<PAGE>
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 SEPTEMBER 30, 2000
[_] 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)
(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 November 8, 2000
Common Stock, Par value $.01 per share 49,660,712
Transitional Small Business Disclosure Format Yes [_] No [X]
<PAGE>
CT HOLDINGS, INC.
FORM 10-QSB
QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Page
----
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
as of September 30, 2000 and February 29, 2000 ................... 3
Condensed Consolidated Statements of Operations
for the three and seven months ended September 30, 2000 and 1999 . 5
Condensed Consolidated Statements of Cash Flow
for the seven months ended September 30, 2000 and 1999 .......... 6
Notes to Condensed Consolidated Financial Statements ............. 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ............................
PART II. OTHER INFORMATION
Item 1. Legal Proceedings .................................................
Item 2. Changes in Securities and Use of Proceeds .........................
Item 5. Other Information ................................................
Item 6. Exhibits and Reports on Form 8-K ..................................
Signatures ................................................................
2
<PAGE>
PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CT HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, FEBRUARY 29,
ASSETS 2000 2000
----------- ------------
(UNAUDITED)
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $1,310,840 $ 707,412
Accounts receivable, less allowance for returns and
doubtful accounts of $1,100,000 and $1,100,000 168,027 55,241
Accounts receivable, other 24,000 --
Notes receivable from related parties 208,934 208,934
Notes receivable from affiliates 600,000 --
Inventory 76,733 80,617
Prepaid expenses 19,631 78,535
---------- ----------
Total current assets 2,408,165 1,130,739
INVESTMENT IN UNCONSOLIDATED AFFILIATES 2,755,775 827,350
PROPERTY AND EQUIPMENT, net 126,598 228,102
PURCHASED SOFTWARE, net of accumulated
amortization of $1,729,648 and $1,505,536 322,752 546,864
CAPITALIZED SOFTWARE DEVELOPMENT COSTS,
net of accumulated amortization of $1,105,760 and $785,762 726,936 944,674
OTHER ASSETS 42,095 154,308
---------- ----------
$6,382,321 $3,832,037
========== ==========
</TABLE>
The accompanying notes are an integral part of these statements.
3
<PAGE>
CT HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS - CONTINUED
<TABLE>
<CAPTION>
SEPTEMBER 30, FEBRUARY 29,
LIABILITIES AND STOCKHOLDERS' EQUITY 2000 2000
------------- ------------
(UNAUDITED)
<S> <C> <C>
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 708,815 $ 1,030,501
Accrual for legal settlement 1,912,500 --
Payable to affiliate 71,299 71,299
Current maturities of long-term debt 150,000 150,000
Notes payable 27,500 111,288
------------ ------------
Total current liabilities 2,870,114 1,363,088
Total liabilities 2,870,114 1,363,088
COMMITMENTS AND CONTINGENCIES -- --
STOCKHOLDERS' EQUITY
Common stock, $.01 par value per share; authorized 60,000,000
shares; issued, 53,825,325 shares at September 30,
2000 and 50,136,400 shares at February 29, 2000 538,253 501,364
Preferred stock, $.01 par value per share;
authorized 1,000,000 shares; issued and outstanding
Series B convertible, 50 shares (liquidation value $50,000) 1 1
Additional paid-in capital 56,356,829 50,390,070
Accumulated deficit (49,547,115) (44,586,725)
Notes receivable for exercise of options/warrants (1,335,522) (1,335,522)
Treasury stock, at cost (4,164,613 shares) (2,500,239) (2,500,239)
------------ ------------
Total stockholders' equity 3,512,207 2,468,949
------------ ------------
$ 6,382,321 $ 3,832,037
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
4
<PAGE>
CT HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEVEN MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2000 1999 2000 1999
------------- ------------ --------- ----------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Net sales $ 200,614 $ 793,030 $ 412,825 $1,175,617
Cost of sales, excluding depreciation and
amortization 2,316 6,981 47,900
------------- ------------ ----------- -----------
Gross profit 198,298 772,920 405,844 1,127,717
Operating expenses
Selling, general and administrative
expense 458,378 662,898 1,474,777 2,473,620
Research and development expenses -- 94,287 112,992 244,870
Nonrecurring litigation settlement charge -- -- 1,912,500 --
Depreciation and amortization expense 269,335 428,350 657,828 855,998
------------- ------------ ----------- -----------
727,713 1,185,535 4,158,097 3,574,488
------------- ------------ ----------- -----------
Operating loss (529,415) (412,615) (3,752,253) (2,446,771)
Other income (expense)
Interest (expense) (352) (2,923) (1,883) (16,134)
Settlement of lawsuits (9,232) (46,500) (15,076) (25,000)
Other 15,000 54,851 29,338 21,555
Equity in loss of unconsolidated
affiliate (105,734) (3,779,733) (1,220,516) (4,855,462)
------------- ------------ ----------- -----------
(100,318) (3,774,305) (1,208,137) (4,875,041)
------------- ------------ ----------- -----------
Net loss (629,733) (4,186,920) (4,960,390) (7,321,812)
Preferred stock dividend requirement -- (9,041) -- (64,493)
------------- ------------ ----------- -----------
Net loss allocable to common
stockholders $ (629,733) $ (4,195,961) $(4,960,390) $(7,386,305)
============= ============ =========== ===========
Loss per share - basic and diluted
Net loss per share $ (0.01) $ (0.10) $ (0.10) $ (0.18)
============= ============ =========== ===========
Weighted average shares outstanding 48,252,675 43,192,209 47,289,391 41,851,728
============= ============ =========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
5
<PAGE>
CT HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SEVEN MONTHS ENDED
SEPTEMBER 30,
2000 1999
------------ ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (4,960,390) $ (7,321,812)
Adjustments to reconcile net loss to net cash
used by operating activities
Depreciation and amortization 657,828 855,998
Equity in loss of unconsolidated affiliate 1,220,516 4,855,462
Common stock and options issued as payment
of expenses 30,439 --
Noncash employee severance 556,725 --
Changes in operating assets and liabilities
Accounts receivable (136,786) (218,828)
Notes receivable from related parties -- 5,201
Prepaid expenses 58,904 131,865
Inventory 3,884 (656)
Software development costs (102,261) (313,376)
Accounts payable and accrued expenses (321,686) (1,038,877)
Accrual for legal settlement 1,912,500 289,907
Other assets (168,857) 102,302
------------ ------------
NET CASH USED BY OPERATING ACTIVITIES (1,249,184) (2,652,814)
CASH FLOWS FROM INVESTING ACTIVITIES
Increase in notes receivable from affiliates (600,000) --
Capital expenditures -- (70,388)
Cash contributions to unconsolidated affiliate -- (140,786)
Reduction in cash due to deconsolidation of Parago, Inc. -- (1,176,292)
------------ ------------
NET CASH USED BY INVESTING ACTIVITIES (600,000) (1,387,466)
CASH FLOW FROM FINANCING ACTIVITIES
Payments on notes payable (433,788) (219,347)
Proceeds from notes payable 350,000 --
Proceeds from sale of common stock 2,536,400 873,258
------------ ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 2,452,612 653,911
------------ ------------
Net increase (decrease) in cash
and cash equivalents 603,428 (3,386,369)
Cash and cash equivalents at the beginning
of the period 707,412 3,386,369
------------ ------------
Cash and cash equivalents at the end
of the period $ 1,310,840 $ --
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
6
<PAGE>
CT HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION AND DESCRIPTION OF BUSINESS
CT Holdings, Inc., formerly Citadel Technology, Inc., and its majority-owned
subsidiaries (collectively, "CT Holdings") is an incubator of Internet service
companies that provides early stage ventures with a single source of management
capital, as well as consulting on operations, marketing and strategic planning.
Its incubator model is designed to enable the start up companies with whom it
partners to become online market leaders in their industries. CT Holdings began
its Internet activities in 1999 with the formation of Parago, Inc., an
application service provider (ASP) and Internet based business process
outsourcer (BPO) that provides an online suite of offerings designed to increase
sales, reduce costs, retain customers and increase client profitability. These
services include online promotional management, online rebate processing,
proactive email, online surveys, online multimedia product demonstrations and
manuals, and online customer data warehousing, analysis and reporting. Parago's
comprehensive integrated suite of outsourced customer care solutions are
marketed across multiple industry lines. In May 2000, CT Holdings acquired a
minority interest in River Logic, Inc., which is headquartered in Beverly,
Massachusetts and creates and operates integrated decision support networks for
industries such as K-12 education, utilities, forest products, health care and
others. These networks are designed to leverage the flow and processing of
knowledge and information to provide a competitive advantage. Inherent in the
incubation of early stage ventures are risks that our investments may become
impaired and could result in the complete loss of the Company's investments.
(See Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations - General Risks).
In addition to its incubation business, CT Holdings continues to operate its
"Citadel Technology" security software line, which is focused on developing and
marketing security and administration software products for both computer
networks and desktop personal computers. Its 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.
The 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.
CT Holdings' core focus is on its incubation services, and CT Holdings is
currently analyzing various strategic alternatives for its 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 line. As a result, management
believes that the results of operations for the Citadel Technology security
software business will continue to be adversely affected in the future by CT
Holdings' core focus on incubation services.
The consolidated financial statements of CT Holdings as of September 30, 2000
and for the three and seven month periods ended September 30, 2000 and September
30, 1999 are unaudited and, in the opinion of management, contain all
adjustments 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 29, 2000. The results of operations for the three and seven month
periods ended September 30, 2000 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 October 2000, CT Holdings changed its fiscal year end from February 28 to
December 31. Therefore, the seven months ended September 30, 2000 represents the
period from March 1, 2000 through September 30, 2000. The fiscal year ending
December 31, 2000 will be a transition period consisting of a ten month period.
Principles of Accounting for Ownership Interests in Investees
The ownership interests that the Company holds in Parago, Inc. ("Parago"),
formerly How2.com, and River Logic, Inc. ("River Logic") as of September 30,
2000 have been accounted for under the equity method for Parago and the cost
method for River Logic. The Company records its investments in equity-method and
cost-method investees on its consolidated balance sheets as "Investment in
Unconsolidated Affiliates" and its share of the equity-method investee's losses
in "Equity in Loss of Unconsolidated Affiliate."
7
<PAGE>
CT HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
NOTE 1. BASIS OF PRESENTATION -- CONTINUED
For the three and seven month periods ended September 30, 2000, the Company's
investment in Parago is presented under the equity method of accounting, because
the Company has the ability to exercise significant influence, but not control,
over the investee. Significant influence generally represents an ownership
interest of the affiliate's voting stock of between 20% and 50%. Accordingly,
under the equity method of accounting, the Company's share of the investee's
income or losses is included in the consolidated statements of operations. Under
the equity method, when Parago sells its common stock to unrelated parties at a
price in excess of its book value, the Company's net investment in that
affiliate increases. The Company records a contribution to additional paid in
capital representing the difference between the carrying value of the Company's
investment and its proportionate share of the underlying net book value of the
affiliate after sales of the affiliate's common stock to unrelated parties. The
Company's share of any changes in the affiliate's net book value due to stock
based compensation incurred by the affiliate is recorded as income by the
Company within the "equity in loss of unconsolidated affiliate." If the carrying
value of the Company's net investment falls below zero, the Company is required
by the guidelines set forth under the equity method of accounting to discontinue
applying the equity method until the carrying value of the net investment rises
above zero. In addition, in the event the value of the Company's equity
investment rises above zero, the Company will resume applying the equity method
and will recognize an investment in Parago after the Company's share of net
losses not recognized during the period the equity method was suspended are
recovered by income or an increase in equity. As of September 30, 2000, the
Company's share of Parago's net losses during the period the equity method was
suspended was approximately $8 million. The Company continues to hold 20,000,000
shares of common stock of Parago at September 30, 2000.
