As filed with the Securities and Exchange Commission on October 11, 2005
An Exhibit List can be found on page II-4.
Registration No. 333-124325
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
- --------------------------------------------------------------------------------
AMENDMENT NO. 1
TO
FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
-----------------------------
CAPE SYSTEMS GROUP, INC.
(Name of small business issuer in its charter)
New Jersey 7372 22-2050350
(State or other Jurisdiction (Primary Standard Industrial (I.R.S. Employer
of Incorporation or Classification Code Number) Identification No.)
Organization)
3619 Kennedy Road
South Plainfield, New Jersey 07080
(908) 756-2000
(Address and telephone number of principal executive offices and
principal place of business)
Nicholas R. Toms, Chief Executive Officer
CAPE SYSTEMS GROUP, INC.
3619 Kennedy Road
South Plainfield, New Jersey 07080
(908) 756-2000
(Name, address and telephone number of agent for service)
Copies to:
Gregory Sichenzia, Esq.
Sichenzia Ross Friedman Ference LLP
1065 Avenue of the Americas, 21st Flr.
New York, New York 10018
(212) 930-9700
(212) 930-9725 (fax)
APPROXIMATE DATE OF PROPOSED SALE TO THE PUBLIC:
From time to time after this Registration Statement becomes effective.
If any securities being registered on this Form are to be offered on a delayed
or continuous basis pursuant to Rule 415 under the Securities Act of 1933, other
than securities offered only in connection with dividend or interest
reinvestment plans, check the following box: [X]
If this Form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ] ________
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ] ________
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ] ________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ] _________
CALCULATION OF REGISTRATION FEE
- ------------------------------------------------ --------------------- ------------------ -------------------- --------------
Title of each class of securities to be Amount to be Proposed Proposed maximum Amount of
registered registered (1) maximum aggregate registration
offering price offering price fee
per share (2)
- ------------------------------------------------ --------------------- ------------------ -------------------- --------------
Common stock, $.005 par value issuable upon 370,000,000 (3) $.085 $31,450,000 $3,701.67
conversion of the secured convertible notes
- ------------------------------------------------ --------------------- ------------------ -------------------- --------------
Common stock, $.005 par value issuable upon 55,400,000 (4) $.085 $4,709,000 $554.25
conversion of the class C-1 convertible
preferred stock
- ------------------------------------------------ --------------------- ------------------ -------------------- --------------
Common stock, $.005 par value issuable upon 423,100,000 (4) $.085 $35,963,500 $4,232.90
conversion of the class D convertible
preferred stock
- ------------------------------------------------ --------------------- ------------------ -------------------- --------------
Common stock, $.005 par value issuable upon 6,000,000 (5) $.11 $660,000 $77.68
exercise of warrants
- ------------------------------------------------ --------------------- ------------------ -------------------- --------------
Common stock, $.005 par value issuable upon 3,700,000 (6) $.09 $333,000 $39.19
exercise of warrants
- ------------------------------------------------ --------------------- ------------------ -------------------- --------------
Total 858,200,000 $73,115,500.00 $8,605.69
- ------------------------------------------------ --------------------- ------------------ -------------------- --------------
(1) Includes shares of our common stock, par value $0.005 per share, which may
be offered pursuant to this registration statement, which shares are issuable
upon conversion of secured convertible notes and the exercise of warrants held
by the selling stockholders. In addition to the shares set forth in the table,
the amount to be registered includes an indeterminate number of shares issuable
upon conversion of the secured convertible notes and exercise of the warrants,
as such number may be adjusted as a result of stock splits, stock dividends and
similar transactions in accordance with Rule 416. The number of shares of common
stock registered hereunder represents a good faith estimate by us of the number
of shares of common stock issuable upon conversion of the secured convertible
notes and upon exercise of the warrants. For purposes of estimating the number
of shares of common stock to be included in this registration statement, we
calculated a good faith estimate of the number of shares of our common stock
that we believe will be issuable upon conversion of the secured convertible
notes and upon exercise of the warrants to account for market fluctuations, and
antidilution and price protection adjustments, respectively. Should the
conversion ratio result in our having insufficient shares, we will not rely upon
Rule 416, but will file a new registration statement to cover the resale of such
additional shares should that become necessary. In addition, should a decrease
in the exercise price as a result of an issuance or sale of shares below the
then current market price, result in our having insufficient shares, we will not
rely upon Rule 416, but will file a new registration statement to cover the
resale of such additional shares should that become necessary.
(2) Estimated solely for purposes of calculating the registration fee in
accordance with Rule 457(c) and Rule 457(g) under the Securities Act of 1933,
using the average of the high and low price as reported on the Over-The-Counter
Bulletin Board on April 22, 2005, which was $.085 per share.
(3) Includes a good faith estimate of the shares underlying secured convertible
notes to account for market fluctuations.
(4) Includes a good faith estimate of the shares underlying class C-1 and class
D convertible preferred stock to account for market fluctuations.
(5) Includes a good faith estimate of the shares underlying warrants exercisable
at $.11 per share to account for antidilution and price protection adjustments.
(6) Includes a good faith estimate of the shares underlying warrants exercisable
at $.09 per share to account for antidilution and price protection adjustments.
----------------------------
The registrant hereby amends this registration statement on such date
or dates as may be necessary to delay its effective date until the registrant
shall file a further amendment which specifically states that this registration
statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the registration statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
================================================================================
THE INFORMATION CONTAINED IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED.
WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
PRELIMINARY PROSPECTUS SUBJECT TO COMPLETION, DATED OCTOBER 11, 2005
CAPE SYSTEMS GROUP, INC.
858,200,000 SHARES OF
COMMON STOCK
This prospectus relates to the resale by the selling stockholders of up
to 858,200,000 shares of our common stock, including up to 370,000,000 shares of
common stock underlying secured convertible notes in a principal amount of
$4,415,382, up to 55,400,000 shares of common stock underlying class C-1
convertible preferred stock, up to 423,100,000 shares of common stock underlying
class D convertible preferred stock and up to 9,700,000 issuable upon the
exercise of common stock purchase warrants. The class C-1 convertible preferred
stock and the class D convertible preferred stock are 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. $2,588,656 of the
secured convertible notes are convertible into our common stock at the lower of
$0.30 or 40% 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. The remaining $1,850,000 of the secured
convertible notes are convertible into our common stock at the lower of $0.09 or
40% 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. The selling stockholders may sell common stock from time to
time in the principal market on which the stock is traded at the prevailing
market price or in negotiated transactions. The selling stockholders may be
deemed underwriters of the shares of common stock, which they are offering. We
will pay the expenses of registering these shares.
Our common stock is registered under Section 12(g) of the Securities
Exchange Act of 1934 and is listed on the Over-The-Counter Bulletin Board under
the symbol "CYSG". The last reported sales price per share of our common stock
as reported by the Over-The-Counter Bulletin Board on October 7, 2005, was $.05.
Investing in these securities involves significant risks. See "Risk
Factors" beginning on page 4.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
Prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
The date of this prospectus is ________, 2005.
The information in this Prospectus is not complete and may be changed.
This Prospectus is included in the Registration Statement that was filed by Cape
Systems Group, Inc. with the Securities and Exchange Commission. The selling
stockholders may not sell these securities until the registration statement
becomes effective. This Prospectus is not an offer to sell these securities and
is not soliciting an offer to buy these securities in any state where the sale
is not permitted.
1
TABLE OF CONTENTS
Cautionary Note Regarding Forward-Looking Statements 3
Prospectus Summary 4
Risk Factors 7
Use Of Proceeds 13
Market For Common Equity And Related Stockholder Matters 20
Management's Discussion And Analysis Of Financial Condition And Results Of Operations 21
Description Of Business 29
Description Of Properties 36
Legal Proceedings 36
Management 39
Executive Compensation 40
Certain Relationships And Related Transactions 42
Security Ownership Of Certain Beneficial Owners And Management 43
Description Of Securities 45
Commission's Position On Indemnification For Securities Act Liabilities 47
Plan Of Distribution 48
Selling Stockholders 50
Legal Matters 57
Experts 57
Available Information 57
Index to Consolidated Financial Statements 58
2
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus and any prospectus supplement contain forward-looking
statements. We have based these forward-looking statements on our current
expectations and projections about future events.
In some cases, you can identify forward-looking statements by words
such as "may," "should," "expect," "plan," "could," "anticipate," "intend,"
"believe," "estimate," "predict," "potential," "goal," or "continue" or similar
terminology. These statements are only predictions and involve known and unknown
risks, uncertainties and other factors, including the risks outlined under "Risk
Factors," that may cause our or our industry's actual results, levels of
activity, performance or achievements to be materially different from any future
results, levels of activity, performance or achievements expressed or implied by
such forward-looking statements.
Unless we are required to do so under U.S. federal securities laws or
other applicable laws, we do not intend to update or revise any forward-looking
statements.
3
PROSPECTUS SUMMARY
The following summary highlights selected information contained in this
prospectus. This summary does not contain all the information you should
consider before investing in the securities. Before making an investment
decision, you should read the entire prospectus carefully, including the "risk
factors" section, the financial statements and the notes to the financial
statements.
CAPE SYSTEMS GROUP, INC.
We are a provider of supply chain management technologies, including
enterprise software systems and applications, 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.
For the years ended September 30, 2004 and 2003, we generated revenues
in the amount of $2,566,520 and $4,226,187 and net losses of $2,184,992 and
$3,650,353, respectively. For the nine months ended June 30, 2005, we generated
revenues in the amount of $2,696,270 and a net loss of $3,631,487. As a result
of recurring losses from operations and a net deficit in both working capital
and stockholders' equity, our Independent Registered Public Accounting Firm, in
their report dated December 10, 2004, have expressed substantial doubt about our
ability to continue as going concern.
Our principal offices are located at 3619 Kennedy Road, South
Plainfield, New Jersey 07080, and our telephone number is (908) 756-2000. We are
a New Jersey corporation.
The Offering
Common stock offered
by selling
stockholders.......... Up to 858,200,000 shares, including up to
370,000,000 shares of common stock underlying
secured convertible notes in the principal amount
of $4,415,382, up to 55,400,000 shares of common
stock underlying class C-1 convertible preferred
stock, up to 423,100,000 shares of common stock
underlying class D convertible preferred stock and
up to 9,700,000 shares of common stock issuable
upon the exercise of common stock purchase
warrants, with 6,000,000 at an exercise price of
$.11 per share and 3,700,000 at an exercise price
of $.09 per share, based on current market prices
and assuming full conversion of the secured
convertible notes and the full exercise of the
warrants (includes a good faith estimate of the
shares underlying secured convertible notes and
shares underlying warrants to account for market
fluctuations, and antidilution and price
protection adjustments, respectively).
This number represents 90.30% of our current
outstanding common stock.
4
Common stock to be
outstanding after
the offering.......... Up to 950,386,066 shares
Use of proceeds.... We will not receive any proceeds from the sale of
the common stock. However, we will receive the
sale price of any common stock we sell to the
selling stockholders upon exercise of the
warrants. We expect to use the proceeds received
from the exercise of the warrants, if any, for
general working capital purposes. However, the
selling stockholders will be entitled to 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 that the selling
stockholder exercises the warrants on a cashless
basis, then we will not receive any proceeds.
Over-The-Counter
Bulletin Board Symbol. CYSG
The above information regarding common stock to be outstanding after
the offering is based on 92,186,066 shares of common stock outstanding as of
October 7, 2005 and assumes the subsequent conversion of our issued secured
convertible notes, with interest and our series C-1 and D convertible preferred
stock and exercise of warrants by our selling stockholders.
April 2004 Securities Purchase Agreement
To obtain funding for our ongoing operations, we entered into a
Securities Purchase Agreement with four accredited investors on April 28, 2004,
and amended on December 30, 2004, for the sale of (i) $3,000,000 in secured
convertible notes and (ii) warrants to buy 3,000,000 shares of our common stock.
