<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED NOVEMBER 30, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _________ TO _________
COMMISSION FILE NUMBER: 0-08718
CT HOLDINGS, INC.
(EXACT NAME OF SMALL BUSINESS ISSUER AS SPECIFIED IN ITS CHARTER)
DELAWARE 75-2432011
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
3811 TURTLE CREEK BLVD., SUITE 770, DALLAS, TX 75219
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(214) 520-9292
(ISSUER'S TELEPHONE NUMBER)
CITADEL TECHNOLOGY, INC.
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR,
IF CHANGED SINCE LAST REPORT)
Indicate by check mark whether the issuer (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months
(or for such shorter period the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
Yes X No
Indicate the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date.
Class Outstanding at January 10, 2000
- -------------------------------------- -------------------------------
Common Stock, Par value $.01 per share 43,667,698
Transitional Small Business Disclosure Format Yes [ ] No [X]
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CT HOLDINGS, INC.
(FORMERLY CITADEL TECHNOLOGY, INC.)
FORM 10-QSB
FOR THE THREE AND NINE MONTHS ENDED NOVEMBER 30, 1999
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
Page
----
<S> <C>
Item 1. Financial Statements
Consolidated Balance Sheets
as of November 30, 1999 and February 28, 1999..................... 3
Consolidated Statements of Operations
for the three and nine months ended November 30, 1999 and 1998.... 5
Consolidated Statements of Cash Flow
for the nine months ended November 30, 1999 and 1998.............. 6
Notes to Consolidated Financial Statements........................... 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................................. 9
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.................................................... 28
Item 6. Exhibits and Reports on Form 8-K..................................... 28
Signatures.................................................................... 29
</TABLE>
2
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PART I. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
CT HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
NOVEMBER 30, FEBRUARY 28,
ASSETS 1999 1999
------------ ------------
(UNAUDITED)
<S> <C> <C>
CURRENT ASSETS
Cash $ 178,344 $ 2,210,377
Accounts receivable, less allowance for returns and
doubtful accounts of $963,729 and $1,208,000 323,899 466,288
Notes receivable from related parties 208,934 478,933
Inventory 144,522 148,676
Other 92,287 208,223
------------ ------------
Total current assets 947,986 3,512,497
INVESTMENT IN AND ADVANCES TO UNCONSOLIDATED
AFFILIATE 6,536,639 4,458,819
PROPERTY AND EQUIPMENT, net of accumulated
depreciation of $681,494 and $510,051 285,847 386,901
PURCHASED SOFTWARE, net of accumulated amortization
of $3,085,944 and $2,718,486 1,027,248 1,394,706
CAPITALIZED SOFTWARE DEVELOPMENT COSTS,
net of accumulated amortization of $1,037,422
and $577,000 1,181,524 1,181,052
OTHER ASSETS 327,390 448,372
------------ ------------
$ 10,306,634 $ 11,382,347
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
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CT HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS - CONTINUED
<TABLE>
<CAPTION>
NOVEMBER 30, FEBRUARY 28,
LIABILITIES AND STOCKHOLDERS' EQUITY 1999 1999
------------ ------------
(UNAUDITED)
<S> <C> <C>
CURRENT LIABILITIES
Current maturities of long-term debt $ 174,587 $ 311,812
Notes payable 249,084 347,424
Accounts payable and accrued expenses 875,478 2,230,859
------------ ------------
Total current liabilities 1,299,149 2,890,095
COMMITMENTS AND CONTINGENCIES -- --
STOCKHOLDERS' EQUITY
Common stock, $.01 par value per share; authorized
60,000,000 shares; issued, shares 47,443,301
at 11/30/99 and 43,259,274 shares at 2/28/99 474,433 432,592
Preferred stock, $.01 par value per share;
authorized 1,000,000 shares; issued and outstanding
Series B convertible, 50 shares (liquidation value $50,000);
none outstanding as of 11/30/99 -- 1
Series D convertible, 2,000 shares (liquidation value $2,000,000
at 2/28/99); none outstanding as of 11/30/99 -- 20
Equity notes -- 150,000
Additional paid-in capital 47,639,911 32,835,018
Accumulated deficit (35,023,916) (20,641,875)
Notes receivable for exercise of options/warrants (1,582,704) (1,783,265)
Treasury stock, at cost (4,164,613 shares) (2,500,239) (2,500,239)
------------ ------------
Total stockholders' equity 9,007,485 8,492,252
------------ ------------
$ 10,306,634 $ 11,382,347
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
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CT HOLDINGS, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
NOVEMBER 30, NOVEMBER 30,
1999 1998 1999 1998
------------ ------------ ------------ ------------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Net sales $ 311,057 $ 1,937,454 $ 1,413,449 $ 4,048,965
Cost of sales (excludes depreciation and
amortization expense) 6,833 33,780 54,610 165,022
------------ ------------ ------------ ------------
Gross profit 304,224 1,903,674 1,358,839 3,883,943
Operating expenses
Research and development expenses 99,737 158,996 344,607 410,329
Selling and marketing expenses 417,102 983,297 2,177,547 2,413,595
General and administrative expenses 217,435 495,065 687,120 1,216,556
Depreciation and amortization expense 358,889 410,355 1,015,598 1,134,270
------------ ------------ ------------ ------------
1,093,163 2,147,713 4,226,872 5,334,750
------------ ------------ ------------ ------------
Operating loss (788,939) (244,039) (2,868,033) (1,450,807)
Other income (expense)
Interest expense (2,509) (52,972) (17,638) (136,409)
Other 1,783 8,082 (2,162) 16,085
Litigation expense -- (537,000) -- (537,000)
Equity in loss of unconsolidated
affiliate (8,655,820) -- (11,253,865) --
------------ ------------ ------------ ------------
(6,656,546) (581,590) (11,273,665) (657,324)
------------ ------------ ------------ ------------
Net loss before extraordinary item (9,445,485) (825,929) (14,141,689) (2,108,131)
Extraordinary item - forgiveness of debt -- 73,354 -- 806,421
------------ ------------ ------------ ------------
Net loss (9,445,485) (752,575) (14,141,689) (1,301,710)
Preferred stock dividend requirement -- (54,849) (64,493) (118,982)
------------ ------------ ------------ ------------
Net loss allocable to common stockholders $ (9,445,485) $ (752,575) $(14,206,182) $ (1,301,710)
============ ============ ============ ============
Basic and diluted loss per share data
Net loss before extraordinary item (.22) (0.03) (.34) (0.09)
Extraordinary item -- 0.00 -- 0.03
------------ ------------ ------------ ------------
Net loss per share (.22) (0.03) (.34) (0.05)
============ ============ ============ ============
Shares used in computing loss per share
Basic and diluted 43,221,974 29,683,492 42,144,252 25,970,307
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
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CT HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS ENDED
NOVEMBER 30,
1999 1998
------------ ------------
(unaudited) (unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(14,141,689) $ (1,301,710)
Adjustments to reconcile net loss to net cash
used by operating activities
Depreciation and amortization 1,015,598 1,134,270
Equity in loss of unconsolidated affiliate 11,253,865 --
Gain on settlement of debt -- (806,421)
Provision for uncollectible accounts -- 115,000
Changes in operating assets and liabilities
Accounts receivable 142,389 (2,578,972)
Notes receivable from related parties 269,999 (352,947)
Other current assets 115,936 (315,753)
Inventory 4,154 (103,254)
Bank overdraft -- (10,249)
Accounts payable and accrued expenses (1,355,381) (53,231)
Other assets 120,982 105,201
------------ ------------
NET CASH USED BY OPERATING ACTIVITIES (2,574,147) (4,168,066)
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (86,656) (126,314)
Development of software (460,901) (820,207)
------------ ------------
NET CASH USED BY INVESTING ACTIVITIES (547,557) (946,521)
CASH FLOW FROM FINANCING ACTIVITIES
Net change in notes payable 135,011 (354,355)
Proceeds from sale of preferred stock -- 2,567,391
Proceeds from sale of common stock 954,661 4,076,265
Redemption of preferred stock -- (567,500)
------------ ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 1,089,672 5,721,801
------------ ------------
Net increase (decrease) in cash (2,032,033) 607,214
Cash at the beginning of the period 2,210,377 8,555
------------ ------------
Cash at the end of the period $ 178,344 $ 615,769
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
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CT HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The consolidated financial statements of CT Holdings, Inc., formerly Citadel
Technology, Inc., and its majority-owned subsidiaries (collectively, "CT
Holdings") as of November 30, 1999 and for the three and nine months November
30, 1999 and November 30, 1998 are unaudited and, in the opinion of management,
contain all adjustments, consisting of only normal recurring items, necessary
for the fair presentation of the financial position and results of operations
for the interim period. These consolidated financial statements should be read
in conjunction with the Consolidated Financial Statements and notes thereto
included in CT Holdings' Form 10-KSB for the year ended February 28, 1999. The
results of operations for the three and nine months ended November 30, 1999 are
not necessarily indicative of the results to be expected for the entire year
(see "Part II. Item 1. Management's Discussion and Analysis of Results of
Operations and Financial Condition - Risk Factors"). All significant
intercompany accounts and transactions have been eliminated.
In December 1998, CT Holdings received a comment letter from the Securities and
Exchange Commission with respect to its Form 10-KSB for the fiscal year ended
February 28, 1998 and Quarterly Reports on Form 10-QSB for the periods ended May
31, 1998 and November 30, 1998. The comment letter contained questions relating
to accounting for certain acquisitions, including questions relating to the
write-off of associated in-process research and development costs, and certain
other matters. While CT Holdings has responded to these questions, CT Holdings
cannot determine at this time the effect, if any, that the outcome of this
matter may have on its reported financial position or results of operations. As
a result, it is possible that annual and quarterly financial statements for
fiscal 1998, 1999 and 2000 may need to be restated.
