UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the Quarterly Period Ended June 30, 2005
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the Transition Period from _________ to _________
Commission file number: 000-15066
CAPE SYSTEMS GROUP, INC.
(Exact name of registrant as specified on its charter)
New Jersey 22-2050350
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
3619 Kennedy Road
South Plainfield, New Jersey 07080
(Address of principle executive offices)
(908) 756-2000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has 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 that 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 |_|
Common stock, par value $.005 per share: 88,686,066 shares outstanding as of
August 15, 2005.
Preferred stock, Series "A", par value $.01 per share: 1,356,852 shares
outstanding as of August 15, 2005.
Preferred stock, Series "B", par value $.01 per share: 1,000 shares outstanding
as of August 15, 2005.
Preferred stock, Series "C-1", par value $.01 per share: 997 shares outstanding
as of August 15, 2005.
Preferred stock, Series "D", par value $.01 per share: 7,615 shares outstanding
as of August 15, 2005.
INDEX
PART I FINANCIAL INFORMATION
ITEM 1 Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of
June 30, 2005 (Unaudited) and September 30, 2004 3-4
Condensed Consolidated Statements of Operations for
the three and nine months Ended June 30, 2005 and
2004 (Unaudited) 5
Condensed Consolidated Statement of Changes in
Stockholders' Deficiency for the nine months ended
June 30, 2005 (Unaudited) 6-7
Condensed Consolidated Statements of Cash Flows for
the nine months ended June 30, 2005 and 2004 (Unaudited) 8
Notes to Condensed Consolidated Financial Statements
(Unaudited) 9-23
ITEM 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 24-29
ITEM 3 Controls and Procedures 30
PART II OTHER INFORMATION
ITEM 1 Legal proceedings 31
ITEM 2 Unregistered sales of equity securities and use of
proceeds 31-32
ITEM 3 Defaults upon senior securities 32
ITEM 4 Submission of matters to a vote of security holders 32
ITEM 5 Other information 33
ITEM 6 Exhibits 34
SIGNATURES 35
2
PART 1 - FINANCIAL INFORMATION
ITEM 1 - CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, 2005 (Unaudited) and September 30, 2004
ASSETS
June 30, 2005 September 30, 2004
(Unaudited) (See Note 1)
--------------- ---------------
CURRENT ASSETS:
Cash $ 184,397 $ 101,390
Restricted Cash - short-term -- 300,000
Accounts receivable, less
allowance for doubtful accounts of $456,358 715,799 350,935
Inventories, net of valuation allowance 269,326 368,086
Prepaid expenses and other current assets 158,290 71,696
Assets associated with subsidiaries in liquidation 1,983,350 2,033,970
--------------- ---------------
Total current assets 3,311,162 3,226,077
Equipment and improvements, net of
accumulated depreciation and
amortization of $1,374,673 and $1,359,090 45,391 33,748
Restricted cash - long-term -- 150,000
Deferred financing costs,
net of accumulated amortization of
$189,354 and $54,189 125,761 260,926
Goodwill 350,000 --
Other intangible assets, net of accumulated
amortization of $241,425 1,304,982 --
Other assets 204,407 111,273
--------------- ---------------
Total assets $ 5,341,703 $ 3,782,024
=============== ===============
See notes to unaudited condensed consolidated financial statements.
3
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, 2005 (Unaudited) and September 30, 2004
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
June 30, 2005 September 30, 2004
(Unaudited) (See Note 1)
--------------- ---------------
CURRENT LIABILITIES:
Notes payable - unrelated parties $ 1,227,500 $ 1,227,500
Mandatory redeemable Series D preferred stock -
504 shares at redemption value 504,713 504,713
Accounts payable 4,172,181 3,653,751
Liabilities associated with subsidiaries
in liquidation 9,505,577 9,748,753
Payroll and related benefits accrual 1,675,811 1,994,852
Litigation related accruals 3,655,323 3,655,323
Other accrued expenses and liabilities 3,676,893 3,749,685
Deferred revenue 575,377 354,203
Convertible notes payable -
unrelated parties, net of
unamortized debt discount 4,159,926 2,549,724
--------------- ---------------
Total liabilities 29,153,301 27,438,504
--------------- ---------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' DEFICIENCY:
Series A preferred stock, par value
$.01 per share; 2,000,000 shares authorized,
1,356,852 shares issued and outstanding
($10,000,000 aggregate liquidation preference) 13,569 13,569
Series B preferred stock, par value $0.01 per
share; 1,000 shares authorized, 1,000 shares
issued and outstanding($1,000,000 aggregate
liquidation preference) 10 10
Series C-1 preferred stock, par value $0.01 per
share; 10,000 shares authorized, 997 shares
issued and outstanding ($997,000 aggregate
liquidation preference) 10 10
Series D preferred stock, par value $0.01 per
share; 10,000 shares authorized, 7,111 shares
issued and outstanding (excluding 504 shares
subject to mandatory redemption)($7,109,995
aggregate liquidated preference) 71 71
Common stock, par value $.005 per share;
1,000,000,000 shares authorized; 84,237,478
and 56,116,342 shares issued; 84,149,766
and 56,028,630 shares outstanding 421,188 280,583
Additional paid-in capital 167,655,427 164,442,227
Subscription receivable (74,000) --
Accumulated deficit (190,148,534) (186,517,047)
Accumulated other comprehensive loss (1,612,099) (1,808,663)
Less: Treasury stock, 87,712 shares of
common stock (at cost) (67,240) (67,240)
--------------- ---------------
Total stockholders' deficiency (23,811,598) (23,656,480)
--------------- ---------------
Total liabilities and stockholders' deficiency $ 5,341,703 $ 3,782,024
=============== ===============
See notes to unaudited condensed consolidated financial statements.
4
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
For the Three Months For the Nine Months
Ended June 30, Ended June 30,
-------------------------- --------------------------
2005 2004 2005 2004
----------- ---------- ----------- ----------
REVENUES $ 681,705 $ 706,208 $ 2,696,270 $2,056,294
COST OF SALES 411,719 339,110 1,308,152 1,114,825
----------- ---------- ----------- ----------
GROSS PROFIT 269,986 367,098 1,388,118 941,469
----------- ---------- ----------- ----------
OPERATING EXPENSES:
Selling and administrative 1,142,482 520,077 3,116,215 1,623,726
Depreciation and
amortization of intangibles 134,718 35,383 257,008 118,463
----------- ---------- ----------- ----------
Total operating expenses 1,277,200 555,460 3,373,223 1,742,189
----------- ---------- ----------- ----------
OPERATING LOSS (1,007,214) (188,362) (1,985,105) (800,720)
----------- ---------- ----------- ----------
OTHER INCOME (EXPENSE):
Interest expense (includes
beneficial conversion
charge of $1,428,375 in
2005) (347,655) (266,381) (2,285,221) (780,687)
Gain on settlements of
liabilities 1,556 1,042,939 168,813 1,042,939
Gain on liquidation of
foreign subsidiaries -- -- 320,951
Other 90 268 13,163 (38,858)
----------- ---------- ----------- ----------
Net other income (expense) (346,009) 776,826 (2,103,245) 544,345
----------- ---------- ----------- ----------
INCOME (LOSS) BEFORE
CREDIT FOR INCOME TAXES (1,353,223) 588,464 (4,088,350) (256,375)
----------- ---------- ----------- ----------
Credit for sale of state tax
benefits -- -- (456,863) --
----------- ---------- ----------- ----------
Net Income (loss) $(1,353,223) $ 588,464 $(3,631,487) $(256,375)
=========== ========== =========== ==========
Net loss per share of common
stock:
Basic ($.02) $.01 ($.05) ($.01)
Diluted ($.02) $.01 ($.05) ($.01)
Weighted Average number of
shares outstanding:
Basic 79,811,693 48,201,978 73,656,191 48,201,978
Diluted 79,811,693 60,147,292 73,656,191 48,201,978
See notes to unaudited condensed consolidated financial statements.
5
CAPE SYSTEMS GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' DEFICIENCY
FOR THE NINE MONTHS ENDED JUNE 30, 2005
(UNAUDITED)
Preferred Stock Common Stock Additional
--------------------------- --------------------------- Paid-In
Shares Amount Shares Amount Capital
------------ ------------ ------------ ------------ -----------
Balance September 30, 2004 1,365,960 $ 13,660 56,116,342 $ 280,583 $ 164,442,227
Conversion of notes payable -
unrelated parties into
common stock 11,245,615 56,228 256,870
Common stock issued for accrued
401(k) plan contribution and
other liabilities 6,748,574 33,742 385,106
Common stock issued in
exchange for services 8,876,947 44,385 781,599
Beneficial conversion feature
related to long-term convertible debt 1,428,375
Common stock issued related to
subscription agreement 1,250,000 6,250 93,750
Effects of issuance of warrants
with notes payable - unrelated parties 129,500
Stock options issued in exchange
for services 138,000
Net loss
Change in unrealized foreign
exchange translation gains/
(losses) (a)
------------ ------------ ------------ ----------- ------------
Balance June 30, 2005 1,365,960 $ 13,660 84,237,478 $ 421,188 $167,655,427
============ ============ ============ =========== ============
(a) Comprehensive income/(loss) for the three and nine months ended June 30,
2005 totaled $(817,680) and $(3,434,923) and totaled $(659,126) and $515,553
for the three and nine months ended June 30, 2004.
See notes to unaudited condensed consolidated financial statements.
6
CAPE SYSTEMS GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' DEFICIENCY
FOR THE NINE MONTHS ENDED JUNE 30, 2005
(UNAUDITED)
(CONTINUED)
Accumulated
Other
Subscription Accumulated Comprehensive Treasury
Receivable Deficit Loss Stock Total
------------ ------------- ------------- ----------- -------------
Balance September 30, 2004 -- $(186,517,047) $ (1,808,663) $ (67,240) $(23,656,480)
Conversion of notes payable -
unrelated parties into
common stock 313,098
Common stock issued for accrued
401(k) Plan contribution
and other liabilities 418,848
Common stock issued in exchange
for services 825,984
Beneficial conversion feature
related to additional long-term
convertible debt 1,428,375
Common stock issued related to
subscription agreement (74,000) 26,000
Effects of issuance of warrants
with notes payable - unrelated
parties 129,500
Stock options issued in exchange
for services 138,000
Net loss (3,631,487) (3,631,487)
Change in unrealized foreign
exchange translation gains 196.564 196,564
------------ ------------- ------------- ----------- -------------
Balance June 30, 2005 $ (74,000) $(190,148,534) $ (1,612,099) $ (67,240) $ (23,811,598)
============ ============= ============= =========== =============
See notes to unaudited condensed consolidated financial statements.