Because the Company owned less than 20% of the ownership interest in River Logic
at September 30, 2000 the investment has been accounted for under the cost
method of accounting. Under this method, the Company's share of the income or
losses of River Logic is not included in the Company's consolidated statements
of operations. As discussed above, our investment in Parago was reduced to below
zero for accounting purposes and, therefore, not recognized on our consolidated
balance sheet at September 30, 2000. Accordingly, the investment in affiliate at
September 30, 2000 represents our investment in River Logic.
Reclassifications
Certain amounts for the three and seven month periods ended September 30, 1999
have been reclassified to conform to the presentation for the three and seven
month periods ended September 30, 2000.
Net Loss Per Common Share
Basic loss per common share is computed by dividing net loss by the weighted
average number of shares of common stock outstanding during the period. Basic
loss per share excludes any dilutive effects of options. Diluted loss per common
share includes the dilutive effect of options and warrants calculated using the
treasury stock method, and, includes the effect of convertible preferred stock
using the if-converted method. Stock options and warrants to purchase 5,784,105
shares of common stock have been excluded from the computation of diluted loss
per share, as the effect would be anti-dilutive. In addition, approximately
41,000 shares (based on the price per share for the Company's common stock on
September 30, 2000), which would be issued upon the conversion of Series B
preferred stock, have been excluded from the computation of loss per share.
Cash Flow Requirements
Since inception, we have incurred losses, and at September 30, 2000, we had an
accumulated deficit of $49,547,115 and our current liabilities exceeded our
current assets by $461,949. Our ultimate success in fully implementing our new
strategy, continuing our existing business line and meeting our cash flow
obligations is dependent on our ability to raise additional capital, as to which
there can be no assurances. While the Company currently believes that it has the
ability to obtain additional equity or debt financing, we have received a
commitment from our President to fund up to $1,500,000 of our expected operating
cash flow needs through March 1, 2001 in the event the Company's cash flows from
operating, investing and financing activities are insufficient to meet the
expected operating obligations of the Company as they come due. We had used
approximately $400,000 of this commitment through July 17, 2000; however, this
amount was repaid to our President as of September 30, 2000. We also plan to
sell stock in private equity financings during fiscal year 2001 to cover cash
flow deficiencies not covered by the
8
<PAGE>
CT HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
NOTE 1. BASIS OF PRESENTATION -- CONTINUED
commitment by our President. During the quarter ended September 30, 2000, we
sold 2,500,000 restricted shares of common stock to members of our Board of
Directors for $2,500,000. We expect that our equity investee, Parago, will incur
losses in the foreseeable future as it continues to develop and upgrade its
technology and infrastructure, develop and expand its product and service
offerings, establish and sustain relationships with manufacturers, retailers and
service organizations. If Parago does not complete an initial public offering or
find an alternative source of funds, its business and results of operations will
be seriously harmed.
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.
NOTE 2. CAPITAL TRANSACTIONS
During the quarter ended September 30, 2000, CT Holdings sold 2,500,000
restricted shares of its common stock to two members of its Board of Directors
for $2,500,000.
During the quarter ended May 31, 2000 CT Holdings issued 55,583 shares of its
common stock in connection with the exercise of certain options and warrants for
net proceeds of $36,400. The Company and its former Vice President of Business
Development agreed to terminate the employee's employment with the Company and
his employment agreement was terminated effective March 1, 2000. In connection
with the termination of his employment agreement, the former employee and the
Company entered into a Settlement and Release Agreement which provides, among
other things, for the accelerated vesting of his 83,342 remaining options, the
waiver of payment of the exercise price of those options, and the former
employee's forfeiture of any right to severance payments, resulting in a charge
of $556,725 for the quarter ended May 31, 2000.
On May 5, 2000, CT Holdings completed a previously announced transaction whereby
it acquired a significant minority interest in River Logic, Inc., a Delaware
corporation formerly known as iNetze.com, Inc. The Company acquired an aggregate
of approximately 5.9% of the outstanding shares of capital stock (as of May 5,
2000) of River Logic, Inc. ("River Logic") from Robert C. Whitehair, Tim
Collins, and F. Shanahan McAdoo in exchange for 333,333 shares of the Company's
common stock. The Company also acquired shares of Series A Convertible Preferred
Stock from River Logic in exchange for the contribution by a wholly-owned
subsidiary of the Company of certain assets (the "ESRN Network"), as described
below. The acquired shares of Series A Convertible Preferred Stock are
convertible into shares of common stock that, upon conversion, would represent
approximately 13.1% of the outstanding shares of capital stock of River Logic as
of May 5, 2000. In connection with the transaction, the Company, River Logic and
certain of River Logic's stockholders entered into a Stockholders Agreement
providing for, among other things, restrictions on the transferability of River
Logic securities, rights of first refusal and co-sale with respect to River
Logic securities, and registration rights with respect to River Logic
securities. The Stockholders Agreement also provides the Company with the right
to appoint one member of River Logic's Board of Directors so long as the Company
continues to own at least 10% of River Logic's capital stock on a fully diluted
basis.
In connection with the transaction, the Company also made two $300,000 bridge
loans to River Logic that together are convertible into 800,000 shares, in the
aggregate, of common stock that, upon conversion, would represent approximately
3.8% of the outstanding capital stock of River Logic as of May 5, 2000. Each of
the bridge loans (i) bears interest at a rate of 12% per annum through its first
anniversary and at one percent above the prime rate per annum thereafter, (ii)
is secured by certain assets of River Logic, (iii) is payable upon the Company's
demand and (iv) is prepayable by River Logic commencing on its third anniversary
date. As a result of the transaction, the Company possesses approximately 19%
(22.2% in the event the bridge loans are converted in full) of the voting power
with respect to River Logic as of May 5, 2000.
9
<PAGE>
CT HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
NOTE 2. CAPITAL TRANSACTIONS -- CONTINUED
The ESRN Network consists of the EBSCO School Resource Network, an educational
network catering to kindergarten through 12th grade ("K-12"). The ESRN Network
is designed to support school administrators, teachers, students and parents by
providing them with a comprehensive set of tools and resources targeting their
specific needs and is comprised of learning applications that integrate EBSCO
Industries' database of content relating to K-12. The ESRN Network was acquired
by a wholly-owned subsidiary of the Company from EBSCO Industries in connection
with the transaction in exchange for 666,667 shares of the Company's common
stock.
The consideration paid by the Company in connection with the transaction was
determined on the basis of arm's-length negotiations between the parties.
Although the Company also received an option to purchase certain additional
shares of capital stock of River Logic, the Company elected not to exercise this
option prior to its expiration.
River Logic, headquartered in Beverly, Massachusetts, creates and operates
integrated decision support networks for industries such as K-12 Education. In
addition to K-12 education, River Logic has several other industry-specific
networks in development.
The Company has announced that it intends to distribute to its shareholders,
shares of common stock of Parago upon compliance with Securities and Exchange
Commission (SEC) requirements applicable to CT Holdings and Parago in connection
with the proposed spin-off and upon the expiration of a 180 day lockup agreement
between the underwriters of Parago's proposed initial public offering and
Parago. Compliance with SEC requirements and state law requirements could delay
or prevent the completion of the spin-off. There can be no assurances that CT
Holdings will be able to effect the distribution of the shares of Parago to CT
Holdings' stockholders on a timely basis or at all.
In addition, CT Holdings has agreed to convert certain shares of Parago common
stock issued in connection with certain acquisitions by Parago as well as issued
pursuant to the terms of the stock purchase agreements between Parago and some
of its stockholders into shares of CT Holdings common stock. This could result
in the issuance of up to 500,000 additional shares of CT Holdings common stock
(in connection with Parago's acquisition of 2-Lane Media) and up to 414,000
additional shares of CT Holdings common stock at a conversion price of $3.75 per
share (in connection with the stock purchase agreements), which would have the
effect of diluting CT Holding's stockholders if the market price for CT
Holding's stock is above that price at the time of conversion.
NOTE 3. INVESTMENT IN UNCONSOLIDATED AFFILIATE
In the first quarter of fiscal year 2000, the Company accounted for its
investment in Parago under the consolidation method. Through subsequent sale and
distribution by Parago of shares of its common stock, the Company's ownership
was reduced below 50% beginning in July 1999. As a result, beginning July 1999,
the Company began accounting for its remaining investment in Parago under the
equity method of accounting rather than the consolidated method. Prior to these
events, the operating results of Parago were consolidated in the Company's
consolidated financial statements. At September 30, 2000, the Company owns 45%
of Parago's outstanding shares of common stock.
From January to March 2000, Parago raised an aggregate of $36,500,000, including
$21,500,000 through the issuance of 430,000 shares of Series C Convertible
Preferred Stock to THLee.Putnam Internet Partners LP, Dain Rauscher Wessels
Investors LLC and Watershed Capital I, L.P. At the time of issuance, the Series
C preferred stock is convertible into 4,300,000 shares of Parago common stock.
In addition, in September 2000, Parago sold an additional $10,000,000 in Series
D Preferred Stock to THLee.Putnam and Watershed Capital, with a commitment for
and additional $5,000,000 from THLee.Putnam subject to customary closing
conditions including satisfaction of Hart-Scott-Rodino requirements related to
the investment. In connection with the Series A, B, C and D preferred stock
financings, the preferred stockholders were issued approximately 5,618,000
warrants to purchase common stock. The warrants vest immediately and have a
weighted average exercise price of $1.25.
10
<PAGE>
CT HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
NOTE 3. INVESTMENT IN UNCONSOLIDATED AFFILIATE -- CONTINUED
The following is the unaudited condensed financial information of Parago at
September 30, 2000 and for the three and seven months then ended.
SUMMARIZED BALANCE SHEET SEPTEMBER 30, 2000
------------------------ ------------------
Current assets $ 13,949,928
Noncurrent assets 24,046,727
------------------
Total assets $ 37,996,665
==================
Current liabilities $ 16,509,538
Long-term debt 1,326,415
------------------
Total liabilities 17,835,953
------------------
Redeemable common stock 2,000,000
Shareholders' equity 18,160,702
------------------
$ 37,996,655
==================
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEVEN MONTHS ENDED
SUMMARIZED STATEMENT OF OPERATIONS SEPTEMBER 30, 2000 SEPTEMBER 30, 2000
---------------------------------- ------------------ -----------------
<S> <C> <C>
Revenues $ 5,564,207 $ 10,583,482
Operating expenses 13,477,343 30,681,566
Loss on sale of assets 1,490,000 1,490,000
Net loss (9,464,618) (21,678,517)
</TABLE>
NOTE 4. COMMITMENTS AND CONTINGENCIES
On January 7, 1998, the Company's former Houston landlord filed a lawsuit
against the Company alleging that the Company breached a certain lease covering
the Company's former Houston office space. The suit seeks damages to date of
approximately $486,000, plus attorney's fees, pre and post judgment interest and
court costs. In July 1999, the parties reached an agreement in principle to
settle the suit for $325,000 to be paid over nine months. This settlement was
paid in full as of September 30, 2000.
In January 2000 the parties in the previously disclosed Vestcom v. Citadel
lawsuit 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).
This action was dismissed for want of prosecution on the announcement of
settlement by the parties. Assuming Vestcom received actual or constructive
notice of that dismissal near the time of its entry, the Company believes that
the time to seek reinstatement of the case, a new trial, or review before the
Court of Appeals has expired. However, as of the date of issuance of these
financial statements, no binding agreement has been signed by both parties.
