UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
COMMISSION FILE NUMBER: 0-08718
CT HOLDINGS, INC.
(NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)
DELAWARE 75-2432011
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
8750 N. CENTRAL EXPRESSWAY, SUITE 100, DALLAS, TEXAS 75231
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(214) 520-9292
(ISSUER'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT: NONE
SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE
(TITLE OF CLASS)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or
for such shorter period the Registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days. Yes [X]
No [ ]
Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B is not contained in this form, and no disclosure will be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference to such filing requirements incorporated by reference
in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [ ]
State issuer's revenue from continuing operations for its most recent fiscal
year $ 0
As of April 9, 2002 the last reported sale price of the Company's common stock
was $ 0.295 per share. The aggregate market value of the voting and non-voting
common stock held by non-affiliates of the Company was $12,613,840 as of April
9, 2002.
As of April 9, 2002, there were 49,829,608 shares of common stock, $.01 par
value per share, outstanding.
Transitional Small Business Disclosure Format. Yes [ ] No [X]
CT HOLDINGS, INC.
FORM 10-KSB
ANNUAL REPORT
FOR THE FISCAL YEAR ENDED
DECEMBER 31, 2001
Table of Contents
PART I
Item 1. Description of Business 3
Item 2. Description of Property 26
Item 3. Legal Proceedings 26
Item 4. Submission of Matters to a Vote of Security Holders 27
PART II
Item 5. Market for Common Equity and Related Stockholder Matters 28
Item 6. Management's Discussion and Analysis 29
Item 7. Financial Statements 35
Item 8. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 35
PART III
Item 9. Directors, Executive Officers, Promoters and Control
Persons; Compliance with Section 16(a) of the Exchange Act 36
Item 10. Executive Compensation 38
Item 11. Security Ownership of Certain Beneficial Owners
and Management 41
Item 12. Certain Relationships and Related Transactions 43
Item 13. Exhibits and Reports on Form 8-K 45
This Annual Report on Form 10-KSB contains forward-looking statements that
involve known and unknown risks and uncertainties. The statements contained in
this Report that are not purely historical are forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, including
statements regarding the Company's expectations, beliefs, intentions or
strategies regarding the future. In this Report, the words anticipates,
believes, expects, estimates, intends, future and similar expressions identify
forward-looking statements. All forward-looking statements included in this
document are based on information available to the Company on the date hereof,
and the Company assumes no obligation to update any such forward-looking
statements. The Company's actual results could differ materially from those
discussed herein. Factors that could cause or contribute to such differences
include, but are not limited to, those discussed elsewhere in this Report under
the heading Factors That May Affect Future Operating Results as well as those
discussed elsewhere in this Report, and the risks discussed in our Securities
and Exchange Commission filings.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
OVERVIEW OF CT HOLDINGS
CT Holdings, Inc. was incorporated in Delaware in 1992 and previously operated
under the name Citadel Technology Inc. Our business model is designed to enable
the companies in whom we invest or acquire to become market leaders in their
industries. Our strategy over the years has led to the development, acquisition
and operation of technology based businesses with strong business models and
compelling valuations. We believe that the anticipated growth in technology
creates strong opportunities for us to increase shareholder value by investing
in early stage ventures well positioned for growth in their respective
marketplaces. We will attempt to increase the value of each investee by
providing management, marketing and financial expertise along with financial
capital and then realize this new value through a subsequent liquidity event
such as a spin-off, sale, merger or initial public offering of the investee
companies.
At December 31, 2001 the Company held investments in Citadel Security Software
Inc. ("Citadel" or "Citadel Security Software"), Parago, Inc. ("Parago"), River
Logic, Inc. ("River Logic"), and Encore Telecommunications, Inc. ("Encore"). An
overview of each business is provided below. In November 2001 the Company
announced the proposed spin-off of its Citadel Security Software subsidiary as a
special dividend to shareholders of CT Holdings. Citadel filed a registration
statement on Form 10-SB with the U. S. Securities and Exchange Commission
("SEC") with respect to the distribution of this dividend on January 11, 2002
and filed amendments to the Form 10-SB on March 8, 2002 and April 5, 2002 and
became a separate reporting company under the Securities Exchange Act of 1934.
(See "The Citadel Security Software Distribution" below.) The Distribution
remains subject to the completion of the SEC's review of the Form 10-SB.
On January 30, 2002 we announced the signing of a letter of intent to acquire
American Natural Technology Sciences ("ANTS"), a company engaged in the research
and development of products in the agricultural and biological industries,
including products that treat fire ant stings and control fire ant mounds.
Although the letter of intent has expired the companies are continuing their due
diligence process and may extend or renegotiate the terms of the letter of
intent. (See "Pending Acquisition" below.)
The Citadel Security Software Distribution
In November 2001, CT Holdings' board of directors declared a pro rata
distribution payable to the holders of outstanding CT Holdings common stock (the
Distribution). In March 2002 and in April 2002 Citadel filed amendments to the
registration statement on Form 10-SB with the SEC to register the securities
that are proposed to be distributed as a result of the Distribution. The
Distribution consists of one (1) share of Citadel common stock for every four
(4) shares of CT Holdings common stock (the Distribution Ratio) outstanding on
the Record Date. After the Distribution, Citadel will be an independent company,
with CT Holdings having no continuing ownership interest in Citadel. However
some directors will be directors of both companies and some CT Holdings
employees will transfer to Citadel. The Distribution is intended to be a
tax-free distribution for U.S. federal tax purposes although neither we nor
Citadel have requested or obtained opinions regarding the tax treatment of the
Distribution. The Record Date and the Distribution Date will be set based on the
timing of the effectiveness with the Securities and Exchange Commission. The
Registration Statement filed by Citadel has additional important information
regarding the Distribution.
On or before the Distribution Date, CT Holdings and Citadel will enter into a
series of agreements including a distribution agreement, a transition services
agreement, and a tax disaffiliation agreement which will provide for, among
other things, the principal corporate transactions required to effect the
Distribution, to provide for an orderly transition to the status of two
independent companies and to define the continuing relationship between Citadel
and CT Holdings after the Distribution.
The distribution agreement provides that on or prior to the Distribution Date,
Citadel will have issued to CT Holdings a number of Citadel Shares equal to one
fourth of the total number of shares of CT Holdings common stock outstanding on
the Distribution Date (approximately 15,000,000 shares based on approximately
60,000,000 shares of CT Holdings common stock anticipated to be outstanding at
the Distribution Date) plus an additional immaterial number of Citadel Shares
to be distributed with respect to fractional shares that are rounded up. CT
Holdings will effect the Distribution by delivering a certificate representing
100% of the Citadel Shares to the Distribution Agent. Citadel will assume, and
will agree to indemnify CT Holdings against, all liabilities, litigation and
claims, including related insurance costs, arising out of Citadel's businesses
(including discontinued or sold security software business), and CT Holdings
will retain, and will agree to indemnify Citadel against, all other liabilities,
litigation and claims, including related insurance costs. The foregoing
obligations will not entitle an indemnified party to recovery to the extent any
such liability is covered by proceeds received by such party from any third
party insurance policy. For a two-year period beginning on the Distribution
Date, except in limited circumstances, Citadel will not solicit or recruit any
CT Holdings employee without CT Holdings' prior written consent, and, likewise,
CT Holdings will not solicit or recruit any Citadel employee without Citadel's
prior written consent. The distribution agreement will also provide that each of
CT Holdings and Citadel shall be granted access to certain records and
information in the possession of the other, and will require the retention by
each of CT Holdings and Citadel for a period of six years following the
Distribution Date of all such information in its possession.
On or before the Distribution Date Citadel will enter into a transition services
agreement with CT Holdings. This agreement will provide that in return for a
monthly service fee Citadel will provide CT Holdings with the services of
Citadel's CEO, CFO and its finance and
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administration staff to provide such services as executive management of CT
Holdings' business development and technology business incubator activities,
information management technology, sharing of office space, financial accounting
and reporting, tax compliance reporting, and other areas where CT Holdings may
need transitional assistance and support. Initially, CT Holdings will pay
Citadel a monthly service fee of $20,000, subject to adjustment on a quarterly
basis. The management and administrative services agreement generally provides
that each of Citadel and CT Holdings will undertake to provide substantially the
same level of service and use substantially the same degree of care as their
respective personnel provided and used in providing such services prior to the
execution of the agreement. The agreement generally will extend for a one year
term, but may be terminated earlier under certain circumstances, including a
default, and may be renewed for additional one year periods with fees to be
renegotiated with each renewal. CT Holdings believes that the terms and
conditions of the transition services agreement are as favorable to CT Holdings
as those available from unrelated parties for a comparable arrangement.
In March 2002 Citadel entered into a three year lease agreement for office space
and has relocated the office to 8750 N. Central Expressway, Suite 100, Dallas,
Texas 75231. The initial monthly rental rate is approximately $9,740 and
increaes to $17,243 starting in the seventeenth month of the lease term. The CEO
of Citadel and CT Holdings has signed a personal guarantee related to the
sublease. CT Holdings will share employees located in this space with Citadel
and will pay for the space as part of a monthly administrative charge to CT
Holdings.
On or before the Distribution Date, CT Holdings and Citadel will have entered
into a tax disaffiliation agreement which sets out each party's rights and
obligations with respect to deficiencies and refunds, if any, of federal, state,
local or foreign taxes for periods before and after the Distribution and related
matters such as the filing of tax returns and the conduct of Internal Revenue
Service and other audits. Under the tax disaffiliation agreement, Citadel will
indemnify CT Holdings for all taxes and liabilities incurred as a result of
Citadel's or an affiliate's post-Distribution action or omission contributing to
an Internal Revenue Service determination that the Distribution was not
tax-free. CT Holdings will indemnify Citadel for all taxes and liabilities
incurred solely because CT Holdings or an affiliate's post-Distribution action
or omission contributes to an Internal Revenue Service determination that the
Distribution was not tax-free. If the Internal Revenue Service determines that
the Distribution was not tax-free for any other reason, CT Holdings and Citadel
will indemnify each other against all taxes and liabilities pro rata based on
relative values based on the closing market values of the respective company's
common stock one day after the Distribution Date. Citadel will indemnify CT
Holdings against any taxes resulting from any internal realignment undertaken to
facilitate the Distribution on or before the Distribution Date.
On or before the Distribution Date, CT Holdings and Citadel will enter into the
distribution agreement, which will provide for, among other things, the
principal corporate transactions required to effect the Distribution and certain
other agreements relating to the continuing relationship between Citadel and CT
Holdings after the Distribution.
OVERVIEW OF CITADEL SECURITY SOFTWARE
At December 31, 2001 Citadel was a wholly owned subsidiary of CT Holdings. The
company was formed in December 1996 as a Delaware corporation and since then,
until the authorization of the Distribution by the CT Holdings' board of
directors in November 2001, the management and employees of CT Holdings operated
the security software business. Citadel will operate as a standalone company
separate from CT Holdings following the completion of the Distribution. Citadel
maintains a website at www.citadel.com
Citadel develops and markets computer security and privacy software in one of
the fastest growing software industry segments today - security "inside the
firewall." Citadel's software products, Hercules, Secure PC and NetOFF, are
marketed through direct and indirect channels to customers in a wide range of
industries, including healthcare, financial services, and government and
education agencies. The products enable network security administrators to
remediate vulnerabilities and enforce security policies from a single point of
control across multiple operating systems and platforms and have been designed
to secure system configurations, protect them from unauthorized changes and to
remediate system vulnerabilities caused by changes in network or workstation
configurations or the new installation or update of operating systems and
applications software. In addition, Citadel's software products provide the
flexibility and scalability that network security administrators are demanding
for managing security policies within their computing environments. Furthermore,
Citadel's products enable organizations to address and enforce the policies
mandated by HIPAA and Gramm-Leach-Bliley legislation for the health care and
financial industries. Citadel's customers include IBM Global Services,
Washington Mutual, Merrill Lynch, the U.S. Navy and several large health care
companies.
Citadel's Strategy
The core focus of the security software business, is forming strategic alliances
with third parties, developing new applications of the technology, and executing
new third party licensing or joint venture arrangements. An objective is to
increase stockholder value by leveraging Citadel's position in segments of the
financial, governmental and corporate markets into opportunities for additional
revenues from licensing its software products and entering into strategic
alliances to enhance revenues. Citadel intends to build upon its market
reputation and leverage its installed customer base to offer related security
software products, which generally have relatively high margins. More
specifically, to achieve this objective Citadel intends to implement the
following strategies:
. DEVELOP NEW, HIGH-VALUE SECURITY SOFTWARE SOLUTIONS. Focus development
on innovative, high-value software solutions that will complement
existing products. Use Citadel's expertise in research, development
and marketing,
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as well as existing relationships with members of the corporate
community, to achieve market acceptance of these potential products.
In March 2002 Hercules, a vulnerability remediation software product,
was released for commercial availability.
. ENTER INTO STRATEGIC ALLIANCES. Citadel seeks to enter into strategic
alliances related to the marketing and licensing of its products. It
entered into a master services agreement with SBC Services (a division
of SBC Communications) pursuant to which products will be made
available to SBC for distribution directly by SBC to its customers,
and through SBC for joint revenue campaigns. We will seek to renew
this agreement following its expiration on April 1, 2002. Citadel has
also entered into a strategic alliance with EBSCO Information
Services, one of the world's largest providers of subscription
services, reference databases and online journals, to offer security
and privacy software to EBSCO's client base in the library and
business communities.
. ENHANCE AND EXTEND PRODUCT OFFERINGS. Citadel seeks to establish
itself as a market leader in particular segments of the security
software market. Many of the products enjoy brand name recognition and
established reputations. Citadel is committing increased resources
within research and development to create product enhancements and
next generation products that can strengthen market position. For
example, next-generation and new lines of security software products
are currently in the planning stage.
. LEVERAGE SALES CHANNELS. Sales and marketing resources will be added
to support the launch of Hercules and the growth in the licensing of
Citadel's software products. Products will be marketed directly to
those customers who benefit most from increased security, such as
financial and health care companies and government agencies who are
bound by industry specific legislation such as HIPAA and the
Gramm-Leach-Bliley Act and those corporate customers that are focused
on minimizing the costs of network vulnerability remediation. In
addition, the business development team seeks to secure third party
alliances to provide additional revenue opportunities to the direct
sales force and increase awareness of Citadel's products through joint
marketing, license and OEM relationships.
. PURSUE VALUE-ADDED ACQUISITIONS. Citadel will seek to acquire and
integrate businesses and new technologies that will complement its
product lines, enhance competitiveness in the marketplace, be
synergistic and enhance stockholder value.
Citadel Products
Hercules
Hercules was released for beta testing at several large organizations in
December 2001 and was released for commercial availability in March 2002. In
January 2002 Citadel filed a provisional patent application with respect to some
of the business applications and intellectual property rights incorporated
within the Hercules software program. Hercules is being positioned as Citadel's
flagship product providing an automated remediation solution across an
organization's computing environment for system vulnerabilities identified by
scanning software and network administrators. It is believed to be the only
solution currently available that automatically identifies and deploys the
specified patches and fixes to repair system vulnerabilities from a central
point of control, thus more efficiently strengthening the security of the
organization's computing environment.
The Hercules software solution uses aggregated vulnerability information
identified and published by key industry resources throughout the Internet and
provides customers with real-time remediation updates. Security vulnerabilities
are introduced to a computing environment from external sources accessed by
systems administrators and users who alter desktop configurations or install new
applications and inadvertently introduce security vulnerabilities inside the
firewall. The Hercules product is designed to for use in conjunction with
industry leading vulnerability scanning and assessment tools to automatically
generate and deploy a remediation strategy based on the results of the
vulnerability assessment. System administrators and security officers are in
full control of the remediation process allowing them to selectively target
systems and deploy resolutions of the identified vulnerabilities from a single
point of control. It is believed that Hercules will save significant costs and
time as IT management and personnel resources that were previously needed to
examine each computer individually and then manually apply the specific fix may
now apply the patch or fix to all computers in the network from one point of
control. This reduces the risk of unnecessary security exposure due to lack of
resources to eliminate vulnerabilities in a timely manner on each computer
within the computing environment.
Capabilities of Hercules include:
. Integrates with industry leading vulnerability scanning products to
provide true coverage for vulnerability assessment and remediation.
. Allows the systems administrators and security officers to selectively
deploy resolutions of vulnerabilities across the computing environment
from a single point of control.
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. Automated system allows remediation to be scheduled during non-peak
hours.
. Provides full reporting on status of the deployment process.
. Provides continuous monitoring of remediation process to ensure
compliance after initial deployment.
. Designed to run on Microsoft Windows NT, 2000 and XP, with future
support for Unix and Linux variants.
. Supported by the Hercules Server, which coordinates the real-time
receipt of updated vulnerability information from Citadel and provides
a centralized repository for deploying selected vulnerability
resolutions to the targeted host computers.
Secure PC
Secure PC provides desktop security and access control for computers. Its
advanced set of features allows users to apply security policies to users or
groups of users within an organization. Secure PC provides a rich feature set
that can prevent users from accidentally or deliberately changing configuration
settings on their computer which may result in downtime, loss of data, or expose
the computer or network to security vulnerabilities. Secure PC also provides
hardening of system files that deliver the first line of defense against
viruses, malicious code and unauthorized access or theft of confidential
information. In addition, Secure PC can be configured to provide additional
protection against viruses by protecting operating system files, application
executable files and other system components that are typical targets of worms,
Trojan horses or other malicious viruses. Secure PC provides desktop security
and access control for computers running Microsoft Windows versions 95, 98, ME,
NT, 2000 and XP. Its advanced set of features allows users to apply security
policies to users or groups of users within an organization.
The product is licensed in two configurations. Secure PC Workstation is designed
for home, educational or commercial non-networked computers. Secure PC Network
is designed for environments with multiple computers connected to a Windows or
Novell network. The network version of Secure PC has been designed to scale
dynamically within network environments ranging from departmental local area
networks (LANs) to global wide area network (WAN) capacity and includes tools
that provide remote installation and configuration of the Secure PC client
software.
Secure PC provides a rich feature set that can prevent users from accidentally
or deliberately changing configuration settings on their computer that can
result in downtime or loss of data, or expose the computer or network to
security vulnerabilities. During 1999 and 2000 Secure PC was awarded several
editorial awards including NT Security.Net's Ultimate Security Toolkit,
WinMag.Com's WinList, and Curriculum Administrator Magazine's top 100.
NetOFF
NetOFF is designed to protect a network by shutting down unattended client
personal computers (PCs) automatically after a specified period of inactivity.
Network administrators may also use NetOFF to shut down PCs to enhance backup
operations or assist with the distribution of new software and anti-viral
updates. The product ensures an orderly shutdown by automatically closing all
open files and applications on the PC and saving the information. The product
ensures an orderly shutdown by automatically closing all open files and
applications on the PC and saving the information. NetOFF is available for
Windows NT and NetWare platforms and supports Windows 95, 98, ME, Windows NT,
Windows 2000 and Windows XP. The benefits of NetOFF include:
. Enhancing Overall Computer Security. Unattended desktop PCs subject
the network and PC to a heightened risk of data theft. NetOFF protects
confidential files and information by loading a screen blocker and
logging off the unattended PCs, thus shutting off access to the data
that resides on them and the networks they are connected to.
. Increased Back-Up Reliability. To protect important information,
almost every company employs a back-up system. The back-up system is a
magnetic tape drive or other storage medium that periodically copies
all of the data stored in the network. Should a data loss occur from a
power failure, mechanical failure or other error, the lost information
can be restored in a relatively short time, saving the company the
time and effort necessary to attempt to reconstruct lost data and
files. However, most back-up systems back up only closed files. If a
computer is logged on during the backup process, data in open files
can be corrupted or omitted from the back-up tape. NetOFF eliminates
these problems by automatically logging off network client stations at
a time pre-selected by the network administrator and closing those
files that were left open.
. Conserving Resources. Software license fees are often based on the
number of actual users of the licensed product. Many companies pay
excess license fees for programs that are left open on unattended
computers. NetOFF helps customers reduce costs by logging off
unattended PCs.
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. Regulatory Compliance. NetOFF's unique screen blocking and automated
logoff features help organizations achieve and maintain HIPAA and
Gramm-Leach-Bliley Act compliance. The Health Insurance Portability
and Accountability Act of 1996 requires each organization that uses
communications or networks to protect communications containing health
information that are transmitted electronically over open networks so
that they cannot be easily intercepted and interpreted by parties
other than the intended recipient. The Gramm-Leach-Bliley Act imposes
similar regulatory requirements on financial institutions.
. Enhanced Software Distribution. Many electronic software distribution
mechanisms rely on users logging on to the network to push the
software updates to the computer. This process never occurs if
machines are left logged in because the users never logoff the
network. Some antivirus products rely upon this process of updating
and can cause a security risk for the organization if virus signature
databases or other software updates are not updated in a timely
manner.
Product Development
Product development stresses the following standards in developing Citadel
products:
. Standards Compliance and Network Compatibility. The products comply
with industry standards and are designed to be compatible with the
leading operating systems, including Microsoft, Novell, Unix and Linux
variants. To that end, the products are currently developed using
industry standard tools such as XML, C++ and various platform
dependent toolkits.
. Ease of Use. The products are designed to function without extensive
and continual user involvement. The aim is to simplify, not
complicate, the user's work environment.
Citadel plans to capitalize on the existing security and network administration
technology and in-house expertise in research, development and marketing to
expand the current product offerings to address the growing market needs for
security software solutions. In-house product development work remains the key
component of bringing new Citadel product lines to market. Citadel's product
development staff is currently designing the next-generation of the Company's
products as well as new products. However, release schedules for the development
and completion of high technology products are inherently difficult to predict,
and accordingly there can be no assurance that target release and shipment dates
for any of our products will be achieved when initially announced, or at all. In
addition, to meet product demands Citadel may pursue a partnering strategy to
develop or acquire new products.
Business Development
The Business Development team at Citadel has three primary functions.
1. Negotiate and secure strategic alliances related to its security
software products;
2. Manage OEM and reseller accounts; and
3. Provide qualified leads for the sales staff.
Strategic Alliances
The Citadel Business Development team is currently engaged in securing strategic
alliances related to marketing and licensing Citadel's software products. As a
result of the March 2002 release of Hercules, an automatic vulnerability
remediation tool, Citadel is building relationships with companies that perform
the systems scans that look for vulnerabilities within a network structure.
Citadel is engaged in ongoing talks with some of the leading scanning software
companies worldwide that perform this work. By entering into strategic alliances
with these companies, Citadel will seek to obtain access to an installed
customer base as well as new sales opportunities of their products combined with
Citadel's remediation product.
Citadel recently announced an alliance with SecurityFocus, a provider of
enterprise threat management systems. Hercules will use the library of
vulnerabilities and malicious code information contained in the SecurityFocus
Vulnerability Database as a source for developing remediations for those
vulnerabilities.
In addition to the leading scanning software companies, Citadel is seeking to
enter into relationships with some of the large accounting firms and information
technology consultants, such as IBM Global Services and EDS. Each of these firms
is engaged in security issues and the threats and vulnerabilities associated
with networks. The process used by these firms and the time to implement these
processes can be dramatically reduced by using Hercules as a remediation tool.
Citadel is in the process of contacting these firms and arranging meetings to
work with them in the same manner Citadel would work with the scanning
companies.
Manage OEM and Reseller accounts
The Business Development team is managing existing and new OEM and reseller
relationships. While the products are sold primarily on a direct basis, Citadel
has agreements with five resellers that sell Secure PC and NetOFF. The Business
Development team is actively engaged in providing the existing resellers with
literature, pricing, and leads, and technical support. Citadel continues to look
for new resellers that will serve as an extension of the sales team.
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Sales Leads
Through alliances and marketing relationships, the Business Development team is
looking for ways to increase the number of qualified leads that can be
cultivated by the Citadel sales team. Forming strong third party alliances and
marketing relationships can increase the number of resources available to sell
Citadel products, and provide qualified customer leads for Citadel's inside
sales staff while not significantly increasing the related costs of sales.
Sales, Marketing and Customer Support
Citadel markets and licenses the majority of its products by employing a direct
selling model. As opportunity warrants, Citadel also works with a third party
resellers to increase revenue opportunities.
Citadel's sales consultants are experienced in selling technology software and
specialize by industry. This allows them to fully address the customer needs,
trends, regulations and customer desires in order to meet customer security
requirements "inside the firewall." Key industry verticals include: Healthcare,
Finance & Insurance, Education and Government. In 2002 Citadel will add sales
resources to address the needs of the large enterprise customers in the Fortune
2000. Within these verticals, current and prospective clients are segregated by
number of employees focusing our most experienced sales consultants on the
larger opportunities. In addition, the executive team brings a wealth of selling
experience and is highly involved in the selling process. Citadel's customers
include financial institutions, health care providers, cross-industry
corporations, governmental agencies and educational institutions.
Marketing and partnering efforts are targeted to provide qualified leads. Lead
generation sources include database mining of prospects and customers, partner
database mining, opt-in email, events and conferences, and an updated Citadel
web site. The web site allows software downloads and tracking as well as on-line
order fulfillment. Citadel may also participate in partner events and regional
seminars. All leads are entered and tracked utilizing a networked customer
retention and quote management system.
Citadel believes that its direct selling model, coupled with targeted marketing
activities and focused alliance efforts with vulnerability scanning providers
and managed service providers, will empower Citadel to increase revenues from
existing products and enable effective new product launches. These efforts will
provide the opportunity for increased market penetration without requiring
significant additional sales and marketing resources.
Competition
The security software industry is intensely competitive and rapidly changing.
Citadel competes against large companies (such as Microsoft, Novell, Computer
Associates, Network Associates, Symantec and others) that offer network and
desktop PC security and administration software as a segment of their
businesses. It also competes with a large number of small companies that offer
security and administration software products for networks and desktop PCs as a
portion of their product line. Some of these competitors offer products that
address multiple aspects of network and desktop security and administration and
management, while other competitors market products that provide narrow
solutions. Many of Citadel's competitors have longer operating histories and
significantly greater financial, technical, sales, marketing and other
resources, as well as greater name recognition and a larger installed customer
base. Further, many competitors have established relationships with Citadel's
customers and end users of its products. Citadel's competitors could, in the
future, introduce products with more features and lower prices than current
product offerings. These companies could also bundle existing or new products
with other, more established products in order to compete with Citadel.
Customers And Product Licensing
Citadel licenses its software products to corporations, hospitals and other
healthcare groups, government organizations, educational agencies and other
entities that have a compelling need to reduce computing vulnerabilities and to
manage security and privacy policies within their computing environments. The
products are licensed for use on standalone computers, within a single network,
or within a network of computers across single or multiple customer sites. The
license agreement restricts the use of the software to a single computer or
designated network or site(s) and generally prohibits the reproduction,
transfer, reverse engineering and disclosure of the program code. Citadel's
customers and alliances include SBC Communications, IBM Global Services,
Washington Mutual Bank, Merrill Lynch, EBSCO Information Services, the U.S.
Navy, and numerous health care, education and corporate clients. In December
2001, Citadel entered into a master services agreement with SBC Services (a
division of SBC Communications), pursuant to which its products will be made
available to SBC for distribution directly by SBC to its customers, and through
SBC for joint revenue campaigns. This contract expires on April 1, 2002 and
Citadel expects to renew this contract. Citadel has also recently entered into a
strategic alliance with EBSCO Information Services, one of the world's leading
providers of subscription services, reference databases and online journals, to
offer its security and privacy software to EBSCO's client base in the library
and business communities.
During the year ended December 31, 2001, revenue from Washington Mutual
accounted for approximately 31% of Citadel's revenue. During the ten months
ended December 31, 2000, no single customer accounted for more than 10% of
Citadel's revenue. Citadel does not depend upon any one customer or group of
customers for a significant source of recurring revenue. Citadel expects that in
the future its customers will enter into annual renewal contracts for post sale
customer support but no assurance is provided that this expectation will be met.
8
Intellectual Property Rights
Citadel's software and related product documentation are regarded as proprietary
intellectual property. Citadel has been and will be dependent in part on its
ability to protect this proprietary technology. A combination of laws covering
copyrights, trademarks and trade secrets, as well as confidentiality agreements
and other measures to establish and protect its rights in its proprietary
technology are necessary to protect Citadel's intellectual property rights.
Although Citadel has filed a provisional patent application with respect to some
of its business applications and intellectual property rights related to the
Hercules software, there are no patents or statutory copyrights on any of its
proprietary technology which are believed to be material to Citadel's future
success, and Citadel cannot be certain that others will not develop
substantially equivalent or superseding proprietary technology. The provisional
patent application requires that Citadel file one or more non-provisional patent
applications within 12 months from the date of filing to specify the claims
asserted for patent protection. Furthermore, there can be no assurance that any
confidentiality agreements between employees and Citadel will provide meaningful
protection of its proprietary information in the event of any unauthorized use
or disclosure of such proprietary information.
There can be no assurance that Citadel will not become the subject of claims of
infringement with respect to intellectual property rights associated with its
products. In addition, Citadel may initiate claims or litigation against third
parties for infringement of its proprietary rights or to establish the validity
of its proprietary rights. Any such claims could be time consuming and could
result in costly litigation or lead Citadel to enter into royalty or licensing
agreements rather than disputing the merits of such claims.
OVERVIEW OF PARAGO
CT Holdings formed Parago in 1999 and brought in private equity financing from
venture capital investors in 2000. Parago's patent-pending technology platform
and processes represent an innovative approach designed to improve the
promotional marketing industry. Parago provides a range of Internet-based
customer relationship management products, PromoCenter(SM), ValueRewards(SM) and
KnowledgeCenter(SM), which are created to increase sales, reduce costs, enhance
customer retention for its clients and improve loyalty. These products comprise
Parago's Continuous Customer Interaction(SM) model, which helps retailers,
manufacturers and service organizations reduce the cost of conducting promotions
and drive incremental revenue by cross-selling and upselling new products and
services. During the relationship management process, Parago captures fresh,
accurate and usable transaction and buyer demographic data that can be used by
its clients to improve their promotional marketing programs. Parago maintains a
web site at www.parago.com.