7
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Nine Months Ended
June 30,
--------------------------
2005 2004
---------- ----------
Cash Flows from Operating Activities:
Net loss ($3,631,487) ($256,375)
Adjustments to reconcile net loss to
net cash provided by (used in) operating activities:
Depreciation and amortization 257,008 118,463
Common stock issued in exchange for services 825,984 --
Amortization of deferred financing costs and
debt discount 337,965 --
Variable stock option charge 41,400 --
Charges to interest expense for warrants
issued with note payable - related parties -- 80,250
Charges to interest expense for beneficial
conversion features of notes payable - unrelated
parties 1,428,375 --
Gain on liquidation of foreign subsidiaries: -- (320,951)
Gain on settlement of liabilities -- (1,042,939)
Changes in operating assets and liabilities:
net of effects of acquisitions
Restricted cash -- (418,750)
Accounts receivable (150,102) 440,983
Inventory 134,246 123,106
Prepaid expenses and other current assets 56,510 (2,818)
Other assets and restricted cash 358,378 19,732
Accounts payable 493,838 59,833
Accrued expenses and other liabilities (18,106) (501,035)
Deferred revenue 62,933 81,008
---------- ----------
Net cash provided by (used in) operating activities 196,942 (1,619,493)
---------- ----------
Cash Flows from Investing Activities:
Acquisition of businesses - net of cash acquired (1,989,935) --
---------- ----------
Cash Flows from Financing Activities:
Proceeds from notes and convertible notes payable:
Related parties -- 137,339
Unrelated parties 1,850,000 2,250,000
Repayment of notes payable - unrelated parties -- (391,735)
Deferred financing -- (236,722)
Cash received from sale of common stock 26,000 --
---------- ----------
Net cash provided by Financing Activities 1,876,000 1,758,882
---------- ----------
Net increase in cash 83,007 139,389
Cash at beginning of period 101,390 25,265
---------- -----------
Cash at end of period $ 184,397 $ 164,654
========== ===========
Noncash investing and financing activities:
Long-term convertible notes payable -
unrelated parties converted into common stock $ 313,098
Common stock issued for payment of liabilities $ 418,848
Stock options issued for services $ 138,000
See notes to unaudited condensed consolidated financial statements.
8
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. NATURE OF BUSINESS AND BASIS OF PRESENTATION
Background and Description of Business
CAPE SYSTEMS GROUP, Inc. ("Cape" or "Vertex" or "we" or "our" or the "Company")
is a provider of supply chain management technologies, including enterprise
software systems and applications, radio frequency identification systems, and
software integration solutions, that enable our customers to manage their order,
inventory and warehouse management needs, consultative services, and software
and hardware service and maintenance. We serve our clients through two general
product and service lines: (1) enterprise solutions; and (2) service and
maintenance for our products and services, including service and maintenance of
software and hardware we resell for third parties. Our enterprise solutions
include a suite of Java-architected software applications, applications devoted
to the AS/400 customer base, as well as a portfolio of "light-directed" systems
for inventory, warehouse and distribution center management. We provide a full
range of software and hardware services and maintenance on a 24-hour, 7-days a
week, 365-days a year basis, including the provision of wireless and wired
planning and implementation services for our customers' facilities.
In connection with an acquisition described below, we changed our name on April
8, 2005 from Vertex Interactive, Inc. to Cape Systems Group, Inc. We also
increased the number of authorized shares of common stock, par value $.005 per
share, of the Company from 400,000,000 shares to 1,000,000,000 shares.
In August 2002, Cape formed XeQute Solutions, Inc. ("XeQute"), a Delaware
corporation, which is an indirect, wholly-owned subsidiary. XeQute purchased
most of the operating assets and assumed certain liabilities of both Vertex and
its principal North American subsidiaries and became the principal operating
entity of the group effective October 1, 2002. These assets comprise
substantially all of the enterprise software businesses of Vertex. XeQute is a
wholly-owned subsidiary of XeQute Solutions PLC ("XeQute PLC") which is a
holding company that is a direct, wholly-owned subsidiary of Vertex.
The Company's securities received approval to return to the NASDAQ bulletin
board for trading as of March 31, 2004. From February 17, 2003 to March 30,
2004, the Company's securities were quoted on the Pink Sheets, under the symbol
"VETXE".
Going Concern Matters
Based upon our substantial working capital deficiency ($25,842,000) and
stockholders' deficiency ($23,812,000) at June 30, 2005, our recurring losses,
our historic rate of cash consumption, the uncertainty arising from our default
on one of our notes payable, the uncertainty of our liquidity-related
initiatives described in detail below, and the reasonable possibility of
on-going negative impacts on our operations from the overall economic
environment for a further unknown period of time, there is substantial doubt as
to our ability to continue as a going concern.
The successful implementation of our business plan has required, and our ability
to continue as a going concern will require on a going forward basis, the
Company to raise substantial funds to finance (i) continuing operations, (ii)
the further development of our enterprise software technologies, (iii) the
settlement of existing liabilities including past due payroll obligations to our
employees, officers and directors, and our obligations under existing or
possible litigation settlements, (iv) possible selective acquisitions to achieve
the scale we believe will be necessary to enable us to remain competitive in the
global SCM industry and (v) the integration of the recently completed
acquisition of Cape Systems (as hereinafter defined). There can be no assurance
that we will be successful in raising the necessary funds or integrate the
recently completed acquisition.
9
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Outlook:
We had current obligations at June 30, 2005 accumulated during the past several
years that substantially exceeded our current assets and, to the extent we
cannot settle existing obligations in stock or defer payment of our obligations
until we generate sufficient operating cash, we will require significant
additional funds to meet accrued non-operating obligations, to fund operating
losses, if required, short-term debt and related interest, capital expenditures
and expenses related to cost-reduction initiatives, and to pay liabilities that
could arise from litigation claims and judgments.
Our sources of ongoing liquidity include the cash flows from our operations,
potential new credit facilities and potential additional equity investments.
Consequently, the Company continues to aggressively pursue obtaining additional
debt and equity financing, the restructuring of certain existing debt
obligations, and the reduction of its operating expenses. In addition, it has
structured its overall operations and resources around high margin enterprise
products and services. However, in order to remain in business, the Company must
raise additional cash in a timely fashion.
Initiatives Completed or in Process:
The following initiatives related to raising required funds, settling
liabilities and/or reducing expenses have been completed or are in process:
(i) The Company completed the sale of certain entities and assets during fiscal
2002. After being unsuccessful in attempting to sell its five remaining European
operations (Vertex UK, Vertex Service and Maintenance Italy, Vertex Italy,
Euronet and Vertex France), and based on the continuing cash drain from these
operations, during fiscal 2002 the respective boards of directors determined
that in the best interest of their shareholders that they would seek the
protection of the respective courts in each country, which have agreed to an
orderly liquidation of these companies for the benefit of their respective
creditors. During the year ended September 30, 2004, we recognized a noncash
gain of $321,000 from the approval by creditors of the liquidation of the net
liabilities of the Company's U.K. subsidiary. Upon legal resolution of the
approximately $7,522,000 of net liabilities of these remaining European entities
as of June 30, 2005, we expect to recognize a non-cash gain (and no significant
cash outlay), however the amount and timing of such gain and cash outlay, if
any, is totally dependent upon the decisions to be issued by the respective
court appointed liquidators.
(ii) The Company is negotiating with vendors to settle balances at substantial
discounts. In addition, the Company is negotiating to settle certain notes
payable and approximately $3,700,000 of litigation accruals at a discount or
with the issuance of shares of Cape.
(iii) During the nine months ended June 30, 2005, we realized net gains of
approximately $168,800 from settlements of liabilities totaling $520,800 through
the payments of approximately $352,000 in cash.
(iv) During the nine months ended June 30, 2005 convertible notes payable to
unrelated parties in the principal amount of $313,098 were converted into
11,245,615 shares of common stock.
(v) On January 11, 2005, we entered into a Securities Purchase Agreement and
sold (i) $1,850,000 in secured convertible notes and (ii) warrants to purchase
1,850,000 shares of our common stock. The secured convertible notes bear
interest at 10%, mature two years from the date of issuance, and are convertible
into our common stock, at the investors' option, at the lower of $0.09 per share
or 40% of the average of the three lowest intraday trading prices for the common
stock on the NASDAQ bulletin board for the 20 trading days before but not
including the conversion date.
10
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The full principal amount of the secured convertible notes, plus a default
interest rate of 15%, is due upon a default under the terms of the secured
convertible notes. In addition, we granted the investors a security interest in
substantially all of our assets, including the assets of our wholly-owned
subsidiaries, and intellectual property. We are required to file a registration
statement with the Securities and Exchange Commission which includes the common
stock underlying the secured convertible notes and the warrants. If the
registration statement is not filed and declared effective within 60 days from
the date of closing, we are required to pay liquidated damages to the investors.
In the event that we breach any representation or warranty in the Securities
Purchase Agreement, we are required to pay liquidated damages in shares of our
common stock or cash, at the election of the investors, in an amount equal to 3%
of the outstanding principal amount of the secured convertible notes per month
plus accrued and unpaid interest.
We are currently in default pursuant to secured convertible notes issued
pursuant to a securities purchase agreement dated April 28, 2004 (the "SPA").
Pursuant to the SPA, we are obligated to have two times the number of shares
that the convertible notes are convertible into registered pursuant to an
effective registration statement. We filed a registration statement on Form S-1,
as amended, that was declared effective by the Securities and Exchange
Commission on August 9, 2004. All of the shares of common stock underlying the
secured convertible notes that were registered on the S-1 have been issued. On
April 26, 2005, we filed a registration statement on Form SB-2 registering
additional shares to be issued upon conversion of the secured convertible notes
pursuant to the SPA, however, the SB-2 registration statement is currently being
reviewed and has not been declared effective.
The warrants are exercisable until five years from the date of issuance at a
purchase price of $0.09 per share. The exercise price of the warrants is subject
to anti-dilution provisions.
The investors have agreed to restrict their ability to convert their secured
convertible notes or exercise their warrants and receive shares of our common
stock such that the number of shares of common stock held by them in the
aggregate and their affiliates after such conversion or exercise does not exceed
4.9% of the then issued and outstanding shares of our common stock.