In July 2000, following mediation of the disputes between us and Janssen-Meyers
Associates L.P. ("JMA"), we and JMA entered into an agreement to settle the
lawsuit for $1.5 million in cash and 300,000 shares of common stock with a
guaranteed value of $5 per share as of January, April and October, 2001, subject
to execution of definitive settlement documents and approval of the boards of
directors of the companies. The Company recorded an estimated accrual for legal
settlement as of May 31, 2000 for $1,912,500. The Company may be required to
record additional charges (in the amount of the difference between $1.5 million
and the gross proceeds from the sales of the stock by JMA at the relevant
periods) in the event its shares of common stock do not trade above $5 per share
for the five consecutive trading days during the guarantee periods. In August
1998, JMA filed a lawsuit against us arising out of an alleged 1995 contract
with our predecessor "("Old Citadel"). The suit alleged that Old Citadel
breached a letter of intent dated September 1995 and/or a Placement Agency
Agreement dated November 1995 between JMA and Old Citadel. As its damages, JMA
claimed that it was entitled to, among other things, the cash value of 1.8
million $0.89 warrants valued during May 1996. According to JMA's valuation of
those warrants, potential damages were alleged to exceed $40 million. The
Company vigorously disputes that it breached either the letter of intent or the
Placement Agency Agreement or that it is liable to JMA. The lawsuit was styled
Janssen-Meyers Associates, L.P. v. Citadel Technology, Inc., and was filed in
the Supreme Court of the State of New York, County of New York. The Company has
also filed a lawsuit against JMA to recover excess amounts charged by JMA in
connection with related bridge loans.
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CT HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
NOTE 4. COMMITMENTS AND CONTINGENCIES -- CONTINUED
In June 2000, the Company was served with a lawsuit filed in state court in
Houston, Texas by Michael and Patricia Ferguson for breach of contract, tortious
interference and negligence. Specifically, the Fergusons claim that they were
damaged when they attempted to exercise certain warrants during a time when the
Company's related registration statement could not be used. On June 29, 2000,
the Company moved to transfer venue from Harris County, Texas, to Dallas County,
Texas. On June 30, 2000, the Company answered (subject to its Motion to Transfer
Venue). On July 28, 2000, also subject to its Motion to Transfer, the Company
filed a third party petition against Yorkton Securities, Inc. and Yorkton
Capital, Inc., which acted as the Fergusons' broker in connection with the
transaction at issue. In the third party petition, the Company contends that the
Yorkton entities are liable to the Company based on negligence and contribution
for, among other things, failing to disclose to the Fergusons that the
registration statement could not be used. The Company believes that the claims
asserted by the Fergusons are without merit and will vigorously defend the
claims and the Company will vigorously prosecute the claims it has filed against
Yorkton Securities.
At this time, the Company is unable to predict the ultimate outcome of some of
these suits, the costs associated with defending the claims and pursuing
counterclaims, and monetary compensation awarded, if any. The Company has, when
appropriate, recorded its current estimate of the amounts necessary to settle
the litigation.
The Company is also involved in other litigation. Such litigation is not
material to the Company's consolidated financial condition or results of
operations.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
We are an incubator of Internet service companies that provides early stage
ventures with a single source of management capital, as well as consulting on
operations, marketing and strategic planning. Our incubator model is designed to
enable the start up companies with whom we partner to become online market
leaders in their industries. We began our Internet activities in 1999 with the
formation of Parago, Inc., an application service provider (ASP) and Internet
based business process outsourcer (BPO) that provides an online suite of
offerings designed to increase sales, reduce costs, retain customers and
increase client profitability. These services include online promotional
management, online rebate processing, proactive email, online surveys, online
multimedia product demonstrations and manuals, and online customer data
warehousing, analysis and reporting. Parago's comprehensive integrated suite of
outsourced customer care solutions are marketed across multiple industry lines.
In May 2000, we acquired a minority interest in River Logic, Inc., which is
headquartered in Beverly, Massachusetts and creates and operates integrated
decision support networks for industries such as K-12 education, utilities,
forest products, health care and others. These networks are designed to leverage
the flow and processing of knowledge and information to provide a competitive
advantage.
In addition to our incubation business, we continue to operate our "Citadel
Technology" security software 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 is on our 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 line. As a result, management believes that the results
of operations for our Citadel Technology security software business will
continue to be adversely affected in the future by our core focus on incubation
services.
OVERVIEW OF OUR PARAGO SUBSIDIARY
In January 1999, we announced that we had formed a subsidiary, Parago, Inc.
(formerly How2.com), to implement our Internet and e-commerce strategies. Parago
is an application service provider (ASP) and Internet based business process
outsourcer (BPO) that provides an online suite of continuous customer
interaction offerings designed to increase sales, reduce costs, retain customers
and increase client profitability. These services include online promotional
management (including online rebate processing), proactive email, online
surveys, online multimedia product demonstrations and manuals, and online
customer data warehousing, analysis and reporting. Parago's comprehensive
integrated suite of outsourced continuous customer interaction solutions are
marketed across multiple industry lines.
Parago provides Internet-based solutions that automate customer relationship
management. Parago's solutions enable both brick-and-mortar and e-commerce
businesses to more efficiently develop, retain and extend customer relationships
and improve sales, marketing and customer retention. Parago's Internet-enabled
enterprise solutions include PromoCenter, InfoCenter and KnowledgeCenter. By
automating customer care activities such as online and traditional rebate
processing and promotions, Parago allows its clients to enhance customer
retention, increase revenue opportunities and improve operating efficiencies.
Parago's Internet-based solutions seek to transform promotional management and
product information from customer service liabilities to retention and extension
opportunities.
Parago's online solutions provide a new vehicle for its clients to conduct
targeted marketing to customers with whom they have traditionally lost contact
subsequent to the point of purchase. Parago is developing proprietary software
that will provide an online mechanism for customers, many of whom have immediate
purchasing power in the form of promotional proceeds, to apply those proceeds
towards the purchase of additional products or services. Parago's solutions also
capture valuable customer information that can help its clients better
understand customer behavior. Parago plans to provide fee-based customer
specific or aggregated data analyses to assist clients in designing future
promotions. Parago's solutions also enable businesses to improve operating
efficiencies by allowing them to analyze the results of their promotions and
manage these promotions on a real time basis.
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Parago has increased the number of its clients to approximately 175 as of
September 30, 2000, which include leading national retailers, manufacturers and
service providers. For Parago's quarter ended September 30, 2000, Parago
reported record revenues of approximately $5,600,000, a 137% increase over the
1999 third quarter and a 40% increase from the second quarter of 2000.
Parago has completed several acquisitions since its inception. In March
1999, Parago acquired 2-Lane Media, Inc., an award-winning
interactive/multimedia communications firm. The principal asset acquired in this
transaction was the technical expertise of the 2-Lane personnel, who, prior to
the acquisition, offered Web site and e-commerce design services for a diverse
client roster. In May 1999, Parago completed its acquisition of FCI Services,
Inc., Forward Communications, Inc. and Forward Freight, Inc. (collectively,
"Forward"), a product rebate and promotional fulfillment operation that offered
its clients solutions for designing, implementing and fulfilling merchandise and
consumer rebate programs. In addition to processing rebates, Forward handled
fulfillment assignments for e-commerce, high technology and other companies. In
August 1999, Parago completed its acquisition of some of the assets of Broadcast
Production Group, Inc. used in multimedia production and content conversion (to
convert traditional media formats into web-enabled content). In addition, in
connection with the acquisition, Parago retained certain members of Broadcast
Production Group's management team as employees of Parago. In connection with
Parago's acquisition of 2-Lane, we agreed to convert the Parago shares of common
stock issued in connection with the merger into up to 500,000 of our shares at
the option of the 2-Lane shareholders. In addition, pursuant to the terms of the
subscription agreements between Parago and some of its stockholders, we may be
required to issue up to 414,000 shares of our common stock to such stockholders
based upon a conversion price of $3.75 per share. These provisions could have
the effect of diluting our stockholders if the market price of our common stock
is above the effective conversion prices at the time of conversion.
At September 30, 2000, we owned 20,000,000 shares of the common stock of
Parago, representing less than 50% of the outstanding common stock of Parago. As
a result, we account for our ownership interest in Parago using the equity
method of accounting. Since its inception, Parago has incurred net losses and
now has a substantial accumulated deficit, which have had an impact upon and are
reflected in our financial statements. For example, for the three and seven
month periods ended September 30, 2000, we recorded an "equity in loss of
unconsolidated affiliate" of $105,734 and $1,220,516, respectively. We
understand that Parago expects to incur net losses for the foreseeable future,
and, even though our investment in Parago is currently carried at zero and will
not be further reduced, we may record significant losses relating to our Parago
subsidiary as it continues to develop its business services in the future if
increases in Parago equity occur.
Parago filed a registration statement with the Securities and Exchange
Commission relating to an initial public offering of shares of its common stock
in October 1999, but applied to withdraw this registration statement in March
2000. Parago plans to refile a registration statement covering its proposed
initial public offering. We previously announced that we intend to distribute
15% of the shares of Parago common stock that we hold to our stockholders,
subject to compliance with the SEC requirements applicable to the proposed
distribution and upon the expiration of a 180-day lock-up agreement between the
underwriters of the Parago proposed initial public offering and us. If there are
some problems associated with compliance with SEC requirements or state law,
then the distribution of Parago shares may be delayed or may not occur. There
can be no assurance that Parago's initial public offering will be completed, or
that we will otherwise complete the distribution of a portion of our shares to
our stockholders on the proposed terms or at all.
OVERVIEW OF RIVER LOGIC
On May 5, 2000 we completed a previously announced transaction whereby we
acquired a minority interest in River Logic, Inc. (formerly iNetze.com, Inc.).
As part of this transaction we acquired approximately 5.9% of the outstanding
shares of capital stock of River Logic, Inc. from several of its existing
shareholders in exchange for 333,333 shares of our common stock. We also
acquired shares of Series A Convertible Preferred Stock from River Logic in
exchange for the contribution by one of our wholly-owned subsidiaries of the
ESRN Assets, as described below. The acquired shares of River Logic's preferred
stock are convertible into shares of common stock that represent approximately
13.1% of the currently outstanding shares of capital stock of River Logic on a
post conversion basis as of May 5, 2000.
In July 2000, River Logic closed a $3 million private placement of shares of
its Series B preferred stock to a venture capital firm that specializes in early
stage technology firms that offer B2B Internet solutions that provide strong
value-oriented models for their prospective market-space.
In addition, one of River Logic's resellers, Heads Up! Systems, LLC, and
PriceWaterhouseCoopers, LLC entered into a strategic alliance offering clients
of process- and supply-chain modeling applications reliability in the use of
enterprise modeling tools. New software such as COR Technology(C) by River
Logic, provides business planners and managers with the ability to
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identify profit improvement opportunities, design and communicate supply chain
and business process information, and to develop model-based tactical and
strategic plans. The crucial step of model validation - ensuring that these
complex and detailed models accurately and reliably represent business behaviors
and financial results - is vital for instilling confidence by users and ensuring
that models function properly.
Our Chief Executive Officer, Steven B. Solomon, serves on the board of
directors of River Logic.
In connection with our investment in River Logic, we also made two $300,000
bridge loans to River Logic that together are convertible into 800,000 shares,
in the aggregate, of common stock that would represent approximately 3.8% of the
currently outstanding capital stock of River Logic on a post conversion basis as
of May 5, 2000. Each of the bridge loans (i) bears interest at a rate of 12% per
annum through its first anniversary and at one percent above the prime rate per
annum thereafter, (ii) is secured by certain assets of River Logic, (iii) is
payable upon our demand and (iv) is prepayable by River Logic commencing on its
third anniversary date. As a result of the transaction, we owned approximately
19% (22.2% in the event the bridge loans and other securities are converted in
full) of the voting stock of River Logic as of May 5, 2000.
The ESRN Assets consist of the EBSCO School Resource Network (ESRN Network),
an educational network catering to kindergarten through 12th grade (K-12). The
ESRN Network is designed to support school administrators, teachers, students
and parents by providing them with a comprehensive set of tools and resources
targeting their specific needs. The ESRN Network is comprised of learning
applications that integrate EBSCO Industries' database of content relating to
K-12. The ESRN Network was acquired by a wholly-owned subsidiary of CT Holdings
from a subsidiary of EBSCO Industries in connection with this transaction in
exchange for 666,667 shares of CT Holdings' common stock. We have filed a resale
registration statement relating to the shares of our common stock issued in
connection with this transaction.
As we hold a less than 20% ownership interest in River Logic the investment
has been accounted for under the cost method of accounting. Under this method,
our share of the earnings or losses of River Logic is not included in the
consolidated statements of operations.