Parago's Technology Approach to Promotional Management
Parago offers a technology platform that is designed to improve the promotional
management industry by using the power of the Internet. Parago's customers
include retailers, manufacturers or service providers who are looking for
increased return on their marketing investment improved customer retention and
operational efficiencies.
Current State of the Industry
Currently there is a substantial amount of dissatisfaction and ineffectiveness
associated with marketing programs such as rebates and instant discounts. Many
companies feel that these programs are a necessary evil required to maintain or
increase their position in their competitive marketplaces. The evolution of the
Internet as a purchasing channel has made promotional marketing even more
necessary. Online customers have a much easier task when it comes to product and
price comparisons. With many products viewed by consumers as interchangeable,
price and/or promotional incentives are often deciding factors. Consequently,
many companies offer incentive programs to influence the purchase decision.
One disadvantage of many traditional promotional programs is that they tend to
condition customers to be price sensitive. Additionally, they often fail to
address the retention of the customer: a company offers a promotion
(rebate/discount), a customer accepts the offer and the interaction between the
company and their customer ends after the check is sent or the discount
received. These programs focus on acquiring customers rather than retaining them
through enhanced continuous customer interaction. Customers may be satisfied
with that particular experience, but there is no real reason for them to return
unless companies continue to discount their product or service.
Parago's PromoCenter solution offers its business clients the opportunity to
increase sales, strengthen brand loyalty and increase customer retention via a
fully functional web-based promotion center, branded with the look and feel of
the clients' own web sites and powered by Parago. To the customers of Parago's
clients, the PromoCenter is a part of the clients' web sites, while behind the
scenes, it is completely developed, maintained and serviced by Parago.
Parago's Solutions
With Parago, companies may actually benefit from increased redemptions. At the
point of redemption, Parago introduces a patent-pending, technology
upsell/cross-sell platform called ValueRewards(SM), which allows customers to
exchange their promotional offer for other products and services of a higher
retail value. Often, these products and services complement the product or
service
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just purchased. Additionally, ValueRewards can be customized and dynamically
changed at any time. By leveraging the power of the Internet, this targeted
upsell/cross-sell offering all happens online.
When customers exchange promotional dollars for ValueReward items, Parago
believes that everybody can benefit. The company offering the promotion
recognizes additional revenue, lower overall promotional costs and better
customer relationships. Customers may be more satisfied with the incremental
value received from ValueRewards, and loyalty increases as the client company
demonstrates an understanding of customer needs and preferences.
All transactions from promotions and ValueRewards are aggregated into
KnowledgeCenter (Parago's data warehouse). Parago and its clients can analyze
this data to determine promotional effectiveness in real time. In addition,
Parago clients can use this fresh, accurate and usable data derived from
KnowledgeCenter to target new promotions through an email campaign.
This combination of a promotional transaction with a ValueReward option and
collection of resulting data through Parago's technology platform is called
Continuous Customer Interaction(SM).
Parago believes that the following benefits result from its Continuous Customer
Interaction model:
Increased Sales: When a customer selects a ValueReward in exchange for the
promotional offer, the value of the offer becomes additional top-line revenue to
the client company offering the promotion (to the extent the ValueReward is a
product or service offered by the client). There is also an opportunity for
additional transactions when Parago integrates into the client's shopping cart.
Additionally, since companies will now know the e-mail address of their
customers who have opted in, the client is in a position to initiate additional
commerce discussions, potentially resulting in increased sales of higher margin
products and/or services.
Reduced Promotion Costs: Every time a customer selects ValueRewards, the
client's overall promotion cost is reduced. A higher value product and/or
service are typically offered to the customer that bears a lower cost to the
client.
Improved Marketing Efficiencies: Parago collects and aggregates the promotion
and transaction information that it collects on behalf of its clients into its
KnowledgeCenter solution. Information on the success of the promotional program
can be evaluated daily, and the promotion can be modified to improve
effectiveness. This detailed information can be analyzed to determine, among
other things, how best to promote products, what channels are effective for each
type of promotion and which customers will be most likely to take advantage of a
promotional offer. Parago clients may realize a better return on their
promotional investment when effectively using the data analysis available in
KnowledgeCenter.
Enhanced Customer Relationships: As a result of Parago's innovative approach to
promotional marketing, clients may develop better relationships with their
customers. Features such as proactive email to confirm the receipt of their
promotional request, the ability of customers to do online status checks, and a
quick turnaround time on check payment all contribute to increased customer
satisfaction and ultimately to customer loyalty. Further, ValueRewards
opportunities create a value-add for customers, and future targeted marketing of
peripheral products and services may extend the customer relationship.
The ideal Parago client is a company who is looking at promotions not just as a
short-term selling tactic, but also as part of an overall Customer Relationship
Management (CRM) solution. Parago helps clients integrate this lofty but
critical discipline into their day-to-day business operations. Leveraging
Parago's Continuous Customer Interaction technology platform may enable clients
to increase sales, lower costs and enhance relationships with their customers.
At December 31, 2001 the Company holds 20,000 shares of Parago common stock and
warrants to purchase 28.8749 shares of Series A preferred stock (convertible
into 2,887 shares of common stock), after giving effect to 1 for 1000 reverse
stock split in connection with Parago's Series E preferred stock offering in
December 2001 to February 2002, in which the Company elected not to participate.
In December 2001 Parago raised equity financing of approximately $13.6 million.
Approximately $1.4 million of equity financing was closed in February 2002. As a
result of the equity financing, and our decision not to participate in the
financing, our ownership percentage in Parago was reduced to approximately 1%.
Our investment in Parago for the period from January 1, 2001 through December
12, 2001 and the ten months ended December 31, 2001 was accounted for under the
equity method of accounting for investments and accordingly as a result of our
ownership falling below 20%, will be accounted for using the cost method of
accounting beginning December 13, 2001. Under the cost method of accounting, the
Company's share of the income or loss from Parago is not included in operations.
Under the equity method of accounting, the Company's share of the investee's
income or losses is included in the statements of operations. If the carrying
value of the Company's net investment falls below zero, the Company discontinues
applying the equity method until the carrying value of the net investment rises
above zero. In addition, in the event the Company's ownerships percentage
exceeds 20% and the value of the Company's equity investment rises above zero,
after recovering the cumulative losses from the time that the value fell to
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 is
recovered through our proportionate share of net income if Parago turns
profitable. Parago's unaudited revenue for the year ended December 31, 2001 was
$26.0 million and unaudited net loss was $19.9 million. While Parago continues
to incur operational losses we believe that our initial $50,000 investment in
Parago represented by 20,000 shares of common stock and 28.8749 warrants
(convertible into 2,887 shares of Parago common stock) may ultimately provide an
appropriate return.
During the second quarter of 2001 the Company, along with other investors in
Parago, participated in a bridge loan financing of Parago of $692,740 plus
guaranteed $1,406,472 of a bank term loan to Parago. In accordance with
Accounting Principles Board Opinion No. 18 the Equity Method of Accounting for
Investments in Common Stock the Company recognized a charge to earnings of
$2,099,212 in June 2001. Upon closing of the Parago equity financing in December
2001 Parago repaid the bridge loan and the bank guarantee was released. As a
result the Company reversed the $2,099,212 in the fourth quarter of 2001.
10
OVERVIEW OF RIVER LOGIC
In May 2000 CT Holdings acquired a minority interest in River Logic. River Logic
develops decision-support applications for industry. Using open and
rapid-application development (ORAD) system, developers at River Logic create
applications that enable industry professionals to model complex enterprises and
explore financial relationships on a desktop computer or laptop. Embedded
analytics allow end-users to understand the financial implications of critical
business decisions easily by manipulating graphical icons that model their
enterprise. The company's solution incorporates several patented technologies
and leverages research originally conducted at University of Massachusetts and
the Russian Academy of Sciences. River Logic maintains a website at
www.riverlogic.com.
Headquartered in Beverly, Massachusetts, with an office in Dallas, River Logic
is a privately held corporation receiving venture capital support from Cardinal
Investment, Inc., CT Holdings, EBSCO CASIAS, eMed Ventures, the Intel 64 Fund,
and Mercury Ventures. The company's solution incorporates several patented
technologies and leverages research originally conducted at University of
Massachusetts and the Russian Academy of Sciences.
River Logic, PricewaterhouseCoopers, LLC and one of River Logic's resellers,
Heads Up! Systems, 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 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.
On May 5, 2000 we made an investment in River Logic by acquiring shares of
common stock of River Logic 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 ("Series A") from River Logic in exchange
for the contribution by one of our wholly-owned subsidiaries of the ESRN Assets,
as described below. In connection with our investment in River Logic, we also
made two bridge loans totaling $600,000 to River Logic that together were
convertible into shares of capital stock. 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 payable in advance by River Logic commencing on its third anniversary
date. In addition, we also incurred cash expenses for professional fees related
to these transactions and we issued 50,000 shares of our common stock to a
consultant for identifying the investment. After the closing of the transaction
the consultant became the Chief Operating Officer of River Logic and we granted
him 100,000 fully vested options to purchase our common stock at $5 per share
(which was above the fair market value on the date of issuance).
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 the Company
from EBSCO Industries in connection with this transaction in exchange for
666,667 shares of the Company's common stock. We filed a resale registration
statement on Form SB-2 in August 2000 relating to the shares of our common stock
issued in connection with this transaction.
In July 2000, River Logic closed a $3 million private placement of shares of its
Series B preferred stock to a venture capital firm specializing in early stage
technology firms offering Internet solutions that provide strong value-oriented
models for their prospective market-space. We did not participate in this
private placement.
In April 2001, River Logic received a strategic investment in shares of its
Series C Preferred Stock ("Series C") from the Intel 64 Fund, an affiliate of
Intel Corporation, Cardinal Investment, Inc., eMed Ventures and Mercury
Ventures, and we converted $450,000 of our convertible notes into shares of the
Series C Preferred Stock offered by River Logic and received approximately
$216,000 in cash for payment of the remaining bridge loan principal plus
interest.
Our Chief Executive Officer, Steven B. Solomon, serves on the board of directors
of River Logic.
River Logic is an early stage company, has a history of operating losses and may
require additional funding to attain profitability. At December 31, 2001, based
on the fair value of the Series C financing, we determined that the fair value
of our investment in River Logic was approximately $2.7 million and accordingly
we reduced our carrying value of our investment by $360,000. At December 31,
2001 we own approximately 12% of River Logic common stock plus our ownership of
shares of Series A and Series C preferred stock as if converted into shares of
River Logic common stock. As we hold a less than 20% ownership interest in River
Logic the investment has been accounted for using the cost method of accounting
for investments in common stock.
11
OVERVIEW OF ENCORE (formerly PerClick)
We hold a minor investment in Encore as a result of our initial investment in
PerClick.com Inc. ("PerClick"). PerClick developed and marketed billing and
customer management software to Internet telephony service providers. In
September 2000 the Company, as part of a group of investors, agreed to provide
$130,000 of bridge financing to PerClick. The Company also signed a letter of
intent to acquire a 40% ownership interest in PerClick but later decided not to
proceed with the acquisition. The bridge loan was represented by a convertible
demand note in the amount of $130,000 with an interest rate of 10% per annum.
The convertible demand note was convertible into 130,000 shares of common stock
of PerClick at anytime and at the option of the holder. In the first quarter of
2001 Vonova Corporation ("Vonova") acquired all of the equity of PerClick.
Vonova signed a note guarantee agreeing to the terms and conditions of the
PerClick note. In October 2001 Encore Telecommunications ("Encore") acquired the
assets of Vonova. As part of the asset acquisition agreement, CT Holdings
agreed to convert its note into an investment in Encore. The value of the
investment in Encore is approximately $32,000. Accordingly the Company reduced
the value of its original investment of $130,000 in PerClick to $32,000. The
investment in Encore is accounted for using the cost method.
PENDING ACQUISITION
CT Holdings announced on January 30, 2002 that it entered into a letter of
intent to acquire 100% of the shares of American Natural Technology Sciences
("ANTS") for a combination of stock and a future interest in royalties. While
the letter of intent expired by its terms in March 2002, we are continuing our
due diligence review of ANTS and may extend or renegotiate the terms of the
letter of intent. ANTS is a company engaged in the research and development of
products in the agricultural and biological industries, including products that
treat fire ant stings and control fire ant mounds. ANTS has successfully
researched, tested, and formulated environmentally friendly, patent pending
products that are unique in their efficacy and mode of action. ANTS continues to
discover proprietary commercial products and has discovered several additional
patentable prospects aimed at controlling fire ants and other insect pests.
ANTS has completed development of four new products, including Mitigator(TM)
Sting Treatment, Mitigator(TM) Fire Ant Bait, Mitigator(TM) Fire Ant Mound
Treatment, and Mitigator(TM) Barrier Treatment, and is developing Mitigator(TM)
Vermafuge. ANTS has filed a patent application for the Sting Treatment and a
patent application and EPA registration for the Fire Ant Mound Treatment.
The acquisition is subject to, among other things, extending or renegotiating
the letter of intent, the negotiation and execution of a definitive acquisition
agreement, due diligence, and other customary closing conditions. There can be
no assurance that we will complete the acquisition of ANTS.
EMPLOYEES
As of December 31, 2001, CT Holdings had 16 employees primarily assigned to
Citadel with seven employees in sales, marketing and customer support, four in
technology/R&D and technical support, and five in corporate and finance.
Following the Distribution and pursuant to the to the transition services
agreement between Citadel and CT Holdings all employees will become part of
Citadel. Approximately three to five employees of Citadel including the CEO and
CFO will spend 20% to 33% of their time managing the business development
activities of CT Holdings. Citadel will receive a fee from CT Holdings to cover
the costs of the shared employees. Our CEO also serves as a director of Parago
and River Logic.
Our future success depends in significant part upon the continued service of our
senior management personnel and our continuing ability to support the incubator
and business development activities. Competition for such personnel is intense,
and there can be no assurance that we can retain our key managerial employees or
that we can assimilate or retain other highly qualified personnel in the future.
None of our employees are represented by a labor union. We have not experienced
any work stoppages and consider our relations with our employees to be good.
GOVERNMENT REGULATION
Government regulation has not had a material effect on the conduct of our
business to date. Except for the requirement of compliance with United States
export controls relating to the export of high technology products, our products
and we are not subject to government approval procedures or other regulations
for the licensing of our products. The nature of our business does not subject
us to environmental laws in any material manner. Citadel's products enable
organizations to address and enforce the policies mandated by HIPAA and
Gramm-Leach-Bliley legislation for the health care and financial industries. As
the United States and other governments consider legislation to address the
growing requirements for increased security and privacy of data, particularly
health, financial and personal information, new opportunities to license
Citadel's existing and future products may arise.
If the pending acquisition of ANTS is completed there will be increased
environmental and other government regulations regarding the manufacture and
distribution of the pesticide products made by ANTS.
ACCOUNTANT'S REPORT
We have received a report from our independent auditors for our year ended
December 31, 2001 containing an explanatory paragraph that describes the
uncertainty regarding our ability to continue as a going concern due to our
historical negative cash flow,
12
our recurring operating losses, our significant working capital deficiency and
because, as of the date they rendered their opinion, we did not have access
to sufficient committed capital to meet our projected operating needs for at
least the next 12 months. Please see Management's Discussion and Analysis --
Liquidity and Capital Resources and Note A to our financial statements that
discuss some of the conditions that could impact our ability to continue
operations under the current business conditions.
FORWARD-LOOKING STATEMENTS
The following discussion contains 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.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
Investing in our common stock involves a high degree of risk. Any of the
following risks could materially adversely affect our business, operating
results and financial condition and could result in a complete loss of your
investment.
In addition to the other information in this Report, the following factors
should be considered carefully in evaluating the Company and its business. This
disclosure is for the purpose of qualifying for the safe harbor provisions of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. It contains factors that 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, or results of operations 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
OUR BUSINESS FOCUS IS THE DEVELOPMENT AND ACQUISITION OF EARLY STAGE COMPANIES;
HENCE, WE WILL ENCOUNTER NUMEROUS RISKS ASSOCIATED WITH OUR BUSINESS FOCUS AND
OUR PRIOR OPERATING HISTORY MAY NOT BE A MEANINGFUL GUIDE TO EVALUATING OUR
FUTURE PERFORMANCE.
Our business model is designed to enable the companies in whom we invest or
acquire to become market leaders in their industries. Our strategy over the
years has led to the development, acquisition and operation of technology based
businesses with strong business models and compelling valuations. We believe
that the anticipated growth in technology creates strong opportunities for us to
increase shareholder value by investing in early stage ventures well positioned
for growth in their respective marketplace. We will attempt to increase the
value of each investee by providing management, marketing and financial
expertise along with financial capital and then realize this new value through a
subsequent liquidity event such as a sale, merger or initial public offering of
the investee companies.
At December 31, 2001 the Company held investments in four companies, Citadel,
Parago, River Logic and Encore. In November 2001 the Company announced the
spin-off of Citadel. On January 30, 2002 we announced that a letter of intent
had been signed to acquire ANTS. Other than our formation and development of
these companies, we have a brief history in executing our business strategy. As
a consequence, our prior operating history may not provide a meaningful guide to
our prospects in emerging markets. Moreover, our 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. We may be unable to execute our strategy of
developing our business due to numerous risks, including the following:
. We may be unable to identify or develop relationships with attractive
emerging companies.
. Any 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.
13
. Our business model is unproven and depends on the willingness of
companies to participate in our business development model and
collaborate with each other and us.
. Our expenses will increase as we build the infrastructure necessary to
implement this model.
. We face competition from incubators, 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
business model and we may not be able to obtain these resources on
attractive terms, if at all.
WE HAVE INVESTED IN EARLY STAGE VENTURES; AND THERE CAN BE NO ASSURANCE THAT OUR
INVESTMENTS WILL PROVE TO BE FINANCIALLY ATTRACTIVE.
We have developed and invested in Citadel, Parago, River Logic and Encore and
are in negotiations acquire ANTS (our "investees" or "investee companies").
Inasmuch as our investee companies are early stage ventures, it is difficult to
judge their future prospects. Economic, governmental, industry and internal
company factors outside of our control affect each of our investee companies. A
significant portion of our assets is comprised of ownership interests in our
investee companies. If our investee companies do not succeed, the value of our
assets will decline.
CT HOLDINGS WILL NOT HAVE ACCESS TO THE CASH FLOW OR ASSETS OF CITADEL, AND MAY
BE UNABLE TO OPERATE PROFITABLY FOLLOWING THE DISTRIBUTION
Historically, since the businesses that comprise each of Citadel and CT Holdings
have been under one ultimate parent, they have been able to rely, to some
degree, on the earnings, assets and cash flow of each other for capital
requirements. After the Distribution, CT Holdings will not be able to rely on
the security software business for such requirements. Following the
Distribution, CT Holdings will continue to maintain its own credit and banking
relationships and perform its own financial and investor relations functions.
Because a significant number of key employees of CT Holdings will be employed by
Citadel following the Distribution, there can be no assurance that CT Holdings
will be able to successfully put in place the financial, administrative and
managerial structure necessary to continue to operate as an independent public
company, or that the development of such structure will not require a
significant amount of management's time and other resources.
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 voided, and a
court-appointed receiver could take control of us and liquidate our business.
Following the Distribution of Citadel, we may be deemed to be an investment
company unless we qualify for a safe harbor within the time permitted under the
1940 Act.
Although we have yet to make any investments in the investment securities of
companies other than Citadel, Parago, River Logic and Encore, 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.
WE HAVE A HISTORY OF NET LOSSES AND WILL NEED ADDITIONAL FINANCING TO CONTINUE
AS A GOING CONCERN.
We have incurred recurring operating losses and have a significant working
capital deficiency. Cash used in continuing operations was approximately
$113,000 during the year ended December 31, 2001. We have no cash balance at
December 31, 2001 and current liabilities exceed current assets by approximately
$2.4 million. We and our investee companies continue to be dependent upon
external financing to perform our business development activities, invest in
unconsolidated affiliates and provide for ongoing working capital requirements.
During 2001, substantially all of this financing has been provided by related
parties. As outlined below, our assets do not reflect the value that may be
realized from our investments in Parago, River Logic and Encore.
Our strategy of continuing to support and expand our business development
activities requires us to obtain additional capital. The complete implementation
of this element of our strategy will not generate positive cash flow in the
foreseeable future. Achieving positive cash flow is currently highly dependent
upon obtaining liquidity from our investments in unconsolidated affiliates. We
estimate we will need to raise additional funds to support the incubator and
business development activities of the Company through the remainder of 2002 and
substantially greater amounts if we expect to continue to acquire investments or
if amounts become
14
due to settle contingent liabilities. Historically, we have obtained short-term
bridge funding from our Chief Executive Officer or Directors of the Company.
While this may occur in the future there can be no assurance that such financing
will be available, or if available on terms that we would be willing to accept.
We have made investments in four companies and we are in negotiations to acquire
a fifth company that we believe may provide liquidity to us in the long term. In
November 2001 we announced the spin-off and tax-free distribution of shares in
Citadel, our security software business previously operated by us. Stockholders
in CT Holdings will receive one share of common stock in Citadel for every four
shares of stock held in CT Holdings. We believe that as a result of the
Distribution, each of Citadel and CT Holdings will have improved access to
capital, a more focused team of management and employees, and management
incentives linked more directly to the objective performance of that company's
stock in the public markets. We also believe that separating the security
software business from the rest of CT Holdings' operations will enhance value
for our stockholders and give Citadel the financial and operational flexibility
to take advantage of growth opportunities in the security software business. The
Distribution will enhance the ability of each of Citadel and CT Holdings to
focus on strategic initiatives and new business opportunities, improve cost
structures and operating efficiencies and design equity-based compensation
programs targeted to the performance of each company. In addition, the
transition to an independent company will heighten Citadel management's focus,
provide Citadel with greater access to capital and allow the investment
community to measure Citadel's performance relative to its peers. The security
software business also has some important traits that make this business
distinct from CT Holdings' other operations with respect to markets, products,
capital needs and plans for growth. However the Distribution will not provide
liquidity for CT Holdings as we will retain no ownership in the newly spun off
company.
In 1999 we formed Parago with an original equity investment of $50,000 provided
by us and no revenue. Parago's unaudited revenue and net loss were approximately
$26.0 million and $19.9 million, respectively for the year ended December 31,
2001. As expected in an early stage company, Parago has grown revenue year over
year but has not been profitable and experiences cash flow deficiencies as it
implements its business plan. We believe, however, that our investment of 20,000
common shares of Parago and warrants to purchase 28.8749 shares of Parago's
Series A-3 Preferred Stock (convertible into 2,887 shares of Parago's common
stock) may ultimately provide an appropriate return. Until we are able to create
liquidity from our investments through a sale to a strategic investor, an
initial public offering or some other liquidity transaction, we will continue to
require working capital to fund our own operating expenses.
Similarly, our investment in River Logic we believe has also been successful.
Since our initial investment, River Logic has made substantial progress in
executing its strategy through its development and introduction of new products
and establishment of new customer relationships. In addition, during April, 2001
River Logic obtained a significant strategic investment from the Intel 64 Fund,
Cardinal Investments, eMed Ventures, and Mercury Ventures. As part of that
round, we converted $450,000 of demand notes receivable into shares of River
Logic Series C Preferred stock, the same equity instruments purchased by the
other investees. The remainder of our note receivable plus accrued interest
totaling approximately $216,000 was paid in April 2001. Similar to the
investments in Parago, we recognized that these investments would be illiquid
initially and subject to changes in fair value. At December 31, 2001 we wrote
down our investment in River Logic by $360,000 to its estimated fair value of
$2.7 million. The carrying value of our initial $50,000 investment in Parago was
reduced to zero during 2000. While we are pleased with the progress in the
execution of business strategies and operating performance of Parago and River
Logic to date, there can be no assurance that we will ever achieve liquidity for
our investments.
There can be no assurance that management's plans will be successful or what
other actions may become necessary. Although we have been successful raising
capital in the past, any inability to raise capital may require us to sell
assets or reduce the level of our operations. In addition, we may suffer
dilution of our equity ownership in our investee companies if they require
additional financing and we elect not to participate in those additional
financings. Such actions could have a material adverse effect on our business
and operations and result in charges that could be material to our business and
results of operations.
THE ACQUISITION OF ANTS WILL PRESENT NEW BUSINESS RISKS AND GOVERNMENT
REGULATION TO CT HOLDINGS' MANAGEMENT
The pending acquisition of ANTS is dependent upon the final negotiation and
execution of a definitive acquisition agreement, completion of due diligence and
other customary closing procedures. While the letter of intent expired in March
2002, we are continuing our due diligence review of ANTS and may extend or
renegotiate the terms of the letter of intent. We may not be successful in
accomplishing these tasks or facts and circumstances found in the course of
negotiation and due diligence may change the deal structure such that it cannot
be completed as announced or at an amount we are willing to invest. This could
have an adverse effect on CT Holdings' liquidity, financial position and results
of operations.
ANTS is in the business of developing environmentally friendly pesticides. The
management of CT Holdings has no experience in the pesticide industry and will
therefore rely on the ANTS management team already in place for specific
industry expertise. As a result there is no guarantee that ANTS' products will
be successfully financed, manufactured, marketed or licensed to OEM
manufacturers by the management of either entity.
The pesticide industry is subject to seasonality with most products sold to the
end users in the spring and summer. Adverse weather conditions could also impact
buying patterns and subsequent use of the pesticide products which in turn will
have a direct impact on the timing of sales in the spring and summer quarters.
Pesticides are subject to local, state, federal and foreign laws and regulations
relating to environmental matters. In the United States, all products containing
pesticides must be registered with the United States Environmental Protection
Agency ("EPA") and in some case, similar state agencies. The inability to obtain
or the subsequent cancellation of any registration could have an adverse effect
on
15
ANTS' business. We believe we can operate in substantial compliance with these
laws and regulations. Compliance with these regulations and the obtaining of
registrations does not assure, however, that our products will not cause injury
to the environment or to people under all circumstances.
Our products are intended to be environmentally friendly. In some cases it takes
years to know the impact of a specific chemical on the environment. Industry
examples such as DDT, Dursban and Diazinon once widely used were subsequently
determined to be detrimental to the environment. As a result the ANTS products
currently believed to be environmentally friendly could be ruled detrimental to
the environment at some point in the future which would have a material adverse
effect on future results of operations of the ANTS business.
Regulations regarding the use of pesticides may include that only certified
professional users apply the products, that the products be used only in
specified locations or that certain ingredients not be used. Users my be
required to post notices on properties to which the products have been or will
be applied and may be required to notify individuals in the vicinity that the
products will be applied in the future. Even if we are able to comply with all
such regulations and obtain all necessary registrations, we cannot assure that
ANTS products will not cause injury to the environment or to people under all
circumstances. The costs of compliance, remediation or products liability could
materially affect future quarterly or annual operating results.
OUR STOCK IS TRADED IN THE OVER THE COUNTER MARKET.
Our common stock was de-listed from the Nasdaq SmallCap Market on May 17, 2001,
because we did not meet the Nasdaq's requirements for continued listing. Our
common stock now trades on the OTC Bulletin Board maintained by the National
Quotation Bureau, Inc. The OTC Bulletin Board is generally considered to be a
less efficient market, and our stock price, as well as the liquidity of our
common stock, may be adversely impacted as a result.
WE ARE INVOLVED IN LEGAL PROCEEDINGS THAT COULD HAVE A MATERIAL ADVERSE EFFECT
ON OUR BUSINESS
We are involved in legal proceedings as described in Item 3. Legal Proceedings
and from time to time, we may be subject to other legal proceedings, including
but not limited to claims that we have infringed the intellectual property
rights of others, product liability claims, or other claims incidental to our
business. While we intend to defend such lawsuits, adverse decisions or
settlements, and the costs of defending such suits, could have a material
adverse effect on our business.
OUR EARNINGS AND STOCK PRICE ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS.
Due to the factors noted in this Report, 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.
RISKS RELATED TO CITADEL SECURITY SOFTWARE AND THE DISTRIBUTION
At December 31, 2001 Citadel Security Software is a wholly owned subsidiary of
CT Holdings. Its balance sheet and results of operations are presented as
discontinued operations in CT Holdings financial statements due to the pending
spin-off of Citadel as a standalone public company. Because the spin-off had not
happened as of December 31, 2001 management feels that the risk factors related
to the Citadel should be presented herein to provide the reader a more complete
disclosure of the business and incubator activities of CT Holdings, the risks
associated with Citadel's business and the risks associated with the
distribution.
CITADEL HAS A HISTORY OF NET LOSSES AND WILL NEED ADDITIONAL FINANCING TO
CONTINUE AS A GOING CONCERN.
Citadel has incurred recurring operating losses and has a stockholders' deficit
of approximately $694 thousand. It used cash in operations of approximately $704
thousand during the year ended December 31, 2001. At December 31, 2001 Citadel
had a cash balance of approximately $75 thousand and current liabilities
exceeded current assets by approximately $936 thousand. Citadel has and may
continue to be dependent upon outside and related party financing to develop and
market its software products, perform its business development activities and
provide for ongoing working capital requirements. During the year ended December
31, 2001, substantially all of this financing was provided by related parties.
Citadel expects to generate cash from the sale of its software products and will
incur costs relating to such product development, marketing and general
corporate overhead that may result in a continuing cash deficiency. Achieving
positive cash flow is currently highly dependent upon increasing sales of its
products. Citadel estimates it will need to raise additional capital to fund its
business plan through the remainder of 2002 and substantially greater funds if
amounts become due to settle contingent liabilities. It may be
16
required to seek additional funds from related parties, including its directors
and officers. Historically, Citadel was funded by CT Holdings, which obtained
its funding on a short-term bridge basis from its Chief Executive Officer and
directors. While Citadel may seek similar funding in the future, there can be no
assurance that such financing will be available, or if available, on terms that
Citadel would be willing to accept.
