suite 770, Dallas, Texas,
75219-4421, pursuant to a lease that expires in 2001 with two five-year renewal
options. The Company believes that these facilities are adequate for its current
needs and that suitable additional or alternative space will be available in the
future on commercially reasonable terms as needed.
The Company's Internet subsidiary, How2HQ.com, also leases approximately 14,500
square feet of office space in Dallas, Texas, 67,000 square feet of warehouse
and office space in Coppell, Texas, approximately 4,500 square feet in Seattle,
Washington and 4,500 square feet in Los Angeles, California.
The telephone number of its principal office is (214) 520-9292. The Company
maintains a site on the World Wide Web at http://www.citadel.com.
ITEM 3. LEGAL PROCEEDINGS
Set forth below are certain litigation matters in which the Company is a party.
The Company believes that it has meritorious defenses and will vigorously defend
itself. However, an unfavorable resolution of or settlement or defense costs
related to one or more of these lawsuits could have a material adverse effect on
the Company's business, results of operations or financial condition.
In January 1999, the Company settled a lawsuit with a former employee of
LoneStar Hospitality Corporation (the Company's predecessor) who had filed a
lawsuit against the Company and one of its officers and directors alleging that
the Company and/or the individual owed 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 sought damages of approximately $2,300,000, plus attorneys' fees, pre-
and post-judgement interest and costs of the lawsuit. The case was styled
Heredia v. Citadel, et. al., in the 298th Court of Dallas County, Texas. As part
of the settlement, the Company paid $400,000 in cash and issued 25,000 shares of
the Company's Common Stock to the plaintiff. The lawsuit was dismissed with
prejudice in May 1999.
In addition, in January 1999, the Company settled two lawsuits with two former
employees of the Company who had 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 seeking damages in excess of
$400,000 and claims under an employment agreement. The Company reached a
settlement with one of the employees under the terms of a promissory note and
agreed judgement. The court severed the claims of the remaining party, who
amended his claims to include amounts allegedly owing under an employment
agreement (in the amount of approximately $168,000). In January 1999, the
Company reached a settlement with the remaining party to the lawsuit for
$140,000 in cash plus 220,000 shares of the Company's Common Stock. The cases
were styled Nesbitt and Wesolek vs. Citadel, in the 193rd Judicial District
Court, Dallas County, Texas, and Nesbitt vs. Citadel, in the 193rd Judicial
District Court, Dallas County, Texas, and each has been dismissed with
prejudice.
21
<PAGE> 24
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 and to file
counter-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.
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. The parties entered an
agreed order dismissing the lawsuit.
In January, 1998, the Company's former Houston landlord filed a lawsuit against
the Company, styled Lenhndorff 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. In April 1999, plaintiff amended its
complaint to seek damages alleged as anticipatory breaches of the lease in the
amount of approximately $486,000. The parties reached an agreement in principle
to settle the case in July 1999 for the payment of $325,000 over nine months
with an agreed judgment in the event of default by Citadel.
The Company and its president are involved in an arbitration proceeding, styled
Vestcom Ltd. v. Citadel Computer Systems, Incorporated, etc. 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 the value of 100,000 shares of the
Company's common stock (alleged to be $1,900,000) 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 claims. The Company and its
president filed a declaratory judgment action against Vestcom seeking to
determine that the alleged contract was not valid based on the Company's
defenses. The case is styled Citadel Computer Systems, Inc. and Steven B.
Solomon v. Vestcom, Ltd., in the 193rd Judicial District Court in Dallas County,
Texas. In October 1998, the Texas state court entered a judgment and preliminary
injunction in favor of the Company and its president that the purported
agreement was a forgery. As a result the arbitration proceeding was dismissed by
the American Arbitration Association. The defendant has appealed the decision of
the Texas court. In November 1998 Vestcom filed a lawsuit against the Company in
Texas state court styled Vestcom v. Citadel in the 68th Judicial District Court,
Dallas County, Texas, reasserting the same basic claims as in the arbitration
proceeding. This case is set for mediation in September, 1999. The Company
intends to vigorously defend against the claim, including on the basis that the
prior Texas state court decision acts as a bar.
Subsequently to the end of fiscal 1999, the Company and Zanett Lombardier
settled a lawsuit related to a convertible note in the amount of $50,000 by the
issuance of stock due on conversion and the payment of attorney's fees in the
amount of approximately $135,000.
At this time, the Company is unable to predict the ultimate outcome of these
suits, the costs associated with defending the claims and pursuing
counterclaims, and monetary compensation awarded, if any.
The Company is also involved in routine litigation from time to time. Such
litigation is not material to the Company's consolidated financial condition or
results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of fiscal 1999.
On September 18, 1998, the Company held its Annual Stockholders Meeting, at
which time the stockholders of the Company approved the following matters:
Proposal 1 -- The election of the following individuals as directors of the
Company: Chris A. Economou (for - 24,792,033, withheld - 238,610); Gilbert
Gertner (for - 24,759,633, withheld - 271,010); Kenneth Johnsen (for -
24,845,633, withheld - 185,010); Victor Kiam II (for - 24,844,631, withheld -
186,012); Mark Rogers (for - 24,846,633, withheld - 184,010); Dr. Axel
Sawallich (for - 24,790,633, withheld - 240,010); and Steven Solomon (for -
24,820,033, withheld - 210,610).
Proposal 2 -- The ratification of the selection of Grant Thornton, LLP, as
the Company's independent certified public accountants for the fiscal year
ending February 28, 1999 (for - 24,800,104, against - 206,268, abstain -
24,271).
22
<PAGE> 25
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The Company's common stock is currently traded on the OTC Bulletin Board under
the symbol 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. 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 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>
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 2.20 .80 2.25 .85
------------------------------------------------------------------------
3rd Quarter 1.05 .40 1.09 .47
------------------------------------------------------------------------
4th Quarter 4.09 .65 4.12 .68
------------------------------------------------------------------------
2000
1st Quarter 3.62 1.94 3.65 2.00
------------------------------------------------------------------------
2nd Quarter 2.75 1.34 2.75 1.37
(through August 9, 1999)
------------------------------------------------------------------------
</TABLE>
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.
Recent Sales Of Unregistered Securities
In the fourth quarter of fiscal 1999, the Company's subsidiary, How2HQ.com,
issued 1,375,666 shares of its common stock pursuant to private placements to
accredited investors under Section 4(2) under the Securities Act for commitments
for proceeds of $7,242,000. Certain of the securities are convertible into up to
414,000 shares of shares of Citadel common stock at a conversion price of $3.75
per share in the event How2HQ.com has not completed a public offering before
February 2000.
23
<PAGE> 26
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS
The following discussion should be read in conjunction with the financial
statements and notes thereto found elsewhere herein, as well as the disclosure
relating to forward-looking statements set forth below under the caption
"Certain Factors That May Affect Future Operating Results."
RESULTS OF OPERATIONS
YEAR ENDED FEBRUARY 28, 1999, AS COMPARED WITH YEAR ENDED FEBRUARY 28, 1998
During the fiscal year ended February 28, 1999, the Company had net sales of
$4,439,608, an increase of $2,826,282 or 175.3%, over net sales of $1,613,326
during the fiscal year ended February 28, 1998. The Company attributes the
sales increase to increased industry recognition of its products, its partnering
with IBM Global Services, its bundling relationships with Microsoft and Compaq,
and its distributor relationships recently established in Japan and Mexico. The
Company terminated its distribution agreement with its UK distributor during
the fourth quarter and does not expect it to have a significant impact on the
on-going business of the Company. While the Company's revenues for the 1999
fiscal year increased significantly over the previous fiscal year, the Company
for the fourth quarter of fiscal 1999 and the first quarter of fiscal 2000 has
experienced a significant decline in sales. The Company attributes this decline
to the impact of delays in purchases as a result of Y2K issues and a significant
decrease in international distributor related sales.
The Company introduced the NT and Network versions of its WinShield product,
along with its new versions of its Folder Bolt product during the 1999 fiscal
year. The Company expects to launch its WinShield Secure PC product, the total
security solution for desktops, and other exciting new products and upgrades
during fiscal 2000. These products will continue to provide ease-of-use
security solutions for Internet and intranet applications on Microsoft and
Novell platforms.
The cost and expenses incurred in connection with producing the Company's
products were $190,461 during the fiscal year ended February 28, 1999, an
increase of $112,032 or approximately 142.8%, from cost of sales of $78,429
incurred in the previous fiscal year. This resulted primarily from the increase
in sales during this fiscal year. As a percentage of net sales, costs of sales
decreased in the fiscal year ended February 28, 1999, to 4.3% from 4.9% in the
prior period. The decrease in the cost of sales, on a percentage basis, was
primarily due to the increase of sales sold through corporate or OEM channels,
which tend to have a lower cost of sales expense on a per unit basis. In
addition, the Company continued to improve on its operational and order
procurement and fulfillment efficiencies during the year.
Selling, general and administrative expenses for the fiscal year ended February
28, 1999, were $5,817,188, a increase of $2,760,780, or 90.3%, over selling,
general and administrative expenses of $3,056,408 during the prior year. During
the 1999 fiscal year, the Company increased both its general marketing
expenditures, which were aimed at increasing the Company's name and product
recognition, as well as its direct marketing expenditures, which were aimed
directly at a particular market segment, i.e. education, corporate, government,
etc. In addition to these expenditures and in connection with its entry into
the international markets, the Company established marketing reserves to be used
to help promote the Company's products overseas. The Company also continued to
expand its inside and outside sales force during the year.
Provision for uncollectable accounts increased from $368,897 for the fiscal year
ended February 28, 1998 to $1,231,092 for fiscal year 1999, or an increase of
$862,195 or 233.7%. The majority of the provision in the current year was
specific in nature and related to the Company's international sales. Given the
current economic difficulties internationally, the Company felt it would be
prudent to reserve part of these sales in the current year. In addition, a
portion of the reserve was general in nature and related to the increase in the
sales for fiscal year 1999 over fiscal 1998.
Depreciation and amortization expense increased to $1,569,519 in the fiscal year
ended February 28, 1999, from $1,270,708, or an increase of 23.5% over the prior
fiscal year. This increase is due to the commencement of amortization on
certain capitalized software development costs relating to products that became
available for sale during the period and a full year's amortization on those
products that became available for sale last fiscal year.
Research and development expenses charged to operations for the year ended
February 28, 1999 were $485,275, compared to $161,010 for the year ended
February 28, 1998, or an increase of $324,265 or 201.4%. During the year, the
Company spent more time on non-capitalizable activities and out-sourced a major
portion of its new product development activities (approximately $600,000) to
Metamor Worldwide, Inc., a major shareholder in the Company. The Company
capitalized $882,101 and $568,963 in software development costs for fiscal year
1999 and 1998, respectively. The increase in capitalized costs related primarily
to the development of NT and Network versions of the Company's products. These
products were generally completed within the time schedule originally
established and development costs were generally within the range that had been
originally projected. Metamor has recently announced plans to sell a
number of its operating units. The Company does not feel this will have a
significant impact on the Company's ability to continue to development new
products and enhance existing products in the future. Sales of several of the
Company's products (CPR, Phantom of the Console, Server Sentry) to date have
been nominal. The Company does not believe that it will be able to generate
revenues from these products at a significant level, in the future, based on its
existing marketing model. Therefore, capitalized development costs relating to
these products were written down by $1,137,208, to $250,000 in the current year.
The Company expects to recover the remaining balance through product sales or
sales of the underlying technologies. The Company also incurred, during the
year, significant costs in upgrading several of its products to be Microsoft NT
compliant. It was determined that the costs associated with making two of its
products (Server Sentry and Phantom of the Console) NT compliant outweighed the
potential benefit based on its existing marketing model. Therefore, the Company
abandoned the project on these products and wrote-off the associated cost of
approximately $285,489.
The Company, in connection with the settlement of a number of lawsuits,
recognized a charge to earnings of $822,000 during the fiscal year ended
February 28, 1999. The major portion of this expense related to the settlement
of three suits styled Heredia v. Citadel, et. al., Zanett Lombardier v.
Citadel, and Lehndorff Four Oaks Place Joint Venture v. Citadel. Reference is
made to Item 3 - Legal Proceedings section of this report for further discussion
on these settlements.
Interest expense for the year ended February 28, 1999 was $141,806 compared to
$128,929 for the year ended February 28, 1998. The increase was due to the
Company having more interest bearing debt outstanding during the year than it
did last year.
As a result of the foregoing, the Company reported a net loss before
extraordinary items of $7,209,498 for the fiscal year ended February 28, 1999,
compared to a net loss of $3,522,710 for the year ended February 28, 1998.
24
<PAGE> 27
During fiscal year 1999, the Company recognized gains on the settlement of debts
of $459,592. The gains resulted primarily from the restructuring of a certain
note payable and the settlement of certain accrued obligations. In connection
with the settlement of a certain note payable, the holder agreed to reduce the
amount of the note and accrued interest payable thereon by $520,816. In
exchange, the Company agreed to a shorter maturity and the issuance of 250,000
shares of restricted stock to the holder (valued at $92,500 as of the date of
the transaction). The value of the stock was treated as a reduction in the gain
and the transaction resulted in a net gain of approximately $428,000. In
connection with the settlement of accrued obligations, the Company settled
approximately $96,000 in obligations for approximately $65,000.
As a result, the Company for the year ended February 28, 1999 reported a net
loss of $6,749,906, compared to a net loss of $3,522,710 for the year ended
February 28, 1998.
LIQUIDITY AND CAPITAL RESOURCE
The Company's cash and cash equivalents (on a consolidated basis) at February
28, 1999 were $3,386,369 (which included approximately $1,176,292 of cash and
cash equivalents of How2HQ.com).
Cash flows from operations was a negative $5,209,211 for the fiscal year ended
February 28, 1999, compared to a negative $2,661,326 for the fiscal year ended
February 28, 1998. The decrease was due principally to the increased net loss
of the Company for the period, which related principally to increased marketing
expenditures, the increase in the provision uncollectible receivables, which
related principally to the Company's international sales, and the increase in
software development costs, which related to the Company making its products NT
and network compliant.
Cash used in investing activities was $197,095 in the fiscal year ended February
28, 1999, compared to $4,780 in the prior year. The increase was primarily due
to a slight increase in capital expenditures this year, which was not offset by
proceeds from the sale of securities of $156,100, as in the previous year.
Cash flows from financing activities were $8,784,120 in the fiscal year ended
February 28, 1999, compared to $2,659,561 in the fiscal year ended February 28,
1998. This increase was primarily due to greater funds being raised this year
compared to last year through the sale of common stock, which related
principally to the exercise of Citadel options and warrants, and preferred stock
issuances, and the sale of How2HQ.com common stock.
As a result of the aforementioned factors, cash and cash equivalents on a
consolidated basis increased by $3,377,814 in the fiscal year ended February 28,
1999.
INFLATION
Inflation did not have a material effect on the Company's results during the
periods discussed.
YEAR 2000 DISCLOSURE
The Year 2000 issue arises as a result of computer programs which were written
using two digits rather than four digits to define the applicable year. The
Company's computer equipment and software and devices with embedded technology
that are time-sensitive may recognize a date using "00" as the year 1900 rather
than the year 2000. This could result in a system failure or miscalculations
causing disruptions of operations, including, among other things, a temporary
inability to process transactions, send invoices, or engage in similar normal
business activities.
The Company uses up-to-date, PC and network-based software for its internal
accounting and other functions. The Company has tested its internal accounting
and other significant applications and has
25
<PAGE> 28
found no material Year 2000 defects. The Company has checked its software
products for Year 2000 defects and has found none.
The Company may encounter some Year 2000 defects in the software it uses
internally, but believes that these can be resolved as they are encountered. The
Company does not intend to do further testing of its internal systems for Year
2000 defects. The Company has no contingency plans related to the Year 2000
issue.
The Company could encounter some Year 2000 defects in the products and services
it produces and markets. The Company intends to continue to evaluate its
products and services to ensure they perform correctly in the year 2000. If Year
2000 defects are encountered, the Company could be liable for substantial legal
claims and litigation, and the adverse publicity could have a material adverse
effect on the future sales of the Company's products and services, even after
any Year 2000 defects are resolved. However, any material adverse effect on the
Company's financial position and results of operations and cash flows cannot be
currently estimated.
The Company relies on outside suppliers for components of its software, outside
distributors and OEM partners for its software products, financial institutions
for its banking, and a number of other third parties in its normal business
operations. If these third-party suppliers and service providers have
substantial Year 2000 problems, it could have material adverse effects on the
Company's business. The Company is not requiring its suppliers and service
providers to provide Year 2000 readiness information.
The Company has not incurred and does not anticipate incurring material costs in
addressing Year 2000 issues.
The Company believes its largest risk regarding the Year 2000 issue is from
legal claims and litigation. The Company expects that there may be a large
number of lawsuits filed over Year 2000 issues in the United States because of
the great publicity of the Year 2000 issue. Even small Year 2000 problems
encountered by the Company could result in substantial legal claims, lawsuits,
and class action lawsuits against the Company, which in turn could have a
material adverse effect in the Company's financial position.
26
<PAGE> 29
ITEM 7. CONSOLIDATED FINANCIAL STATEMENTS
The Financial Statements for the fiscal year ended February 28, 1999, are found
following the signature page of this Report.
27
<PAGE> 30
ITEM 8. CHANGES IN, AND DISAGREEMENTS WITH, ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL MATTERS
There has been no change in the principal accountant of the Company during the
Company's two most recent fiscal years.
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934
DIRECTORS
The following table contains information about the Company's directors. The
Company expects that these persons will serve as directors until the next
annual meeting or until their respective successors are duly elected and
qualified.
<TABLE>
<CAPTION>
DIRECTORS 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
Lawerence Lacerte 46 Director 1999
Mark Rogers 40 Director 1996
Kenneth Johnsen 45 Director 1997
Chris A. Economou 44 Director 1993
Axel Sawallich 55 Director 1993
Michael Ruff 23 Director 1998
Edward L. Pierce 42 Director 1999
</TABLE>
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 Ronson P.L.C., The Franzusco, PIC Design
Corp., Lady Remington Jewelry, Cirrus Health Care, 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, as a director of the Company since February 1996, and as
Chief Operating Officer of the Company from February 1996 through April 1997.
Since January 1999, he has also served as Chairman and Chief Executive Officer
of How2HQ.com, Inc. 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 in February 1996
(the "Merger"). 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.