River Logic, headquartered in Beverly, Massachusetts, creates and operates
integrated decision support networks for industries such as K-12 Education,
Utilities, Forest Products, Healthcare and others. These networks are designed
to leverage the flow and processing of knowledge and information to provide a
decisive competitive advantage. River Logic has several industry-specific
networks in development. Additionally, River Logic develops and licenses its
technologies to key industry partners.
TERMINATION OF LETTERS OF INTENT
In the quarter ended September 30, 2000, we determined not to proceed with
the previously announced letters of intent with ideavillage.com and
PerClick.com, based on the results of our due diligence reviews.
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 29, 2000 for further discussion of these and other risk factors related
to the 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.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
Investing in our common stock involves a high degree of risk. Any of
the following risks could materially adversely affect our business, operating
results and financial condition and could result in a complete loss of your
investment.
In addition to the other information in this Report, the following
factors should be considered carefully in evaluating the Company and its
business. This disclosure is for the purpose of qualifying for the "safe harbor"
provisions of Section 27A of the
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Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended. It contains factors which could cause results to differ
materially from such forward-looking statements. These factors are in addition
to any other cautionary statements, written or oral, which may be made or
referred to in connection with any such forward-looking statement.
The following matters, among other things, may have a material adverse
effect on the business, financial condition, liquidity, results of operations or
prospects, financial or otherwise, of the Company. Reference to these factors in
the context of a forward-looking statement or statements shall be deemed to be a
statement that any one or more of the following factors may cause actual results
to differ materially from those in such forward-looking statement or statements.
Before you invest in our common stock, you should be aware of various
risks, including those described below. Investing in our common stock involves a
high degree of risk. You should carefully consider these risk factors, together
with all of the other information included in this Report, before you decide
whether to purchase shares of our common stock. Our business and results of
operations could be seriously harmed by any of the following risks. The trading
price of our common stock could decline due to any of these risks, and you may
lose part or all of your investment.
GENERAL RISKS
WE RECENTLY DECIDED TO CHANGE OUR BUSINESS TO FOCUS ON INCUBATION OF EARLY STAGE
B2B 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 early stage B2B ventures. Other than our formation
and development of Parago, 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:
. We may be unable to identify or develop relationships with attractive
emerging B2B companies.
. 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.
. 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.
. 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.
. 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.
. 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.
WE RECENTLY COMPLETED OUR FIRST INVESTMENT IN AN EARLY STAGE B2B VENTURE
FOLLOWING OUR FORMATION AND DEVELOPMENT OF PARAGO; THERE CAN BE NO ASSURANCE
THAT THIS INVESTMENT WILL PROVE TO BE A FINANCIALLY ATTRACTIVE INVESTMENT.
We recently completed a transaction in which we acquired approximately 19%
of the shares of River Logic, Inc. We have never done business with River Logic
before and this is our first investment in an early stage B2B venture following
our formation and development of Parago. Inasmuch as River Logic is an early
stage venture, it is difficult to judge its future prospects.
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WE MAY INCUR SIGNIFICANT COSTS TO AVOID INVESTMENT COMPANY STATUS AND MAY SUFFER
OTHER ADVERSE CONSEQUENCES IF WE ARE DEEMED TO BE AN INVESTMENT COMPANY.
We may incur significant costs to avoid investment company status and may
suffer other adverse consequences if we are deemed to be an investment company
under the Investment Company Act of 1940. Some of our contemplated equity
investments in other businesses may constitute investment securities under the
1940 Act. A company may be deemed to be an investment company if it owns
investment securities with a value exceeding 40% of its total assets, subject to
certain exclusions. Investment companies are subject to registration under, and
compliance with, the 1940 Act unless a particular exclusion or Securities and
Exchange Commission safe harbor applies. If we were to be deemed an investment
company, we would become subject to the requirements of the 1940 Act. As a
consequence, we would be prohibited from engaging in some businesses or issuing
our securities and might be subject to civil and criminal penalties for
noncompliance. In addition, certain of our contracts might be voidable, and a
court-appointed receiver could take control of us and liquidate our business.
Although we have yet to make any investments in the investment securities of
an incubation startup or existing company other than Parago and River Logic,
such investments, if and when made, could fluctuate in value, which may cause
the value of such securities to exceed 40% of our total assets. Unless an
exclusion or safe harbor were available to us, we would have to attempt to
reduce our investment securities as a percentage of our total assets. This
reduction could be accomplished in a number of ways, including the disposition
of investment securities and the acquisition of non-investment security assets.
If we were required to sell investment securities, we may sell them sooner than
we may otherwise have preferred. These sales may be at depressed prices and we
might never realize anticipated benefits from, and may incur losses on, these
investments. Some investments may not be sold due to contractual or legal
restrictions or the inability to locate a suitable buyer. Moreover, we may incur
tax liabilities when we sell assets. We may also be unable to purchase
additional investment securities that may be important to our operating
strategy. If we decide to acquire non-investment security assets, we may not be
able to identify and acquire suitable assets and businesses.
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 some
of our acquisitions, including questions relating to the write-off of associated
in-process research and development costs and other matters. While we have
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 INTERNET SUBSIDIARY, PARAGO, INC.
The following are some risks related to the business of Parago, Inc., our
Internet subsidiary, and should be considered in addition to the risk factors
described in this Report. Any of these factors could have a material adverse
effect on us, as we owned 20,000,000 of the outstanding shares of common stock
of Parago at September 30, 2000. Parago filed a registration statement with the
Securities and Exchange Commission relating to an initial public offering of
shares of its common stock in October 1999, but applied to withdraw this
registration statement in March 2000. Parago plans to refile a registration
statement covering its proposed initial public offering.
THERE CAN BE NO ASSURANCE THAT PARAGO'S CONTEMPLATED INITIAL PUBLIC OFFERING
WILL TIMELY, OR EVER, BE SUCCESSFULLY COMPLETED.
The delay or complete abandonment of the contemplated Parago initial public
offering could have a material adverse effect on our stock price due to our
substantial equity interest in Parago. You cannot be assured that the initial
public offering will occur in the near future or ever at all. In addition, we
have agreed to convert the shares of Parago common stock issued in connection
with the acquisition of 2-Lane Media by Parago into up to 500,000 of our shares
at the option of the 2-Lane Media shareholders. Pursuant to the terms of the
subscription agreements between Parago and some 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
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issuance) at the option of such stockholders. 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 PARAGO SHARES.
We previously announced that we intend to distribute shares of Parago 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 the
underwriters of Parago's proposed initial public offering and us. If there are
problems associated with compliance with SEC requirements or state law, then the
distribution of Parago 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.
PARAGO'S BUSINESS AND FUTURE PROSPECTS ARE EXTREMELY DIFFICULT TO EVALUATE
BECAUSE ITS OPERATING HISTORY IS VERY LIMITED AND ITS BUSINESS MODEL IS NEW,
UNPROVEN AND EVOLVING.
Parago was formed in January 1999. Since its formation, Parago has:
. acquired its rebates operation in May 1999;
. launched its Web site in September 1999; and
. completed the initial development of its online rebate application
in December 1999.
As a result, Parago has only a limited operating history on which one can
base an investment decision. You should consider its prospects in light of the
uncertainties and difficulties frequently encountered by companies in their
early stages of development.
In addition, its business model is new, unproven and evolving. In December
1999, Parago focused its business to concentrate on its online customer care
solutions. Parago cannot assure that its new, focused business model will be
commercially successful. Parago cannot assure you that that its online solutions
will be accepted by businesses or consumers. If Parago is unable to establish
pricing and service models acceptable to manufacturers, retailers and service
providers and attractive to their customers, its Internet-based solution may not
be commercially successful.
SOME MAJOR COMPONENTS OF PARAGO'S BUSINESS STRATEGY HAVE NOT YET BEEN
IMPLEMENTED AND THE TECHNOLOGIES AND APPLICATIONS NECESSARY TO IMPLEMENT ITS
ENTIRE BUSINESS STRATEGY HAVE NOT YET BEEN DEVELOPED. IF PARAGO DOES NOT DEVELOP
THESE TECHNOLOGIES AND APPLICATIONS IN A TIMELY MANNER, ITS RESULTS OF
OPERATIONS WILL SUFFER.
Some of Parago's business strategies related to its Internet-based solution
have not yet been implemented. To implement these strategies Parago must develop
new applications and enhance its existing applications. Its online promotional
management and product information applications are new, unproven and evolving
and Parago continues to develop enhancements to these applications. Its
technology that enables its clients' customers to apply promotional proceeds to
additional products and services immediately following submission has not yet
been completed. Further, the more advanced aspects of its technology that
enables clients to access customized, real time customer data analysis are still
in the design phase. These applications and technologies are critical to the
success of its business. The development and implementation of these
technologies and applications is complicated and time consuming. Parago cannot
assure you that Parago will successfully develop all of its planned technologies
and applications. If Parago does not develop and implement these technologies
and applications in a timely manner, its results of operations will suffer.
PARAGO HAS A HISTORY OF NET LOSSES AND EXPECTS TO CONTINUE TO INCUR SUBSTANTIAL
NET LOSSES IN THE FUTURE.
Parago had a net loss of approximately $9.5 million and $21.7 million for
the three and seven month periods ended September 30, 2000 which includes an
estimated loss on the sale of 2Lane assets of $1.5 million. Parago also has an
accumulated deficit of approximately $59.5 million at September 30, 2000. Parago
anticipates that its operating expenses will increase in the foreseeable future
as Parago continues to develop its technology and applications, increase its
sales and marketing activities, expand its outsourced solutions capabilities and
improve its operational and financial systems. In addition, because its
increasing expense levels are based, in part, on expectations of its future
revenues, any decline in its revenues below its expectations would have a
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disproportionately adverse impact on its operating results. Accordingly, Parago
expects to incur additional losses for the foreseeable future. If its revenues
do not grow as Parago anticipates, Parago may never be profitable.
PARAGO'S REBATE AND RELATED SERVICES HAVE ACCOUNTED FOR SUBSTANTIALLY ALL OF ITS
REVENUES SINCE INCEPTION, AND PARAGO EXPECTS TO DEPEND ON ITS PROMOTIONAL
MANAGEMENT APPLICATION AND PROCESSING SERVICES FOR A SIGNIFICANT PORTION OF ITS
REVENUES FOR THE FORESEEABLE FUTURE.
Parago's rebate and related services accounted for substantially all of its
total revenues for the three months ended September 30, 2000. Parago anticipates
that revenues from its rebate solution will continue to constitute the major
portion of its revenues for the foreseeable future. A decrease in the amount of
promotional dollars spent on rebate programs by its clients or a decrease in the
rebate service fees Parago receives would negatively impact its results of
operations.
PARAGO IS DEPENDENT ON FOUR CLIENTS FOR A SUBSTANTIAL PORTION OF ITS BUSINESS.
Parago is dependent upon its relationship with a small number of clients for
a substantial portion of its existing and anticipated revenues. Four of its
rebate clients accounted for approximately 87.0% of its aggregate invoiced
revenue for the three months ended September 30, 2000. As a result of this
concentration of sales, Parago's business, operating results or financial
condition would suffer as a result of the termination of or adverse change in
its relationship with any of these clients.
In addition, Parago cannot assure you that its relationship with these
clients will continue, or if continued, that the revenues from these clients
will remain at current levels or increase in any future period. The initial term
of its agreement with Staples expired in July 2000 and is in the process of
being renewed. In addition, Staples' vendors may not use, or may discontinue
their use of, Parago's rebate solution. Based on the nature of these agreements,
Parago cannot assure you that Parago will generate significant revenues in
future periods from any of its principal rebate clients. The loss of all or any
part of Parago's relationship with any of these clients would seriously harm its
business.
MANY OF PARAGO'S CLIENT AGREEMENTS ARE TERMINABLE BY THE CLIENT AT WILL.
Parago does not have any long-term agreements with its clients. In addition,
many of its agreements with its clients are terminable by the client at will.