Pursuant to a registration statement on Form S-1 (333-116714) declared effective
with the SEC on August 9, 2004, we previously registered 10,000,000 shares of
common stock underlying the convertible debentures and 3,000,000 shares of
common stock underlying the warrants. We are registering 130,000,000 shares in
this offering underlying the convertible debentures and we are registering
6,000,000 shares underlying the warrants. As of October 7, 2005, $434,618 of the
convertible debentures has been converted and $2,565,382 remains outstanding.
This prospectus relates to the resale of the common stock underlying
these secured convertible notes and warrants. The investors provided us with an
aggregate of $3,000,000 as follows:
o $1,500,000 was disbursed on April 28, 2004;
o $750,000 was disbursed on May 28, 2004; and
o $750,000 was disbursed on August 12, 2004.
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
selling stockholders' option, at the lower of (i) $0.30 or (ii) 40% 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. Accordingly, there is in fact no limit on the number of shares into which
the notes may be converted. As of October 7, 2005, the average of the three
lowest intraday trading prices for our common stock during the preceding 20
trading days as reported on the Over-The-Counter Bulletin Board was $.04667 and,
therefore, the conversion price for the secured convertible notes was $.018668.
Based on this conversion price, the $2,565,382 remaining of the secured
convertible notes, excluding interest, are convertible into 137,421,363 shares
of our common stock.
5
The selling stockholders have contractually agreed to restrict their
ability to convert or exercise their warrants and receive shares of our common
stock such that the number of shares of common stock held by them and their
affiliates after such conversion or exercise does not exceed 4.9% of the then
issued and outstanding shares of common stock. See the "Selling Stockholders"
and "Risk Factors" sections for a complete description of the secured
convertible notes.
Investment Restructuring Agreement
On May 26, 2004, we entered into an Investment Restructuring Agreement
with six accredited investors, MidMark Capital L.P., MidMark Capital II, L.P.,
Paine Webber Custodian F/B/O Wayne Clevenger, Joseph Robinson, O'Brien Ltd
Partnership and Matthew Finlay and Teresa Finlay JTWROS, who are also our
principal stockholders. On September 27, 2004, we completed the terms and
conditions of an Investment Restructuring Agreement. On June 25, 2004, as part
of the Investment Restructuring Agreement, we exchanged class C preferred stock
for class C-1 convertible preferred stock on a 1:1 basis. On September 27, 2004,
we issued 7,615 shares of class D convertible preferred stock to MidMark
Capital, L.P. in exchange for $7,614,708 of debt owed by our subsidiaries and us
to MidMark Capital II, L.P. Each share of the class C-1 convertible preferred
stock and class D convertible preferred stock is convertible into $1,000 worth
of our common stock, at the selling stockholders' option, at the lower of (i)
$0.30 or (ii) 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. Accordingly, there is in fact no limit on the
number of shares into which the preferred stock may be converted. As of October
7, 2005, the average of the three lowest intraday trading prices for our common
stock during the preceding 20 trading days as reported on the Over-The-Counter
Bulletin Board was $.04667 and, therefore, the conversion price for the class
C-1 and D convertible preferred stock was $.028002. Based on this conversion
price, the 997 shares of class C-1 convertible preferred stock were convertible
into 35,604,600 shares of our common stock and the 7,615 shares of class D
convertible preferred stock were convertible into 271,944,862 shares of our
common stock.
January 2005 Securities Purchase Agreement
To obtain funding for our ongoing operations, we entered into a
Securities Purchase Agreement with four accredited investors on January 11, 2005
for the sale of (i) $1,850,000 in secured convertible notes and (ii) warrants to
buy 1,850,000 shares of our common stock.
This prospectus relates to the resale of the common stock underlying
these secured convertible notes and warrants. The investors purchased all the
secured convertible notes on January 11, 2005.
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
selling stockholders' option, at the lower of (i) $0.09 or (ii) 40% 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. Accordingly, there is in fact no limit on the number of shares into which
the notes may be converted. As of October 7, 2005, the average of the three
lowest intraday trading prices for our common stock during the preceding 20
trading days as reported on the Over-The-Counter Bulletin Board was $.04667 and,
therefore, the conversion price for the secured convertible notes was $.018668.
Based on this conversion price, the $1,850,000 secured convertible notes,
excluding interest, is convertible into 99,100,065 shares of our common stock.
The selling stockholders have contractually agreed to restrict their
ability to convert or exercise their warrants and receive shares of our common
stock such that the number of shares of common stock held by them and their
affiliates after such conversion or exercise does not exceed 4.9% of the then
issued and outstanding shares of common stock. See the "Selling Stockholders"
and "Risk Factors" sections for a complete description of the secured
convertible notes.
6
RISK FACTORS
This investment has a high degree of risk. Before you invest you should
carefully consider the risks and uncertainties described below and the other
information in this prospectus. If any of the following risks actually occur,
our business, operating results and financial condition could be harmed and the
value of our stock could go down. This means you could lose all or a part of
your investment.
Risks Relating to Our Business:
We Have a History Of Losses Which May Continue, and May Negatively Impact Our
Ability to Achieve Our Business Objectives.
We incurred net losses of $2,184,992 and $3,650,353 for the years ended
September 30, 2004 and 2003, respectively. For the nine months ended June 30,
2005, we incurred a net loss of $3,631,487. We cannot assure you that we can
achieve or sustain profitability on a quarterly or annual basis in the future.
Our operations are subject to the risks and competition inherent in the
establishment of a business enterprise. There can be no assurance that future
operations will be profitable. Revenues and profits, if any, will depend upon
various factors, including whether we will be able to continue expansion of our
revenue. We may not achieve our business objectives and the failure to achieve
such goals would have an adverse impact on us.
If We Are Unable to Obtain Additional Funding, Our Business Operations Will be
Harmed and If We Do Obtain Additional Financing, Our Then Existing Shareholders
May Suffer Substantial Dilution.
We will require additional funds to sustain and expand our sales and
marketing activities. We anticipate that we will require up to approximately
$2,000,000 to fund our continued operations for the next twelve months from the
date of this prospectus, depending on revenues from operations. Additional
capital will be required to effectively support the operations and to otherwise
implement our overall business strategy. There can be no assurance that
financing will be available in amounts or on terms acceptable to us, if at all.
The inability to obtain additional capital will restrict our ability to grow and
may reduce our ability to continue to conduct business operations. If we are
unable to obtain additional financing, we will likely be required to curtail our
marketing and development plans and possibly cease our operations. Any
additional equity financing may involve substantial dilution to our then
existing shareholders.
Our Independent Registered Public Accounting Firm Has Stated There is
Substantial Doubt About Our Ability to Continue As a Going Concern, Which May
Hinder Our Ability to Obtain Future Financing.
In their report dated December 10, 2004 on our consolidated financial
statements as of and for the year ended September 30, 2004, our independent
registered public accounting firm stated that our recurring losses and our
working capital and stockholders' deficiencies as of September 30, 2004 raised
substantial doubt about the Company's ability to continue as a going concern.
Since September 30, 2004, we have continued to experience net operating losses.
Our ability to continue as a going concern is subject to our ability to generate
a profit and/or obtain necessary funding from outside sources, including
obtaining additional funding from the sale of our securities, increasing sales
or obtaining loans and grants from various financial institutions where
possible. Our continued net operating losses and stockholders' deficiency
increase the difficulty in meeting such goals and there can be no assurances
that such methods will prove successful.
If We Are Unable to Retain the Services of Messrs. Toms and Biermann or If We
Are Unable to Successfully Recruit Qualified Managerial and Sales Personnel
Having Experience in Business, We May Not Be Able to Continue Our Operations.
Our success depends to a significant extent upon the continued service
of Mr. Nicholas Toms, our Chief Executive Officer and Chief Financial Officer
and Mr. Hugo Biermann, our Executive Chairman of the Board. Loss of the services
of Messrs. Toms or Biermann could have a material adverse effect on our growth,
revenues, and prospective business. We do not maintain key-man insurance on the
life of Mr. Biermann. In addition, in order to successfully implement and manage
our business plan, we will be dependent upon, among other things, successfully
recruiting qualified managerial and sales personnel having experience in
business. Competition for qualified
7
individuals is intense. There can be no assurance that we will be able to find,
attract and retain existing employees or that we will be able to find, attract
and retain qualified personnel on acceptable terms.
Many Of Our Competitors Are Larger and Have Greater Financial and Other
Resources Than We Do and Those Advantages Could Make It Difficult For Us to
Compete With Them.
The supply chain management industry is extremely competitive and
includes several companies that have achieved substantially greater market
shares than we have, and have longer operating histories, have larger customer
bases, and have substantially greater financial, development and marketing
resources than we do. If overall demand for our products should decrease, it
could have a materially adverse affect on our operating results.
Our Trademark and Other Intellectual Property Rights May not be Adequately
Protected Outside the United States, Resulting in Loss of Revenue.
We believe that our trademarks, whether licensed or owned by us, and
other proprietary rights are important to our success and our competitive
position. In the course of our international expansion, we may, however,
experience conflict with various third parties who acquire or claim ownership
rights in certain trademarks. We cannot assure that the actions we have taken to
establish and protect these trademarks and other proprietary rights will be
adequate to prevent imitation of our products by others or to prevent others
from seeking to block sales of our products as a violation of the trademarks and
proprietary rights of others. Also, we cannot assure you that others will not
assert rights in, or ownership of, trademarks and other proprietary rights of
ours or that we will be able to successfully resolve these types of conflicts to
our satisfaction. In addition, the laws of certain foreign countries may not
protect proprietary rights to the same extent as do the laws of the United
States.
Risks Relating to Our Current Financing Arrangement:
There Are a Large Number of Shares Underlying Our Secured Convertible Notes,
Class C-1 Convertible Preferred Stock, Class D Convertible Preferred Stock and
Warrants That May be Available for Future Sale and the Sale of These Shares May
Depress the Market Price of Our Common Stock.
As of October 7, 2005, we had 92,186,066 shares of common stock issued
and outstanding, secured convertible notes outstanding that may be converted
into an estimated 236,521,428 shares of common stock at current market prices,
class C-1 convertible preferred stock outstanding that may be converted into an
estimated 35,604,600 shares of common stock at current market prices, class D
convertible preferred stock outstanding that may be converted into an estimated
271,944,862 shares of common stock at current market prices and outstanding
warrants to purchase 4,850,000 shares of common stock. In addition, the number
of shares of common stock issuable upon conversion of the outstanding secured
convertible notes, class C-1 convertible preferred stock and class D convertible
preferred stock may increase if the market price of our stock declines. All of
the shares, including all of the shares issuable upon conversion of the notes,
class C-1 convertible preferred stock or class D convertible preferred stock and
upon exercise of our warrants, may be sold without restriction. The sale of
these shares may adversely affect the market price of our common stock.
The Continuously Adjustable Conversion Price Feature of Our Secured Convertible
Notes, Class C-1 Convertible Preferred Stock and Class D Convertible Preferred
Stock Could Require Us to Issue a Substantially Greater Number of Shares, Which
Will Cause Dilution to Our Existing Stockholders.
Our obligation to issue shares upon conversion of our secured
convertible notes, class C-1 convertible preferred stock and class D convertible
preferred stock is essentially limitless. The following is an example of the
amount of shares of our common stock that are issuable, upon conversion of our
secured convertible notes (excluding accrued interest), class C-1 convertible
preferred stock and class D convertible preferred stock, based on market prices
25%, 50% and 75% below the market price as of October 7, 2005 of $0.05 per
share.
8
Secured Convertible Notes
Number % of
% Below Price Per With Discount of Shares Outstanding
Market Share at 60% Issuable Stock
- ------ ----- ------ -------- -----
25% $.0375 $.015 294,225,467 76.14%
50% $.025 $.01 441,338,200 82.72%
75% $.0125 $.005 882,676,400 90.54%
Class C-1 Convertible Preferred Stock
Number % of
% Below Price Per With Discount of Shares Outstanding
Market Share at 40% Issuable Stock
- ------ ----- ------ -------- -----
25% $.0375 $.0225 44,311,112 32.46%
50% $.025 $.015 66,466,667 41.89%
75% $.0125 $.0075 132,933,334 59.05%
Class D Convertible Preferred Stock
Number % of
% Below Price Per With Discount of Shares Outstanding
Market Share at 40% Issuable Stock
- ------ ----- ------ -------- -----
25% $.0375 $.0225 338,444,445 78.59%
50% $.025 $.015 507,666,667 84.63%
75% $.0125 $.0075 1,015,333,334 91.68%
As illustrated, the number of shares of common stock issuable upon
conversion of our secured convertible notes, class C-1 convertible preferred
stock and class D convertible preferred stock will increase if the market price
of our stock declines, which will cause dilution to our existing stockholders.
