As summarized by the Company’s FORM 10-K For The Fiscal Year Ended December 31, 2006, in September 2006, the parties in the securities and derivative suits applied for a Preliminary Order (“Preliminary Order”) approving settlement of all of these suits and the fairness of the terms and conditions of the settlement. The hearing was held on December 15, 2006 and the Preliminary Order was approved by the court. Liabilities under this settlement were fully covered under the Company's insurance policies.
According to a press release dated October 16, 2006, pursuant to Court Order, hearings will be held regarding proposed settlements (the "Settlements") in the cases Ruth Lentz v. Citadel Security Software, Inc., et al., Civil Action No. 3-05-CV-0100-D (the "Class Action"), and Hans J. Baier v. Steven B. Solomon, et al., Civil Action No. 3:05-CV-0846-D (the "Derivative Action"), both docketed in the United States District Court for the Northern District of Texas.
The hearing on whether to approve the Settlement in the Class Action will be held before the Honorable Sidney A. Fitzwater, United States District Judge, at Courtroom 1516 of the United States Courthouse, United States District Court, Northern District of Texas, Dallas Division, 1100 Commerce Street, Dallas, Texas, on December 15, 2006 at 11: 00 a.m. The purpose of the Settlement of the Class Action is to settle the claims asserted on behalf of the Class against the Company in exchange for a settlement amount to be distributed to Class members. At this hearing, the Court will determine: (1) whether the terms of the Settlement described in the Stipulation of Settlement ("Stipulation") dated September 19, 2006 and filed with the Court, which among other things, provides for creation of a Settlement Fund in the amount of $1,750,000, should be approved as fair, just, reasonable and adequate; (2) whether the proposed plan to distribute the Settlement Fund to the Class ("Plan of Allocation") is fair, just, reasonable and adequate; (3) whether the Class Action should be dismissed with prejudice as set forth in the Stipulation; and (4) whether the application of Plaintiffs' counsel in the Class Action for an award of attorneys' fees and expenses should be approved, a portion of which will be used to compensate Plaintiffs' counsel in the Derivative Action.
The hearing for the Settlement in the Derivative Action will be held before the Honorable Sidney A. Fitzwater, United States District Judge, at Courtroom 1516 of the United States Courthouse, United States District Court, Northern District of Texas, Dallas Division, 1100 Commerce Street, Dallas, Texas, on December 15, 2006 at 11:00 a.m. The purpose of the Settlement of the Derivative Action (which is an action brought on behalf of the Company, rather than on behalf of shareholders) is to provide a benefit to the Company, rather than provide a direct benefit to stockholders. At this hearing the Court will determine whether the settlement of the Derivative Action, whereby the case will be dismissed with prejudice as set forth in the Stipulation, is in the best interests of the Company, given the substantial benefit to the Company that will be received as a result of the dismissal of the Derivative Action in light of the harm that the Company would suffer as a result of continued litigation. Derivative actions do not provide common stock holders with direct monetary compensation as a result of the Settlement of the Derivative Action.
The original complaint charges Citadel Security, with violations of the Securities Exchange Act of 1934. Citadel Security Software Inc. develops and markets computer security and privacy software. Its information technology ("IT") security computer software products include security and management solutions for networks and personal workstations designed to secure and manage personal computers and local area networks. According to the complaint, the Company failed to disclose and misrepresented the following material adverse facts which were known to defendants or recklessly disregarded by them: (1) that customer demand in the commercial portion of the Company's business was slowing; (2) that the much touted, sizable pipeline of potential contracts failed to materialize due to poor management execution; (3) that as a consequence of the above the Company's growth was lagging; and (4) therefore, the defendants' statements about the Company were lacking in any reasonable basis when made. Additionally, the complaint alleges that during the Class Period, defendants sold a total of 754,500 shares for proceeds totaling more than $3 million.
In addition, on or about December 17, 2004, Citadel Security provided a financial update for its year-ended December 31, 2004. More specifically, the Company stated that based upon preliminary estimates, Citadel now expects its revenue for the full year 2004 to be between $15.2 million and $16.0 million, compared to previous guidance of full-year revenue of $18.5 million to $21 million. As a result, the Company will not meet its previously released net income guidance for the second half of 2004 which was for net income of $1.0 million to $2.0 million. The Company expects to end 2004 with approximately $4.9 million of deferred revenues, most of which will be earned in 2005.
News of this shocked the market. Shares of Citadel Security fell $1.80 per share, or 41.96 percent, to close at $2.49 per share on unusually high trading volume.