LAWRENCE LACERTE has served as a director of the Company since January 1999 and
as Vice Chairman of How2HQ.com since March 1999. Mr. Lacerte founded Lacerte
Software Corporation in 1978. By 1998, Lacerte Software had grown to be one of
the largest software companies offering a complete library of in-house tax
preparation software and supporting computer equipment. Lacerte Software is
considered the leader in the tax software industry commanding the highest
percentage of market share. In June 1998, Lacerte Software was acquired by
Intuit Corporation.
MARK ROGERS has served as a director of the Company since July 1996 and as a
director of How2HQ.com since January 1999. 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
was chief operating officer of NFT Transportation from 1992 to 1994, where he
was brought in to turn around the business. NFT Transportation grew to a $500
million company and went from a $5 million loss in 1992 to a net income of $3.5
million in 1994. Mr. Rogers also serves on the boards of directors of several
other high-tech companies.
28
<PAGE> 31
KENNETH JOHNSEN has served as a director of the Company since October 1997.
Since June 1999, Mr. Johnsen has been the president, chief operating officer and
a director of How2HQ.com, Inc. Prior to joining How2HQ.com, Mr. Johnsen served
in various executive capacities with Metamor Worldwide, Inc., most recently as
President, Chief Operating Officer and a Director. Metamor (formerly Corestaff,
Inc.) is one of the largest publicly traded 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.
CHRIS ECONOMOU has served as a director of the Company since February 1996, and
was a director of LoneStar from June 1993 until the Merger. Since January 1999,
he has also served as a director of How2HQ.com. 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.
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. 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 1985 to 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.
EDWARD L. PIERCE has served as a director of the Company since July 1999. He
has served as Senior Vice President, Chief Financial Officer and Assistant
Secretary of Metamor since September 1996. Mr. Pierce previously served as Vice
President-Finance and prior thereto as Vice President and Controller of
Metamor. Prior to joining Metamor in November 1994, Mr. Pierce served in
various financial management capacities with American Oil and Gas Corporation,
including Corporate Controller and Director of Accounting, Taxation and
Reporting from January 1990 to November 1994 and as an Audit Manager for Arthur
Andersen & Co. prior thereto. 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.
BOARD COMMITTEES AND MEETINGS
Each director is elected to serve until the next annual meeting of stockholders
or until the director's successor is duly elected and qualified. Officers serve
at the discretion of the Board of Directors. The Company currently has an
executive committee, and in July 1999, the Company appointed an audit committee
and a compensation committee. The Company does not currently have a nominating
committee.
29
<PAGE> 32
EXECUTIVE COMMITTEE
The Company currently has an executive committee comprised of Messrs. Solomon,
Johnsen, Economou and Rogers. The Executive Committee is authorized to act on
behalf of the Board on all corporate actions for which applicable law does not
require participation by the full Board.
AUDIT COMMITTEE. In July 1999, the Board appointed an audit committee. The
Audit Committee consists of Messrs. Kiam, Pierce and Economou. The audit
committee examines and considers matters relating to the financial affairs of
the Company, including reviewing the Company's annual financial statements, the
scope of the independent annual audit and the independent auditor's letter to
management concerning the effectiveness of the Company's internal financial and
accounting controls.
COMPENSATION COMMITTEE. In July 1999 the Board appointed a compensation
committee, which is comprised of Messrs. Johnsen, Rogers and Lacerte. The
compensation committee considers and makes recommendations to the Company's
board of directors with respect to programs for human resource development and
management organization and succession, approves changes in senior executive
compensation and makes recommendations to the Company's board of directors with
respect to compensation matters and policies. The compensation committee also
administers the Company's benefit plans.
MEETINGS
During the fiscal year ended February 28, 1999, the Board of Directors held one
meeting and took action by unanimous consent on one occasion, and the executive
committee took action by unanimous consent on thirteen occasions. Each director,
attended at least 75% of the aggregate number of meetings held by the Company's
Board of Directors and committees on which he served during the fiscal year
ended February 28, 1999.
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 1999 applicable to such persons were complied with,
except Messrs. Kiam and Sawallich filed a Form 5 late (such Form 5s related to
the exercise of certain options) and Messrs. Doxey and Klein each filed a Form
4 late relating to the sale and purchase of securities, respectively.
EXECUTIVE OFFICERS OF THE COMPANY
The executive officers of the Company are:
<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. 43 Chief Financial Officer, Chief Operating Officer and Secretary
Carl E. Banzhof 33 Chief Technology Officer
Bennett Klein 44 Vice President of Business Development
Jack Doxey 32 Vice President of Marketing
Lester Sideropoulos 44 Vice President of Sales
</TABLE>
30
<PAGE> 33
Information concerning the business experience of Mr. Solomon is provided under
the caption "Election of 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 DOXEY has served as Vice President of Marketing since August 1998, and
Vice President of Sales and Marketing from October 1997 to May 1998. 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, MO. 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, GA. 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.
LESTER SIDEROPOULOS has served as Vice President of Sales since joining the
Company is January 1999. Mr Sideropoulos has over 20 years experience in sales.
Prior to joining the Company, Mr. Sideropoulos was Director of Business
Technology at Constellation Technology, a developer of data acquisition systems
from January 1998 to January 1999, Director of Sales for Oxford Instruments, a
developer of nuclear detection systems from May 1993 to January 1998, and held
various other product management and direct sales positions during his 20 year
career.
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.
ITEM 10. EXECUTIVE COMPENSATION
The total compensation for the three fiscal years ended February 28, 1999,
Steven Solomon, the Company's Chief Executive Officer; Richard Travis, the
Company's Chief Operating and Financial Officer; Carl Banzhof, the Company's
Chief Technology Officer; Bennett Klein, the Company's Vice President of
Business Development; and Jack Doxey,
31
<PAGE> 34
the Company's Vice President of Marketing (the "Named Executive Officers"), is
set forth below in the following Summary Compensation Table. No other person
received cash compensation in excess of $100,000 during the fiscal year ended
February 28, 1999.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------
LONG-TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
------------------------------------ ---------
OTHER
ANNUAL SHARES ALL OTHER
FISCAL SALARY BONUS COMPENSATION UNDERLYING COMPENSATION
NAME AND POSITION (S) YEAR ($) ($) ($) OPTIONS ($)
------------------------- ------ ------- ------- ------ ---------- ------
<S> <C> <C> <C> <C> <C> <C>
Steve Solomon
President, Chief 1999 150,538 120,500 11,400(1) 0(5) 9,975(1)
Executive Officer 1998 135,000 104,000(1) 11,400(1) 2,000,000 8,342(1)
and Asst. Sect'y 1997 120,000 66,496 11,400(1) 0 7,446(1)
------------------------- ------ ------- ------- ------ ---------- ------
Richard Travis
Chief Operating 1999 136,667 25,000 11,400(2) 0(5) 5,400
and Financial 1998 130,000 10,000 11,400(2) 1,150,000 23,552(2)
Officer and Sect'y 1997 29,791(2) 0 2,650(2) 0 0
------------------------- ------ ------- ------- ------ ---------- ------
Carl Banzhof 1999 115,000 0 0 0 4,093
Chief Technology 1998 100,625 500 0 100,000 3,552
Officer 1997 103,228 1,000 0 0 0
------------------------- ------ ------- ------- ------ ---------- ------
Bennett Klein
Vice President of 1999 135,000 37,000(3) 0 0 61,467(3)
Business Development 1998 21,548(3) 0 0 300,000 0
------------------------- ------ ------- ------- ------ ---------- ------
Jack Doxey
Vice President of 1999 87,083 17,115 0 0 3,693(4)
Marketing 1998 42,519(4) 0 0 200,000 0
------------------------- ------ ------- ------- ------ ---------- ------
</TABLE>
(1) During fiscal 1998, 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 health, life and disability insurance during
each fiscal year.
(2) Mr. Travis received a car allowance of $950 per month for fiscal years 1997
(December through February 1997) 1998 and 1999 and health, life and disability
insurance. 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
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
(valued at $20,000). Mr. Travis started to work for the Company in December
1996.
(3) Mr. Klein started to work for the Company in January 1998. In connection
with his employment agreement Mr. Klein received a relocation package of
$56,542 and 100,000 shares of the Company's Common Stock as a sign-on bonus,
valued at $37,000 as of the date of grant. Mr. Klein also receives, as part of
his employment agreement, health, life and disability insurance.
(4) Mr. Doxey started to work for the Company in October 1997. Mr. Doxey left
the employment of the Company from May 1998 until August 1998. Mr. Doxey also
receives health, life and disability insurance as part of his employment with
the Company.
(5) Excludes 1,650,000 and 30,000 shares granted during the year by How2HQ.com
to Messrs. Solomon and Travis respectively.
OPTION GRANTS DURING 1999 FISCAL YEAR
The Company did not grant any stock options or stock appreciation rights to the
Named Officers of the Company during the fiscal year ended February 28, 1999.
The Company's subsidiary, How2HQ.com, granted the following stock options to the
32
<PAGE> 35
Named Officers of the Company during the fiscal year. How2HQ.com did not issue
any stock appreciation rights during the fiscal year ended February 28, 1999.
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS By HOW2HQ.COM
- --------------------------------------------------------------
NUMBER OF PERCENT OF
SECURITIES TOTAL OPTIONS/
UNDERLYING SARS GRANTED EXERCISE OR
NAME OPTIONS/SARS TO EMPLOYEES BASE PRICE EXPIRATION
GRANTED (#)(3) IN FISCAL YEAR ($ / SH)(3) DATE
- -------------------------- ------------------- --------------- ---------------------- ---------------------
<S> <C> <C> <C> <C>
Steven Solomon (1) 1,000,000 27.7 $ .10 1/09
650,000 18.0 $1.00 1/09
- -------------------------- ------------------- --------------- ---------------------- ---------------------
Richard Travis (2) 30,000 1.0 $1.00 1/09
- -------------------------- ------------------- --------------- ---------------------- ---------------------
</TABLE>
(1) The How2HQ.com options disclosed in the table were granted as of January,
1999. Mr. Solomon exercised his options to purchase 1,000,000 shares on January
8, 1999 and 250,000 shares were exercised in July 1999. The exercise price
associated with the options was financed by How2HQ.com. The notes are secured by
the shares of How2HQ.com stock, bear interest at 5% per annum and are payable on
or before January 2001. Mr. Solomon's remaining 400,000 options vest quarterly
over two years.
(2) Mr. Travis's options vest annually over three years.
(3) Before giving effect to a four-for-one stock split effective in July 1999.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES
The following table describes, for each of the Named Officers, options
exercised and the potential values for their unexercised in-the-money options
at February 28, 1999 (the Company issued no SARs during the year):
<TABLE>
<CAPTION>
NUMBER OF
SECURITIES VALUE OF
UNDERLYING UNEXERCISABLE IN-
UNEXERCISED THE-MONEY OPTIONS/
OPTIONS/SARS AT SARS AT FISCAL
FISCAL YEAR END YEAR END
($) ($)(2)
---------------------- ----------------------
SHARES VALUE
ACQUIRED ON REALIZED EXERCISABLE/ EXERCISABLE/
NAME EXERCISE (#) ($)(1) UNEXERCISABLE UNEXERCISABLE
-------------------------- --------- -------- ---------------------- ----------------------
<S> <C> <C> <C> <C>
Steven Solomon 3,175,000(3) $873,750(3) 0/0(4) 0/0(4)
-------------------------- --------- -------- ---------------------- ----------------------
Richard Travis 1,100,000 363,750 0/0(4) 0/0(3)
-------------------------- --------- -------- ---------------------- ----------------------
Carl Banzhof 0 0 100,000/0 298,000/0
-------------------------- --------- -------- ---------------------- ----------------------
Bennett Klein 0 0 133,328/166,672 387,984/485,016
-------------------------- --------- -------- ---------------------- ----------------------
Jack Doxey 0 0 77,165/122,835 224,250/357,450
-------------------------- --------- -------- ---------------------- ----------------------
</TABLE>
33
<PAGE> 36
(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, 1999 of per share less the exercise price payable for each share.
(3) Excludes options to purchase 1,000,000 shares of How2HQ.com granted to and
exercised by Mr. Solomon during the fiscal year and 250,000 shares granted to
and exercised by Mr. Solomon subsequent to the end of the fiscal year (prior to
a four-for-one stock split effective in July 1999).
(4) Excludes How2HQ.com options to purchase 400,000 shares (400,000
unexercisable), and 30,000 shares (30,000 unexercisable), for Messrs. Solomon
and Travis, respectively (prior to a four-for-one stock split effective in July
1999).
COMPENSATION OF DIRECTORS
The members of the Board of Directors do not receive cash compensation in
connection with their service but are entitled to reimbursement for their
expenses incurred in connection with attendance at meetings of the Board of
Directors or committees.
EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with each of Messrs. Solomon,
Travis and Klein. The annual base salaries being paid to Messrs. Solomon, Travis
and Klein were $165,000 $140,000, and $135,000, respectively, as of February 28,
1999, and the employment agreements provide for periodic salary increases and
bonuses. The employment agreements continue until February 2002, May 2002, and
January 2001, respectively for Messrs. Solomon, Travis and Klein, and annually
thereafter until terminated by either party. In addition, the employment
agreements provide for severance benefits ranging from six months (for Mr.
Klein) on the greater of (i) the remaining term of the contract, discounted at a
rate of six percent, or (ii) 24 months of base salary (for Messrs. Solomon and
Travis), in the event of termination without cause or constructive termination.
Mr. Solomon has entered into an Employment Agreement with How2HQ.com effectively
as of January 1, 1999, and Citadel ceased paying Mr. Solomon's salary effective
as of July 1, 1999. The agreement with How2HQ.com is on similar terms as Mr.
Solomon's agreement with Citadel.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the number of shares of the Company's Common
Stock beneficially owned, as of August 9, 1999 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 directors, (iii) each
executive officer named in the Summary Compensation Table (the "Named Officers")
and (iv) all directors, 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 August 9,
1999 are outstanding. Except as otherwise indicated, all shares are owned
directly and the owner has the sole voting and investment power with respect
thereto, and shares and options related to How2HQ.com give effect to a
four-for-one stock split effective in July 1999.
34
<PAGE> 37
<TABLE>
<CAPTION>
NUMBER OF APPROXIMATE
NAME AND ADDRESS CITADEL SHARES OWNED PERCENT OF CLASS
------------------------------------------ -------------------- ----------------
<S> <C> <C>
Carl Banzhof
3811 Turtle Creek Blvd., Suite 770
Dallas, Texas 75219 159,401(1) .4%
------------------------------------------ ---------- ----
Jack Doxey
3811 Turtle Creek Blvd., Suite 600
Dallas, Texas 75219 105,545(2) .2%
------------------------------------------ ---------- ----
Gilbert Gertner
1300 Post Oak Blvd., Suite 1985
Houston, Texas 77056 2,345,500(3) 5.2%
------------------------------------------ ---------- ----
Chris A. Economou
150 North Federal Highway, Suite 210
Fort Lauderdale, Florida 33301 474,400(4) 1.1%
------------------------------------------ ---------- ----
Icarus Investments I, Ltd.
8144 Walnut Hill Lane, Suite 172
Dallas, Texas 75231 4,750,000(5) 10.5%
------------------------------------------ ---------- ----
Kenneth Johnsen
3811 Turtle Creek Blvd, Suite 600
Dallas, Texas 75719 155,000(6) .4%
------------------------------------------ ---------- ----
Victor Kiam, II
RPI Corporation
350 Fifth Avenue, Suite 5408
New York, New York 10018 744,452(7) 1.7%
------------------------------------------ ---------- ----
Bennett Klein
3811 Turtle Creek Blvd., Suite 770
Dallas, Texas 75219 266,660(8) .6%
------------------------------------------ ---------- ----
Lawrence Lacerte
13155 Noel Road - Suite 2200
Dallas, Texas 75225 100,000(9) .2%
------------------------------------------ ---------- ----
Metamor Worldwide, Inc.
4400 Post Oak Parkway, Suite 1100
Houston, Texas 77027 6,581,937(10) 13.9%
------------------------------------------ ---------- ----
Thomas Oxley
2727 South Ocean Blvd., Apt. 803
Highland Beach, Florida 33487 2,000,000(11) 4.6%
------------------------------------------ ---------- ----
Mark Rogers
NFT Ventures, Inc.
751 Laurel Street, No.19
San Carlos, California 94070 401,500(12) .9%
------------------------------------------ ---------- ----
Michael Ruff
Icarus Investments I, Ltd.
8144 Walnut Hill Lane, Suite 172
Dallas, Texas 75231 4,895,000(5) 10.9%
------------------------------------------ ---------- ----
Dr. Axel Sawallich
Beatrixgasse 3
A-1030 Vienna, Austria 137,144(13) .3%
------------------------------------------ ---------- ----
Steven Solomon
3811 Turtle Creek Blvd., Suite 600
Dallas, Texas 75219 5,485,993(14) 12.7%
------------------------------------------ ---------- ----
Richard Travis
3811 Turtle Creek Blvd., Suite 770
Dallas, Texas 75219 1,244,000 2.9%
------------------------------------------ ---------- ----
All officers and directors
As a group (12 persons): 14,169,095(15) 31.2%
------------------------------------------ ---------- ----
</TABLE>
(1) Includes 100,000 shares presently issuable pursuant to options to purchase
Common Stock and 2,000 shares owned by his spouse.
(2) Includes 45,045 shares presently issuable pursuant to options to purchase
Common Stock. Excludes 26,667 shares issuable upon exercise of outstanding
How2HQ.com options that are exercisable within 60 days after August 11, 1999.
(3) Includes 1,462,500 shares presently issuable pursuant to options to
purchase Common Stock held by Mr. Gertner.
(4) Excludes 100,000 shares of How2HQ owned by Mr. Economou and 125,000 shares
issuable upon exercise of outstanding How2HQ options that are exercisable within
60 days of August 11, 1999.
(5) 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 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 shares owned by Mr.
Ruff,
35
<PAGE> 38
individually. Mr. Ruff's and Icarus's shares both exclude 2,000,000 shares of
How2HQ.com presently owned by Icarus and 850,000 shares issuable upon exercise
of outstanding How2HQ options that are exercisable within 60 days of August 11,
1999.
(6) Includes 5,000 shares owned by his spouse. Excludes 2,000,000 shares of
How2HQ presently owned and 500,000 shares issuable upon exercise of outstanding
How2HQ options that are exercisable within 60 days of August 11, 1999.
(7) Includes 250,000 shares held by RPI, Inc., a company owned and controlled
by Mr. Kiam. Excludes 116,667 shares issuable upon exercise of outstanding
How2HQ.com options that are exercisable within 60 days of August 11,
1999.