Citadel received a report from its independent auditors for its year ended
December 31, 2001 containing an explanatory paragraph that describes the
uncertainty regarding its ability to continue as a going concern due to
historical negative cash flows and because, as of the date they rendered their
opinion, Citadel did not have access to sufficient committed capital to meet its
projected operating needs for at least the next 12 months.
There can be no assurance that management's operating plans will be successful
or what other actions may become necessary. Although Citadel has been successful
raising capital in the past as part of CT Holdings, any inability to raise
capital may require the company to reduce the level of its operations. Such
actions could have a material adverse effect on its business operations and
result in charges that could be material to its financial condition and results
of operations.
FOLLOWING THE DISTRIBUTION CITADEL STOCKHOLDERS MAY EXPERIENCE SIGNIFICANT
DILUTION IF FUTURE EQUITY OFFERINGS ARE USED TO FUND OPERATIONS, TO ACQUIRE
COMPLEMENTARY BUSINESSES OR RESULTING FROM THE EXERCISE OF EMPLOYEE STOCK
OPTIONS.
If future acquisitions are financed through the issuance of equity securities,
Citadel stockholders could experience significant dilution. In addition,
securities issued in connection with future financing activities or potential
acquisitions may have rights and preferences senior to the rights and
preferences of the Citadel Shares.
Citadel has granted options to purchase approximately 2,995,000 shares of
Citadel common stock employees, including officers and directors, and Citadel
may grant additional stock options in the future. The issuance of Citadel shares
upon the exercise of these options may result in dilution to the Citadel
stockholders.
CITADEL HAS NO OPERATING HISTORY AS AN INDEPENDENT PUBLIC COMPANY AND MAY
BE UNABLE TO OPERATE PROFITABLY AS A STAND-ALONE COMPANY
Although CT Holdings and its predecessors have operated as a reporting public
company since 1994 and have sold security software since 1992, Citadel does not
have an operating history as an independent public company. Historically, since
the businesses that comprise each of Citadel and CT Holdings have been under one
ultimate parent, they have been able to rely, to some degree, on the earnings,
assets and cash flow of each other for capital requirements. After the
Distribution, Citadel will be able to rely only on the security software
business for such requirements. The security software business has operated at a
loss in the past for CT Holdings, and there can be no assurance that, as an
independent company, such losses will not continue or increase. Additionally,
Citadel's business has relied on CT Holdings for financial, administrative and
managerial expertise in conducting its operations. Following the Distribution,
CT Holdings will continue to maintain its own credit and banking relationships
and perform its own financial and investor relations functions. While a
significant number of key employees of CT Holdings will be employed by Citadel
following the Distribution, there can be no assurance that Citadel will be able
to successfully put in place the financial, administrative and managerial
structure necessary to operate as an independent public company, or that the
development of such structure will not require a significant amount of
management's time and other resources.
CITADEL'S HISTORICAL FINANCIAL INFORMATION MAY BE OF LIMITED RELEVANCE
The financial statements of Citadel include the accounts of the security
software business of CT Holdings and have been prepared on an historical cost
basis in accordance with accounting principles generally accepted in the United
States and present Citadel's financial position, results of operations, and cash
flows as derived from CT Holdings' historical financial statements. CT Holdings
assets, liabilities and expenses relating to the security software business have
been allocated to Citadel based on specific identification or where specific
identification was not readily available Citadel used an estimate of the
proportion of corporate amounts allocable to Citadel, based on such factors as
revenues, number of employees, and other relevant factors deemed appropriate for
the allocation. In the opinion of Citadel's management, the allocations have
been made on a reasonable basis and Citadel believes that all amounts allocated
to Citadel are a reasonable representation of the assets, liabilities, revenues,
costs and expenses that would have been recorded if Citadel had performed these
functions as a stand-alone company.
The historical financial information included in Citadel's separate financial
statements represents an estimate of the results of operations, financial
position and cash flows of Citadel had it operated as a separate stand-alone
entity during the periods presented and does not, and may not, be representative
of Citadel's future results of operations, financial position and cash flows.
The financial information included herein does not reflect any changes that may
occur in the funding and operations of Citadel as a result of the Distribution.
CITADEL EARNINGS AND STOCK PRICE ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS.
The historical earnings and stock price of CT Holdings of which Citadel has been
a wholly owned subsidiary, have been subject to significant volatility,
particularly on a quarterly basis. The security software business as part of CT
Holdings has 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 its common stock. As a stand-alone company this may occur in
the future and have a significant adverse impact on the stock price of Citadel
following the Distribution.
17
IF CITADEL LOSES THE SERVICES OF ANY OF ITS KEY PERSONNEL, INCLUDING THE CHIEF
EXECUTIVE OFFICER OR DIRECTORS, ITS BUSINESS MAY SUFFER.
Citadel is dependent on its key officers, including Steven B. Solomon, its
Chairman and Chief Executive Officer, directors, and key employees in finance,
technology, sales and marketing. Citadel's business could be negatively impacted
if Citadel were to lose the services of one or more of these persons.
MEMBERS OF CITADEL'S BOARD OF DIRECTORS AND MANAGEMENT MAY HAVE CONFLICTS OF
INTEREST AFTER THE DISTRIBUTION
Members of the board of directors and management of Citadel will own shares of
both Citadel and CT Holdings common stock after the Distribution because of
their prior relationship and, in some cases, continuing relationships as
directors or executive officers with CT Holdings. In addition, two of the five
initial directors of Citadel will also be directors of CT Holdings, and the
Chief Executive Officer and Chief Financial Officer of Citadel will also
continue to serve as Chief Executive Officer and Chief Financial Officer of CT
Holdings. These relationships could create, or appear to create, potential
conflicts of interest when Citadel's directors and management are faced with
decisions that could have different implications for Citadel and CT Holdings.
Examples of these types of decisions might include the resolution of disputes
arising out of the agreements governing the relationship between CT Holdings and
Citadel following the Distribution. Also, the appearance of conflicts, even if
such conflicts do not materialize, might adversely affect the public's
perception of Citadel following the Distribution.
THE SOFTWARE INDUSTRY IS CHARACTERIZED BY RAPID TECHNOLOGICAL CHANGE AND CITADEL
WILL NEED TOADAPT ITS DEVELOPMENT TO THESE CHANGES.
Citadel participates in a highly dynamic industry characterized by rapid change
and uncertainty relating to new and emerging technologies and markets. Future
technology or market changes may cause some of its products to become obsolete
more quickly than expected.
INTRODUCTION OF NEW OPERATING SYSTEMS MAY CAUSE SIGNIFICANT FLUCTUATIONS IN
CITADEL'S FINANCIAL RESULTS AND STOCK PRICE.
If Citadel is 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 Citadel's products, future 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 Citadel's products, including those currently under development.
THE TREND TOWARD CONSOLIDATION IN THE SOFTWARE INDUSTRY MAY IMPEDE CITADEL'S
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 Citadel, ranging from desktop to enterprise solutions.
Citadel may not be able to compete effectively against these competitors.
Furthermore, Citadel may use strategic acquisitions, as necessary, to acquire
technology, people and products to execute its overall product strategy. As part
of CT Holdings, Citadel 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 the software 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
Citadel's future revenues and operating results.
CITADEL FACES INTENSE PRICE-BASED COMPETITION FOR LICENSING OF ITS PRODUCTS.
Price competition is often intense in the software market, especially for
security software products. Many of Citadel's 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.
CITADEL 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 Citadel's software
products and the functionality of some of its products. If Citadel is
unsuccessful in timely assimilating changes in the Internet environment into its
business operations and product development efforts, its future net revenues and
operating results could be adversely affected.
18
CITADEL MAY BE UNSUCCESSFUL IN UTILIZING NEW DISTRIBUTION CHANNELS.
Citadel currently licenses its products over the Internet and through direct
marketing, among other channels. It may not be able to effectively adapt its
existing, or adopt new, methods of distributing its 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 future revenues and profitability.
PRODUCT RETURNS MAY AFFECT CITADEL's REVENUE.
Citadel's current sales model is to sell its products directly to individuals,
organizations and corporations ("End Users"). Should the product not perform
substantially in accordance with written product documentation the End Users may
return products purchased within a reasonable period, generally thirty (30) days
from the date of shipment for a full refund. Should Citadel enter into
agreements with distributors and resellers where a contractual right of return
exsits, then product returns could occur when upgrades and new versions of
products are released or when distributors or resellers have excess inventories.
Under similar agreements in the past Citadel's return policy allowed
distributors, subject to various limitations, to return products in exchange for
new products or for credit toward future purchases of products. Citadel
estimates and maintains reserves for product returns. However, future returns
could exceed the reserves established, which could have a material adverse
affect on Citadel's operating results.
THE INCREASED USE OF SITE LICENSES AND VOLUME LICENSING AGREEMENTS MAY INCREASE
FLUCTUATIONS IN FINANCIAL RESULTS AND COULD AFFECT CITADEL'S BUSINESS.
Citadel's typical licensing pattern involves the licensing of a small number of
licenses with high margins, a short sales cycle and without deployment of
significant resources. Often times a licensee downloads software products from
Citadel's website and pays the license fee with a credit card. Citadel is now
beginning to emphasize corporate site licenses and volume licensing agreements
to corporations and small and mid sized businesses. A corporate site license
typically allows a customer to use Citadel's software products across his entire
business or an entire site within his business. A volume license agreement
typically provides the customer with a large number of licenses at a
significantly reduced price. These licensing arrangements tend to result in
larger revenue per customer but also involve a longer sales cycle, require
greater investment of resources in establishing the enterprise relationship and
can sometimes result in lower operating margins. The timing of the execution of
these licenses and the associated renewal of support services, or their
non-renewal or renegotiation by the customers, could cause Citadel's results of
operations to vary significantly from quarter to quarter. In addition, if the
corporate marketplace grows and becomes a larger component of the overall market
opportunity, Citadel may not be successful in expanding its corporate segment to
take advantage of this growth.
THE RESULTS OF RESEARCH AND DEVELOPMENT EFFORTS ARE UNCERTAIN.
Citadel believes that it will need to continue to make significant research and
development expenditures to remain competitive. While Citadel performs extensive
usability and beta testing of new products, the products currently under
development or may develop in the future may not be technologically successful.
If they are not technologically successful, the resulting products may not
achieve market acceptance and may not compete effectively with products of
competitors currently in the market or introduced in the future.
THE LENGTH OF THE PRODUCT DEVELOPMENT CYCLE IS DIFFICULT TO PREDICT.
The length of the product development cycle has generally been greater than
originally expected. Therefore Citadel is likely to experience delays in future
product development. These delays could have a material adverse affect on the
amount and timing of future revenues.
CITADEL MUST MANAGE AND RESTRUCTURE ITS OPERATIONS EFFECTIVELY
Citadel continually evaluates its product and corporate strategy. Citadel has in
the past undertaken and will in the future undertake organizational changes
and/or product and marketing strategy modifications as business conditions make
necessary from time-to-time. 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 Citadel may not realize
any benefit from these efforts.
CITADEL MUST ATTRACT AND RETAIN PERSONNEL WHILE COMPETITION FOR PERSONNEL IN ITS
INDUSTRY IS INTENSE.
Citadel believes that its future success will depend in part on its ability to
recruit and retain highly skilled management, sales, marketing and technical
personnel. Competition in recruiting personnel in the software industry is
intense. Citadel may not be successful in attracting and retaining qualified
personnel. The loss of the services of any key personnel or Citadel's inability
to hire new personnel with the requisite skills could restrict its ability to
develop new products or enhance existing products in a timely
19
manner, license products to its customers or manage its business effectively. To
continue to attract ad retain qualified employees, Citadel believes that it must
provide personnel with a competitive compensation package, including stock
options. Citadel may not be able to hire or retain qualified personnel if unable
to offer competitive salaries and benefits, or if the Citadel stock does not
perform well. In addition, as a stand-alone company Citadel may find it more
difficult to attract personnel. Citadel may have to increase salaries and
benefits which would increase its expenses and reduce profitability or increase
losses.
CITADEL'S SOFTWARE PRODUCTS MAY BE SUBJECT TO DEFECTS AND PRODUCT LIABILITY.
Software products frequently contain errors or defects, especially when first
introduced or when new versions or enhancements are released. Citadel tests its
products prior to release and has not experienced any material adverse effects
resulting from any of these defects or errors to date. Nonetheless, defects and
errors could be found in current versions of its 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 Citadel's operating results. Most of its
license agreements with customers contain provisions designed to limit exposure
to potential product liability claims. It is possible, however, that these
provisions limiting liability may not be valid under federal, state, local or
foreign laws or ordinances or as a result of unfavorable judicial decisions. A
successful product liability claim could have a material adverse affect on
Citadel's business, operating results and financial condition.
CITADEL'S SOFTWARE PRODUCTS AND WEBSITE MAY BE SUBJECT TO INTENTIONAL
DISRUPTION.
While Citadel has not been the target of software viruses or other attacks
specifically designed to impede the performance of its products or disrupt its
website, such viruses or other attacks could be created and deployed against its
products or website in the future. Similarly, experienced computer programmers,
or hackers, may attempt to penetrate its network security or the security of its
website from time to time. A hacker who penetrates Citadel's network or website
could misappropriate proprietary information or cause interruptions of its
services. Citadel might be required to expend significant capital and resources
to protect against, or to alleviate, problems caused by virus creators and
hackers.
CITADEL RELIES ON THIRD PARTY TECHNOLOGIES.
Citadel's software products are designed to run on multiple operating systems
and integrate with security products from other vendors. Although Citadel
believes that the target operating systems and products 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 Citadel does not
support. Moreover, if its products and technology are not compatible with new
developments from these companies, as to which there can be no assurances, its
business, results of operations and financial condition could be materially and
adversely affected.
CITADEL RELIES ON OUTSIDE RESEARCH ORGANIZATIONS.
With respect to security vulnerability research, Citadel has contracted with
Security Focus to provide updated vulnerability research data in addition to its
own research efforts. Citadel's research team uses publicly available sources to
find information on known and new vulnerabilities and their attributes. There
can be no assurance that Security Focus or the publicly available sources will
continue to operate as a going concern and that the data they provide will be
delivered without interruption.
CITADEL FACES AGGRESSIVE COMPETITION IN MANY AREAS OF ITS BUSINESS, AND WILL BE
HARMED IF IT FAILS TO COMPETE EFFECTIVELY.
Citadel encounters aggressive competition from numerous competitors in many
areas of its business. Many of its current and potential competitors have longer
operating histories, greater name recognition and substantially greater
financial, technical and marketing resources than Citadel and accordingly it may
not be able to compete effectively with these competitors. To remain
competitive, Citadel must develop new products and periodically enhance its
existing products in a timely manner. Citadel anticipates that it may have to
adjust the prices of many of its products to stay competitive. In addition, new
competitors may emerge, and entire product lines may be threatened by new
technologies or market trends that reduce the value of these product lines.
The market in which Citadel competes is influenced by the strategic direction of
major computer hardware manufacturers and operating system software providers.
Citadel's competitiveness depends on its ability to enhance existing products
and to introduce successful new products on a timely basis. Citadel has limited
resources and must restrict product development efforts to a relatively small
number of projects.
20
CITADEL'S QUARTERLY FINANCIAL RESULTS ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS,
WHICH COULD CAUSE ITS STOCK PRICE TO DECREASE.
Citadel has been subject to substantial fluctuations in quarterly net revenues
and operating results, and these fluctuations may occur in the future.
Fluctuations may be caused by a number of factors, including:
. the timing and volume of customer orders, customer cancellations, and
reductions in orders by distributors;
. the timing and amount of expenses;
. 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
revenues 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
Citadel's results could diverge from the expectations of investors and analysts.
If so, the market price of Citadel's stock would likely decrease.
CITADEL'S MANAGEMENT TEAM IS NEW.
Citadel has only recently assembled its management team, as part of the
distribution and changes in its operating structure. While some members of the
management team have worked with each other in the past, Citadel cannot
assess at this time the effectiveness of their working relationships after the
Distribution.
CITADEL RELIES ON INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS.
Citadel regards its software and the underlying technology as proprietary.
Citadel seeks to protect its proprietary rights through a combination of
confidentiality agreements, licenses and copyright, patent, trademark and trade
secret laws. However, Citadel does not employ technology to prevent copying of
its products. Third parties may copy aspects of products or otherwise obtain and
use Citadel's proprietary information without authorization or develop similar
technology independently.
Citadel does not have any patents or statutory copyrights on any of its
proprietary technology that it believes to be material to its future success.
Although Citadel has filed a provisional patent application with respect to some
of its business applications and intellectual property rights related to its
Hercules software, Citadel has not been issued any patents and cannot assure you
that any will be issued from its provisional patent application. Future patents,
if any, may be successfully challenged and may not provide Citadel with any
competitive advantages. Citadel may not develop proprietary products or
technologies that are patentable and other parties may have prior claims.
In selling its products, Citadel relies primarily on shrink-wrap licenses that
are not signed by licensees, and, therefore, such licenses may be unenforceable
under the laws in 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 proprietary rights as the
laws of the United States.
Patent, trademark and trade secret protection is important to Citadel because
developing and marketing new technologies and products is time-consuming and
expensive. Citadel does not own any U.S. or foreign patents or registered
intellectual property. Citadel may not be able to obtain access to issued
patents or other protection from any future patent applications owned by or
licensed to Citadel.
Citadel's competitive position is also dependent upon unpatented trade secrets.
Trade secrets are difficult to protect. Citadel's competitors may independently
develop proprietary information and techniques that are substantially equivalent
to Citadel's or otherwise gain access to its trade secrets, such as through
unauthorized or inadvertent disclosure of Citadel trade secrets.
There can be no assurance that Citadel's means of protecting its proprietary
rights will be adequate or that its competitors will not independently develop
similar technology substantially equivalent or superseding proprietary
technology. Furthermore, there can be no assurance that any confidentiality
agreements between Citadel employees and the company will provide meaningful
protection of its proprietary information, in the event of any unauthorized use
or disclosure thereof. Any legal action that Citadel may bring to protect
proprietary information could be expensive and may distract management from
day-to-day operations.
21
CITADEL IS INVOLVED IN LITIGATION, AND MAY BECOME INVOLVED IN FUTURE LITIGATION,
WHICH MAY RESULT IN SUBSTANTIAL EXPENSE AND MAY DIVERT ATTENTION FROM THE
IMPLEMENTATION OF ITS BUSINESS STRATEGY.
Citadel believes that the success of its business strategy depends, in part, on
obtaining intellectual property protection for its products, defending its
intellectual property once obtained and preserving its trade secrets. Litigation
may be necessary to enforce its intellectual property rights, to protect its
trade secrets and to determine the validity and scope of its proprietary rights.
Any litigation could result in substantial expense and diversion of management
attention from the business strategy, and may not adequately protect Citadel's
intellectual property rights.
In addition, Citadel may be sued by third parties who claim that Citadel's
products infringe on the intellectual property rights of others. This risk is
exacerbated by the fact that the validity and breadth of claims covered in
technology patents involve complex legal and factual questions for which
important legal principles are unresolved. Any litigation or claims against
Citadel, whether or not valid, could result in substantial costs, place a
significant strain on its financial resources, divert management resources and
harm Citadel's reputation. Such claims could result in awards of substantial
damages, which could have a significant adverse impact on Citadel's results of
operations. In addition, intellectual property litigation or claims could force
Citadel to:
. cease licensing, incorporating or using any of its products that
incorporate the challenged intellectual property, which would
adversely affect revenue;
. obtain a license from the holder of the infringed intellectual
property right, which license may not be available on reasonable
terms, if at all; and
. redesign its products, which would be costly and time-consuming.
As part of the Distribution, CT Holdings has assigned to Citadel a legal
proceeding in which CT Holdings is a defendant. From time to time, Citadel may
be subject to legal claims incidental to its business. Citadel may suffer an
unfavorable outcome as a result of one or more these claims. Citadel does not
expect the final resolution of these claims to have a material adverse effect on
its financial position, individually or in the aggregate. However, depending on
the amount and timing of unfavorable resolutions of claims against Citadel, or
the costs of settlement or litigation, its future results of operations or cash
flows could be materially adversely affected.
CT Holdings is a party to some legal proceedings, to which Citadel is not a
party. If a court in a lawsuit by an unpaid creditor or representative of
creditors, such as a trustee in bankruptcy, were to find that at the time CT
Holdings effected the Distribution, CT Holdings or Citadel (1) was insolvent;
(2) was rendered insolvent by reason of the Distribution; (3) was engaged in a
business or transaction for which their respective remaining assets constituted
unreasonably small capital; or (4) intended to incur, or believed it would
incur, debts beyond its ability to pay as such debts matured, such court may be
asked to void the Distribution (in whole or in part) as a fraudulent conveyance
and require that the stockholders return the Citadel Shares (in whole or in
part) to CT Holdings or require Citadel to fund certain liabilities for the
benefit of creditors. The measure of insolvency for purposes of the foregoing
will vary depending upon the jurisdiction whose law is being applied. Generally,
however, CT Holdings or Citadel would be considered insolvent if the fair value
of their respective assets were less than the amount of their respective
liabilities or if they incurred debt beyond their ability to repay such debt as
it matures.
See Our Business -- Legal Proceedings.
CITADEL MAY INCUR INCREASED EXPENSES IF THE TRANSITION SERVICES AGREEMENT WITH
CT HOLDINGS IS TERMINATED
In connection with the Distribution, Citadel will enter into a transition
services agreement with CT Holdings. This agreement will provide that CT
Holdings and Citadel will provide each other services for a fee in such areas as
information management and technology, employee benefits administration,
payroll, financial accounting and reporting, claims administration and
reporting, and other areas where CT Holdings and Citadel may need transitional
assistance and support following the Distribution. The agreement will generally
extend for one year after the Distribution, but may be terminated earlier under
certain circumstances, including a default. If the agreement is terminated,
Citadel may be required to obtain such services from a third party or increase
its headcount to provide such services. This could be more expensive than the
fees which Citadel will be required to pay under the transition services
agreement.
SOME PROVISIONS OF CITADEL'S CERTIFICATE OF INCORPORATION, BYLAWS AND THE TAX
DISAFFILIATION AGREEMENT MAY DISCOURAGE TAKEOVERS
Citadel's certificate of incorporation and bylaws contain some anti-takeover
provisions that may make more difficult or expensive or that may discourage a
tender offer, change in control or takeover attempt that is opposed by Citadel's
board of directors. In particular, Citadel's certificate of incorporation and
bylaws:
(1) classify Citadel's board of directors into three groups, so that
stockholders elect only one-third of the board each year;
22
(2) permit stockholders to remove directors only for cause and only by the
affirmative vote of at least 80% of Citadel's voting shares;
(3) permit a special stockholders' meeting to be called only by a majority
of the board of directors;
(4) do not permit stockholders to take action except at an annual or
special meeting of stockholders;
(5) require stockholders to give Citadel advance notice to nominate
candidates for election to Citadel's board of directors or to make
stockholder proposals at a stockholders' meeting;
(6) permit Citadel's board of directors to issue, without stockholder
approval, preferred stock with such terms as the board may determine;
(7) require the vote of the holders of at least 80% of Citadel's voting
shares for stockholder amendments to Citadel's bylaws; and
(8) require, for the approval of a business combination with stockholders
owning 5% or more of Citadel's voting shares, the vote of at least 50%
of Citadel's voting shares not owned by such stockholder, unless
certain fair price requirements are met or the business combination is
approved by the continuing directors of Citadel.
These provisions of Citadel's certificate of incorporation and bylaws, and
Delaware law could discourage potential acquisition proposals and could delay or
prevent a change in control of Citadel, even though a majority of Citadel's
stockholders may consider such proposals, if effected, desirable. These
provisions could also make it more difficult for third parties to remove and
replace the members of Citadel's board of directors. Moreover, these provisions
could diminish the opportunities for stockholders to participate in some tender
offers, including tender offers at prices above the then-current market value of
the Citadel Shares, and may also inhibit increases in the trading price of the
Citadel Shares that could result from takeover attempts or speculation.
In connection with the Distribution, Citadel has agreed to indemnify CT Holdings
for all taxes and liabilities incurred as a result of Citadel's or an
affiliate's post-Distribution action or omission contributing to an Internal
Revenue Service determination that the Distribution was not tax-free. Unless CT
Holdings effectively rebuts the presumption that a change in control transaction
involving Citadel or disposition of Citadel occurring within the four-year
period beginning two years prior to the Distribution Date is pursuant to the
same plan or series of related transactions as the Distribution, the Internal
Revenue Service might determine that the Distribution was not tax-free, giving
rise to Citadel's indemnification obligation. These provisions of the tax
disaffiliation agreement may have the effect of discouraging or preventing an
acquisition of Citadel or a disposition of Citadel's businesses, which may in
turn depress the market price for the Citadel Shares.
THE DISTRIBUTION MAY CAUSE THE TRADING PRICE OF CT HOLDINGS COMMON STOCK TO
DECLINE
Following the Distribution, CT Holdings expects that its common stock will
continue to be listed and traded on the Over The Counter Bulletin Board under
the symbol CITN. There can be no assurance that a trading market will continue
for the shares of CT Holdings common stock or develop for the Citadel Shares. As
a result of the Distribution, the trading price of CT Holdings common stock
immediately following the Distribution may be substantially lower than the
trading price of CT Holdings common stock immediately prior to the Distribution.
Following the Distribution, CT Holdings' operations will consist of the equity
interests in its incubation holdings, Parago, River Logic and Encore, and CT
Holdings' related business development operations, including potential future
acquisitions. Further, the combined trading prices of CT Holdings common stock
and the Citadel Shares after the Distribution may be less than the trading price
of CT Holdings common stock immediately prior to the Distribution.
SUBSTANTIAL SALES OF CT HOLDINGS COMMON STOCK MAY HAVE AN ADVERSE IMPACT ON THE
TRADING PRICE OF THE CT HOLDINGS COMMON STOCK
After the Distribution, some CT Holdings stockholders may decide that they do
not want shares in a company consisting of the incubation ventures and related
business development operations, and may sell their CT Holdings common stock
following the Distribution. If CT Holdings stockholders sell large numbers of
shares of CT Holdings common stock over a short period of time, or if investors
anticipate large sales of CT Holdings common stock over a short period of time,
this could adversely affect the trading price of the CT Holdings common stock.
SUBSTANTIAL SALES OF CITADEL SHARES MAY HAVE AN ADVERSE IMPACT ON THE TRADING
PRICE OF THE CITADEL SHARES
Based on the number of shares of CT Holdings common stock anticipated to be
outstanding on the Record Date CT Holdings will distribute to CT Holdings'
stockholders a total of approximately 15,000,000 Citadel Shares. Under the
United States federal securities
23
laws, substantially all of these shares may be resold immediately in the public
market, except for (1) Citadel Shares held by affiliates of Citadel or (2)
shares which are issued in respect of restricted shares of CT Holdings common
stock. Some of the CT Holdings stockholders who receive Citadel Shares may
decide that they do not want shares in a company consisting of the security
software business, and may sell their Citadel Shares following the Distribution.
Citadel cannot predict whether stockholders will resell large numbers of Citadel
Shares in the public market following the Distribution or how quickly they may
resell these Citadel Shares. If Citadel stockholders sell large numbers of
Citadel Shares over a short period of time, or if investors anticipate large
sales of Citadel Shares over a short period of time, this could adversely affect
the trading price of the Citadel Shares.
THERE CAN BE NO ASSURANCE THAT AN ACTIVE TRADING MARKET FOR CT HOLDINGS COMMON
STOCK WILL RETURN
Even though CT Holdings is currently a publicly held company, there can be no
assurance as to whether an active trading market for CT Holdings common stock
will be maintained after the Distribution or as to the prices at which the CT
Holdings common stock will trade. Some CT Holdings stockholders may decide that
they do not want shares in a company consisting of the incubation ventures and
related business development operations, and may sell their CT Holdings common
stock following the Distribution. These and other factors may delay or hinder
the return to an orderly trading market in the CT Holdings common stock
following the Distribution. Whether an active trading market for CT Holdings
common stock will be maintained after the Distribution and the prices for CT
Holdings common stock will be determined in the marketplace and may be
influenced by many factors, including the depth and liquidity of the market for
the shares, CT Holdings' results of operations, what investors think of CT
Holdings and the incubation ventures and business development industries,
changes in economic conditions in its industries and general economic and market
conditions. Market fluctuations could have a material adverse impact on the
trading price of the CT Holdings common stock.
THERE HAS NOT BEEN ANY PRIOR TRADING MARKET FOR THE CITADEL SHARES AND THERE CAN
BE NO ASSURANCE THAT ONE WILL DEVELOP
There is no current trading market for the Citadel Shares, although a
when-issued trading market may develop prior to completion of the Distribution.
The Citadel Shares will be listed on the Over The Counter Bulletin Board under a
symbol to be assigned by the OTCBB prior to commencement of trading. There can
be no assurance as to whether the Citadel Shares will be actively traded or as
to the prices at which the Citadel Shares will trade. Some of the CT Holdings
stockholders who receive Citadel Shares may decide that they do not want shares
in a company consisting of a security software business, and may sell their
Citadel Shares following the Distribution. This may delay the development of an
orderly trading market in the Citadel Shares for a period of time following the
Distribution. Until the Citadel Shares are fully distributed and an orderly
market develops, the prices at which the Citadel Shares trade may fluctuate
significantly and may be lower than the price that would be expected for a fully
distributed issue. Prices for Citadel Shares will be determined in the
marketplace and may be influenced by many factors, including the depth and
liquidity of the market for the shares, Citadel's results of operations, what
investors think of Citadel and the security software industry, changes in
economic conditions in the security software industry, and general economic and
market conditions. Market fluctuations could have a material adverse impact on
the trading price of the Citadel Shares.