CT HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
NOTE 2. CAPITAL TRANSACTIONS
CT Holdings has previously announced that it will distribute to its shareholders
of record as of March 18, 1999, shares of common stock of How2.com, Inc. upon
compliance with Securities and Exchange Commission ("SEC") requirements
applicable to the proposed distribution. In addition, in connection with the
proposed initial public offering of How2, the underwriters will require CT
Holdings, as a major stockholder of How2, to enter into a lockup agreement that
will cause the distribution to be commenced 180 days after the initial public
offering. Compliance with SEC requirements and state law could delay or prevent
the distribution, as proposed. There can be no assurances that the proposed
initial public offering of How2 will be completed or that CT Holdings will be
able to effect the distribution of the shares of How2 to CT Holdings
stockholders on a timely basis,on the previously disclosed terms or at all.
CT Holdings has agreed to convert certain shares of How2 common stock issued in
connection with certain subscription agreements into shares of CT Holdings
common stock in the event How2 does not become publicly traded within one year
from the dates of such agreements. This could result in the issuance of up to
414,000 additional shares of CT Holdings common stock at a conversion price of
$3.75 per share. In addition, CT Holdings has agreed to convert the shares of
How2 common stock issued in connection with the acquisition of 2-Lane Media by
How2 into up to 500,000 CT Holdings shares at the option of the 2-Lane Media
shareholders in the event How2 does not become publicly traded by March 2000.
These potential issuances would have the effect of diluting CT Holdings'
stockholders if the market price for CT Holdings' common stock is above that
price at the time of conversion.
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NOTE 3. COMMITMENTS AND CONTINGENCIES
On January 7, 1999, our former Houston landlord filed a lawsuit against us
alleging a breach of a lease covering our former Houston office space. The suit
sought damages in excess of $750,000, plus attorney's fees, pre and post
interest and court costs. In July 1999, the parties reached an agreement to
settle the suit for $325,000 to be paid over nine months. We are, to date, in
compliance with all the terms and conditions of the settlement agreement.
CT Holdings and its President were involved in an arbitration proceeding with
Vestcom Ltd., a group that claimed it was entitled to compensation and a
finder's fee for introducing CT Holdings to a third party. Vestcom Ltd. sought
damages of the value of 100,000 shares of CT Holdings' common stock (alleged to
be valued at $1,900,000), plus 50% of additional compensation paid by CT
Holdings to such third party. CT Holdings and its President filed a declaratory
judgment action against Vestcom seeking to determine that the alleged contract
was not valid based on CT Holdings' defenses. The case was 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 CT
Holdings 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 appealed the decision of the Texas court. In November
1998, Vestcom filed a lawsuit against CT Holdings in Texas state court styled
Vestcom v. Citadel in the 68th Judicial Court, Dallas County, Texas, reasserting
the same basic claims as in the arbitration proceeding. In January 2000 the
parties reached an agreement to settle the suit for the original amount of the
warrants claimed (100,000 shares at $1.375).
In August 1998, Janssen Meyers Associates L.P. ("JM") filed a lawsuit against CT
Holdings. The suit alleges that CT Holdings owes the plaintiffs a fee in the
amount of $6,000,000 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. CT Holdings believes such claims are without
merit and intends to vigorously defend against the claims. The lawsuit, styled
Janssen Meyers Associates, L.P. v. Citadel Technology, Inc., was filed in the
Supreme Court of the State of New York, County of New York. CT Holdings has
removed the case to federal court in the Southern District of New York.
Subsequent to the end of the most recent fiscal quarter, Janssen Meyers filed a
motion for partial summary judgment and CT Holdings filed a motion for summary
judgment in the matter.
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NOTE 4. INVESTMENT IN UNCONSOLIDATED AFFILIATE
CT Holdings' ownership interest in How2 as of February 28, 1999 was 62%. As of
November 30, 1999 CT Holdings' ownership interest in How2 was 45.6%. As such, CT
Holdings no longer has a majority ownership interest. CT Holdings accounts for
its ownership interest in How2 using the equity method of accounting. For
comparability purposes, February 28, 1999 information has been restated to
account for CT Holdings' investment in How2 under the equity method of
accounting.
The following is a summary of condensed unaudited financial information
pertaining to How2:
<TABLE>
<CAPTION>
SUMMARIZED BALANCE SHEET NOVEMBER 30, 1999
- ------------------------ -----------------
<S> <C>
Current assets $ 12,373,409
Other assets 20,964,231
------------
Total assets $ 33,337,640
============
Current liabilities $ 18,098,865
Long-term debt 494,451
------------
Total liabilities 18,593,316
------------
Shareholders' equity 14,744,324
------------
$ 33,337,640
============
</TABLE>
<TABLE>
<CAPTION>
3 MONTHS ENDED 9 MONTHS ENDED
SUMMARIZED STATEMENT OF OPERATIONS NOVEMBER 30, 1999 NOVEMBER 30, 1999
- ---------------------------------- ----------------- -----------------
<S> <C> <C>
Revenues $ 3,255,311 $ 5,021,382
Gross profit 2,081,930 3,478,541
Sales and Marketing Expenses 12,429,857 12,532,116
Operating loss (19,813,038) (25,459,692)
Net loss (18,980,877) (24,541,880)
</TABLE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
The following discussion and this Quarterly Report on Form 10-QSB contain
forward-looking statements that involve known and unknown risks, uncertainties
and other factors that may cause our actual results, levels of activity,
performance, or achievements to be materially different from any future results,
levels of activity, performance, or achievements expressed or implied by such
forward-looking statements. Such factors include, among others things, those
risk factors set forth in this section and elsewhere in this report. We identify
forward-looking statements by words such as "may," "will," "should," "could,"
"expects," "plans," "anticipates," "believes," "estimates," "predicts,"
"potential," or "continue" or similar terms that refer to the future. We cannot
guarantee future results, levels of activity, performance or achievements.
Please refer to our annual report on Form 10-KSB for the fiscal year ended
February 28, 1999 and How2's Registration Statement on Form S-1 for further
discussion of these and other risk factors related to CT Holdings and its
subsidiaries. The trading price of our common stock could decline due to any of
these risks, and you may lose all or part of your investment.
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OVERVIEW
OVERVIEW OF CT HOLDINGS
CT Holdings, Inc., formerly Citadel Technology, Inc., is an incubator of
business-to-business (B2B) Internet companies that provides early stage
business-to-business "dot.com" ventures with a single source of management
capital, as well as consulting on operations, marketing and strategic planning.
Our B2B incubator model is designed to enable the start up companies with whom
we partner to establish a clear path for growth so that they may become online
market leaders in their respective industries. We believe that by exclusively
focusing on B2B Internet companies, we are well positioned to identify the
latest trends and opportunities and attract promising companies and talent in
this nascent industry. Our strategy is to leverage the B2B expertise of our
management and partners and to capitalize upon opportunities to cross pollinate
the strongest qualities among our holdings. We believe that the anticipated
growth in B2B e-commerce creates strong opportunities for us to increase
shareholder value and for well positioned early stage ventures in this industry.
Forrester Research estimates that the United States B2B e-commerce market,
defined as the intercompany trade of hard goods over the Internet, will grow
from $43 billion in 1998 to more than $1.3 trillion by 2003.
We began our Internet activities in 1999 with the formation of How2.com, which
provides online outsourced customer care services. How2's comprehensive suite of
outsourced services includes manufacturer rebate processing, extended
warranties, product information, customer data asset management and other
services that are marketed across multiple industry lines. How2's approximately
150 clients include Staples, eMachines and Southwestern Bell.
In addition to our B2B incubation business, we continue to operate our "Citadel
Technology" business line, which is focused on developing and marketing security
and administration software products for both computer networks and desktop
personal computers. Our integrated, easy-to-use software 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. These software 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. Our Citadel Technology
software 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. Our core focus will be on our B2B
incubation services, and we are currently analyzing various strategic
alternatives for our Citadel Technology security software business, including
new strategic alliances with third parties, new applications of the technology,
new third party licensing or joint venture arrangements or the sale of the
business. As a result, management believes that our results of operations for
our Citadel Technology security software business were adversely affected and
may be adversely affected in the future.
In December 1999, we changed our corporate name to CT Holdings, Inc. We believe
that our new name is more descriptive of our focus on incubation of emerging B2B
ventures and our current substantial investment in How2.com. We believe that any
goodwill associated with our former legal name will be preserved due to the
continued use of the name "Citadel Technology" to identify our software
business. Following the inadvertent failure of our outside consultants to file a
return with the Delaware franchise tax authority in November 1999 another entity
obtained the name Citadel Technology, Inc. in Delaware. When we filed
reinstatement materials in Delaware, we adopted our new name CT Holdings, Inc.
pursuant to statutory procedures.
NEW CITADEL TECHNOLOGY PRODUCTS
In August 1999, we completed beta testing and launched our new WinShield Secure
PC product, the next generation WinShield desktop security and configuration
tool. We expect to complete and launch the network version of WinShield Secure
PC in our current fiscal year ending February 2000. This product provides new
Internet security features that allow Internet filtering and blocking which
permit 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
provides are security mechanisms such as screen saver control with network
authentication,
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event management for automatic logoff, as well as timed application usage.
WinShield Secure PC is available for network or stand alone workstations.
CITADEL TECHNOLOGY PRODUCT RECOGNITION
During the quarter, our WinShield Secure PC won the "Best of Breed" award from
WinMag.com in October 1999, and our software products were featured in the
following publications: Curriculum Administrator, Technology & Learning, Windows
NT Systems, WinMag.com, Media & Methods, and Windows NT Magazine.