(8) Includes 166,660 shares presently issuable pursuant to options to purchase
Common Stock.
(9) Excludes 2,400,000 shares of How2HQ.com presently owned and 335,000 shares
issuable upon exercise of outstanding How2HQ options that are exercisable within
60 days of August 11, 1999.
(10) Includes 2,000,000 shares presently issuable pursuant to warrants to
purchase Common Stock.
(11) 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. Excludes
800,000 shares of How2HQ.com presently owned by Mr. Oxley.
(12) Excludes 100,000 shares of How2HQ.com presently owned and 125,000 shares
issuable upon exercise of outstanding How2HQ.com options that are exercisable
within 60 days of August 11, 1999.
(13) Includes 12,144 shares held by Dr. Sawallich as trustee, over which he has
voting and dispositive power.
(14) Excludes 5,000,000 shares of How2HQ.com presently owned by Mr. Solomon and
200,000 shares issuable upon exercise of outstanding How2HQ.com options that are
exercisable within 60 days of August 11, 1999.
(15) Includes shares presently issuable pursuant to presently exercisable
options or warrants held by Messrs. Banzhof, Klein, Ruff, Doxey, and/or their
affiliates. Excludes 11,600,000 shares and 2,278,334 options exercisable within
60 days of August 11, 1999 related to How2HQ.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
During fiscal year 1999, the Company advanced funds to Mr. Solomon in the amount
of approximately $780,000 during the third quarter and $745,000 during the
fourth quarter. Both advances were evidenced by unsecured promissory notes
bearing interest at 5%. The entire balance with the exception of $145,000 was
repaid prior to the end of the fiscal year. The remaining balance was paid as of
April 30, 1999.
The Company contracted with Metamor Software Solutions, division of Metamor
Worldwide, Inc. (formerly CORESTAFF, Inc.) to provide various development
services for the Company. The Company incurred approximately $600,000 and
$115,000 in expenses related to these services during the fiscal years ended
February 28, 1999 and 1998. Mr. Johnsen, one of the Company's directors, was the
executive vice president of Metamor during this time period, and Mr. Pierce, a
director of the Company, was Chief Financial Officer of Metamor during that
time. In June 1999, Mr. Johnsen joined How2HQ.com as president and chief
operating officer. In connection therewith, Mr. Johnsen was granted options to
purchase 950,000 shares of How2HQ.com (500,000 was granted with an exercise
price of $.10 per share and was immediately vested and the remaining balance has
an exercise price of $1.00 per share and vest over two years) (prior to the
four-for-one stock split effective July 1999).
During the fiscal year ended February 28, 1999, the Company and How2HQ.com
incurred legal fees in the amount of approximately $140,000 to Wood, Exall &
Bonnet, L.L.P. In fiscal 1998, the Company incurred approximately $70,000 in
legal fees to such firm. David Wood, a partner of such firm, is the
brother-in-law of Steven Solomon. Mr. Wood owns 200,000 shares of Citadel common
stock. Mr. Wood also serves as general counsel of How2HQ.com and was granted
options to purchase 200,000 shares of How2HQ.com with an exercise price of $1.00
per share, which vest over two years (before giving effect to the four-for-one
stock split effective July 1999).
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 Gilbert
Gertner and George Sharp, two of the Company's directors at the time (the
"Purchasers"). At the date of the agreement, the Purchasers owned
36
<PAGE> 39
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. As of the Record Date, the Company had not 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.
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. George
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 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, 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.
37
<PAGE> 40
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBITS
2.1 Second Amended and Restated Plan of Merger, dated February 29, 1996, by and
between LoneStar Hospitality Corporation, LSHC Acquisition, Inc. and Citadel
Computer Systems Incorporated (without exhibits) (incorporated by reference to
Exhibit 2.1 of the Company's Current Report on Form 8-K dated February 29,
1996).
2.2 Purchase and Sale Agreement, dated March 1, 1996, by and between LoneStar
Hospitality Corporation, LS Holding Corp. and Miami Subs USA, Inc. (without
exhibits) (incorporated by reference to Exhibit 2.2 of the Company's Current
Report on Form 8-K dated February 29, 1996).
2.3 Technology Transfer Agreement, by and between LoneStar Hospitality
Corporation and Circuit Masters Software, Inc., dated February 29, 1996 (without
exhibits) (incorporated by reference to Exhibit 2.3 of the Company's Current
Report on Form 8-K dated February 29, 1996).
2.4 Technology Transfer Agreement, by and between Citadel Computer Systems
Incorporated and Bill Mulvany, dated February 29, 1996 (without exhibits)
(incorporated by reference to Exhibit 2.4 of the Company's Current Report on
Form 8-K dated February 29, 1996).
2.5 Technology Transfer Agreement, by and between Citadel Computer Systems
Incorporated and Kim Marie Newman, dated February 29, 1996 (without exhibits)
(incorporated by reference to Exhibit 2.5 of the Company's Current Report on
Form 8-K dated February 29, 1996).
2.6 Agreement, by and between Citadel Computer Systems, Inc.; Circuit Masters
Software, Inc., Patrick William Mulvany and Kim Marie Newman, dated May 16,
1996, 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).
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).
38
<PAGE> 41
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).
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 of 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 of 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 10.3 of 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).
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).
39
<PAGE> 42
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
of 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
of 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 of the Company's
Annual Report on Form 10-KSB for the fiscal year ended February 28, 1998).
10.15* Stock Purchase Agreement, dated March 11, 1999, among How2HQ.com, inc.,
2-Lane Media, Inc., and the shareholders of 2-Lane Media, Inc.
10.16 Stock Purchase Agreement, dated May 20, 1999, among How2HQ.com, inc.,
Forward Communications, Inc., FCS Services Inc., and the shareholders of Forward
Communications, Inc. and FCS Services Inc. (incorporated by reference to exhibit
2.1 to the Company's Current Report on Form 8-K filed June 3, 1999).
10.17 Agreement and Plan of Reorganization, dated May 20, 1999, among
How2HQ.com, inc., Forward Freight, Inc., and the shareholders of Forward Freight
Inc. (incorporated by reference to exhibit 2.1 to the Company's Current Report
on Form 8-K filed June 3, 1999).
*21 Subsidiaries of the Company.
*23.1 Consent of Grant Thornton LLP.
*27 Financial Data Schedule.
- ---------------------------------
* Filed herewith.
REPORTS ON FORM 8-K
The Company filed no Current Reports on Form 8-K for the fourth quarter of the
fiscal year ended February 28, 1999.
40
<PAGE> 43
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
CITADEL TECHNOLOGY, INC.
/s/ STEVEN B. SOLOMON
- ----------------------------------------------
Steven B. Solomon
President and Chief Executive Officer
Dated: August 10, 1999
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the Registrant and in the capacities and on the
dates indicated:
<TABLE>
Name and Title Date
- -------------- ----
<S> <C>
/s/ VICTOR K. KIAM, II August 10, 1999
- ----------------------------------------------------
Victor K. Kiam, II
Chairman of the Board of Directors
/s/ STEVEN B. SOLOMON August 10, 1999
- ----------------------------------------------------
Steven B. Solomon
President, Chief Executive Officer, Secretary and
Director (Principal Executive Officer)
/s/ RICHARD L. TRAVIS, JR. August 10, 1999
- ----------------------------------------------------
Richard L. Travis, Jr.
Chief Financial Officer and Chief Operating Officer
(Principal Accounting Officer)
/s/ LARRY LACERTE August 10, 1999
- ----------------------------------------------------
Larry Lacerte
Director
/s/ MICHAEL RUFF August 10, 1999
- ----------------------------------------------------
Michael Ruff
Director
/s/ MARK ROGERS August 6, 1999
- ----------------------------------------------------
Mark Rogers
Director
/s/ CHRIS A. ECONOMOU August 10, 1999
- ----------------------------------------------------
Chris A. Economou
Director
August __, 1999
- ----------------------------------------------------
Dr. Axel Sawallich
Director
/s/ KEN JOHNSEN August 10, 1999
- ----------------------------------------------------
Ken Johnsen
Director
August __, 1999
- ----------------------------------------------------
Edward L. Pierce
Director
</TABLE>
41
<PAGE> 44
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
<S> <C>
Report to Independent Certified Public Accountants..........................F-2
Consolidated Balance Sheets as of February 28, 1999 and 1998................F-3
Consolidated Statements of Operations for the years ended
February 28, 1999 and 1998................................................F-5
Consolidated Statement of Stockholders' Equity (Deficit)
for the years ended February 28, 1999 and 1998............................F-6
Consolidated Statements of Cash Flows for the years ended
February 28, 1999 and 1998................................................F-8
Notes to Consolidated Financial Statements..................................F-10
</TABLE>
F-1
<PAGE> 45
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, 1999 and 1998, 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, 1999 and 1998, 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
Dallas, Texas
June 11, 1999
F-2
<PAGE> 46
CITADEL TECHNOLOGY, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
February 28,
-----------------------------
ASSETS 1999 1998
------------- -------------
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $ 3,386,369 $ 8,555
Accounts receivable-trade, less allowance for returns and
doubtful accounts of $1,208,000 and $681,000 466,288 435,615
Receivables from sale of common stock of subsidiary 6,042,000 --
Notes receivable from related parties 478,933 376,487
Inventory 148,676 57,513
Prepaid expenses 208,223 71,980
------------- -------------
Total current assets 10,730,489 950,150
PROPERTY AND EQUIPMENT, NET 386,901 387,923
PURCHASED SOFTWARE, net of accumulated
amortization of $2,718,486 and $1,788,000 1,394,706 3,462,879
CAPITALIZED SOFTWARE DEVELOPMENT COSTS,
net of accumulated amortization of $577,000 and $150,000 1,181,052 1,011,432
OTHER ASSETS 448,372 350,650
------------- -------------
$ 14,141,520 $ 6,163,034
============= =============
</TABLE>
F-3
<PAGE> 47
CITADEL TECHNOLOGY, INC.
CONSOLIDATED BALANCE SHEETS - CONTINUED
<TABLE>
<CAPTION>
February 28,
----------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY 1999 1998
--------------- ---------------
<S> <C> <C>
CURRENT LIABILITIES
Cash overdraft $ -- $ 10,249
Current maturities of long-term debt 311,812 1,270,565
Notes payable 347,424 842,174
Accounts payable and accrued expenses 2,247,600 2,274,141
--------------- ---------------
Total current liabilities 2,906,836 4,397,129
OTHER LIABILITIES
Debt, less current maturities -- 478,044
Minority interest in consolidated subsidiary 2,742,432 --
--------------- ---------------
Total liabilities 5,649,268 4,875,173
COMMITMENTS AND CONTINGENCIES -- --
STOCKHOLDERS' EQUITY
Common stock, $.01 par value per share; authorized,
60,000,000 shares; issued and outstanding, 43,259,274
shares in 1999 and 25,881,327 shares in 1998 432,592 258,813
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, 5,000 shares in 1998 (liquidation
value, $500,000) -- 50
Series D convertible, 2,000 shares in 1999 (liquidation
value, $2,000,000) 20 --
Equity notes 150,000 944,000
Additional paid-in capital 32,985,018 16,058,442
Accumulated deficit (20,641,875) (13,473,206)
Treasury stock, at cost (4,164,613 common shares) (2,500,239) (2,500,239)
Notes receivable for the exercise of stock options
Officers and directors (1,857,577) --
Others (75,688) --
--------------- ---------------
Total stockholders' equity 8,492,252 1,287,861
--------------- ---------------
$ 14,141,520 $ 6,163,034
=============== ===============
</TABLE>
The accompanying notes are an integral part of these statements.
F-4
<PAGE> 48
CITADEL TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Years ended February 28,
----------------------------
1999 1998
------------ ------------
<S> <C> <C>
NET SALES $ 4,439,608 $ 1,613,326
COST OF SALES, EXCLUDING DEPRECIATION AND AMORTIZATION 190,461 78,429
------------ ------------
Gross profit 4,249,147 1,534,897
OPERATING EXPENSES
Selling, general and administrative expenses 5,817,188 3,056,408
Provision for uncollectible receivables 1,231,092 368,897
Depreciation and amortization 1,569,519 1,270,708
Research and development expense 485,275 161,010
Write-off of capitalized software costs 1,422,697 --
------------ ------------
10,525,771 4,857,023
Operating loss (6,276,624) (3,322,126)
OTHER INCOME (EXPENSE)
Interest expense (141,806) (128,929)
Loss on sales of marketable securities -- (199,672)
Litigation settlement expense (822,000) --
Other 30,932 128,017
------------ ------------
(932,874) (200,584)
Loss before extraordinary item (7,209,498) (3,522,710)
EXTRAORDINARY ITEM - FORGIVENESS OF DEBT 459,592 --
------------ ------------
Net loss (6,749,906) (3,522,710)
Preferred stock dividend requirement (128,956) (14,557)
------------ ------------
Net loss allocable to common stockholders $ (6,878,862) $ (3,537,267)
============ ============
Loss per share-basic and diluted
Loss before extraordinary item $ (0.26) $ (0.21)
Extraordinary item 0.01 --
------------ ------------
Net loss $ (0.25) $ (0.21)
============ ============
Weighted average shares outstanding 27,807,748 16,801,818
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
F-5
<PAGE> 49
CITADEL TECHNOLOGY, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Common stock Additional
---------------------------- Preferred Equity paid-in
Shares Amount stock notes capital
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Balance at March 1, 1997 16,501,980 $ 165,020 $ 5 $ 300,000 $ 13,370,627
Exercise of stock options
and warrants 1,258,100 12,581 -- -- 376,197
Sale of equity notes, net of
issuance costs of $182,244 -- -- -- 1,625,000 (182,244)
Sale of Series C preferred stock -
5,000 shares, net of
issuance costs of $78,835 -- -- 50 -- 421,115
Conversions to common stock
Debt, net of unamortized
debt issuance costs of
$38,667 2,964,093 29,641 -- -- 871,685
Series B preferred stock
and equity notes 2,285,257 22,852 (4) (481,000) 458,152
Redemption of equity notes -- -- -- (500,000) (100,000)
Payment of dividends on
equity notes 275,897 2,759 -- -- 93,670
Common stock issued for
services 96,000 960 -- -- 24,240
Sale of common stock 2,500,000 25,000 -- -- 725,000
Purchase of treasury stock-
3,900,000 shares -- -- -- -- --
Comprehensive income (loss)
Change in unrealized
loss on securities
available for sale -- -- -- -- --
Net loss -- -- -- --
Total
------------ ------------ ------------ ------------ ------------
Balance at February 28, 1998 25,881,327 258,813 51 944,000 16,058,442
<CAPTION>
Accumulated
other
Accumulated comprehensive Treasury Notes
deficit income stock receivable Total
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Balance at March 1, 1997 $ (9,854,067) $ (355,772) $ (353,590) $ -- $ 3,272,223
Exercise of stock options
and warrants -- -- -- -- 388,778
Sale of equity notes, net of
issuance costs of $182,244 -- -- -- -- 1,442,756
Sale of preferred stock -
5,000 shares, net of
issuance costs of $78,835 -- -- -- -- 421,165
Conversions to common stock
Debt, net of unamortized
debt issuance costs of
$38,667 -- -- -- -- 901,326
Preferred stock and
equity notes -- -- -- -- --
Redemption of equity notes -- -- -- -- (600,000)
Payment of dividends on
equity notes (96,429) -- -- -- --
Common stock issued for
services -- -- -- -- 25,200
Sale of common stock -- -- -- -- 750,000
Purchase of treasury stock-
3,900,000 shares -- -- (2,146,649) -- (2,146,649)
Comprehensive income (loss)
Change in unrealized
loss on securities
available for sale -- 355,772 -- -- 355,772
Net loss (3,522,710) -- -- -- (3,522,710)
------------
Total -- -- -- -- (3,166,938)
------------ ------------ ------------ ------------ ------------
Balance at February 28, 1998 (13,473,206) -- (2,500,239) -- 1,287,861
</TABLE>
F-6
<PAGE> 50
CITADEL TECHNOLOGY, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY - CONTINUED
<TABLE>
<CAPTION>
Common stock Additional
--------------------------- Preferred Equity paid-in
Shares Amount stock notes capital
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Exercise of stock options
and warrants 10,943,099 $ 109,431 $ -- $ -- $ 3,760,738
Sale of preferred stock -
2,000 shares of Series D
and 5,000 shares of
Series E -- -- 70 -- 2,253,572
Conversion of debt to 253
shares of Series D
preferred stock -- -- 3 -- 252,997
Conversions to common stock
Debt 1,254,766 12,548 -- -- 831,535
Equity notes and preferred
stock - 5,000 shares of
Series C and 253 shares
of Series D 1,735,082 17,350 (53) (794,000) 1,190,466
Redemption of Series E
preferred stock - 5,000
shares -- -- (50) -- (562,450)
Stock options and common
stock granted as payment
of liabilities 445,000 4,450 -- -- 345,150
Sale of common stock,
net of issuance costs
of $268,855 3,000,000 30,000 -- -- 3,705,000
Stock options granted as
consideration for
assumption of debt by
stockholder -- -- -- -- 500,000
Equity in sales of common
stock by subsidiary -- -- -- -- 4,649,568
Net loss -- -- -- -- --
------------ ------------ ------------ ------------ ------------
Balances at February 28, 1999 43,259,274 $ 432,592 $ 21 $ 150,000 $ 32,985,018
============ ============ ============ ============ ============
<CAPTION>
Accumulated
other
Accumulated comprehensive Treasury Notes
deficit income stock receivable Total
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Exercise of stock options
and warrants $ -- $ -- $ -- $ (1,933,265) $ 1,936,904
Sale of preferred stock -
2,000 shares of Series D
and 5,000 shares
of Series E -- -- -- -- 2,253,642
Conversion of debt to 253
shares of Series D
preferred stock -- -- -- -- 253,000
Conversions to common stock
Debt -- -- -- -- 844,083
Equity notes and preferred
stock - 5,000 shares of
Series C and 253 shares
of Series D (413,763) -- -- -- --
Redemption of Series E
preferred stock - 5,000
shares (5,000) -- -- -- (567,500)
Stock options and common
stock granted as payment
of liabilities -- -- -- -- 349,600
Sale of common stock,
net of issuance costs
of $268,855 -- -- -- -- 3,735,000
Stock options granted as
consideration for
assumption of debt by
stockholder -- -- -- -- 500,000
Equity in sales of common
stock by subsidiary -- -- -- -- 4,649,568
Net loss (6,749,906) -- -- -- (6,749,906)
------------ ------------ ------------ ------------ ------------
Balances at February 28, 1999 $(20,641,875) $ -- $ (2,500,239) $ (1,933,265) $ 8,492,252
============ ============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of this statement.