FAILURE TO QUALIFY AS A TAX-FREE TRANSACTION COULD RESULT IN SUBSTANTIAL
LIABILITY
CT Holdings and Citadel intend for the Distribution to be tax-free for U.S.
federal income tax purposes. Neither CT Holdings nor Citadel has requested an
advance ruling from the Internal Revenue Service, or any opinion of their tax
advisors, as to the tax consequences of the Distribution. No assurance can be
given that the Internal Revenue Service or the courts will agree that the
Distribution is tax-free.
If the Distribution does not qualify for tax-free treatment, a substantial
corporate tax would be payable by the consolidated group of which CT Holdings is
the common parent measured by the difference between (1) the aggregate fair
market value of the Citadel Shares on the Distribution Date and (2) CT Holdings'
adjusted tax basis in the Citadel Shares on the Distribution Date. The corporate
level tax would be payable by CT Holdings. However, Citadel has agreed under
certain circumstances to indemnify CT Holdings for all or a portion of this tax
liability. This indemnification obligation, if triggered, could have a material
adverse effect on the results of operations and financial position of Citadel.
In addition, under the applicable treasury regulations, each member of CT
Holdings' consolidated group (including Citadel) is severally liable for such
tax liability.
Furthermore, if the Distribution does not qualify as tax-free, each CT Holdings
stockholder who receives Citadel Shares in the Distribution would be taxed as if
he had received a cash dividend equal to the fair market value of his Citadel
Shares on the Distribution Date.
Even if the Distribution qualifies as tax-free, CT Holdings could nevertheless
incur a substantial corporate tax liability under Section 355(e) of the Internal
Revenue Code of 1986, as amended (the Internal Revenue Code or the Code), if CT
Holdings or Citadel were to undergo a change in control (whether by acquisition,
additional share issuance or otherwise) pursuant to a plan or series of related
transactions which include the Distribution. Any transaction which occurs within
the four-year period beginning two years prior to the
24
Distribution is presumed to be part of a plan or series of related transactions
which includes the Distribution unless CT Holdings establishes otherwise. Under
certain circumstances, Citadel would be obligated to indemnify CT Holdings for
all or a portion of this substantial corporate tax liability under the tax
disaffiliation agreement. This indemnification obligation would have a material
adverse effect on the results of operations and financial position of Citadel.
RISKS RELATED TO OUR INVESTEES
The following are some risks related to the business of Parago, River Logic and
Encore, our investees, 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.
THERE CAN BE NO ASSURANCE THAT OUR INVESTEES WILL COMPLETE AN INITIAL PUBLIC
OFFERING OR OTHER LIQUIDITY EVENT.
There can be no assurance that any of our investees will complete an initial
public offering or other liquidity event. The failure to complete an offering or
other liquidity event such as an acquisition by a third party could have a
material adverse effect on our stock price. You cannot be assured that an
initial public offering or other liquidity event 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 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 previously 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.
OUR INVESTEES' BUSINESSES AND FUTURE PROSPECTS ARE EXTREMELY DIFFICULT TO
EVALUATE BECAUSE THEIR OPERATING HISTORIES ARE VERY LIMITED AND THEIR BUSINESS
MODELS ARE NEW, UNPROVEN AND EVOLVING.
Our investees were formed recently, therefore each investee has only a limited
operating history on which one can base an investment decision. You should
consider their prospects in light of the uncertainties and difficulties
frequently encountered by companies in their early stages of development.
In addition, each investee's business model is new, unproven and evolving. We
cannot assure that our investees' business models will be commercially
successful, or that their solutions will be accepted by businesses or consumers.
If our investees are unable to establish pricing and service models acceptable
to manufacturers, retailers and service providers and attractive to their
customers, their solutions may not be commercially successful.
EACH INVESTEE HAS A HISTORY OF NET LOSSES AND EXPECTS TO CONTINUE TO INCUR
SUBSTANTIAL NET LOSSES IN THE FUTURE.
Each investee had a unaudited net losses for the year ended December 31, 2001
and we anticipate that each investee will incur additional losses for the
foreseeable future. If our investees' revenues do not grow as they anticipate,
our investees may never be profitable.
25
TO CONTINUE THEIR OPERATIONS AND BUSINESSES, OUR INVESTEES MUST RAISE ADDITIONAL
FINANCING.
Our investees' ability to maintain and grow their businesses is dependent on
access to sufficient funds to support their working capital and capital
expenditure needs. If our investees do not raise additional funds, their
businesses and results of operations will be seriously harmed, and our assets
and share price would be materially and adversely impacted. This additional
financing may not be available to our investees on a timely basis if at all, or,
if available, on terms acceptable to our investees. Moreover, additional
financing may cause material and immediate dilution to existing stockholders of
our investees, including us.
IN THE EVENT OF THE COMPLETION OF AN INITIAL PUBLIC OFFERING BY ANY OF OUR
INVESTEES, THEIR STOCK PRICE IS LIKELY TO BE VERY VOLATILE.
Currently, the securities of our investees cannot be bought or sold publicly.
There can be no assurance that any of our investees will be able to complete an
initial public offering. Although it is anticipated that the initial public
offering price (if an initial public offering is completed) would be determined
based on several factors, the market price after the offering may vary
significantly from the initial offering price. The market price of our
investees' 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 their 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,
if it becomes publicly traded.
Sales of a substantial number of shares of our investees' common stock in the
public market after its initial public offering could depress the market price
of their common stock and could impair their ability to raise capital through
the sale of additional equity securities.
ITEM 2. DESCRIPTION OF PROPERTY
On March 25, 2002 Citadel Security Software signed a sublease agreement for
approximately 13,400 square feet of office space in an office tower located at
8750 N. Central Expressway, Suite 100, Dallas, Texas 75231. The sublease calls
for a rent of $9,740 per month through May 2003 and $17,242 per month thereafter
through expiration in February 2005. The CEO of Citadel and CT Holdings has
signed a personal guarantee related to this sublease. CT Holdings as part of the
transition services agreement will be allocated space for its shared employees
for which the cost of the space will be included in its monthly administrative
fee described in "Relationship Between CT Holdings and Citadel Following the
Distribution--Transition Services Agreement." We believe that these facilities
will be sufficient to meet our needs for the foreseeable future.
The telephone number of our principal office is (214) 520-9292. The Company
maintains a site on the World Wide Web at http://www.ct-holdings.com.
ITEM 3. LEGAL PROCEEDINGS
Set forth below are litigation matters to which we are a party. We believe that
we have meritorious defenses and will vigorously defend ourselves. However, an
unfavorable resolution of, 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 August 1998, Janssen-Meyers Associates L.P. ("JMA") filed a lawsuit against
CT Holdings arising out of an alleged 1995 contract with CT Holdings'
predecessor. The suit alleged that this predecessor breached a letter of intent
dated September 1995 and/or a Placement Agency Agreement dated November 1995
between JMA and the predecessor. As its damages, JMA claimed that it was
entitled to, among other things, the cash value of warrants to purchase 1.8
million shares of CT Holdings common stock at an exercise price of $0.89 per
share, valued during May 1996. According to JMA's valuation of those warrants,
potential damages were alleged to exceed $40 million. CT Holdings 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. CT Holdings removed the case to
federal court in the Southern District of New York. Following mediation in July
2000, CT Holdings entered into a settlement term sheet to attempt to resolve the
disputes between it and JMA, pursuant to which CT Holdings and JMA agreed in
principle 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 was subject to execution
of definitive settlement documents and approval of the boards of directors of
the companies. CT Holdings and JMA were unable to negotiate the final definitive
settlement agreement and, as a result, the matter was not settled. The case was
dismissed in August 2000 without any resolution of this issue. On March 27,
2001, JMA attempted to reopen this matter, but the Court hearing the JMA lawsuit
issued a Summary Order denying JMA's motion to enforce the settlement term sheet
and confirmed the prior dismissal of the lawsuit. The Court further ruled that
JMA would either have to bring an action on the proposed settlement or move to
re-open the dismissed case. The Court stated that it did not express any view
with respect to the merits of the proposed settlement that brought about the
dismissal of the case. There was no activity on the case from March 2001 through
August 2001. On August 27, 2001 JMA refiled its lawsuit with a federal court in
New York, and CT Holdings filed a motion to dismiss the case because the
plaintiffs lacked the required diversity jurisdiction to pursue the claims in
federal court. On October 31, 2001 the case was dismissed in federal court. In
December 2001, the plaintiffs refiled the lawsuit in the state court seeking to
enforce the settlement term sheet. The case was filed in Supreme Court of New
York, that state's trial court, in a case styled Roan
26
Meyers v. CT Holdings. CT Holdings intends to vigorously defend against this
lawsuit and has filed a counterclaim to, among other things, recover excess
amounts charged by JMA in connection with related bridge loans. Trial has not
been set on this matter.
In June 2000, CT Holdings 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 warrants during a time when CT Holdings'
related registration statement could not be used. CT Holdings believes that the
claims asserted by the Fergusons are without merit and will vigorously defend
the claims. The case is set for trial on April 22, 2002.
In June 2000, Tech Data Corporation filed suit against CT Holdings, alleging a
breach of a Software Distribution Agreement ("the Agreement") with CT Holdings.
The lawsuit is styled Tech Data Corporation v. Citadel Technology, Inc. (now
known as CT Holdings), and was filed in Dallas County Court at Law No. 2.
Because CT Holdings was not properly served, Tech Data obtained a default
judgment for $101,048.53. When CT Holdings discovered the default judgment, it
filed and won a motion to set aside this judgment. In June 2001, Tech Data
properly served CT Holdings. CT Holdings answered and demanded binding
arbitration pursuant to the agreement. The parties filed a Joint Motion to
Arbitrate in December 2001. The judge granted this motion, and CT Holdings
expects that this matter will be referred to binding arbitration in the second
quarter of 2002. As part of the Distribution, we anticipate that Citadel
Security Software will assume responsibility for this lawsuit, although there
can be no assurance that we will be released from the lawsuit.
We may become involved from time to time in litigation on various matters which
are routine to the conduct of our business. We believe that none of these
actions, individually or in the aggregate, will have a material adverse effect
on our financial position or results of operations, though any adverse decision
in these cases or the costs of defending or settling such claims could have a
material adverse effect on our business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
27
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
Our common stock trades on the OTC Bulletin Board under the symbol CITN. Between
February 2000 and May 2001 our stock was traded on the Nasdaq SmallCap
Market. In May 2001 our stock was delisted from the Nasdaq SmallCap Market
because we did not meet the requirements for continued listing. The following
table sets forth, for the periods indicated, the high and low sale prices for
the Common Stock as reported by the NASDAQ and displayed on its website.
High Low
Fiscal Year Ended February 29, 2000
1st Quarter $3.62 $1.94
2nd Quarter 2.97 1.34
3rd Quarter 3.13 1.81
4th Quarter 7.84 2.13
Ten Months Ended December 31, 2000
1st Quarter
(March 1 - 31) $7.38 $4.91
2nd Quarter
(April 1 - June 30) 5.22 1.34
3rd Quarter
(July 1 - September 30) 2.38 0.72
4th Quarter
(October 1 - December 31) 1.31 0.25
Fiscal Year Ended December 31, 2001
1st Quarter $0.81 $0.28
2nd Quarter 0.60 0.16
3rd Quarter 0.42 0.17
4th Quarter 0.58 0.26
Holders of common stock are entitled to dividends when and if declared by the
Board of Directors out of funds legally available therefor. The Company has
never paid cash dividends on its Common Stock, and management intends, for the
immediate future, to retain any earnings for the operation and expansion of the
Company's business. Any future determination regarding the payment of dividends
will depend upon results of operations, capital requirements, the financial
condition of the Company and such other factors that the Board of Directors of
the Company may consider. The Company has issued preferred stock, which entitles
the holders thereof to preferences as to payment of dividends and liquidation
proceeds.
Recent Sales of Unregistered Securities
None
28
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS
The following discussion should be read in conjunction with the financial
statements and notes thereto found elsewhere herein, as well as the disclosure
relating to forward-looking statements set forth above under the caption Factors
That May Affect Future Operating Results.
OVERVIEW
CT Holdings, Inc. provides management expertise and capital to early stage
companies. At December 31, 2001 the Company held investments in Citadel Security
Software, Parago, River Logic and Encore. The Company was incorporated in
Delaware in 1992 and previously operated under the name Citadel Technology Inc.
Our business model is designed to enable the companies in whom we invest or
acquire to become market leaders in their industries. Our strategy over the
years has led to the development, acquisition and operation of technology based
businesses with compelling valuations and strong business models. We believe
that the anticipated growth in technology creates strong opportunities for us to
increase shareholder value by investing in well-positioned early stage ventures.
Our goal is to realize the value of our investments for our shareholders through
a subsequent liquidity event such as a spin-off, sale, merger or initial public
offering of the investee companies.
In November 2001 the Company announced a plan to spin-off of its Citadel
subsidiary as a special dividend to shareholders of CT Holdings. (See "The
Citadel Security Software Distribution and Discontinued Operations" below). This
transaction had not closed as of December 31, 2001 and the results of operations
of Citadel are presented as discontinued operations in the Financial Statements
of the CT Holdings.
In January 2002 we signed a letter of intent to acquire American Natural
Technology Sciences ("ANTS"), a developer of environmentally friendly pesticides
for the control of fire ants and other insects. While this letter of intent has
expired, we are continuing to conduct a due diligence review of ANTS and may
extend or renegotiate the terms of the letter of intent. (See Notes to the
Financial Statements.)
THE CITADEL SECURITY SOFTWARE DISTRIBUTION AND DISCONTINUED OPERATIONS
In November 2001, CT Holdings' board of directors declared a pro rata dividend
distribution payable to the holders of outstanding CT Holdings common stock (the
Distribution) as of the Record Date. In January 2002 Citadel filed a
registration statement on Form 10-SB with the SEC to register securities that
are proposed to be distributed as a result of the Distribution. This
registration statement was amended on March 8, 2002 and April 5, 2002.
The Distribution consists of one (1) share of Citadel common stock for every
four (4) shares of CT Holdings (the Distribution Ratio) common stock outstanding
on the Record Date. After the Distribution, Citadel will be an independent
company, with CT Holdings having no continuing ownership interest in Citadel.
Two of five directors of CT Holdings will be directors of Citadel and the Chief
Executive Officer and the Chief Financial Officer of CT Holdings will hold the
same positions with Citadel. It is expected that 20% to 33% of the officers'
time will be allocated to CT Holdings. All other employees of CT Holdings will
become employees of Citadel. Under the transition services agreement Citadel
will provide, accounting, administrative, information management and other
services, including the services of the two officers, to CT Holdings in return
for a payment of a monthly administrative fee initially estimated at $20,000 per
month. The fee may be adjusted quarterly subject to a reallocation of the
estimated time devoted to each company.
The Distribution is intended to be a tax-free distribution for U.S. federal tax
purposes, although neither we nor Citadel have requested or obtained any
opinions as to the tax treatment of the Distribution. On or before the
Distribution Date, CT Holdings and Citadel will enter into a series of
agreements including a distribution agreement, a transition services agreement,
and a tax disaffiliation agreement which will provide for, among other things,
the principal corporate transactions required to effect the Distribution, to
provide for an orderly transition to the status of two independent companies and
to define the continuing relationship between Citadel and CT Holdings after the
Distribution.
As a result of the Distribution the financial statements and the results of
operations of Citadel are presented as discontinued operations in CT Holdings'
financial statements. Summary financial information is provided below:
Ten Months
Year Ended Ended
December 31, December 31,
2001 2000
------------ ------------
Results of operations:
Revenue $ 580,039 $ 460,985
Net Loss (1,865,981) (2,984,007)
Balance sheet data:
Current assets 171,954 182,219
Current liabilities 1,107,647 798,177
Property and equipment 43,006 94,054
Capitalized software development costs 174,110 485,221
Stockholder's (deficit) equity (693,926) 112,116
29
OVERVIEW OF CITADEL SECURITY SOFTWARE
Citadel develops, markets and licenses a line of desktop and network security
software products that address security inside the firewall, a growing segment
within the software industry. Citadel's security software products are generally
licensed for perpetual use on standalone personal computers or on single or
multiple networks across single or multiple customer computing sites. Its
software products, Hercules, WinShield Secure PC and NetOFF, provide the
flexibility and scalability that security administrators demand for identifying
and repairing computing vulnerabilities and managing security policies within
the computing environments. These security tools operate inside the firewall and
are designed to secure computers and networks against unauthorized configuration
changes and software installations that cause a large number of system
vulnerabilities.
After the Distribution, Citadel will be an independent public company, with CT
Holdings having no continuing ownership interest in Citadel. Citadel has been
allocated the CT Holdings corporate assets, liabilities and expenses related to
the security software business based on an estimate of the proportion of such
amounts allocable to Citadel, utilizing such factors as total revenues, employee
headcount and other relevant factors. CT Holdings and Citadel believe that these
allocations have been made on a reasonable basis and that all costs allocated to
Citadel are a reasonable representation of the costs that Citadel would have
incurred if Citadel had performed these functions as a stand-alone company.
Citadel operates in one business segment of the software industry, security
software. It's products, Hercules, WinShield Secure PC and NetOFF, provide
customers with network security solutions inside the firewall. Customers license
Citadel's products for various reasons ranging from a simple need for a security
solution (NetOFF) to limit access to an unattended computer, to a desire for
centralized computer systems configuration and policies management (WinShield
Secure PC), to a concern for internal for external attacks caused by system
vulnerabilities and their remediation (Hercules) to preclude such attacks or to
meet the mandates of law. Hercules, WinShield Secure PC and NetOFF address the
policies mandated by the Health Insurance Portability and Accountability Act
(HIPAA) and Gramm-Leach-Bliley legislation, which impose strict security and
privacy requirements on personal data in the health care and financial
industries, respectively. The direct impact of these laws on revenue is
difficult to specifically determine however revenue from healthcare
organizations, insurance companies and financial institutions represent
approximately 40% and 8% of Citadel's total revenue for the year ended December
31, 2001 and the ten months ended December 31, 2000, respectively. Citadel
expects that increasing concern for security and privacy of personal data will
continue to drive revenue from healthcare and financial institutions.
Hercules is a new vulnerability remediation software application that provides
an automated remediation solution for corporate and government computing
environments, and Citadel believes that it is the only solution that can
automatically identify and deploy the appropriate patches and fixes to repair
the vulnerability, and enhance the security of the environment. Citadel released
Hercules for beta testing in December 2001 and for commercial availability in
March 2002. In January 2002 Citadel filed for a provisional patent application
with respect to the core technologies and intellectual property rights related
to Hercules.
WinShield Secure PC enforces security policies from a single point of control
across multiple operating systems and platforms. Additionally, Secure PC
provides hardening of system files that deliver the first line of defense
against viruses, malicious code and unauthorized access or theft of confidential
information. Version 4.21 was released in October 2001.
NetOFF is designed to protect a network by shutting down unattended client PCs
automatically after a specified period of inactivity. Network administrators may
also use NetOFF to shut down PCs to enhance backup operations or assist with the
distribution of new software and anti-viral updates. The product ensures an
orderly shutdown by automatically closing all open files and applications on the
PC and saving the information. Version 7.53 was released in February 2001.
In addition to current product offerings, Citadel is also developing additional
features and functions for products that it anticipates launching in 2002.
Citadel's current products are not subject to rapid changes in consumer
preferences or technological obsolescence due to the introduction of new
operating systems or computing products. However it is reasonably possible that
these factors may change in the future as our business model is adapted to
changes in technology, changes in buying patterns of our customers and changes
in the software industry's licensing models.
OVERVIEW OF PARAGO
We began our business development activities in January 1999 with the formation
of Parago, Inc., an application service provider (ASP) and Internet based
business process outsourcer (BPO) that provides a suite of technology offerings
(including PromoCenter, ValueRewards and KnowledgeCenter) designed to increase
sales, reduce costs, and retain customers for retailers, manufacturers and
service organizations. Parago's continuous customer interaction services include
online promotional management (including online rebate processing), proactive
email, online surveys, and customer data analysis and reporting. Parago's
comprehensive integrated suite of outsourced customer care solutions are
marketed across multiple industry lines. Parago's preliminary unaudited results
for the year ended December 31, 2001 included revenues of approximately $26.0
million and net loss of approximately $19.9 million. Through December 2001,
Parago had received approximately $96.3 million in private equity financing from
venture capital investors including TH Lee Putnam Ventures, Dain Rauscher
Wessels Investors, Watershed Capital and Seaboard Ventures, as well as angel
investors. CT Holdings continues to hold 20,000 shares of Parago common stock
and warrants to purchase 28.8749 shares of Parago's Series A-3 Preferred Stock
(convertible into 2,887 shares of Parago's common stock).
30
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, ValueRewards 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 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. Parago markets its solutions to
retailers, manufacturers and service providers across multiple industries.
In connection with an acquisition by Parago in March 1999, 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 shareholders of the Company
acquired by Parago. 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.
After a 1 for 1000 reverse stock split by Parago in connection with its Series E
preferred stock offering in December 2001 to February 2002, in which the Company
elected not to participate, the Company holds 20,000 shares of common stock of
Parago and warrants to purchase 28.8749 shares of Parago's Series A-3 Preferred
Stock (convertible into 2,887 shares of Parago's common stock) at December 31,
2001. In December 2001 Parago completed an equity financing of approximately
$13.6 million. Approximately $1.4 million of equity financing was closed in
February 2002. As a result of the equity financing our ownership percentage in
Parago was reduced to approximately 1%. Our investment in Parago for the period
from January 1, 2001 through December 12, 2001 and the ten months ended December
31, 2001 was accounted for under the equity method of accounting for investments
and accordingly as a result of our ownership falling below 20%, will be
accounted for using the cost method of accounting beginning December 13, 2001.
Under the cost method of accounting, the Company's share of the income or loss
from Parago is not included in operations. Under the equity method of
accounting, the Company's share of the investee's income or losses is included
in the statements of operations. If the carrying value of the Company's net
investment falls below zero, the Company discontinues applying the equity method
until the carrying value of the net investment rises above zero. In addition, in
the event the Company's ownership percentage exceeds 20% and 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 is recovered through our proportionate share
of net income if Parago turns profitable. Parago's revenue for the year ended
December 31, 2001 was $26.0 million (unaudited) and its net loss was $19.9
million (unaudited). While Parago continues to incur operational losses we
believe that our $50,000 investment in Parago represented by 20,000 shares of
Parago's common stock and warrants to purchase 28.8749 shares of Series A-3
preferred stock (convertible into 2,887 shares of Parago common stock) may
ultimately provide an appropriate return.
During the second quarter of 2001 the Company, along with other investors in
Parago, participated in a bridge loan financing of Parago of $692,740 plus
guaranteed $1,406,472 of a bank term loan to Parago. Accordingly the Company
recognized a charge to earnings of $2,099,212 in June 2001. Upon closing of the
Parago equity financing in December 2001 Parago repaid the bridge loan and the
bank guarantee was released. As a result the Company reversed the $2,099,212 in
the fourth quarter of 2001.
OVERVIEW OF RIVER LOGIC
In May 2000, we made an investment in River Logic by acquiring shares of common
stock of River Logic 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 ("Series A") from River Logic in exchange for the
contribution of assets acquired from a third party by the Company through
exchange of 666,667 shares of our common stock. In connection with the
investment in River Logic, we also made two bridge loans totaling $600,000 to
River Logic that were convertible into shares of capital stock of River Logic.
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 repayable by River Logic commencing on its
third anniversary date. In addition, we also incurred cash expenses for
professional fees related to these transactions and we issued 50,000 shares of
our common stock to a consultant for identifying this investment. After the
closing of the transaction the consultant became the Chief Operating Officer of
River Logic and we granted him 100,000 fully vested options to purchase our
common stock at $5 per share (which was above the fair market value at the date
of issuance).
In April 2001, River Logic received a strategic investment from the Intel 64
Fund, Cardinal Investment, Inc, eMed Ventures and Mercury Ventures, and the
Company converted $450,000 of the principal amount of the notes into shares of
the Series C Preferred Stock, and River Logic repaid the $216,000 balance of
these notes plus interest in April 2001.
The carrying value of the River Logic investment is approximately $2,7 million
representing an ownerhsip percentage of approximately 12%. Our investment in
River Logic is accounted for using the cost method of accounting for investments
in common stock.
31
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of operations
are based upon our financial statements, which have been prepared in accordance
with accounting principles generally accepted in the United States of America.
The preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses and related disclosure of contingent assets and liabilities. On an
on going basis, we evaluate our estimates, including those related to our
investments in our investee companies and commitments and contingencies. We base
our estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities.
Actual results may differ from these estimates under different assumptions or
conditions.
We believe the following critical accounting policies are most important to the
presentation of our financial statements and require the most difficult,
subjective and complex judgments.
Impairment Charges
We periodically evaluate the carrying value of our ownership interests in our
investee companies for possible impairment based on achievement of business plan
objectives and milestones, the value of each ownership interest in the investee
company relative to carrying value, the financial condition and prospects of the
investee company, and other relevant factors. The business plan objectives and
milestones we consider include, among others, those related to financial
performance such as achievement of planned financial results or completion of
capital raising activities, and those that are not primarily financial in nature
such as obtaining key business relationships or the hiring of key employees.
If an indication of impairment exists with respect to the carrying value of an
investee company, we perform an evaluation by comparing the estimated fair value
of the asset with its carrying value. Fair value is determined by estimating the
cash flows related to the asset, including estimated proceeds on disposition, if
any. If the fair value is less than the carrying value a loss is recorded.
Deferred Income Taxes
We record a valuation allowance to reduce our deferred tax assets to the amount
that is more likely than not to be realized. We consider future taxable income
and prudent and feasible tax planning strategies in determining the need for a
valuation allowance. In the event that we determine that we would not be able to
realize all or part of our net deferred tax assets, an adjustment to the
deferred tax assets is charged to earnings in the period such determination is
made. Likewise, if we later determine that it is more likely than not that the
net deferred tax assets would be realized, then the previously provided
valuation allowance would be reversed.
Commitments and Contingencies
From time to time, we are a defendant or plaintiff in various legal actions,
which arise in the normal course of business. We are also a guarantor of various
third-party obligations and commitments. We are required to assess the
likelihood of any adverse judgments or outcomes to these matters as well as
potential ranges of probable losses. A determination of the amount of reserves
required for these contingencies, if any, which would be charged to earnings, is
made after careful analysis of each individual issue. The required reserves may
change in the future due to new developments in each matter or changes in
circumstances, such as a change in settlement strategy. Changes in required
reserves could increase or decrease our earnings in the period the changes are
made.
Effect of Various Accounting Methods on our Results of Operations
The various interests that we acquire in our investee companies are accounted
for under three broad methods: consolidation, equity method and cost method. The
applicable accounting method is generally determined based on our percentage
ownership in an investee company.
Consolidation Method: Investee companies in which we directly or indirectly own
more than 50% of the outstanding securities or those where we have effective
control are generally accounted for under the consolidation method of
accounting. Under this method, an investee company's accounts are consolidated
within our financial statements. Participation of other unrelated stockholders
in the earnings or losses of a consolidated investee company would be reflected
as a minority interest in consolidated financial statements. Minority interest
adjusts our consolidated net results of operations to reflect only our share of
the earnings or losses of the consolidated investee company. At December 31,
2001 and 2000 we had no investee company qualified for this accounting method.
Equity Method: Investee companies whose results we do not consolidate, but over
whom we exercise significant influence, are generally accounted for under the
equity method of accounting. Whether or not we exercise significant influence
with respect to an investee company depends on an evaluation of several factors
including, among others, representation on the investee company's board of
directors and percentage ownership level, which is generally a 20% to 50%
interest in the securities of the investee company, including our holdings in
common, preferred and other convertible instruments in the investee company
where we may have voting rights. Under the equity method of accounting, an
investee company's accounts are not reflected within our financial statements;
however, our share of the earnings or losses of the investee company is
reflected in our statements of operations.
Cost Method: Investee companies not accounted for under either the consolidation
or the equity method of accounting are accounted for under the cost method of
accounting. Under this method, our share of the earnings or losses of these
companies is not included in our statements of operations.
RESULTS OF OPERATIONS
FISCAL YEAR
During 2000, CT Holdings changed its fiscal year end from February 28 to
December 31. Therefore, the period ending December 31, 2000 is a transition
period consisting of a ten month period from March 1, 2000 through December 31,
2000.
YEAR ENDED DECEMBER 31, 2001 COMPARED WITH THE TEN MONTHS ENDED DECEMBER 31,
2000
CT Holdings' continuing operations consists of costs and expenses from providing
services to our investee companies and the activities to identify additional
technologies and companies in which CT Holdings might invest. The financial
statements of a previously consolidated wholly owned subsidiary, Citadel, are
presented as discontinued operations in all periods to reflect the plan for a
dividend distribution to CT Holdings' shareholders and spin off of the business
as a separate company. Due to an additional investment in Parago by unrelated
third parties our ownership percentage fell below the 20% ownership threshold
required to account for the investment under the equity method. Therefore, the
results of operations for CT Holdings consist of costs and expenses of
maintaining an office, legal and administrative costs and any applicable share
of loss in Parago through December 12, 2001. Our investments in Parago, River
Logic and Encore at December 31, 2001 are accounted for using the cost method
of accounting for investments in common stock.
General and Administrative Expenses
We had general and administrative expenses for the year ended December 31, 2001
and the ten months ended December 31, 2000 of $735,379 and $505,310
respectively, an increase of $230,069, or 46%. The increase is primarily a
result of legal fees associated with ongoing legal matters and defense costs
related to the various legal claims (See Item 3--Legal Proceedings) and travel
costs related to the Company's business development and incubator activities.
Forgiveness of Notes from Related Parties
At December 31, 2000, the Company had $1,335,522 in notes receivable that were
outstanding from current and former directors and employees which were fully
reserved during the period ended December 31, 2000. A majority of these notes
were due during the ten months ended December 31, 2000. The notes were issued in
fiscal 1999 in connection with the exercise of stock options granted to the
directors and employees. At the time of issuance the notes were issued with
recourse, interest at 5%, and were collateralized by the Company's common stock
held by the directors and employees. During the Company's evaluation and review
of the non-cash compensation strategies available to continue to provide
incentives to these directors and employees and to respond to changing equity
market conditions, the Company determined it would forgive all such notes
receivable. Consequently, the Company recorded a provision to write off all of
the notes receivable. Additionally, during the ten months ended December 31,
2000 the Company determined that it would forgive a $208,934 note receivable
issued to the Company's CEO in connection with the exercise of stock options.