Therefore, Parago cannot assure you that any of its clients will continue to use
its online solutions for any period of time. The loss of a significant number of
its clients would seriously harm its business.
PARAGO'S REVENUE IS DEPENDENT UPON ITS CLIENTS' BUSINESS AND PRODUCT SALES.
Parago's revenue is primarily transaction based and will fluctuate with the
volume of transactions or levels of sales of products by its business clients
for which Parago provides its online customer relationship management solutions.
Its business would suffer if its clients decrease their activity that relates to
its online customer relationship management solutions.
PARAGO'S BUSINESS MODEL IS DEPENDENT ON ITS ABILITY TO SUCCESSFULLY ENTER INTO
RELATIONSHIPS WITH CLIENTS, OF WHICH PARAGO CURRENTLY HAS ONLY A LIMITED NUMBER.
MOST OF THESE RELATIONSHIPS WILL NOT BE EXCLUSIVE AND MAY BE TERMINATED BY ITS
CLIENTS AT ANY TIME.
Parago's ability to become profitable depends on its ability to successfully
enter into relationships with manufacturers, retailers and service providers
that wish to use its online promotional management and product information
solutions. Parago currently has these business relationships with only a limited
number of clients. Currently, Parago has four principal promotional management
clients that use its promotional management application. Parago only recently
began marketing its online product information solution and currently does not
have any clients using this solution. Parago anticipates that its arrangements
with clients will typically not be exclusive and will be subject to termination
upon short notice. In addition, Parago cannot assure you that these arrangements
will result in revenues or be profitable for it. If Parago cannot develop
relationships with new clients, its results of operations will be significantly
and negatively impacted.
PARAGO'S QUARTERLY OPERATING RESULTS WILL LIKELY VARY SIGNIFICANTLY IN THE
FUTURE.
Parago 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
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likely to fall below expectations. Any shortfall will likely adversely affect
the price of its common stock in a manner that may be unrelated to its long-term
operating performance.
Its 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 online promotional management and product information
solutions;
. fluctuations in the average promotion amount and number of the
transactions processed by it;
. seasonality in its clients' rebate promotions;
. its ability to develop, introduce and market new applications and
enhancements to its existing applications on a timely basis;
. its ability to attract and retain clients and to generate client
satisfaction;
. changes in its pricing policies or those of its competitors;
. changes in accounting standards and revenue recognition policies; and
. costs related to the acquisition of technologies and businesses.
Because of its limited operating history, Parago has limited insight into
trends that may emerge and affect its operating results.
THE AMOUNT OF REVENUES PARAGO RECOGNIZES AS A RESULT OF EXPIRED OR UNCASHED
REBATE CHECKS MAY BE REDUCED BY ABANDONED PROPERTY LAWS OR AN INCREASE IN THE
PERCENTAGE OF REBATE CHECKS CASHED BY CONSUMERS.
Parago bills its rebate clients for the full amount of the rebate checks
that it issues to its customers, plus a processing fee. Some customers never
cash their rebate checks. In the rebate industry, expired or uncashed checks are
referred to as "slippage". Slippage is recorded on its books as an increase to
revenues. The unclaimed property and escheat laws of each state provide that
under circumstances defined in that state's statutes, holders of unclaimed or
abandoned property, possibly including slippage, must surrender that property to
the state. As a result, any state into which Parago sends rebate checks could
assert that it is entitled to unclaimed rebate checks that Parago has issued to
consumers in that state.
Its operating results could suffer if any state is entitled to a significant
portion of these slippage amounts as a result of its unclaimed property or
escheat laws.
Furthermore, Parago expects that more of its clients' customers will cash
their rebate checks as a result of its online rebate solution, which would
reduce slippage. A decline in the amount of slippage that Parago retain could
decrease its revenues and negatively impact its results of operations.
TO CONTINUE ITS OPERATIONS AND BUSINESS, PARAGO MUST COMPLETE ITS INITIAL PUBLIC
OFFERING OR FIND ALTERNATIVE FINANCING.
Parago's ability to maintain and grow its business is dependent on its
access to sufficient funds to support its working capital and capital
expenditure needs. If Parago does not complete its initial public offering,
Parago must find an alternative method of financing. If Parago does not complete
its initial public offering or find an alternative source of funds, its business
and results of operations will be seriously harmed. Parago believes that the net
proceeds from its initial public offering, if completed, will be sufficient to
fund its working capital and capital expenditure needs for at least the next 12
months.
PARAGO'S BRAND MAY NOT ACHIEVE THE BROAD RECOGNITION AND LOYALTY NECESSARY TO
SUCCEED.
Parago believes that broad recognition and favorable business perception of
the Parago brand are essential to its future success. Accordingly, Parago is
pursuing an aggressive brand-enhancement strategy, which includes advertising,
trade shows, promotional programs and public relations activities. Successful
positioning of its Parago brand will largely depend upon:
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. its ability to provide high quality service to its clients and their
customers, including online and offline responses to customer inquiries
regarding the status of their promotional proceeds;
. the success of its promotional programs and public relations activities;
and
. the technical performance and visual appearance of its applications and
Web site.
To increase awareness of the Parago brand Parago spent significant amounts
in a sales and marketing campaign in the last half of 1999 and will spend
significant amounts in the future on marketing and promotions programs targeted
at decision makers within its prospective clients' organizations. These
expenditures may not result in a sufficient increase in net revenues to cover
these marketing and promotion expenses. Even if brand recognition increases, its
number of clients, the number of transactions processed through its online
solutions or number of licenses sold to use its applications may not increase.
Between September and December 1999, Parago spent approximately $17.0
million on a brand advertising campaign that was partially related to
informational tutorials related to lifestyle topics Parago offered on its Web
site. In December 1999, Parago focused its business model to concentrate on its
online solutions. Therefore, Parago may not be able to realize the full benefit
of the advertising expenses that related to the information tutorials that did
not relate primarily to its online solutions.
THE DAY-TO-DAY OPERATIONS OF PARAGO'S COMPUTER AND COMMUNICATIONS EQUIPMENT ARE
DEPENDENT ON THIRD PARTIES. THE PERFORMANCE OF EXODUS COMMUNICATIONS, INC. IS
CRITICAL TO ITS OPERATIONS.
Parago depends upon third parties for several critical elements of its
technology. Parago 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.
To assist Parago with its technical operations, Exodus maintains Parago's
communications lines and manages the network data centers where its network data
is stored. If Exodus does not perform to its requirements, Parago would have to
obtain similar services from another provider or perform these functions
themselves. Parago may not be able to successfully obtain or perform these
services on a timely or cost-effective basis. Due to the third party
installation of the computers, communications equipment and software needed for
the day-to-day operations of its Web site, Parago may be entirely dependent on
that party to manage, maintain and provide security for this technology. Any
termination or breach of these contracts could have a material adverse effect on
its business.
IN ORDER TO MANAGE ITS GROWTH AND EXPANSION, PARAGO WILL NEED TO IMPROVE AND
IMPLEMENT NEW SYSTEMS, PROCEDURES AND CONTROLS.
Since its formation, Parago has experienced significant expansion of its
operations. Since its inception in January 1999, Parago has expanded from one
employee to more than 360 employees. Further, since inception, Parago has
expanded from operating solely from its Dallas headquarters to operating from
three additional facilities located in Coppell, Texas and the metropolitan areas
of Los Angeles and San Jose, California. This expansion has placed a strain upon
its management systems by increasing management responsibilities, consuming more
of management's time and making close coordination among its executive, finance,
accounting, sales, marketing and operations organizations more complex. Other
resources, such as the cash required to meet increased expenses associated with
expansion, have also been strained. Its ability to compete effectively and to
manage future expansion of its operations, if any, will require it to continue
to improve its financial and management controls, reporting systems and
procedures as well as continue to train and manage its employee work force. If
Parago is unable to manage its growth and expansion, its business will be
materially adversely affected.
ADOPTION AND INTEGRATION OF ITS APPLICATIONS BY LARGE CLIENTS IS COMPLEX, TIME
CONSUMING AND EXPENSIVE AND PARAGO MAY EXPEND RESOURCES ON DEVELOPING NEW
RELATIONSHIPS THAT DO NOT MATERIALIZE.
Parago recruits clients to process their promotions, and their vendors'
promotions in the case of retail clients and includes their product information
as part of its online solutions. Most of the clients Parago recruits are large
companies. The adoption and integration of its solutions by large companies
tends to be complex, time consuming and expensive. In many cases, its clients
must change established business practices and conduct business in new ways in
order to use Parago's online solutions and associated
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applications. In addition, they generally consider a wide range of other issues,
including the benefits, ease of use, ability to work with existing systems,
functionality and reliability of Parago's applications, before committing to use
its online solutions. It frequently takes several months to complete the sale of
an online solution to a client and requires approval at a number of management
levels within the client's organization. These long cycles may cause delays in
its sales and Parago may spend a large amount of time and resources on potential
clients who decide not to use any of its online solutions, which could
materially and adversely affect its business.
IF PARAGO LOSES ANY OF ITS KEY PERSONNEL, INCLUDING ITS CHAIRMAN AND CHIEF
EXECUTIVE OFFICER, PRESIDENT AND CHIEF OPERATING OFFICER, OR THE KEY EMPLOYEES
OF ITS FINANCE, TECHNOLOGY, LEGAL, SALES AND MARKETING OPERATIONS, ITS BUSINESS
MAY SUFFER.
Since formation in January 1999, Parago has employed many of its key
personnel, including Steven B. Solomon, its Chairman, Kenneth R. Johnsen, its
President and Chief Executive Officer, and the key employees in its finance,
technology, legal, sales and marketing operations. Parago has life insurance
policies that would pay proceeds to it upon the death of Messrs. Solomon and
Johnsen. Parago's business could be negatively impacted if it were to lose the
services of one or more of these persons.
PARAGO HAS LIMITED EXPERIENCE WITH THE HOSTING OF ITS APPLICATIONS ON OTHER WEB
SITES AND PRICING OF THESE TRANSACTIONS.
Parago's business plan contemplates that it will host its technology, for a
fee, to businesses that want to provide its applications through their own Web
sites. However, Parago has limited experience with negotiating or pricing these
transactions.
Parago intends to sell hosting services on an annual or fixed-price basis.
To do this, Parago must estimate the amount of work involved in implementing its
application on a client's Web site and the value of the application. If Parago
underestimates the amount of time or resources required to implement its
applications on clients' Web sites or the value of its application, its revenues
and results of operations will suffer.
Parago also intends to sell hosting services on a varying price basis where
Parago would receive an initial fee and share in revenues generated by the use
of its applications on a client's Web site. To do this, Parago must estimate the
amount of work involved in implementing an application on a client's Web site,
the value of the application and the revenues that will be generated by the use
of its application on a particular client's Web site. If Parago underestimates
these amounts and revenues, its revenues and results of operations will suffer.
PARAGO'S APPLICATIONS MAY CONTAIN ERRORS OR DEFECTS THAT COULD RESULT IN LOST
REVENUES, DELAYED OR LIMITED MARKET ACCEPTANCE OR PRODUCT LIABILITY CLAIMS.
Parago's applications are complex. Complex applications often contain errors
or defects, particularly when first introduced or when new enhancements to those
applications are introduced. Despite internal testing and testing by clients as
Parago licenses the use of its applications, its applications may contain
serious defects of which Parago is unaware.
Since Parago plans to license its applications to clients for critical
customer interaction activities, such as promotional processing and hosting
product information, and uses the same applications themselves for clients
outsourcing these activities to it, any errors, defects or other performance
problems in the applications could result in damage to its clients. Injured
clients could seek significant compensation for their losses from it. Even if
not successful, a product liability claim brought against it would likely be
time-consuming and costly. Errors or defects in Parago's applications could also
result in delayed market acceptance of its applications, diversion of its
developmental resources to correcting these errors or defects and lost revenues.