F-7
<PAGE> 51
CITADEL TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years ended February 28,
--------------------------
1999 1998
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(6,749,906) $(3,522,710)
Adjustments to reconcile net loss to net cash used
by operating activities
Depreciation and amortization 1,569,519 1,270,708
Common stock and options issued as payment of expenses 349,600 25,200
Loss on sale of securities -- 199,672
Write-down of software development costs 1,422,697 --
Extraordinary item (459,592) --
Provision for losses on accounts receivable
and sales returns 1,231,092 368,897
Other 49,054 --
Changes in operating assets and liabilities
Accounts receivable (1,261,765) (280,803)
Notes receivable (102,446) (131,487)
Prepaid expenses (136,243) (44,887)
Inventory (91,163) (27,500)
Software development costs (895,546) (568,963)
Cash overdraft (10,249) (157,007)
Accounts payable and accrued expenses (26,541) 294,984
Other assets (97,722) (87,430)
----------- -----------
NET CASH USED IN OPERATING ACTIVITIES (5,209,211) (2,661,326)
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (197,095) (160,880)
Proceeds from sale of securities -- 156,100
----------- -----------
NET CASH USED IN INVESTING ACTIVITIES (197,095) (4,780)
</TABLE>
F-8
<PAGE> 52
CITADEL TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
<TABLE>
<CAPTION>
Years ended February 28,
----------------------------
1999 1998
------------ ------------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on notes payable $ (355,167) $ (628,441)
Proceeds from notes payable 471,900 514,528
Proceeds from long-term debt -- 489,865
Repayments on long-term debt (40,659) (119,090)
Proceeds from sale of preferred stock 2,253,642 421,165
Proceeds from sale of equity notes -- 1,442,756
Proceeds from sale of common stock 5,821,904 1,138,778
Proceeds from sale of subsidiary stock 1,200,000 --
Redemption of equity notes -- (600,000)
Redemption of preferred stock (567,500) --
------------ ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 8,784,120 2,659,561
------------ ------------
Net increase (decrease) in cash 3,377,814 (6,545)
Cash at beginning of the year 8,555 15,100
------------ ------------
Cash at end of the year $ 3,386,369 $ 8,555
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
F-9
<PAGE> 53
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
February 28, 1999 and 1998
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. In
January 1999, the Company incorporated How2HQ.com, inc., which was a 63%
owned subsidiary at February 28, 1999. How2HQ.com, inc. had not begun
operations at February 28, 1999. See Note L.
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.
Principles of Consolidation
The consolidated financial statements include the accounts of Citadel
Technology, Inc. (Citadel) and its majority-owned subsidiaries
(collectively, "the Company"). All material intercompany accounts and
transactions have been eliminated.
Cash and Cash Equivalents
Cash and cash equivalents include cash in banks and all highly liquid
investments with initial maturities of three months or less.
Revenue Recognition
The Company recognizes revenues when a customer's purchase order has been
received, the software has been shipped (or electronically delivered), the
remaining obligations are insignificant and the collection of the resulting
receivables is 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.
F-10
<PAGE> 54
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1999 and 1998
NOTE A - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -
CONTINUED
Revenues related to significant post-contract support agreements (generally
product maintenance agreements) are deferred and recognized over the period
of the agreements.
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.
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 greater of
the revenue method or 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 $485,275 and $161,010 in 1999 and 1998,
respectively. Capitalized costs are amortized using the greater of the
revenue method or the straight-line method with 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. Amortization expense was
$1,371,402 and $1,083,479 in fiscal 1999 and 1998, respectively.
During fiscal 1999, software costs were written down by $1,422,697. It is
reasonably possible that future events could cause a reduction in the
amortization period of software costs, or additional write downs may be
required.
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 F.
F-11
<PAGE> 55
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1999 and 1998
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 and cash equivalents,
marketable securities, notes receivable and debt instruments. Carrying
values approximate fair value because of their short-term maturities.
Net Income (Loss) Per Common Share
The Company computes basic income (loss) per common share based on the
weighted average number of common shares outstanding. Income (loss) per
common share - diluted 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. Per
share data - diluted has not been presented because the effect of potential
common shares is antidilutive.
Securities and Exchange Commission Matters
The Company has received requests from the staff of the Securities and
Exchange Commission for additional information regarding the accounting for
certain of its acquisitions, including questions relating to the write-off
of associated in-process research and development costs, and certain other
matters. While the Company has responded to these requests, the Company
cannot determine at this time the effect, if any, that the outcome of this
matter will have on its reported financial position or results of
operations. It is possible that annual and quarterly financial statements
for fiscal 1998 and 1999 will need to be restated.
NOTE B - PROPERTY AND EQUIPMENT
Major classes of property and equipment and their estimated useful lives are
as follows:
<TABLE>
<CAPTION>
February 28,
----------------------------
Lives 1999 1998
------------- ------------ ------------
<S> <C> <C> <C>
Furniture 5-10 years $ 138,770 $ 82,978
Office equipment 3-7 years 82,712 74,339
Leasehold improvements Lease term 68,672 62,184
Computer equipment 3-7 years 606,798 480,671
------------ ------------
896,952 700,172
Less accumulated depreciation (510,051) (312,249)
------------ ------------
Net property and equipment $ 386,901 $ 387,923
============ ============
</TABLE>
F-12
<PAGE> 56
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1999 and 1998
NOTE C - NOTES PAYABLE
Notes payable consist of the following:
<TABLE>
<CAPTION>
February 28,
---------------------------
1999 1998
------------ ------------
Unsecured notes payable to individuals, including $80,000 in 1998 to
related parties, due at various dates in 1999 and 1998, bearing
interest at rates ranging from 0% to 10%; weighted average
<S> <C> <C>
interest rate is approximately 6.1% (1) $ 192,500 $ 652,500
Note payable to bank, bearing interest at 11.50% -- 102,340
Note payable to banks, bearing interest at 7.35% to 7.45% 120,833 --
Other notes payable 34,091 87,334
------------ ------------
$ 347,424 $ 842,174
============ ============
</TABLE>
(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 $400,000 was
converted into common stock, at $1.075 per share during the year
ended February 28, 1999.
NOTE D - LONG-TERM DEBT
<TABLE>
<CAPTION>
February 28,
---------------------------
1999 1998
------------ ------------
<S> <C> <C>
Redeemable convertible notes, interest at 5% payable in common
stock, due in March 2000 (1) $ -- $ 330,000
Note payable to Xerox Corporation, non-interest bearing, due
September 1998, interest imputed at 10% (net of discount ) 200,000 995,918
Note payable to a bank, payable in monthly installments with interest
at 9.75%, through January 2000 111,812 162,781
Note payable to an individual, non-interest-bearing, payable by an
initial payment of $25,000, and monthly payments of $10,000 -- 259,910
------------ ------------
311,812 1,748,609
Less current maturities 311,812 1,270,565
------------ ------------
$ -- $ 478,044
============ ============
</TABLE>
(1) These notes were converted into common stock at $.82 per share during
the year ended February 28, 1999.
F-13
<PAGE> 57
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1999 and 1998
NOTE E - 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,
----------------------------------
1999 1998
--------------- ---------------
<S> <C> <C>
Tax benefit at statutory rate $ 2,295,000 $ 1,159,000
Change in valuation allowance (2,228,000) (1,136,000)
Other (67,000) (23,000)
--------------- ---------------
$ -- $ --
=============== ===============
</TABLE>
Significant components of deferred income tax assets and liabilities are as
follows:
<TABLE>
<CAPTION>
February 28,
----------------------------------
1999 1998
--------------- ---------------
<S> <C> <C>
Deferred tax assets
Net operating loss carryovers $ 6,044,000 $ 3,933,000
Accounts receivable 410,000 232,000
Property and equipment -- 32,000
Accounts payable and accrued expenses -- 26,000
Other -- 3,000
--------------- ---------------
6,454,000 4,226,000
Valuation allowance (6,454,000) (4,226,000)
--------------- ---------------
Net deferred tax asset $ -- $ --
=============== ===============
</TABLE>
The Company has net operating loss carryovers of approximately $17,500,000
at February 28, 1999. 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.
F-14
<PAGE> 58
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1999 and 1998
NOTE F - STOCKHOLDERS' EQUITY
Preferred Stock
The Company's outstanding Series B preferred stock is convertible into
shares of common stock at 83% of the average market price of the common
stock for the five days preceding conversion. Each share of Series B
preferred stock has a conversion value of $1,000. Dividends accrue at 5%.
The Series C preferred stock was converted into common stock, at various
prices ranging from $.31 to $.75 per share, during the year ended February
28, 1999.
The Series D preferred stock is convertible into shares of common stock at
$1.075 per share. Dividends accrue at 11%. Dividends in arrears, related to
these shares, were approximately $174,000 at February 28, 1999.
During fiscal 1999, the Company issued and redeemed 5,000 shares of Series E
convertible preferred stock for $452,920 and $567,500, respectively.
Dividends on all series of preferred stock are payable in cash or common
stock at the option of the Company.
Equity Notes
The Company has issued equity notes which are unsecured and are convertible
into common stock at 80% of the average market price of the common stock and
are payable at maturity only in common stock. Interest at 8% is payable only
in common stock. At February 28, 1999, all but $150,000 of the notes had
been converted. The outstanding balance of unconverted notes is classified
on the balance sheet as a component of stockholders' equity. Subsequent to
February 28, 1999, the remaining balance of the notes were converted into
approximately 533,850 shares of common stock.
Common Stock
See Note L regarding potential obligation to issue common shares in
connection with acquisitions.
F-15
<PAGE> 59
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1999 and 1998
NOTE F - 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 three years. Following is a summary of option transactions for the
periods beginning March 1, 1997:
<TABLE>
<CAPTION>
Weighted
average
exercise
Shares price
--------------- ---------------
<S> <C> <C>
Outstanding at March 1, 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
Granted 1,804,088 0.82
Exercised (8,124,181) 0.32
Expired or cancelled (514,500) 1.31
--------------- ---------------
Outstanding at February 28, 1999 2,962,157 $ 0.55
=============== ===============
Exercisable at February 28, 1998 7,786,750 $ 0.44
Exercisable at February 29, 1999 1,163,170 $ 0.63
Weighted-average fair value of options granted during
the year ended February 28, 1998 - $0.18
Weighted-average fair value of options granted during
the year ended February 28, 1999 - $0.73
</TABLE>
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 $.25 per share
for employees and $.40 per share for directors. These options have been
reflected as cancelled and granted in the above summary of option
transactions. In January 1999, the vesting date on 1,125,000 stock options
held by certain officers was accelerated. The options were exercised in
exchange for collateralized notes in the amount of $318,750. These notes,
along with other notes given in payment of option exercises of $1,614,515,
have been deducted from stockholders' equity in the balance sheet at
February 28, 1999.
F-16
<PAGE> 60
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1999 and 1998
NOTE F - STOCKHOLDERS' EQUITY - CONTINUED
The following table summarizes other information regarding stock options at
February 28, 1999:
<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 1,949,907 3.7 $ 0.36 573,702 $ 0.31
0.51 - 1.00 908,750 3.0 0.83 551,528 0.89
1.01 - 3.00 103,500 3.5 1.75 38,500 1.75
---------- ------ --------- ------
2,962,157 $ 0.55 1,163,730 $ 0.63
========== ====== ========= ======
</TABLE>
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, 1999 and 1998, the effect on net loss
and loss per share would have been as follows:
<TABLE>
<CAPTION>
Years ended February 28,
-----------------------------
1999 1998
------------ -----------
<S> <C> <C>
Net loss
As reported $(6,749,906) $(3,522,710)
Pro forma (7,194,115) (4,197,423)
Loss per common share
As reported (.25) (.21)
Pro forma (.26) (.25)
</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,
---------------------------
1999 1998
------------- ------------
<S> <C> <C>
Expected volatility 134-149% 137-147%
Risk-free interest rates 4.2-5.6% 5.7-6.2%
Dividend yield 0% 0%
Expected option lives 1-2 years 1- 4 years
</TABLE>
F-17
<PAGE> 61
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1999 and 1998
NOTE F - STOCKHOLDERS' EQUITY - CONTINUED
The following summarizes the warrant transactions for 1999 and 1998:
<TABLE>
<CAPTION>
Weighted
average
Shares exercise price
--------------- ---------------
<S> <C> <C>
Outstanding at March 1, 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
Issued 5,557,383 1.60
Exercised (3,400,453) 0.58
Expired or cancelled (2,222,263) 1.04
--------------- ---------------
Outstanding at February 28, 1999 6,039,805 $ 2.82
=============== ===============
</TABLE>
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.
During fiscal 1999, the Company issued warrants to purchase 1,750,000 shares
of common stock in connection with the sale of common stock, 150,000 shares
in connection with the sale of preferred stock, 200,000 shares as payment of
liabilities, and 351,125 shares in other transactions. Also, the terms of
warrants to purchase 2,172,263 shares at $.89 per share were adjusted
pursuant to antidilution provisions of the warrant agreements to increase
the number of warrants to 3,106,258 and reduce the price to $.59 per share;
these warrants have been reflected as cancelled and granted in the table
above.
Subsidiary Transactions
During February 1999, How2HQ.com, Inc. (How2HQ) issued 5,502,664 shares of
common stock in private placements for $7,242,000, of which $6,042,000 was
evidenced by subscriptions which were paid prior to June 30, 1999. Certain
of the shares issued are convertible into a maximum of 414,000 shares of the
Company at a conversion price of $3.75 per share in the event How2HQ has not
completed a public offering before March 2000. Options to purchase shares of
common stock of How2HQ, were granted to officers and directors in January
1999. Options to purchase 6,300,000 shares of common stock at $.025 to $.25
per share vested immediately and were exercised for notes. The remaining
options granted cover 7,120,000 shares at a price of $.25 per share and vest
in varying amounts through October 2001.
F-18
<PAGE> 62
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1999 and 1998
NOTE G - 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.
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.
F-19
<PAGE> 63
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1999 and 1998
NOTE G - RELATED PARTY TRANSACTIONS - CONTINUED
Other
During the years ended February 28, 1999 and 1998, the Company loaned
approximately $1,525,000 and $122,000, respectively, exclusive of financing
provided for the exercise of stock options, to its Chief Executive Officer,
Mr. Solomon. At February 28, 1999 and 1998, $354,000 and $226,000,
respectively, remained unpaid.
The Company has contracted with a major shareholder in the Company, Metamor
Software Solutions, a division of Metamor Worldwide, Inc. (Metamor) to
provide various development services for the Company. The Company incurred
approximately $600,000 and $115,000 in expenses related to these services
during fiscal years ended February 28, 1999 and 1998, respectively. Mr. Ken
Johnsen, one of the Company's directors, was the Executive Vice President of
Metamor during this time. In June 1999, Mr. Johnsen joined the Company's
subsidiary, How2HQ as its President and Chief Operating Officer. In
connection therewith, Mr. Johnsen was granted options to purchase 500,000
shares of How2HQ common stock at $.10 per share and options to purchase
450,000 shares at $1.00 per share.
During fiscal years ended February 28, 1999 and 1998, the Company and How2HQ
incurred legal fees in the amount of approximately $140,000 and $70,000,
respectively to Wood, Exall & Bonnet, L.L.P. Mr. David Wood, a partner of
such firm is a relative of Mr. Solomon. Subsequent to February 28, 1999, Mr.
Wood joined How2HQ as its General Counsel.
In August 1998, the Company granted stock options to a stockholder and
reduced the exercise price of certain other stock options in consideration
for the stockholder's assumption of indebtedness of the Company in the
principal amount of $500,000. The transactions resulted in no gain or loss.
At February 28, 1999, the Company had a $125,000 receivable from the
stockholder.
NOTE H - COMMITMENTS AND CONTINGENCIES
The Company leases office space under noncancellable operating lease
agreements expiring at various dates through 2003. Future minimum lease
payments under these leases at February 28, 1999, were as follows:
<TABLE>
<CAPTION>
Year ending
February 28,
------------
<S> <C>
2000 $ 301,204
2001 312,416
2002 289,468
2003 9,490
-----------
Total $ 912,578
===========
</TABLE>
Rental expense totaled approximately $316,000 and $303,000 for the years
ended February 28, 1999 and 1998, respectively.
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 $486,000, plus attorney's fees, pre and post
judgment interest and court costs. In July 1999, the parties reached an
agreement in principle to settle the suit for $325,000 to be paid over nine
months.
The Company and its President are involved in an arbitration proceeding
with Vestcom Ltd., 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 the value of 100,000 shares of the Company's common stock
(alleged to be $1,900,000) plus 50% of additional compensation paid by the
Company to such third party. The Company believes it has defenses to such
claims. The Company and its president filed a declaratory judgment action
against Vestcom seeking to determine that the alleged contract was not valid
based on the Company's defenses. The case is styled Citadel Computer
Systems, Inc. and Steven B. Solomon v. Vestcom, Ltd., in the 193rd Judicial
District Court in Dallas County, Texas. In October 1998, the Texas state
court entered a judgment and preliminary injunction in favor of the Company
and its president that the purported agreement was a forgery. As a result
the arbitration proceeding was dismissed by the American Arbitration
Association. The defendant has appealed the decision of the Texas court. In
November 1998 Vestcom filed a lawsuit against the Company in Texas state
court styled Vestcom v. Citadel in the 68th Judicial District Court, Dallas
County, Texas, reasserting the same basic claims as in the arbitration
proceeding. This case is set for mediation in September, 1999.
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 the Company and the Company's predecessor in 1996, and related
matters. The Company believes such claims are without merit and intends to
vigorously defend against the claim.
F-20
<PAGE> 64
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1999 and 1998
NOTE H - COMMITMENTS AND CONTINGENCIES - CONTINUED
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, 1999, the Company has employment agreements with three of
its officers. The agreements expire in 2000 to 2002. How2HQ has an
employment agreement with its chief executive officer, who is also the
Company's chief executive officer, that expires in 2004.