Cash Paid and Stock Issued to Employees as Severance
The Company and Richard L. Travis, Jr., the Company's former Chief Operating
Officer and Chief Financial Officer, agreed to terminate his employment with the
Company and his employment agreement was terminated effective as of January 14,
2000. In connection with the termination of his employment with the Company and
the termination of his employment agreement, Mr. Travis and the Company entered
into a Settlement and Release Agreement which provided among other things, for
the payment of an aggregate of $50,001 to Mr. Travis in three equal monthly
installments of $16,667 commencing on the last day of each of the first three
months following Mr. Travis' termination of employment with the Company. The
Settlement and Release Agreement also provided for Mr. Travis to perform certain
financial consulting services for the Company (as an independent contractor)
until April 14, 2000. Also, in connection with the Settlement and Release
Agreement, the Company agreed to forgive an aggregate of $295,000, plus accrued
interest, of indebtedness owed by Mr. Travis to the Company. In addition, Parago
accelerated certain of the Parago options granted to Mr. Travis, which resulted
in compensation expense of $285,000 to the Company.
The Company and Bennet S. Klein, the Company's former Vice President of Business
Development, agreed to terminate his employment with the Company and his
employment agreement was terminated effective as of March 1, 2000. In connection
with the termination of his employment with the Company, the executive and the
Company entered into a Settlement and Release Agreement which provided for the
executive to forego the remaining compensation due him under his employment
agreement in exchange for the Company's agreement to accelerate the vesting of
his remaining stock options and to pay the exercise price related to those
shares. The acceleration of vesting and forgiveness of the exercise cost
resulted in $583,392 of compensation expense based on the fair market value of
the Company's stock on the date of termination. There was no similar charge
during the year ended December 31, 2001.
Reversal of Litigation Settlement Charge
In August 1998, Janssen-Meyers Associates L.P. (JMA) filed a lawsuit against the
Company arising out of an alleged 1995 contract with the Company's predecessor.
The suit alleged that this predecessor breached a letter of intent dated
September 1995 and/or a Placement Agency Agreement dated November 1995 between
JMA and the predecessor. As its damages, JMA claimed that it was entitled to,
among other things, the cash value of warrants to purchase of 1.8 million shares
of CT Holdings common stock at an exercise price of $0.89 per share 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. We removed the case to federal court in the
Southern District of New York.
Following mediation in July 2000, the Company entered into a settlement term
sheet, to attempt to resolve the disputes between it and JMA, pursuant to which
the Company and JMA agreed in principle to settle the lawsuit for an aggregate
of $3 million, in a combination of $1.5 million in cash and 300,000 shares of
the Company's 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 was subject to execution of definitive settlement
documents and approval of the boards of directors of the companies. As a result,
the Company recorded approximately $1,912,500 as a nonrecurring charge related
to the
32
proposed settlement of the litigation.
The Company and JMA were unable to negotiate the final definitive settlement
agreement and, as a result, the matter is still not settled. The case was
dismissed in August 2000 without any resolution of this issue. On March 27,
2001, JMA attempted to reopen this matter, but the Court hearing the JMA lawsuit
issued a Summary Order denying JMA's motion to enforce the settlement term sheet
and confirmed the prior dismissal of the lawsuit. The Court further ruled that
JMA would either have to bring an action on the proposed settlement or move to
re-open the dismissed case. The Court stated that it did not express any view
with respect to the merits of the proposed settlement that brought about the
dismissal of the case. There was no activity on the case from March 2001 through
August 2001. On August 27, 2001 JMA refiled its lawsuit with a federal court in
New York, and the Company filed its motion to dismiss the case because the
plaintiffs lacked the required diversity jurisdiction to pursue the claims in
federal court. On October 31, 2001 the case was dismissed in federal court. In
December 2001, the plaintiffs refiled the lawsuit in the state court seeking to
enforce the proposed settlement term sheet. The case was filed in Supreme Court
of New York, that state's trial court, in a case styled Roan Meyers v. CT
Holdings. Given these recent events, the Company is unable to estimate the
potential loss related to this matter and therefore has removed the previously
recorded accrual for legal settlement of $1,912,500. The Company has also filed
a lawsuit against JMA to recover excess amounts charged by JMA in connection
with related bridge loans.
Equity in Loss of Unconsolidated Affliate
The equity in loss of unconsolidated affiliates $1,220,516 for the ten
months ended December 31, 2000 represents the Company's share of the equity in
loss of Parago to the extent that our investment balance was recorded at zero.
The Company no longer applies the equity method due to our share of Parago's
accumulated losses being in excess of the carrying value of our investment in
Parago at December 31, 2000 and our reduction in ownership percentage to
approximately 1% due to additional equity financings in December 2001 in which
we did not participate. During the second quarter of 2001, the Company, along
with other investors in Parago, participated in a bridge loan financing of
Parago of $692,740 plus guaranteed $1,406,472 of a bank term loan to Parago.
Accordingly, the Company recognized a charge to earnings of $2,099,212 in second
quarter of 2001. Upon the first closing of the Parago Preferred Series E equity
financing in December 2001 Parago repaid the bridge loan to the Company and the
bank guarantee was released. As a result the Company reversed the charge to
earnings of $2,099,212 in the fourth quarter of 2001.
Interest and Other Income (Expense)
Interest expense for the year ended December 31, 2001 of $9,255 compares to
$9,129 for the ten months ended December 31, 2000. Interest and other income
consists of interest income from notes receivable, miscellaneous refunds and
terms unrelated to operations. Interest and other income was $64,319 for the
year ended December 31, 2001 compared to $59,995 for the ten months ended
December 31, 2000.
Writedown of Note Receivable
In 2001 the Company agreed to restructure its note receivable from Encore and
accordingly wrote down the value of the note by $98,000 to its restructured
value of $32,000.
Writedown of Investment in Affiliate
We periodically evaluate the carrying value of our ownership interest in our
investee companies taking into consideration, among other factors, the investee
company's valuation following a recent infusion of capital. The Series C
preferred stock financing in April 2001 reflected a valuation below our carrying
value. Since River Logic is an early stage company, has a history of operating
losses and may require additional funding to attain profitability, we made an
assessment of the fair value of our investment in River Logic and determined
that our investment had a fair value of approximately $2,700,000 at December 31,
2001 and accordingly reduced its carrying value by $360,000.
Net Loss
As a result of these factors, for the year ended December 31, 2001, we reported
income from continuing operations of $774,185, compared to a net loss from
continuing operations of $5,131,956 for the ten months ended December 31, 2000.
The loss from discontinued operations related to Citadel Security Software for
the year ended December 31, 2001 was $1,865,981 compared to $2,984,007 for the
ten months ended December 31, 2000.
LIQUIDITY AND CAPITAL RESOURCES
All cash and cash equivalents at December 31, 2001 were allocated to the Citadel
Security Software business shown as discontinued operations in the CT Holdings
financial statements as a result of the pending pro rata distribution of shares
to the shareholders of CT Holdings. Completion of the distribution is expected
following the effectiveness of Citadel's registration statement first filed with
the SEC on January 11, 2002 and amended on March 8, 2002 and April 5, 2002.
Unless otherwise noted all amounts discussed below are from the continuing
operations of CT Holdings represented by its business development and incubator
activities. The net cash used in operations of $112,714 for the year ended
December 31, 2001 is principally a result of the income from continuing
operations of $774,185, the writedown of the Encore note receivable of $98,000,
the writedown of our investment in River Logic of $360,000, and the change in
operating assets and liabilities of $1,344,900 primarily consisting an increase
in accounts payable and accrued expenses of $522,352 offset by the reversal of a
litigation settlement accrual of $1,912,500 previously recorded in the ten
months ended December 31, 2000.
33
In the ten months ended December 31, 2000 there was cash provided by operating
activities of $784,148 consisting of a loss from continuing operations of
$5,131,956, the equity in loss of Parago of $1,220,516, and other transactions,
generally of a nonrecurring nature, including noncash severance of $583,392 and
the forgiveness of notes receivable of $1,544,456 as part of the separation
agreements of two former officers of the Company. In addition, payment of
$506,000 of compensation was offset against a related party note receivable
resulting in a noncash charge to operating activities. Changes in operating
assets and liabilities included the $1,912,500 accrual for a legal settlement of
a 2000 claim dispute that was dismissed in 2001. All other changes in operating
assets and liabilities resulted from the Company's ongoing operating activities.
Cash flows used by investing activities were $738,560 for the year ended
December 31, 2001 consisting of the repayment proceeds of notes receivable from
related parties of $588,560 and $150,000 from affiliates which were partially
offset by the $98,000 writedown of a convertible note receivable from PerClick
into an investment in Encore, the successor company to PerClick.
Cash flows provided by financing activities were $434,093 for the year ended
December 31, 2001, primarily resulting from the proceeds of notes payable from a
director of the Company for $250,000 and cash advances from the Company's CEO
for $290,330. Separately the Company repaid notes payable to an insurance
company of $27,501 and repaid advances to the Company's CEO of $126,028.
Proceeds of $47,292 from the exercise of warrants resulted in the issuance of
168,904 shares of the Company's common stock. During the ten months ended
December 31, 2000 the cash flow provided by financing activities was $2,480,567
primarily the result of the proceeds $2,536,400 from the sale of 2,500,000
shares of common stock to a related party and the exercise of 55,583 stock
options and warrants. As previously noted we rely on related parties to
finance ongoing operations.
As a result of the aforementioned factors, net cash provided by continuing
operations was $1,059,939 and $1,407,656 for the year ended December 31, 2001
and the ten months ended December 31, 2000, respectively. Net cash used by
discontinued operations, related to funding Citadel Security Software, was
$1,059,939 and $1,407,656 for the year ended December 31, 2001 and the ten
months ended December 31, 2000, respectively. The Company had no cash at
December 31, 2001 and current liabilities exceed current assets by approximately
$2.4 million.
Because of the filing of a Form 10-SB in January 2002, on March 11, 2002 Citadel
Security Software became a reporting company under the Securities Exchange Act
of 1934 upon expiration of the statutory sixty day period. Accordingly revenues
and expenses related to the security software business will be recognized and
reported by Citadel in filings separate from CT Holdings' filings. CT Holdings
will continue to show Citadel's business as discontinued operations until the
completion of the Distribution. Ongoing CT Holdings will incur expenses relating
to corporate overhead related to the execution of its business model and the
operations of businesses acquired. The Company will require cash from financing
activities to fund the deficits expected over the next year. The Company's
operation requires the Company to obtain additional capital. The Company will
need to raise additional capital to fund its incubator and business development
activities through 2002. Historically, the Company obtained short-term bridge
loans from its Chief Executive Officer or Directors of the Company. The Company
has been and continues to be dependent upon related party financing to fund its
business development and incubator activities. During the year ended December
31, 2001, related parties have provided substantially all financing and
management will continue to rely on related parties to fund future operations.
We may need to rely on similar funding from related parties for future funding
needs. While this may occur in the future there can be no assurance that such
financing will be available or if available, on terms the Company would be
willing to accept. There can be no assurance that management's plans for CT
Holdings incubator business model will be successful or what other actions may
become necessary. Although the Company has been successful raising capital in
the past, the inability of the Company to raise capital may require the Company
to sell assets or reduce the level of its operations. Such actions could have a
material adverse effect on the Company's investee companies, its business or
operations and may result in charges that could be material to the Company's
business and results of operations. The Company has no material purchase
commitments for property and equipment at December 31, 2001.
34
ITEM 7. FINANCIAL STATEMENTS
The Financial Statements for the year ended December 31, 2001 and the ten month
period ended December 31, 2000 are found following the signature page of this
report.
ITEM 8. CHANGES IN, AND DISAGREEMENTS WITH, ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL MATTERS
On October 30, 2001, the Audit Committee of CT Holding's Board of Directors
determined to dismiss its independent public accountants, Ernst & Young LLP
("EY"), and engage a new accounting firm for fiscal year 2001. This decision was
made as a result of CT Holdings' focus on operating efficiencies and reductions
in cost. For these reasons the Audit Committee determined that the engagement of
a different independent public accounting firm would be in the best interests of
CT Holdings at that time. The reports of EY on the Company's financial
statements for the past two fiscal years did not contain an adverse opinion or a
disclaimer of opinion and were not qualified or modified as to uncertainty,
audit scope, or accounting principles except for the addition of an explanatory
paragraph regarding to CT Holdings' ability to continue as a going concern. In
connection with the audits of CT Holdings' financial statements for each of the
two fiscal periods ended December 31, 2000 and February 28, 2000 and in the
subsequent interim periods, there were no disagreements with EY on any matters
of accounting principles or practices, financial statement disclosure, or
auditing scope and procedures which, if not resolved to the satisfaction of EY
would have caused EY to make reference to the matter in their report. CT
Holdings requested Ernst & Young LLP to furnish it a letter addressed to the
Commission stating whether it agrees with the above statements. A copy of that
letter, dated November 6, 2001 is filed as Exhibit 1 to Form 8-K filed on
November 6, 2001.
On November 14, 2001, the Audit Committee of CT Holdings' Board of Directors
engaged King Griffin & Adamson P.C. (KGA) as the independent public accountants
for both CT Holdings and Citadel Security Software. KGA advised the Company that
neither the firm nor any of its associates has any material relationship with
the Company or any affiliate of the Company except that KGA is also the
independent accountant for the Company's wholly owned subsidiary Citadel
Security Software which is being been spun off as a separate public company.
During the each of the Company's two most recent fiscal years and the subsequent
interim periods prior to engaging KGA, the Company has not consulted KGA
regarding either: (i) the application of accounting principles to a specific
transaction, either completed or proposed, or the type of audit opinion that
might be rendered on the Company's financial statements, for which advice was
provided that KGA concluded was an important factor considered by the Company in
reaching a decision as to an accounting, auditing or financial reporting issue;
or (ii) any matter that was either the subject of a disagreement (as defined in
paragraph (a)(1)(iv) of Regulation S-K Item 304) or a reportable event (as
described in paragraph (a)(1)(v) of Regulation S-K, Item 304).
35
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934
DIRECTORS The names of our directors, their principal occupations and the year
in which each current Director of CT Holdings, Inc. (the "Company") initially
joined the Board of Directors are set forth below.
NAME AGE POSITION WITH THE COMPANY DIRECTOR SINCE
Steven B. Solomon 37 President, Chief Executive Officer, and Secretary 1992
Lawrence Lacerte 49 Director 1999
Chris A. Economou 46 Director 1993
Mark Rogers 41 Director 1996
Phillip J. Romano 61 Director 2000
Dr. Axel Sawallich 56 Director 1993
STEVEN B. SOLOMON has served as President and Chief Executive Officer of CT
Holdings since May 1997 and as a director of CT Holdings since February 1996,
and as the President and Chief Executive Officer of Citadel Security since its
formation in December 1996. Mr. Solomon also serves as a Director of Parago,
Inc., an incubation venture of CT Holdings that is an application solution
provider and Internet-based business process outsourcer that provides an on-line
suite of promotional offerings designed to automate promotional management and
optimize the customer care services offered by its clients, and he served as
Chairman of the Board of Directors of Parago from January 1999 to April 2001,
and Chief Executive Officer of Parago from January 1999 to August 2000. From
February 1996 through April 1997, Mr. Solomon served as Chief Operating Officer
of CT Holdings. Since May 5, 2000, Mr. Solomon has also served as a director of
River Logic, Inc., an incubation venture of CT Holdings that creates and
operates integrated networks of decision support tools, elearning solutions and
ecommerce capabilities designed to enable decision makers to leverage knowledge
and information to gain competitive advantage. We anticipate that Mr. Solomon
will devote approximately 20-33% of his business time to CT Holdings following
the Citadel Distribution.
LAWRENCE LACERTE has served as a director of the Company since January 1999. Mr.
Lacerte has served as President of Lacerte Technologies, Inc., a Dallas based
investment firm, since July 1998. From 1978 until July 1998, Mr. Lacerte served
as Chairman and Chief Executive Officer of Lacerte Software Corporation, a tax
and accounting software company. In June 1998, Lacerte Software was acquired by
Intuit Corporation. Mr. Lacerte also serves on the Boards of Directors of
Universal Display Corporation, a publicly traded company engaged in the research
and development of flat panel displays, and Teraglobal Communications Corp., a
publicly traded communications technology company that designs and markets
microprocessor and software-based products and services for real-time
communications. Mr. Lacerte also serves on the Board of Directors of Citadel and
Parago.
CHRIS A. ECONOMOU has served as a director of the Company since February 1996,
and was a director of LoneStar Hospitality Corp. from June 1993 until its merger
with the Company. Mr. Economou has been engaged in the private practice of law
in Fort Lauderdale, Florida, primarily in the transactional and corporate areas
since 1988. Mr. Economou also served as a director of Parago during its
incubation phase from January 1999 to February 2000. Mr. Economou serves as a
director of Citadel.
MARK ROGERS has served as a director of the Company since July 1996. Since 1989,
Mr. Rogers has served as a partner and Chief Operating Officer of NFT Ventures,
a venture capital fund established by Ray Noorda, the founder of Novell, Inc. In
connection with his position at NFT Ventures, Mr. Rogers advises several
computer software companies in Texas, Utah and Silicon Valley, with respect to
various strategic and developmental matters. Mr. Rogers also serves on the
boards of directors of CollegeLink.com Incorporated, an online college
application assistance company, and several other high-tech companies. Mr.
Rogers also served as a director of Parago during its incubation phase from
January 1999 to February 2000.
PHILLIP J. ROMANO has served as a director of the Company since August 2000. Mr.
Romano also serves as a consultant to and joint venture partner of Brinker
International, Inc., a publicly traded national operator, developer and
franchisor of numerous restaurant concepts, including Chili's Grill & Bar and
Romano's Macaroni Grill. In addition, Mr. Romano has served as a venture
capitalist, including as an original investor, and former Chairman and Director
of Docucon, Inc., a publicly traded technology company, and a principal in EGP,
a partnership that held the licensing rights to the Palmaz-Schatz Stent
cardiovascular device that was purchased by Johnson & Johnson in 1998. Mr.
Romano also serves on the Board of The Cox School of Business at Southern
Methodist University and The M.D. Anderson Cancer Center. Mr. Romano also serves
as a director of Citadel.
DR. AXEL SAWALLICH has served as a director of the Company since February 1996
and was a director of LoneStar from March 1993 until its merger with the
Company. Since January 1997, Dr. Sawallich has been chief investment consultant
for Lifeplan Investments, Vienna, Austria. Since 1993, he has been the managing
partner of Global Invest, an investment firm located in Vienna. From 1991 until
1994, he also was a consultant for Serco Investment Counseling Corporation. From
1989 to 1990, Dr. Sawallich was the general manager and director of the Vienna
regional branch of Allgemeine Sparkasse Bank AG. From 1985 to 1989, Dr.
Sawallich was with Bank fur Arbeit und Wirtschaft AG, Vienna, serving as the
deputy head of the credit department until 1986 and as the
36
Executive Vice President of the Bank's Bureau for Commercial Customers
thereafter. Dr. Sawallich has also been acting as an independent, publicly
certified, investment advisor since 1993.
There are no family relationships among any of the directors or executive
officers of the Company. See "Certain Relationships and Related Transactions"
for a description of transactions between the Company and its directors,
executive officers or their affiliates. Section 16(a) of the Exchange Act, as
amended, requires the Company's Directors, executive officers and persons who
own more than 10% of a registered class of the Company's equity securities to
file certain reports regarding ownership of the Company's Common Stock with the
SEC. These insiders are required by SEC regulations to furnish the Company with
copies of all Section 16(a) forms they file. To the Company's knowledge, based
solely on a review of the copies of the Section 16(a) forms furnished to the
Company during 2001, or written representations from certain reporting persons
that no Forms 5 were required for those persons, all Section 16(a) filing
requirements applicable to the Company's officers, Directors and beneficial
owners of more than 10% of the outstanding shares of Common Stock were filed on
a timely basis, other than a Form 5 for Mr. Solomon and Form 3s for Mr. Speyer
and Mr. Guillory.
EXECUTIVE OFFICERS
The executive officers of the Company as of March 31, 2001 are as follows:
NAME AGE POSITION WITH THE COMPANY
Steven B. Solomon 37 President, Chief Executive Officer, Secretary and Director
Richard Connelly 50 Chief Financial Officer
Carl E. Banzhof 34 Chief Technology Officer
Billy Austin 31 Executive Vice President of Sales
Richard W. Speyer 48 Executive Vice President of Business Development
Michael P. Guillory 36 Vice President of Marketing
STEVEN B. SOLOMON has served as President and Chief Executive Officer of CT
Holdings since May 1997 and as a director of CT Holdings since February 1996,
and as the President and Chief Executive Officer of Citadel Security since its
formation in December 1996. Mr. Solomon also serves as a Director of Parago,
Inc., an incubation venture of CT Holdings that is an application solution
provider and Internet-based business process outsourcer that provides an on-line
suite of promotional offerings designed to automate promotional management and
optimize the customer care services offered by its clients, and he served as
Chairman of the Board of Directors of Parago from January 1999 to April 2001,
and Chief Executive Officer of Parago from January 1999 to August 2000. From
February 1996 through April 1997, Mr. Solomon served as Chief Operating Officer
of CT Holdings. Since May 5, 2000, Mr. Solomon has also served as a director of
River Logic, Inc., an incubation venture of CT Holdings that creates and
operates integrated networks of decision support tools, elearning solutions and
ecommerce capabilities designed to enable decision makers to leverage knowledge
and information to gain competitive advantage. Mr. Solomon also serves as a
director of Citadel. We anticipate that Mr. Solomon will devote approximately
20-33% of his business time to CT Holdings after the Citadel Distribution.
RICHARD CONNELLY joined the Company in March 2002 and serves as its Chief
Financial Officer. Mr. Connelly also serves as Chief Financial Officer of
Citadel Security Software. Prior to joining the Company, Mr. Connelly served as
a financial consultant to Citadel and CT Holdings from January 2002 until March
2002. Prior to this, he served as Chief Financial Officer for several venture
funded technology companies including from February 2000 until December 2000 at
ASSET InterTech, Inc. a boundary scan software tool developer, from September
1998 through November 1999 at JusticeLink, Inc., an ecommerce legal services
provider and from April 1997 through July 1998 at AnswerSoft, Inc. a developer
of computer telephony software. From February 1987 through March 1997 Mr.
Connelly served in various financial management capacities at Sterling Software
Inc., an enterprise software development company, including Vice President
Corporate Controller, Vice President Treasurer and Group Vice President Finance
& Administration of Sterling's Systems Management Group. We anticipate that Mr.
Connelly will devote approximately 20-33% of his business time to CT Holdings
following the Citadel Distribution.
CARL E. BANZHOF has served as Chief Technology Officer since July 1997, prior to
which he served as Vice President - Development of Network Products since
joining the Company in February 1996. Mr. Banzhof has more than 15 years of
experience in the software industry, including designing, developing and
marketing software products, building software development teams and
organizations and managing products in network management and PC desktop
markets. He was the founding partner and Vice President of Software Engineering
from 1992 to 1995 of Circuit Masters Software, Inc., a software company which
developed and marketed network management utilities for Novell NetWare
environments, and was acquired by the Company in February 1996. Prior to joining
Circuit Masters, Mr. Banzhof was lead software developer from 1988 to 1992 at
Fluor Daniel Engineering, a software development and worldwide engineering
company. We anticipate that Mr. Banzhof will no longer serve as an officer of CT
Holdings following the Citadel Distribution.
BILLY AUSTIN serves as Executive Vice President of Sales for the company's
wholly owned subsidiary Citadel Security Software. From 1999 until joining
Citadel in March 2002 Mr. Austin served as Vice President of Sales and Marketing
for Intrusion.com, an intrusion detection systems and vulnerability assessment
software company. From 1996 to 1999 Mr. Austin was the Business Development
Manager for Enstar Security Consulting where he was responsible for sales,
consulting and business partner relations. Prior to Enstar, Mr. Austin held
several management positions within sales, engineering and marketing at other
security organizations.
RICHARD SPEYER has served as Executive Vice President of Business Development
for Citadel since May 2001. Prior to joining Citadel, Mr. Speyer served as EVP
of Business Development of Parago, Inc. from June 2000 to May 2001. Prior to
joining Parago, Mr. Speyer worked for Compaq where he was responsible for a
billion dollar P&L managing the business development and partnership activities
for SAP, from 1993 to 1995 and from 1997 to 2000. Mr. Speyer held similar
positions at Novell from 1995 to 1997, where he managed the activities of
licensing complementary software and hardware for the NetWare operating system.
In addition, he was involved in defining the initial specifications and
licensing terms for Novell's High Availability clustering solutions. Mr. Speyer
brings more than19 years of experience in the computer industry to Citadel.
Eight of those years he served as CEO and Executive Vice President of Sales and
Marketing for CPU Corporation, a distributor of networking products. We
anticipate that Mr. Speyer will no longer serve as an officer of CT Holdings
following the Citadel Distribution.
37
MICHAEL GUILLORY has served as our Vice President of Marketing since November
2001 and has over 15 years experience in high-technology marketing and
promotions. He is responsible for directing all marketing and public relations
efforts for CT Holdings. Prior to joining us, Mr. Guillory held the senior level
marketing position at Philips Speech Processing, a division of Royal Philips
Electronics from January 1999 to November 2001. At Philips, he helped to launch
the company's Corporate Voice Dialing product line and build the Value Added
Reseller channel. Prior to Philips, Mr. Guillory spent nearly 10 years directing
the marketing initiatives for five software titles at Sage U.S., Inc., a leader
in business to business accounting, time billing and sales force automation
software. We anticipate that Mr. Guillory will no longer serve as an officer of
CT Holdings following the Citadel Distribution.
ITEM 10. EXECUTIVE COMPENSATION
The total compensation for the three fiscal years ended December 31, 2001
(including the ten months ended December 31, 2000) of Steven B. Solomon, the
Company's Chief Executive Officer, and Carl E. Banzhof, the Company's Chief
Technology Officer (the "Named Executive Officers"), is set forth below in the
following Summary Compensation Table. No other person received annualized cash
compensation in excess of $100,000 during the year ended December 31, 2001.
Because the Company changed its fiscal year to a calendar basis in 2000, the
following tables includes information related to the year ended December 31,
2001, the ten months ended December 31, 2000 and the year ended February 29,
2000.
ANNUAL COMPENSATION LONG TERM COMPENSATION
-------------------------------------------------- -------------------------------
OTHER SHARES
PERIOD ANNUAL UNDERLYING ALL OTHER
NAME AND POSITION ENDED SALARY ($) BONUS ($) COMPENSATION OPTIONS COMPENSATION ($)
----------------- -------- ---------- --------- ------------ ---------- ----------------
Steven B. Solomon 12/31/01 $200,000 (1) $150,000 $0 5,000,000 $17,548 (2)
President, 12/31/00 140,000 (1) 120,500 0 0 12,619 (2)
CEO and Secretary 02/29/00 168,500 120,500 0 0 14,519 (2)
Carl E. Banzhof 12/31/01 115,000 -- 0 200,000 0
Chief Technology 12/31/00 95,833 -- 0 100,000 0
Officer 02/29/00 115,000 10,000 0 100,000 0
(1) Mr. Solomon entered into an employment agreement with Parago, pursuant
to which Parago paid additional salary to Mr. Solomon during part of
1999, 2000, and part of 2001. During fiscal 1998, in connection with
the discharge of a debt owed to the Company, Mr. Solomon forgave
$79,000 in accrued compensation due him.
(2) Mr. Solomon received a car allowance of $950 per month and health,
life and disability insurance during each fiscal year.
OPTION GRANTS DURING THE YEAR ENDED DECEMBER 31, 2001
Number of Percent of total
securities options/SARs
underlying granted to
options/SARs employees in Exercise or base
NAME granted (#) fiscal year price ($/Sh) Expiration date
----------------- ------------ ---------------- ---------------- ---------------
Steven B. Solomon 5,000,000 86.4 $0.20 4/2011
Carl E. Banzhof 100,000 1.7 0.20 4/2011
The Company did not grant any stock options or stock appreciation rights to the
Named Executive Officers during the ten months ended December 31, 2000. Parago
granted stock options to certain of the Named Executive Officers during the year
ended December 31, 2000, as described in "Certain Relationships and Related
Transactions."
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES
The following table describes, for each of the Named Executive Officers, options
exercised and the potential values for their unexercised in-the-money options at
December 31, 2001 (the Company issued no SARs during 2001):
38
VALUE OF
NUMBER OF SECURITIES UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
OPTIONS/SARS AT OPTIONS/SARS AT
FISCAL YEAR END ($) FISCAL YEAR END
---------------------- ($) (2)
SHARES VALUE ---------------
ACQUIRED ON REALIZED EXERCISABLE/ EXERCISABLE/
NAME EXERCISE (#) ($) (1) UNEXERCISABLE UNEXERCISABLE
------------ -------- ---------------------- ---------------
Steven B. Solomon... 0 0 $1,127,500/$922,500(3) $577,500/$472,500(3)
Carl E. Banzhof..... 0 0 51,250/30,750 26,250/15,750
(1) Based on the market price on the date exercised less the exercise
price payable for each share.
(2) Based on the fair market value of the Company's Common Stock (at
December 31, 2001) per share less the exercise price payable for each
share.
(3) Excludes Parago options to purchase 1,400 shares (all of which are
currently exercisable) and 100 shares (all of which are unexercisable)
for Messrs. Solomon and Banzhof respectively (after giving effect to
the four-for-one stock split of Parago's common stock effective in
July 1999 and 1 for 1000 reverse stock split in 2002).