The Continuously Adjustable Conversion Price Feature of our Secured Convertible
Notes, Class C-1 Convertible Preferred Stock and Class D Convertible Preferred
Stock May Encourage Investors to Make Short Sales in Our Common Stock, Which
Could Have a Depressive Effect on the Price of Our Common Stock.
The secured convertible notes are convertible into shares of our common
stock at a 60% discount to the trading price of the common stock prior to the
conversion. The classes C-1 and D convertible preferred stock are convertible
into shares of our common stock at a 40% discount to the trading price of the
common stock prior to the conversion. The significant downward pressure on the
price of the common stock as the selling stockholders convert and sells material
amounts of common stock could encourage short sales by investors. This could
place further downward pressure on the price of the common stock. The selling
stockholders could sell common stock into the market in anticipation of covering
the short sale by converting their securities, which could cause the further
downward pressure on the stock price. In addition, not only the sale of shares
issued upon conversion or exercise of secured convertible notes, class C-1 and
class D convertible preferred stock and warrants, but also the mere perception
that these sales could occur, may adversely affect the market price of the
common stock.
The Issuance of Shares Upon Conversion of the Secured Convertible Notes,
Conversion of the Class C-1 Convertible Preferred Stock, Conversion of the Class
D Convertible Preferred Stock and Exercise of Outstanding Warrants May Cause
Immediate and Substantial Dilution to Our Existing Stockholders.
The issuance of shares upon conversion of the secured convertible
notes, conversion of the class C-1 convertible preferred stock, conversion of
the class D convertible preferred stock and exercise of warrants may result in
substantial dilution to the interests of other stockholders since the selling
stockholders may ultimately convert and sell the full amount issuable on
conversion. Although the selling stockholders may not convert their secured
convertible notes, convert the classes C-1 or D convertible preferred stock
and/or exercise their warrants if
9
such conversion or exercise would cause them to own more than 4.9% of our
outstanding common stock, this restriction does not prevent the selling
stockholders from converting and/or exercising some of their holdings and then
converting the rest of their holdings. In this way, the selling stockholders
could sell more than this limit while never holding more than this limit. There
is no upper limit on the number of shares that may be issued which will have the
effect of further diluting the proportionate equity interest and voting power of
holders of our common stock, including investors in this offering.
In The Event That Our Stock Price Declines, The Shares Of Common Stock Allocated
For Conversion Of The Secured Convertible Notes, Class C-1 Convertible Preferred
Stock and Class D Convertible Preferred Stock and Registered Pursuant To This
Prospectus May Not Be Adequate And We May Be Required to File A Subsequent
Registration Statement Covering Additional Shares. If The Shares We Have
Allocated And Are Registering Herewith Are Not Adequate And We Are Required To
File An Additional Registration Statement, We May Incur Substantial Costs In
Connection Therewith.
Based on our current market price and the potential decrease in our
market price as a result of the issuance of shares upon conversion of the
secured convertible notes, class C-1 convertible preferred stock and class D
convertible preferred stock, we have made a good faith estimate as to the amount
of shares of common stock that we are required to register and allocate for
conversion of the secured convertible notes. Accordingly, we have allocated and
registered 370,000,000 shares to cover the conversion of the secured convertible
notes, 55,400,000 shares to cover the conversion of the class C-1 convertible
preferred stock and 423,100,000 shares to cover the conversion of the class D
convertible preferred stock. In the event that our stock price decreases, the
shares of common stock we have allocated for conversion of the secured
convertible notes and classes C-1 and D convertible preferred stock and are
registering hereunder may not be adequate. If the shares we have allocated to
the registration statement are not adequate and we are required to file an
additional registration statement, we may incur substantial costs in connection
with the preparation and filing of such registration statement.
If We Are Required for any Reason to Repay Our Outstanding Secured Convertible
Notes, We Would Be Required to Deplete Our Working Capital, If Available, Or
Raise Additional Funds. Our Failure to Repay the Secured Convertible Notes, If
Required, Could Result in Legal Action Against Us, Which Could Require the Sale
of Substantial Assets.
In April 2004, we entered into a Securities Purchase Agreement for the
sale of an aggregate of $3,000,000 principal amount of secured convertible
notes. The secured convertible notes are due and payable, with 10% interest, two
years from the date of issuance, unless sooner converted into shares of our
common stock. In January 2005, we entered into another Securities Purchase
Agreement for the sale of an aggregate of $1,850,000 principal amount of secured
convertible notes. The secured convertible notes are due and payable, with 10%
interest, two years from the date of issuance, unless sooner converted into
shares of our common stock. In addition, any event of default such as our
failure to repay the principal or interest when due, our failure to issue shares
of common stock upon conversion by the holder, our failure to timely file a
registration statement or have such registration statement declared effective,
breach of any covenant, representation or warranty in the Securities Purchase
Agreement or related convertible note, the assignment or appointment of a
receiver to control a substantial part of our property or business, the filing
of a money judgment, writ or similar process against our company in excess of
$50,000, the commencement of a bankruptcy, insolvency, reorganization or
liquidation proceeding against our company and the delisting of our common stock
could require the early repayment of the secured convertible notes, including a
default interest rate of 15% on the outstanding principal balance of the notes
if the default is not cured with the specified grace period. We anticipate that
the full amount of the secured convertible notes will be converted into shares
of our common stock, in accordance with the terms of the secured convertible
notes. If we are required to repay the secured convertible notes, we would be
required to use our limited working capital and raise additional funds. If we
were unable to repay the notes when required, the note holders could commence
legal action against us and foreclose on all of our assets to recover the
amounts due. Any such action would require us to curtail or cease operations.
If an Event of Default Occurs under the Securities Purchase Agreement, Secured
Convertible Notes, Warrants, Security Agreement or Intellectual Property
Security Agreement, the Investors Could Take Possession of all Our Goods,
Inventory, Contractual Rights and General Intangibles, Receivables, Documents,
Instruments, Chattel Paper, and Intellectual Property.
10
In connection with the Securities Purchase Agreements we entered into
in April 2004 and January 2005, we executed a Security Agreement and an
Intellectual Property Security Agreement in favor of the investors granting them
a first priority security interest in all of our goods, inventory, contractual
rights and general intangibles, receivables, documents, instruments, chattel
paper, and intellectual property. The Security Agreements and Intellectual
Property Security Agreements state that if an even of default occurs under the
Securities Purchase Agreement, Secured Convertible Notes, Warrants, Security
Agreements or Intellectual Property Security Agreements, the Investors have the
right to take possession of the collateral, to operate our business using the
collateral, and have the right to assign, sell, lease or otherwise dispose of
and deliver all or any part of the collateral, at public or private sale or
otherwise to satisfy our obligations under these agreements.
Risks Relating to Our Common Stock:
If We Fail to Remain Current on Our Reporting Requirements, We Could be Removed
From the OTC Bulletin Board Which Would Limit the Ability of Broker-Dealers to
Sell Our Securities and the Ability of Stockholders to Sell Their Securities in
the Secondary Market.
Companies trading on the OTC Bulletin Board, such as us, must be
reporting issuers under Section 12 of the Securities Exchange Act of 1934, as
amended, and must be current in their reports under Section 13, in order to
maintain price quotation privileges on the OTC Bulletin Board. If we fail to
remain current on our reporting requirements, we could be removed from the OTC
Bulletin Board. As a result, the market liquidity for our securities could be
severely adversely affected by limiting the ability of broker-dealers to sell
our securities and the ability of stockholders to sell their securities in the
secondary market.
Our Common Stock is Subject to the "Penny Stock" Rules of the SEC and the
Trading Market in Our Securities is Limited, Which Makes Transactions in Our
Stock Cumbersome and May Reduce the Value of an Investment in Our Stock.
The Securities and Exchange Commission has adopted Rule 15g-9 which
establishes the definition of a "penny stock," for the purposes relevant to us,
as any equity security that has a market price of less than $5.00 per share or
with an exercise price of less than $5.00 per share, subject to certain
exceptions. For any transaction involving a penny stock, unless exempt, the
rules require:
o that a broker or dealer approve a person's account for
transactions in penny stocks; and
o the broker or dealer receive from the investor a written
agreement to the transaction, setting forth the identity and
quantity of the penny stock to be purchased.
In order to approve a person's account for transactions in penny stocks, the
broker or dealer must:
o obtain financial information and investment experience
objectives of the person; and
o make a reasonable determination that the transactions in penny
stocks are suitable for that person and the person has
sufficient knowledge and experience in financial matters to be
capable of evaluating the risks of transactions in penny
stocks.
The broker or dealer must also deliver, prior to any transaction in a penny
stock, a disclosure schedule prescribed by the Commission relating to the penny
stock market, which, in highlight form:
o sets forth the basis on which the broker or dealer made the
suitability determination; and
o that the broker or dealer received a signed, written agreement
from the investor prior to the transaction.
Generally, brokers may be less willing to execute transactions in securities
subject to the "penny stock" rules. This may make it more difficult for
investors to dispose of our common stock and cause a decline in the market value
of our stock.
Disclosure also has to be made about the risks of investing in penny
stocks in both public offerings and in secondary trading and about the
commissions payable to both the broker-dealer and the registered representative,
current quotations for the securities and the rights and remedies available to
an investor in cases of fraud in penny stock transactions. Finally, monthly
statements have to be sent disclosing recent price information for the penny
stock held in the account and information on the limited market in penny stocks.
11
USE OF PROCEEDS
This prospectus relates to shares of our common stock that may be
offered and sold from time to time by the selling stockholders. We will not
receive any proceeds from the sale of shares of common stock in this offering.
However, we will receive the sale price of any common stock we sell to the
selling stockholder upon exercise of the warrants. We expect to use the proceeds
received from the exercise of the warrants, if any, for general working capital
purposes. However, the selling stockholders will be entitled to 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 that the selling stockholder exercises the warrants on a
cashless basis, then we will not receive any proceeds.
APRIL 2004 SECURITIES PURCHASE AGREEMENT
To obtain funding for our ongoing operations, we entered into a
Securities Purchase Agreement with four accredited investors on April 28, 2004,
and amended on December 30, 2004, for the sale of (i) $3,000,000 in secured
convertible notes and (ii) a warrants to buy 3,000,000 shares of our common
stock.
The investors provided us with the funds as follows:
o $1,500,000 was disbursed on April 28, 2004;
o $750,000 was disbursed on May 28, 2004; and
o $750,000 was disbursed on August 12, 2004.
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:
o $0.30; or
o 40% 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.
The full principal amount of the secured convertible notes is due upon
default under the terms of secured convertible notes. In addition, we have
granted the investors a security interest in substantially all of our assets and
intellectual property and registration rights. We are liable for breach of any
covenant, representation or warranty contained in the Securities Purchase
Agreement for a period of two years from the date that the investors distributed
the final $750,000. In the event that we breach any representation or warranty
regarding the condition of our company as set forth in the Securities Purchase
Agreement, we are liable to pay liquidated damages in shares or cash, at the
election of the investors, equal to three percent of the outstanding amount of
the secured convertible notes per month plus accrued and unpaid interest. In the
event that we breach any covenant as set forth in the Securities Purchase
Agreement, including the failure to comply with blue sky laws, timely file all
public reports, use the proceeds from the sale of the secured convertible notes
in the agreed upon manner, obtain written consent from the investors to
negotiate or contract with a party to for additional financing, reserve and have
authorized the required number of shares of common stock or the maintenance of
our shares of common stock on an exchange or automated quotation system, then we
are liable to pay liquidated damages in shares or cash, at the election of the
investors, equal to three percent of the outstanding amount of the secured
convertible notes per month plus accrued and unpaid interest.