NOTE I - SUPPLEMENTAL CASH FLOW INFORMATION
<TABLE>
<CAPTION>
Years ended February 28,
---------------------------
1999 1998
---------- ------------
<S> <C> <C>
Supplemental disclosures of cash flow information:
Cash paid during the year for interest $ -- $ 128,929
Non-cash investing and financing transactions:
Notes payable converted to preferred stock 253,600 --
Payment of dividends in common stock -- 96,429
Conversions to common stock
Debt 844,083 901,326
Preferred stock and equity notes 1,956,956 481,004
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
Common stock and stock options
issued in satisfaction of debt 849,600 --
Common stock sold for notes or subscriptions 8,245,265 --
</TABLE>
NOTE J - EXTRAORDINARY ITEM
The extraordinary item in fiscal 1999 results from gains on debt
forgiveness, which consists principally of a $428,316 reduction in the note
payable to Xerox Corporation (Note D).
NOTE K - FOURTH QUARTER ADJUSTMENTS
During the fourth quarter of fiscal 1999, the Company wrote off software
development costs of approximately $1,400,000 and increased the allowance
for doubtful accounts by approximately $866,000.
F-21
<PAGE> 65
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1999 and 1998
NOTE L - ACQUISITIONS BY SUBSIDIARY SUBSEQUENT TO FEBRUARY 28, 1999 AND PLANNED
SPIN-OFF (UNAUDITED)
How2HQ completed the acquisitions of 2-Lane Media, Inc. (2-Lane) and The
Forward Companies subsequent to February 28, 1999. Each acquisition will be
accounted for by the purchase method.
2-Lane offers web site and e-commerce design for its clients. The purchase
price was 1,200,000 shares of How2HQ common stock with a guaranteed value of
$1.25 per share; in the event the common stock of How2HQ is not publicly
traded by February 1, 2000, the sellers have the option to convert the
How2HQ shares into common stock of the Company having a value of $1,500,000.
Also, options were granted to the shareholders of 2-Lane to purchase 200,000
shares of How2HQ common stock at $.25 per share.
The Forward Companies provides product rebate promotional fulfillment
services relating to merchandise and consumer rebate programs. The purchase
price consisted of $8,000,000 in cash and 2,200,000 shares of How2HQ common
stock with a guaranteed value of $2.50 per share. Also, options were granted
to the shareholders of The Forward Companies to purchase 800,000 shares of
How2HQ common stock at $2.50 per share if certain earn-out provisions are
met.
Subsequent to February 28, 1999, How2HQ issued 4,743,004 shares of common
stock in private placements for $8,725,500. How2HQ also granted options to
purchase 8,892,000 shares of its common stock to employees, directors and
others at exercise prices ranging from $.25 to $2.50 per share.
As a result of the above acquisitions and sales of common stock, Citadel's
ownership of How2HQ was reduced to approximately 50.1% at July 31, 1999.
The Company has announced that it will distribute to its shareholders,
750,000 shares of common stock of How2HQ upon compliance with Securities and
Exchange Commission (SEC) requirements applicable to Citadel and How2HQ in
connection with the proposed spin-off. Compliance with SEC requirements and
state law requirements could delay or prevent the completion of the
spin-off. There can be no assurances that Citadel will be able to effect the
distribution of the shares of How2HQ to Citadel stockholders on a timely
basis or at all.
In addition, Citadel has agreed to convert certain shares of How2HQ common
stock issued in connection with certain acquisitions completed or proposed
by How2HQ as well as issued pursuant to the terms of the subscription
agreements between How2HQ and its stockholders into shares of Citadel common
stock, in the event How2HQ does not become publicly traded within one year.
This could result in the issuance of up to 414,000 additional shares of
Citadel common stock at a conversion price of $3.75 per share, which would
have the effect of diluting Citadel's stockholders if the market price for
Citadel's stock is above that price at the time of conversion.
F-22
<PAGE> 66
CITADEL TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
February 28, 1999 and 1998
NOTE M - LOSS PER SHARE
<TABLE>
<CAPTION>
Loss before
Extraordinary Extraordinary
credit credit Net loss
-------------- -------------- --------------
<S> <C> <C> <C>
1999
Earnings (loss) $ (7,209,498) $ 459,592 $ (6,749,906)
Preferred dividend requirement (128,956) -- (128,956)
-------------- -------------- --------------
Earnings loss allocable to common stockholders $ (7,338,454) $ 459,592 $ (6,878,862)
============== ============== ==============
Weighted average common shares outstanding 27,807,748 -- 27,807,748
Earnings (loss) per share - basic and diluted $ (0.26) $ 0.01 $ (0.25)
============== ============== ==============
1998
Loss $ (3,522,710) $ -- $ (3,522,710)
Preferred dividend requirement (14,557) -- (14,557)
-------------- -------------- --------------
Loss allocable to common stockholders $ (3,537,267) $ -- $ (3,537,267)
============== ============== ==============
Weighted average common shares outstanding 16,801,818 -- 16,801,818
Loss per share - basic and diluted $ (.21) $ -- $ (.21)
============== ============== ==============
</TABLE>
F-23
<PAGE> 67
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).
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).
</TABLE>
<PAGE> 68
<TABLE>
<S> <C>
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).
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 of 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 of 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 10.3 of 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).
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).
</TABLE>
<PAGE> 69
<TABLE>
<S> <C>
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 of 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 of 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
of the Company's Annual Report on Form 10-KSB for the fiscal year
ended February 28, 1998).
10.15* Stock Purchase Agreement, dated March 11, 1999, among How2HQ.com,
inc., 2-Lane Media, Inc., and the shareholders of 2-Lane Media, Inc.
10.16 Stock Purchase Agreement, dated May 20, 1999, among How2HQ.com, inc.,
Forward Communications, Inc., FCS Services Inc., and the shareholders
of Forward Communications, Inc. and FCS Services Inc. (incorporated by
reference to exhibit 2.1 to the Company's Current Report on Form 8-K
filed June 3, 1999).
10.17 Agreement and Plan of Reorganization, dated May 20, 1999, among
How2HQ.com, inc., Forward Freight, Inc., and the shareholders of
Forward Freight Inc. (incorporated by reference to exhibit 2.1 to the
Company's Current Report on Form 8-K filed June 3, 1999).
*21 Subsidiaries of the Company.
*23.1 Consent of Grant Thornton LLP.
*27 Financial Data Schedule.
</TABLE>
- ---------------------------------
* Filed herewith.
<PAGE> 1
EXHIBIT 10.15
STOCK PURCHASE AGREEMENT
THIS STOCK PURCHASE AGREEMENT (the "Agreement"), dated as of March 10,
1999 by and among inLighten.com, Inc., a Delaware corporation ("Buyer"), 2-Lane
Media, Inc., a California corporation (the "Company"), and the Shareholders
listed on the signature pages of this Agreement ("Sellers" or "Shareholders").
WHEREAS, Sellers own all issued and outstanding shares of capital stock
of the Company (the "Company Shares"), and Sellers desire to sell to Buyer, and
Buyer desires to purchase from Sellers, the Company Shares.
NOW, THEREFORE, for and in consideration of the representations,
warranties, covenants and agreements contained herein, and other good and
valuable consideration, the receipt and adequacy of which are acknowledged, and
upon the terms and subject to the conditions set forth herein, the parties do
agree as follows:
ARTICLE I
PURCHASE AND SALE
1.1 Purchase of Stock. On the Closing Date (defined below), Buyer
agrees to purchase from Sellers, and Sellers shall sell to Buyer, all of the
issued and outstanding shares of common stock, no par value, of the Company (the
"Company Shares") for a total consideration of 300,000 shares (the "Buyer
Shares") of common stock of Buyer (the "Consideration") (subject to conversion
pursuant to Section 1.2).
1.2 Conversion and Guarantees. inLighten.com, Inc. is a wholly owned
subsidiary of Citadel Technology, Inc., a publicly traded company. Buyer
represents that it intends to file and have the United States Securities and
Exchange Commission ("SEC") accept and make effective all documents necessary to
permit Sellers to publicly trade their Buyer's Shares within one year after
Closing. Should Seller's Buyer Shares not be registered with the SEC within one
year after closing, Sellers, and each of them, shall have the option to convert
the 300,000 Buyer Shares into a number of unregistered shares of common stock of
Citadel Technology, Inc. ("Citadel Stock") as determined by dividing $1,500,000
by the average closing trade price of Citadel Stock over the thirty (30) trading
days immediately preceding the Closing Date.
Buyer represents that it shall receive within one hundred and twenty (120) days
from the Closing Date at least Five Million Dollars ($5,000,000) in currency of
the United States ("Cash") from its outside investors, said Cash to be good
funds, unencumbered and immediately available for use by Buyer without
restriction ("Cash Investment"). Should said Cash Investment not be received and
immediately available for use by Buyer within one hundred and twenty (120) days
from the Closing Date, Sellers shall have the option to convert the 300,000
Buyer Shares into a number of unregistered shares of common stock of Citadel
Technology, Inc. ("Citadel Stock") determined by dividing $1,500,000 by the
average closing trade price of Citadel Stock over the 30 trading days
immediately preceding the Closing Date. Buyer agrees to provide Sellers with all
documents necessary to determine the date said Cash Investment was actually
received.
In the event that Sellers exercise the aforementioned options, Citadel
Technology, Inc. covenants to timely convert and issue such shares and include
such shares in the next registration of Citadel common stock filed with the SEC,
but shall register such Citadel Technology, Inc. common stock with the SEC at
Citadel's expense within six months after issuance to Sellers. After
registration, Citadel Technology, Inc. shall re-issue its common stock to
Sellers as fully tradeable without restrictive legends.
ARTICLE II
REPRESENTATIONS AND WARRANTIES OF THE COMPANY AND THE SELLERS
The Company and the Sellers jointly and severally represent and warrant
to Buyer as follows:
2.1 Authorization of Sellers. This Agreement has been duly executed and
delivered by each Seller and constitutes the valid and binding obligation of
such Seller, enforceable in accordance with its terms, except (i) such
enforcement may be subject to bankruptcy, insolvency, reorganization, moratorium
or similar laws affecting creditors' rights generally, (ii) the remedy of
specific performance and injunctive relief are subject to certain equitable
defenses and to the discretion of the court before which any proceedings may be
brought and (iii) rights to indemnification may be limited under applicable
securities laws.
2.2 Existence and Good Standing of the Company. The Company is a
corporation duly organized, validly existing and in good standing under the laws
of the State of California with all requisite corporate power and authority to
own, lease and operate its properties and to carry on its business as now being
conducted. The Company does not have any subsidiaries. The
-1-
<PAGE> 2
Company is duly qualified or licensed as a foreign corporation and in good
standing in each jurisdiction in which the character or location of the property
owned, leased or operated by it or the nature of the business conducted by it
makes such qualification necessary, except where the failure to be so duly
qualified or licensed would not have a material adverse effect on the business,
financial condition, results of operations or prospects of the Company. Schedule
2.2 sets forth is a list of jurisdictions in which the Company is qualified or
licensed to do business as a foreign corporation.
2.3 Capital Stock of the Company. (a) The Company's authorized capital
stock consists of 1,250,000 shares of common stock, of no par value, of which
1,000,000 shares will be issued and outstanding (following the transactions
contemplated by the amendments to the Articles of Incorporation attached as
Annex I to this Agreement). No other shares of capital stock are issued or
outstanding. All of the Company Shares have been validly issued and are fully
paid and nonassessable and no holder thereof is entitled to any preemptive
rights. There are no outstanding conversion or exchange rights, subscriptions,
options, warrants or other arrangements or commitments obligating the Company to
issue any shares of capital stock or other securities except as set forth on
Schedule 2.3.
(b) As of the Closing (following the transactions contemplated by the
amendments to the Articles of Incorporation attached as Annex I to this
Agreement), David Lane, Jonathan Lane, Arthur and Diana Lane, and Utara Capital
(i) will own of record and beneficially and have good and marketable title to
105,000, 105,000, 90,000 and 700,000 of the Company Shares, respectively, free
and clear of any and all liens, mortgages, security interests, encumbrances,
pledges, charges, adverse claims, options, rights or restrictions of any
character whatsoever (collectively, "Liens"), and (ii) has the right to vote the
Company Shares on any matters as to which any shares of the Company common stock
are entitled to be voted under the laws of the State of California and the
Company's articles of incorporation and bylaws, free of any right of any other
person.
2.4 Company Authorization. The Company has full corporate power,
capacity and authority to execute this Agreement and all other agreements and
documents contemplated hereby. The execution and delivery of this Agreement and
such other agreements and documents by the Company and the consummation by the
Company of the transactions contemplated hereby have been duly authorized by the
Company and no other corporate action on the part of the Company is necessary to
authorize the transactions contemplated hereby. This Agreement has been duly
executed and delivered by the Company and constitutes the valid and binding
obligation of the Company, enforceable in accordance with its terms, except that
(i) enforcement may be subject to bankruptcy, insolvency, reorganization,
moratorium or similar laws affecting creditors' rights generally, (ii) remedies
of specific performance and injunctive relief are subject to certain equitable
defenses and to the discretion of the court before which any proceedings may be
brought, and (iii) rights to indemnification may be limited under applicable
securities laws.
2.5 Financial Statements. (a) Sellers have previously furnished to
Buyer the audited balance sheet of the Company as of September 30, 1998 and the
related statements of operations, shareholders' equity and cash flows for the
two fiscal years then ended, together with the report thereon by Gursey,
Schneider & Co. LLP, independent public accountants, and the footnotes thereto
(the "Prior Years Financials"). The Prior Years Financials present fairly the
financial position and results of operations of the Company as of the indicated
dates and for the indicated periods and have been prepared in accordance with
GAAP consistently applied. The Company shall permit Buyer full access to the
work papers pertaining to the Prior Years Financials, including those work
papers in the possession of or prepared by Gursey, Schneider & Co. LLP.
(b) Except to the extent (and not in excess of amounts) reflected in
the September 30, 1998 balance sheet included in the Prior Years Financials or
as disclosed on Schedule 2.5, the Company has no liabilities or obligations
(including, without limitation, taxes payable and deferred taxes and interest
accrued since September 30, 1998) required to be reflected in the Prior Years
Financials (or notes thereto) in accordance with GAAP other than current
liabilities incurred in the ordinary course of business, consistent with past
practice, subsequent to September 30, 1998.
2.6 Tax Matters. The Company has filed all income tax returns required
to be filed by it and all returns of other Taxes (defined below) required to be
filed and has paid or provided for all Taxes shown to be due on returns. No
action or proceeding for the assessment or collection of any Taxes is pending
against the Company; (ii) no deficiency, assessment or other formal claim for
any Taxes has been asserted or made against the Company that has not been fully
paid or finally settled; and (iii) no issue has been formally raised by any
taxing authority in connection with an audit or examination of any return of
Taxes. No federal or state income tax returns of the Company have been examined,
and there are no outstanding agreements or waivers extending the applicable
statutory periods of limitation for such Taxes for any period. All Taxes that
the Company has been required to collect or withhold have been duly withheld or
collected and, to the extent required, have been paid to the proper taxing
authority. No Taxes will be assessed on or after the Closing Date against the
Company for any tax period ending on or prior to the Closing Date, or for any
period ending after the Closing Date with respect to any portion of such tax
period that includes or is prior to the Closing Date. "Taxes" means taxes,
charges, fees, levies or assessments including, without limitation, income,
excise,
-2-
<PAGE> 3
property, withholding, sales and franchise taxes, imposed by federal, state,
county, local or foreign government or subdivision or agency thereof, and
including any interest, penalties or additions.
2.7 Assets and Properties.
(a) Real Property. The Company does not own any real property.
(b) Personal Property. Except as set forth on Schedule 2.7 and except
for inventory and supplies disposed of or consumed, and accounts receivable
collected or written off, and cash utilized, all in the ordinary course of
business consistent with past practice, the Company owns all of its inventory,
equipment and other personal property (both tangible and intangible) reflected
on the latest balance sheet included in the Prior Years Financials or acquired
since September 30, 1998, free and clear of any Liens, except for statutory
Liens for current taxes, assessments or governmental charges or levies on
property not yet due and payable.
(c) Condition of Properties. Except as set forth on Schedule 2.7, the
leasehold estates the subject of the Real Property Leases (defined below) and
the tangible personal property owned or leased by the Company are in good
operating condition and repair, ordinary wear and tear excepted; and none of the
Company or Sellers has any knowledge of any condition or defect, not disclosed
herein, of any such leasehold estate that would materially affect the fair
market value, use or operation of the leasehold estate or otherwise have a
material adverse effect on the Company or its business or operations.
(d) Compliance. To the knowledge of the Company and Sellers, the
continued ownership, operation, use and occupancy of the leasehold estates the
subject of the Real Property Leases as currently operated, used and occupied
will not violate any zoning, building, health, flood control, fire or other law,
ordinance, order or regulation or any restrictive covenant. To the knowledge of
the Company and Sellers, there are no violations of any federal, state, county
or municipal law, ordinance, order, regulation or requirement affecting any
portion of the leasehold estates and no written notice of any such violation has
been issued by any governmental authority.
2.8 Real Property Leases; Options. Schedule 2.8 sets forth a list of
(i) all leases and subleases under which the Company is lessor or lessee or
sublessor or sublessee of any real property, together with all amendments,
supplements, nondisturbance agreements, brokerage and commission agreements and
other agreements pertaining thereto ("Real Property Leases"); (ii) all material
options held by the Company or contractual obligations on the part of the
Company to purchase or acquire any interest in real property; and (iii) all
options granted by the Company or contractual obligations on the part of the
Company to sell or dispose of any material interest in real property. Copies of
all Real Property Leases and such options and contractual obligations have been
delivered to Buyer. The Company has not assigned any Real Property Lease or such
options or obligations. There are no Liens on the Company's interest in the Real
Property Leases, subject only to (i) Liens for taxes and assessments not yet due
and payable and (ii) matters set forth on Schedule 2.8. The Real Property Leases
and options and contractual obligations listed on Schedule 2.8 are in full force
and effect and constitute binding obligations of the Company and the other
parties thereto, and (x) there are no defaults thereunder and (y) no event has
occurred that with notice, lapse of time or both would constitute a default by
the Company or, to the best knowledge of the Company and Sellers, by any other
party.