PARAGO WRITES ITS APPLICATIONS IN THE JAVA PROGRAMMING LANGUAGE AND ITS BUSINESS
COULD BE HARMED IF JAVA LOSES MARKET ACCEPTANCE OR IF PARAGO IS NOT ABLE TO
CONTINUE USING JAVA OR JAVA RELATED TECHNOLOGIES.
Parago writes its applications in the Java computer programming language
which was developed by Sun Microsystems. While many companies have introduced
Internet-based applications based on Java, Java could fall out of favor and
support by Sun Microsystems or other companies could decline. If Parago could
not continue to use Java or related Java technologies or if Java support
decreased, Parago might have to rewrite the source code for its applications to
enable its products to run on other computer platforms. Changes to Java could
also require it to change its products. If Parago failed to implement or develop
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appropriate modifications to its applications in a timely manner, Parago could
lose revenue opportunities and its business could be harmed.
PARAGO'S MARKETS ARE HIGHLY COMPETITIVE.
The promotional management and product information industry is highly
competitive and fragmented. Parago expects competition to persist and to
intensify in the future. Its competitors include small firms offering specific
promotional applications, divisions of larger entities and large independent
firms, such as Young America Corporation and Continental Promotions Group. Some
companies are already engaged in various aspects of the promotional management
business online. A number of competitors have or may develop greater
capabilities and resources than it. Similarly, additional competitors with
greater resources than it may enter the industry. Its performance and growth
could be negatively affected if its existing or potential clients decide to
perform their own promotional management operations that are currently
outsourced or use another provider. In addition, competitive pressures from
current or future competitors could cause its promotional management application
to lose market acceptance or result in significant price erosion. This could
result in a material adverse effect upon its business.
Many of its current and potential competitors have longer operating
histories and significantly greater financial, technical, marketing, production
and other resources. In addition, some have significantly greater name
recognition and a larger base of clients, and many have well-established
relationships with its current and potential clients and have extensive
knowledge of its industry. Its current and potential competitors have
established or may establish cooperative relationships among themselves or with
third parties to increase the ability of their products and services to address
clients' needs. Accordingly, it is possible that new competitors or alliances
among competitors may emerge and rapidly acquire significant market share.
Competition may also increase as a result of industry consolidations. In the
event a larger company acquires one or more of its competitors, Parago would
face increased competition.
In order to remain competitive, Parago may need to acquire additional
businesses, applications, technologies, expertise, products or other resources.
Parago may not be able to identify suitable acquisition candidates or negotiate
satisfactory terms for acquisitions successfully, finance the acquisitions or
integrate the acquired operations into its existing business. Further,
completing a potential acquisition and integrating the acquired businesses or
resources will cause significant diversions of management time and resources. If
Parago consummates significant acquisitions in which the consideration consists
of stock or other equity securities, your ownership could be significantly
diluted. If Parago proceeds with significant acquisitions in which the
consideration includes cash, Parago could have to use a substantial portion of
its available cash to consummate these acquisitions. Acquisition financing may
not be available on favorable terms, or at all. In addition, Parago 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. Parago has no current plans, commitments or
agreements with respect to any acquisitions, and Parago may not make any
acquisitions.
PARAGO'S BUSINESS IS VERY DEPENDENT ON ITS TECHNICAL SUPPORT AND SALES
PERSONNEL.
Parago's future success depends on its ability to attract, hire, train and
retain highly skilled personnel. In addition, Parago will need to add a
significant number of new technical support and sales personnel to develop and
market its existing and new applications. Competition for qualified personnel is
intense, and Parago may fail to attract or retain these personnel, in which case
its business would be negatively impacted. Parago expects to hire approximately
40 additional technical support and sales and marketing employees by the end of
2000.
Because labor costs are a significant portion of its costs, an increase in
wages, costs of employee benefits or employment taxes could seriously harm its
business. In addition, its facilities are located in areas, including Dallas,
Los Angeles and Silicon Valley (Campbell, California), 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.
IF THE PROTECTION OF PARAGO'S INTELLECTUAL PROPERTY IS INADEQUATE, ITS
COMPETITORS MAY GAIN ACCESS TO ITS CONTENT AND TECHNOLOGY.
Parago depends on its ability to develop and maintain the intellectual
property aspects of its content and technology. To protect its content and
technology, including its promotional management and product information
applications, Parago relies primarily on a combination of contractual
provisions, confidentiality procedures, trade secrets and patent, copyright and
trademark laws. Parago 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 intellectual property to execute confidentiality agreements and
restricting access to its source codes.
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Parago seeks to protect its content, applications, documentation and other
written materials under trade secret and copyright laws, which afford only
limited protection. Parago has no registered copyrights, but claim copyright
protection on most of the content on its Web site. Parago cannot assure you that
any of its intellectual property with respect to its solutions will be viable or
of value in the future because the validity, enforceability and type of
protection of intellectual property in Internet-related industries are uncertain
and still evolving.
Despite its efforts to protect its intellectual property, unauthorized
parties may attempt to copy aspects of its content and other intellectual
property or to obtain and use information that Parago regards as proprietary.
Policing unauthorized use of its products is difficult, and while Parago is
unable to determine the extent to which piracy of its content or other
intellectual property exists, piracy can be expected to be a persistent problem.
In addition, the laws of some foreign countries do not protect its intellectual
property as well as the laws of the United States. Its means of protecting its
intellectual property may not be adequate and its competitors may independently
develop similar technology, duplicate its solutions or applications or design
around patents issued to it or its content or other intellectual property.
PARAGO HAS NO REGISTERED TRADEMARKS AND MAY NOT RECEIVE ANY TRADEMARKS.
Parago has filed 23 trademark applications with respect to trademarks that
Parago has used or is using in connection with its business, but Parago has
received no legal opinion and has not conducted full searches regarding the
registrability of its marks. Parago has not conducted extensive searches
regarding the availability of any of the trademarks for which Parago has filed
applications. Parago has received no trademark registrations to date. Any of its
trademarks may be successfully challenged or may not provide it with any
competitive advantages. None of its trademarks may be registrable and other
parties may have priority of use of such trademarks or variants thereof. Parago
may not successfully carry out its business strategy of establishing a strong
brand name for Parago if Parago cannot prevent others from using its trademarks.
This could impair its ability to increase market share and revenues.
PARAGO HAS NO PATENTS, ITS PATENT APPLICATIONS MAY BE UNSUCCESSFUL AND OTHER
PARTIES MAY HAVE PRIOR CLAIMS TO PATENTS ISSUED TO IT.
Although Parago has filed three patent applications and one provisional
patent application with respect to its online promotional management systems and
processes, Parago has not received any legal opinion or conducted full searches
regarding the patentability of its patent applications. Its three patent
applications specifically relate to its system and method of computer-aided
promotional management processing, its promotional management processing system
and method that offers selectable disbursement options and its promotional
management processing system and method that provides a promotions database and
interface. Its provisional patent application specifically relates to its method
and apparatus for a computer network system designed to facilitate promotional
fulfillment and customer information gathering. Parago has no patents, and may
not receive any patents related to its online promotional management
applications. If Parago receives a patent related to its promotional management
application either resulting from its current patent applications or future
applications, Parago may be unable to claim the filing date of, and priority
from, its existing provisional patent application. Its future patents, if any,
may be successfully challenged, rendering them invalid or unenforceable, or may
not provide it with any competitive advantages.
Parago may not develop technologies that are patentable and other parties
may have prior claims to those technologies. Additionally, other parties may
claim to have rights to any patents issued to it, and, if proven, these parties
would be able to use the patented technology or license it to others without its
consent. The validity and enforceability of its future patents, if any, may also
be affected by future legislative actions or judicial decisions, especially to
the extent such future patents may be deemed "method of doing business" patents.
PARAGO MAY BE SUBJECT TO CLAIMS THAT ITS APPLICATIONS, CONTENT, OR SERVICES
INFRINGE ON THE INTELLECTUAL PROPERTY OF OTHERS.
There has been a substantial amount of litigation regarding intellectual
property rights relating to the Internet. While Parago has not been the subject
of any infringement claims, it is possible that in the future third parties may
claim that Parago or its current or potential future applications, content or
services infringe upon their intellectual property. Parago expects that
developers and providers of Internet-based solutions and applications will
increasingly be subject to infringement claims as the number of products and
competitors in this industry segment grows and products in different industry
segments overlap. Any claims, made against it, with or without merit, could be
time-consuming, result in costly litigation, cause delays in implementation of
its services or require it to enter into royalty or licensing agreements.
Royalty or licensing agreements, if required, may not be available on terms
acceptable to it, which could seriously harm its business.
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PARAGO IS DEPENDENT ON ITS DOMAIN NAMES, AND PARAGO COULD SUFFER LOSSES IF ITS
DOMAIN NAMES ARE NOT PROTECTED.
Parago currently owns and controls the Internet domain names that Parago
currently uses, "www.parago.com" and "www.rebateshq.com" as well as
approximately 300 various other names, and names that Parago acquired in
acquisitions of businesses and assets that Parago does not currently use.
Generally, Internet regulatory bodies regulate domain names. 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, Parago may not acquire or maintain the domain names
"www.parago.com" and "www.rebateshq.com" in all of the countries in which Parago
conducts business.
The relationship between regulations governing domain names and laws
protecting trademarks and similar proprietary rights is unclear. Therefore,
Parago may be unable to prevent third parties from acquiring or using domain
names that infringe or otherwise decrease the value of its trademarks and other
intellectual property.
CAPACITY CONSTRAINTS AND SYSTEM FAILURES COULD HARM PARAGO'S BUSINESS.
While Parago has not experienced capacity constraint or system failure
problems in the past, if Parago cannot expand its systems in the future to cope
with any increased demand, or its technology systems fail to perform properly,
Parago 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.
Any of these factors could impair its reputation, damage the Parago brand
and materially and adversely affect its business.
Parago's ability to provide high quality client and consumer service
depends on the efficient, uninterrupted operation of its computer and
communications hardware systems. While Parago has not had any computer or
communications hardware systems related interruptions in the past, 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 Parago plans to
establish redundant servers and a mirror site to provide limited service during
system disruptions, Parago does not currently have fully redundant systems, a
formal disaster recovery plan, alternative providers of hosting services or a
mirror site.
Parago's business is highly dependent on its computer and telephone
equipment and software systems. While Parago maintains backup systems, the
temporary or permanent loss of any of this equipment or these systems, through
casualty loss due to events such as fire, flood, earthquake or tornado, or
operating malfunction, could seriously harm its business. While Parago has
property and business interruption insurance, its insurance may not adequately
compensate it for all losses.
PARAGO'S MARKET IS SUBJECT TO RAPID TECHNOLOGICAL CHANGE AND TO COMPETE PARAGO
MUST CONTINUALLY ENHANCE ITS SYSTEM AND APPLICATIONS TO COMPLY WITH EVOLVING
STANDARDS.
To remain competitive, Parago must continue to enhance and improve the
responsiveness, functionality and features of its applications. If Parago is
unable to adapt to changing market conditions, client requirements or emerging
industry standards, its business could be adversely affected. The Internet is
characterized by rapid technologic change, changes in user requirements and
preferences, frequent new product and service introductions embodying new
technologies and emergence of new industry standards and practices that could
render its technology and applications obsolete. To succeed, Parago must
internally develop and license leading technologies to enhance its existing
solutions and applications and develop new applications. Parago must continue to
address the increasingly sophisticated and varied needs of its clients and
respond to technological advances and emerging
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industry standards and practices on a cost-effective and timely basis. The
development of proprietary technology involves significant technical and
business risks. Parago may fail to develop new technologies effectively or to
adapt its proprietary technology and systems to client requirements or emerging
industry standards.
PARAGO MUST EXPAND EXISTING TECHNOLOGY SYSTEMS AND DEVELOP AND IMPLEMENT NEW
TECHNOLOGY SYSTEMS AS PARAGO INTRODUCES NEW AND ENHANCED SOLUTIONS AND
APPLICATIONS AND AS DEMAND FOR ITS SOLUTIONS AND APPLICATIONS INCREASES.