RISK FACTORS
GENERAL RISKS
WE RECENTLY DECIDED TO CHANGE OUR BUSINESS TO FOCUS ON B2B INCUBATION OF EARLY
STAGE COMPANIES; HENCE, WE WILL ENCOUNTER NUMEROUS RISKS ASSOCIATED WITH OUR NEW
BUSINESS FOCUS AND OUR PRIOR OPERATING HISTORY MAY NOT BE A MEANINGFUL GUIDE TO
EVALUATING OUR FUTURE PERFORMANCE.
In January 2000 we announced that we were changing our business model to focus
on the incubation of B2B early stage ventures. Other than our formation and
development of How2, we have little experience in this area. As a consequence,
our prior operating history may not provide a meaningful guide to our prospects
in the emerging B2B market. Moreover, our new business model and prospects must
be considered in light of the risk, expense and difficulties frequently
encountered by companies in early stages of development, particularly companies
in new and rapidly evolving markets such as B2B e-commerce. We may be unable to
execute our strategy of developing our B2B incubation business due to numerous
risks, including the following:
o We may be unable to identify or develop relationships with attractive
emerging B2B companies
o Any B2B companies that we are able to attract may not succeed and the
value of our assets and the price of our common stock could
consequently decline
o Our new business model is unproven and depends on the willingness of
companies to participate in our incubator and collaborate with us and
each other
o Our expenses will increase as we refocus on our new B2B incubation
business model and seek to build the infrastructure necessary to
implement this model
o We face competition from other incubators of B2B e-commerce companies,
some of which are publicly traded companies, venture capital companies
and large corporations; many of these competitors have greater
financial resources and brand name recognition than we do, which may
make it difficult for us to effectively compete
o We will require additional capital resources in order to implement our
new B2B e-commerce business model and we may not be able to obtain
these resources on attractive terms, if at all.
OUR EARNINGS AND STOCK PRICE ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS.
Due to the factors noted below, our earnings and stock price have been and may
continue to be subject to significant volatility, particularly on a quarterly
basis. We have previously experienced shortfalls in revenue and earnings from
levels expected by investors, which have had an immediate and significant
adverse effect on the trading price of our common stock. This may occur again in
the future.
Additionally, we have received requests from the staff of the Securities and
Exchange Commission for additional information regarding the accounting for
certain of our acquisitions, including questions relating to the write-off of
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associated in-process research and development costs and other matters. While we
has responded to these requests, we cannot determine at this time the effect, if
any, that the outcome of this matter will have on our reported financial
position or results of operations. However, should the staff of the Securities
and Exchange Commission require us to retroactively record any adjustments, the
effect could have a material adverse impact on the future trading price of our
common stock.
RISKS RELATED TO OUR CITADEL TECHNOLOGY BUSINESS
OUR INDUSTRY IS CHARACTERIZED BY RAPID TECHNOLOGICAL CHANGE AND WE WILL NEED TO
ADAPT OUR DEVELOPMENT TO THESE CHANGES.
We participate in a highly dynamic industry characterized by rapid change and
uncertainty relating to new and emerging technologies and markets. The recent
trend toward server-based applications in networks and applications distributed
over the Internet could have a material adverse affect on sales of our products.
Future technology or market changes may cause certain of our products to become
obsolete more quickly than expected.
THE MARKET FOR OUR PRODUCTS IS INTENSELY COMPETITIVE AND WE EXPECT THAT
COMPETITION WILL CONTINUE AND MAY INCREASE.
The market in which we compete is influenced by the strategic direction of major
microcomputer hardware manufacturers and operating system providers. Our
competitiveness depends on our ability to enhance existing products and to offer
successful new products on a timely basis. We have limited resources and must
restrict product development efforts to a relatively small number of projects.
INTRODUCTION OF NEW OPERATING SYSTEMS MAY CAUSE SIGNIFICANT FLUCTUATIONS IN OUR
FINANCIAL RESULTS AND STOCK PRICE.
If we are unable to successfully and timely develop products that operate under
existing or new operating systems, or if pending or actual releases of the new
operating systems delay the purchase of our products, our future net revenues
and operating results could be materially adversely affected. Additionally, as
hardware vendors incorporate additional server-based network management and
security tools into network operating systems, the demand may decrease for some
of our products, including those currently under development.
THE TREND TOWARD CONSOLIDATION IN OUR INDUSTRY MAY IMPEDE OUR ABILITY TO COMPETE
EFFECTIVELY.
As consolidation in the software industry continues, fewer companies dominate
particular markets, changing the nature of the market and potentially providing
consumers with fewer choices. Also, many of these companies offer a broader
range of products than us, ranging from desktop to enterprise solutions. We may
not be able to compete effectively against these competitors. Furthermore, we
may use strategic acquisitions, as necessary, to acquire technology, people and
products for our overall product strategy. We have completed a number of
acquisitions and dispositions of technologies, companies and products and may
acquire and dispose of other technologies, companies and products in the future.
The trend toward consolidation in our industry may result in increased
competition in acquiring these technologies, people or products, resulting in
increased acquisition costs or the inability to acquire the desired
technologies, people or products. Any of these changes may have a significant
adverse effect on our future revenues and operating results.
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WE MUST EFFECTIVELY ADAPT TO CHANGES IN THE DYNAMIC TECHNOLOGICAL ENVIRONMENT OF
THE INTERNET IN A TIMELY MANNER.
Critical issues concerning the commercial use of the Internet, including
security, reliability, cost, ease of use, accessibility, quality of service or
potential tax or other government regulation, remain unresolved and may affect
the use of the Internet as a medium to distribute or support our software
products and the functionality of some of our products. If we are unsuccessful
in timely assimilating changes in the Internet environment into our business
operations and product development efforts, our future net revenues and
operating results could be adversely affected.
WE FACE INTENSE PRICE-BASED COMPETITION FOR SALES OF OUR PRODUCTS.
Price competition is often intense in the software market, especially for
utility and security products. Many of our competitors have significantly
reduced the price of their products. Price competition may continue to increase
and become even more significant in the future, resulting in reduced profit
margins.
THE TRANSITION TO INTEGRATED SUITES OF UTILITIES MAY RESULT IN REDUCED REVENUES.
We and our competitors now provide integrated suites of utility products. The
price of integrated utility suites is significantly less than the aggregate
price of stand-alone products that are included in these utility suites when
sold separately. As a result of the shift to integrated utility suites, price
competition is intense and we have experienced cannibalization of our
stand-alone products that are included within the suite. As a result, there may
be a negative impact on our revenues and operating income from selling
integrated utility suites rather than individual products, as the lower price of
integrated utility suites may not be offset by increases in the total volume of
utility suites sold. Additionally, our products may not compete effectively with
competitors' products or integrated utility suites introduced in the future.
OUR QUARTERLY FINANCIAL RESULTS ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS.
We have been subject to substantial fluctuations in quarterly net revenues, and
these fluctuations may occur in the future. Fluctuations may be caused by a
number of factors, including:
o the timing of announcements and releases of new or enhanced versions
of our products and product upgrades;
o the introduction of competitive products by existing or new
competitors;
o reduced demand for any given product;
o seasonality in the end-of-period buying patterns of foreign and
domestic software markets; and
o the market's transition between operating systems.
Due to the aforementioned factors, forecasts may not be achieved, either because
expected sales do not occur or because they occur at lower prices or on terms
that are less favorable to us. In addition, these factors increase the chances
that our results could diverge from the expectations of investors and analysts.
WE MAY BE UNSUCCESSFUL IN UTILIZING NEW DISTRIBUTION CHANNELS.
We currently offer products over the Internet. We may not be able to effectively
adapt our existing, or adopt new, methods of distributing our software products
utilizing the rapidly evolving Internet and related technologies. The adoption
of new channels may adversely impact existing channels and/or product pricing,
which may reduce our future revenues and profitability.
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PRODUCT RETURNS MAY AFFECT OUR NET REVENUES.
Product returns can occur when we introduce upgrades and new versions of
products or when distributors or retailers have excess inventories. Our return
policy allows distributors, subject to various limitations, to return purchased
products in exchange for new products or for credit towards future purchases.
End users may return our products through dealers and distributors within a
reasonable period from the date of purchase for a full refund. In addition,
retailers may return older versions of our products. We estimate and maintain
reserves for product returns. However, future returns could exceed the reserves
we have established, which could have a material adverse affect on our operating
results.
OUR INCREASED SALES OF SITE LICENSES MAY INCREASE FLUCTUATIONS IN OUR FINANCIAL
RESULTS AND COULD AFFECT OUR BUSINESS.
We sell corporate site licenses through the distribution channel and through
corporate resellers. We are increasingly emphasizing sales to corporations and
small businesses through volume licensing agreements. These licensing
arrangements tend to involve a longer sales cycle than sales through other
distribution channels, require greater investment of resources in establishing
the enterprise relationship and can sometimes result in lower operating margins.
The timing of the execution of volume licenses, or their non-renewal or
re-negotiation by large customers, could cause our results of operations to vary
significantly from quarter to quarter and could have a material adverse impact
on our results of operations. In addition, if the corporate marketplace grows
and becomes a larger component of the overall marketplace, we may not be
successful in expanding our corporate segment to take advantage of this growth.
WE DEPEND ON DISTRIBUTION BY VALUE ADDED RESELLERS AND INDEPENDENT SOFTWARE
VENDORS FOR A SIGNIFICANT PORTION OF OUR REVENUES.
We distribute some of our products through value added resellers and independent
software vendors under arrangements through which our products are included with
these resellers' and vendors' hardware and software products prior to sale by
them through retail channels. If we are unsuccessful in maintaining our current
relationships and securing license agreements with additional value added
resellers and independent software vendors, or if these resellers and vendors
are unsuccessful in selling their products, our future net revenues and
operating results may be adversely affected.