In connection with the Securities Purchase Agreement, we executed a
Security Agreement and an Intellectual Property Security Agreement in favor of
the investors granting them a first priority security interest in all of our
goods, inventory, contractual rights and general intangibles, receivables,
documents, instruments, chattel paper, and intellectual property. Under the
Security Agreement and Intellectual Property Security Agreement, events of
default occur upon:
o The occurrence of an event of default (as defined in the
secured convertible notes) under the secured convertible
notes;
13
o Any representation or warranty we made in the Security
Agreement or in the Intellectual Property Security Agreement
shall prove to have been incorrect in any material respect
when made;
o The failure by us to observe or perform any of our obligations
under the Security Agreement or in the Intellectual Property
Security Agreement for ten (10) days after receipt of notice
of such failure from the investors; and
o Any breach of, or default under, the Warrants.
An event of default under the secured convertible notes occurs if we:
o Fail to pay the principal or interest when due;
o Do not issue shares of common stock upon receipt of a
conversion notice;
o Fail to file a registration statement within 60 days after
April 28, 2004 or fail to have the registration statement
effective within 115 days after April 28, 2004;
o Breach any material covenant or other material term or
condition in the secured convertible notes or the Securities
Purchase Agreement;
o Breach any representation or warranty made in the Securities
Purchase Agreement or other document executed in connection
therewith;
o Apply for or consent to the appointment of a receiver or
trustee for us or any of our subsidiaries or for a substantial
part of our of our subsidiaries' property or business, or such
a receiver or trustee shall otherwise be appointed;
o Have any money judgment, writ or similar process shall be
entered or filed against us or any of our subsidiaries or any
of our property or other assets for more than $50,000, and
shall remain unvacated, unbonded or unstayed for a period of
twenty (20) days unless otherwise consented to by the
investors;
o Institute or have instituted against us or any of our
subsidiaries any bankruptcy, insolvency, reorganization or
liquidation proceedings or other proceedings for relief under
any bankruptcy law or any law for the relief of debtors;
o Fail to maintain the listing of our common stock on one of the
OTCBB or an equivalent replacement exchange, the Nasdaq
National Market, the Nasdaq SmallCap Market, the New York
Stock Exchange, or the American Stock Exchange; or
o Default under any other secured convertible note issued
pursuant to the Securities Purchase Agreement.
Upon occurrence of any event of default under either the Security
Agreement or the Intellectual Property Security Agreement, the investors shall
have the right to exercise all of the remedies conferred under the Security
Agreement, the Intellectual Property and under the secured convertible notes,
and the investors shall have all the rights and remedies of a secured party
under the Uniform Commercial Code and/or any other applicable law (including the
Uniform Commercial Code of any jurisdiction in which any collateral is then
located). The investors shall have the following rights and powers:
o To take possession of the collateral and, for that purpose,
enter, with the aid and assistance of any person, any premises
where the collateral, or any part thereof, is or may be placed
and remove the same, and we shall assemble the collateral and
make it available to the investors at places which the
investors shall reasonably select, whether at our premises or
elsewhere, and make available to the investors, without rent,
all of our respective premises and facilities for the purpose
of the investors taking possession of, removing or putting the
collateral in saleable or disposable form; and
o To operate our business using the collateral and shall have
the right to assign, sell, lease or otherwise dispose of and
deliver all or any part of the collateral, at public or
private sale or otherwise, either with or without special
conditions or stipulations, for cash or on credit or for
future delivery, in such parcel or parcels and at such time or
times and at such place or places, and upon such terms and
conditions as the investors may deem commercially reasonable,
all without (except as shall be required by applicable statute
and cannot be waived) advertisement or demand upon or notice
to us or our right of redemption, which we expressly waived.
Upon each such sale, lease, assignment or other transfer of
collateral, the investors may, unless prohibited by applicable
law which cannot be waived, purchase all or any part of the
collateral being sold, free from and discharged of all trusts,
claims, right of redemption and equities by us, which we
waived and released.
14
The warrants are exercisable until five years from the date of issuance
at a purchase price of $0.11 per share. The selling stockholders will be
entitled to 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 that the selling stockholder exercises 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 this warrant or issued in connection with the secured
convertible notes issued pursuant to the Securities Purchase Agreement, dated
April 28, 2004.
Upon the 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.
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 selling stockholders have contractually 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 and their affiliates in the aggregate after such conversion
or exercise does not exceed 4.9% of the then issued and outstanding shares of
common stock.
JANUARY 2005 SECURITIES PURCHASE AGREEMENT
To obtain funding for our ongoing operations, we entered into a
Securities Purchase Agreement with four accredited investors on January 11, 2005
for the sale of (i) $1,850,000 in secured convertible notes and (ii) a warrants
to buy 1,850,000 shares of our common stock. The investors provided us with
$1,850,000 on January 11, 2005.
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:
o $0.09; or
o 40% 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.
The full principal amount of the secured convertible notes is due upon
default under the terms of secured convertible notes. In addition, we have
granted the investors a security interest in substantially all of our assets and
intellectual property and registration rights. We are liable for breach of any
covenant, representation or warranty contained in the Securities Purchase
Agreement for a period of two years from January 11, 2005. In the event that we
breach any representation or warranty regarding the condition of our company as
set forth in the Securities Purchase Agreement, we are liable to pay liquidated
damages in shares or cash, at the election of the investors, equal to three
percent of the outstanding amount of the secured convertible notes per month
plus accrued and unpaid interest. In the event that we breach any covenant as
set forth in the Securities Purchase Agreement, including the failure to comply
with blue sky laws, timely file all public reports, use the proceeds from the
sale of the secured convertible notes in the agreed upon manner, obtain written
consent from the investors to negotiate or contract with a party to for
additional financing, reserve and have authorized the required number of shares
of common stock or the maintenance of our shares of common stock on an exchange
or automated quotation system, then we are liable to pay liquidated damages in
shares or cash, at the election of the investors, equal to three percent of the
outstanding amount of the secured convertible notes per month plus accrued and
unpaid interest.
15
In connection with the Securities Purchase Agreement, we executed a
Security Agreement and an Intellectual Property Security Agreement in favor of
the investors granting them a first priority security interest in all of our
goods, inventory, contractual rights and general intangibles, receivables,
documents, instruments, chattel paper, and intellectual property. Under the
Security Agreement and Intellectual Property Security Agreement, events of
default occur upon:
o The occurrence of an event of default (as defined in the
secured convertible notes) under the secured convertible
notes;
o Any representation or warranty we made in the Security
Agreement or in the Intellectual Property Security Agreement
shall prove to have been incorrect in any material respect
when made;
o The failure by us to observe or perform any of our obligations
under the Security Agreement or in the Intellectual Property
Security Agreement for ten (10) days after receipt of notice
of such failure from the investors; and
o Any breach of, or default under, the Warrants.
An event of default under the secured convertible notes occurs if we:
o Fail to pay the principal or interest when due;
o Do not issue shares of common stock upon receipt of a
conversion notice;
o Fail to file a registration statement within 30 days after
January 11, 2005 or fail to have the registration statement
effective within 60 days after January 11, 2005;
o Breach any material covenant or other material term or
condition in the secured convertible notes or the Securities
Purchase Agreement;
o Breach any representation or warranty made in the Securities
Purchase Agreement or other document executed in connection
therewith;
o Apply for or consent to the appointment of a receiver or
trustee for us or any of our subsidiaries or for a substantial
part of our of our subsidiaries' property or business, or such
a receiver or trustee shall otherwise be appointed;
o Have any money judgment, writ or similar process shall be
entered or filed against us or any of our subsidiaries or any
of our property or other assets for more than $50,000, and
shall remain unvacated, unbonded or unstayed for a period of
twenty (20) days unless otherwise consented to by the
investors;
o Institute or have instituted against us or any of our
subsidiaries any bankruptcy, insolvency, reorganization or
liquidation proceedings or other proceedings for relief under
any bankruptcy law or any law for the relief of debtors;
o Fail to maintain the listing of our common stock on one of the
OTCBB or an equivalent replacement exchange, the Nasdaq
National Market, the Nasdaq SmallCap Market, the New York
Stock Exchange, or the American Stock Exchange; or
o Default under any other secured convertible note issued
pursuant to the Securities Purchase Agreement.
Upon occurrence of any event of default under either the Security
Agreement or the Intellectual Property Security Agreement, the investors shall
have the right to exercise all of the remedies conferred under the Security
Agreement, the Intellectual Property and under the secured convertible notes,
and the investors shall have all the rights and remedies of a secured party
under the Uniform Commercial Code and/or any other applicable law (including the
Uniform Commercial Code of any jurisdiction in which any collateral is then
located). The investors shall have the following rights and powers:
o To take possession of the collateral and, for that purpose,
enter, with the aid and assistance of any person, any premises
where the collateral, or any part thereof, is or may be placed
and remove the same, and we shall assemble the collateral and
make it available to the investors at places which the
investors shall reasonably select, whether at our premises or
elsewhere, and make available to the investors, without rent,
all of our respective premises and facilities for the purpose
of the investors taking possession of, removing or putting the
collateral in saleable or disposable form; and
o To operate our business using the collateral and shall have
the right to assign, sell, lease or otherwise dispose of and
deliver all or any part of the collateral, at public or
private sale or otherwise, either with or without special
conditions or stipulations, for cash or on credit or for
16
future delivery, in such parcel or parcels and at such time or
times and at such place or places, and upon such terms and
conditions as the investors may deem commercially reasonable,
all without (except as shall be required by applicable statute
and cannot be waived) advertisement or demand upon or notice
to us or our right of redemption, which we expressly waived.
Upon each such sale, lease, assignment or other transfer of
collateral, the investors may, unless prohibited by applicable
law which cannot be waived, purchase all or any part of the
collateral being sold, free from and discharged of all trusts,
claims, right of redemption and equities by us, which we
waived and released.
The warrants are exercisable until five years from the date of issuance
at a purchase price of $0.09 per share. The selling stockholders will be
entitled to 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 that the selling stockholder exercises 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 this warrant or issued in connection with the secured
convertible notes issued pursuant to the Securities Purchase Agreement, dated
January 11, 2005.
Upon the 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.
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 selling stockholders have contractually 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 and their affiliates in the aggregate after such conversion
or exercise does not exceed 4.9% of the then issued and outstanding shares of
common stock.
A complete copy of the April 2004 and January 2005 Securities Purchase
Agreements and related documents are incorporated by reference as exhibits to
our amended Form SB-2 registration statement relating to this prospectus.
Sample Conversion Calculation
The number of shares of common stock issuable upon conversion of the
secured convertible notes is determined by dividing that portion of the
principal of the notes to be converted and interest, if any, by the conversion
price. For example, assuming conversion of the $4,415,382 of secured convertible
notes issued and outstanding on October 7, 2005, at a conversion price of
$0.018668, the number of shares issuable upon conversion would be:
$4,415,382/$0.018668 = 236,521,428 shares
The following is an example of the amount of shares of our common stock
that are issuable, upon conversion of the principal amount of our secured
convertible notes, based on market prices 25%, 50% and 75% below the market
price as of October 7, 2005 of $0.05.
17
Secured Convertible Notes
Number % of
% Below Price Per With Discount of Shares Outstanding
Market Share at 60% Issuable Stock
- ------ ----- ------ -------- -----
25% $.0375 $.015 294,225,467 76.14%
50% $.025 $.01 441,338,200 82.72%
75% $.0125 $.005 882,676,400 90.54%
INVESTMENT RESTRUCTURING AGREEMENT
On May 26, 2004, we entered into an Investment Restructuring Agreement
with six accredited investors, MidMark Capital L.P., MidMark Capital II, L.P.,
Paine Webber Custodian F/B/O Wayne Clevenger, Joseph Robinson, O'Brien Ltd
Partnership and Matthew Finlay and Teresa Finlay JTWROS, who are also our
principal stockholders. On September 27, 2004, we completed the terms and
conditions of an Investment Restructuring Agreement. On June 25, 2004, as part
of the Investment Restructuring Agreement, we exchanged class C preferred stock
for class C-1 convertible preferred stock on a 1:1 basis. On September 27, 2004,
we issued 7,615 shares of class D convertible preferred stock to MidMark
Capital, L.P. in exchange for $7,614,708.38 of debt owed by our subsidiaries and
us to MidMark Capital II, L.P.