EMPLOYMENT AGREEMENTS AND TERMINATION OF EMPLOYMENT AGREEMENTS
The Company has entered into an employment agreement with Mr. Solomon. The
annual base salary payable to Mr. Solomon was $168,000 as of December 31, 2000,
and the employment agreement provides for periodic salary increases and bonuses.
The employment agreement continues until February 2002 and annually thereafter
until terminated by either party. In addition, the employment agreement provides
for a severance benefit of the greater of (i) the remaining term of the
contract, discounted at a rate of six percent, or (ii) 24 months of base salary,
in the event of termination without cause or constructive termination. Following
the Distribution, Mr. Solomon will waive his compensation under this employment
agreement. Mr. Solomon entered into an Employment Agreement with Parago
effective as of January 1, 1999, and the Company accrued payments of Mr.
Solomon's salary during the period from July 1, 1999 to December 31, 2000.
Citadel and Mr. Solomon have entered into an employment agreement with Mr.
Solomon, Chief Executive Officer of Citadel. The annual base salary payable to
Mr. Solomon was $200,000 as of January 2002, and the employment agreement
provides for an annual bonus of $150,000. The employment agreement has an
initial term of five years and is renewable for one year terms following the
initial term unless terminated. If Mr. Solomon is terminated for any reason
other than for cause, he is entitled to a severance payment equal to three times
his base salary and up to three times his bonus.
The transition services agreement to be entered into by Citadel and CT Holdings
calls for the sharing of the salaries and benefits of the CEO, CFO and some
administrative employees of Citadel that perform services for CT Holdings but
whose payroll and benefits are assigned to Citadel. The agreement will allow for
a cross charge to CT Holdings of $20,000 per month represent an allocation of
the payroll, benefits and an allocation of overhead (includes rent and general
office expenses applied as a percentage of payroll & benefits) associated with
the shared employees.
Richard L. Travis, Jr., the Company's former Chief Operating Officer and Chief
Financial Officer, and the Company agreed to terminate his employment with the
Company and his employment agreement was terminated effective as of January 14,
2000. In connection with the termination of his employment with the Company and
the termination of his employment agreement, Mr. Travis and the Company entered
into a Settlement and Release Agreement which provided, among other things, for
the payment of an aggregate of $50,001 to Mr. Travis in three equal monthly
installments of $16,667 commencing on the last day of each of the first three
months following Mr. Travis' resignation from the Company, forgiveness of
indebtedness of $295,000, acceleration of options to purchase 60,000 Parago
shares, and termination of Mr. Travis' remaining 60,000 options to purchase
Parago shares. The Settlement and Release Agreement also provided for Mr. Travis
to perform certain financial consulting services for the Company (as an
independent contractor) until April 14, 2000.
39
The Company and Bennett Klein, CT Holdings' former Vice President of Business
Development, agreed to terminate his employment with CT Holdings and his
employment agreement was terminated effective March 1, 2000. In connection with
the termination of his employment with CT Holdings and the termination of his
employment agreement, Mr. Klein and CT Holdings 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 Mr. Klein's forfeiture of any right to severance
payments. The Settlement and Release Agreement also provides for Mr. Klein to
perform certain financial consulting services for the Company (as an independent
contractor).
40
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
As of April 9, 2002, there were issued and outstanding approximately 49,829,608
shares of Common Stock. There is no other class of voting security of the
Company issued or outstanding. The following table sets forth the number of
shares of the Company's Common Stock beneficially owned, as of April 9, 2002 by
(i) each person known to the Company to own more than 5% of the Common Stock of
the Company (the only class of voting securities now outstanding), (ii) each
director, (iii) each executive officer named in the Summary Compensation Table
and (iv) all directors, named executive officers and other executive officers as
a group. The number and percentage of shares beneficially owned is determined in
accordance with Rule 13d-3 of the Securities Exchange Act and the information is
not necessarily indicative of beneficial ownership for any other purpose. Under
this rule, beneficial ownership includes any shares to which the individual has
the right to acquire within 60 days of April 9, 2002 through the exercise of any
stock option or other right. Unless otherwise indicated in the footnotes or
table, each person or entity has sole voting and investment power (or shares
such powers with his or her spouse) with respect to the shares shown as
beneficially owned and has an address of c/o CT Holdings, 8750 North Central
Expressway, Suite 100, Dallas, Texas 75231.
NUMBER OF APPROXIMATE PERCENT
NAME AND ADDRESS SHARES OWNED OF CLASS
---------------- ------------ -------------------
Carl E. Banzhof (1).................... 209,401 *
Chris A. Economou (2)
150 North Federal Highway, Suite 210
Fort Lauderdale, Florida 33301......... 724,400 1.5
Mark Rogers (2)
751 Laurel St. #19
San Carlos, California................. 651,500 1.3
Lawrence Lacerte (3)
5950 Sherry Lane #900
Dallas, Texas 75225.................... 5,450,000 10.9
Phillip J. Romano (4)
Romano Concepts
1925 Cedar Springs, Suite 101
Dallas, Texas 75201.................... 1,280,000 2.6
Dr. Axel Sawallich (5)
Beatrixgasse 3
1030 Vienna, Austria................... 162,144 *
Steven B. Solomon (6).................. 14,785,993 29.7
Thomas E. Oxley (7)
2727 South Ocean Blvd., #803
Highland Beach, FL 33487............... 3,544,800 7.1
All officers and directors
As a group (11 persons)(8)............. 23,425,100 47.0
* Less than 1%
(1) Includes 137,500 shares of Common Stock subject to fully vested options and
12,500 shares of Common Stock subject to options vesting within 60 days of April
9, 2002 pursuant to options to purchase Common Stock and 2,000 shares owned by
his spouse.
41
(2) Includes 250,000 shares of Common Stock subject to fully vested options.
(3) Includes 2,450,000 shares of Common Stock subject to fully vested options.
(4) Includes 750,000 shares of Common Stock subject to fully vested options.
(5) Includes 25,000 shares of Common Stock subject to fully vested options.
(6) Includes 3,125,000 shares of Common Stock subject to fully vested options
and 375,000 shares of Common Stock subject to options vesting within 60 days of
April 9, 2002. Includes 6,000,000 shares of CT Holdings common stock that may be
issued in the event Mr. Solomon exercises his right to exchange 5,000,000 shares
of Parago common stock.
(7) Includes 2,700,000 shares of Common Stock that may be issued upon conversion
of a convertible promissory note.
(8) Includes 7,491,662 shares issuable pursuant to presently exercisable options
or warrants and options or warrants exercisable within 60 days of April 9, 2002
held by all directors and executive officers as a group, and/or their
affiliates, and 6,000,000 shares of CT Holdings Common Stock that may be issued
in the event Mr. Solomon exercises his right to exchange 5,000,000 shares of
Parago common stock for shares of CT Holdings Common Stock.
42
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The following is a description of the material terms of the agreements and
arrangements involving the Company and its subsidiaries.
AGREEMENTS RELATING TO THE CITADEL SECURITY SOFTWARE DISTRIBUTION
Prior to the distribution, CT Holdings will transfer the assets and liabilities
related to its security software operations to Citadel. After the distribution,
Citadel will be an independent, publicly traded company. CT Holdings will not
own any shares of Citadel common stock, two CT Holdings directors, Steven B.
Solomon and Philip Romano will serve on our board of directors and two CT
Holdings officers, Steven B. Solomon and Richard Connelly, will serve as
officers of Citadel. Following the distribution, Citadel's officers will also
include three former CT Holdings officers, including Carl Banzhof, Michael
Guillory, and Rick Speyer.
Citadel will enter into several agreements with CT Holdings to define their
ongoing relationship after the distribution and to allocate tax and other
specified liabilities and obligations arising from periods prior to the
distribution date. Citadel entered into these agreements while it was still a
wholly owned subsidiary of CT Holdings.
CT HOLDINGS' RELATED PARTY TRANSACTIONS
During fiscal year 2001 the Company received substantially all of its financing
from related parties, primarily our CEO Steven B. Solomon and a director,
Lawrence Lacerte. In addition in June 2001, two directors, Messrs. Solomon and
Lacerte, funded and guaranteed CT Holdings' participation in the Parago bridge
loan. In consideration for this funding and guarantees, CT Holdings has agreed
to permit the directors to exchange up to 5,000,000 Parago shares into up to
6,000,000 shares of CT Holdings' common stock. In addition, Mr. Solomon has
signed a personal guarantee for the office space that CT Holdings shares with
Citadel.
From May 2000 to August 2000, the Company's Chief Executive Officer, Steven B.
Solomon, loaned $780,000 to CT Holdings to assist with their working capital
needs and to provide for $600,000 in bridge loans to River Logic. The entire
balance was repaid by CT Holdings in August 2000.
In October 2000, CT Holdings with approval from its board of directors loaned
$1.2 million to its Chief Executive Officer, Steven B. Solomon. The note
receivable was due October 2001 and bore interest at 5% per year. The balance
was repaid in full prior to its maturity in 2001, including payments of
approximately $700,000 and approximately $506,000 in accrued salary and bonus
due to him pursuant to his employment agreement. Further, during CT Holdings'
evaluation and review of the non-cash compensation strategies available to
continue to provide incentives to its Chief Executive Officer and to respond to
changing equity market conditions, CT Holdings determined it would forgive a
note receivable issued in connection with the exercise of stock options granted
to the officer in the amount of $208,934. In June 2001, the Chief Executive
Officer loaned CT Holdings approximately $855,000 in connection with the Parago
bridge loan participation by CT Holdings.
43
Mr. Solomon is also a director of Parago and funded $4 million of his personal
assets to Parago to assist with its working capital needs during the ten months
ended December 31, 2000 and the year ended February 29, 2000. The amounts funded
during each period were repaid in January and April 2001, respectively. Parago
also provided Mr. Solomon with approximately $6.8 million in advances in April
2000 which was repaid during the same month.
At December 31, 2000, CT Holdings had $1,335,522 in notes receivable that were
outstanding from employees and current and former CT Holdings directors
(including Steven B. Solomon, Chris A. Economou and Mark Rogers), which notes
have been fully reserved. A majority of these notes were due during the ten
months ended December 31, 2000. The notes were issued in fiscal 1999 in
connection with the exercise of stock options granted to the directors and
employees. At the time of issuance the notes were issued with recourse, interest
at 5%, and were collateralized by the shares of CT Holdings common stock held by
the directors and employees. During CT Holdings' evaluation and review of the
non-cash compensation strategies available to continue to provide incentives to
these directors and employees and to respond to changing equity market
conditions, CT Holdings determined it would forgive all such notes receivable.
Consequently, CT Holdings recorded a provision to write off all of the notes
receivable. Additionally, during the ten months ended December 31, 2000, the
Company determined that it would forgive a $208,934 note receivable issued to
the Company's CEO on connection with the exercise of stock options.
During the ten months ended December 31, 2000, the fiscal year ended February
29, 2000, and the fiscal year ended December 31, 2001 CT Holdings incurred legal
fees in the amount of approximately $90,000, $86,000, and $60,000 respectively
to a law firm in which David Wood, an attorney who was a former employee and is
a relative of CT Holdings' Chief Executive Officer, Steven B. Solomon, is a
partner. After leaving the Company, this law firm continued to provide legal
services to the Company and subsequent to February 28, 1999, Mr. Wood joined
Parago as an executive officer at a salary of $150,000 per year, from which
position he resigned in October 2001.
During the ten months ended December 31, 2000, CT Holdings sold 2,500,000
restricted shares of its common stock to two of its directors, Messrs. Lacerte
and Romano, in a private placement for proceeds of $2,500,000. During the year
ended December 31, 2001, CT Holdings issued an 8% note payable to Lawrence
Lacerte for a loan of $250,000 payable April 30, 2002. In addition, Steve
Solomon advanced CT Holdings $290,330 in the year ended December 31, 2001.
CT Holdings also had a $130,000 note receivable due from an entity that one of
the Company's directors, Mr. Romano, also serves on the board of directors of
such entity. This note was converted into equity of this entity in 2001.
Citadel has no relationships with Parago, other than the following:
. Steven B. Solomon, Citadel's Chief Executive Officer, is a director
and shareholder of Parago,
. Lawrence Lacerte, one of Citadel's directors, is a director and
shareholder of Parago, and
. CT Holdings owns approximately 1% of the outstanding shares of
common stock of Parago.
44
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBITS
2.1 Second Amended and Restated Plan of Merger dated February 29, 1996, by and
between LoneStar Hospitality Corporation, LSHC Acquisition, Inc. and Citadel
Computer Systems Incorporated (without exhibits) (incorporated by reference to
Exhibit 2.1 of the Company's Current Report on Form 8-K dated February 29,
1996).
2.2 Purchase and Sale Agreement dated March 1, 1996, by and between the LoneStar
Hospitality Corporation, LS Holding Corp. and Miami Subs USA, Inc. (without
exhibits) (incorporated by reference to Exhibit 2.2 of the Company's Current
Report on Form 8-K dated February 29, 1996).
2.3 Technology Transfer Agreement, by and between LoneStar Hospitality
Corporation and Circuit Masters Software, Inc., dated February 29, 1996 (without
exhibits) (incorporated by reference to Exhibit 2.3 of the Company's Current
Report on Form 8-K dated February 29, 1996).
2.4 Technology Transfer Agreement, by and between the Company and Bill Mulvany,
dated February 29, 1996 (without exhibits) (incorporated by reference to Exhibit
2.4 of the Company's Current Report on Form 8-K dated February 29, 1996).
2.5 Technology Transfer Agreement, by and between the Company and Kim Marie
Newman, dated February 29, 1996 (without exhibits) (incorporated by reference to
Exhibit 2.5 of the Company's Current Report on Form 8-K dated February 29,
1996).
2.6 Agreement, by and between the Company, Circuit Masters Software, Inc.,
Patrick William Mulvany and Kim Marie Newman, dated May 16, 1996, effective as
of February 29, 1996 (incorporated by reference to Exhibit 2.6 of the Current
Report on Form 8-K/A filed with the Securities and Exchange Commission on June
10, 1996).
3.1 Certificate of Incorporation (incorporated by reference to the registration
statement on Form S-1, File No. 33-25462, for Apollo Resources, Inc., on
November 10, 1988, and declared effective January 4, 1989).
3.2 Certificate of Amendment to Certificate of Incorporation filed with the
Delaware Secretary of State on June 4, 1990 (incorporated by reference to
Exhibit 3.2 of the Company's Annual Report on Form 10-KSB for the fiscal year
ended February 29, 1996).
3.3 Bylaws (incorporated by reference to the registration statement on Form S-1,
File No. 33-25462, filed with the Securities and Exchange Commission on November
10, 1988).
3.4 Certificate of Amendment to Certificate of Incorporation filed with the
Delaware Secretary of State on October 15, 1991 (incorporated by reference to
the Company's Annual Report on Form 10-KSB for the year ended December 31,
1991).
3.5 Certificate of Amendment to Certificate of Incorporation filed with the
Delaware Secretary of State on July 20, 1994 (incorporated by reference to the
Company's Quarterly Report on Form 10-QSB for the quarter ended June 30, 1994).
3.6 Certificate of Amendment to Certificate of Incorporation filed with the
Delaware Secretary of State on December 11, 1995 (incorporated by reference to
the Company's Quarterly Report on Form 10-QSB for the quarter ended December 31,
1995).
3.7 Certificate of Amendment to Certificate of Incorporation filed with the
Delaware Secretary of State on May 1, 1996 (incorporated by reference to Exhibit
3.7 of the Company's Annual Report on Form 10-KSB for the fiscal year ended
February 29, 1996).
3.8 Certificate of Designations of Series A Preferred Stock. (incorporated by
reference to Exhibit 4 of the Company's Quarterly Report on Form 10-QSB for the
fiscal quarter ended May 31, 1996).
3.9 Certificate of Designations of Series B Preferred Stock (incorporated by
reference to Exhibit 4.2 of the Company's Quarterly Report on Form 10-QSB for
the fiscal quarter ended August 31, 1996).
3.10 Certificate of Amendment to Certificate of Incorporation filed with the
Delaware Secretary of State on February 27, 1998 (incorporated by reference to
Exhibit 4.2 of the Company's registration statement on Form S-8 filed May 20,
1998, File No. 333-53131).
3.11 Certificate of Designations of Series C Preferred Stock (incorporated by
reference to Exhibit 4.6 of the Company's registration statement on Form S-8
filed May 20, 1998, File No. 333-53131).
45
3.12 Certificate of Designations of Series D Preferred Stock (incorporated by
reference to Exhibit 4.8 of the Company's registration statement on Form S-8
filed May 20, 1998, File No. 333-53131).
3.13 Certificate of Designations of Series E Preferred Stock (incorporated by
reference to Exhibit 4.7 of the Company's registration statement on Form S-8
filed May 20, 1998, File No. 333-53131).
3.14 Certificate for Renewal and Revival of Charter filed with the Delaware
Secretary of State on October 29, 1999 (incorporated by reference to Exhibit
3.14 to the Company's Annual Report on Form 10-KSB for the fiscal year ended
February 29, 2000).
10.1 Employment Agreement dated July 15, 1997, by and between the Company and
Steven Solomon (incorporated by reference to Exhibit 10.1 to the Company's
Annual Report on Form 10-KSB for the fiscal year ended February 28, 1998).
10.2 Stock Purchase Agreement, dated August 16, 1996, among the Company,
Kent-Marsh Ltd., Inc., Bob Wesolek and Vance Nesbitt. (incorporated by reference
to Exhibit 2.1 of the Company's Current Report on Form 8-K filed September 3,
1996).
10.3 Stock Purchase Agreement, dated August 16, 1996, among the Company,
Astonishing Developments, Inc., Bob Wesolek and Vance Nesbitt (incorporated by
reference to Exhibit 2.2 of the Company's Current Report on Form 8-K filed
September 3, 1996).
10.4 Agreement dated April 11, 1997, among the Company, George Sharp and Gil
Gertner (incorporated by reference to Exhibit 99.1 of the Company's Current
Report on Form 8-K filed April 11, 1997).
10.5 Form of Offshore Securities Subscription Agreement, Convertible Notes,
Warrants and Registration Rights Agreement between the Company and First Bermuda
Securities Limited (incorporated by reference to Exhibits 99.1 through 99.4 of
the Company's Current Report on Form 8-K filed March 26, 1997).
10.6 Form of Offshore Securities Subscription Agreement, Convertible Notes,
Warrants and Registration Rights Agreement between the Company and Willora
Company Ltd. (incorporated by reference to Exhibits 99.1 through 99.4 of the
Company's Current Report on Form 8-K filed April 28, 1997).
10.7 Form of Offshore Securities Subscription Agreement, Convertible Notes,
Warrants and Registration Rights Agreement between the Company and Silenus Ltd.
(incorporated by reference to Exhibits 99.1 through 99.4 of the Company's
Current Report on Form 8-K filed June 24, 1997).
10.8 Purchase Agreement between the Company and CORESTAFF, Inc., dated October
6, 1997 (incorporated by reference to Exhibit 10.10 to the Company's Annual
Report on Form 10-KSB for the fiscal year ended February 28, 1997).
10.9 Warrant to Purchase Common Stock of the Company issued to Worldwide
PetroMoly Inc. (incorporated by reference to Exhibit 10.11 to the Company's
Annual Report on Form 10-KSB for the fiscal year ended February 28, 1997).
10.10 Series D Preferred Stock Purchase Agreement between the Company and
METAMOR WORLDWIDE, Inc., dated May 15, 1998 (incorporated by reference to
Exhibit 10.12 to the Company's Annual Report on Form 10-KSB for the fiscal year
ended February 28, 1998).
10.11 Stock Purchase Agreement between the Company and Precision Capital Limited
Partnership I, dated April 30, 1998 (incorporated by reference to Exhibit 10.13
to the Company's Annual Report on Form 10-KSB for the fiscal year ended February
28, 1998).
10.12 Stock Purchase Agreement between the Company and Icarus Investments I,
Ltd., dated May 27, 1998 (incorporated by reference to Exhibit 10.14 to the
Company's Annual Report on Form 10-KSB for the fiscal year ended February 28,
1998).
10.13 Stock Purchase Agreement, dated March 11, 1999, among inLighten.com, Inc.,
2-Lane Media, Inc., and the shareholders of 2-Lane Media, Inc. (incorporated by
reference to Exhibit 10.15 to the Company's Annual Report on Form 10-KSB for the
fiscal year ended February 28, 1999).
10.14 Stock Purchase Agreement, dated May 20, 1999, among inLighten.com, Inc.,
Forward Communications, Inc., FCI Services Inc., and the shareholders of Forward
Communications, Inc. and FCI Services Inc. (incorporated by reference to Exhibit
2.1 to the Company's Current Report on Form 8-K filed June 3, 1999).
10.15 Agreement and Plan of Reorganization dated May 20, 1999, among
inLighten.com, Inc., Forward Freight, Inc., and the shareholders of Forward
Freight Inc. (incorporated by reference to Exhibit 2.1 to the Company's Current
Report on Form 8-K filed June 3, 1999).
46
10.16 Settlement and Release Agreement dated January 14, 2000 by and among
Richard L. Travis, How2.com, Inc. and the Company (incorporated by reference to
Exhibit 10.18 to Post-Effective Amendment No. 1 to the Company's Registration
Statement on Form SB-2 filed March 23, 2000).
10.17 Settlement and Release Agreement dated March 1, 2000 by and among Bennett
Klein and the Company (incorporated by reference to Exhibit 10.19 to
Post-Effective Amendment No. 1 to the Company's Registration Statement on Form
SB-2 filed March 23, 2000).
10.18 Standard Office Lease, dated August 2, 1999, between Arden Realty Limited
Partnership and How2HQ.com, Inc. (Santa Monica, California) (incorporated by
reference to Exhibit 10.18 to the Company's Annual Report on Form 10-KSB for the
fiscal year ended February 29, 2000).
10.19 Guaranty of Lease, dated August 2, 1999, by the Company to Arden Realty
Limited Partnership, with respect to certain obligations of How2HQ.com, Inc.
under Standard Office Lease (incorporated by reference to Exhibit 10.19 to the
Company's Annual Report on Form 10-KSB for the fiscal year ended February 29,
2000).
10.20 Promissory Note dated September 30, 1999 payable to How2HQ.com, Inc.
(incorporated by reference to Exhibit 10.20 to the Company's Annual Report on
Form 10-KSB for the fiscal year ended February 29, 2000).
10.21 Asset Purchase Agreement dated as of May 5, 2000 by and between EBSCO
CASIAS, Inc., iNetze.com, Inc., ESRN Acquisition, LLC and the Company
(incorporated by reference to Exhibit 2.1 to the Company's Current Report on
Form 8-K filed June 12, 2000).
10.22 Asset Contribution Agreement dated as of May 5, 2000 by and between
iNetze.com, Inc., ESRN Acquisition, LLC, the Company and the stockholders set
forth on the signature pages attached hereto (incorporated by reference to
Exhibit 2.2 to the Company's Current Report on Form 8-K filed June 12, 2000).
10.23 Stock Purchase Agreement dated as of May 5, 2000 by and between the
Company, Tim Collins, F. Shanahan McAdoo and Robert C. Whitehair (incorporated
by reference to Exhibit 2.3 to the Company's Current Report on Form 8-K filed
June 12, 2000).
10.24* Form of Plan and Agreement of Distribution between the Company and
Citadel Security Software Inc.
10.25* Form of Tax Disaffiliation Agreement between the Company and Citadel
Security Software Inc.
10.26* Form of Transition Services Agreement between the Company and Citadel
Security Software Inc.
21 Subsidiaries of the Company (incorporated by reference to Exhibit 21 to the
Company's Annual Report on Form 10-KSB for the fiscal year ended February 29,
2000).
*23.1 Consent of King Griffin & Adamson P.C.
* Filed herewith.
REPORTS ON FORM 8-K
On November 6, 2001 and November 20, 2001 the Company filed reports on form 8-K
announcing the change in independent public accountants. See the discussion
under Item 8. Changes in, and disagreements with, accountants on accounting and
financial matters
47
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, as amended, the Registrant has duly caused this Annual Report on
Form 10-KSB to be signed on its behalf by the undersigned, thereunto duly
authorized.
Date: April 15, 2002 CT HOLDINGS, INC.
By: /s/ STEVEN B. SOLOMON
--------------------------------
Steven B. Solomon, President and
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Steven B. Solomon his true and lawful
attorney-in-fact and agent, with full power of substitution and resubstitution,
to sign any and all amendments to this Annual Report on Form 10-KSB and to file
the same, with all exhibits thereto and other documents in connection therewith,
with the Securities and Exchange Commission, granting unto said attorney-in-fact
and agent full power and authority to do and perform each and every act and
thing requisite and necessary to be done in connection therewith, as fully to
all intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorney-in-fact and agent, or his substitute or
substitutes, or any of them, shall do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
SIGNATURE TITLE DATE
/s/ STEVEN B. SOLOMON
--------------------------------- President, Chief Executive Officer
Steven B. Solomon and Director April 15, 2002
(Principal Executive Officer and
Principal Accounting Officer)
/s/ LAWRENCE LACERTE
--------------------------------- Director April 15, 2002
Lawrence Lacerte
/s/ CHRIS A. ECONOMOU
--------------------------------- Director April 15, 2002
Chris A. Economou
/s/ MARK ROGERS
----------------------- Director April 15, 2002
Mark Rogers
/s/ PHILLIP J. ROMANO
----------------------- Director April 15, 2002
Phillip J. Romano
/s/ DR. AXEL SAWALLICH
----------------------- Director April 15, 2002
Dr. Axel Sawallich
48
INDEX TO FINANCIAL STATEMENTS
Report of Independent Certified Public Accountants F-2
Balance Sheets as of December 31, 2001 and 2000 F-3
Statements of Operations for the year ended December 31, 2001
and the ten months ended December 31, 2000 F-4
Statements of Stockholders' Equity for the year ended
December 31, 2001 and the ten months ended December 31, 2000 F-5
Statements of Cash Flows for the year ended December 31, 2001
and the ten months ended December 31, 2000 F-7
Notes to Financial Statements F-8
F-1
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors
CT Holdings, Inc.
We have audited the accompanying balance sheets of CT Holdings, Inc. (the
Company) as of December 31, 2001 and 2000, and the related statements of
operations, stockholders' equity and cash flows for the year ended December 31,
2001 and the ten months ended December 31, 2000. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of CT Holdings, Inc. as of
December 31, 2001 and 2000, and the results of its operations and its cash flows
for the year ended December 31, 2001 and the ten months ended December 31, 2000
in conformity with accounting principles generally accepted in the United
States.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As more fully described in Note A, the
Company has incurred recurring operating losses and has a significant working
capital deficiency at December 31, 2001. These conditions raise substantial
doubt about the Company's ability to continue as a going concern. Management's
plans in regard to these matters are also described in Note A. The financial
statements do not include any adjustments that may result from the outcome of
this uncertainty.
/S/ King Griffin & Adamson P.C.
Dallas, Texas
March 28, 2002
F-2
CT HOLDINGS, INC.
BALANCE SHEETS
December 31,
2001 2000
------------ ------------
ASSETS
CURRENT ASSETS
Accrued interest receivable -- 45,250
Notes receivable from related parties -- 588,559
Notes receivable from affiliates -- 730,000
------------ ------------
Total current assets -- 1,363,809
INVESTMENT IN UNCONSOLIDATED AFFILIATES 2,735,975 2,613,976
NET LONG-TERM ASSETS OF DISCONTINUED OPERATIONS 241,767 728,074
------------ ------------
$ 2,917,742 $ 4,705,859
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 911,333 $ 388,983
Accrual for legal settlement -- 1,912,500
Advances and notes payable to related parties 540,330 126,028
Notes payable -- 27,501
Net current liabilities of discontinued operations 935,693 615,958
------------ -----------
Total current liabilities 2,387,356 3,070,970
COMMITMENTS AND CONTINGENCIES (NOTE G)
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value;
authorized, 1,000,000 shares; no shares
issued or outstanding
Common stock, $.01 par value;
authorized, 60,000,000 shares; issued
53,994,221 and 53,825,317 shares at
December 31, 2001 and 2000 539,943 538,254
Additional paid-in capital 56,429,100 56,383,496
Accumulated deficit (53,878,418) (52,786,622)
Treasury stock, at cost (4,164,613 common shares) (2,500,239) (2,500,239)
------------ ------------
Total stockholders' equity 590,386 1,634,889
------------ ------------
$ 2,977,742 $ 4,705,859
============ ============
The accompanying notes are an integral part of these financial statements.
F-3
CT HOLDINGS, INC.
STATEMENTS OF OPERATIONS
Ten Months
Year Ended Ended
December 31, December 31,
2001 2000
------------ ------------
REVENUE $ -- $ --
OPERATING EXPENSES
General and administrative expenses 735,379 505,310
Forgiveness of notes due from related parties -- 1,544,456
----------- -----------
735,379 2,049,766
----------- -----------
Operating income (loss) (735,379) (2,049,766)
OTHER INCOME (EXPENSE)
Legal settlement reversal (accrual) 1,912,500 (1,912,500)
Equity in loss of unconsolidated affiliate -- (1,220,516)
Writedown of investment in affiliate (360,000) --
Interest expense (9,255) (9,129)
Interest income and other 64,319 59,954
Writedown of note receivable from affiliate (98,000) --
----------- -----------
1,509,564 (3,082,191)
----------- -----------
Income (loss) from continuing operations 774,185 (5,131,957)
Loss from discontinued operations (1,865,981) (2,984,007)
----------- -----------
Net loss $(1,091,796) $(8,115,964)
=========== ===========
Income (loss) per share data
Continuing operations $ 0.02 $ (0.11)
Discontinued operations (0.04) (0.06)
----------- -----------
Net loss $ (0.02) $ (0.17)
=========== ===========
Weighted average shares outstanding 49,733,710 47,643,782
=========== ===========
The accompanying notes are an integral part of these financial statements.