THE RESULTS OF OUR RESEARCH AND DEVELOPMENT EFFORTS ARE UNCERTAIN.
We believe that we will need to make significant research and development
expenditures to remain competitive. While we perform extensive usability and
beta testing of new products, the products we are currently developing or may
develop in the future may not be technologically successful. If they are not
technologically successful, our resulting products may not achieve market
acceptance and our products may not compete effectively with products of our
competitors currently in the market or introduced in the future.
THE LENGTH OF THE PRODUCT DEVELOPMENT CYCLE IS DIFFICULT TO PREDICT.
The length of our product development cycle has generally been greater than we
originally expected. We are likely to experience delays in future product
development. These delays could have a material adverse affect on the amount and
timing of future revenues.
WE MUST MANAGE AND RESTRUCTURE OUR OPERATIONS EFFECTIVELY.
We continually evaluate our product and corporate strategy. We have in the past
undertaken and will in the future undertake organizational changes and/or
product and marketing strategy modifications. These organizational changes
increase the risk that objectives will not be met due to the allocation of
valuable limited resources to implement
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changes. Further, due to the uncertain nature of any of these undertakings,
these efforts may not be successful and we may not realize any benefit from
these efforts.
WE MUST ATTRACT AND RETAIN PERSONNEL WHILE COMPETITION FOR PERSONNEL IN OUR
INDUSTRY IS INTENSE.
We believe that our future success will depend in part on our ability to recruit
and retain highly skilled management, marketing and technical personnel.
Competition in recruiting personnel in the software industry is intense. To
accomplish this, we believe that we must provide personnel with a competitive
compensation package, including stock options, which requires ongoing
stockholder approval.
WE RELY ON INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS.
We regard our software as proprietary and underlying technology as proprietary.
We seek to protect our proprietary rights through a combination of
confidentiality agreements and copyright, patent, trademark and trade secret
laws. However, we do not employ technology to prevent copying of our products.
Third parties may copy aspects of our products or otherwise obtain and use our
proprietary information without authorization or develop similar technology
independently. CT Holdings does not have any patents or statutory copyrights on
any of its proprietary technology which CT Holdings believes to be material to
its future success, although How2 has filed a provisional patent application
with respect to certain of its business applications and intellectual property
rights. In selling its products, CT Holdings 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, existing
copyright laws afford limited practical protection. Furthermore, the laws of
some foreign countries do not offer the same level of protection of our
proprietary rights as the laws of the United States. There can be no assurance
that CT Holdings' means of protecting its proprietary rights will be adequate or
that CT Holdings' competitors will not independently develop similar technology
substantially equivalent or superseding proprietary technology. Furthermore,
there can be no assurance that any confidentiality agreements between CT
Holdings and its employees will provide meaningful protection of CT Holdings'
proprietary information, in the event of any unauthorized use or disclosure
thereof. Any legal action that we may bring to protect proprietary information
could be expensive and may distract management from day-to-day operations.
WE ARE INVOLVED IN LITIGATION WHICH COULD, AND FUTURE CLAIMS AGAINST US MAY,
AFFECT OUR FINANCIAL RESULTS.
From time to time, we may be subject 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. We are involved in a number of judicial and administrative proceedings
incidental to our business. We intend to defend and/or pursue all claims against
us. We may suffer an unfavorable outcome as a result of one or more claims. We
do not expect the final resolution of these claims to have a material adverse
effect on our financial position, individually or in the aggregate. However,
depending on the amount and timing of unfavorable resolutions of claims against
us, or the costs of settlement or litigation, our future results of operations
or cash flows could be materially adversely affected in a particular period.
Year 2000 - Product Liability Litigation
We believe the software products that we currently develop and actively market
are Year 2000 compliant for significantly all functionality. However, these
products could contain errors or defects related to the Year 2000. In addition,
earlier versions of our products, those that are not the most currently released
or are not currently being developed, may not be Year 2000 compliant. We have
sold some of our older products, which are not being actively developed and
updated. These older products are also not necessarily Year 2000 compliant and
are no longer sold by us.
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Software Defects and Product Liability
Software products frequently contain errors or defects, especially when first
introduced or when new versions or enhancements are released. For example, in
the past, our anti-virus software products have incorrectly detected viruses
that do not exist. We have not experienced any material adverse effects
resulting from any of these defects or errors to date and we test our products
prior to release. Nonetheless, defects and errors could be found in current
versions of our products, future upgrades to current products or newly developed
and released products. Software defects could result in delays in market
acceptance or unexpected reprogramming costs, which could materially adversely
affect our operating results. Most of our license agreements with customers
contain provisions designed to limit our exposure to potential product liability
claims. It is possible, however, that these provisions limiting our liability
may not be valid as a result of federal, state, local or foreign laws or
ordinances or unfavorable judicial decisions. A successful product liability
claim could have a material adverse affect on our business, operating results
and financial condition.
OUR SOFTWARE PRODUCTS AND WEB SITE MAY BE SUBJECT TO INTENTIONAL DISRUPTION.
While we have not been the target of software viruses specifically designed to
impede the performance of our products, such viruses could be created and
deployed against our products in the future. Similarly, experienced computer
programmers, or hackers, may attempt to penetrate our network security or the
security of our web site from time to time. A hacker who penetrates our network
or web site could misappropriate proprietary information or cause interruptions
of our services. We might be required to expend significant capital and
resources to protect against, or to alleviate, problems caused by virus creators
and hackers.
WE HAVE EXPERIENCED REDUCED DEMAND FOR OUR PRODUCTS DUE TO CHANGES IN CUSTOMER
BEHAVIOR RESULTING FROM YEAR 2000 PREPARATION.
With the emerging requirements of Year 2000 compliance and functionality, many
enterprise customers used their Information Technology budgets in 1999 to focus
on Year 2000 issues. In addition, some of our customer's Information Technology
organizations were 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 reduced sales of our
products and had an adverse affect on revenues. In addition, we have experienced
and may continue to experience significantly reduced revenues from our product
sales as demand may significantly decline and could adversely affect our future
operating results.
WE MAY EXPERIENCE DISRUPTION OF OUR INTERNAL SYSTEMS AS A RESULT OF THE YEAR
2000.
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. Systems that do not properly recognize such information
could generate erroneous data or cause a system to fail.
CT Holdings has conducted Year 2000 compliance reviews for its internal systems.
The review is comprised of four phases: (i) assessment of all of CT Holdings'
systems and technology; (ii) remediation; (iii) implementation and testing of
modifications to or replacements of existing systems and technology; and (iv)
contingency planning.
Failures of our internal software and hardware systems containing 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. CT Holdings is also
vulnerable to our key partners' and suppliers' potential failure to remediate
their own Year 2000 issues.
CT Holdings believes the software and hardware it uses internally complies with
Year 2000 requirements. However, serious, unanticipated negative consequences,
including material costs caused by undetected errors or defects in the
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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.
We have funded our Year 2000 compliance review from operating cash flows and has
not separately accounted for these costs in the past. To date we have not
incurred material costs in addressing Year 2000 issues. However, there can be no
assurances that the actual costs of implementing our Year 2000 plan will exceed
our estimates or that our business will not be materially adversely affected by
Year 2000 issues.
WE MAY NEED ADDITIONAL FINANCING.
We currently fund our Citadel Technology product development and 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 our Citadel Technology
anticipated operations, we 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 our then-current shareholders.
ADDITIONAL RISKS RELATED TO OUR INTERNET SUBSIDIARY, HOW2.COM
The following are certain risks related to the business of How2.Com, Inc.
("How2"), our Internet subsidiary, and should be considered in addition to the
risk factors described above. Any of these factors could have a material adverse
effect on us, as we owned a 45.2 % interest in How2 at December 31, 1999. How2
filed a registration statement with the Securities and Exchange Commission
relating to an initial public offering of shares of its common stock on October
19, 1999.
THERE CAN BE NO ASSURANCE THAT HOW2'S CONTEMPLATED INITIAL PUBLIC OFFERING WILL
TIMELY, OR EVER, BE SUCCESSFULLY COMPLETED.
o The delay or complete abandonment of the contemplated How2 initial
public offering would have a material adverse effect on CT Holdings'
stock price due to our substantial equity interest in How2. You cannot
be assured that the initial public offering will occur in the near
future or ever at all.
o In addition, we have agreed to convert the shares of How2 common stock
issued in connection with the acquisition of 2-Lane Media by How2 into
up to 500,000 of our shares at the option of the 2-Lane Media
shareholders in the event How2 does not become publicly traded by
March 2000. Pursuant to the terms of the subscription agreements
between How2 and certain of its stockholders, we may be required to
issue up to 414,000 shares of our 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 How2 does not become publicly traded by either
February or March 2000, as the case may be. These provisions could
have the effect of diluting our stockholders if the market price for
our stock is above that price at the time of conversion.
WE MAY NOT BE ABLE TO EFFECT THE DISTRIBUTION OF HOW2 SHARES.
We previously announced that we intend to distribute shares of How2 common stock
to our shareholders upon compliance with the Securities and Exchange Commission
(SEC) requirements applicable in connection with the proposed distribution and
upon the expiration of a 180 day lockup agreement between CT Holdings and the
underwriters of How2's proposed initial public offering. If there are certain
problems associated with compliance with SEC requirements or state law, then the
distribution of How2 shares may be delayed or may not occur. There can be no
assurance that we will complete the distribution on the proposed terms or at
all.