Each share of the class C-1 and D convertible preferred stock is
convertible into $1,000 worth of shares of our common stock, at the selling
stockholders' option, at the lower of:
o $0.30; or
o 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.
The conversion price of the class C-1 and D convertible preferred stock
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 selling stockholders have contractually agreed to restrict their
ability to convert their class C-1 and D convertible preferred stock such that
the number of shares of common stock held by them and their affiliates in the
aggregate after such conversion or exercise does not exceed 4.9% of the then
issued and outstanding shares of common stock.
A complete copy of the Investment Restructuring Agreement and related
documents are incorporated by reference as exhibits to our amended Form SB-2
registration statement relating to this prospectus.
Sample Conversion Calculation
The number of shares of common stock issuable upon conversion of the
class C-1 and D convertible preferred stock is determined by multiplying the
number of class C-1 or D convertible preferred stock to be converted by 1,000
and dividing that number by the conversion price. For example, assuming
conversion of 997 shares of class C-1 convertible preferred stock and 7,615
shares of class D convertible preferred stock on October 7, 2005, a conversion
price of $0.028002 per share, the number of shares issuable upon conversion
would be:
(997+7,615) * 1,000/$.028002 = 307,549,461 shares
The following is an example of the amount of shares of our common stock
that are issuable, upon conversion of the principal amount of our secured
convertible notes, based on market prices 25%, 50% and 75% below the market
price, as of October 7, 2005 of $0.05.
Class C-1 Convertible Preferred Stock
Number % of
% Below Price Per With Discount of Shares Outstanding
Market Share at 40% Issuable Stock
- ------ ----- ------ -------- -----
25% $.0375 $.0225 44,311,112 32.46%
50% $.025 $.015 66,466,667 41.89%
75% $.0125 $.0075 132,933,334 59.05%
Class D Convertible Preferred Stock
Number % of
% Below Price Per With Discount of Shares Outstanding
Market Share at 40% Issuable Stock
- ------ ----- ------ -------- -----
25% $.0375 $.0225 338,444,445 78.59%
50% $.025 $.015 507,666,667 84.63%
75% $.0125 $.0075 1,015,333,334 91.68%
18
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is quoted on the OTC Bulletin Board under the symbol
"CYSG". Prior to August 20, 2002, our common stock was quoted on the Nasdaq
National Market. From August 21, 2002 until February 17, 2003 our Common Stock
was traded on the NASDAQ Bulletin Board. From February 18, 2003 until March 28,
2004 our common stock traded on the Pink Sheets under the symbol VETXE. Prior to
April 8, 2005, our common stock traded under the symbol "VETX."
For the periods indicated, the following table sets forth the high and
low bid prices per share of common stock. These prices represent inter-dealer
quotations without retail markup, markdown, or commission and may not
necessarily represent actual transactions.
High($) Low ($)
------ --------
Fiscal Year 2004
First Quarter 0.09 0.03
Second Quarter 0.19 0.04
Third Quarter 0.28 0.09
Fourth Quarter 0.24 0.07
Fiscal Year 2005
First Quarter 0.15 0.04
Second Quarter 0.14 0.06
Third Quarter 0.12 0.05
Fourth Quarter 0.09 0.04
Fiscal Year 2006
First Quarter (1) 0.05 0.05
(1) As of October 7, 2005
HOLDERS
As of October 7, 2005, we had approximately 433 holders of our common
stock. The number of record holders was determined from the records of our
transfer agent and does not include beneficial owners of common stock whose
shares are held in the names of various security brokers, dealers, and
registered clearing agencies. The transfer agent of our common stock is
Continental Stock Transfer & Trust Company, 17 Battery Place, New York, New York
10004.
We have never declared or paid any cash dividends on our common stock.
We do not anticipate paying any cash dividends to stockholders in the
foreseeable future. In addition, any future determination to pay cash dividends
will be at the discretion of the Board of Directors and will be dependent upon
our financial condition, results of operations, capital requirements, and such
other factors as the Board of Directors deem relevant.
19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Some of the information in this prospectus contains forward-looking
statements that involve substantial risks and uncertainties. You can identify
these statements by forward-looking words such as "may," "will," "expect,"
"anticipate," "believe," "estimate" and "continue," or similar words. You should
read statements that contain these words carefully because they:
o discuss our future expectations;
o contain projections of our future results of operations or of
our financial condition; and
o state other "forward-looking" information.
We believe it is important to communicate our expectations. However,
there may be events in the future that we are not able to accurately predict or
over which we have no control. Our actual results and the timing of certain
events could differ materially from those anticipated in these forward-looking
statements as a result of certain factors, including those set forth under "Risk
Factors," "Business" and elsewhere in this prospectus. See "Risk Factors."
Overview
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.
a) We estimate the collectibility of our trade receivables. A
considerable amount of judgment is required in assessing the ultimate
realization of these receivables including analysis of historical collection
rates and the current credit-worthiness of significant customers. Significant
changes in required reserves have been recorded in recent periods and may occur
in the future due to the current market and economic conditions.
b) We establish reserves for estimated excess or obsolete inventory
equal to the difference between the cost of inventory and the estimated fair
value based upon assumptions about future demand and market conditions.
Inventory reserves have increased as a result of the decision to discontinue or
significantly reduce certain non-core product lines. If actual market conditions
are less favorable than those projected by management, additional inventory
write-downs may be required.
c) Prior to 2003, we have recorded significant impairment charges
related to the carrying value of goodwill and other intangibles. In assessing
the recoverability of our goodwill and other intangibles, we have made
assumptions regarding estimated future cash flows and considered various other
factors impacting the fair value of these assets, as more fully described below
in the discussions of the results of operations- provision for impairment of
goodwill. However, as of September 30, 2003, our only remaining intangible
asset, software development costs, became fully amortized in fiscal 2004.
d) We regularly evaluate our ability to recover the reported amount of
our deferred income taxes considering several factors, including our estimate of
the likelihood that we will generate sufficient taxable income in future years
in which temporary differences reverse. Due to the uncertainties related to,
among other things, the extent and timing of future income and the potential
changes in the ownership of the Company, which could subject our net operating
loss carry forwards to substantial annual limitations, we offset our net
deferred tax assets by an equivalent valuation allowance as of September 30,
2004.
20
e) As described in the Sales or Divestitures of Non-Core Businesses
section of Note 2 to the Consolidated Financial Statements we have sought the
protection of the respective courts in three European countries, which have
agreed to orderly liquidations of five of our European subsidiaries. We have
used a liquidation accounting model in the establishment of the net liabilities
associated with these entities at September 30, 2004 and 2003. This accounting
model required the estimation of the fair value of the assets of these entities.
A considerable amount of judgment was used in determining the amount of cash to
be recovered through the collection of receivables or the sale of inventory and
equipment in a liquidation environment, that will then be available for the
respective creditors. If actual market conditions are less favorable than those
projected by management, the net assets available for creditors may be less than
estimated. However, since the liabilities of these entities remain on our
balance sheet at historical values (and exceed the fair value of their net
assets by approximately $7,715,000 at September 30, 2004), we expect to
recognize a gain upon legal resolution of the liquidations. The amount and
timing of such gain is totally dependent upon the decisions to be issued by the
respective court appointed liquidators. We received notice that the liquidation
of the UK companies, which were under liquidation as of September 30, 2003 and
2002, has 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 $320,000 in fiscal 2004.
f) Revenue related to software license sales is recorded at the time of
shipment provided that (i) no significant vendor obligations remain outstanding
at the time of sale; (ii) the collection of the related receivable is deemed
probable by management; and (iii) vendor specific objective evidence
("V.S.O.E.") of fair value exists for all significant elements, including
post-contract customer support ("PCS") in multiple element arrangements. Almost
all of our revenue related to software license sales is recorded at the time of
shipment. We do not offer our customers a right of return.
g) Where the services relate to arrangements requiring significant
production, modification or customization of software, and the service element
does not meet the criteria for separate accounting, the entire arrangement,
including the software element, revenue is accounted for in conformity with
either the percentage-of-completion or completed contract accounting method.
Percentage-of-completion generally uses input measures, primarily labor costs,
where such measures indicate progress to date and provide a basis to estimate
completion. Very little of our revenue related to software license sales is
recorded by percentage-of-completion accounting.
Results of Operations
Year ended September 30, 2004 compared to year ended September 30, 2003.
Operating Revenues:
Operating revenues decreased by approximately $1,660,000 (or 39.3%) to
approximately $2,567,000 in 2004.
Revenues were negatively impacted by the continued weak demand in its
key markets and exacerbated by the Company's lack of financial condition.
Products and Services
Sales to customers by the two significant product and service line
groupings for the years ended September 30, 2004 and 2003 (in thousands) are as
follows:
September 30
---------------------------
2004 2003
---------- ---------
Enterprise Solutions $ 84 $ 889
Service, Maintenance and Other 2,483 3,337
-------- -------
$ 2,567 $ 4,226
======== =======
21
Enterprise solutions revenues decreased to $84,000 in 2004 from
$889,000 in 2003. The decrease was a result of our strategy of de-emphasizing
lower margin product sales, together with the impact of the downturn in the
economy, especially post-September 11, in North America and our lack of
financial condition.
Service, maintenance and other revenues have decreased approximately
$854,000 from 2003. The decrease was a result of our strategy of de-emphasizing
lower margin product sales, together with the impact of the downturn in the
economy, especially post-September 11, in North America and our lack of
financial condition.
We anticipate that our revenues will, at a minimum, stabilize at these
levels or improve slightly as we continue to restructure the Company and look
for target acquisitions.
Gross Profit:
Gross profit decreased by approximately $808,000 (or 38.7%) to
$1,279,085 in 2004. As a percent of operating revenues, gross profit was 49.8%
in 2004 as compared to 49.4% in 2003. The gross profit percentage was flat when
compared to last year.
Operating Expenses:
Selling and administrative expenses decreased approximately $1,717,000
(or 37%) to $2,925,000 in 2004. During 2004 we continued various cost reduction
measures, including reduction in the number of our employees, facilities
consolidations, as well as reductions in other expenses deemed redundant such as
marketing and advertising and other headcount-related expenses. We expect our
selling and administrative expenses to remain at these levels until which time
our financial condition improves.
There were no research and development ("R&D") expenses in 2004 or in
2003. As a result of the slow economy and our cost cutting efforts, we suspended
R&D, focusing our technical resources on maintenance services, until which time
additional financing is received. It is anticipated that R&D spending will
recommence in 2005.
The decrease in the depreciation and amortization to $154,694 in 2004,
as compared to $235,363 in 2003, is the direct result of certain of our assets
becoming fully depreciated and or amortized during the period.
As a result of the aforementioned, our operating loss decreased by
approximately $989,000 to approximately $1,801,000 for fiscal 2004 as compared
to our operating loss of approximately $2,790,000 for fiscal 2003.
Interest expense increased by approximately $1,117,000 to $1,969,000 in
2004. This increase is due to a non-cash charge for the beneficial conversion
feature for long-term convertible debt.
During 2004 we settled certain of our liabilities and recognized a gain
of $1,072,000, mainly due to our ability to settle $1,564,500 in debts and
obligations for $492,500.
Gain on liquidation of foreign subsidiaries increased due to $320,000
gain on liquidation of the UK operations.
The income tax provision is negligible in both years due primarily to
operating losses.
22
Nine months ended June 30, 2005 compared to the nine months ended June 30, 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.
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 back 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.
23
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 & Capital Resources
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.