F-4
CT HOLDINGS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
Common Stock Additional
-------------------- paid-in Accumulated
Shares Amount capital deficit
---------- -------- ----------- ------------
Balances at March 1, 2000 50,136,400 $501,365 $50,390,070 $(44,670,658)
Exercise of stock options and warrants 55,583 556 35,844 --
Issuance of common stock to related party for
cash 2,500,000 25,000 2,475,000 --
Equity increase in Parago -- -- 393,166 --
Non-employee stock-based compensation -- -- 30,440 --
Common stock issued in connection with
investment in unconsolidated affiliate 1,050,000 10,500 2,476,417 --
Stock issued to employee as severance upon
termination 83,334 833 582,559 --
Forgiveness of notes from related parties --
Net loss from operations -- -- -- (8,115,964)
---------- -------- ----------- ------------
Balances at December 31, 2000 53,825,317 $538,254 $56,383,496 $(52,786,622)
========== ======== =========== ============
Treasury Notes
stock receivable Total
----------- ----------- -----------
Balances at March 1, 2000 $(2,500,239) $(1,335,522) $ 2,385,016
Exercise of stock options and warrants -- -- 36,400
Issuance of common stock to related party for
cash -- -- 2,500,000
Equity increase in subsidiary -- -- 393,166
Non-employee stock-based compensation -- -- 30,440
Common stock issued in connection with
investment in unconsolidated affiliate -- -- 2,486,917
Stock issued to employee as severance upon
termination -- -- 583,392
Forgiveness of notes from related parties -- 1,335,522 1,335,522
Net loss from operations -- -- (8,115,964)
----------- ----------- -----------
Balances at December 31, 2000 $(2,500,239) -- $ 1,634,889
=========== =========== ===========
F-5
CT HOLDINGS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY Continued
Common Stock Additional
-------------------- paid-in Accumulated
Shares Amount capital deficit
---------- -------- ----------- ------------
Balances at December 31, 2000 53,825,317 $538,254 $56,383,496 $(52,786,622)
Exercise of stock warrants 168,904 1,689 45,604
Net loss -- -- -- (1,091,796)
---------- -------- ----------- ------------
Balances at December 31, 2001 53,994,221 $539,943 $56,429,100 $(53,878,418)
========== ======== =========== ============
Treasury
stock Total
----------- ----------
Balances at December 31, 2000 $(2,500,239) $1,634,889
Exercise of stock warrants 47,293
Net loss -- (1,091,796)
----------- ----------
Balances at December 31, 2001 $(2,500,239) $ 590,386
=========== ==========
The accompanying notes are an integral part of these financial statements.
F-6
CT HOLDINGS, INC.
STATEMENTS OF CASH FLOWS
Year Ended Ten Months Ended
------------ ----------------
December 31, December 31,
2001 2000
------------ ----------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(1,091,796) $(8,115,964)
Less net (loss) from discontinued operations 1,865,981 2,984,007
Adjustments to reconcile net loss to
net cash (used) provided by continuing
operating activities:
Writedown of investment in affiliate 360,000 --
Writedown of note receivable from affiliate 98,000 --
Equity in loss of unconsolidated
affiliate -- 1,220,516
Common stock and options issued
as payment of expenses -- 30,440
Forgiveness of notes from related
parties -- 1,544,456
Noncash employee severance expense -- 583,392
Accrued compensation offset to
notes receivable from related party -- 506,000
Accrual for legal settlement (1,912,500) 1,912,500
Changes in operating assets and liabilities:
Accrued interest receivable 45,249 (45,249)
Accounts payable and accrued expenses 522,352 103,882
Payable to affiliate -- 54,729
Other -- 5,439
----------- -----------
NET CASH (USED) PROVIDED BY OPERATIONS (112,714) 784,148
CASH FLOWS FROM INVESTING ACTIVITIES
Decrease (increase) in notes receivable
from related parties, net 588,560 (1,100,000)
Proceeds from certificate of deposit -- 100,000
Decrease (increase) in notes receivable from
affiliates 150,000 (730,000)
Additional investment in
unconsolidated affiliates -- (127,059)
----------- -----------
NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES 738,560 (1,857,059)
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on notes payable (27,501) (103,312)
Proceeds from notes payable 250,000 47,479
Proceeds from related party advances 290,330 780,000
Repayments to related party advances (126,029) (780,000)
Proceeds from issuance of common stock 47,293 2,536,400
----------- -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 434,093 2,480,567
----------- -----------
NET CASH PROVIDED BY CONTINUING OPERATIONS 1,059,939 1,407,656
NET CASH USED BY DISCONTINUED OPERATIONS (1,059,939) (1,407,656)
----------- -----------
Net change in cash -- --
Cash at beginning of the period -- --
----------- -----------
Cash at end of the period $ -- $ --
=========== ===========
NON-CASH INVESTING AND FINANCING ACTIVITIES:
As discussed in Notes A and E during 2001, the Company converted $450,000
of notes receivable from River Logic into River Logic preferred stock and a
$130,000 note receivable from PerClick into an investment in Encore with a fair
value of $32,000.
The accompanying notes are an integral part of these financial statements
F-7
CT HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
CT Holdings, Inc. (the "Company" or "CT Holdings") provides management expertise
including consulting on operations, marketing and strategic planning and a
single source of capital to early stage technology companies. The Company
previously operated under the name Citadel Technology Inc. and was incorporated
in Delaware in 1992. At December 31, 2001 the Company held investments in
Citadel Security Software Inc. ("Citadel"), Parago Inc. ("Parago"), River Logic
Inc. ("River Logic") and Encore Telecommunications, Inc. ("Encore"). The
business model is designed to enable the companies with whom the Company
acquires or invests to become market leaders in their industries. The strategy
over the years has led to the development, acquisition and operation of
technology based businesses with compelling valuations and strong business
models. The anticipated growth in technology creates strong opportunities to
increase shareholder value by investing in well-positioned early stage ventures.
The goal is to realize the value of these investments for the Company's
shareholders through a subsequent liquidity event such as a sale, merger or
initial public offering of the investee companies.
During 2001 the Company's percentage ownership in Parago was reduced to
approximately 1% as a result of an additional private equity financing by Parago
begun in December 2001 and completed in February 2002 in which the Company did
not participate. The Company's investment in Parago was accounted for using the
equity method through December 12, 2001 the date of the first closing of the
financing. Subsequent to the financing the Company's investment has been
accounted for using the cost method. See Investment in Unconsolidated Affiliates
below. Parago was formed in 1999 as an application service provider ("ASP") and
Internet based business process outsourcer 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, and
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.
("River Logic"), which develops decision-support applications for industry.
Using COR Technology, a rapid-application development system, developers at
River Logic create applications that enable industry professionals to model
complex enterprises and explore financial relationships on a desktop computer or
laptop. Embedded analytics allow end-users to understand the financial
implications of critical business decisions easily by manipulating graphical
icons that model their enterprise. The Company accounts for its investment in
River Logic using the cost method.
In January 2002 CT Holdings filed a registration statement and in March and
April 2002 filed amendments to the registration statement with the Securities
and Exchange Commission ("SEC") to spin off as a separate public company its
wholly owned subsidiary Citadel in a pro rata dividend distribution of the
common stock of Citadel to CT Holdings' shareholders. (See the Citadel Security
Software Distribution below.) The registration statement will become effective
upon completion of the SEC's normal review procedures. Once effective, a
declaration date will be set and the pro rata dividend distribution will be
completed. The financial statements of its wholly owned subsidiary, Citadel,
previously consolidated with the financial statements of the Company are
presented in these financial statements as discontinued operations pursuant to
the completion of the planned Distribution.
Citadel develops, markets and licenses security 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 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.
During 2001 the Company agreed to restructure a note receivable from Per
Click.com Inc. ("PerClick") into an investment in Encore who acquired the assets
of Per Click, including the Company's note.
Citadel Security Software Distribution
In November 2001, the board of directors of CT Holdings approved the spin-off of
Citadel through the declaration of a pro rata dividend distribution to the
holders of record of the outstanding shares of CT Holdings common stock (the
"Distribution"). The Distribution consists of one (1) share of Citadel common
stock for every four (4) shares of CT Holdings (the Distribution Ratio) held by
CT Holdings shareholders as of a record date to be determined following the
effective date of a registration statement filed with the U.S. Securities and
Exchange Commission ("SEC"). Following the Distribution, Citadel will be an
independent
F-8
company and CT Holdings will have no continuing ownership interest in Citadel.
The Distribution is intended to be a tax free distribution for U.S. federal tax
purposes and is expected to be completed in the second quarter of 2002. The
Distribution is subject to the registration statement being approved by the SEC.
On the Distribution Date, CT Holdings and Citadel will enter into a series of
agreements including a distribution agreement, a transition services agreement,
a sublease agreement, an indemnity agreement and a tax disaffiliation agreement
which will provide for, among other things, the principal corporate transactions
required to effect the Distribution, to provide for an orderly transition to the
status of two independent companies and to define the continuing relationship
between Citadel and CT Holdings after the Distribution.
Pending Acquisition
On January 28, 2002 a letter of intent was signed to acquire American Natural
Technology Sciences ("ANTS"), a developer of environmentally friendly pesticides
for the control of fire ants and other insects. When the transaction is
completed the acquisition will be accounted for as a purchase under the guidance
of Statement of Financial Accounting Standards No. 141 - Business Combinations
and Statement of Financial Accounting Standards No. 142 - Goodwill and Other
Intangible Assets. Although the letter of intent has expired, the Company is
continuing its due diligence process and may extend or renegotiate the terms of
the letter of intent. The completion of the acquisition transaction is subject
to, among other things, extending the letter of intent, the negotiation and
execution of a definitive acquisition agreement, due diligence, and other
customary closing conditions.
Fiscal Year
During 2000, CT Holdings changed its fiscal year end from February 28 to
December 31. Therefore, the fiscal year ending December 31, 2000 is a transition
period consisting of a ten month period from March 1, 2000 through December 31,
2000. The following table shows the Year ended December 31, 2001 and the
comparative year ended December 31, 2000.
Year Ended
---------------------------
December 31, December 31,
2001 2000
(Audited) (Unaudited)
------------ -------------
Costs & expenses $ 735,379 $ 638,532
Legal settlement accrual(reversal) (1,912,500) 1,912,500
Forgiveness of notes from related parties -- 1,544,456
Equity in loss of unconsolidated affiliate -- 4,658,781
Writedown of investment in affiliate (360,000) --
Writedown of note receivable from
affiliate (98,000) --
Net income from continuing operations 774,185 (8,754,269)
Net loss from discontinued operations (1,865,981) (4,985,723)
Net loss (1,091,796) (13,739,992)
Income (Loss) per common share:
From continuing operations $ 0.02 $ (0.11)
From discontinued operations (0.04) (0.06)
Liquidity
The Company has incurred recurring operating losses and has a significant
working capital deficiency at December 31, 2001. Cash used in operations was
approximately $113,000 during the year ended December 31, 2001. The Company had
no cash balance at December 31, 2001 and current liabilities exceed current
assets from continuing operations by approximately $2.4 million. Immediate
funding needs of the business are expected to be provided by financings through
short-term notes payable and additional investments from related parties. The
Company has been and continues to be dependent upon outside financing to perform
its business development activities, make investments in new technology
companies and to fund operations. During 2001 and 2000, related parties provided
substantially all of this financing. Future cash may come from the realization
of the value of our investments in Parago, River Logic and Encore however there
can be no assurance that any value will ever be realized from these investments.
(See below).
The Company's strategy of continuing to support and expand its business
development activities requires the Company to obtain additional capital. The
complete implementation of this element of our strategy will not generate
positive cash flow in the foreseeable future. Achieving positive cash flow is
currently highly dependent upon obtaining liquidity from the Company's
investments in unconsolidated affiliates. The Company estimates it will need to
raise $500 thousand to $1 million to support its incubator and business
development
F-9
activities through the remainder of 2002. Historically, the Company has obtained
short-term bridge funding from its Chief Executive Officer or Directors of the
Company. While this may occur in the future there can be no assurance that such
financing will be available or if available with terms that the Company would be
willing to accept.
The Company has made investments in entities that it believes may provide
liquidity to the Company in the long term. The Company believes that the
investment in Parago has been successful in that it has grown from the original
$50,000 of equity provided by the Company with no revenue, to net revenue of
approximately $26 million for the year ended December 31, 2001 (unaudited). As
expected in an early stage company, Parago has not been profitable and has
experienced cash flow deficiencies as it implements its business plan. During
2001 the Company's percentage ownership in Parago was reduced to 1% as a result
of an additional equity financing raised by Parago in December 2001. The Company
believes, however, that the investment of 20,000 common shares of Parago
(following a 1-for-1000 reverse stock split) and warrants to purchase 28.8749
shares of Series A-3 preferred stock (convertible into 2,887 shares of common
stock) may ultimately provide an appropriate return.
Similarly, the Company believes its investment in River Logic has also been
successful. Since our initial investment, River Logic has made progress in
executing its strategy through its development and introduction of new products
and establishment of new customer relationships. In addition, during April, 2001
River Logic obtained a significant strategic investment from the Intel 64 Fund,
Cardinal Investments, eMed Ventures, and Mercury Ventures. As part of this
equity financing, the Company converted $450,000 of demand notes receivable into
River Logic Series C Preferred stock, the same equity instruments purchased by
the other investees. The remainder of the notes receivable plus interest
totaling approximately $216,000 was collected in April 2001. Similar to the
investments into Parago, the Company recognized that this investment would be
initially illiquid. The company's minority position in Encore is immaterial and
is not expected to provide liquidity to the Company in the foreseeable future.
While the Company is pleased with the performance of its investee companies to
date, there can be no assurance that the Company will ever achieve liquidity for
its investments.
There can be no assurance that management's plans will be successful or what
other actions may become necessary. Until the Company is able to create
liquidity from its investments through sale to a strategic investor, an initial
public offering or some other liquidity transaction, the Company will continue
to require working capital to fund its own operating expenses. Although the
Company has been successful raising capital in the past, the inability of the
Company to raise capital may require the Company to sell assets or reduce the
level of its operations. Such actions could have a material adverse effect on
the Company's business and operations and result in charges that could be
material to the Company's business and results of operations.
Basis of Presentation
The accompanying consolidated financial statements of CT Holdings have been
prepared in accordance with accounting principles generally accepted in the
United States. Accordingly all material intercompany transactions with its
consolidated subsidiary and unconsolidated affiliates have been eliminated in
consolidation pursuant to the applicable accounting principles for consolidation
and the equity method of accounting. The balance sheet, results of operations
and the cash flows of the Company's wholly owned subsidiary, Citadel are
presented as discontinued operations due to the planned Distribution. Where
appropriate, prior year amounts have been reclassified to conform to the current
period presentation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements. Actual results could
differ from those estimates.
Investment in Unconsolidated Affiliates
The Company holds investments in three companies, Parago, River Logic, and
Encore. The Company records its investments under equity method or the cost
method of accounting as applicable, and presents its investments in these
companies on its balance sheets as Investment in Unconsolidated Affiliates and
its share of the equity-method investee's losses, if applicable, on the
statements of operations as Equity in Loss of Unconsolidated Affiliate. All
significant intercompany accounts and transactions have been eliminated.
After a 1 for 1000 reverse stock split the Company holds 20,000 shares of common
stock of Parago and warrants to purchase 28.8749 shares of Series A-3 preferred
stock (convertible into 2,887 shares of common stock) at December 31, 2001. In
December 2001 Parago completed an equity financing of approximately $13.6
million of a total $15 million financing. Approximately $1.4 million of equity
financing was closed in February 2002. As a result of the equity financing the
Company's ownership percentage in Parago was reduced to approximately 1%. The
Company's investment in Parago for the period from January 1, 2001 through
December 12, 2001 and the ten months ended December 31, 2001 was accounted for
under the equity method of accounting for investments and accordingly as a
result of the Company's ownership falling below 20%, has been accounted for
using the cost method of accounting beginning December 13, 2001. Under the cost
method, the Company's share of income or loss of Parago is not included in the
Compnay's Statements of operations. Under the equity method of accounting, the
Company's share of the investee's income or losses is included in the statements
of operations. If the carrying value of the Company's net investment falls below
zero, as it did during the ten months ended December 31, 2000, the Company
discontinues applying the equity method until the carrying value of the net
investment rises above zero. In addition, in the event the Company's ownership
percentage exceeds 20% and the value of the Company's equity investment rises
above zero, the Company will resume applying the equity method and will
F-10
recognize an investment in Parago after the Company's share of net losses not
recognized is recovered through its proportionate share of net income if Parago
turns profitable.
During the second quarter of 2001 the Company, along with other investors in
Parago, participated in a bridge loan financing transaction completed by Parago
totalling $692,740 and guaranteed $1,406,472 of a bank term loan to Parago. In
accordance with Accounting Principles Board Opinion No. 18, The Equity Method of
Accounting for Investments in Common Stock the Company recognized a charge to
earnings of $2,099,212 in June 2001. Upon closing of the Parago Equity Financing
in December 2001 Parago repaid the bridge loan and the bank guarantee was
released. As a result the Company reversed the $2,099,212 in the fourth quarter
of 2001.
As the Company owned less than 20% of the ownership interest in River Logic at
December 31, 2001 and 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 statements of
operations. The Company's investment in River Logic is $2,703,975 and $2,613,975
at December 31, 2001 and 2000, respectively.
In September 2000 the Company, as part of a group of investors, agreed to
provide $130,000 of bridge financing to PerClick. The Company also signed a
letter of intent to acquire a 40% ownership interest in PerClick but later
decided not to proceed with the acquisition. The bridge loan was represented by
a convertible demand note in the amount of $130,000 with an interest rate of 10%
per annum. The convertible demand note was convertible into 130,000 shares of
common stock of PerClick at anytime and at the option of the holder. In the
first quarter of 2001 Vonova Corporation ("Vonova") acquired all of the equity
of PerClick. Vonova signed a note guarantee agreeing to the terms and conditions
of the PerClick note. In October 2001 Encore acquired the assets of Vonova. As
part of the asset acquisition agreement CT Holdings agreed to exchange the note
for an investment in Encore with a fair value of $32,000. Accordingly the
Company reduced the value of its original note to $32,000 at December 31, 2001.
The Company periodically evaluates the investments in its investee companies for
impairment based upon the prospects of the entity and the value of the
investment when compared to other investments in the entity from other unrelated
parties. If these factors indicate that an other than temporary impairment
exists, then the Company will write down the value of the investment to its
realizable value. At December 31, 2001 the Company determined that a writedown
of $360,000 in its investment in River Logic was necessary based on the value
ascribed to River Logic financing transactions during 2001. The investment in
Parago was written down to zero during 2000 through equity accounted losses.
Impairment of Long-Lived Assets
In accordance with Statement of Financial Accounting Standards No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets, the Company
reviews its long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable and exceeds its fair value. If conditions indicate an asset might be
impaired, the Company estimates the future cash flows expected to result from
the use of the asset and its eventual disposition. The impairment would be
measured by the amount by which the asset exceeds its fair value typically
represented by the future discounted cash flow associated with the asset.
Income Taxes
Deferred income tax expenses are provided based upon estimated future tax
effects of differences between the carrying amounts of assets and liabilities
for financial reporting purposes and the amounts used for income tax purposes
calculated based upon provisions of enacted laws.
Stock-Based Compensation
The Company has elected to account for stock-based compensation to employees
using the intrinsic value method prescribed in Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25") and related
interpretations. Accordingly, compensation cost for stock options is measured as
the excess, if any, of the fair market value of the Company's stock at the date
of the grant over the amount an employee must pay to acquire the stock. See Note
D regarding the pro forma net loss and earnings per share information as
required by the alternative fair value accounting provided for under Financial
Accounting Standards Board Statement No. 123, Accounting for Stock-Based
Compensation ("SFAS No. 123").
The Company accounts for equity instruments issued to non-employees in
accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force
("EITF") Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to
Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services." All transactions in which goods or services are the consideration
received for the issuance of equity instruments are accounted for based on the
fair value of the consideration received or the fair value of the equity
instrument issued, whichever is more reliably measurable. The measurement date
of the fair value of the equity instrument issued is the earlier of the date on
which the counterparty's performance is complete or the date on which it is
probable that performance will occur.
Fair Value of Financial Instruments
The Company's financial instruments, including cash and cash equivalents,
accounts receivable, accounts payable and notes payable are carried at cost,
which approximates fair value due to the short maturity of these instruments.
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
F-11
outstanding during the period. Basic loss per share excludes any dilutive
effects of options. Stock options and warrants to purchase 13,029,951 shares of
common stock have been excluded from the computation of diluted loss per share,
as the effect would be anti-dilutive.
Recently Issued Accounting Standards
In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 141 "Business Combinations" which requires
the purchase method of accounting for business combination transactions
initiated after June 30, 2001.
In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 142 "Goodwill and Other Intangible Assets."
The statement requires that goodwill recorded on acquisitions completed prior to
July 1, 2001 be amortized through December 31, 2001. Goodwill amortization is
precluded on acquisitions completed after June 30, 2001. Effective January 1,
2002, goodwill will no longer be amortized but will be tested for impairment as
set forth in the statement.
In August 2001, the FASB issued Statement of Financial Accounting Standards No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("FAS
144"). FAS 144 supercedes FAS 121, "Accounting for Long-Lived Assets and for
Long-Lived Assets to be Disposed of" ("FAS 121") and the accounting and
reporting provisions of the Accounting Principles Board Opinion No. 30,
"Reporting the Results of Operations - Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions." FAS 144 establishes a single accounting model, based
on the framework established by FAS 121, for long-lived assets to be disposed of
by sale and resolved significant implementation issues related to FAS 121. FAS
144 retains the requirements of FAS 121 to recognize an impairment loss only if
the carrying amount of a long-lived asset is not recoverable from its
undiscounted cash flows and measure an impairment loss as the difference between
the carrying amount and the fair value of the asset. FAS 144 excludes goodwill
from its scope, describes a probability-weighted cash flow estimation approach,
and establishes a "primary-asset" approach to determine the cash flow estimation
period for groups of assets and liabilities. FAS 144 is effective for fiscal
years beginning after December 15, 2001, and interim periods within those fiscal
years, with early application encouraged.
The new standards described above have been evaluated and in the opinion of
management, when adopted, will not have a material effect on the Company's
future financial condition, results of operations, and accounting policies and
practices.
NOTE B - DISCONTINUED OPERATIONS
In January 2002 Citadel filed a registration statement with the SEC to be spun
off as a pro rata dividend distribution to shareholders of CT Holdings. (See the
"Citadel Security Software Distribution") The operating results for the year
ended December 31, 2001 and the ten months ended December 31, 2000 are as
follows:
Ten Months
Year Ended Ended
December 31, December 31,
2001 2000
------------ ------------
Revenue $ 580,039 $ 460,985
Costs of revenue 26,459 8,310
Software amortization 594,923 783,444
Write-down of purchased software and
capitalized software development costs -- 230,643
----------- -----------
Total costs of revenue 621,382 1,022,397
Selling, general and administrative expenses 1,610,922 2,174,362
Research and development expenses 118,432 112,992
Depreciation expense 95,284 134,047
Other -- 1,194
----------- -----------
Total operating expenses 1,824,638 2,422,595
----------- -----------
Operating loss (1,865,981) (2,984,007)
----------- -----------
F-12
Provision for income taxes --
----------- -----------
Net loss $(1,865,981) $(2,984,007)
=========== ===========
At December 31, 2001 and 2000 the net current liabilities and the net long-term
assets of Citadel were as follows:
December 31,
2001 2000
---------- --------
Current assets
Cash and cash equivalents $ 75,030 $ 11,131
Accounts receivable, net 24,222 54,794
Inventory -- 22,077
Prepaid expenses 72,702 94,217
---------- --------
Total current assets 171,954 182,219
Current liabilities
Accounts payable and accrued expenses 862,262 727,253
Payroll tax obligations 245,385 --
Note payable -- 70,924
---------- --------
Total current liabilities 1,107,647 798,177
---------- --------
Net current liabilities of discontinued operations $ 935,693 $615,958
========== ========
Property and equipment, net $ 43,006 $ 94,054
Purchased software, net -- 106,704
Capitalized software development costs, net 174,110 485,221
Other assets 24,651 42,095
---------- --------
Net long-term assets of discontinued operations $ 241,767 $728,074
========== ========
NOTE C - INCOME TAXES
The significant components of the Company's deferred tax liabilities and assets
are as follows:
December 31,
2001 2000
----------- -----------
Deferred tax assets (liabilities)
Net operating loss carryforwards $ 896,000 $ 1,305,000
Investment in subsidiary -- 17,000
Accounts payable and accrued expenses (25,000) --
----------- -----------
Total deferred tax assets, net 871,000 1,322,000
Valuation allowance (871,000) (1,322,000)
----------- -----------
Total deferred tax assets, net $ -- $ --
=========== ===========
F-13
The difference between the provision for income taxes and the amount computed by
applying the federal statutory rate to loss before provision for income taxes
are as follows:
December 31,
2001 2000
----------- -----------
Benefit computed at federal statutory rate $ 371,000 $ 2,800,000
Loss related to discontinued operations (634,000) (1,015,000)
Increase (decrease) in valuation allowance 329,000 (1,743,000)
Other (66,000) 42,000
----------- -----------
$ -- $ --
=========== ===========
For federal income tax purposes, at December 31, 2001 the Company had a net
operating loss carryforward of approximately $30,600,000 of which approximately
$28,000,000 is attributable to the net operating loss carryforward of Citadel
shown as discontinued operations. The net operating loss carryover, which is
subject to annual limitations as prescribed by the Internal Revenue Code, is
available to offset future taxable income through 2021. A valuation allowance
has been recorded for the entire amount of the net deferred tax asset due to
uncertainty of realization.
NOTE D - STOCK OPTIONS AND WARRANTS
The Company has issued stock options to purchase common stock to directors,
employees and consultants. Options are granted at no less than fair value at
date of grant. Generally, the options vest over no more than three years.
Following is a summary of option transactions for the periods beginning March 1,
2000:
Weighted
average
exercise
price
Shares per share
---------- ---------
Outstanding at March 1, 2000 1,266,267 $3.07
Granted 155,000 4.06
Exercised (107,667) 0.33
Expired or canceled (15,000) 3.00
----------
Outstanding at December 31, 2000 1,298,600 3.41
Granted 9,990,000 0.25
Exercised --
Expired or cancelled (610,250) 4.01
----------
Outstanding at December 31, 2001 10,678,350 $0.51
==========
Exercisable at December 31, 2000 1,202,386 $3.59
Exercisable at December 31, 2001 7,519,157 $0.63
F-14
The following table summarizes other information regarding stock options at
December 31, 2001:
Outstanding Exercisable
----------------------------------- --------------------
Weighted
average
remaining Weighted Weighted
contractual average average
Range of life exercise exercise
exercise prices Shares (in years) price Shares price
--------------- ---------- ----------- -------- --------- --------
$0.20 - 0.26 7,005,000 9.2 $0.20 4,182,082 $0.20
0.32 - 0.67 3,100,350 8.6 0.39 2,765,350 0.40
1.75 - 5.00 573,000 1.9 4.89 571,725 4.90
---------- ---------
10,678,350 $0.51 7,519,157 $0.63
========== =========
If the Company had recognized compensation expense based upon the fair value at
the grant date for options granted to employees during the year ended December
31, 2001 and the ten months ended December 31, 2000, the pro forma effect on net
loss and loss per share would have been as follows:
Ten Months
Year Ended Ended
December 31, December 31,
2001 2000
------------ ------------
Net loss
As reported $(1,091,796) $(8,115,964)
Pro forma (2,242,946) (8,761,035)
Loss per common share
As reported (0.02) (0.17)
Pro forma (0.05) (0.18)
The fair value of these options were estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions:
Year Ten Months
Ended Ended
------------ ------------
December 31, December 31,
2001 2000
------------ ------------
Expected volatility 160% 124%
Risk-free interest rates 4.75% 5.7%
Dividend yield 0% 0%
Expected option lives 5 years 5 years
F-15
The following summarizes the activity of warrants to purchase common stock for
the year ended December 31, 2001 and the ten months ended December 31, 2000:
Weighted
average
Shares exercise price
---------- --------------
Outstanding at February 29, 2000 4,556,755 $3.55
Exercised (31,250) 0.89
---------- -----
Outstanding at December 31, 2000 4,525,505 2.68
Terminated and cancelled (2,005,000) 3.36
Exercised (168,904) 0.28
---------- -----
Outstanding at December 31, 2001 2,351,601 $3.95
========== =====
All the outstanding warrants are exercisable at December 31, 2001 and 2000
expire at varying times through September 2003.
NOTE E. INVESTMENT IN UNCONSOLIDATED AFFILIATE
Parago Investment
In the quarter ending May 31, 1999, 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% in July 1999. In December 2001 Parago closed approximately $13.6
million of a $15 million equity financing. Approximately $1.4 million of equity
financing was closed in February 2002. As a result of this equity financing, the
Company's ownership percentage in Parago was reduced to approximately 1% of the
capital stock outstanding. Accordingly, beginning July 1999 and through December
12, 2001, the Company accounted for its investment in Parago under the equity
method of accounting. Following the December 2001 equity financing transaction
the Company accounted for its investment in Parago under the cost method of
accounting.
In May 2001, Parago obtained a Term Loan from Comerica Bank--Texas (Comerica) in
the principal amount of $8.0 million. The funds from the Term Loan were
necessary to enable Parago to continue operations, as Parago's cash resources
were depleted. Parago repaid the Term Loan with proceeds from the sale of shares
of a the Series E Stock preferred stock issued in December 2001. As a condition
to the extension of the Term Loan, Comerica required a guarantee of Parago's
obligations under the Term Loan from certain affiliates of TH Lee.Putnam
Internet Partners, L.P. (collectively, "TH Lee"), which own shares of Parago's
Series C Convertible Preferred Stock ("Series C Stock") and Series D Convertible
Preferred Stock ("Series D Stock"), common stock and certain warrants. TH Lee
executed the Guaranty in consideration of its receipt of 110,000 warrants to
purchase shares of Parago's Series A-3 Preferred Stock, convertible into
11,000,000 shares of Parago common stock, a new series of preferred stock that
was created in connection with the bridge loan and guaranty transaction, and, in
the event that TH Lee is called upon to make payment under the Guaranty, its
receipt of shares of Series A-1 Stock and Series A-2 Stock, two new series of
preferred stock the issuance of which could have the effect of substantially
diluting Parago's existing stockholders, including CT Holdings, in the event
such holders do not participate in the guaranty.