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HOW2'S BUSINESS AND FUTURE PROSPECTS ARE EXTREMELY DIFFICULT TO EVALUATE BECAUSE
ITS OPERATING HISTORY IS VERY LIMITED.
o How2 was formed in January 1999. It acquired its rebates operation in
May 1999 and commenced warranty operations in December 1999. As a
result, it has only a limited operating history and is subject to all
of the uncertainties and difficulties encountered by companies in
their early stages of development.
o How2 cannot be certain that its customer care services will be
embraced by businesses, yet it expects to derive all of its revenue
from its customer care services for the foreseeable future. If How2 is
unable to establish pricing and revenue models acceptable to
manufacturers, retailers, and service organizations, its online
customer care services may not be commercially successful.
HOW2 HAS A HISTORY OF NET LOSSES AND EXPECTS TO CONTINUE TO INCUR SUBSTANTIAL
NET LOSSES IN THE FUTURE.
o How2 had both a net loss and an accumulated deficit of approximately
$30.7 million for the period from its inception, January 7, 1999,
through December 31, 1999. It anticipates that its operating expenses
will increase substantially in the foreseeable future as it continues
to develop its technology, increase its sales and marketing
activities, expand its outsourced services capabilities and improve
its operational and financial systems. Accordingly, How2 expects to
incur additional losses for the foreseeable future.
HOW2'S REVENUE IS DEPENDENT UPON ITS CLIENTS' BUSINESS AND PRODUCT SALES; MANY
OF ITS CLIENT AGREEMENTS ARE TERMINABLE BY THE CLIENT AT WILL.
o How2's revenue is primarily transaction based and will fluctuate with
the volume of transactions or level of sales of products by its
business clients for which it provides customer care services. In
addition, many of How2's agreements with its clients are terminable by
the client at will. Therefore, How2 cannot be assured that any of its
clients will continue to use its services for any period of time.
HOW2 IS DEPENDENT ON eMACHINES AND STAPLES AND ITS VENDORS FOR A SUBSTANTIAL
PORTION OF ITS BUSINESS.
o How2 is dependent upon its relationship with a small number of
customers who use its rebate services for a substantial portion of its
existing and anticipated revenues.
o Four of How2's customers accounted for approximately 85.34% of its
aggregate invoiced revenue (67.14%, 3.73%, 9.73% and 4.74% of its
aggregate invoiced revenue was derived from eMachines, Staples and its
vendors, Umax and Southwestern Bell, respectively) for the year ended
December 31, 1999. How2 cannot be assured that its relationships with
eMachines or Staples and its vendors will continue, or if continued,
will increase in any future period.
HOW2'S QUARTERLY OPERATING RESULTS WILL LIKELY VARY SIGNIFICANTLY IN THE FUTURE.
o How2 expects that its revenues and operating results may vary
significantly from quarter to quarter. As a result, quarter-to-quarter
comparisons of its results of operations may not be meaningful. In
some future quarter or quarters, its operating results are likely to
fall below expectations. Any shortfall will likely adversely affect
the price of How2's common stock in a manner that may be unrelated to
its long-term operating performance.
o How2's quarterly operating results, as well as its operating results
generally, may also vary depending on a number of factors, including
but not limited to: demand for its rebate and related services;
fluctuations in the average face amount of the rebates processed;
seasonality in manufacturers' rebate promotions; actions by How2's
competitors or entry of new competitors into its markets; changes in
How2's pricing or that of its competitors; How2's ability to expand
its sales and marketing operations; its ability to attract and retain
clients and maintain client satisfaction; increased expenses related
to sales and marketing, site development or administration;
technological changes in How2's markets; changes in accounting
standards and revenue recognition policies; costs related to possible
acquisitions; seasonality of Internet use; and general economic
conditions.
o In addition, because How2's increasing expense levels are based in
part on expectations of its future revenues, any decline in its
revenues below its expectations would have a disproportionately
adverse impact on its operating results.
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HOW2'S REBATE AND RELATED SERVICES HAVE ACCOUNTED FOR SUBSTANTIALLY ALL OF ITS
REVENUES SINCE INCEPTION, AND IT EXPECTS TO DEPEND ON ITS REBATE AND RELATED
SERVICES FOR A SIGNIFICANT PORTION OF ITS REVENUES FOR THE FORESEEABLE FUTURE.
o How2's rebate and related services accounted for approximately 76.4%
of its total revenues from inception through December 31, 1999. How2
anticipates that revenues from its rebate services will continue to
constitute a significant portion of its revenues for the foreseeable
future. A decrease in the amount of promotional dollars spent on
rebate programs by its clients would negatively impact its results of
operations.
o For the period from January 7, 1999 to December 31, 1999, How2's net
revenues included $ 2.3 million of slippage, representing 38.5% of its
net revenues for the period. How2's operating results could suffer if
the slippage percentage decreases or if any state is entitled to the
slippage amounts as a result of its unclaimed property or escheat
laws. Furthermore, How2 expects that more consumers will cash their
rebate checks as a result of its online rebate process, which will
further reduce slippage. A decline in the amount of slippage that How2
retains or a decrease in the rebate service fees it receives could
decrease its net revenues and negatively impact its results of
operations.
IN THE FUTURE, HOW2 WILL NEED TO RAISE ADDITIONAL CAPITAL, AND THIS CAPITAL MAY
NOT BE AVAILABLE ON ACCEPTABLE TERMS, IF AT ALL.
o How2 expect the net proceeds from its initial public offering will be
sufficient to meet its working capital and capital expenditure needs
for at least the next 12 months. Assuming the initial public offering
is even consummated, How2 may still need to raise additional funds. In
addition, within the next 12 months How2 may need to raise additional
funds in order to take advantage of new business opportunities, to
react to unforeseen difficulties or to otherwise respond to pressures
from its competitors. If How2 does not complete its initial public
offering on a timely basis or otherwise cannot raise funds on
acceptable terms, if and when needed, its business will suffer.
HOW2'S BRAND MAY NOT ACHIEVE THE BROAD RECOGNITION AND LOYALTY NECESSARY TO
SUCCEED.
o How2 believes that broad recognition and favorable business and
consumer perception of the How2.com brand are essential to its future
success. Accordingly, How2 is pursuing an aggressive brand-enhancement
strategy, which includes trade shows, promotional programs and public
relations activities.
HOW2 DEPENDS UPON STRATEGIC ALLIANCES TO DEVELOP AND IMPLEMENT ITS TECHNOLOGY
SOLUTIONS.
o How2 depends upon third parties for several critical elements of its
business and technology.
o How2 has entered into material contracts with Exodus Communications,
Inc. for its data center hosting and plans to continue to enter into
material contracts with other third parties, to manage, maintain and
expand the computer and communications equipment and software needed
for the day-to-day operations of its business.
IN ORDER TO MANAGE ITS GROWTH AND EXPANSION, HOW2 WILL NEED TO IMPROVE AND
IMPLEMENT NEW SYSTEMS, PROCEDURES AND CONTROLS.
o Since its formation, How2 has experienced significant expansion of its
operations. This expansion has placed a strain upon its management
systems and other resources.
o As How2 introduces new customer care services, How2 will need to
develop and implement new technology systems.
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ADOPTION AND INTEGRATION OF HOW2'S PRODUCTS AND SERVICES BY LARGE RETAIL CLIENTS
IS COMPLEX, TIME CONSUMING AND EXPENSIVE.
o How2 recruits retail clients to process their vendors' rebates. The
adoption and integration of How2's services by large companies is
complex, time consuming and expensive. These long cycles may cause
delays in How2's sales and it may spend a large amount of time and
resources on potential clients who decide not to use its services,
which could materially and adversely affect its business.
IF HOW2 LOSES ITS KEY PERSONNEL OR CANNOT RECRUIT ADDITIONAL PERSONNEL, ITS
BUSINESS MAY SUFFER.
o Since its formation in January 1999, How2 has employed many of its key
personnel, including Steven B. Solomon, its Chairman and Chief
Executive Officer, Kenneth R. Johnsen, its President and Chief
Operating Officer, and the leaders of its finance, technology, legal,
sales and marketing operations, and other key managerial, marketing,
planning, financial, technical and operations personnel.
o How2 does not have life insurance policies that would pay proceeds to
it upon the death of any of its key personnel. How2's business could
be negatively impacted if it were to lose the services of one or more
of these persons.
HOW2'S BUSINESS IS VERY LABOR INTENSIVE AND, AS A RESULT, HOW2 IS DEPENDENT ON
ITS EMPLOYEE BASE.
o How2's future success depends on its ability to attract, hire, train
and retain highly skilled personnel. In addition, How2 will need to
add a significant number of new technical support and operations
personnel to support the operations of its customer care services.
Competition for qualified personnel is intense, and How2 may fail to
attract or retain these personnel, in which case its business would be
negatively impacted.
o Because labor costs are a significant portion of its costs, an
increase in wages, costs of employee benefits or employment taxes
could seriously harm How2's business. In addition, How2's facilities
are located in areas, including Dallas, Los Angeles, and Silicon
Valley, with high demand for technical and other personnel and
relatively low unemployment rates. It is more difficult and costly to
hire qualified personnel in these areas.
HOW2'S MARKETS ARE HIGHLY COMPETITIVE.
o The rebate and fulfillment industry is highly competitive and
fragmented. How2 expects competition to persist and to intensify in
the future. Its competitors include small firms offering specific
promotion fulfillment applications, divisions of larger entities and
large independent firms, such as Young America Corporation and
Continental Promotions Group.
o Many of How2's current and potential competitors have longer operating
histories, significantly greater financial, technical, marketing,
production and other resources. In addition, some have significantly
greater name recognition and a larger base of customers, and many have
well-established relationships with How2's current and potential
clients and have extensive knowledge of its industry.