Our audited and unaudited consolidated financial statements have been
prepared on a basis that contemplates our continuation as a going concern and
the realization of assets and liquidation of liabilities in the ordinary course
of business. Our audited and unaudited consolidated financial statements do not
include any adjustments, with the exception of the provision to reduce 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 we fail to raise capital when needed, the lack of capital will have
a material adverse effect on our business, operating results and financial
condition.
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.
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.
24
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.
(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.
25
(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.
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.
(vii) On August 10, 2005, we entered into a Securities Purchase
Agreement for the sale of (i) $850,000 in secured convertible notes and (ii)
warrants to purchase 850,000 shares of our common stock to accredited investors.
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 we 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 $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 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.
26
BUSINESS
OVERVIEW
We are a provider of supply chain management (SCM) technologies,
including enterprise software systems and applications, 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.
We have achieved our current focused product and service portfolio as a
result of various acquisitions over the past four years. Our customers use our
software to reduce procurement and distribution costs, and manage and control
inventory along the supply chain, thereby increasing sales and improving
customer satisfaction and loyalty. We also resell third party software and
hardware as part of our integrated solutions. We provide service and support for
all of our software and systems from established facilities in North America.
Historically, we have sold our products and services worldwide, but now
operate primarily in North America, through a direct sales force and through
strategic reseller alliances with complementary software vendors and consulting
organizations. We target customers with a need to manage high volumes of
activity along their supply chains from order intake and fulfillment, through
inventory, warehouse and distribution center management to the ultimate delivery
of goods to end users.
Our principal executive offices are located at 3619 Kennedy Road, South
Plainfield, New Jersey and our telephone number is (908) 756-2000. We were
organized in the State of New Jersey in November 1974.
Recent Developments
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 all of the issued and outstanding shares of common stock of Cape
Systems and Consulting Services Ltd. 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.
Cape Systems and Consulting Services Ltd. together with Cape Systems,
Inc. is a provider of palletizing and packaging configuration, and
truck/container loading software that improves pallet and truck utilization, and
reduces packaging, storage and transportation costs. Its programs optimize
pallet patterns, create new case sizes and product packaging, create efficient
bundles of corrugated flat packs, build display pallet loads and test the
strength of corrugated board. Its customer base, numbering approximately 3,700,
includes, among others, such companies as Wal-Mart, Sam's Club, Kraft, Nestle,
Procter & Gamble, Smurfit-Stone and Coca-Cola.
In connection with the acquisition, we changed our name on April 8,
2005 to Cape Systems Group, Inc.
Outlook
The successful implementation of our business plan has required, and
will require on an ongoing basis, substantial funds to finance (i) continuing
operations, (ii) the further development of our enterprise software
technologies, (iii) expected future operating losses, (iv) the settlement of
existing liabilities, including past due payroll obligations to our employees,
officers and directors, and (v) from time to time, selective acquisitions. In
order to meet future cash flow needs, we are aggressively pursuing additional
27
equity and debt financings including through our enterprise software subsidiary
XeQute Solutions, Inc., and continued cost cutting measures. Historically, we
have financed these activities through both equity and debt offerings. There can
be no assurance that we will continue to be successful in these efforts. As a
result there is substantial doubt as to our ability to continue as a going
concern.
Throughout 2003, we experienced continued weakness in our core markets,
continued operating losses and a consistent shortfall in working capital. In
order to survive in these circumstances, we continued our strategy to focus on
our core enterprise level products, while continuing to reduce costs.
By the summer of 2002, it became apparent that the sharp downturn in
capital spending in our major markets was likely to continue for the foreseeable
future. This factor combined with the continuing working capital shortfall
(which had already caused us to focus on our enterprise level software and sell
off non-core businesses to raise cash to fund current operations as mentioned
above) required us to look anew at our operations with a view to raising
additional working capital and to reducing costs further. In light of the
depressed price of our common stock and the related shrinking trading volumes,
we elected to fund our enterprise software group separately from us in order to
achieve better values than could be obtained by funding through us directly. At
the same time as mentioned above, we needed to further contain costs and
streamline operations.
In August 2002, we formed a wholly owned subsidiary, XeQute Solutions,
Inc., into which, effective October 1, 2002, we transferred all of the assets
and certain of the liabilities of our Enterprise Software Division. This action
was intended to consolidate all of the enterprise level products and services in
one entity, under a single brand, namely XeQute Solutions, to streamline
operations, reduce costs, provide a more effective route to market, and also to
provide a new platform for hiring. Then in October 2002, we entered into an
agreement with underwriter Charles Street Securities to raise approximately
$3,800,000 of equity into XeQute Solutions, Inc., on a best efforts basis, in a
United Kingdom offering of XeQute Solutions Plc, the parent company of XeQute
Solutions, Inc., under the terms of which we would retain control of XeQute
Solutions, Inc. Pending completion of this offering, Charles Street Securities
procured on our behalf a bridge loan in an amount of $500,000; $250,000 equally
from the Aryeh Trust and MidMark Capital. MidMark Capital is a shareholder of
ours and certain MidMark Managing Directors have served as directors of us. The
offering is no longer going forward.
The Supply Chain Management Industry
The term "supply chain management" refers to a wide spectrum of
software applications, consulting services, maintenance services and hardware
products intended to enable businesses to manage their chains of supply. The
primary goals of successful supply chain planning and execution are to reduce
the costs of sales, recognize early opportunities and act on them to increase
sales and to detect problems as they emerge to address them promptly to reduce
their impact on the operations of the business. The SCM industry is evolving
toward a more software-driven model as enterprises increasingly seek ways to
manage their supply chains in real-time at a lower cost and in a more
decentralized environment.
SCM spending falls within the Information Technology industry. Because
SCM technologies and services enable enterprises to manage a critical aspect of
their operations, namely the chain of supply of components into products to be
manufactured, sold and delivered to end customers, we believe that, despite some
cyclicality that may always characterize investment in software, over the
long-term, SCM solutions are likely to remain significant factors in corporate
IT budgeting. We believe that applications and value-added services such as
implementation and consulting will play a more significant role in the overall
IT investment of companies in our target market, as enterprises increasingly
focus on generating the highest return possible on their asset base-the primary
focus of SCM technology.
The Opportunity
Recent analysis from Gartner Dataquest concludes that as macroeconomic
factors that adversely affected spending on technology in 2001 and 2002 begin to
ease in 2003 and beyond, users will want to derive more value from the effective
integration of existing IT investment. According to Gartner Dataquest
outsourcing demand will continue to spur information technology growth over the
next few years, and pent-up demand for consulting as well as development and
integration of new technologies will be important growth factors.
28
According to the U.S. Bureau of Commerce, approximately 10% of the U.S.
gross domestic product, or more than $900 billion in 1999, is spent annually on
the movement and storage of raw materials, parts, finished goods and other
activities along the supply chain. Globalization and the rise of the Internet
are working in conjunction as catalysts for the emergence of supply chain
technologies designed not only to reduce the costs inherent in the global
economy, but to give enterprises unprecedented visibility into and dynamic
control over their supply chains. Our strategy is grounded in the conviction
that supply chain optimization and management, driven by software applications
and integrated systems is a long-term growth industry still in its early stages
of development, in which there is an attractive opportunity for companies with
sufficient scale and the right product set to emerge as global leaders in this
industry.
AMR Research had forecasted the worldwide SCM industry to reach $21
billion by 2005, a five year compound annual growth rate of approximately 32%.
Application software license revenues, which in 2001 comprised an estimated 41%
of total SCM industry sales, according to AMR, are forecast to continue to grow
at a 29% compound annual growth rate and to reach nearly $8 billion by 2005.
Software maintenance, which AMR estimated to generate nearly $1 billion in
industry revenues in 2001, is expected to grow at a 36% compound annual growth
rate and to reach $3 billion by 2005.
The two largest geographic markets for SCM technology and services are
North America and Europe. AMR estimated that in 2001 these two markets accounted
for roughly 86% of worldwide sales, with the North American market expected to
grow at a 28% annual compound growth rate through 2005 and Europe expected to
grow at a 38% annual compound growth rate over the same period. In light of the
continuing impact of the recessionary economies in North American and Europe,
management believes that AMR's current industry growth forecasts may prove to be
aggressive. Asia/Pacific and Central and South America are forecast to grow more
rapidly over this period, but today these markets account only for an estimated
13% of industry sales and are forecast to reach about 17% by 2005.
The industry opportunity is being defined by three worldwide trends:
Two Major Catalysts: Global Competition and the Internet
Many observers point to two fundamental drivers of long-term growth in
the SCM industry: (i) the increase in globalization and the competitive
pressures that trend is creating for businesses; and (ii) the rise of the
Internet as a medium for commerce at virtually every level of the economy.
As competitive barriers fall around the world, we believe that there is
a secular trend toward more open global commerce that has the potential to
impact businesses of nearly every size. This may create opportunities for our
products in large as well as in small enterprises.
Coincidental with the increase in the pressures of global competition,
has been the arrival of the Internet. Electronic commerce is characterized by
more interdependent relationships among companies, their vendors and their
customers. Managing the supply chain in an e commerce environment lies at the
heart of our suite of products.
An Industry Evolving
Despite billions of dollars of capital investment in new software
systems in the decade of the nineties, the benefits of this investment have been
achieved more slowly than corporate buyers had expected. As corporate buyers
began to return to their technology needs during 2002 and into 2003, after a
slowdown in 2001 and early 2002, their approach is a more modest one, seeking
affordable solutions targeted at specific problems and whose projected return on
investment can be more rigorously assessed.
We are focusing the marketing of our product portfolio to meet such
buyer expectations and are seeking to offer specific supply chain products, at a
predictable total cost of ownership, with predictable time to complete
implementation.
29
Beyond the "Four Walls"
Traditionally, companies have viewed their supply chains as a series of
discrete activities that could be managed largely independently of each other
and almost certainly independently of a company's vendors and customers. This
approach is changing. Corporate buyers understand the interdependence of each
stage and of each participant in the supply chain and are seeking "visibility"
into their supply chain.
This transition to a new operating model poses challenges for corporate
managers because few internal IT systems or business practices are yet fully
capable of taking advantage of the new opportunity to access and manage
enterprise information in a decentralized environment. Increasingly,
corporations are taking advantage of opportunities to add value at many more
places along the supply chain. This is placing a more complex set of functional
needs on legacy supply chain management practices and technologies. These
challenges include:
Implementing and managing more dynamic, customer-driven fulfillment
processes;
Supporting a new array of relationships with partners, vendors, trading
partners and customers;
Enhancing visibility into order, inventory, warehouse and
transportation status;
Improving real-time co-ordination among enterprise facilities;
Extending supply chain visibility beyond the enterprise;
Permitting dynamic scalability to address unpredictable increases in
transaction volumes;
Allowing least-cost routing;
Enabling the application of value-added services along the supply
chain;
Providing means to monitor activity along the supply chain; and
Managing events in the supply chain in the optimum time to take
advantage of revenue opportunities and avoid costs.
A premium is developing on SCM systems and software that are more
integrated, scaleable, offering real-time capabilities and that can support a
more complex and dynamic web of business relationships with vendors, partners
and customers. We believe that our software and services, coupled with our
expertise in the areas of order fulfillment, inventory, warehouse and
transportation management offer important value-added in the evolving SCM
marketplace.
Our Business and Products
We are a provider of products designed to meet the emerging opportunity
described above. These products principally involve the provision of services
and enterprise level software for order fulfillment comprising order management,
warehouse and inventory management and distribution management. This market is
sometimes referred to as supply chain "execution management" software. The
business benefits from an established, revenue-producing suite of proven
products which have been sold to a client base consisting principally of Fortune
500 clients in the United States, in our target vertical markets. These vertical
markets are pharmaceuticals; consumer packaged goods, third party logistics
providers; and bulk food distributors.