2.9 Environmental Laws and Regulations.
(a)(i) The ownership and operations of the "Subject Property" and any
use, storage, treatment, disposal, or transportation of "Hazardous Substances"
that has occurred in or on the Subject Property prior to the date of this
Agreement have been in compliance with "Environmental Requirements"; (ii) during
the ownership, occupancy and operation of the Subject Property by the Company,
or, to the best knowledge of the Company and Sellers, prior to its ownership,
occupancy or operation, no release, leak, discharge, spill, disposal or emission
of Hazardous Substances has occurred in, on or under the Subject Property in a
quantity or manner that violates or requires further investigation or
remediation under Environmental Requirements; (iii) the Subject Property is free
of Hazardous Substances as of the date of this Agreement, except for the
presence of small quantities of Hazardous Substances utilized by the Company or
other tenants of the Subject Property in the ordinary course of their business;
(iv) there is no pending or threatened litigation or administrative
investigation or proceeding concerning the Subject Property involving Hazardous
Substances or Environmental Requirements; (v) there is no ACM (as defined
below), within the Subject Property, whether friable or non-friable, and there
are no above-ground or underground storage tank systems located at the Subject
Property; and (vi) the Company has never owned, operated, or leased any real
property other than the Subject Property. As used in this Agreement, the
following terms shall have the following meanings: "Environmental Requirements"
means all laws, statutes, rules, regulations, ordinances, guidance documents,
judgments, decrees, orders, agreements and other restrictions and requirements
(whether now or hereafter in effect) of any governmental authority, including,
without limitation, federal, state and local
-3-
<PAGE> 4
authorities, relating to the regulation or protection of human health and
safety, natural resources, conservation, the environment, or the storage,
treatment, disposal, transportation, handling or other management of industrial
or solid waste, hazardous waste, hazardous or toxic substances or chemicals, or
pollutants. "Hazardous Substance" means (i) any "hazardous substance" as defined
in Section 101(14) of the Comprehensive Environmental Response, Compensation,
and Liability Act of 1980, as amended from time to time (42 U.S.C. Sections 9601
et seq.)("CERCLA") or any regulations promulgated thereunder; (ii) petroleum and
petroleum by-products; (iii) asbestos or asbestos-containing material ("ACM");
or (iv) any additional substances or materials that have been or are currently
classified or considered to be pollutants, hazardous or toxic under
Environmental Requirements. "Subject Property" means all property subject to the
Real Property Leases.
2.10 Contracts. Schedule 2.10 sets forth a list of all material
contracts, arrangements and commitments (whether oral or written) to which the
Company is a party or by which the Company's assets or business are bound
including, without limitation, contracts, arrangements or commitments that
relate to (i) the sale, lease or other disposition by the Company of all or any
substantial part of the business or assets of the Company (otherwise than in the
ordinary course of business), (ii) the purchase or lease by the Company of a
substantial amount of assets (otherwise than in the ordinary course of
business), (iii) the supply by the Company of any customer's requirements for
any item or the purchase by the Company of its requirements for any item or of a
vendor's output of any item, (iv) lending or advancing funds by the Company, (v)
borrowing of funds or guarantying the borrowing of funds by any other person,
whether under an indenture, note, loan agreement or otherwise, (vi) any
transaction or matter with any Affiliate of the Company, (vii) noncompetition or
employment, (viii) licenses and grants to or from the Company relating to any
intangible property listed on Schedule 2.16, (ix) the acquisition by the Company
of any operating business or the capital stock of any person since September 30,
1998, or (x) any other matter that is material to the business, assets or
operations of the Company ("Contracts"). Except as set forth in Schedule 2.10,
each Contract is in full force and effect on the date hereof, the Company is not
in default under any Contract, the Company has not given or received notice of
any default under any Contract, and, to the knowledge of the Company and
Sellers, no other party to any Contract is in default thereunder.
2.11 No Violations. The execution, delivery and performance of this
Agreement and the other agreements and documents contemplated hereby by the
Company and Sellers and the consummation of the transactions contemplated hereby
will not (i) violate any provision of the articles of incorporation or bylaws of
the Company, (ii) violate any statute, rule, regulation, order or decree of any
public body or authority by which the Company or a Seller or its respective
properties or assets are bound, or (iii) result in a violation or breach of, or
constitute a default under, or result in the creation of any encumbrance upon,
or create any rights of termination, cancellation or acceleration in any person
with respect to any Contract or any material license, franchise or permit of the
Company or any other agreement, contract, indenture, mortgage or instrument to
which the Company is a party or by which any of its properties or assets is
bound.
2.12 Consents. Except as set forth on Schedule 2.12, no consent,
approval or other authorization of any governmental authority or under any
Contract or other material agreement or commitment to which the Company or a
Seller is a party or by which its respective assets are bound is required as a
result of or in connection with the execution or delivery of this Agreement and
the other agreements and documents to be executed by the Company and Sellers or
the consummation by the Company and Sellers of the transactions contemplated
hereby.
2.13 Litigation and Related Matters. Set forth on Schedule 2.13 is a
list of all actions, suits, proceedings, investigations or grievances pending
against the Company or, to the best knowledge of the Company and Sellers,
threatened against the Company, the Company's business or any property or rights
of the Company, at law or in equity, before or by any court or federal, state,
municipal or other governmental department, commission, board, bureau, agency or
instrumentality, domestic or foreign ("Agencies"). None of the actions, suits,
proceedings or investigations listed on Schedule 2.13 either (i) results or
would, if adversely determined, result in any material adverse change in the
business, operations or assets or the condition, financial or otherwise, or
results of operations or prospects of the Company or (ii) affects or would, if
adversely determined, affect the right or ability of the Company to carry on its
business substantially as now conducted. The Company is not subject to any
continuing court or Agency order, writ, injunction or decree applicable
specifically to the business, operations or assets of the Company or employees
of the Company, nor in default with respect to any order, writ, injunction or
decree of any court or Agency with respect to its assets, business, operations
or employees. Schedule 2.13 lists (x) all worker's compensation claims
outstanding against the Company as of the date hereof and (y) all actions, suits
or proceedings filed by or against the Company since September 30, 1998.
2.14 Product Liability and Warranty Proceedings. No product liability
or warranty actions, suits or proceedings arising from the manufacture or sale
of goods by the Company have been asserted against the Company since September
30, 1998, except as set forth in Schedule 2.14.
-4-
<PAGE> 5
2.15 Compliance with Laws. The Company (a) is in compliance with all
applicable laws, regulations (including federal, state and local procurement
regulations), orders, judgments and decrees except where the failure to so
comply would not have a material adverse effect on the business, prospects,
financial condition or results of operation or prospects of the Company and (b)
possesses all necessary licenses, franchises, permits and governmental
authorizations to conduct its business in the manner in which and in the
jurisdictions and places where such business is now conducted. Set forth on
Schedule 2.15 is a list of all material licenses, franchises, permits and
governmental authorizations and all applications pending before any agency or
authority for the issuance of any licenses, franchises, permits or governmental
authorizations or the renewal thereof.
2.16 Patents, Trademarks, Etc. Schedule 2.16 lists the patents, patent
applications and licenses, software licenses, trade names, trademarks, service
marks, trademark registrations and applications, service mark registrations and
applications, and copyright registrations and applications owned by the Company
or used in the operation of the business of the Company (collectively, the
"Intellectual Property"), which Schedule indicates (i) the term and exclusivity
of its rights with respect to the Intellectual Property and (ii) whether each
item of Intellectual Property is owned or licensed by the Company, and if
licensed, the licensor and the license fees therefor. Unless otherwise indicated
in Schedule 2.16, the Company has the right to use and license the Intellectual
Property, and the consummation of the transactions contemplated hereby will not
result in the loss or material impairment of any rights of the Company in the
Intellectual Property. Each item constituting part of the Intellectual Property
has been, to the extent indicated in Schedule 2.16, registered with, filed in or
issued by, as the case may be, the United States Patent and Trademark Office or
such other government entity, domestic or foreign, as is indicated in Schedule
2.16; all such registrations, filings and issuances remain in full force and
effect; and all fees and other charges with respect thereto are current. There
are no pending proceedings or adverse claims made or, to the best knowledge of
the Company and Sellers, threatened against the Company with respect to the
Intellectual Property; there has been no litigation commenced or threatened in
writing within the past five (5) years with respect to the Intellectual Property
or the rights of the Company therein; and the Company and Sellers have no
knowledge that (i) the Intellectual Property or the use thereof by the Company
conflicts with any patents, patent applications, patent licenses, trade names,
trademarks, service marks, trademark or service mark registrations or
applications or copyright registrations or applications of others ("Third Party
Intellectual Property"), or (ii) such Third Party Intellectual Property or its
use by others or any other conduct of a third party conflicts with or infringes
upon the Intellectual Property or its use by the Company.
2.17 Employee Benefit Plans. The Company does not have any employee
benefit plan within the meaning of Section 3(3) of the Employee Retirement
Income Security Act of 1974, as amended ("ERISA"), maintained or contributed to
by the Company or any of its Group Members (defined below) (collectively, the
"Plans"). Neither the execution and delivery of this Agreement by the Company or
the consummation of the transactions contemplated hereby will (i) entitle any
current or former employee of the Company to severance pay, unemployment
compensation or any similar payment, (ii) accelerate the time of payment or
vesting, or increase the amount of, any compensation due to any such employee or
former employee, or (iii) directly or indirectly result in any payment made or
to be made to or on behalf of any person to constitute a "parachute payment"
(within the meaning of Section 280G of the Code). For purposes of this
Agreement, "Group Member" shall mean any member of any "affiliated service
group" as defined in Section 414(m) of the Code that includes the Company, any
member of any "controlled group of corporations" as defined in Section 1563 of
the Code that includes the Company, or any member of any group of "trades or
businesses under common control" as defined by Section 414(c) of the Code that
includes the Company.
2.18 Employees; Employee Relations. (a) Schedule 2.18 sets forth (i)
the name and current annual salary and other compensation (including, without
limitation, bonus, profit-sharing and other compensation) payable by the Company
to each employee whose current total annual compensation or estimated
compensation is $50,000 or more, (ii) any increase to become effective after the
date of this Agreement in the total compensation payable by the Company to each
such person, (iii) any increase to become payable after the date of this
Agreement by the Company to employees other than those specified in clause (i)
of this Section 2.18(a), (iv) all presently outstanding loans and advances
(other than routine travel advances to be repaid or formally accounted for
within sixty (60) days) made by the Company to, or made to the Company by, any
director, officer or employee, (v) all other transactions between the Company
and any director, officer or employee of the Company since September 30, 1998,
and (vi) all accrued but unpaid vacation pay owing to any officer or employee
that is not disclosed on the Prior Years Financials. (a) The Company is not a
party to nor bound by the terms of any collective bargaining agreement and the
Company has not experienced any material labor difficulties during the last five
years. Except as set forth on Schedule 2.18, there are no labor disputes
existing, or to the best knowledge of the Company and Sellers, threatened
involving, by way of example, strikes, work stoppages, slowdowns, picketing, or
any other interference with work or production, or any other concerted action by
employees. No charges or proceedings before the National Labor Relations Board,
or similar agency, exist, or to the best knowledge of the Company and Sellers,
are threatened. (b) The Company's relationship with its employees is good and
the Company and Sellers have no knowledge of any facts that would indicate that
the Company's employees will not continue in its employ following the Closing on
a basis similar to that existing on the date of this Agreement. Except as
disclosed on Schedule 2.18, the Company is not a party to any employment
contract with any individual or employee, either express or implied. No legal
proceedings, charges,
-5-
<PAGE> 6
complaints, or similar actions exist under any federal, state or local laws or
regulations affecting the employment relationship; and to the best knowledge of
the Company and Sellers, no proceedings, charges, or complaints are threatened
under any such laws or regulations and no facts or circumstances exist that
would give rise to any such proceedings, charges, complaints, or claims, whether
valid or not. The Company is not subject to any settlement or consent decree
with any present or former employee, employee representative or any government
or Agency relating to claims of discrimination or other claims in respect to
employment practices and policies; and no government or Agency has issued a
judgment, order, decree or finding with respect to the labor and employment
practices (including practices relating to discrimination) of the Company. (c)
Since September 30, 1998, the Company has not incurred any liability or
obligation under the Worker Adjustment and Retraining Notification Act or
similar state laws. The Company has not laid off more than ten percent (10%) of
its employees at any single site of employment in any ninety (90) day period
during the twelve (12) month period ending September 30, 1998. It shall be the
obligation of the Company and Sellers to provide any notice required by said Act
by reason of the provisions, execution or operation of this Agreement. (d) The
Company and Sellers are in full compliance with the provisions of the Americans
with Disabilities Act (the "ADA").
2.19 Insurance. Schedule 2.19 contains a list of the policies and
contracts (including insurer, named insured, type of coverage, limits of
insurance, required deductibles or co-payments, annual premiums and expiration
date) for fire, casualty, liability and other forms of insurance maintained by,
or for the benefit of, the Company. All such policies are in full force and
effect and are adequate for the business in which the Company engages. Neither
the Company nor either Seller has received any notice of cancellation or
non-renewal or of significant premium increases with respect to any such policy.
No pending claims made by or on behalf of the Company under such policies have
been denied or are being defended against third parties under a reservation of
rights by an insurer of the Company. All premiums due prior to the date hereof
for periods prior to the date hereof with respect to such policies have been
timely paid, and all premiums due before the Closing Date for periods between
the date hereof and the Closing Date will be timely paid.
2.20 Accounts Receivable. The accounts receivable set forth in the
Prior Years Financials and those accounts receivable accruing through the
Closing Date represent valid and bona fide sales to third parties incurred in
the ordinary course of business, collectible in accordance with their terms,
subject to no defenses, set-offs or counterclaims, except to the extent of any
reserves for doubtful accounts reflected in the September 30, 1998 balance sheet
included in the Prior Years Financials.
2.21 Interests in Customers, Suppliers, Etc. No shareholder, officer,
director or Affiliate of the Company possesses, directly or indirectly, any
financial interest in, or is a director, officer, employee or Affiliate of, any
corporation, firm, association or business organization that is a client,
supplier, customer, lessor, lessee or competitor of the Company. Ownership of
securities of a corporation whose securities are registered under the 1934 Act
not in excess of five percent (5%) of any class of such securities shall not be
deemed to be a financial interest for purposes of this Section 2.21.
2.22 Business Relations. Schedule 2.22 contains an accurate list of all
significant customers of the Company (i.e., those customers representing 5% or
more of the Company's revenues for the 12 months ended September 30, 1998 or who
have paid to the Company $50,000 or more over any four consecutive fiscal
quarters in the two years ended September 30, 1998). Except as set forth in
Schedule 2.22, to the best knowledge of the Company and Sellers, no customer or
supplier of the Company will cease to do business with the Company after the
consummation of the transactions contemplated hereby, which cessation would have
a material adverse effect on the business, operations or financial condition of
the Company. Except as set forth in Schedule 2.22, since September 30, 1998, the
Company has not experienced any difficulties in obtaining any inventory items
necessary to the operation of its business, and, to the best knowledge of the
Company and Sellers, no such shortage of supply of inventory items is threatened
or pending. The Company is not required to provide any bonding or other
financial security arrangements in any material amount in connection with any
transactions with any of its customers or suppliers.
2.23 Officers and Directors. Schedule 2.23 sets forth a list of
officers and directors of the Company.
2.24 Bank Accounts and Powers of Attorney. Schedule 2.24 sets forth
each bank, savings institution and other financial institution with which the
Company has an account or safe deposit box and the names of all persons
authorized to draw thereon or to have access thereto. Each person holding a
power of attorney or similar grant of authority on behalf of the Company is
identified on Schedule 2.24. Except as disclosed on such Schedule, the Company
has not given any revocable or irrevocable powers of attorney to any person,
firm, corporation or organization relating to its business for any purpose
whatsoever.
2.25 Accuracy of Information Furnished. Any information furnished to
Buyer by the Company or Sellers prior to, at or after the date of this
Agreement, in the Schedules hereto, or otherwise is, or when furnished will be,
true and correct in all material respects. Such information states, or when
furnished will state, all material facts required to be stated therein or
necessary
-6-
<PAGE> 7
to make the statements therein, in light of the circumstances under which the
statements are made, not misleading.
2.26 Availability of Documents. The Company has made available for
inspection by Buyer and its representatives true, correct, and complete copies
of the articles of incorporation and bylaws of the Company, all written
agreements, arrangements, commitments, and documents referred to in the
Schedules attached hereto, and the corporate minute books of the Company. Such
corporate minute books contain the minutes of all of the meetings of
shareholders, board of directors, and any committees of the Company that have
been held preceding the date hereof and all written consents to action executed
in lieu thereof.
2.27 Brokerage, Financial Advisor or Finder Fees. No agent, advisor,
broker, person or firm acting on behalf of the Company or Sellers is, or will
be, entitled to any commission or broker's, advisor's or finder's fees from any
of the parties hereto, or from any of their respective Affiliates in connection
with any of the transactions contemplated hereby.
2.28 Absence of Certain Changes or Events. Except as set forth in
Schedule 2.28 or as otherwise contemplated by this Agreement, since September
30, 1998, there has not been (a) any damage, destruction or casualty loss to the
physical properties of the Company (whether or not covered by insurance),
materially and adversely affecting the business, operations, prospects or
financial condition of the Company, (b) any material adverse change in the
business, operations, financial condition or results of operations or prospects
of the Company, (c) any entry into any transaction, commitment or agreement
(including, without limitation, any borrowing) material to the Company, except
transactions, commitments or agreements in the ordinary course of business
consistent with past practice, and which, if occurring after the date hereof,
would be in compliance with Section 4.1, (d) any declaration, setting aside or
payment of any dividend or other distribution in cash, stock or property with
respect to the Company's capital stock or other securities, any repurchase,
redemption or other acquisition by the Company of any capital stock or other
securities, or any agreement, arrangement or commitment by the Company to do so,
(e) any increase that is material in the compensation payable or to become
payable by the Company to its directors, officers, employee or agents or any
increase in the rate or terms of any bonus, or other employee benefit plan,
payment or arrangement made to, for or with any such directors, officers,
employees or agents, (f) any sale, transfer or other disposition of, or the
creation of any Lien upon, any part of the Company's assets, tangible or
intangible, except for sales of inventory and use of supplies and collections of
accounts receivables in the ordinary course of business consistent with past
practice, or any cancellation or forgiveness of any debts or claims by the
Company, (g) any change in the relations of the Company with or loss of its
customers or suppliers, of any loss of business or increase in the cost of
inventory items or change in the terms offered to customers, which would
materially and adversely affect the business, operations or financial condition
of the Company, or (i) any capital expenditure (including any capital leases) or
commitment therefor by the Company in excess of $50,000.
ARTICLE III
REPRESENTATIONS AND WARRANTIES OF BUYER
Buyer represents and warrants to Sellers as follows:
3.1 Organization and Authorization. Buyer is a corporation duly
organized, validly existing and in good standing under the laws of the State of
Delaware with all requisite corporate power and authority to own, lease and
operate its properties and to carry on its business as now being conducted.