HOW2 MAY NEED TO CONTINUE TO MAKE ACQUISITIONS IN ORDER TO REMAIN COMPETITIVE IN
ITS MARKET. ITS BUSINESS COULD BE ADVERSELY AFFECTED AS A RESULT OF ANY OF THESE
FUTURE ACQUISITIONS.
o In order to remain competitive, How2 may need to acquire additional
businesses, products, technologies, expertise or other resources. How2
may not be able to identify suitable acquisition candidates or
negotiate terms of acquisitions successfully, finance the acquisitions
or integrate the acquired operations into its existing business. If
How2 consummates significant acquisitions in which the consideration
consists of stock or other equity securities, stock ownership could be
significantly diluted. If How2 proceeds with significant acquisitions
in which the consideration includes cash, How2 could have to use a
substantial portion of its available cash, including proceeds from its
initial public offering, if consummated, to complete these
acquisitions. Acquisition financing may not be available on favorable
terms, or at all. In addition, How2 may be required to amortize
significant amounts of goodwill and other intangible assets in
connection with past and future acquisitions, which would adversely
affect its results of operations.
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HOW2 FACES POTENTIAL CONFLICTS OF INTERESTS RELATING TO CT HOLDINGS.
o Because of its relationship with CT Holdings, which owned 45.2% of
How2's common stock at December 31, 1999, and its interlocking
directors, officers and stockholders, who collectively own 20.7% of
its common stock as of December 31, 1999, How2 is likely to face
potential conflicts of interest relating to CT Holdings.
o Executives, employees and consultants associated with CT Holdings
assisted in the development of How2's business model. Steven B.
Solomon, CT Holdings' CEO and President, is the founder, Chairman and
CEO of How2.com. In addition, Kenneth R. Johnsen, How2's President and
COO, Lawrence Lacerte, Victor K. Kiam II, Mark Rogers, Chris A.
Economou and Edward A. Pierce serve as directors of both CT Holdings
and How2.
o Some of How2's executive officers, key employees and directors also
beneficially own, or hold options or warrants to purchase,
approximately 33.0% of the outstanding common stock of CT Holdings as
of December 31, 1999. Steven B. Solomon owned approximately 13.0% of
CT Holdings' common stock as of December 31, 1999.
o Accordingly, conflicts of interest may arise from time to time between
How2 and CT Holdings, particularly with respect to the pursuit of
overlapping business opportunities. How2 has not adopted any formal
plan or arrangement to address these potential conflicts of interest
and intends to review related-party transactions with CT Holdings on a
case-by-case basis.
o Because How2 has interlocking directors and officers with CT Holdings,
there may be inherent conflicts of interest for these directors and
officers related to transactions between How2 and CT Holdings.
Directors may be required to abstain from voting with respect to
matters involving both CT Holdings and How2. How2 may lose valuable
management input from the directors and officers who have conflicts.
HOW2 MAY BE SUED FOR INFORMATION RETRIEVED FROM ITS WEB SITE OR FOR PRODUCTS AND
SERVICES OFFERED THROUGH ITS WEB SITE.
o How2 may be subject to claims relating to the information How2
publishes on its web site. In addition to monetary damages, any such
claims could harm How2's reputation and public image, causing serious
harm to its business.
o In addition, consumers may sue How2 if any of the products or services
that How2 or its clients sell online are defective, fail to perform
properly or injure the user. Any errors, defects or other performance
problems could result in financial or other damage to How2's
customers.
IF THE PROTECTION OF HOW2'S INTELLECTUAL PROPERTY IS INADEQUATE, ITS COMPETITORS
MAY GAIN ACCESS TO ITS CONTENT AND TECHNOLOGY.
o How2 depends on its ability to develop and maintain the proprietary
aspects of its content and technology. To protect its proprietary
content and technology, How2 relies primarily on a combination of
contractual provisions, confidentiality procedures, trade secrets and
patent, copyright and trademark laws.
o How2 seeks to avoid disclosure of its trade secrets through a number
of means including, but not limited to, requiring those persons with
access to its proprietary information to execute confidentiality
agreements and restricting access to its source codes.
o Although How2 has filed three patent applications and one provisional
patent application with respect to its proprietary online rebate
systems and processes, How2 has not received any legal opinion or
conducted full searches regarding the patentability of its
application. How2 has no patents, and may not receive a patent related
to its proprietary online rebate applications. If How2 receives a
patent related to its proprietary rebate application either resulting
from its current patent applications or future applications, How2 may
be unable to claim the filing date of, and priority from, its existing
provisional patent application. How2's future patents, if any, may be
successfully challenged, rendering them invalid or unenforceable, or
may not provide it with any competitive advantages.
o Additionally, other parties may have equal rights to any patents
issued to How2, through claims of inventorship or otherwise, and, if
so, would be able to use the patented technology or license it to
others without How2's consent. The validity and enforceability of
How2's future patents, if any, may also be affected
21
<PAGE> 22
by future legislative actions or judicial decisions, especially to the
extent such future patents may be deemed "method of doing business"
patents.
o Although How2 has filed trademark applications with respect to various
trademarks that it is using in connection with its business, How2 has
not conducted extensive searches regarding the availability of those
trademarks. How2 has received no trademark registrations, and may not
receive any trademarks from its filed trademark applications. Its
trademarks may be successfully challenged or may not provide it with
any competitive advantages. None of How2's trademarks may be
registrable and other parties may have priority of use of such
trademarks or variants thereof.
o There has been a substantial amount of litigation in the Internet
industry regarding intellectual property rights. It is possible that
in the future third parties may claim that How2 or its current or
potential future content, products or services infringe upon their
intellectual property.
HOW2 IS DEPENDENT ON ITS DOMAIN NAMES, AND HOW2 COULD SUFFER LOSSES IF ITS
DOMAIN NAMES ARE NOT PROTECTED.
o How2 currently owns and controls the Internet domain names
"www.how2.com" and "www.how2hq.com" as well as various other related
names. Domain names generally are regulated by international Internet
regulatory bodies. The regulation of domain names in the United States
and in foreign countries is subject to change. Regulatory bodies could
establish additional top-level domains, appoint additional domain name
registrars or modify the requirements for holding domain names. As a
result, How2 may not acquire or maintain the "www.how2.com" and
"www.how2hq.com" domain names in all of the countries in which How2
conducts business.
CAPACITY CONSTRAINTS AND SYSTEM FAILURES COULD HARM HOW2'S BUSINESS.
o If How2 cannot expand its systems to cope with increased demand, or
its technology systems fail to perform, How2 could experience
unanticipated disruptions in service; slower response times; decreased
client service and satisfaction; decreased customer service and
satisfaction; or delays in the introduction of new products and
services.
o How2 uses internally developed and third party systems to operate its
web site, including transaction processing and order management
systems designed to be scalable. How2 does not know whether it will be
able to accurately project the rate or timing of any increases to
allow it to upgrade its systems and infrastructure in a timely manner
to accommodate these increases. Significant outages, delays and other
difficulties due to system failures could cause customers to perceive
How2's service as not functioning properly and, therefore, cause them
to use other online services.
o How2's ability to provide high quality customer service depends on the
efficient, uninterrupted operation of its computer and communications
hardware systems. Its web site may experience periodic system
interruptions from time to time. Its systems and operations are also
vulnerable to damage or interruption from human error, natural
disasters, power loss, telecommunication failures, break-ins,
sabotage, computer viruses, acts of vandalism and similar events.
While How2 plans to establish redundant servers and a mirror site to
provide limited service during system disruptions, How2 does not have
fully redundant systems, a formal disaster recovery plan, alternative
providers of hosting services or a mirror site.
o How2's business is highly dependent on its computer and telephone
equipment and software systems. While How2 maintains backup systems,
the temporary or permanent loss of any of these equipment or systems,
through casualty loss due to events such as fire, flood, earthquake or
tornado, or operating malfunction, could seriously harm its business.
While How2 has property and business interruption insurance, its
insurance may not adequately compensate it for all losses.
ABANDONED PROPERTY LAWS MAY REQUIRE HOW2 TO SURRENDER UNCLAIMED REBATE PAYMENTS
TO A STATE.
o The unclaimed property and escheat laws of each state provide that
under circumstances defined in the state's statutes, holders of
unclaimed or abandoned property, possibly including rebate checks that
consumers do not cash, also called "slippage", must surrender that
property to the state. As a result, any state into which How2 sends
rebate checks could assert that it is entitled to unclaimed rebate
checks that How2 has issued to
22
<PAGE> 23
consumers in that state. As of December 31, 1999, How2 has recognized
slippage of approximately seven percent of the face amount of checks
issued to consumers, or $2.3 million. If one or more states into which
How2 sends a significant number of rebate checks sought to collect
these rebate checks under their escheat laws, its business could be
materially adversely affected.
HOW2 DEPENDS ON INCREASING USE OF THE INTERNET AND ON THE GROWTH OF E-COMMERCE.
IF THE USE OF THE INTERNET AND E-COMMERCE DOES NOT GROW AS ANTICIPATED, ITS
BUSINESS WILL BE MATERIALLY ADVERSELY AFFECTED.
o How2's services depend on the increased acceptance and use of the
Internet as a medium of commerce. Rapid growth in the use of the
Internet is a recent phenomenon. As a result, acceptance and use may
not develop at projected rates and a sufficiently broad base of users
may not adopt the Internet as a medium of commerce.
o How2's business would be materially adversely affected if use of the
Internet does not continue to increase or increases more slowly than
expected; or the Internet does not create a viable commercial
marketplace, inhibiting the development of e-commerce and reducing the
demand for its products and services.
o The Internet may not be accepted as a viable long-term commercial
marketplace for a number of reasons, including: potentially inadequate
development of the necessary communication and computer network
technology, particularly if rapid growth of the Internet continues;
delayed development of enabling technologies and performance
improvements; delays in the development or adoption of new standards
and protocols; increased governmental regulation; and concerns about
security and confidentiality.