Under a Guaranty and Pledge Agreement, Mr. Nicholas Toms, our Chief Executive
Officer agreed to unconditionally guarantee the timely and full satisfaction of
all obligations under the notes and has pledged 2,006,418 shares of the
Company's common stock he owns as collateral.
(vi) On January 12, 2005, we entered into a Stock Purchase Agreement with Peter
B. Ayling, Elizabeth M. Ayling, Brad L. Leonard, Michael C. Moore, Cape Systems
and Consulting Services Ltd. (the "CSCS Ltd.") and Cape Systems, Inc. ("CSI)
pursuant to which we purchased on that date all of the issued and outstanding
shares of common stock of Cape Systems and Consulting Services Ltd.
(collectively "Cape Systems") from Peter B. Ayling and Elizabeth M. Ayling and
Cape Systems, Inc. from Brad L. Leonard and Michael C. Moore for an aggregate
purchase price of $2,000,000. Pursuant to the Stock Purchase Agreement, the
parties executed an escrow agreement pursuant to which $200,000 of the purchase
price was placed in escrow for a period of 15 months as a fund for indemnity
claims arising out of the transaction. The acquisition was accounted for
pursuant to the purchase method in accordance with Statement of Financial
Accounting Standards No. 141, "Business Combinations" effective as of January
12, 2005.
11
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Basis of Presentation
While we are continuing our efforts to reduce costs, increase revenues, resolve
lawsuits on favorable terms and settle certain liabilities on a non-cash basis
there is no assurance that we will achieve these objectives. In addition, we
will continue to pursue strategic business combinations and opportunities to
raise both debt and equity financing. However, there can be no assurance that we
will be able to raise additional financing in the timeframe necessary to meet
our immediate cash needs, or if such financing is available, whether the terms
or conditions would be acceptable to us.
The accompanying unaudited condensed consolidated financial statements have been
prepared on a basis that contemplates Cape's continuation as a going concern and
the realization of its assets and liquidation of its liabilities in the ordinary
course of business. Such financial statements do not include any adjustments,
with the exception of the provision to adjust the carrying values of the assets
of the subsidiaries in liquidation to their estimated net realizable value,
relating to the recoverability and classification of recorded asset amounts or
the amounts and classification of liabilities that might be necessary should we
be unable to continue as a going concern. If Cape fails to raise additional
capital when needed, the lack of capital will have a material adverse effect on
Cape's business, operating results, financial condition and ability to continue
as a going concern.
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and with the instructions to
Form 10-QSB. Accordingly, they do not include all of the information and notes
required by accounting principles generally accepted in the United States for
complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring adjustments) considered necessary to make the
financial statements not misleading have been included. Operating results for
the three and nine months ended June 30, 2005 are not necessarily indicative of
the results that may be expected for the year ending September 30, 2005.
The condensed consolidated balance sheet at September 30, 2004 has been derived
from the audited financial statements at that date but does not include all of
the information and notes required by accounting principles generally accepted
in the United States for complete financial statements.
For further information, refer to the consolidated financial statements and
notes thereto included in the Company's Annual Report on Form 10-K for the year
ended September 30, 2004 (the "2004 Form 10-K").
2. Sales or Divestitures of Non-Core Businesses
The Company developed and initiated a plan in the quarter ended June 30, 2002
that would result in the sale or divestiture of assets or closings of businesses
that are not part of the Company's current strategic plan or have not achieved
an acceptable level of operating results or cash flows. In connection with this
plan, the Company has completed the sale of certain businesses and assets (see
Note 2 in the 2004 Form 10-K). After being unsuccessful in attempting to sell
its five remaining European operations (Vertex UK-previously PSS, Vertex Service
and Maintenance Italy - previously SIS, Vertex Italy, Euronet and Vertex France
- - previously ICS France) and based on the continuing cash drain from these
operations, the respective boards of directors determined that in the best
interest of their shareholders that they would seek the protection of the
respective courts in each country, which have agreed to an orderly liquidation
of these companies for the benefit of their respective creditors. During the
second quarter of fiscal 2004, the Company recognized a noncash gain from the
approval by creditors of the liquidation of the net liabilities of the Company's
U.K. subsidiary, as explained below. Accordingly, the remaining net assets and
retained liabilities of these businesses are classified as net liabilities
associated with subsidiaries in liquidation in the accompanying June 30, 2005
and September 30, 2004 condensed consolidated balance sheets. While the Company
expects the liquidation process to take through at least December 31, 2005,
significant variations may occur based on the complexity of the entity and
requirements of the respective country.
12
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Retained liabilities are generally carried at their contractual or historical
amounts. The ultimate amounts required to settle these retained liabilities will
differ from estimates based on contractual negotiations, and the outcome of
certain legal actions and liquidation procedures.
The following is a summary of net assets and retained liabilities as of June 30,
2005 and September 30, 2004:
June 30, September 30,
2005 2004
----------- -----------
Cash $ 196,983 $ 200,504
Receivables, net 1,151,066 1,181,413
Inventories, net 635,301 652,053
Accounts payable (2,234,843) (2,288,560)
Accrued liabilities (6,150,189) (6,310,102)
Loans payable - banks (1,120,545) (1,150,091)
----------- -----------
Net liabilities associated with
subsidiaries in liquidation $(7,522,227) $(7,714,783)
=========== ===========
The Company received notice that the liquidation of Vertex UK, which was under
liquidation as of December 31, 2003, had been approved and finalized by the UK
creditors as of January 5, 2004. Based on such notice, management reduced the
Company's net liabilities associated with subsidiaries in liquidation by
approximately $1,400,000, reclassed approximately $1,073,000 of translation loss
from accumulated other comprehensive loss to the consolidated statement of
operations and recognized a gain of approximately $321,000 in the second quarter
of fiscal 2004.
Except for the gain from the liquidation of the U.K. subsidiary and changes in
the unrealized foreign translation loss, the results of operations of these
businesses for the three months and nine months ended June 30, 2005 and 2004
were not significant.
3. Business Combination
As explained in Note 1, on January 12, 2005, the Company entered into a stock
purchase agreement pursuant to which it acquired all of the issued and
outstanding shares of common stock of CSCS Ltd. and its subsidiary, CSI, for an
aggregate purchase price of $2,000,000, excluding acquisition costs of $198,700.
The acquisition, which was completed in order to expand our customer base, was
financed primarily through the sale of $1,850,000 of secured convertible notes
and warrants to purchase 1,850,000 shares of the Company's common stock (see
Note 5).
In addition, prior to January 12, 2005, the Company had made restricted cash
deposits of $418,750 that were held by the purchasers of the secured convertible
notes and had made prepayments of interest of $31,250 on other loans from the
purchasers of the secured convertible notes. In connection, with the
acquisitions and the issuance of the secured convertible notes, the purchasers
released the restricted deposits and returned the prepaid interest.
13
The acquisition was accounted for as a purchase pursuant to Statement of
Financial Accounting Standards No. 141, "Business Combinations." Accordingly,
the assets and liabilities of the acquired companies were recorded based on
their fair values as of the acquisition date with the excess of the acquisition
costs over the fair value of the net assets acquired initially allocated to
goodwill. The Company is in the process of obtaining a valuation report for the
business combination. The cost of the acquisition of $2,198,700 allocated to the
Company's estimation of the fair values of the assets and liabilities of the
acquired companies as follows:
Cash $208,765
Accounts receivable 214,762
Inventories 35,486
Prepaid expenses 97,671
Equipment, furniture and fixtures 34,108
Accrued expenses (42,406)
Deferred revenue (214,778)
Notes payable (6,723)
Accounts payable (24,592)
Other intangible assets 1,546,407
Goodwill 350,000
----------
Total cost allocated $2,198,700
==========
The acquisition closed effective January 12, 2005 and, accordingly, include the
results of operations of the acquired companies from January 12, 2005.
The following table presents unaudited pro forma results of operations of the
Company as if the above described acquisition had occurred at October 1, 2003:
(in thousands except per share data)
Three Months Nine Months
Ended June 30, Ended June 30,
2005 2004 2005 2004
------ ----- ----- ------
Revenues $ 700 $ 1,000 $ 3,200 $ 3,100
Net loss (1,350) (500) (4,050) (2,000)
Net loss per share* (.02) (.01) (.05) (.03)
* Includes a nonrecurring charge of $1,400 ($.02 per share) for the nine months
ended June 30, 2005 for the beneficial conversion feature given to the investors
that provided financing for the acquisition (See Note 5).
The unaudited pro forma results of operations are not necessarily indicative of
what the actual results of operations of the Company would have been had the
acquisitions occurred at the beginning of fiscal 2005, nor do they purport to be
indicative of the future results of operations of the Company.
14
4. NOTES PAYABLE TO UNRELATED PARTIES
Notes payable to unrelated parties classified as current liabilities consist of
past due notes payable to Renaissance Software, Inc. in the amount of $1,227,500
as of June 30, 2005. For additional information, see Note 10 in the 2004 Form
10-K.
5. CONVERTIBLE NOTES PAYABLE - UNRELATED PARTIES
Non-current convertible notes payable to unrelated parties with a carrying value
of $4,159,926 at June 30, 2005 ($4,438,656 of principal, net of unamortized
discount of $278,730) arose from loans under (a) a Securities Purchase Agreement
(the "2004 Agreement") with four accredited investors on April 28, 2004 and
January 11, 2005 for the private placement (the "2004 Private Placement") of (i)
$3,000,000 in convertible notes (the "2004 Convertible Notes") and (ii) warrants
(the "2004 Warrants") to purchase 3,000,000 shares of our common stock; and (b)
a Securities Purchase Agreement (the "2005 Agreement) for the private placement
(the "2005 Private Placement") of (i) $1,850,000 in convertible notes (the "2005
Convertible Notes") and (ii) warrants (the "2005 Warrants") to purchase
1,850,000 shares of common stock.
2004 Convertible Notes
The 2004 Convertible Notes bear interest at 10% and mature two years from the
date of issuance. At the investors' option, 50% of the 2004 Convertible Notes
will be convertible into our common stock at the lower of $0.30 or 60% of the
average of the three lowest intraday trading prices for the common stock on a
principal market for the 20 trading days before but not including the conversion
date and the other 50% of the Convertible Notes will be convertible into our
common stock at the lower of $0.30 or 55% of the same average over the same
trading period. The full principal amount of the 2004 Convertible Notes would
become due upon any default under the terms of the 2004 Convertible Notes. The
2004 Warrants are exercisable until five years from the date of issuance at a
purchase price of $0.11 per share. In addition, we have granted the investors a
security interest in substantially all of our assets and intellectual property
and registration rights. The Company allocated proceeds of $427,500 to the fair
value of the warrants and the remaining $2,572,500 to the fair value of the 2004
Convertible Notes. Based on the excess of the aggregate fair value of the common
shares that would have been issued if the 2004 Convertible Notes had been
converted immediately over the proceeds allocated to the 2004 Convertible Notes,
the investors received a beneficial conversion feature that had an aggregate
intrinsic value of approximately $1,096,000 as of the commitment date.