The following summary relates to the product lines currently offered by
us, principally through our wholly-owned subsidiary, XeQute:
30
1. Warehouse Management Systems (WMS) Products - the eSuite Software Products
Our core product offerings are our Java-architected, enterprise level, supply
chain execution systems, which include order management (eOMS) and warehouse
management (eWMS) applications. Our eSuite of products promotes collaboration
and the exchange of "real-time" critical information among users within their
trading environment, including employees, distributors, manufacturers, suppliers
and customers. Portable by design, the eSuite of products can operate across
multiple operating and hardware environments, incorporate the ability to utilize
various database options, and can easily be integrated with existing IT
infrastructure and third party applications.
eWMS is a Java architected warehouse management system that provides
companies with real-time insight into warehouse operations and inventory
availability. eWMS is a true multi-warehouse/owner system that can be deployed
across industries and has specific functionality for food and third party
warehouse/logistics environments. eWMS can be implemented to interface with
existing enterprise applications or as an integrated component of eOMS to
facilitate a complete supply chain execution solution.
eOMS is a web-based order management system that integrates all users
in a real-time environment: internal employees, external sales force,
distributors, and customers, through any means of deployment: Internet,
Intranet, or Extranet. eOMS provides companies with maximized selling
opportunities by capturing valuable buying pattern information and then uses
this information to broadcast suggestive selling and promotional opportunities
as well as many other benefits. The eOMS market is potentially the single
largest of our products because order management is a function performed by
every business irrespective of whether they operate a warehousing and
distribution facility. The importance of this market is highlighted by the fact
that over the past eighteen months, two of the larger ERP vendors, PeopleSoft
and JD Edwards, among others have entered this segment of the market. We intend
to devote marketing resources to exploit this opportunity.
eOMS represents one of the largest, new market opportunities for us.
Every business has a requirement to manage its customers' orders properly.
Ideally, the order management system should ensure accurate order entry and
timely fulfillment while providing readily available information to customers on
progress in meeting their respective orders. Very few existing order management
systems provide all of this functionality, or all of this functionality in an
easily accessible form. In contrast, eOMS addresses these needs in a single
complete package. First, the system allows customers to enter their orders
directly through a browser-based solution. This permits customers to not only
self enter their orders, but also to track the progress of, and if required
change, such orders during the fulfillment process in real time over the
internet. Again, being Internet based allows for access to, and collaborative
trading among, all of the participants in the chain of supply, namely customers,
employees and vendors.
We have commenced a sales campaign targeted at our existing customer
base initially, with plans to reach the broader market after implementing the
system in certain existing accounts.
In conjunction with the sale of the WMS product suite, we also provide
customers with software maintenance support, business and warehouse consulting,
and other implementation services, including system design and analysis, project
management, and user and technical training.
Customers which have purchased a warehouse management system from us
during the period 2000-2002 have included major US companies such as: McLane, a
division of Walmart Stores and the largest distribution company in the world,
Iowa Beef, ConAgra,CDC Distribution, ABX Logistic, Air Express International,
Branch Electric, Land O'Lakes Dairy, Avery Dennison, The General Printing Office
(US Government) and Rand McNally. The first release of the E Suites product was
delivered to a large retailer in February 2001, who indicated that the software
was capable of processing in excess of 100,000 transactions per hour per
distribution center (of which there were 19). A product for the bulk food and
3PL vertical markets was released in 2002.
The eSuite product line was recently rewritten in JAVA. We believe that
the eSuite product line is presently one of the few completely integrated
internet-based order fulfillment systems in the world. The competitive
importance of this was recently highlighted by SAP's announcement that its web
strategy would center on a new JAVA version of its SAP R/3 operating system. The
JAVA language is critically important to the future of our development in that
it is the first software language to be independent of both operating platforms
and databases; that is to say this software can run in any IT environment
without extensive modifications.
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iSeries WMS
The original product developed by Renaissance was a warehouse
management system, iWMS, developed exclusively for use in an AS/400 environment.
IWMS provides the stability, security and ease-of-implementation that AS/400
users have learned to expect and mandate. iWMS is a well established, highly
functional, warehouse management system, that is currently installed worldwide
in a variety of industries including, third part logistics (3PL),
pharmaceutical, cosmetic and fragrance, food, office supplies, furniture, fast
moving consumer goods among others.
2. Light-Directed Picking and Put Away Systems
The terms "light-directed" or "light-prompted" systems refer to the
stock picking (or put away) functions in warehousing management systems whereby
a light automatically shines in the sector where stock needs to be picked. Such
"light-directed" stock picking systems have a proven track record for making the
order fulfillment process dramatically more efficient with a very significant
reduction in the error rate in the stock picking function and a measured
improvement in productivity.
Our light-directed family of software picking systems was originally
developed by our subsidiary, Data Control Systems. The products offer a design
and implementation of state-of-the-art, IT-based solutions that dramatically
improve productivity for the order fulfillment and warehouse management
functions in manufacturing and distribution companies.
Our light-directed picking solutions interface with a number of ERP
systems and can be modified to work with almost any system. The order
control/fulfillment systems represent an important facet of the complete
E-commerce system. While E-commerce marketing and order taking engines can
generate substantial sales, without an optimized order fulfillment process, the
promise of E-commerce will not be fully realized by companies.
The industry has recognized our products and services and they were
awarded the "Modern Materials Handling" Productivity Achievement Award in 1999
and the Vendor of the Year for Merck Pharmaceuticals in 1998. Our product line
includes a mobile cart based system that appeals to a broader customer base.
This system, CartRite, utilizes light panels and advanced wireless
communications in its warehouse management application.
Typically, after introduction of our light-directed order fulfillment
system, clients eliminate a portion of the staff they previously required to
fill warehouse orders. This is achieved by automating and optimizing the
scheduling, method and the order of picking items without any paper. The system
thus, among other things, eliminates the multiple steps associated with paper
handling and manual reconciliation.
The software products automate the process from order receipt to final
shipment. We have developed standard communication interfaces with the leading
ERP vendors including SAP, JD Edwards, Oracle, Peoplesoft and Microsoft Great
Plains Resources, and other enterprise level systems. We are an authorized
software provider for all the major shippers in the US which includes
UPS/FedEx/RPS/USPS. The software is capable of simultaneous production of
shipping bar codes when labels are generated.
Hundreds of our installations of our WareRite Warehouse Management
Systems (WMS), PicRite, TurnRite, and PutRite light-prompt systems are providing
results in a wide range of industries, including: pharmaceuticals, cosmetics,
publishing, mail order industries, automotive, electronics, direct selling
associations, retail and wholesale distribution. The above product lines along
with the CartRite system have the potential to enhance its clients' E-commerce
related processes. Customers include Merck Pharmaceutical, Pfizer, Wyeth, Estee
Lauder, OfficeMax, Rite Aid, Braun Electronics (a wholly owned subsidiary of
Gillette) and Dr. Mann Pharma in Germany.
32
Competition
The industry today is marked by competition in two industry segments:
SCM planning and SCM execution. We compete primarily in the execution segment.
In this segment, we face competition from numerous foreign and domestic
companies of various sizes, most of which are larger and have greater capital
resources. Competition in these areas is further complicated by possible shifts
in market share due to technological innovation, changes in product emphasis and
applications and new entrants with greater capabilities or better prospects.
Order Management
The order management market is becoming a center of focus for every
business in the world whether or not they run distribution centers. As a result
this market segment could become the largest part of our business in the future.
The importance of this emerging opportunity is highlighted by the recent entry
of JD Edwards, PeopleSoft, i2 and Manugistics into this market. The competition
for our eOrder product is believed to be as follows:
PeopleSoft, an ERP vendor with revenues of $2 billion. We believe that
PeopleSoft has a Java-based product offering which is very competitive with that
offered by us.
JD Edwards & Co Inc, an ERP vendor with revenues of approximately $900
million with a presence in the order management segment.
i2 Technologies, the largest planning supply chain vendor in the US
based on revenues, with sales of approximately $500 million.
Execution Management
In the execution management segment in the US there are approximately
275 companies offering a WMS product, of which only a small number have a top
tier product (defined as able to handle warehouse space in excess of 250,000
square feet and at least 100 simultaneous users of wireless devices at any one
time) and revenues in excess of $10 million. We believe that we are the only
supplier with a complete JAVA based cross-platform solution for Supply Chain
Management. In this segment of the industry, our major competitors for the
warehouse and inventory management components and the transportation and
logistics components of our eSuite product are:
EXE Technologies, a subsidiary of SSA Technologies, with revenues
believed to be approximately $70 million, competes most directly with us in
warehouse management in our main vertical markets.
Manhattan Associates, the largest warehouse management software vendor
in the world with annual revenues of approximately $170 million. They focus
principally on the AS/400 market in retail distribution and fast moving consumer
goods.
Catalyst International, with revenues of $33 million, provides
principally UNIX solution solutions in our vertical markets.
Light-Directed Systems
In the "Pick-to-light" business, we believe that there are some 25
competitors, of which the largest are Real Time Solutions, Rapistan, Kingsway
and Haupt of Austria, all privately held companies. These companies compete with
aggressive pricing and turn key solutions. However, our competitive advantage
centers on our product's flexibility and software capabilities.
Research and Development
Our research and development initiatives focus on enhancing the product
set with additional functionality aimed at our core vertical markets.
For the years ended September 30, 2004 and 2003, there was no research
and development spending as we suspended research and development to focus our
resources on customer support.
The high level of research and development expenditures in 2001 arose
out of the need to complete the Java-architected, enterprise level SCM suite.
Our research and development timetable, over the next 24 months for the
eWMS product includes a number of features and enhancements, which are budgeted
to begin development in mid-2004. However the extent and timing of this
development is dependent upon our ability to raise the required funds.
33
INTELLECTUAL PROPERTY
We have seven trademarks registered with the United States Patent &
Trademark Office. The marks that we have filed and received trademark
registration for are as follows:
Application or Registration or
Trademark Registration No. Filing Date
CARTRITE Reg. No. 2,274,410 August 31, 1999
WARERITE Reg. No. 2,054,680 April 22, 1997 (renewed Mar, 2003)
TURNRITE Reg. No. 2,060,888 May 13,1997 (renewed Mar, 2003)
SHIPRITE Reg. No. 2,052,389 April 15, 1997 (renewed Mar, 2003)
SCALERITE Reg. No. 2,050,615 April 8, 1997 (renewed Mar, 2003)
PUTRITE Reg. No. 2,054,679 April 22,1997 (renewed Mar, 2003)
PICRITE Reg. No. 1,659,547 October 8, 1991(renewed June 4, 2001)
EMPLOYEES
At October 1, 2005, we had approximately 28 employees. 21 of our
employees are in North America and seven are in the United Kingdom.
Approximately 70% are in Installation and Implementation, 10% in Sales and
Marketing (including sales support) and the balance in Executive/Administrative.
Designing and implementing our software solutions requires substantial
technical capabilities in many disparate disciplines, from mechanics and
computer science to electronics and mathematics. While we believe that the
capability and experience of our technical employees compare favorably with
other similar companies, there is no guarantee that it can retain existing
employees or attract and hire capable technical employees it may need in the
future, or if it is successful, that such personnel can be secured on terms
deemed favorable to us.
DESCRIPTION OF PROPERTIES
Our principal executive offices are located at 3619 Kennedy Road, South
Plainfield, New Jersey 07080, and our telephone number is (908) 756-2000. We and
our subsidiaries occupy approximately 15,000 square feet of office & warehouse
space in a building in South Plainfield, New Jersey under a lease expiring in
April 2008. The monthly rent is $10,500. In addition, we lease approximately
2,000 square feet of office space in Paramus, New Jersey, which has been
subleased. The lease expires in May 2008, and we pay $4,100 a month and receive
$3,100 per month from the subleasee. We believe that our current office space
and facilities are sufficient to meet our present needs and do not anticipate
any difficulty securing alternative or additional space, as needed, on terms
acceptable to us.
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. Except as
disclosed below, we are currently not aware of any such legal proceedings or
claims that we believe will have, individually or in the aggregate, a material
adverse affect on our business, financial condition or operating results.