INCREASED GOVERNMENT REGULATION COULD LIMIT THE MARKET FOR, OR IMPOSE SALES AND
OTHER TAXES ON THE SALE OF, HOW2'S PRODUCTS AND SERVICES OR ON PRODUCTS AND
SERVICES PURCHASED THROUGH ITS WEB SITE.
o As Internet commerce evolves, How2 expects that federal, state or
foreign agencies will adopt regulations covering issues such as user
privacy, pricing, content and quality of products and services. It is
possible that legislation could expose companies involved in
e-commerce to liability, which could limit the growth of e-commerce.
Legislation could dampen the growth in Internet usage and decrease its
acceptance as a communication and commercial medium. If enacted, these
laws, rules or regulations could limit the market for How2's products
and services.
o How2 does not collect sales or similar taxes for goods and services
purchased through its web site. However, one or more states may seek
to impose sales tax collection obligations on out-of-state companies
like How2 that engage in or facilitate e-commerce. A number of
proposals have been made at the state and local level that would
impose additional taxes on the sale of goods and services over the
Internet. These proposals, if adopted, could substantially impair the
growth of e-commerce and could adversely affect How2's opportunity to
derive financial benefit from such activities.
ONLINE SECURITY BREACHES COULD HARM HOW2'S BUSINESS.
o Substantial or ongoing security breaches of How2's system or other
Internet-based systems could significantly harm its business. It is
possible that advances in computer capabilities, new discoveries or
other developments could result in a compromise or breach of the
technology used by it to protect customer transaction data.
o How2 will incur substantial expense to protect against and remedy
security breaches and their consequences. A party that is able to
circumvent its security systems could steal proprietary information or
cause interruptions in its operations. Security breaches also could
damage its reputation and expose it to a risk of loss or litigation
and possible liability.
o How2 also faces risks associated with security breaches affecting
third parties conducting business over the Internet.
HOW2 IS HEAVILY DEPENDENT ON TELEPHONE, POSTAL AND DELIVERY SERVICES.
o How2 materially relies on services provided by various local and long
distance telephone companies in connection with its rebate and related
services.
23
<PAGE> 24
o How2's business is also materially dependent on the United States
Postal Service and, to a lesser degree, on private delivery companies.
Postal and delivery service rate increases affect the cost of its
mailings and shipments to consumers.
IN THE EVENT OF THE COMPLETION OF HOW2'S INITIAL PUBLIC OFFERING, HOW2'S STOCK
PRICE IS LIKELY TO BE VERY VOLATILE.
o Currently, How2's common stock can not be bought or sold publicly.
Although it is anticipated that the initial public offering price will
be determined based on several factors, the market price after the
offering may vary significantly from the initial offering price. The
market price of How2's common stock is likely to be highly volatile
and could be subject to wide fluctuations in response to factors which
are beyond its control.
o Domestic and international stock markets often experience extreme
price and volume fluctuations. Market fluctuations, as well as general
political and economic conditions, such as a recession or interest
rate or currency rate fluctuations, could adversely affect the market
price of How2's common stock.
o The market prices for stocks of Internet-related and technology
companies, particularly following an initial public offering,
frequently increase to levels that bear no relationship to the
operating performance of these companies. Those market prices
generally are not sustainable and are subject to wide variations. If
How2's common stock trades at levels significantly above its initial
public offering price, its common stock likely will experience a
material decline.
o Sales of a substantial number of shares of How2's common stock in the
public market after its initial public offering could depress the
market price of the How2 common stock and could impair How2's ability
to raise capital through the sale of additional equity securities.
RESULTS OF OPERATIONS
NET REVENUE
During the three months ended November 30, 1999, we had net sales of $311,057, a
decrease of $1,626,397, or 83.9%, over net sales of $1,937,454 for the three
months ended November 30, 1998. For the nine months ended November 30, 1999, we
had net sales of $1,413,449, a decrease of $2,635,516, or 65.1%, over net sales
of $4,048,965 for the nine months ended November 30, 1998. We attribute the
decrease in our software product revenues for the three month period and the
year to date to our focus on our activities as an Internet business incubator,
as well as the closing of our England distributor, the reduction in purchases
from our Japanese distributor, the deferral of OEM/system integrator purchases
as a result of year 2000 issues, and the late introduction of our WinShield
Secure PC products (desktop and network versions). In addition, during the year
we started to transition the sale of our products to large corporate accounts.
During the second quarter, we started to see increased sales to this market
segment with backlog starting to develop. However, during the current quarter,
we encountered significant unexpected sales resistance from this market segment
due to Y2K concerns. Most of the clients we were working with went into a
lock-down during this quarter and as a result, purchases were delayed. As such,
we started to aggressively market our products to smaller accounts which did not
appear to be as sensitive to Y2K issues; however, most of the quarter was over
before we could react and as a result, our sales during the quarter were
significantly adversely affected. In addition to the Y2K issues, during the same
quarter last year, we had the one large system integrator sale that accounted
for approximately 58% of our revenue during the quarter. While this integrator
accounted for approximately $315,000 of the revenues derived during the second
quarter of this fiscal year, they indicated to us last year that they would be
spending most of the rest of calendar year 1999 on Y2K related issues.
COST OF SALES
The costs and expenses incurred in connection with producing our products for
the three months ended November 30, 1999 were $6,833 compared to $33,780 for the
three months ended November 30, 1998, or a decrease of $26,947, or 79.8%. For
the nine months ended November 30, 1999, cost of sales were $54,610, a decrease
of $110,412, or 66.9%, over cost of sales of $165,022 for the nine months ended
November 30, 1998. As a percentage of sales, cost of sales for the three and
nine months ended November 30, 1999 were 2.2% and 3.9%, respectively, versus
1.7% and 4.1% for
24
<PAGE> 25
the three and nine months ended November 30, 1998. The decrease in our cost of
sales for the nine months ended November 30, 1999 over the comparable period
last year can be attributed to the increase in corporate sales as a percentage
of total sales this year over last year. The increase in the percentage during
the current quarter can be attributed to the large system integrator sale during
the three months ended November 30, 1998, as previously discussed.
RESEARCH AND DEVELOPMENT EXPENSE
Research and development costs charged to expense for the three months ended
November 30, 1999, were $99,737 versus $158,996 for the three months ended
November 30, 1998, or a decrease of $59,259, or 37.3%. For the nine months ended
November 30, 1999, research and development costs were $344,607 versus $410,329
for the nine months ended November 30, 1998, or a decrease of $65,722, or 16.0%.
For the three and nine months ended November 30, 1999, we capitalized
approximately $168,000 and $461,000, respectively, versus $75,000 and $820,000
for the comparable periods last year. The increase in costs capitalized for the
three months ended November 30, 1999 related to the development work being
performed on the network version of WinShield Secure PC. The decrease in costs
capitalized for the nine months ended November 30, 1999 related primarily to a
decrease in the level of development work being performed by outside contract
consultants during this period when compared to the same periods last year. Last
year, we spent considerable resources in upgrading their products to be both
Windows 98 and NT compliant. This year, we internally developed our WinShield
Secure PC product ("Secure PC"), the total security solution for desktops. We
launched the desktop version of Secure PC in August 1999, originally scheduled
to be launched in May 1999. The delay was caused by product enhancements
determined to be beneficial to the product after the product's initial alpha and
beta testing. The network version of this product is expected to be launched in
our fourth fiscal quarter of fiscal 2000 (originally scheduled for release in
October 1999). Due to our relatively limited development resources it may be
reasonable to expect that the development of new products and enhancements and
upgrades to existing products may continue to be delayed in the future, which
could have a negative impact of our Citadel Technology software unit's operating
results.
SELLING AND MARKETING EXPENSE
Selling and marketing expense decreased from $983,297 for the three months ended
November 30, 1998 to $417,102 for the three months ended November 30, 1999, a
decrease of $566,195, or 57.6%. For the year, selling and marketing expenses
decreased from $2,413,595 for the nine months ended November 30, 1998 to $
2,177,547 for the nine months ended November 30, 1999. As a percentage of sales,
selling and marketing expenses for the three and nine months ended November 30,
1999 were 134.1% and 154.1%, respectively, versus 50.7% and 59.6% for the three
and nine months ended November 30, 1998, respectively.
During the first quarter, we increased both our general marketing expenditures,
which were aimed at increasing our name and product recognition, as well as
our direct marketing expenditures, which were aimed at a particular market
segment, i.e., education, corporate, government, etc. The majority of these
direct marketing expenditures were front-loaded, i.e., the costs were recognized
then, while the benefits were not expected to be derived until future quarters.
During the current quarter, we started the implementation of our sales specific
marketing program and general cost control program and spent considerably less
on general marketing, as such, these expenses were reduced 57.6% during the
quarter. In addition, in the past, CT Holdings has allocated considerable
resources to building its inside and outside sales infrastructure. CT Holdings
does not anticipate that it will be required to allocate the same amount of
resources in the future due to operational efficiencies introduced during the
quarter. As a result, CT Holdings would anticipate that, in future quarters,
these expenses would continue to be reduced on a dollar basis as CT Holdings
continues to look for ways to be more efficient in its marketing and sales
efforts.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses for the three months ended November 30, 1999
were $217,435 versus $495,065 for the three months ended November 30, 1998, or a
decrease of $277,630, or 56.1%. General and administrative expenses decreased
$529,436, or 43.5%, from $1,216,556 for the nine months ended November 30, 1998
to $687,120
25
<PAGE> 26
for the nine months ended November 30, 1999. The decrease can be attributed to
the cost control programs implemented that we have implemented since May 1999.
We continue to explore ways to reduce our general and administrative expenses
even further, as evidenced by the continued reduction in these expenses this
quarter (reduction this quarter $277,630, versus an average reduction per
quarter of $176,479 for the year).