Accordingly, the Company recorded an increase in additional paid-in capital and
debt discount of $1,524,000 in connection with the issuance of the 2004
Convertible Notes and 2004 Warrants, of which $1,171,000 was amortized to
interest expense during the year ended September 30, 2004 and $325,850 during
the nine months ended June 30, 2005.
In connection with the acquisitions and related financing transactions, the 2004
Convertible Notes were amended and became convertible at the lower of $0.09 or
40% of the average of the three lowest intraday trading prices for the common
stock on the Over-The-Counter Bulletin Board for the 20 trading days before but
not including the conversion date. The modification to the conversion terms in
January 2005 resulted in an additional charge for the beneficial conversion
feature had an aggregate intrinsic value of approximately $396,000 as of the
modification date. Accordingly, the Company recorded an increase in additional
paid-in capital and the additional debt discount of $396,000 which was amortized
to interest expense immediately since these notes can be converted immediately.
15
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2005 Convertible Notes
The 2005 Convertible Notes bear interest at 10%, mature two years from the date
of issuance, and are convertible into our common stock, at the investors'
option, at the lower of $0.09 per share or 40% of the average of the three
lowest intraday trading prices for the common stock on the NASDAQ bulletin board
for the 20 trading days before but not including the conversion date. The 2005
Warrants are exercisable until five years from the date of issuance at a
purchase price of $0.09 per share. In addition, we have granted the investors a
security interest in substantially all of our assets and intellectual property
and registration rights.
Based on the excess of the aggregate fair value of the common shares that would
have been issued if the 2005 Convertible Notes had been converted immediately
over the proceeds allocated to the 2005 Convertible Notes, the investors
received a beneficial conversion feature that had an aggregate intrinsic value
of approximately $1,161,500 as of the commitment date. Accordingly, the Company
recorded an increase in additional paid-in capital and the additional debt
discount of $1,032,000 which was amortized to interest expense immediately since
these notes can be converted immediately. In addition the aggregate intrinsic
value of the 2005 Warrants was $129,500 which was recorded as additional paid-in
capital and debt discount, $12,100 of which was amortized to interest expense
during the nine months ended June 30, 2005.
During August and September 2004, the Company issued 1,754,384 common shares
upon the conversion of 10% Convertible Notes with an approximate principal
balance of $98,000 at conversion prices of $0.054 and $0.055 per share.. During
the three months ended December 31, 2004, the Company issued 11,245,615 common
shares upon the conversion of 10% Convertible Notes with an approximate
principal balance of $313,000 at conversion prices ranging from $0.02 to $0.05
per share. In addition, on July 5, 2005 the Company issued 786,300 common shares
upon the conversion of 10% Convertible Notes with an approximate principal
balance of $33,000 at a conversion price of $0.04 per share.
6. STOCKHOLDERS' DEFICIENCY
Shares Issued for Services and Directors' Fees and Accrued Liabilities
During the nine months ended June 30, 2005, the Company issued 8,876,947 shares
of common stock for various consulting and professional services rendered and
recorded charges of approximately $825,984, based on the fair value of the
shares issued.
During the nine months ended June 30, 2005, the Company issued: 1,262,718 shares
of common stock to settle various outstanding payroll obligations totaling
approximately $101,800; 1,951,452 shares to its 401K Retirement Plan in
satisfaction of its accrued calendar 2002 and 2003 matching contribution
obligation of approximately $137,000; and 3,534,404 shares in satisfaction of
accrued Directors Fees and other liabilities of $180,000.
During the nine months ended June 30, 2005, the Company issued 1,250,000 shares
of common stock at a price of $0.08 per share totaling $100,000 under the terms
of a subscription agreement dated June 8, 2005. The Company received proceeds of
$26,000 from the sale of 1,250,000 shares of common stock and the balance of
$74,000 is recorded as subscription receivable at June 30, 2005.
16
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
In July 2005, the Company issued 3,750,000 shares of the Company's common stock
under the terms of an agreement that provides the Company with a license to use
proprietary software for real time information and materials in a secure
environment over the Internet.
Preferred Stock
Midmark Capital L.P. and its affiliate, Midmark Capital II, L.P., and certain
individuals related to these two entities, which are referred to collectively as
"Midmark", own shares of the Company's preferred and common stock and have the
ability to purchase a majority interest in the Company (see Note 12 in the 2004
Form 10-K). As also explained in Note 12 in the 2004 Form 10-K, in September
2004, the Company issued 7,615 share of Series "D" convertible preferred stock
to Midmark upon conversion of approximately $7,615,000 of convertible and demand
notes payable and accrued interest. The Company and Midmark also entered into a
Redemption Agreement providing for the redemption of a number of shares of
Series D preferred stock with a value of $504,713 based on the per share
liquidation value of the Series D preferred stock by no later than December 31,
2004. However, the payment was not made and, accordingly, a total of 504 shares
of Series D preferred stock with an aggregate liquidation value of $504,713
remains in current liabilities as mandatory redeemable Series D preferred stock
in the accompanying condensed consolidated balance sheets as of June 30, 2005
and September 30, 2004.
Pro Forma and Other Disclosures Related to Stock Options
As of September 30, 2004, the Company had granted options to purchase a total of
6,808,514 shares of common stock.
As further explained in Note 3 in the 2004 Form 10-K, as permitted by Statement
of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation" the Company accounts for its employee stock option plans using the
intrinsic value method under Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees". Accordingly, it does not recognize
compensation cost for options with exercise prices at or above fair market value
on the date of grant and, instead, it is required by SFAS 123 and SFAS 148,
"Accounting for Stock- Based Compensation - Transition and Disclosure" to make
pro forma disclosures of net income (loss) and earnings (loss) per share as if
the fair value based method of accounting under SFAS 123 had been applied. The
Company granted 1,220,000 stock options to employees during the nine months
ended June 30, 2005 at exercise prices equal to the fair value at the date of
the grant, and did grant any options to employees in the nine months ended June
30, 2004. If the Company had elected to recognize compensation cost based on the
fair value of the options granted at the grant date in all periods and had
amortized the cost over the vesting period pursuant to SFAS 123, net loss, loss
applicable to common stock and net loss per common share would have been
increased to the pro forma amounts indicated in the table below:
Three Months Nine Months
Ended June 30, Ended June 30,
-------------------------- -----------------------
2005 2004 2005 2004
------- -------- --------- ---------
Net income (loss)-as reported ($1,353,223) $ 588,464 ($3,631,487) ($256,375)
Deduct total stock -
based employee
compensation expense
determined under a
fair value based method
for all awards, net of
related tax effects (115,462) (246,111) (569,136) (741,418)
----------- ---------- ---------- ---------
Net loss - pro-forma $(1,468,685) $ (342,353) (4,200,623) $(997,793)
============ =========== =========== ==========
Basic and diluted
Income (loss) per common
share - as reported $ (.02) $ .01 $ (.05) $ (.02)
Basic and diluted
Income (loss) per common
share - pro-forma $ (.02) $ (.01) $ (.06) $ (.02)
The fair value of each option granted is estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions used in
fiscal 2005 (no options were granted in fiscal 2004):
Expected dividend yield 0.00%
Expected stock price volatility 157%
Risk-free interest rate 3.5%
Expected life of options 5 years
As a result of amendments to SFAS 123, the Company will be required to expense
the fair value of all employee stock options over the vesting period beginning
with its fiscal quarter ending December 31, 2006.
7. EARNINGS (LOSS) PER SHARE
The Company presents "basic" earnings (loss) per share and, if applicable,
"diluted" earnings per share pursuant to the provisions of SFAS 128, "Earnings
per Share". Basic earnings (loss) per share is calculated by dividing net income
or loss (there are no dividend requirements on the Company's outstanding
preferred stock) by the weighted average number of common shares outstanding
during each period.
The calculation of diluted earnings per share is similar to that of basic
earnings per share, except that the denominator is increased to include the
number of additional common shares that would have been outstanding if all
potentially dilutive common shares, such as those issuable upon the exercise of
stock options and warrants and the conversion of convertible securities, were
issued during the period and appropriate adjustments were made for the
application of the treasury stock method and the elimination of interest and
other charges related to convertible securities.
As of June 30, 2005, there were 381,189,461 shares of common stock potentially
issuable upon the exercise of stock options (10,228,514 shares), warrants
(4,850,000 shares) and the conversion of convertible securities (366,110,947
shares). However, diluted per share amounts have not been presented in the
accompanying condensed consolidated statements of operations for the nine months
ended June 30, 2005 and 2004 and the three months ended June 30, 2005 because
the Company had net loss in each period and the assumed effects of the exercise
of all of the Company's outstanding stock options and warrants and the
conversion of all of its convertible securities would have been anti-dilutive.
As of June 30, 2004, there were 20,937,628 shares of common stock potentially
issuable upon the exercise of stock options (7,224,456 shares), warrants
(5,569,980 shares) and the conversion of convertible securities (8,143,192
shares). The incremental shares of 11,945,314 were used in the calculation of
diluted earnings per share in the three months ended June 30, 2005
18
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
8. Income Taxes
The State of New Jersey has enacted legislation permitting certain corporations
located in New Jersey to sell state tax loss carryforwards and state research
and development credits, in order to obtain tax benefits. For the state fiscal
years through 2004 (July 1, 2003 to June 30, 2004) the Company had approximately
$7,976,000 of total available net operating loss carryforwards that were
saleable, of which New Jersey permitted the Company to sell approximately
$5,835,000. On December 17, 2004, the Company received approximately $457,000
from the sale of these benefits which was recognized as an income tax credit
during the nine months ended June 30, 2005.
If still available under New Jersey law, the Company will attempt to obtain
approval to sell the remaining available net operating losses of approximately
$2,141,000 between July 1, 2004 and June 30, 2005. This amount, which is a
carryover of its remaining tax benefits from state fiscal year 2004, may
increase if the Company incurs additional tax benefits during state fiscal year
2005. The Company cannot estimate, however, what percentage of its saleable tax
benefits New Jersey will permit it to sell, how much it will receive in
connection with the sale, if it will be able to find a buyer for its tax
benefits or if such funds will be available in a timely manner.