As Parago introduces new and enhanced solutions and applications, Parago
will need to develop and implement new technology systems. Parago uses
internally developed and third party systems to operate its Web site, including
transaction processing and order management systems designed to be scalable.
Parago does not know whether Parago will be able to accurately project the rate
or timing of any increases in demand 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 its failure to expand existing
technology systems or develop and implement new technology systems could cause
its clients and their customers that use its online applications to perceive its
applications as not functioning properly and, therefore, cause them to use other
online solutions.
PARAGO DEPENDS ON INCREASING USE OF THE INTERNET. IF THE USE OF THE INTERNET
DOES NOT GROW AS ANTICIPATED, ITS BUSINESS WILL BE MATERIALLY ADVERSELY
AFFECTED.
Parago's Internet-based solutions 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 of the Internet
may not develop at projected rates and a sufficiently broad base of users may
not adopt the Internet as a medium of conducting commerce. If the Internet is
not broadly adopted as quickly as Parago anticipates, potential and existing
clients may not choose to use its solutions.
CONCERNS REGARDING THE SECURITY OF TRANSMISSION OF CONFIDENTIAL INFORMATION OVER
THE INTERNET MAY REDUCE CONSUMER CONFIDENCE IN PARAGO'S ONLINE SOLUTIONS AND
NEGATIVELY IMPACT ITS BUSINESS.
The secure transmission of confidential information over the Internet is
essential to maintaining consumer and client confidence in Parago's online
solutions. The secure transmission of confidential information over the Internet
is essential in maintaining consumer and supplier confidence in its online
solutions. While Parago has not had security breaches of its system in the past,
substantial or ongoing security breaches of its 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 client and customer
transaction data.
A party that is able to circumvent its security systems could steal
proprietary information or cause interruptions in Parago's operations. Security
breaches also could damage its reputation and expose it to a risk of loss or
litigation and possible liability. Its insurance policies carry low coverage
limits, which may not be adequate to reimburse it for losses caused by security
breaches. While Parago attempt to protect against and remedy security breaches,
Parago cannot guarantee that its security measures will prevent security
breaches.
Parago also faces risks associated with security breaches affecting others
conducting business over the Internet. Any publicized security problems relating
to third parties could heighten concern regarding security and privacy on the
Internet, inhibit the growth of the Internet and, therefore, its Internet
solutions.
PARAGO IS HEAVILY DEPENDENT ON TELEPHONE, POSTAL AND DELIVERY SERVICES.
Parago materially relies on services provided by various local and long
distance telephone companies in connection with its promotional management
solution. A significant increase in the cost of telephone services that Parago
cannot recover through an increase in the pricing of its solutions, or any
significant interruption in telephone services, could have a material adverse
effect on its business.
Its 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. Any increase in postal and other delivery service rates, including
the elimination of existing discounts, could have a material adverse effect on
its business.
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PARAGO AND OUR COMPANY, CT HOLDINGS, COULD FACE POTENTIAL CONFLICTS OF INTERESTS
RELATING TO EACH OTHER.
. Because of Parago's relationship with us, and because we owned 20,000,000
of its outstanding shares of common stock at September 30, 2000, and because of
our interlocking directors and officers, who collectively owned 16.7% of
Parago's outstanding shares of common stock as of September 30, 2000, Parago and
we are likely to face potential conflicts of interest relating to each other.
. Executives, employees and consultants associated with us assisted in the
development of Parago's business model. Steven B. Solomon, our CEO and
President, is the founder, Chairman and CEO of Parago. In addition, Lawrence
Lacerte, Victor K. Kiam II, and Steven B. Solomon serve as directors of both
Parago and us.
. Some of Parago's executive officers, key employees and directors also
beneficially own, or hold options or warrants to purchase, approximately 30.4%
of our outstanding common stock as of September 30, 2000. Steven B. Solomon
owned approximately 11.0% of our common stock as of September 30, 2000.
. Accordingly, conflicts of interest may arise from time to time between
Parago and us, particularly with respect to the pursuit of overlapping business
opportunities. Parago 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.
. Because Parago has interlocking directors and officers with us, there may
be inherent conflicts of interest for these directors and officers related to
transactions between Parago and us. Directors may be required to abstain from
voting with respect to matters involving both us and Parago. Parago may lose
valuable management input from the directors and officers who have conflicts.
IN THE EVENT OF THE COMPLETION OF PARAGO'S INITIAL PUBLIC OFFERING, PARAGO'S
STOCK PRICE IS LIKELY TO BE VERY VOLATILE.
. Currently, Parago'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 Parago's
common stock is likely to be highly volatile and could be subject to wide
fluctuations in response to factors that are beyond its control. A decline in
Parago's stock price will adversely affect our stock price.
. 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 Parago's common stock.
. 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 Parago's common stock trades at levels
significantly above its initial public offering price, its common stock likely
will experience a material decline.
. Sales of a substantial number of shares of Parago's common stock in the
public market after its initial public offering could depress the market price
of the Parago common stock and could impair Parago's ability to raise capital
through the sale of additional equity securities.
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 some of our products
to become obsolete more quickly than expected.
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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.
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.
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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:
. the timing of announcements and releases of new or enhanced versions of
our products and product upgrades;
. the introduction of competitive products by existing or new competitors;
. reduced demand for any given product;
. seasonality in the end-of-period buying patterns of foreign and domestic
software markets; and
. the market's transition between operating systems.
Due to these 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.
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 renegotiation 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.
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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 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. We do not have any patents or statutory copyrights on any of our
proprietary technology which we believe to be material to our future success,
although Parago has filed a provisional patent application with respect to some
of its business applications and intellectual property rights. In selling our
products, we rely primarily on "shrink wrap" licenses that are not signed by
licensees, and, therefore, such licenses may be unenforceable under the laws of
some 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 our means of protecting our
proprietary rights will be adequate or that our competitors will not
independently develop similar technology substantially equivalent or superseding
proprietary technology. Furthermore, there can be no assurance that any
confidentiality agreements between us and our employees will provide meaningful
protection of our 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 THAT 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.
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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.
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.
As a result 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 STILL EXPERIENCE DISRUPTION IN OUR BUSINESS AS A RESULT OF THE YEAR 2000.
Even though the date is now past January 1, 2000, and the Company has not
experienced any immediate adverse impact from the transition to the year 2000,
it cannot provide any assurance that its suppliers and 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, the Company will continue to monitor its year 2000
compliance and the year 2000 compliance of its suppliers and customers. In
assessing the effect of the year 2000 problem, management determined that there
existed two general areas that needed to be evaluated: - Internal infrastructure
and - Supplier/third-party relationships. A discussion of the various activities
related to assessment and actions resulting from those evaluations is set forth
below.
INTERNAL INFRASTRUCTURE. The Company verified that all of its personal computers
and software are Year 2000 compliant. The Company replaced or upgraded all items
that were not to Year 2000 compliant. The costs related to these efforts were
not material.
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SUPPLIERS/THIRD-PARTY RELATIONSHIPS. The Company relies on its outside vendors
for water, electrical, and telecommunications services as well as climate
control, building access, and other infrastructure services. Although the
Company has not experienced any delays or interruptions in its service, it has
received any assurance of compliance from the providers of these services. Any
failure of these third-parties to resolve year 2000 problems with their systems
could have a material adverse effect on the Company's operations.
CONTINGENCY PLANS. Based on the above actions, the Company has not developed a
formal contingency plan to be implemented as part of its efforts to identify and
correct year 2000 problems affecting our internal systems. However, if it deems
necessary, the Company may take the following actions: - Accelerated replacement
of affected equipment or software; - Short to medium-term use of backup
equipment and software; - Increased work hours for Company personnel; - Other
similar approaches. If the Company is required to implement any of these
contingency plans, such plans could have a material adverse effect on its
business. Based on the actions taken to date, and the lack of any problems to
date, the Company is reasonably certain that it has identified and resolved all
year 2000 problems that could hurt its business.
WE HAVE A HISTORY OF NET LOSSES AND WILL NEED ADDITIONAL FINANCING.
Since inception, we have incurred losses, and at September 30, 2000, we had an
accumulated deficit of $49,547,115 and our current liabilities exceeded our
current assets by $461,949. Our ultimate success in fully implementing our new
strategy, continuing our existing business line and meeting our cash flow
obligations is dependent on our ability to raise additional capital, as to which
there can be no assurances. While the Company currently believes that it has the
ability to obtain additional equity or debt financing, we have received a
commitment from our President to fund up to $1,500,000 of our expected operating
cash flow needs through March 1, 2001 in the event the Company's cash flows from
operating, investing and financing activities are insufficient to meet the
expected operating obligations of the Company as they come due. We had used
approximately $400,000 of this commitment, which amount had been repaid as of
September 30, 2000. We also plan to sell stock in private equity financings
during fiscal year 2001 to cover cash flow deficiencies not covered by the
commitment by our President and to repay amounts advanced by our President.
During the quarter ended September 30, 2000, we sold 2,500,000 restricted shares
of common stock for $2,500,000 to certain members of our Board of Directors. We
expect that our equity investee, Parago, will incur losses in the foreseeable
future as it continues to develop and upgrade its technology and infrastructure,
develop and expand its product and service offerings, establish and sustain
relationships with manufacturers, retailers and service organizations.
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.
WE RELY ON MICROSOFT AND NOVELL TECHNOLOGY.
Our software products are designed for Microsoft technologies, including
Windows NT and Windows 95/98, and Novell NetWare. Although we believe that
Microsoft and Novell technologies are and will be widely utilized by businesses
in the corporate market, no assurances can be given that these businesses will
actually adopt such technologies as anticipated or will not in the future
migrate to other computing technologies that the Company does not support.
Moreover, if our products and technology are not compatible with new
developments in Microsoft and Novell technologies, as to which there can be no
assurances, our business, results of operations and financial condition could be
materially and adversely affected.
WE FACE INCREASED RISK AS A RESULT OF OUR INTERNATIONAL OPERATIONS.
We have entered into affiliations in Japan and Mexico. While we have taken
steps to minimize the financial exposure of such ventures, there can be no
assurances that its products will be successful overseas and that these ventures
will not have an adverse impact on our financial condition. In addition, in
order to successfully expand international sales significant management
attention and financial resources could be required and could have an adverse
effect on our operating margins. In addition, we rely significantly on our
distributors and other resellers in international sales efforts, that are not
our employees and do not offer our products exclusively, and there can be no
assurance that they will continue to market our products. Additional risks
inherent in our international business activities generally include unexpected
changes in regulatory requirements, fluctuations in the values of currencies,
tariffs and other trade barriers, costs to localize products, lack of acceptance
of localized products, if any, in foreign countries, longer accounts receivable
payment cycles, difficulties in managing international operations, potentially
adverse tax consequences including restrictions on the repatriation of earnings,
and the burdens of complying with a wide variety of foreign
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laws. There can be no assurance that such factors will not have a material
adverse effect on our future international sales and, consequently, our
business, operating results and financial condition.
RESULTS OF OPERATIONS
NET REVENUE
During the three months ended September 30, 2000, the Company had net sales of
$200,614, a decrease of $592,416 or 74.7%, over net sales of $793,030 during the
three months ended September 30, 1999. For the seven months ended September 30,
2000, the Company had net sales of $412,825, a decrease of $762,792 or 64.9%,
over net sales of $1,175,617 during the seven months ended September 30, 1999.
We attribute the decrease in our software product revenues for the three and
seven month periods ended September 30, 2000 to our focus on our activities as
an Internet business incubator and the late introduction of desktop and network
versions of our WinShield Secure PC products.