Buyer has all requisite corporate power, capacity and authority to execute and
deliver this Agreement and all other agreements and documents contemplated
hereby. The execution and delivery of this Agreement and such other agreements
and documents by Buyer and the consummation by Buyer of the transactions
contemplated hereby have been duly authorized by Buyer and no other corporate
action on the part of Buyer is necessary to authorize the transactions
contemplated hereby. This Agreement has been duly executed and delivered by
Buyer and constitutes the valid and binding obligation of Buyer, enforceable in
accordance with its terms except (i) such enforcement may be subject to
bankruptcy, insolvency, reorganization, moratorium or similar laws affecting
creditors' rights generally, (ii) the remedy of specific performance and
injunctive relief are subject to certain equitable defenses and to the
discretion of the court before which any proceedings may be brought, and (iii)
rights to indemnification may be limited under applicable securities laws.
3.2 No Violations. The execution and delivery of this Agreement and
other agreements and documents contemplated hereby by Buyer and the consummation
of the transactions contemplated hereby will not (a) violate any provision of
the certificate of incorporation or bylaws of Buyer, (b) violate any statute,
rule, regulation, order or decree of any public body or authority by which Buyer
or its properties or assets are bound, or (c) result in a violation or breach
of, or constitute a default under or result in the creation of any encumbrance
upon, or create any rights of termination, cancellation or acceleration in any
person with respect to any agreement, contract, indenture, mortgage or
instrument to which Buyer is a party or any of its properties or assets is
bound.
-7-
<PAGE> 8
3.3 Consents. No consent, approval or other authorization of any
governmental authority or third party is required as a result of or in
connection with the execution and delivery of this Agreement and the other
agreements and documents to be executed by Buyer or the consummation by Buyer of
the transactions contemplated hereby.
3.4 Brokerage, Financial Advisor or Finder Fees. No agent, advisor,
broker, person or firm acting on behalf of Buyer is, or will be, entitled to any
commission or broker's, advisor's or finder's fees from any of the parties
hereto, or from any of their respective Affiliates, in connection with any of
the transactions contemplated hereby.
ARTICLE IV
COVENANTS OF THE PARTIES
4.1 Course of Conduct by the Company. From the date hereof through the
Closing Date, except as approved in writing by Buyer or as permitted or
contemplated by this Agreement, the Company's business shall be conducted in the
ordinary course of business consistent with past practice, and Sellers shall
cause the Company to comply with the following covenants:
(a) Capital Expenditures. The Company shall not make capital
expenditures or commitments which, when combined with capital expenditures or
commitments after September 30, 1998, would exceed $50,000.
(b) Organizational Documents. The Company shall not make any change in
its articles or bylaws, other than to file and have declared effective an
amendment to its Articles of Incorporation in substantially the form attached to
this Agreement as Annex I with the California Secretary of State.
(c) Stock Issuance; Redemptions; Reorganizations. The Company shall not
(i) issue, grant or dispose of, or make any agreement, arrangement or commitment
obligating the Company to issue, grant or dispose of any capital shares or other
securities of the Company, (ii) redeem or acquire, or make any agreement,
arrangement or commitment obligating the Company to redeem or acquire, any
shares of capital stock or other securities of the Company, or (iii) authorize
or effect or make any agreement, arrangement or commitment obligating the
Company to effect, any reorganization, recapitalization or split-up of such
capital stock of the Company (other than as contemplated by the amendments to
the Company's Articles of Incorporation in substantially the form attached as
Annex I to this Agreement).
(d) Employee Matters. The Company shall not (i) make any material
increase in the compensation payable or to become payable to any of the
officers, employees, or agents of the Company, or (ii) make, amend or enter into
any employment contract or any bonus, incentive, stock option, profit sharing,
pension, retirement, stock purchase, hospitalization, medical reimbursement,
insurance, severance benefit or other similar plan or arrangement or make any
voluntary contribution to any such plan or arrangement.
(e) Insurance Coverage. The Company shall maintain insurance coverage
for the benefit of the Company on the same basis as, or on a substantially
equivalent basis to, the current insurance coverage.
(f) Business Organization. The Company shall use commercially
reasonable efforts to preserve intact its business organization and to keep
available the services of its present officers and employees as a group.
(g) Maintenance of Property. The Company shall maintain its property,
equipment and other tangible personal property in its present operating
condition and repair, ordinary wear and tear excepted. The Company will fully
perform and pay for all maintenance, painting, repairs, alterations and other
work required to be performed by the Company as lessee under the Real Property
Leases listed on Schedule 2.8.
(h) Relations with Suppliers, Customers, Etc. The Company will use
commercially reasonable efforts to preserve its relationships with its material
customers and others having material business dealings with it and shall not
change or modify or commit to change or modify any terms offered to customers.
The Company promptly shall notify Buyer if the Company is informed by any of its
customers or suppliers that such customer or supplier will or may cease to do
business with the Company either prior to or following the Closing.
(i) Incurrence of Debt. The Company will not voluntarily incur or
assume, whether directly or by way of guaranty or otherwise, any material
obligation or liability, except obligations and liabilities incurred in the
ordinary course of business, consistent with past practice.
-8-
<PAGE> 9
(j) Liens. The Company will not mortgage, pledge, encumber, create or
allow any Liens not existing on the date hereof upon any of its properties or
assets, tangible or intangible, except Liens created in the ordinary course of
business, consistent with past practice.
(k) Disposition of Assets. The Company will not sell, transfer or
otherwise dispose of any of its tangible or intangible property or assets,
except for inventory and supplies sold, disposed of or consumed and accounts
receivable collected or written off in the ordinary course of business,
consistent with past practice. The Company will not cancel or forgive any debts
or claims except or in the ordinary course of business, consistent with past
practice.
(l) Agreements, Leases and Licenses. The Company will not amend,
terminate, or allow to lapse any material agreement, lease, license or permit to
which it is a party or of which it is the holder.
(m) Accounting Practices. The Company will not make any material
changes in its accounting methods, principles or practices, except as required
by GAAP.
(n) Changes in Business Practice. The Company will not take any action,
the purpose or effect of which is to shift income from post-closing periods to
the pre-closing period or defer expenses from the pre-closing period to
post-closing periods, which action is not in the ordinary course of business,
consistent with past practice.
(o) Transactions with Affiliates. The Company will not enter into any
agreement, arrangement or transaction with, or make any payment, distribution,
loan or advance to, any Affiliate of the Company or any officer, director or
shareholder of the Company, except for salaries and travel advances consistent
with past practices or as otherwise specifically permitted by this Agreement.
(p) Material Transactions. The Company will not enter into any other
agreement, course of action or transaction material to it, except in the
ordinary course of business, consistent with past practice.
4.2 Approvals and Consents. The Company and Sellers shall use their
respective best efforts (i) to cause all conditions to the obligations of Buyer
under this Agreement over which they are able to exercise influence or control
to be satisfied prior to the Closing Date and (ii) to obtain promptly and to
comply with all requisite statutory, regulatory or court approvals, third party
releases and consents, and other requirements necessary for the valid and legal
consummation of the transactions contemplated hereby.
4.3 Investigations. The Company shall provide Buyer and its
representatives and agents such access to the books and records of the Company
and furnish to Buyer such financial and operating data and other information
with respect to the businesses and property of the Company as it may reasonably
request from time to time, and permit Buyer and its respective representatives
and agents to make such inspections of the Company's real and personal
properties as they may reasonably request. Sellers shall promptly arrange for
Buyer and its representatives and agents to meet with such directors, officers,
employees and agents of the Company as requested.
4.4 Records Pertaining to the Company. At the Closing, Sellers will
deliver or cause to be delivered to the Company any records (i) in the
possession of Sellers, (ii) applicable primarily to the Company, and (iii) of
which the Company does not already have copies. Sellers shall, for a period of
seven years (except in the case of any sales invoices, which shall be for three
years) after the Closing Date, neither dispose of nor destroy any of the
business records or files of Sellers that pertain in part to the Company without
first offering to turn over possession of copies thereof to the Company at the
Company's expense, by written notice to the Company, at least thirty (30) days
prior to the proposed date of such disposition or destruction. Sellers shall
allow the Company and its representatives access to all business records and
files of Sellers that pertain in part to the Company, during normal working
hours at the principal place of business of Sellers, or at any location where
such records are stored, and the Company shall have the right, at its own
expense, to make copies of any such records and files. From and after the
Closing Date, Sellers shall make available to Buyer, upon written request, (i)
personnel of Sellers to assist Buyer in locating and obtaining records and files
maintained by Sellers, and (ii) any of the personnel of Sellers, whose
assistance or participation is reasonably required by Buyer in anticipation of,
or preparation for, any existing or future third party actions, Tax or other
matters in which the Company or any of its past, present or future Affiliates is
involved and which relate to the business of the Company. Sellers shall use
their respective best efforts (including, without limitation, furnishing any
certificates reasonably requested, and complying with other reasonable requests
as a prerequisite to availability) to cause Gursey, Schneider & Co. LLP , and
any other independent
-9-
<PAGE> 10
accounting firm that has reviewed or prepared a report on any financial
statements of the Company or any consolidated financial statements of Gursey,
Schneider & Co. LLP for any consolidated group which included the Company with
respect to any financial accounting period commencing on or after Gursey,
Schneider & Co. LLP to make available to Buyer for inspection and copying, at
Buyer's expense and upon its written request therefor, such accounting firm's
work papers with respect to any such financial statements and shall take all
such actions as required by any such accounting firm in connection with such
request.
4.5 Tax Elections. No new elections with respect to Taxes or any
changes in current elections with respect to Taxes affecting the Company shall
be made after the date of this Agreement without prior written consent of Buyer.
4.6 No Solicitation. Except with respect to Buyer and its Affiliates,
after the date hereof, Sellers shall not, and Sellers shall cause the Company
and the respective officers, directors, employees, agents and representatives of
Sellers and the Company (including, without limitation, any investment banker,
attorney or accountant retained by any of them) not to (i) initiate or solicit,
directly or indirectly, any inquiries or the making of any proposal with respect
to a merger, consolidation, sale of shares of capital stock or similar
transaction involving, or any purchase of all or any significant portion of the
assets (other than in the ordinary course of business) of, or any equity
interest in, the Company (an "Acquisition Transaction"), or (ii) engage in any
negotiations concerning, or provide to any other person any information or data
relating to the Company for the purposes of or have any discussions with any
person relating to, or otherwise cooperate in any way with, or assist or
participate in, facilitate or encourage any effort or attempt by any other
person to seek or effect, an Acquisition Transaction. Sellers shall promptly
advise Buyer of, and communicate to Buyer the terms of, any such inquiry or
proposal the Company or Sellers may receive.
4.7 Public Announcements. Prior to the Closing, no party shall make any
press release or public announcement with respect to the transactions
contemplated by this Agreement without the prior written consent of the Buyer
and the Company, which consent shall not be unreasonably withheld.
ARTICLE V
CONDITIONS TO OBLIGATIONS OF BUYER
The obligation of Buyer to purchase the Company Shares, and to cause
the transactions contemplated hereby to occur at Closing, shall be subject to
the satisfaction of each of the following conditions at or prior to Closing:
5.1 Representations and Warranties. Each representation and warranty of
the Company and Sellers contained in this Agreement and in any Schedule or other
disclosure in writing from the Company or Sellers shall be true and correct when
made, and shall be true and correct in all material respects on and as of the
Closing Date with the same effect as though such representation and warranty had
been made on and as of the Closing Date.
5.2 Covenants of Sellers and Company. All of the covenants and
agreements herein on the part of Sellers and the Company to be complied with or
performed on or before the Closing Date shall have been fully complied with and
performed.
5.3 Certificate of the Company and Sellers. There shall be delivered to
Buyer a certificate dated the Closing Date and signed by the President of the
Company and each Seller to the effect set forth in Sections 5.1 and 5.2, which
certificate shall have the effect of a representation and warranty made by the
Company and each Seller on and as of the Closing Date.
5.4 Absence of Litigation. No inquiry, action, suit or proceeding shall
have been asserted, threatened or instituted (i) in which it is sought to
restrain or prohibit the carrying out of the transactions contemplated by this
Agreement or to challenge the validity of such transactions or any part thereof,
(ii) which could, if adversely determined, result in any material adverse change
in the business, operations or assets or the condition, financial or otherwise,
or results of operations or prospects of the Company, or (iii) which could, if
adversely determined, have a material adverse effect on the right or ability of
the Company to carry on its business as now conducted.
5.5 Consents and Approvals. All material authorizations, consents,
approvals, waivers and releases, if any, necessary for Sellers and the Company
to consummate the transactions contemplated hereby shall have been obtained and
copies thereof shall be delivered to Buyer.
5.6 Certificates. The Company and Sellers shall have delivered to Buyer
(i) certificates of the appropriate governmental authorities, dated as of a date
not more than fifteen (15) days prior to the Closing Date, attesting to the
existence and good standing of the Company in the State of California; (ii) a
copy, certified by the Secretary of State of California as of a date not more
than fifteen (15) days prior to the Closing Date, of the charter and all
amendments thereto of the Company; (iii) a copy
-10-
<PAGE> 11
certified by the Secretary of the Company, dated the Closing Date, of the bylaws
of the Company; and (iv) certificates, dated the Closing Date, of the Secretary
of the Company, relating to the incumbency and corporate proceedings in
connection with the consummation of the transactions contemplated hereby.
5.7 Estoppel Certificates. Sellers shall have delivered to Buyer duly
executed estoppel certificates in form and substance satisfactory to Buyer from
the lessors under the Real Property Leases.
5.8 No Material Adverse Change. There shall not have been any material
adverse change since September 30, 1998 in respect of the financial condition,
results of operations, business, assets or prospects of the Company and the
Company shall not have suffered any loss (whether or not insured) by reason of
physical damage caused by fire, earthquake, flood, accident or other calamity
which could have a material adverse effect on the condition, financial or
otherwise, results of operations or business, assets or prospects of the
Company.
5.9 No Transfers to Affiliates. Except as otherwise expressly
contemplated by this Agreement, the Company shall not have distributed or
transferred any of its assets or properties, or made any payments, to or for the
benefit of any of its Affiliates.
5.10 Due Diligence Review. The due diligence review of the Company
(including, without limitation, legal, financial, and operational matters) to be
conducted by or on behalf of Buyer shall have been completed in a manner
satisfactory to Buyer and shall not reveal or produce adverse facts with respect
to the Company, its premises, business, operations, financial condition or
prospects which are not otherwise disclosed in this Agreement or any Schedule
attached. No condition shall exist that was not disclosed in writing to Buyer
prior to the date hereof that would have a material adverse effect on the
business, operations, financial condition or prospects of the Company.
5.11 Nonforeign Affidavit. Sellers shall have furnished to Buyer an
affidavit, stating, under penalty of perjury, that the indicated number is the
transferor's United States taxpayer identification number and that the
transferor is not a foreign person, pursuant to Section 1445(b)(2) of the Code.
5.12 Employment Agreements. The Employees listed on Annex I shall have
executed and delivered to Buyer employment agreements in the form attached
hereto as Exhibit B (the "Employment Agreements").
5.13 Certificates. Sellers shall have tendered certificates
representing the Company Shares, duly endorsed in blank or accompanied by
appropriate stock powers, in proper form for transfer, with all transfer taxes
paid.
5.14 Resignations and Releases of Directors and Officers. Buyer shall
have received the resignations of and releases from each director and officer of
the Company, effective as of the Closing.
5.15 Amendments to Organizational Documents. The Sellers shall have
caused the Company to file and have declared effective amendments to its
Articles of Organization with the California Secretary of State in substantially
the form attached as Annex I.
ARTICLE VI
CONDITIONS TO OBLIGATIONS OF SELLERS
The obligations of Sellers to sell the Company Shares and to cause the
other transactions contemplated hereby to occur at the Closing shall be subject,
except as Sellers may waive in writing, to the satisfaction of each of the
following conditions at or prior to the Closing:
6.1 Representations and Warranties. Each representation and warranty of
Buyer contained in this Agreement and in any Schedule or other disclosure in
writing from Buyer shall be true and correct when made, and shall be true and
correct in all material respects on and as of the Closing Date with the same
effect as though such representation and warranty had been made on and as of the
Closing Date.
6.2 Covenants of Buyer. All of the covenants and agreements herein on
the part of Buyer to be complied with or performed on or before the Closing Date
shall have been fully complied with and performed.
6.3 Certificate of Buyer. Buyer shall have delivered to Sellers a
certificate dated the Closing Date and signed by the
-11-
<PAGE> 12
President or a Vice President of Buyer to the effect set forth in Sections 6.1
and 6.2, which certificate shall have the effect of a representation and
warranty made by Buyer on and as of the Closing Date.
6.4 Absence of Litigation. No inquiry, action, suit or proceeding shall
have been asserted, threatened or instituted in which it is sought to restrain
or prohibit the carrying out of the transactions contemplated by this Agreement
or to challenge the validity of such transactions or any part thereof.
6.5 Consents and Approvals. All material authorizations, consents,
approvals, waivers and releases, if any, necessary for Buyer to consummate the
transactions contemplated hereby have been delivered to Sellers.
6.6 Certificates. Buyer shall have delivered to Sellers (i) a
certificate of the appropriate governmental authority, dated as of a date not
more than fifteen (15) days prior to the Closing Date, attesting to the
existence and good standing of Buyer in the State of Delaware; (ii) copies,
certified by the Secretary of State of Delaware as of a date not more than
fifteen (15) days prior to the Closing Date, of the certificate of incorporation
and all amendments thereto of Buyer; (iii) a copy, certified by the Secretary of
Buyer, dated the Closing Date, of the bylaws of Buyer; and (iv) a certificate,
dated the Closing Date, of the Secretary of Buyer relating to the incumbency and
corporate proceedings in connection with the consummation of the transactions
contemplated hereby.
6.7 Transfer of Shares. Buyer shall have delivered to Sellers the Buyer
Shares specified in Section 7.3.
6.8 Employment Agreements. Buyer shall have executed and delivered to
the Employees listed in Annex I the Employment Agreements.
ARTICLE VII
CLOSING
7.1 Closing. Unless this Agreement is terminated as provided in Section
8.1, subject to the satisfaction or waiver of all the conditions set forth in
Articles V and VI, the closing of the transactions contemplated hereby (the
"Closing") shall take place at the offices of the Company or such other location
as agreed to by Buyer and Sellers, on (i) March 17, 1999, or (ii) such other
date as the parties may agree upon in writing (the "Closing Date").