9. COMMITMENTS AND CONTINGENCIES
Pending Litigation
We are party to a number of claims, which have been previously disclosed by the
Company, and claims by vendors, landlords and other service providers seeking
payment of balances owed. Since such amounts have already been recorded in
accounts payable or accrued liabilities, these claims are not expected to have a
material affect on the stockholders' deficiency of the Company. However, they
could lead to involuntary bankruptcy proceedings.
a) On April 16, 2003, an action was commenced in the Supreme Court of the State
of New York, County of Suffolk, entitled Bautista v. Vertex Interactive, Inc and
Renaissance Software, Inc. The action, which demands $394,000, is brought by a
former employee claiming breach of his employment agreement. On March 29, 2004,
a judgment was granted against the Company in the amount of $350,482. However,
given the Company's current cash position, the judgment has not been paid.
b) On October 31, 2001, an action was commenced in the United States District
Court, Southern District of New York entitled Edgewater Private Equity Fund II,
L.P. et al. v. Renaissance Software, Inc. et al. The action, brought against
Renaissance Software, Inc., a subsidiary of Vertex, and Vertex, alleged the
default by Renaissance Software, Inc. in payment of certain promissory notes in
the principal aggregate sum of $1,227,500. Vertex guaranteed the notes. The
noteholders demanded $1,227,500, together with interest accruing at the rate of
8% per annum from June 30, 2001. On March 12, 2002, the noteholders were
successful in obtaining a judgment against Renaissance Software, Inc. in the
aggregate amount of $1,271,407 including interest, late charges and attorneys'
fees. However, given the Company's current cash position, we have been unable to
pay the judgment and have been pursuing non cash alternatives.
19
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
c) As part of the settlement entered into between the Company and three former
principals of a company acquired by Vertex in 2000, consent judgments in the
amount of approximately $1,000,000 each were entered against Vertex on July 19,
2002. However, given the Company's current cash position, we have been unable to
pay the judgment and have been pursuing non cash alternatives. The Company is
currently negotiating with the former owners to accept forms of payment other
than cash. However, there can be no assurance that a non-cash settlement will be
concluded. In July 2002, the former owners obtained a court levy upon several of
the Company's bank accounts, placing a hold on approximately $70,000 of the
Company's funds. The Company, together with its secured lenders, objected to the
turnover of these funds, however a turnover order was granted by the court in
October 2002.
d) On February 9, 2003, in the matter captioned Scansource, Inc. vs. Vertex
Interactive, Inc., Superior Court of New Jersey, Essex County, a judgment was
granted against the Company in the amount of $142,155. The action alleged non
payment by the Company for computer hardware. However, given the Company's
current cash position, we have been unable to pay the judgment and have been
pursuing non cash alternatives.
e) On or about March 22, 2004, an action against Vertex and Renaissance
Software, Inc. was commenced in New York State Supreme Court, Nassau County,
captioned Great Oak LLC vs. Vertex Interactive, Inc. et al. The action, which
demands $327,676, alleges two months rent totaling $23,737 and an early
termination fee of $303,939 to be due Great Oak LLC, the landlord of premises
leased to Renaissance Software Inc. We vigorously contest the allegations and
anticipate defending the case vigorously.
Settled Litigation
a) On or about October 29, 2004, an action against Vertex was commenced in New
York State Supreme Court, New York County, captioned NautaDutilh vs. Vertex
Interactive, Inc. The action, which demanded $434,189, alleged nonpayment by
Vertex of attorneys' fees allegedly incurred by Vertex in connection with a
potential acquisition transaction and the reorganization of Vertex's foreign
business operations. The Company had accrued the amount demanded. In January
2005, this action was settled for $300,000 and the gain on settlement of
approximately $134,000 was recognized in the nine months ended June 30, 2005.
Payroll Obligations
As a result of its severe cash constraints (see Note 1 - Going Concern section),
the Company had fallen as much as two to three months behind in meeting its
payroll obligations to its employees subsequent to September 30, 2002. The
Company has been meeting its current payroll obligations, and has attempted to
pay overdue employee payroll obligations as cash resources become available.
However, in a letter dated April 3, 2003, the New Jersey Department of Labor
(N.J.D.O.L.) has assessed the Company a penalty of $154,000 for failure to pay
payroll on a timely basis. The Company entered into Consent Order and Agreement
with the N.J.D.O.L. to pay down this obligation, starting with an initial
payment on April 30, 2004 of $18,000, which the Company has made, and then
monthly payments of $30,000 starting on June 1, 2004, which the Company has
made, until the balance of the payroll obligations are paid.
In addition, a number of former employees of a California based division of the
Company had filed claims with the California Department of Labor for non payment
of wages for the second half of July 2002; the final payroll prior to the
closing of the division. The Company had disputed the claims, primarily on the
basis of the lack of documentation for hours worked during the period. However
in July 2003, these claims were heard by the California DOL and the amounts
claimed, together with interest and penalties aggregating approximately $100,000
which remain unpaid as of June 30, 2005, were granted to these former employees.
20
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The Company believes, although there can be no assurances, that the payroll
obligations including penalties as of June 30, 2005 totaling approximately
$428,000 to both the N.J.D.O.L and the California DOL will be satisfied by the
fiscal quarter ending September 30, 2006.
For the three and nine months ended June 30, 2005 the Company recorded a charge
of approximately $113,000 in penalties and interest in connection with
delinquent filings of the Company's Form 5500 annual reports.
Employment Agreements
In connection with the acquisition, we entered into an employment agreement with
Brad L. Leonard to serve as Vice President General Manager - Sales, Cape
Systems. Pursuant to the employment agreement, Mr. Leonard will receive an
annual salary of $110,000. He was granted options to purchase 1,000,000 shares
of common stock upon execution, of which 200,000 options vest immediately and
the balance of 800,000 options vest over a period of five years. The Company
accounts for these options as a variable stock option plan. The employment
agreement can be terminated by the Company upon 30 days written notice to Mr.
Leonard and by Mr. Leonard upon written notice to the Company for just cause, as
defined therein.
In connection with the acquisition, we entered into a consulting agreement with
IMC Development Group ("IMC"), which is owned by Peter and Elizabeth Ayling.
Pursuant to the IMC consulting agreement, we retained IMC for a period of 18
months to July 2006 to provide administrative and management advisory services.
The consulting agreement is automatically renewable on a month-to-month basis.
IMC will be paid approximately $14,000 per month based on current exchange
rates. IMC was granted options to purchase 1,800,000 shares of common stock upon
execution, of which 300,000 options vest immediately and the balance of
1,500,000 options vest over a period of three years. Additionally, Mr. Ayling
will serve as our Vice President of Marketing.
10. Geographic Area Data
The Company operated in one business segment and in North America in 2004 and
prior to the acquisition of Cape Systems in January 2005. After the acquisition
of Cape Systems, the Company still operates only in one segment and has
operations in North America and the United Kingdom.
The following geographic information presents total revenues, gross margins and
identifiable assets for the three and nine months ended June 30, 2005:
21
Three Months Nine Months
Ended June 30, 2005 Ended June 30, 2005
Revenues
North America $ 552,972 $ 2,406,741
United Kingdom 128,733 289,529
---------- -----------
$ 681,705 $ 2,696,270
========== ===========
Gross Profit
North America $ 237,189 $ 1,283,776
United Kingdom 32,797 104,412
---------- -----------
$ 269,986 $ 1,388,118
========== ===========
Identifiable assets
North America $ 3,056,561
United Kingdom 301,792
-----------
$ 3,358,353
===========
11. Related Party Transaction
The Company hired Mr. David Sasson as Chief Operating Officer effective May 1,
2005. Mr. Sasson is a majority owner of a privately held company, Open Terra,
which provides customer service and technical support to the Company. During the
three and nine months ended June 30, 2005 the Company paid Open Terra
approximately $22,500 and $67,500 for these services, respectively.
12. Subsequent Events
On August 10, 2005, the Company entered into an agreement to sell up to $850,000
principal amount of secured convertible notes and warrants to purchase 850,000
shares of the Company's common stock with certain institutional investors. The
secured convertible notes bear interest at 10%, mature three years from the date
of issuance, and are convertible into the Company's common stock, at the
investor's option, at the lower of (a) $0.09 or (b) 40% of the average of the
three lowest intraday trading prices for the common stock on the
Over-The-Counter Bulletin Board for the 20 trading days before but not including
the conversion date. The warrants are exercisable over a five year period from
the date of issuance at a purchase price of $0.09 per share. The agreement
provided for an initial tranche of $250,000 upon entering into the agreement,
with further monthly tranches of $100,000 on the final business day of each
month beginning in September 2005 and ending in February 2006. In the event that
a registration statement registering the shares of common stock underlying the
secured convertible notes and warrants is declared effective prior to the final
tranche, the Company shall sell the remaining secured convertible notes and
warrants to the investors within five business days after effectiveness. In
addition, either the Company or a majority in interest of the buyers can cancel
the subsequent tranches upon 30 days written notice to the other party. The new
funding is to provide additional working capital for the Company over the period
of the draw-down. The initial tranche of $250,000 was received on August 10,
2005.
22
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Quarterly Report on Form 10-QSB contains, in addition to historical
information, certain forward-looking statements that involve significant risks
and uncertainties. Such forward-looking statements are based on management's
belief, as well as assumptions made by and information currently available to,
management pursuant to the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995. Our actual results could differ materially from
those expressed in or implied by the forward-looking statements contained
herein. Factors that could cause or contribute to such differences include, but
are not limited to, those discussed herein and in Item 1: "Business", included
in our Annual Report on Form 10-K for the year ended September 30, 2004. Cape
undertakes no obligation to release publicly the result of any revisions to
these forward-looking statements that may be made to reflect events or
circumstances after the date of this Quarterly Report or to reflect the
occurrence of other unanticipated events.
This discussion and analysis should be read in conjunction with the unaudited
condensed consolidated financial statements and related notes of the Company
contained elsewhere in this report. In this discussion, the years "2005" and
"2004" refer to the three and nine months ended June 30, 2005 and 2004,
respectively.
Critical Accounting Policies and Estimates
The preparation of the consolidated financial statements requires management to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and the related disclosure of contingent
assets and liabilities. Management bases its estimates and judgments on
historical experience and on various other factors 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 that are
not readily apparent from other sources. Management continuously evaluates its
estimates and judgments, and actual results may differ from these estimates
under different assumptions or conditions.