COST OF SALES, EXCLUDING DEPRECIATION AND AMORTIZATION
The costs and expenses incurred in connection with producing the Company's
products were $2,316 during the three months ended September 30, 2000, a
decrease of $17,794 or 88.5%, over cost of sales of $20,110 for the same period
last year. For the seven months ended September 30, 2000, cost of sales were
$6,981, a decrease of $40,919 or 85.4%, over cost of sales of $47,900 for the
seven months ended September 30, 1999. As a percentage of sales, the Company's
cost of sales for the three and seven month periods ended September 30, 2000
were 1.2% and 1.7%, respectively, as compared to 2.5% and 4.1% for the three and
seven month periods ended September 30, 1999.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for the three months ended
September 30, 2000 were $458,378 as compared to $757,185 for the three months
ended September 30, 1999, or a decrease of $298,807 or 39.5%. For the seven
months ended September 30, 2000, selling, general and administrative expenses
decreased $998,843 or 40.4% to $1,474,777 for the seven month period ended
September 30, 2000 as compared to $2,473,620 for the same period in prior year.
The decrease in our selling, general and administrative expenses for the three
and seven month periods ended September 30, 2000 resulted primarily from the
shift in our business to an Internet business incubator model and our decreased
emphasis on selling and marketing activities related to our software business.
Accordingly, we have incurred significantly lower costs in advertising,
marketing and other general and administrative activities, as well as reduced
employee and recruiting expenses, which resulted from our reduced headcount.
RESEARCH AND DEVELOPMENT EXPENSE
For the seven month period ended September 30, 2000, research and development
costs charged to expense were $112,992 as compared to $244,870 for the same
period last year, or a decrease of $131,878, or 53.9%. For the three month
periods ended September 30, 2000 and September 30, 1999, we capitalized $0 and
$165,000, respectively. For the seven month periods ended September 30, 2000 and
September 30, 1999 we capitalized approximately $102,261 and $293,000,
respectively. The decrease in costs capitalized for the three and seven month
periods ended September 30, 2000 related primarily to a decrease in the level of
development work being performed by outside contract consultants when compared
to the same periods last year. In fiscal 2000, we internally developed our
WinShield Secure PC product ("Secure PC"), the total security solution for
desktops, while we completed upgrading Secure PC to become Office 2000
compatible during the first quarter of fiscal year 2001.
NONRECURRING LITIGATION SETTLEMENT CHARGE
In July 2000, we entered into a settlement term sheet to resolve the disputes
between us and Janssen-Meyers Associates L.P. ("JMA"), pursuant to which we and
JMA agreed to settle the lawsuit for an aggregate of $3 million, in a
combination of $1.5 million in cash and 300,000 shares of common stock with a
guaranteed value of $5 per share as of January, April and October 2001 (with
respect to 100,000 of the shares for each period). The settlement is subject to
execution of definitive settlement documents and approval of the boards of
directors of the companies. As a result, we recorded approximately $1,912,500 as
a nonrecurring charge related to the settlement of the litigation during the
first fiscal quarter of 2001. We may be required to record additional charges
(in the amount of the difference between $1,500,000 and the gross proceeds from
the sales of the stock by JMA at the relevant periods) in the event our shares
of common stock do not trade above $5 per share for five consecutive trading
days during the guarantee periods.
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DEPRECIATION AND AMORTIZATION EXPENSE
Depreciation and amortization expense decreased $159,015, or 37.1%, to $269,335
for the three months ended September 30, 2000 from $428,350 for the three months
ended September 30, 1999. For the seven months ended September 30, 2000,
depreciation and amortization expense was $657,828 compared to $855,998 for the
same period in prior year, or a decrease of $198,170, or 23.2%. During the last
quarter of the fiscal year 1999, the Company wrote-off approximately $1,400,000
of purchased software costs. This reduction in depreciation and amortization
expense was offset by the commencement of amortization on certain capitalized
product development costs.
OTHER INCOME (EXPENSE)
Interest expense for the three and seven month periods ended September 30, 2000
were $352 and $1,883, respectively as compared to $2,923 and $16,134 for the
same periods in prior year. This decrease in expenses resulted primarily from
the Company having less interest bearing debt during these periods than we did
in the same periods last year. Equity in loss of unconsolidated affiliate was
$105,734 and $1,220,516 for the three and seven month periods ended September
30, 2000, resulting primarily from Parago allocating a considerable amount of
resources to development and sales of its 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.
Included in other income (expense) for the seven months ended September 30, 2000
and September 30, 1999 is a charge to earnings of $15,076 and $25,000,
respectively, reserved in connection with the settlement of a number of
lawsuits.
Other income of $29,338 during the seven months ended September 30, 2000
primarily represents interest income earned on notes receivable from affiliate
during the quarter.
DIVIDENDS ON PREFERRED STOCK
For the seven months ended September 30, 1999, preferred stock dividends
consisted primarily of dividends accrued on Series D preferred stock. In June
1999, the Company converted the $2,000,000 of Series D preferred stock, plus
dividends in arrears of approximately $238,000, into 2,081,937 shares of the
Company's 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 September 30, 2000 were $1,310,840.
Cash flows used in operations were $1,249,184 for the seven months ended
September 30, 2000, as compared to $2,652,814 for the seven months ended
September 30, 1999. The decrease results primarily from an increase in our
accrued liabilities resulting primarily from our nonrecurring legal settlement
charge.
Cash flows used for investing activities were $600,000 for the seven months
ended September 30, 2000 as compared to cash used of $1,387,466 for the same
period last fiscal year. The change results from an increase in notes receivable
from affiliates related to the bridge loan issued to River Logic, Inc offset by
the reduction in cash due to deconsolidation of Parago in 1999.
Cash flows provided by financing activities were $2,452,612 for the seven months
ended September 30, 2000, as compared to $653,911 for the seven months ended
September 30, 1999. The increase primarily results from the sale of our common
stock during the seven months ended September 30, 2000 for $2,500,000.
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As a result of the aforementioned factors, cash and cash equivalents increased
by $603,428 for the seven months ended September 30, 2000, versus a decrease of
$3,386,369 for the same period last fiscal year.
Since inception, we have incurred losses, and at September 30, 2000, we had an
accumulated deficit of $49,547,115 and our current liabilities exceed our
current assets by $461,949. Our ultimate success in fully implementing our new
strategy, continuing our existing business line and meeting our cash flow
obligations is dependent on our ability to raise additional capital, as to which
there can be no assurances. While the Company currently believes that it has the
ability to obtain additional equity or debt financing, we have received a
commitment from our President to fund up to $1,500,000 of our expected operating
cash flow needs through March 1, 2001 in the event the Company's cash flows from
operating, investing and financing activities are insufficient to meet the
expected operating obligations of the Company as they come due. We had used
approximately $400,000 of this commitment through July 17, 2000; however, this
amount has been repaid as of September 30, 2000. We also plan to sell stock in
private equity financings during fiscal year 2001 to cover cash flow
deficiencies not covered by the commitment by our President. We expect that our
equity investee, Parago, will incur losses in the foreseeable future as it
continues to develop and upgrade its technology and infrastructure, develop and
expand its product and service offerings, establish and sustain relationships
with manufacturers, retailers and service organizations.
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.
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
Set forth below are certain litigation matters in which we are a party. We
believe that we have meritorious defenses and will vigorously defend ourselves.
However, an unfavorable resolution of or settlement or defense costs related to
one or more of these lawsuits could have a material adverse effect on our
business, results of operations or financial condition.
In January 2000 the parties in the previously disclosed Vestcom v. Citadel
lawsuit 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).
This action was dismissed for want of prosecution on the announcement of
settlement by the parties. Assuming Vestcom received actual or constructive
notice of that dismissal near the time of its entry, the Company believes that
the time to seek reinstatement of the case, a new trial, or review before the
Court of Appeals has expired. However, as of the date of issuance of this
Report, no binding agreement has been signed by both parties.
In July 2000, following mediation of the disputes between us and Janssen-Meyers
Associates L.P. ("JMA"), we and JMA entered into an agreement to settle the
lawsuit for an aggregate of $3 million, in a combination of $1.5 million in cash
and 300,000 shares of common stock with a guaranteed value of $5 per share as of
January, April and October, 2001, subject to execution of definitive settlement
documents and approval of the boards of directors of the companies. In August
1998, JMA filed a lawsuit against us arising out of an alleged 1995 contract
with our predecessor "("Old Citadel"). The suit alleged that Old Citadel
breached a letter of intent dated September 1995 and/or a Placement Agency
Agreement dated November 1995 between JMA and Old Citadel. As its damages, JMA
claimed that it was entitled to, among other things, the cash value of 1.8
million $0.89 warrants valued during May 1996. According to JMA's valuation of
those warrants, potential damages were alleged to exceed $40 million. The
Company vigorously disputes that it breached either the letter of intent or the
Placement Agency Agreement or that it is liable to JMA. The lawsuit was styled
Janssen-Meyers Associates, L.P. v. Citadel Technology, Inc., and was filed in
the Supreme Court of the State of New York, County of New York. The Company has
also filed a lawsuit against JMA to recover excess amounts charged by JMA in
connection with related bridge loans.
In June 2000, the Company was served with a lawsuit filed in state court in
Houston, Texas by Michael and Patricia Ferguson for breach of contract, tortious
interference and negligence. Specifically, the Fergusons claim that they were
damaged when they attempted to exercise certain warrants during a time when the
Company's related registration statement could not be used. On June 29, 2000,
the Company moved to transfer venue from Harris County, Texas, to Dallas County,
Texas. On June 30, 2000, the
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Company answered (subject to its Motion to Transfer Venue). On July 28, 2000,
also subject to its Motion to Transfer, the Company filed a third party petition
against Yorkton Securities, Inc. and Yorkton Capital, Inc., which acted as the
Fergusons' broker in connection with the transaction at issue. In the third
party petition, the Company contends that the Yorkton entities are liable to the
Company based on negligence and contribution for, among other things, failing to
disclose to the Fergusons that the registration statement could not be used. The
Company believes that the claims asserted by the Fergusons are without merit and
will vigorously defend the claims, and the Company will vigorously prosecute the
claims it has filed against Yorkton Securities.
At this time, the Company is unable to predict the ultimate outcome of
these suits, the costs associated with defending the claims and pursuing
counterclaims, and monetary compensation awarded, if any. Unfavorable
resolutions of these lawsuits or costs of litigation and settlement could have a
material adverse effect on our results of operations or financial condition.
We are a party to some 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
During the fiscal quarter ended September 30, 2000, the Company sold 2,500,000
restricted shares of its common stock to two of its directors pursuant to
private placements to accredited investors under Section 4(2) of the Securities
Act, for proceeds of $2,500,000.
ITEM 5. OTHER INFORMATION
In October 2000, we changed our fiscal year end from February 28 to December 31,
as described in "Part I -- Financial Information, Notes to Condensed
Consolidated Financial Statements, Note 1. Basis Of Presentation."
On May 5, 2000, we completed the acquisition of a significant minority interest
in River Logic, Inc., a Delaware corporation formerly known as iNetze.com, Inc.,
as described under "Part I - Financial Information, Item 2. Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Overview of River Logic." In July 2000, River Logic closed a $3,000,000 private
placement by Mercury Ventures Ltd.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Ex - 27 Financial Data Schedule
Ex - 99 Parago Shareholder Letter
(b) REPORTS ON FORM 8-K.
The Company filed a Current Report on Form 8-K during the quarter ended
September 30, 2000 related to its acquisition of a minority interest in River
Logic. The Company also filed a Current Report on Form 8-K during the quarter
ended September 30, 2000 related to its change in fiscal year end from February
28 to December 31.
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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.
(REGISTRANT)
Date: November 16, 2000 By: /s/ STEVEN B. SOLOMON
Steven B. Solomon, President and Chief
Executive Officer (Duly Authorized Signatory and
Principal Executive and Financial Officer)
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INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
27 Financial Data Schedule
99 Parago Stockholder Letter
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS OF CT HOLDINGS, INC. FOR THE SEVEN MONTHS
ENDED SEPTEMBER 30, 2000 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
CONSOLIDATED FINANCIAL STATEMENTS.
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM (A) THE
CONSOLIDATED FINANCIAL STATEMENTS OF CT HOLDINGS, INC. FOR THE QUARTER ENDED
SEPTEMBER 30, 2000 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH (B)
FINANCIAL STATEMENTS.
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