Parago securityholders (including CT Holdings) who met the required suitability
criteria were offered the opportunity to participate in the Guaranty through a
Pro Rata Participation Interest. In the event that TH Lee was required to pay
all or a portion of the Term Loan under the Guaranty, those offerees who had
participated in the offering and paid their pro rata portion of the Guaranty
when it would have been due would maintain their percentage equity ownership in
Parago, while those offerees who did not participate in the offering, and those
participants who failed to make their Guaranty payments when due, would be
substantially diluted. If offerees holding a significant portion of Parago's
current equity ownership failed to make their Guaranty payments when due, had
they become due, then TH Lee would gain a controlling interest in Parago as a
result of the transactions. CT Holdings participated in this offering. Pursuant
to the participation in the Parago bridge loan guaranty the Company was required
under the equity method of accounting to recognize equity in losses equal to its
cash participation of $692,739 and the Company's share of the guaranty of
$1,406,472 in May 2001. Following the Parago equity financing in December 2001
the $692,739 loan was repaid and the $1,406,472 loan guarantee was released.
Accordingly the adjustment to equity in losses of $2,099,211 was reversed in
December 2001.
F-16
At December 31, 2001 following a 1 for 1000 reverse stock split the Company held
20,000 shares of common stock of Parago and warrants to purchase 28.8749 shares
of Series A-3 preferred stock (convertible into 2,887 shares of common stock).
In addition after consideration of the effect of the 1 for 1000 reverse stock
split the Company holds warrants to purchase 28.87490 shares of Series A-3
Preferred Stock, convertible into 2,887.49 shares of Parago common stock, issued
in connection with the guarantee participation. The warrants expire on the
earlier of the filing of a registration statement for an initial public offering
or after January 9, 2004.
The Company has also agreed to convert shares of Parago common stock issued in
connection with a 1999 acquisition by Parago into up to 500,000 of the Company's
common shares at the option of the acquired entity's shareholders. Pursuant to
the terms of the subscription agreements between Parago and some of its
stockholders, the Company may be required at the option of such stockholders to
issue up to 414,000 shares of the Company's common stock. In consideration of
certain of its directors' funding of the Company's participation in the Parago
bridge loan, the Company has agreed to permit the directors to exchange up to
5,000,000 prereverse stock split Parago shares into up to 6,000,000 shares of
the Company's common stock.
The following is the unaudited condensed financial information of Parago at
December 31, 2001 and 2000 and for the years ended December 31, 2001 and 2000:
December 31,
------------------------------
Unaudited Summarized Balance Sheet 2001 2000
---------------------------------- ----------- -----------
Current assets $33,315,469 $29,416,701
Noncurrent assets 20,989,881 24,724,368
----------- -----------
Total assets $54,305,350 $54,141,069
=========== ===========
Current liabilities $33,300,368 $30,768,193
Long-term debt and capital
lease obligations 1,598,041 2,390,910
----------- -----------
Total liabilities 34,898,409 33,159,103
----------- -----------
Capital Stock and paid in capital 109,705,836 2,000,000
Accumulated deficit (90,303,444) 18,981,966
----------- -----------
$54,305,350 $54,141,069
=========== ===========
Unaudited Summarized Years Ended December 31,
Results of Operations 2001 2000
------------------------ ------------ -----------
Revenues $ 26,002,852 $17,075,779
Operating expenses 33,192,403 40,397,689
Loss on sale of assets -- 1,786,135
Operating loss (16,922,364) (30,416,577)
Net loss (19,897,890) (32,449,476)
F-17
River Logic Investment
In May 2000, the Company made an investment in River Logic by acquiring shares
of River Logic common stock from several existing shareholders in exchange for
333,333 shares of CT Holdings common stock. The Company also acquired shares
of River Logic Series A Convertible Preferred Stock ("Series A") in exchange for
assets acquired from a third party for 666,667 shares of CT Holdings common
stock. In addition, the Company made two bridge loans totaling $600,000 to River
Logic. The bridge loans were convertible into shares of River Logic capital
stock. The Company also incurred cash expenses for professional fees related to
these transactions and issued 50,000 shares of CT Holdings common stock to a
consultant for identifying the investment. After the closing of the transaction
the consultant became Chief Operating Officer of River Logic and was granted
100,000 fully vested stock options to purchase CT Holdings common stock at $5
per share which was above the fair market value at the date of issuance. As a
result of these transactions, the Company recorded an investment in River Logic
of approximately $2,614,000 plus notes receivable from affiliate for the
$600,000 in bridge loans.
In April 2001, River Logic issued shares of Series C Convertible Preferred Stock
("Series C") in return for a venture capital investment from the Intel 64 Fund,
Cardinal Investment, Inc. eMed Ventures and Mercury Ventures. In connection with
this investment, the Company converted $450,000 of principal in the bridge loans
into shares of Series C and received approximately $216,000 of cash from River
Logic representing the payment of the remaining bridge loan principal plus
interest.
The Company periodically evaluates the carrying value of its ownership interests
in its investee companies taking into consideration, among other factors, the
investee company's valuation following a recent infusion of capital. The Series
C preferred stock financing in April 2001 reflected a valuation below the
carrying value River Logic. Since River Logic is an early stage company, has a
history of operating losses and may require additional funding to attain
profitability the Company made an assessment of the fair value of its investment
in River Logic and determined that the carrying value of its investment had a
fair value of approximately $2,700,000 and accordingly reduced the carrying
value by $360,000.
At December 31, 2001 the Company owns approximately 12% of River Logic based on
its ownership of River Logic common stock plus its ownership of shares of Series
A and Series C preferred stock as if converted into shares of common stock.
Since the Company's ownership percentage is less than 20% the investment in
River Logic is accounted for using the cost method of accounting for investments
in common stock.
Investment in Encore (formerly PerClick)
PerClick developed and marketed billing and customer management software to
Internet telephony service providers. PerClick's strategy was to act as an ASP
or service bureau for companies in this market segment, providing turnkey
hardware and software support for its clients. PerClick supports voice over
internet protocol ("VoIP") and voice over Net ("VON") services for carriers,
telephone companies, Internet service providers and Internet telephony service
providers with products and services designed to provide comprehensive customer
management, billing and other solutions. At December 31, 2000 the Company held a
$130,000, 10% bearing convertible note with a conversion price of $1 per share.
In January 2001 the Company received notice of the acquisition of PerClick by
Vonova. Encore subsequently acquired Vonova's net assets, including the
Company's note. As part of this acquisition the Company agreed to restructure
the note into an investment in Encore with a fair value of $32,000.
NOTE F - RELATED PARTY TRANSACTIONS
During the year ended December 31, 2001 CT Holdings issued an 8% note payable to
a director for $250,000 payable April 30, 2002. In addition the CEO of the
Company advanced the Company $290,330 to fund operations.
In June 2001, two directors funded and guaranteed CT Holdings' participation in
the Parago bridge loan. In consideration for this funding and guarantees, CT
Holdings has agreed to permit the directors to exchange up to 5,000,000 pre
reverse stock split Parago shares into up to 6,000,000 shares of CT Holdings'
common stock.
From May 2000 to August 2000, the Company's Chief Executive Officer loaned
$780,000 to the Company to assist with working capital needs and provide for the
$600,000 in bridge loans to River Logic. The entire $780,000 was repaid by the
Company in August 2000.
In October 2000, the Company with approval from the board of directors loaned
$1.2 million to the Chief Executive Officer. The note receivable is callable
after April 2, 2001 and bears interest at 5% per year. The balance at December
31, 2000 is approximately $589,000, which is net of payments of approximately
$100,000 and approximately $506,000 in accrued salary and bonus due to him
pursuant to the CEO's employment agreement. The note was paid in full during
2001. Further, during the Company's evaluation and review of the non-cash
compensation strategies available to continue to provide incentives to the Chief
Executive Officer and to respond to changing equity market conditions, the
Company determined it would forgive a note receivable issued in connection with
the exercise of stock options granted to the officer in the amount of $208,934
during 2000.
The Chief Executive Officer is also a director of Parago and funded $4 million
of his personal assets to Parago to assist with its working capital needs during
the ten months ended December 31, 2000. The amounts funded were repaid in April
2001, respectively. Parago also provided the Chief Executive Officer with
approximately $6.8 million in advances in April 2000 which was repaid during the
same month.
F-18
At December 31, 2000, the Company had $1,335,522 in notes receivable that were
outstanding from current and former directors and employees which were written
off during the period ended December 31, 2000 have been fully reserved. A
majority of these notes were due during the ten months ended December 31, 2000.
The notes were issued in fiscal 1999 in connection with the exercise of stock
options granted to the directors and employees. At the time of issuance the
notes were issued with recourse, interest at 5%, and were collateralized by the
Company's common stock held by the directors and employees. During the Company's
evaluation and review of the non-cash compensation strategies available to
continue to provide incentives to these directors and employees and to respond
to changing equity market conditions, the Company determined it would forgive
all such notes receivable. Consequently, the Company recorded a provision to
write off all of the notes receivable.
During the fiscal year ended December 31, 2001 and the ten months ended December
31, 2000 CT Holdings incurred legal fees in the amount of approximately $60,000,
and $90,000 respectively to an attorney who was a former employee and is a
relative of CT Holdings' Chief Executive Officer.
Richard L. Travis, Jr., the Company's former Chief Operating Officer and Chief
Financial Officer, resigned from the Company and his employment agreement was
terminated effective as of January 14, 2000. In connection with his resignation
from the Company and the termination of his employment agreement, Mr. Travis and
the Company entered into a Settlement and Release Agreement which provides,
among other things, for the payment of an aggregate of $50,001 to Mr. Travis in
three equal monthly installments of $16,667 commencing on the last day of each
of the first three months following Mr. Travis' resignation from the Company.
The Settlement and Release Agreement also provides for Mr. Travis to perform
certain financial consulting services for the Company (as an independent
contractor) until April 14, 2000. Also, in connection with the Settlement and
Release Agreement, the Company agreed to forgive an aggregate of $295,000, plus
accrued interest, of indebtedness owed by Mr. Travis to the Company. In
addition, Parago accelerated certain of the Parago options granted to Mr.
Travis, which resulted in compensation expense of $285,000 to the Company.
Bennet S. Klein, the Company's former Vice President of Business Development,
resigned the Company and his employment agreement was terminated effective as of
March 1, 2000. In connection with his resignation, the executive and the Company
entered into a Settlement and Release Agreement which provided for the executive
to forego the remaining compensation due him under his employment agreement in
exchange for the Company's agreement to accelerate the vesting of his remaining
stock options and to pay the exercise price related to those shares. The
acceleration of vesting and forgiveness of the exercise cost resulted in
$583,392 of compensation expense based on the fair market value of the Company's
stock on the date of termination during the period ended December 31, 2010.
During the ten months ended December 31, 2000, the Company sold 2,500,000
restricted shares of its common stock to two of its directors under a private
placement for proceeds of $2,500,000.
At December 31, 2000 the Company had a $130,000 note receivable due from
PerClick that one of the Company's directors also served on the board of
directors of such entity. This note was converted into an investment in Encore
as part of Encore's acquisition of the assets of PerClick.
Parago
On January 7, 1999, the Company acquired an investment in Parago common
stock in an organizational subscription for an aggregate purchase price of
$50,000 and sharing of the Company's resources, including personnel,
administrative and financial resources. The Company continued to provide these
resources to Parago through June 30, 1999. In consideration for these resources,
the Company allocated a portion of its overhead costs related to these services
to Parago. These allocated expenses, totaling approximately $141,000, were
recognized by Parago as a contribution to equity, as the services were provided
in connection with the Company's initial equity investment.
Until March 31, 2002 the Company subleased a portion of its headquarters' office
space to Parago and remained fully obligated on such lease. Approximately,
$360,000 in the year ended December 31, 2001 and approximately $300,000 for the
ten months ended December 31, 2000 was paid directly by Parago to the Company's
lessor based upon square footage utilized by Parago. In March Citadel entered
into a sublease agreement for office space and the Company will share office
space with Citadel. Citadel will be reimbursed for the cost of this space
pursuant to a transition services agreement to be negotiated and finalized prior
to the Citadel Security Software Distribution. (See Note G) During the fiscal
year ended February 29, 2000, the Company borrowed cash from Parago to cover
short-term cash requirements. As a result, the Company issued promissory notes
to Parago for approximately $571,299 for its initial investment of $50,000 in
Parago and sharing of other cash disbursements made to assist the Company in
meeting short-term cash requirements. The promissory notes are secured by
300,000 shares of Parago common stock, are due on demand and bear interest at
five percent. The balance of the notes at December 31, 2000 is $71,299. At
December 31, 2000 the Company also owes Parago $54,729 for various resources the
equity investee provided to the Company. Both amounts were repaid during 2001.
F-19
During the ten months ended December 31, 2000, the Company provided $900,000 in
funding to Parago to cover the equity investee's working capital needs, and the
entire amount was repaid during the period ended December 31, 2000.
During the ten months ended December 31, 2000, one of the Company's directors
who is also a director of Parago funded $2 million to Parago to provide interim
working capital. All of the $2 million was repaid by December 31, 2000. Two of
the Company's directors also have approximately $52,000 of notes receivable due
to Parago in aggregate at December 31, 2000 which were repaid during 2001.
NOTE G - COMMITMENTS AND CONTINGENCIES
The Company leases office space and certain equipment under noncancellable
operating lease agreements expiring at various dates through 2002. Future
minimum lease payments under these leases at December 31, 2001 are $51,062.
There are no minimum lease commitments beyond 2002.
Rental expense totaled $13,582 and $11,629 for the year ended December 31, 2001
and ten months ended December 31, 2000, respectively. The Company's lease for
office space expired in March 2002. The Company will share space with Citadel
Security Software under a transition services agreement that will be entered
into as part of the Citadel Security Software Distribution. Subject to the
negotiation and acceptance of final terms and as a part of the transition
services agreement with Citadel it is anticipated that the Company will be
obligated to pay Citadel approximately $20,000 per month as an administrative
fee covering the costs of shared employees, office space and overhead expenses.
In August 1998, Janssen-Meyers Associates L.P. (JMA) filed a lawsuit against the
Company arising out of an alleged 1995 contract with the Company's 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 warrants to purchase 1.8 million
shares of CT Holdings common stock at an exercise price of $0.89 per share,
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 removed the case to
federal court in the Southern District of New York.
Following mediation in July 2000, the Company entered into a settlement term
sheet, to attempt to resolve the disputes between it and JMA, pursuant to which
the Company and JMA agreed in principle to settle the lawsuit for an aggregate
of $3 million, in a combination of $1.5 million in cash and 300,000 shares of
the Company's 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 was subject to execution of definitive settlement
documents and approval of the boards of directors of both parties. As a result,
the Company recorded approximately $1,912,500 ($1.5 million in cash and 300,000
shares of the Company's Common Stock at the market price of $1.375 per share) as
a nonrecurring charge related to the settlement of the litigation in the ten
months ended December 31, 2000.
However, the Company and JMA were unable to negotiate the final definitive
settlement agreement. The case was dismissed in August 2000 without any
resolution of this issue. On March 27, 2001, JMA attempted to reopen this
matter, but the Court hearing the JMA lawsuit issued a Summary Order denying
JMA's motion to enforce the settlement term sheet and confirmed the prior
dismissal of the lawsuit. The Court further ruled that JMA would either have to
bring an action on the proposed settlement or move to re-open the dismissed
case. The Court stated that it did not express any view with respect to the
merits of the settlement that brought about the dismissal of the case. There was
no activity on the case from March 2001 through August 2001. On August 27, 2001
JMA refiled its lawsuit with a federal court in New York, and the Company filed
its motion to dismiss the case because the plaintiffs lacked the required
diversity jurisdiction to pursue the claims in federal court. On October 31,
2001 the case was dismissed in federal court. In December 2001, the plaintiffs
refiled the lawsuit in the state court seeking to enforce the proposed
settlement term sheet. The case was filed in Supreme Court of New York, that
state's trial court, in a case styled Roan Meyers v. CT Holdings. Given these
events, including the dismissal of the lawsuit and the failure of the plaintiffs
to refile a lawsuit for more than one year after the date of the dismissal, the
Company, in the year ended December 31, 2001, reversed the nonrecurring charge
that the Company had previously recorded related to the settlement of the
lawsuit.
In June 2000, CT Holdings 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 warrants during a time when CT Holdings'
related registration statement could not be used and asserted damages between
$300,000 and $1,500,000. CT Holdings believes that the claims asserted by the
Fergusons are without merit and will vigorously defend the claims. The case is
set for trial on April 22, 2002.
In June 2000, Tech Data Corporation filed suit against CT Holdings, alleging a
breach of a Software Distribution Agreement ("the Agreement") with CT Holdings.
The lawsuit is styled Tech Data Corporation v. Citadel Technology, Inc. (now
known as CT Holdings), and was filed in Dallas County Court at Law No. 2.
Because CT Holdings was not properly served, Tech Data obtained a default
judgment for $101,049. When CT Holdings discovered the default judgment, it
filed and won a motion to set aside this judgment. In June 2001, Tech Data
properly served CT Holdings. CT Holdings answered and demanded binding
arbitration pursuant to the agreement. The parties filed a Joint Motion to
Arbitrate in December 2001. The judge granted this motion, and CT Holdings
expects that this matter will be referred to binding arbitration in the second
quarter of 2002. The Company has recorded a liability of $101,049 at December
31, 2001 and 2000 related to this lawsuit. As part of the Distribution, the
Company anticipates that Citadel will assume responsibility for this lawsuit,
although there can be no assurance that we will be released from the lawsuit.
Although there can be no assurance that the Company will be released from the
lawsuit.
F-20
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, however the Company does not
believe the outcome of such litigation will be material to the Company's
financial condition or results of operations.
The Company may become involved from time to time in litigation on various
matters which are routine in conducting its business. The Company believes that
none of these actions, individually or in the aggregate, will have a material
adverse effect on its financial position or results of operations, though any
adverse decision in these cases or the costs of defending or settling such
claims could have a material adverse effect on the Company's operations.
F-21
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
2.1 Second Amended and Restated Plan of Merger, dated February 29, 1996,
by and between LoneStar Hospitality Corporation, LSHC Acquisition,
Inc. and Citadel Computer Systems Incorporated (without exhibits)
(incorporated by reference to Exhibit 2.1 of the Company's Current
Report on Form 8-K dated February 29, 1996).
2.2 Purchase and Sale Agreement, dated March 1, 1996, by and between the
LoneStar Hospitality Corporation, LS Holding Corp. and Miami Subs USA,
Inc. (without exhibits) (incorporated by reference to Exhibit 2.2 of
the Company's Current Report on Form 8-K dated February 29, 1996).
2.3 Technology Transfer Agreement, by and between LoneStar Hospitality
Corporation and Circuit Masters Software, Inc., dated February 29,
1996 (without exhibits) (incorporated by reference to Exhibit 2.3 of
the Company's Current Report on Form 8-K dated February 29, 1996).
2.4 Technology Transfer Agreement, by and between the Company and Bill
Mulvany, dated February 29, 1996 (without exhibits) (incorporated by
reference to Exhibit 2.4 of the Company's Current Report on Form 8-K
dated February 29, 1996).
2.5 Technology Transfer Agreement, by and between the Company and Kim
Marie Newman, dated February 29, 1996 (without exhibits) (incorporated
by reference to Exhibit 2.5 of the Company's Current Report on Form
8-K dated February 29, 1996).
2.6 Agreement, by and between the Company, Circuit Masters Software, Inc.,
Patrick William Mulvany and Kim Marie Newman, dated May 16, 1996,
effective as of February 29, 1996 (incorporated by reference to
Exhibit 2.6 of the Current Report on Form 8-K/A filed with the
Securities and Exchange Commission on June 10, 1996).
3.1 Certificate of Incorporation (incorporated by reference to the
registration statement on Form S-1, File No. 33-25462, for Apollo
Resources, Inc., on November 10, 1988, and declared effective January
4, 1989).
3.3 Certificate of Amendment to Certificate of Incorporation filed with
the Delaware Secretary of State on June 4, 1990 (incorporated by
reference to Exhibit 3.2 of the Company's Annual Report on Form 10-KSB
for the fiscal year ended February 29, 1996).
3.3 Bylaws (incorporated by reference to the registration statement on
Form S-1, File No. 33-25462, filed with the Securities and Exchange
Commission on November 10, 1988).
3.4 Certificate of Amendment to Certificate of Incorporation filed with
the Delaware Secretary of State on October 15, 1991 (incorporated by
reference to the Company's Annual Report on Form 10-KSB for the year
ended December 31, 1991).
3.5 Certificate of Amendment to Certificate of Incorporation filed with
the Delaware Secretary of State on July 20, 1994 (incorporated by
reference to the Company's Quarterly Report on Form 10-QSB for the
quarter ended June 30, 1994).
3.6 Certificate of Amendment to Certificate of Incorporation filed with
the Delaware Secretary of State on December 11, 1995 (incorporated by
reference to the Company's Quarterly Report on Form 10-QSB for the
quarter ended December 31, 1995).
3.7 Certificate of Amendment to Certificate of Incorporation filed with
the Delaware Secretary of State on May 1, 1996 (incorporated by
reference to Exhibit 3.7 of the Company's Annual Report on Form 10-KSB
for the fiscal year ended February 29, 1996).
3.8 Certificate of Designations of Series A Preferred Stock. (incorporated
by reference to Exhibit 4 of the Company's Quarterly Report on Form
10-QSB for the fiscal quarter ended May 31, 1996).
3.9 Certificate of Designations of Series B Preferred Stock (incorporated
by reference to Exhibit 4.2 of the Company's Quarterly Report on Form
10-QSB for the fiscal quarter ended August 31, 1996).
3.10 Certificate of Amendment to Certificate of Incorporation filed with
the Delaware Secretary of State on February 27, 1998 (incorporated by
reference to Exhibit 4.2 of the Company's registration statement on
Form S-8 filed May 20, 1998, File No. 333-53131).
3.11 Certificate of Designations of Series C Preferred Stock (incorporated
by reference to Exhibit 4.6 of the Company's registration statement on
Form S-8 filed May 20, 1998, File No. 333-53131).
3.12 Certificate of Designations of Series D Preferred Stock (incorporated
by reference to Exhibit 4.8 of the Company's registration statement on
Form S-8 filed May 20, 1998, File No. 333-53131).
3.13 Certificate of Designations of Series E Preferred Stock (incorporated
by reference to Exhibit 4.7 of the Company's registration statement on
Form S-8 filed May 20, 1998, File No. 333-53131).
3.14 Certificate for Renewal and Revival of Charter filed with the Delaware
Secretary of State on October 29, 1999. (incorporated by reference to
Exhibit 3.14 to the Company's Annual Report on Form 10-KSB for the
fiscal year ended February 29, 2000).
10.1 Employment Agreement dated July 15, 1997, by and between the Company
and Steven Solomon (incorporated by reference to Exhibit 10.1 to the
Company's Annual Report on Form 10-KSB for the fiscal year ended
February 28, 1998).
10.2 Stock Purchase Agreement, dated August 16, 1996, among the Company,
Kent- Marsh Ltd., Inc., Bob Wesolek and Vance Nesbitt. (incorporated
by reference to Exhibit 2.1 of the Company's Current Report on Form
8-K filed September 3, 1996).
10.3 Stock Purchase Agreement, dated August 16, 1996, among the Company,
Astonishing Developments, Inc., Bob Wesolek and Vance Nesbitt
(incorporated by reference to Exhibit 2.2 of the Company's Current
Report
on Form 8-K filed September 3, 1996).
10.4 Agreement, dated April 11, 1997, among the Company, George Sharp and
Gil Gertner (incorporated by reference to Exhibit 99.1 of the
Company's Current Report on Form 8-K filed April 11, 1997).
10.5 Form of Offshore Securities Subscription Agreement, Convertible Notes,
Warrants and Registration Rights Agreement between the Company and
First Bermuda Securities Limited (incorporated by reference to
Exhibits 99.1 through 99.4 of the Company's Current Report on Form 8-K
filed March 26, 1997).
10.6 Form of Offshore Securities Subscription Agreement, Convertible Notes,
Warrants and Registration Rights Agreement between the Company and
Willora Company Ltd. (incorporated by reference to Exhibits 99.1
through 99.4 of the Company's Current Report on Form 8-K filed April
28, 1997).
10.7 Form of Offshore Securities Subscription Agreement, Convertible Notes,
Warrants and Registration Rights Agreement between the Company and
Silenus Ltd. (incorporated by reference to Exhibits 99.1 through 99.4
of the Company's Current Report on Form 8-K filed June 24, 1997).
10.8 Purchase Agreement between the Company and CORESTAFF, Inc., dated
October 6, 1997 (incorporated by reference to Exhibit 10.10 to the
Company's Annual Report on Form 10-KSB for the fiscal year ended
February 28, 1997).
10.9 Warrant to Purchase Common Stock of the Company issued to Worldwide
PetroMoly Inc. (incorporated by reference to Exhibit 10.11 to the
Company's Annual Report on Form 10-KSB for the fiscal year ended
February 28, 1997).
10.10 Series D Preferred Stock Purchase Agreement between the Company and
METAMOR WORLDWIDE, Inc., dated May 15, 1998 (incorporated by reference
to Exhibit 10.12 to the Company's Annual Report on Form 10-KSB for the
fiscal year ended February 28, 1998).
10.11 Stock Purchase Agreement between the Company and Precision Capital
Limited Partnership I, dated April 30, 1998 (incorporated by reference
to Exhibit 10.13 to the Company's Annual Report on Form 10-KSB for the
fiscal year ended February 28, 1998).
10.12 Stock Purchase Agreement between the Company and Icarus Investments I,
Ltd., dated May 27, 1998 (incorporated by reference to Exhibit 10.14
to the Company's Annual Report on Form 10-KSB for the fiscal year
ended February 28, 1998).
10.13 Stock Purchase Agreement, dated March 11, 1999, among inLighten.com,
Inc., 2-Lane Media, Inc., and the shareholders of 2-Lane Media,
Inc.(incorporated by reference to Exhibit 10.15 to the Company's
Annual Report on Form 10-KSB for the fiscal year ended February 28,
1999).
10.14 Stock Purchase Agreement, dated May 20, 1999, among inLighten.com,
Inc., Forward Communications, Inc., FCI Services Inc., and the
shareholders of Forward Communications, Inc. and FCI Services Inc.
(incorporated by reference to Exhibit 2.1 to the Company's Current
Report on Form 8-K filed June 3, 1999).
10.15 Agreement and Plan of Reorganization, dated May 20, 1999, among
inLighten.com, Inc., Forward Freight, Inc., and the shareholders of
Forward Freight Inc. (incorporated by reference to Exhibit 2.1 to the
Company's Current Report on Form 8-K filed June 3, 1999).
10.16 Settlement and Release Agreement dated January 14, 2000 by and among
Richard L. Travis, How2.com, Inc. and the Company (incorporated by
reference to Exhibit 10.18 to Post-Effective Amendment No. 1 to the
Company's Registration Statement on Form SB-2 filed March 23, 2000).
10.17 Settlement and Release Agreement dated March 1, 2000 by and among
Bennett Klein and the Company (incorporated by reference to Exhibit
10.19 to Post-Effective Amendment No. 1 to the Company's Registration
Statement on Form SB-2 filed March 23, 2000).
10.18 Standard Office Lease, dated August 2, 1999, between Arden Realty
Limited Partnership and How2HQ.com, Inc. (Santa Monica, California).
(incorporated by reference to Exhibit 10.18 to the Company's Annual
Report on Form 10-KSB for the fiscal year ended February 29, 2000).
10.19 Guaranty of Lease, dated August 2, 1999, by the Company to Arden
Realty Limited Partnership, with respect to certain obligations of
How2HQ.com, Inc. under Standard Office Lease. (incorporated by
reference to Exhibit 10.19 to the Company's Annual Report on Form
10-KSB for the fiscal year ended February 29, 2000).
10.20 Promissory Note dated September 30, 1999 payable to How2HQ.com, Inc.
(incorporated by reference to Exhibit 10.20 to the Company's Annual
Report on Form 10-KSB for the fiscal year ended February 29, 2000).
10.21 Asset Purchase Agreement dated as of May 5, 2000 by and between EBSCO
CASIAS, Inc., iNetze.com, Inc., ESRN Acquisition, LLC and the Company
(incorporated by reference to Exhibit 2.1 to the Company's Current
Report on Form 8-K filed June 12, 2000).
10.22 Asset Contribution Agreement dated as of May 5, 2000 by and between
iNetze.com, Inc., ESRN Acquisition, LLC, the Company and the
stockholders set forth on the signature pages attached hereto
(incorporated by reference to Exhibit 2.2 to the Company's Current
Report on Form 8-K filed June 12, 2000).
10.23 Stock Purchase Agreement dated as of May 5, 2000 by and between the
Company, Tim Collins, F. Shanahan McAdoo and Robert C. Whitehair
(incorporated by reference to Exhibit 2.3 to the Company's Current
Report on Form 8-K filed June 12, 2000).
10.24* Form of Plan and Agreement of Distribution between the Company and
Citadel Security Software Inc.
10.25* Form of Tax Disaffiliation Agreement between the Company and Citadel
Security Software Inc.
10.26* Form of Transition Services Agreement between the Company and Citadel
Security Software Inc.
21 Subsidiaries of the Company (incorporated by reference to Exhibit 21
to the Company's Annual Report on Form 10-KSB for the fiscal year
ended February 29, 2000).
*23.1 Consent of King Griffin Adamson P.C.