Those estimates and judgments that were most critical to the preparation of the
financial statements involved the allowance for doubtful accounts, inventory
reserves, recoverability of intangible assets and the estimation of the net
liabilities associated with subsidiaries in liquidation as further explained in
the Company's Annual Report on Form 10-K for the year ended September 30, 2004.
Impairment of long-lived assets:
Impairment losses are recorded on long-lived assets used in operations when
indicators of impairment are present and the undiscounted cash flows estimated
to be generated by those assets are less than the net carrying amount of the
assets. The Company has evaluated the value of its long-lived assets for
impairment in accordance with Statement of Financial Accounting Standards No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets." As a
result of its review, the Company does not believe that any change has occurred.
If such changes in circumstances are present, a loss is recognized to the extent
the carrying value of the asset is in excess of the sum of the discounted cash
flows expected to result from the use of the asset and amounts expected to be
realized upon its eventual disposition.
Goodwill:
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
("SFAS 142"). Under this pronouncement, intangible assets with indefinite lives,
such as goodwill, are no longer amortized, but are subject to reductions only
when their carrying values exceed their estimated fair values based on annual
impairment tests. Fair values for goodwill are based on models that incorporate
estimates of future profitability and cash flows.
23
Variable plan accounting:
The stock options issued to consultants during 2005 are subject to variable plan
accounting treatment under applicable accounting standards.
RECENT ACCOUNTING PRONOUNCEMENTS:
In December 2004, the Financial Accounting Standards Board, (the "FASB") issued
SFAS No. 123(R) "Share-Based Payment" ("SFAS 123(R)"), which amends SFAS 123 and
will be effective for public companies that are small business issuers for
annual periods beginning after December 15, 2005. The new standard will require
us to expense all employee stock options and other share-based payments over the
service period. The FASB believes the use of a binomial lattice model for option
valuation is capable of more fully reflecting certain characteristics of
employee share options compared to the Black-Scholes options pricing model. The
new standard may be adopted in one of three ways - the modified prospective
transition method, a variation of the modified prospective transition method or
the modified retrospective transition method. We are currently evaluating how we
will adopt the standard and evaluating the effect that the adoption of SFAS
123(R) will have on our financial position and results of operations. Since we
have used the intrinsic value method for employee stock options and, generally,
have not recorded any related expense, the adoption of a fair value method for
employee stock options is likely to generate additional compensation expense.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs, an amendment
of Accounting Research Bulletin No. 43, Chapter 4" ("SFAS 151"). This statement
amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing," to clarify
the accounting for abnormal amounts of idle facility expense, freight, handling
costs, and wasted material (spoilage). Paragraph 5 of ARB No. 43, Chapter 4,
previously stated that "...under some circumstances, items such as idle facility
expense, excessive spoilage, double freight, and rehandling costs may be so
abnormal as to require treatment as current period charges ..." SFAS 151
requires that those items be recognized as current-period charges regardless of
whether they meet the criterion of "so abnormal." In addition, this statement
requires that allocation of fixed production overheads to the costs of
conversion be based on the normal capacity of the production facilities. The
provisions of SFAS 151 shall be applied prospectively and are effective for
inventory costs incurred during fiscal years beginning after June 15, 2005, with
earlier application permitted for inventory costs incurred during fiscal years
beginning after the date this Statement was issued. The adoption of SFAS 151 is
not expected to have a material impact on our financial position and results of
operations.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary
Assets, an amendment of APB Opinion No. 29" ("SFAS 153") The guidance in APB
Opinion No. 29, "Accounting for Nonmonetary Transactions," ("APB 29") is based
on the principle that exchanges of nonmonetary assets should be measured based
on the fair value of assets exchanged. The guidance in APB 29, however, included
certain exceptions to that principle. This Statement amends APB 29 to eliminate
the exception for nonmonetary exchanges of similar productive assets that do not
have commercial substance. A nonmonetary exchange has commercial substance if
the future cash flows of the entity are expected to change significantly as a
result of the exchange. SFAS 153 is effective for nonmonetary exchanges
occurring in fiscal periods beginning after June 15, 2005. The adoption of SFAS
153 is not expected to have a material impact on our financial position and
results of operations.
Results of Operations
24
Three months ended June 30, 2005 ("2005") compared to the three months ended
June 30, 2004 ("2004").
Operating Revenues:
Operating revenues decreased by approximately $24,000 (or 3.4%) from
approximately $706,000 in 2004 to approximately $682,000 in 2005.
Revenues generated by the operations in London and Dallas which were not owned
by us in 2004 accounted for approximately $326,000 of the increase offset by a
decrease of $350,000 resulting from a decline in hardware/software sales and the
loss of a few maintenance contracts.
Products and Services
Sales to customers by the two significant product and service line groupings for
the three months ended June 30, 2005 and 2004 are as follows:
June 30
------------------------------
2005 2004
--------- ----------
Enterprise Solutions $ 171,000 $ --
Service, Maintenance and Other 511,000 706,000
--------- ----------
$ 682,000 $ 706,000
========= ==========
Enterprise Solutions revenues increased by $171,000 during the period mainly due
to warehouse expansions by customers which did not occur in 2004 due primarily
to a weak economy and our financial position.
Service, maintenance and other revenues decreased approximately $195,000 from
2004. The decrease was due to revenues generated in London and Dallas of
approximately $326,000, operations that were not owned by us in 2004 offset by
the loss of a few service contracts in the period.
We anticipate that our revenues will, at a minimum, stabilize at these levels or
improve slightly as we continue to restructure and look for target acquisitions.
Gross Profit:
Gross profit decreased by approximately $97,000 (or 26.4%) to $270,000 in 2005.
As a percent of operating revenues, gross profit was 39.6% in 2005 as compared
to 52.0% in 2004. The gross profit was unfavorably impacted by the loss of
higher margin service and maintenance contracts.
Operating Expenses:
Selling and administrative expenses increased approximately $622,000 (or 119.7%)
from approximately $520,000 in 2004 to $1,143,000 in 2005. Approximately
$258,000 of the increase is due to the London and Dallas operations that were
not owned by us in 2004 and the balance of approximately $364,000 due to
professional fees incurred resulting from numerous regulatory filings and
contractual obligations. During 2005, we continued to maintain our various cost
control initiatives and anticipate these costs to be stable.
25
There were no research and development expenses ("R&D"). As a result of the slow
economy and our cost cutting efforts, we suspended R&D, focusing our technical
resources on maintenance services.
The increase in depreciation and amortization expense to approximately $135,000
in 2005, as compared to approximately $35,000 in 2004, is primarily due to the
amortization of intangible assets in connection with the Cape Systems purchase
of approximately $128,000.
Interest expense increased by approximately $82,000 to $348,000 in 2005. The
increase is due primarily to interest and penalties of approximately $113,000 in
connection with delinquent filings of the Company's Form 5500 annual report
offset by lower amortization of deferred financing costs.
Gain on settlements increased approximately $1,556 mainly due to our ability to
settle a certain debt and obligation for less than its book value.
There is no provision for income taxes in 2004 or 2005 due primarily to the net
operating loss carryforwards.
The net loss for the period increased by approximately $1,942,000 to
approximately $1,353,000 from net income of $588,000 in 2004, mainly due to a
gain in the settlement of certain liabilities of approximately $1,043,000 in
2004 which did not occur in 2005 and the factors mentioned above.
Nine months ended June 30, 2005 ("2005") compared to the nine months ended June
30, 2004 ("2004").
Operating Revenues:
Operating revenues increased by approximately $640,000 (or 31.1%) from
approximately $2,056,000 in 2004 to $2,696,000 in 2005.
Revenues from the London and Dallas operations, which were not owned by us in
2004, accounted for approximately $682,000 of the increase with the balance of
approximately $42,000 resulting from increased enterprise solution sales offset
by the loss of service contracts.
Products and Services
Sales to customers by the two significant product and service line groupings for
the nine months ended June 30, 2005 and 2004 are as follows:
June 30
---------------------------------
2005 2004
----------- --------------
Enterprise Solutions $ 981,000 $ 84,000
Service, Maintenance and Other 1,715,000 1,972,000
----------- -------------
$ 2,696,000 $ 2,056,000
=========== =============
Enterprise Solutions revenues increased by $897,000 during the period mainly due
to a number of warehouse expansions by customers.
26
Service, maintenance and other revenues have decreased approximately $257,000
from 2004. The decrease was a result of the loss of service contracts offset
partially by revenues from the London and Dallas operations of approximately
$682,000 that were not owned by us in 2004.
We anticipate that our revenues will, at a minimum, stabilize at these levels or
improve slightly as we continue to restructure and look for target acquisitions.
Gross Profit:
Gross profit increased by approximately $447,000 (or 47.5%) to $1,388,000 in
2005. As a percent of operating revenues, gross profit was 51.5% in 2005 as
compared to 45.7% in 2004. The gross profit was favorably impacted primarily by
the addition of the London and Dallas operations of $426,000 (90.6%) which we
did not own in 2004.
Operating Expenses:
Selling and administrative expenses increased approximately $1,492,000 (or
91.9%) from approximately $1,624,000 in 2004 to $3,116,000 in 2005.
Approximately $507,000 of the increase is due to the London and Dallas
operations that were not owned by us in 2004 and the balance of approximately
$985,000 due to professional fees incurred resulting from numerous regulatory
filings and contractual obligations. During 2005 we continued to maintain our
various cost control initiatives and anticipate these costs to be stable.
There were no research and development expenses ("R&D"). As a result of the slow
economy and our cost cutting efforts, we suspended R&D in 2004, focusing our
technical resources on maintenance services.
The increase in depreciation and amortization expense to approximately $257,000
in 2005, as compared to approximately $118,000 in 2004, is primarily due to the
amortization of intangible assets in connection with the Cape Systems purchase
of approximately $241,000.
Interest expense increased by approximately $1,504,000 to $2,285,000 in 2005.
The increase is due to a charge for the beneficial conversion of convertible
debt of $1,428,000, interest and penalties of approximately $113,000 in
connection with delinquent filings of the Company's Form 5500 annual report
offset by reduced amortization of deferred financing costs.
Gain on settlements totaled approximately $169,000 in 2005 mainly due to our
ability to settle certain debts and obligations for less than their book value.
There is no provision for income taxes in 2004 or 2005 due primarily to the net
operating loss carryforwards.