7.2 Delivery of the Shares. At the Closing, Sellers shall deliver or
cause to be delivered to Buyer the stock certificate(s) evidencing all of the
Company Shares owned by them, duly endorsed or accompanied by duly executed
stock powers assigning the Company Shares to Buyer and otherwise in good form
for transfer.
7.3 Payments to Sellers. At the Closing, Buyer shall deliver as
designated by Sellers the Consideration.
ARTICLE VIII
TERMINATION PRIOR TO CLOSING
8.1 Termination. (a) This Agreement may be terminated and abandoned at
any time prior to the Closing: (i) by the written mutual consent of Buyer and
Sellers; (ii) by Buyer on the Closing Date if any of the conditions set forth in
Article V shall not have been fulfilled on or prior to the Closing Date; (iii)
by Sellers on the Closing Date if any of the conditions set forth in Article VI
shall not have been fulfilled on or prior to the Closing Date; (iv) by either
Buyer or Sellers if the Closing shall not have occurred on or before April 1,
1999 (unless extended by the Buyer for an additional 30 days); and (v) by Buyer,
upon written notice to Sellers, if the examination of the Company, including its
assets, liabilities, operations, business and prospects, by Buyer or its
representatives or agents, discloses the existence or nonexistence of any
matters or things that, in the sole judgment of Buyer, would be reasonably
likely to result in a material loss or damage to Buyer or the Company or a
material diminution in value of the Company.
(b) Any termination pursuant to this Article VIII shall not affect the
obligations of the parties under Sections 4.8 and 10.16 hereof and shall be
without prejudice to the terminating party's rights and remedies under this
Agreement by reason of any violation of this Agreement occurring prior to such
termination. In the event of a termination pursuant to this Article VIII, each
party shall bear its own costs and expenses incurred with respect to the
transactions contemplated hereby.
-12-
<PAGE> 13
ARTICLE IX
INDEMNIFICATION
9.1 Buyer's Losses. (a) Sellers jointly and severally agree to
indemnify and hold harmless Buyer and the Company and their respective
directors, officers, employees, representatives, agents and attorneys from,
against and in respect of any and all Buyer's Losses (as defined below)
suffered, sustained, incurred or required to be paid by any of them by reason of
(i) any representation or warranty made the Company or Sellers in or pursuant to
this Agreement (including, without limitation, the representations and
warranties contained in any certificate delivered pursuant to Section 5.3) being
untrue or incorrect in any respect; (ii) any failure by the Company or Sellers
to observe or perform their covenants and agreements set forth in this Agreement
or any other agreement or document executed by them in connection with the
transactions contemplated hereby; (iii) any liability for warranty claims
arising from the sale of goods or services by the Company through the Closing
Date; or (iv) the termination of or withdrawal by the Company or any Group
Member from any employee pension benefit plan, as defined in Section 3(2)(A) of
ERISA that is maintained pursuant to a collective bargaining agreement under
which more than one employer makes contributions and to which the Company or any
Group Member is then making or accruing an obligation to make contributions or
has within the preceding five (5) plan years made contributions, except in any
instance to the extent Buyer's Losses result from Buyer's own gross negligence
or willful misconduct. This Section 9.1 is intended to indemnify Buyer, the
Company and their respective directors, officers, employees, representatives,
agents and attorneys from the results of their negligence.
(b) "Buyer's Losses" shall mean all damages (including, without
limitation, amounts paid in settlement with Sellers' consent, which consent may
not be unreasonably withheld), losses, obligations, liabilities, liens,
deficiencies, costs (including, without limitation, reasonable attorneys' fees),
penalties, fines, interest, monetary sanctions and expenses, including, without
limitation, reasonable attorneys' fees and costs incurred to comply with
injunctions and other court and agency orders, and other costs and expenses
incident to any suit, action, investigation, claim or proceeding or to establish
or enforce Buyer's or such other persons' right to indemnification hereunder.
9.2 Sellers' Losses. (a) Buyer and the Company jointly and severally
agree to indemnify and hold harmless Sellers, and their respective directors,
officers, employees, representatives, agents and attorneys from, against, for
and in respect of any all Sellers' Losses (defined below) suffered, sustained,
incurred or required to be paid by either Seller by reason of (i) any
representation or warranty made by Buyer in or pursuant to this Agreement
(including, without limitation, representations and warranties contained in
certificates delivered pursuant to Section 6.3) being untrue or incorrect in any
respect; (ii) any failure by Buyer to observe or perform its covenants and
agreements set forth in this Agreement or any other agreement or document
executed by it in connection with the transactions contemplated hereby; or (iii)
any liability for warranty claims arising from the sale of goods or services by
the Company subsequent to the Closing Date, except in any instance to the extent
Seller's Losses result from Sellers' own gross negligence or willful misconduct.
This Section 9.3 is intended to indemnify Sellers and their directors, officers,
employees, representatives, agents and attorneys from the results of their
negligence.
(b) "Sellers' Losses" shall mean all damages (including, without
limitation, amounts paid in settlement with Buyer's consent, which consent may
not be reasonably withheld), losses, obligations, liabilities, claims,
deficiencies, costs (including, without limitation, reasonable attorneys' fees)
and expenses, including, without limitation, reasonable attorneys' fees and
costs incurred to comply with injunctions and other court and agency orders, and
other costs and expenses incident to any suit, action, investigation, claim or
proceeding or to establish or enforce Sellers' or such other persons' right to
indemnification hereunder.
9.3 Notice of Loss. Except to the extent set forth in the next
sentence, Buyer and Sellers will not have any liability under the indemnity
provisions of this Agreement with respect to a particular matter unless a notice
setting forth in reasonable detail the breach or other matter which is asserted
has been given to the Indemnifying Party (defined below) and, in addition, if
such matter arises out of a suit, action, investigation, proceeding or claim,
such notice is given promptly, but in any event within thirty (30) days after
the Indemnified Party (defined below) is given notice of the claim or the
commencement of the suit, action, investigation or proceeding. Notwithstanding
the preceding sentence, failure of the Indemnified Party to give notice
hereunder shall not release the Indemnifying Party from its obligations under
this Article, except to the extent the Indemnifying Party is actually prejudiced
by such failure to give notice. With respect to Buyer's Losses, Sellers, jointly
and severally, shall be the Indemnifying Party and Buyer, the Company and their
respective directors, officers, employees, representatives, agents and attorneys
shall be Indemnified Parties. With respect to Sellers' Losses, Buyer shall be
the Indemnifying Party and Sellers and their respective directors, officers,
employees, representatives, agents and attorneys shall be the Indemnified Party.
9.4 Right to Defend. Upon receipt of notice of any suit, action,
investigation, claim or proceeding ("Action") for which indemnification might be
claimed by an Indemnified Party, the Indemnifying Party shall be entitled to
defend, contest or otherwise protect against any such Action at its own cost and
expense, and the Indemnified Party must cooperate in any such
-13-
<PAGE> 14
defense or other action. The Indemnified Party shall have the right, but not the
obligation, to participate at its own expense in defense thereof by counsel of
its own choosing, but the Indemnifying Party shall be entitled to control the
defense unless the Indemnified Party has relieved the Indemnifying Party from
liability with respect to the particular matter or the Indemnifying Party fails
to assume defense of the matter. In the event the Indemnifying Party shall fail
to defend, contest or otherwise protect in a timely manner against any such
Action, the Indemnified Party shall have the right, but not the obligation,
thereafter to defend, contest or otherwise protect against the same and make any
compromise or settlement thereof and recover the entire cost thereof from the
Indemnifying Party including, without limitation, reasonable attorneys' fees,
disbursements and all amounts paid as a result of such Action or the compromise
or settlement thereof; provided, however, that the Indemnified Party must send a
written notice to the Indemnifying Party of any such proposed settlement or
compromise, which settlement or compromise the Indemnifying Party may reject, in
its reasonable judgment, within thirty (30) days of receipt of such notice.
Failure to reject such notice within such thirty (30) day period shall be deemed
an acceptance of such settlement or compromise. The Indemnified Party shall have
the right to effect a settlement or compromise over the objection of the
Indemnifying Party; provided, that if (i) the Indemnifying Party is contesting
such claim in good faith or (ii) the Indemnifying Party has assumed the defense
from the Indemnified Party, the Indemnified Party waives any right to indemnity
therefor. If the Indemnifying Party undertakes the defense of such matters, the
Indemnified Party shall not, so long as the Indemnifying Party does not abandon
the defense thereof, be entitled to recover from the Indemnifying Party any
legal or other expenses subsequently incurred by the Indemnified Party in
connection with the defense thereof other than the reasonable costs of
investigation undertaken by the Indemnified Party with the prior written consent
of the Indemnifying Party.
9.5 Cooperation. The Company, Buyer, Sellers and each of their
Affiliates, successors and assigns shall cooperate with each other in the
defense of any suit, action, investigation, proceeding or claim by a third party
and, during normal business hours, shall afford each other access to their books
and records and employees relating to such suit, action, investigation,
proceeding or claim and shall furnish each other all such further information
that they have the right and power to furnish as may reasonably be necessary to
defend such suit, action, investigation, proceeding or claim, including, without
limitation, reports, studies, correspondence and other documentation relating to
EPA, OSHA, and EEOC matters.
9.6 Waiver of Contribution and Indemnification. Sellers hereby waive
and release any rights of indemnification or contribution they may have against
the Company as a result of payments made under this Article.
ARTICLE X
MISCELLANEOUS
10.1 Entire Agreement. This Agreement (including the exhibits and
schedules hereto) constitutes the entire agreement and supersedes all prior
agreements and understandings, both written and oral, between the parties hereto
with respect to the subject matter hereof, and no party shall be liable or bound
to the other in any manner by any representations or warranties not set forth
herein.
10.2 Successors and Assigns. The terms and conditions of this Agreement
shall inure to the benefit of and be binding upon the parties hereto and their
respective successors and permitted assigns. Neither this Agreement nor any
rights, interests, or obligations hereunder may be assigned by any party hereto
without the prior written consent of all other parties hereto, and any purported
assignment in violation of this Section 10.2 shall be null and void.
10.3 Counterparts. This Agreement may be executed in one or more
counterparts, each of which shall for all purposes be deemed to be an original
and all of which shall constitute the same instrument.
10.4 Headings. The headings of the articles and sections of this
Agreement are inserted for convenience only and shall not be deemed to
constitute part of this Agreement or to affect the construction hereof.
10.5 Construction. As used in this Agreement, the words "herein,"
"hereof" and "hereunder" and other words of similar import refer to this
Agreement as a whole and not to any particular article, section, paragraph or
other subdivision.
10.6 Modification/Waiver. Any term or condition hereof may be waived in
writing at any time by the party entitled to the benefits thereof, and this
Agreement may be modified or amended by a written instrument executed by Buyer,
the Company and each Seller. No supplement, modification or amendment of this
Agreement shall be binding unless executed in writing by all of the parties
hereto. No waiver of any of the provisions of this Agreement shall be deemed or
shall constitute a waiver of any other provision hereof (whether or not similar)
nor shall such waiver constitute a continuing waiver.
-14-
<PAGE> 15
10.7 Schedules, Etc. All exhibits and schedules annexed hereto are
expressly made a part of this Agreement as though fully set forth herein. Buyer
acknowledges receipt under separate cover of all information required under the
aforementioned schedules.
10.8 Notices. Any notice, request, document or other communication to
be given hereunder by any party hereto to any other party hereto shall be in
writing and validly given if (i) delivered personally, (ii) sent by telecopy
with electronic confirmation of receipt, (iii) delivered by overnight express,
or (iv) sent by registered or certified mail, postage prepaid, as follows: if to
Buyer, to shoppingwave.com, inc., 3811 Turtle Creek Boulevard, Suite 600,
Dallas, Texas 75219, Attention: Steven B. Solomon, Telecopy No. (214) 520-0034;
if to Sellers or the Company, 2-Lane Media, Inc., 1575 Westwood Boulevard, Suite
300, Los Angeles, California 90024, Attention: David Lane and Ian Foo, Telecopy
No. ( 310) 473-3706; or at such other address for a party as shall be specified
by like notice. Any notice that is delivered personally, or sent by telecopy or
overnight express in the manner provided herein shall be deemed to have been
duly given to the party to whom it is directed upon actual receipt by such
party. Any notice that is addressed and mailed in the manner herein provided
shall be conclusively presumed to have been given to the party to whom it is
addressed at the close of business, local time of the recipient, on the fourth
day after the day it is so placed in the mail.
10.9 GOVERNING LAW. THIS AGREEMENT SHALL BE CONSTRUED, ENFORCED, AND
GOVERNED BY THE INTERNAL LAWS OF THE STATE OF TEXAS (WITHOUT REGARD TO ITS
CHOICE OF LAW PRINCIPLES).
10.10 Survival of Covenants, Agreements, Representations and
Warranties.
(a) Covenants and Agreements. All covenants and agreements made
hereunder or pursuant hereto or in connection with the transactions contemplated
hereby shall survive the Closing and shall continue in full force and effect
thereafter according to their terms without limit as to duration.
(b) Representations and Warranties. All representations and warranties
contained herein shall survive the Closing and shall continue in full force and
effect thereafter for a period of two years following the Closing, except that
(i) the representations and warranties contained in Section 2.6 hereof shall
survive until the earlier of (x) the expiration of the applicable periods
(including any extensions) of the respective statutes of limitation applicable
to the payment of the Taxes to which such representations and warranties relate
without an assertion of a deficiency in respect thereof by the applicable taxing
authority or (y) the completion of the final audit and determinations by the
applicable taxing authority and final disposition of any deficiency resulting
therefrom, (ii) the representations and warranties contained in Section 2.17
shall survive until the expiration of the applicable period of the statutes of
limitation applicable to ERISA matters, and (iii) the representations and
warranties contained in Sections 2.1, 2.2, 2.3, 2.4 and 2.9 shall survive
indefinitely.
10.11 Invalid Provisions. If any provision of this Agreement is held to
be illegal, invalid or unenforceable under present or future laws, such
provision shall be fully severable, this Agreement shall be construed and
enforced as if such illegal, invalid or unenforceable provision had never
comprised a part of this Agreement, and the remaining provisions of this
Agreement shall remain in full force and effect and shall not be affected by the
illegal, invalid or unenforceable provision or by its severance from this
Agreement.
10.12 Expenses. Sellers, on the one hand, and Buyer, on the other hand,
shall be solely responsible for their respective costs and expenses incurred in
connection with the transactions contemplated hereby.
10.13 Third Party Beneficiaries. Except as otherwise specifically
provided in Article IX, no individual or firm, corporation, partnership or other
entity shall be a third-party beneficiary of the representations, warranties,
covenants and agreements made by any party hereto.
10.14 Number and Gender of Words. Whenever the singular number is used,
the same shall include the plural where appropriate, and words of any gender
shall include each other gender where appropriate.
10.15 Further Assurances. From time to time after the Closing, at the
request of any other party but at the expense of the requesting party, Buyer,
the Company or Sellers, as the case may be, will execute and deliver any such
other instruments of conveyance, assignment and transfer, and take such other
action as the other party may reasonably request in order to consummate or
evidence the transactions contemplated hereby.
-15-
<PAGE> 16
IN WITNESS WHEREOF, the parties have executed and delivered this Agreement as of
the date above written.
BUYER:
INLIGHTEN.COM, INC.
By: /s/ STEVEN B. SOLOMON
--------------------------------
Steven B. Solomon, President
GUARANTOR:
Citadel Technology, Inc.
By: /s/ STEVEN B. SOLOMON
--------------------------------
Steven B. Solomon, President
Title: President
--------------------------------
COMPANY:
2-LANE MEDIA, INC.
By: /s/ DAVID LANE
--------------------------------
Title: CEO
--------------------------------
SHAREHOLDERS
/s/ DAVID LANE
----------------------------------------
David Lane
/s/ JONATHAN LANE
----------------------------------------
Jonathan Lane
/s/ ARTHUR LANE DEANNA LANE
----------------------------------------
Arthur and Deanna Lane, JTWROS
UTARA CAPITAL
By: /s/ MIRZAN MAHATHIR
--------------------------------
Mirzan Mahathir
-16-
<PAGE> 1
EXHIBIT 21
LIST OF SUBSIDIARIES
Kent-Marsh Ltd., Inc.
Astonishing Developments, Inc.
DanaSoft, Inc.
LSHC Acquisition Corp.
Liberty Recovery Corp.
How2HQ.com, inc.
2-Lane Media, Inc.
F3 Acquisition Corporation
Forward Freight, Inc.
FCI Services, Inc.
Forward Communications, Inc.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We have issued our report dated June 11, 1999, accompanying the consolidated
financial statements included in the Annual Report of Citadel Technology, Inc.
on Form 10-KSB as of February 28, 1999. We hereby consent to the incorporation
by reference of said report in the Registration Statements of Citadel
Technology, Inc. on Form S-8 (File No. 33-65189, No. 333-03291, No. 333-15665,
No. 333-53151 and No. 333-63051 effective December 20, 1995, May 8, 1996,
November 6, 1996, May 20, 1998, and September 8, 1998, respectively) and Form
SB-2, effective November 25, 1998 (File No. 333-65089).
GRANT THORNTON LLP
/s/ Grant Thornton LLP
Dallas, Texas
August 11, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS OF CITADEL TECHNOLOGY, INC. FOR THE YEAR
ENDED FEBRUARY 28, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> FEB-28-1999
<PERIOD-START> MAR-01-1998
<PERIOD-END> FEB-28-1999
<CASH> 3,386,369
<SECURITIES> 0
<RECEIVABLES> 1,674,288
<ALLOWANCES> 1,208,000
<INVENTORY> 148,676
<CURRENT-ASSETS> 10,730,489
<PP&E> 896,952
<DEPRECIATION> 510,051
<TOTAL-ASSETS> 14,141,520
<CURRENT-LIABILITIES> 2,906,836
<BONDS> 0
21
0
<COMMON> 432,592
<OTHER-SE> 7,059,639
<TOTAL-LIABILITY-AND-EQUITY> 14,141,520
<SALES> 4,439,608
<TOTAL-REVENUES> 4,439,608
<CGS> 190,461
<TOTAL-COSTS> 190,461
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 1,231,092
<INTEREST-EXPENSE> 141,806
<INCOME-PRETAX> (7,209,498)
<INCOME-TAX> 0
<INCOME-CONTINUING> (7,209,498)
<DISCONTINUED> 0
<EXTRAORDINARY> 459,592
<CHANGES> 0
<NET-INCOME> (6,749,906)
<EPS-BASIC> (.25)
<EPS-DILUTED> (.25)
</TABLE>