DEPRECIATION AND AMORTIZATION EXPENSE
Depreciation and amortization expense for the three months ended November 30,
1999 was $358,889, compared to $410,353 for the three months ended November 30,
1998. For the nine months ended November 30, 1999, depreciation and amortization
expense was $1,015,598, compared to $1,134,270 for the nine months ended
November 30, 1998, or a decrease of $118,672, or 10.5%. During the last quarter
of the previous fiscal year, we wrote-off approximately $1,200,000 of purchased
software costs which had the impact of reducing the depreciation and
amortization expense for the three and nine months ended November 30, 1999 by
approximately $125,000 and $375,000, respectively. This reduction was offset by
the commencement of amortization on certain capitalized product development
costs relating to products that became available for sale during the periods.
OTHER INCOME (EXPENSE)
Interest expense for the three months and nine months ended November 30, 1999
was $2,509 and $17,639, respectively, compared to $52,972 and $136,409 for the
three and nine months ended November 30, 1998, respectively. This resulted
primarily from the fact that we had less interest bearing debt during this
period than we did during the same period last year. Equity in loss of
unconsolidated affiliate was $8,655,820 for the three months ended November 30,
1999 and $11,253,865 for the nine months ended November 30, 1999. The large
increase in the loss during the current quarter related to our How2 Internet
subsidiary allocating a considerable amount of resources to its marketing and
advertising programs aimed at building name/brand awareness for its web site and
business-to-business services. We expect that these losses would continue to be
significant for at least the foreseeable future as our Internet subsidiary
continues to develop its business services.
OPERATING LOSS BEFORE EXTRAORDINARY ITEM
As a result of the foregoing, for the three months ended November 30, 1999, we
reported a net loss before extraordinary items of $9,445,485 (which included the
$8,655,820 related to our Internet subsidiary referred to above), compared to a
net loss of $825,929 for the same period last year. For the nine months ended
November 30, 1999, we reported a net loss before extraordinary items of
$14,141,689 (which included $11,253,865 related to our Internet subsidiary)
compared to $2,108,131 for the same period last year.
EXTRAORDINARY ITEM - FORGIVENESS OF DEBT
During the three and nine months ended November 30, 1998, we recognized a gain
on the settlement of debts of $75,354 and $806,421, respectively. These gains
related primarily to the restructuring of a note payable to Inxight, a division
of Xerox. In connection with the restructuring, Inxight agreed to reduce the
principal amount of the note and accrued interest due from us by $520,816. In
exchange we agreed to a shorter maturity on the note and the issuance of 250,000
shares of our common stock to Inxight (valued at $92,500 as of the date of the
transaction). The value of the stock was been treated as a reduction in the gain
associated with the transaction. The remaining balance relates to miscellaneous
gains recognized by us associated with the settlement of balances due various
vendors during the period.
NET LOSS
As a result of these factors, for the three and nine months ended November 30,
1999, we reported a net loss of $9,445,485 and $14,141,689 respectively,
compared to a net loss of $752,575 and $1,301,710 for the three and nine months
ended November 30, 1998.
26
<PAGE> 27
DIVIDENDS ON PREFERRED STOCK
Preferred stock dividends consisted primarily of dividends accrued on Series D
preferred stock. In June 1999, we converted $2,000,000 of Series D preferred
stock, plus dividends in arrears of approximately $238,000, into 2,081,937
shares of our common stock.
YEAR 2000 COMPLIANCE
Even though the date is now past January 1, 2000, and we experienced no
immediate adverse impact from the transition to the year 2000, we cannot provide
any assurance that our key partners, suppliers or customers have not been
affected in a manner that is not yet apparent. In addition, certain computer
programs which were date sensitive to the year 2000 may not have been programmed
to process the year 2000 as a leap year, and any negative consequential effects
remain unknown. As a result, we will continue to monitor our year 2000
compliance and the year 2000 compliance of our key partners, suppliers and
customers. The financial impact of Year 2000 compliance has not been, and is not
expected to be, material to our financial position or results of operations in
any given year.
LIQUIDITY AND CAPITAL RESOURCES
Our cash and cash equivalents at November 30, 1999 were $178,344.
Cash flows from operations were a negative $2,574,147 for the nine months ended
November 30, 1999, compared to negative $4,168,066 for the nine months ended
November 30, 1998. This decrease was primarily due to an increase in our
accounts receivable turnover offset by an increase in our accounts payable
turnover and an increase in the net loss for the period.
Cash used in investing activities were approximately $547,557 for the nine
months ended November 30, 1999, compared to approximately $946,521 for the same
period last year. This decreased resulted from our spending less on software
development activities this period.
Cash flows provided by financing activities were $1,089,672 for the nine months
ended November 30, 1999, compared to $5,721,801 for the nine months ended
November 30, 1998. This decrease was due primarily to less capital being raised
by us during this period.
As a result of the aforementioned factors, cash and cash equivalents decreased
by $2,032,033 for the nine months ended November 30, 1999, versus an increase of
approximately $607,214 for the same period last year.
During the second quarter of the fiscal year, we started to implement various
cost control and reduction measures aimed at decreasing our operational overhead
and made various operational changes aimed at making us more efficient. For the
quarter ended November 30, 1999, these changes alone saved us over $950,000
($1,095,163 for the quarter ended November 30, 1999 versus $2,147,713 for the
quarter ended November 30, 1998). We continue to look for ways to cut our
overhead costs, while not impairing our operational efficiencies or our software
products' competitive advantage.
Unless software sales increase, we may need to seek additional capital to fund
our Citadel Technology operations for at least the remainder of the fiscal year.
Moreover, we will need additional capital resources to implement our new B2B
incubation business model. While we have been successful in the past in raising
additional capital when needed, there can be no assurances that we will be
successful in the future, or if successful, that capital will be available on
acceptable terms or will not have a dilutive effect on existing shareholders.
27
<PAGE> 28
PART II. OTHER INFORMATION
Except as listed below, all information required by Part II is omitted because
the items are inapplicable or the answer is negative.
ITEM 1. LEGAL PROCEEDINGS
We and one of our officers were involved in an arbitration proceeding with
Vestcom Ltd., which claimed compensation and a finder's fee for introducing us
to a third party. Vestcom sought damages of the value of 100,000 shares of our
common stock (alleged to be valued at $1,900,000), plus 50% of additional
compensation paid by us to the third party. We filed a declaratory judgment
action against Vestcom to determine that the alleged contract was not valid
based on our defenses. The case was 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 court entered a judgment and
preliminary injunction in favor of us and our officer that the purported
agreement was a forgery. As a result, the arbitration proceeding was dismissed
by the American Arbitration Association. The defendant appealed the decision of
the Texas court. In November 1998, Vestcom filed a lawsuit against us in Texas
state court styled Vestcom v. Citadel in the 68th Judicial Court, Dallas County,
Texas, reasserting the same basic claims as in the arbitration proceeding. In
January 2000 the parties reached an agreement to settle the suit for the
original amount of the warrants claimed (100,000 shares with an exercise price
of $1.375 per share).
We are a party to certain other legal proceedings. At this time, we are unable
to predict the ultimate outcome of these proceedings, the costs associated with
defending the claims and pursuing counterclaims, and monetary compensation
awarded, if any. Unfavorable resolutions of these proceedings or the costs of
litigation and settlement could have a material adverse effect on our results of
operations or financial condition.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
SALES OF UNREGISTERED SECURITIES DURING THE QUARTER
In the quarter our subsidiary, How2.com, issued 416,125 shares of its common
stock pursuant to private placements to accredited investors under Section 4(2)
of the Securities Act, for commitments for proceeds of $3,143,780.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Exhibit 27 Financial Data Schedule
(b) REPORTS ON FORM 8-K.
No reports on Form 8-K were filed during the quarter ended November 30,
1999.
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<PAGE> 29
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.
CT HOLDINGS, INC.
(FORMERLY CITADEL TECHNOLOGY, INC.)
<TABLE>
<S> <C>
Date: January 14, 2000 By: /s/ STEVEN B. SOLOMON
-------------------------------------------------------------
Steven B. Solomon, President and Chief Executive Officer
(Duly Authorized Signatory and Principal Executive Officer)
By: /s/ RICHARD L. TRAVIS, JR.
-------------------------------------------------------------
Richard L. Travis, Jr., Chief Operating and Financial Officer
(Duly Authorized Signatory and Principal Financial Officer)
</TABLE>
29
<PAGE> 30
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
27 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS OF CT HOLDINGS, INC. FOR THE NINE MONTHS ENDED
NOVEMBER 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
CONSOLIDATED FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> FEB-28-2000
<PERIOD-START> MAR-01-1999
<PERIOD-END> NOV-30-1999
<CASH> 178,344
<SECURITIES> 0
<RECEIVABLES> 1,287,628
<ALLOWANCES> 963,729
<INVENTORY> 144,522
<CURRENT-ASSETS> 947,986
<PP&E> 967,341
<DEPRECIATION> 681,494
<TOTAL-ASSETS> 10,306,634
<CURRENT-LIABILITIES> 1,299,149
<BONDS> 0
0
0
<COMMON> 474,433
<OTHER-SE> 8,533,052
<TOTAL-LIABILITY-AND-EQUITY> 10,306,634
<SALES> 1,413,449
<TOTAL-REVENUES> 1,413,449
<CGS> 54,610
<TOTAL-COSTS> 54,610
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 17,638
<INCOME-PRETAX> (14,141,689)
<INCOME-TAX> 0
<INCOME-CONTINUING> (14,141,689)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (14,141,689)
<EPS-BASIC> (.34)
<EPS-DILUTED> (.34)
</TABLE>