We realized a tax credit of approximately $457,000 by selling NJ State net
operating loss carryforwards during the nine months ended June 30, 2005.
The net loss for the period increased by approximately $3,375,000 to
approximately $3,631,000 from a loss of $256,000 in 2004, mainly due to the
factors mentioned above.
Liquidity and Capital Resources
27
Based upon our substantial working capital deficiency ($25,842,000) and
stockholders' deficiency ($23,812,000) at June 30, 2005, our recurring losses,
our historic rate of cash consumption, the uncertainty arising from our default
on our notes payable, the uncertainty of our liquidity-related initiatives
described in detail below, and the reasonable possibility of on-going negative
impacts on our operations from the overall economic environment for a further
unknown period of time, there is substantial doubt as to our ability to continue
as a going concern.
The successful implementation of our business plan has required, and will
require on a going forward basis, substantial funds to finance (i) continuing
operations, (ii) further development of our enterprise software technologies,
(iii) settlement of existing liabilities including past due payroll obligations
to the employees, officers and directors, and our obligations under existing or
possible litigation settlements, (iv) possible selective acquisitions to achieve
the scale we believe will be necessary to remain competitive in the global SCM
industry and (v) the integration of the recently completed acquisition of Cape
Systems. There can be no assurance that we will be successful in raising the
necessary funds or integrate the recently completed acquisition.
Fiscal 2005 Outlook:
We had current obligations at June 30, 2005 accumulated during the past several
years that substantially exceeded our current assets and, to the extent we
cannot settle existing obligations in stock or defer payment of our obligations
until we generate sufficient operating cash, we will require significant
additional funds to meet accrued non-operating obligations, to fund operating
losses, if required, short-term debt and related interest, capital expenditures
and expenses related to cost-reduction initiatives, and to pay liabilities that
could arise from litigation claims and judgments.
Our sources of ongoing liquidity include the cash flows from our operations,
potential new credit facilities and potential additional equity investments.
Consequently, we continue to aggressively pursue obtaining additional debt and
equity financing, the restructuring of certain existing debt obligations, and
the reduction of our operating expenses. In addition, we have structured our
overall operations and resources around high margin enterprise products and
services. However, in order to remain in business, we must raise additional cash
in a timely fashion.
Initiatives Completed or in Process:
The following initiatives related to raising required funds, settling
liabilities and/or reducing expenses have been completed or are in process:
(i) We completed the sale of certain entities and assets during fiscal 2002.
After being unsuccessful in attempting to sell our five remaining European
operations (Vertex UK, Vertex Service and Maintenance Italy, Vertex Italy,
Euronet and Vertex France), and based on the continuing cash drain from these
operations, during fiscal 2002 the respective boards of directors determined
that in the best interest of their shareholders that they would seek the
protection of the respective courts in each country, which have agreed to an
orderly liquidation of these companies for the benefit of their respective
creditors. During the year ended September 30, 2004, we recognized a noncash
gain of $321,000 from the approval by creditors of the liquidation of the net
liabilities of the Company's U.K. subsidiary. Upon legal resolution of the
approximately $7,522,000 of net liabilities of these remaining European entities
as of June 30, 2005, we expect to recognize a non-cash gain (and no significant
cash outlay), however the amount and timing of such gain and cash outlay, if
any, is totally dependent upon the decisions to be issued by the respective
court appointed liquidators.
28
(ii) The Company is negotiating with vendors to settle balances at substantial
discounts. In addition, the Company is negotiating to settle certain notes
payable and approximately $3,700,000 of litigation accruals at a discount or
with the issuance of shares of Cape.
(iii) During the nine months ended June 30, 2005, we realized net gains of
$168,800 from settlements of liabilities totaling $520,800 through the payments
of approximately $352,000 in cash.
(iv) During the nine months ended June 30, 2005 convertible notes payable to
unrelated parties in the principal amount of $313,098 were converted into
11,245,615 shares of common stock.
(v) On January 11, 2005, we entered into a Securities Purchase Agreement and
sold (i) $1,850,000 in secured convertible notes and (ii) warrants to purchase
1,850,000 shares of our common stock to accredited investors. The secured
convertible notes bear interest at 10%, mature two years from the date of
issuance, and are convertible into our common stock, at the investors' option,
at the lower of $0.09 per share or 40% of the average of the three lowest
intraday trading prices for the common stock on the NASDAQ bulletin board for
the 20 trading days before but not including the conversion date.
The full principal amount of the secured convertible notes, plus a default
interest rate of 15%, is due upon a default under the terms of secured
convertible notes. In addition, we granted the investors a security interest in
substantially all of our assets, including the assets of our wholly owned
subsidiaries, and intellectual property. We are required to file a registration
statement with the Securities and Exchange Commission which includes the common
stock underlying the secured convertible notes and the warrants. If the
registration statement is not filed and declared effective within 60 days from
the date of closing, we are required to pay liquidated damages to the investors.
In the event that we breach any representation or warranty in the Securities
Purchase Agreement, we are required to pay liquidated damages in shares of our
common stock or cash, at the election of the investors, in an amount equal to 3%
of the outstanding principal amount of the secured convertible notes per month
plus accrued and unpaid interest.
The warrants are exercisable until five years from the date of issuance at a
purchase price of $0.09 per share. The investors may exercise the warrants on a
cashless basis if the shares of common stock underlying the warrants are not
then registered pursuant to an effective registration statement. In the event
the investors exercise the warrants on a cashless basis, we will not receive any
proceeds. In addition, the exercise price of the warrants will be adjusted in
the event we issue common stock at a price below market, with the exception of
any securities issued as of the date of the warrants or issued in connection
with the secured convertible notes issued pursuant to the Securities Purchase
Agreement.
(vi) On January 12, 2005, we entered into a Stock Purchase Agreement with Peter
B. Ayling, Elizabeth M. Ayling, Brad L. Leonard, Michael C. Moore, Cape Systems
and Consulting Services Ltd. and Cape Systems, Inc. pursuant to which we
purchased on that date all of the issued and outstanding shares of common stock
of Cape Systems and Consulting Services Ltd. (collectively "Cape Systems") from
Peter B. Ayling and Elizabeth M. Ayling and Cape Systems, Inc. from Brad L.
Leonard and Michael C. Moore for an aggregate purchase price of $2,000,000.
Pursuant to the Stock Purchase Agreement, the parties executed an escrow
agreement pursuant to which $200,000 of the purchase price was placed in escrow
for a period of 15 months as a fund for indemnity claims arising out of the
transaction. The acquisition was accounted for pursuant to the purchase method
in accordance with Statement of Financial Accounting Standards No. 141,
"Business Combinations" effective as of January 12, 2005. In connection with the
Stock Purchase Agreement, we entered into an employment agreement with Brad L.
Leonard and a consulting agreement with IMC Development Group.
29
While we are continuing our efforts to reduce costs, increase revenues, resolve
lawsuits on favorable terms and settle certain liabilities on a non-cash basis
there is no assurance that we will achieve these objectives. In addition, we
will continue to pursue strategic business combinations and opportunities to
raise both debt and equity financing. However, there can be no assurance that we
will be able to raise additional financing in the timeframe necessary to meet
our immediate cash needs, or if such financing is available, whether the terms
or conditions would be acceptable to us.
30
CAPE SYSTEMS GROUP, INC.
ITEM 3. CONTROLS AND PROCEDURES
a) Evaluation of Disclosure Controls and Procedures: As of June 30,
2005, our management carried out an evaluation, under the
supervision of our Chief Executive Officer and Chief Financial
Officer of the effectiveness of the design and operation of our
system of disclosure controls and procedures pursuant to the
Securities and Exchange Act, Rule 13a-15(e) and 15d-15(e) under the
Exchange Act). Based on that evaluation, our chief executive officer
and chief financial officer concluded that our disclosure controls
and procedures are not effective to ensure that information required
to be disclosed in the repots we file under the Exchange Act is
recorded, processed, summarized and reported on a timely basis.
Please see the subsection "Significant Deficiencies In Disclosure
Controls And Procedures Or Internal Controls" below.
b) Except for changes in controls described above, there were no
changes in internal controls over financial reporting that occurred
during the period covered by this report that have materially
affected, or are reasonably likely to materially effect, our
internal control over financial reporting. As described below, as a
result of our evaluation of our disclosure controls and procedures
as of June 30, 2005, we determined that our controls and procedures
are not effective and subsequent to the period of this report, began
to implement changes to our internal controls.
Significant Deficiencies In Disclosure Controls And Procedures Or Internal
Controls
During our preparation of Form 10-QSB for the quarter ended June 30, 2005, our
independent registered public accounting firm identified certain material
weaknesses. These material weaknesses did not result in the restatement of any
previously reported financial statements or any other related financial
disclosure. As defined by the Public Company Accounting Oversight Board Auditing
Standard No.2, a material weakness is a significant control deficiency or a
combination of significant control deficiencies that result in there being more
than a remote likelihood that a material misstatement in the annual or interim
financial statements will not be prevented or detected. These deficiencies and
issues include:
o Stock options that we had granted to non-employee consultants during
the second quarter of fiscal 2005 should have been accounted for
under variable accounting and we have corrected the accounting for
these stock options as of the third quarter of fiscal 2005. The
changes that would have resulted in the financial statements for the
second quarter of fiscal 2005 were deemed immaterial; and
o Revenue recognized for a particular contract during the third
quarter of fiscal 2005 should have been deferred to the fourth
quarter of fiscal 2005 and we have corrected the accounting for this
revenue recognition as of the third quarter of fiscal 2005.
In order to remediate this issue, we have instituted a policy requiring at least
two accounting personnel, one of which must be the Chief Financial Officer, to
review all contracts and provide an independent assessment of how revenue should
be accounted for. In the event that such personnel have conflicting opinions on
the recognition of revenue, we will seek outside, independent advice to
determine the method of revenue recognition.
31
CAPE SYSTEMS GROUP, INC.
PART II - OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
From time to time, we may become involved in various lawsuits and legal
proceedings, which arise in the ordinary course of business. However, litigation
is subject to inherent uncertainties, and an adverse result in these or other
matters may arise from time to time that may harm our business. We have
previously disclosed in our annual and quarterly filings all legal proceedings
or claims, of which we are aware, that we believe will have, individually or in
the aggregate, a material adverse affect on our business, financial condition or
operating results. There have been no material developments during the period
covered by this report.
Payroll Obligations
As a result of its severe cash constraints (see Note 1 - Going Concern
section), the Company had fallen as much as two to three months behind in
meeting its payroll obligations to its employees subsequent to September 30,
2002. The Company has been meeting its current payroll obligations, and has
attempted to pay overdue employee payroll obligations as cash resources become
available. However, in a letter dated April 3, 2003, the New Jersey Department
of Labor (N.J.D.O.L.) has assessed the Company a penalty of $154,000 for failure
to pay payroll on a timely basis. The Company entered into Consent Order and
Agreement with the N.J.D.O.L. to pay down this obligation, starting with an
initial payment on April 30, 2004 of $18,000, which the Company has made, and
then monthly payments of $30,000 starting on June 1, 2004, which the Company has
made, until the balance of the payroll obligations including the penalty are
paid.
In addition, a number of former employees of a California based
division of the Company had filed claims with the California Department of Labor
for non payment of wages for the second half of July 2002; the final payroll
prior to the closing of the division. The Company had disputed the claims,
primarily on the basis of the lack of documentation for hours worked during the
period. However in July 2003, these claims were heard by the California DOL and
the amounts claimed, together with interest and penalties aggregating
approximately $100,000 which remain unpaid as of June 30, 2005, were granted to
these former employees.
The Company believes, although there can be no assurances, that the
payroll obligations including penalties as of June 30, 2005 totaling
approximately $428,000 to both the N.J.D.O.L and the California DOL will be
satisfied by the fiscal quarter ending September 30, 2006.
ITEM 2 UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the quarter ended June 30, 2005, we issued 3,000,000 shares of
our common stock to three consultants for services provided. This issuance is
considered exempt under Regulation D of the Securities Act of 1933 and Rule 506
promulgated thereunder.
During the quarter ended June 30, 2005, we issued 701,417 shares of our
common stock to Jeffrey Marks for legal services rendered. This issuance is
considered exempt under Regulation D of the Securities Act of 1933 and Rule 506
promulgated thereunder.
32
During the quarter ended June 30, 2005, we issued 565,659 shares to two
former employees in settlement of outstanding payroll obligations. This issuance
is considered exempt under Regulation D of the Securities Act of 1933 and Rule
506 promulgated thereunder.
The following table provides information about purchases by us and our
affiliated purchasers during the quarter ended June 30, 2005 of equity
securities that are registered by us pursuant to Section 12 of the Securities
Exchange Act of 1934:
ISSUER PURCHASES OF EQUITY SECURITIES
Period (a) (b) (c) (d)
Total Number of Average Price Total Number of Shares (or Maximum Number (or Approximate
Shares (or Units) Paid per Units) Purchased as Part of Dollar Value) of Shares (or Units)
Purchased) Share (or Publicly Announced Plans or that May Yet Be Purchased Under
Unit) Programs (1) the Plans or Programs (1)
10/01/04-10/31/04 0 $0 0 0
11/01/04-11/30/04 0 $0 0 0
12/01/04-12/31/04 0 $0 0 0
(1) We have not entered into any plans or programs under which we may repurchase
its common stock.
ITEM 3 DEFAULTS UPON SENIOR SECURITIES
We are currently in default pursuant to secured convertible notes
issued pursuant to a securities purchase agreement dated April 28, 2004 (the
"2004 SPA"). Pursuant to the 2004 SPA, we are obligated to have two times the
number of shares that the secured convertible notes are convertible into
registered pursuant to an effective registration statement. We filed a
registration statement on Form S-1, as amended, that was declared effective by
the Securities and Exchange Commission on August 9, 2004. All of the shares of
common stock underlying the secured convertible notes that were registered on
the S-1 have been issued. On January 11, 2005, we entered into a securities
purchase agreement (the "2005 SPA") pursuant to which we issued secured
convertible notes and warrants. The terms of the 2005 SPA required us to have a
registration statement registering the shares underlying the secured convertible
notes and warrants effective within 60 days of closing. We are currently in
default under the 2005 SPA. On April 26, 2005, we filed a registration statement
on Form SB-2 registering shares to be issued upon conversion of the secured
convertible notes pursuant to the 2005 SPA, however, the SB-2 registration
statement is currently being review and has not been declared effective.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5 OTHER INFORMATION
On August 10, 2005, we entered into a Securities Purchase Agreement
with AJW Offshore, Ltd., AJW Qualified Partners, LLC, AJW Partners, LLC and New
Millennium Capital Partners II, LLC for the sale of (i) $850,000 in secured
convertible notes and (ii) warrants to purchase 850,000 shares of our common
stock.
33
CAPE SYSTEMS GROUP, INC.
PART II - OTHER INFORMATION
The investors are obligated to provide us with the funds as follows:
o $250,000 was disbursed on August 10, 2005; and
o $100,000 will be disbursed on the final business day of each month
beginning in September 2005 and ending in February 2006.
However, the aggregate $850,000 principal amount of secured convertible
notes and the warrants to purchase an aggregate of 850,000 shares of common
stock shall be sold by us and purchased by the investors no later than five
business days after effectiveness of a registration statement registering the
shares of common stock underlying the secured convertible notes and warrants. In
addition, either the Company or a majority-in-interest of the investors may
terminate their obligation to participate in the additional monthly tranches
upon 30 days written notice to the other party.
The secured convertible notes bear interest at 10%, mature three years
from the date of issuance, and are convertible into our common stock, at the
investors' option, at the lower of:
o $0.09; or
o 40% of the average of the three lowest intraday trading prices for
the common stock on the Over-The-Counter Bulletin Board for the 20
trading days before but not including the conversion date.
The full principal amount of the secured convertible notes are due upon
a default under the terms of secured convertible notes. In addition, we granted
the investors a security interest in substantially all of our assets, including
the assets of our wholly owned subsidiaries, and intellectual property. We are
required to file a registration statement with the Securities and Exchange
Commission within 45 days of closing, which will include the common stock
underlying the secured convertible notes and the warrants. If the registration
statement is not filed within 45 days of closing or if the registration
statement is not declared effective within 90 days from the date of closing, we
are required to pay liquidated damages to the investors. In the event that we
breach any representation or warranty in the Securities Purchase Agreement, we
are required to pay liquidated damages in shares or cash, at the election of the
investors, in an amount equal to three percent of the outstanding principal
amount of the secured convertible notes per month plus accrued and unpaid
interest.
The warrants are exercisable until five years from the date of issuance
at a purchase price of $0.09 per share. The investors may exercise the warrants
on a cashless basis if the shares of common stock underlying the warrants are
not then registered pursuant to an effective registration statement. In the
event the investors exercise the warrants on a cashless basis, then we will not
receive any proceeds. In addition, the exercise price of the warrants will be
adjusted in the event we issue common stock at a price below market, with the
exception of any securities issued as of the date of the warrants or issued in
connection with the secured convertible notes issued pursuant to the Securities
Purchase Agreement.
Upon an issuance of shares of common stock below the market price, the
exercise price of the warrants will be reduced accordingly. The market price is
determined by averaging the last reported sale prices for our shares of common
stock for the five trading days immediately preceding such issuance as set forth
on our principal trading market. The exercise price shall be determined by
multiplying the exercise price in effect immediately prior to the dilutive
issuance by a fraction. The numerator of the fraction is equal to the sum of the
number of shares outstanding immediately prior to the offering plus the quotient
of the amount of consideration received by us in connection with the issuance
divided by the market price in effect immediately prior to the issuance. The
denominator of such issuance shall be equal to the number of shares outstanding
after the dilutive issuance.
34
The conversion price of the secured convertible notes and the exercise
price of the warrants may be adjusted in certain circumstances such as if we pay
a stock dividend, subdivide or combine outstanding shares of common stock into a
greater or lesser number of shares, or take such other actions as would
otherwise result in dilution of the selling stockholder's position.
The investors have agreed to restrict their ability to convert their
secured convertible notes or exercise their warrants and receive shares of our
common stock such that the number of shares of common stock held by them in the
aggregate and their affiliates after such conversion or exercise does not exceed
4.99% of the then issued and outstanding shares of common stock.
ITEM 6 EXHIBITS
4.1 Securities Purchase Agreement, dated August 10, 2005, by and among Cape
Systems Group, Inc. and AJW Offshore, Ltd., AJW Qualified Partners, LLC,
AJW Partners, LLC and New Millennium Capital Partners II, LLC.
4.2 Callable Secured Convertible Note issued to AJW Offshore, Ltd., dated
August 10, 2005.
4.3 Callable Secured Convertible Note issued to AJW Qualified Partners, LLC,
dated August 10, 2005.
4.4 Callable Secured Convertible Note issued to AJW Partners, LLC, dated
August 10, 2005.
4.5 Callable Secured Convertible Note issued to New Millennium Capital
Partners II, LLC, dated August 10, 2005.
4.6 Stock Purchase Warrant issued to to AJW Offshore, Ltd., dated August 10,
2005.
4.7 Stock Purchase Warrant issued to AJW Qualified Partners, LLC, dated August
10, 2005.
4.8 Stock Purchase Warrant issued to AJW Partners, LLC, dated August 10, 2005.
4.9 Stock Purchase Warrant issued to New Millennium Capital Partners II, LLC,
dated August 10, 2005.
4.10 Registration Rights Agreement, dated as of August 10, 2005, by and among
Cape Systems Group, Inc., AJW Offshore, Ltd., AJW Qualified Partners, LLC,
AJW Partners, LLC and New Millennium Capital Partners II, LLC.
4.11 Security Agreement, dated as of August 10, 2005, by and among Cape Systems
Group, Inc., AJW Offshore, Ltd., AJW Qualified Partners, LLC, AJW
Partners, LLC and New Millennium Capital Partners II, LLC.
4.12 Intellectual Property Security Agreement, dated August 10, 2005, by and
among Cape Systems Group, Inc., AJW Offshore, Ltd., AJW Qualified
Partners, LLC, AJW Partners, LLC and New Millennium Capital Partners II,
LLC.
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14 and Rule
15d-14(a), promulgated under the Securities and Exchange Act of 1934, as
amended
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14 and Rule
15d 14(a), promulgated under the Securities and Exchange Act of 1934, as
amended
32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Executive Officer)
32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Financial Officer)
35
CAPE SYSTEMS GROUP, INC.
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
CAPE SYSTEMS GROUP, INC.
Date: August 19, 2005 By: /s/ NICHOLAS R. TOMS
---------------------
Nicholas R. Toms
Chief Executive Officer (Principal
Executive Officer) and
Chief Financial Officer (Principal
Financial Officer and
Principal Accounting Officer)
36