34
We are party to a number of claims, which have been previously
disclosed by us, 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 us. However, they
could lead to involuntary bankruptcy proceedings.
a) On or about March 22, 2004, an action against the Company and its
subsidiary Renaissance Software, Inc. was commenced in New York State Supreme
Court, Nassau County, captioned Great Oak LLC vs. Vertex Interactive, Inc. et.
al., Index no. 03-7270 The action, which demands $327,666, alleges two months
rent totaling $23,737 and an early termination fee of $303,929 to be due Great
Oak LLC, the landlord of premises leased to Renaissance Software Inc. The
Company is vigorously defending the action.
b) 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, was 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. As of the date of this filing, the judgment has not been
paid.
c) 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 the Company, and the
Company, alleged the default by Renaissance Software, Inc. in payment of certain
promissory notes in the principal aggregate sum of $1,227,500. The Company
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. As of the date of this
filing, the judgment has not been paid.
d) As part of the settlement entered into between the Company and three
former principals of a company acquired by the Company in 2000, consent
judgments in the amount of approximately $1,000,000 each were entered against
the Company on July 19, 2002. The incremental liability has been included in
other expense (provision for litigation) for the year ended September 30, 2003.
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. As of the date of this filing,
the judgments have not been paid.
e) 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. As of the date of this filing,
the judgment has not been paid.
PAYROLL OBLIGATIONS
As a result of our severe cash constraints, we had fallen as much as
two to three months behind in meeting our payroll obligations to our employees
subsequent to September 30, 2002. We have been meeting our current payroll
obligations, and have 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 us a penalty of
$154,000 for failure to pay payroll on a timely basis. We 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 we have made, and
then monthly payments of $30,000 starting on June 1, 2004, which we have made,
until the balance of the payroll obligations including the penalty are paid.
35
In addition, a number of former employees of a California based
division of ours 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. We 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.
We believe, 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.
36
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
Name Age Position
- --------------------------------------------------------------------------------
Hugo H. Biermann 56 Executive Chairman
Nicholas R. H. Toms 56 Chief Executive Officer, Chief
Financial Officer and Director
Otto Leistner 64 Director
Barbara H. Martorano 48 Secretary
Directors are elected to serve until the next annual meeting of
stockholders and until their successors are elected and qualified. Currently
there are three seats on our board of directors.
Directors serve without cash compensation and without other fixed
remuneration. Officers are elected by the Board of Directors and serve until
their successors are appointed by the Board of Directors. Biographical resumes
of each officer and director are set forth below.
Hugo H. Biermann has served as Executive Chairman of the Board of
Directors since July 2001 and served as Joint Chairman and Joint Chief Executive
Officer and a Director of ours from September 1999 through June 2001. Mr.
Biermann has been a principal in Edwardstone & Company, Incorporated
("Edwardstone"), an investment management company, since 1986 as well as serving
as President of Edwardstone since 1989. From 1988 to 1995 Mr. Biermann served as
Director and Vice Chairman of Peak Technologies Group, Incorporated ("Peak
Technologies"), a company involved in automated data capture technologies.
Nicholas R. H. Toms has served as Chief Executive Officer and a
director since July, 2001 and served as Joint Chairman of the Board of
Directors, Joint Chief Executive Officer and a Director of ours from September
1999 through June 2001. Mr. Toms has been a principal of Edwardstone, an
investment management company, since 1986 and Chairman and Chief Executive
Officer of Edwardstone since 1989. From 1988 to 1997, Mr. Toms served as
Chairman, President and Chief Executive Officer of Peak Technologies.
Otto Leistner has been a Director since April 2000. He has been a
Partner since 1995 in Leistner Pokoj Schnedler, a midsize accounting and
consulting firm in Frankfurt, Germany with a staff of approximately 100.
Barbara H. Martorano joined us in June 1990 and has served in a variety
of positions, including Sales Order Processing Coordinator, Office
Administrator, Executive Assistant to the President, CEO and Chairman of the
Board, as well as Corporate Secretary as of January 17, 1996.
37
EXECUTIVE COMPENSATION
The following tables set forth certain information regarding our CEO
and each of our most highly-compensated executive officers whose total annual
salary and bonus for the fiscal year ending September 30, 2004, 2003 and 2002
exceeded $100,000:
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION
Other
Annual Restricted Options LTIP
Name & Principal Salary Bonus Compen- Stock SARs Payouts All Other
Position Year ($) ($) sation ($) Awards($) (#) ($) Compensation
- ------------------------ ------- ------------ ------------ ------------ ------------- ----------- ------------ --------------
Hugo H. Biermann 2004 0 0 0 - - - -
Executive Chairman of 2003 0 0 0 - - - -
the Board of Directors 2002 300,000 0 0 - - - -
- ------------------------ ------- ------------ ------------ ------------ ------------- ----------- ------------ --------------
Nicholas R. H. Toms 2004 50,000 0 0 - - - -
Chief Executive Officer 2003 91,667 0 0 - - - -
Chief Financial Officer 2002 300,000 0 0 - - - -
- ------------------------ ------- ------------ ------------ ------------ ------------- ----------- ------------ --------------
Mark A. Flint 2004 0 0 0 - - - -
Chief Financial Officer 2003 218,589 (1) 0 0 - - - -
2002 275,000 100,000 (2) 0 - - - -
- ------------------------ ------- ------------ ------------ ------------ ------------- ----------- ------------ --------------
Donald W. Rowley 2004 0 0 0 - - - -
Executive VP - 2003 101,667 (3) 0 0 - - - -
Strategic Development 2002 225,000 0 0 - - - -
- ------------------------ ------- ------------ ------------ ------------ ------------- ----------- ------------ --------------
Robert Schilt 2004 100,000 0 0 - - - -
Chief Technology Officer2003 214,475 0 0 - - - -
XeQute Solutions, Inc. 2002 235,828 105,000 0 - - - -
- ------------------------ ------- ------------ ------------ ------------ ------------- ----------- ------------ --------------
Timothy Callahan 2004 50,000 0 0 - - - -
Vice President 2003 198,750 0 0 - - - -
Sales and Marketing 2002 170,625 0 0 - - - -
(1) Mr. Flint was laid off in August, 2003.
(2) Such amount is accrued however unpaid as of October 7, 2005.
(3) Mr. Rowley resigned as an officer in February, 2003, and was laid off in
June, 2003.
Option/SAR Grants in Last Fiscal Year
During the fiscal year ended September 30, 2004, no stock or stock
options were granted.
Directors and Committee Members did not receive, and were not eligible
for, compensation from us during the fiscal year ending September 30, 2004.
Stock Option Plans
On October 10, 1985, the board of directors adopted our 1985 Incentive
Stock Option Plan which was amended on February 14, 2000. We reserved 8,000,000
shares of common stock for issuance upon exercise of options granted from time
to time under the 1985 plan. The 1985 stock option plan is intended to assist us
in securing and retaining key employees, directors and consultants by allowing
them to participate in our ownership and growth through the grant of stock
options.
Under the stock compensation plan, we may grant stock options only to
employees and consultants. The 1985 stock option plan is administered directly
by our board of directors.
Subject to the provisions of the stock option plan, the board will
determine who shall receive stock options, the number of shares of common stock
that may be purchased under the options, the time and manner of exercise of
options and exercise prices.
As of October 1, 2005, there were 4,160,500 stock options granted under
the 1985 plan that were outstanding.
38
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On June 25, 2004, as part of an Investment Restructuring Agreement with
six shareholders, who are also our principal shareholders, we exchanged class C
preferred stock for class C-1 convertible preferred stock on a 1:1 basis. Each
share of Series C-1 convertible preferred stock is convertible into $1,000 worth
of our common stock, at the selling stockholders' option, at the lower of (i)
$0.30 or (ii) 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.
On September 27, 2004, we issued 7,615 shares of class D convertible
preferred stock to MidMark Capital, L.P. in exchange for $7,614,708 of debt,
including accrued interest, owed by our subsidiaries and us to MidMark Capital
II, L.P. In addition, on September 27, 2004, we issued 5,569,980 shares of
common stock to MidMark Capital, L.P. upon exercise of warrants by MidMark
Capital, L.P. The exercise price for the warrants was exchanged for the
retirement of $315,309 in debt owed by us to MidMark Capital, L.P. As well, on
September 27, 2004, we issued 240,000 shares of common stock to MidMark Capital
II, L.P. upon exercise of warrants by MidMark Capital II, L.P. The exercise
price for the warrants was exchanged for the retirement of $2,400 in debt owed
by us to MidMark Capital II, L.P. Each share of the class D convertible
preferred stock is convertible into $1,000 worth of our common stock, at MidMark
Capital's option, at the lower of (i) $0.30 or (ii) 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.
39
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding beneficial
ownership of our common stock as of October 7, 2005
o by each person who is known by us to beneficially own more
than 5% of our common stock;
o by each of our officers and directors; and
o by all of our officers and directors as a group.
PERCENTAGE OF PERCENTAGE OF
CLASS CLASS
NAME AND ADDRESS NUMBER OF PRIOR TO AFTER
OF OWNER TITLE OF CLASS SHARES OWNED(1) OFFERING(2) OFFERING(3)
- -----------------------------------------------------------------------------------------------------
Hugo H. Biermann Common Stock 2,863,010 (4) 3.09% *
3619 Kennedy Road
South Plainfield, NJ 07080
Nicholas R. H. Toms Common Stock 3,563,418 (5) 3.85% *
3619 Kennedy Road
South Plainfield, NJ 07080
Otto Leistner Common Stock 2,672,875 (6) 2.90% *
3619 Kennedy Road
South Plainfield, NJ 07080
Barbara Martorano Common Stock 19,000 (7) * *
3619 Kennedy Road
South Plainfield, NJ 07080
All Officers and Directors Common Stock 9,118,303 (8) 9.78% *
As a Group (4 persons)
- ----------------------------
American Marketing Complex Common Stock 9,455,000 10.26% *
330 East 33rd Street, Suite 15M
New York, NY 10016
MidMark Capital L.P. Common Stock 7,142,529 (9) 7.65% *
177 Madison Avenue
Morristown, NJ 07960
MidMark Capital II L.P. Common Stock 300,932,809 (10) 76.60% *
177 Madison Avenue
Morristown, NJ 07960
=====================================================================================================
Pitney Bowes, Inc. Preferred A 1,356,852 100% 100%
One Elmcroft Road
Stamford, CT 06926
=====================================================================================================
Pitney Bowes, Inc. Preferred B 1,000 100% 100%
One Elmcroft Road
Stamford, CT 06926
=====================================================================================================
MidMark Capital II L.P. Preferred C-1 805 80.74% 0%
177 Madison Avenue
Morristown, NJ 07960
Paine Webber Custodian Preferred C-1 50 5.02% 0%
F/B/O Wayne Clevenger
177 Madison Avenue
Morristown, NJ 07960
Joseph Robinson Preferred C-1 50 5.02% 0%
177 Madison Avenue
Morristown, NJ 07960
O'Brien Ltd Partnership Preferred C-1 50 5.02% 0%
177 Madison Avenue
Morristown, NJ 07960
=====================================================================================================
MidMark Capital II, L.P. Preferred D 7,615 100% 0%
177 Madison Avenue
Morristown, NJ 07960
40
(1) Beneficial Ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or investment
power with respect to securities. Shares of common stock subject to options or
warrants currently exercisable or convertible, or exercisable or convertible
within 60 days of October 7, 2005 are deemed outstanding for computing the
percentage of the person holding such option or warrant but are not deemed
outstanding for computing the percentage of any other person.
(2) For purposes of calculating the percentage beneficially owned, the number of
shares of each class of stock deemed outstanding include 92,186,066 common
shares; 1,356,852 Preferred "A" Shares; 1,000 Preferred "B" Shares; 997
Preferred "C" Shares and 7,615 Preferred "D" Shares outstanding as of October 7,
2005.
(3) Percentage based on 950,386,066 shares of common stock outstanding.
(4) Includes 475,000 shares issuable pursuant to presently exercisable options
and 388,010 shares held in the name of Bunter BVI Limited of which Mr. Biermann
may be deemed to be a beneficiary. Mr. Biermann, however, disclaims such
beneficial ownership.
(5) Includes 475,000 shares issuable pursuant to presently exercisable options,
7,000 shares held by his wife, Caroline Toms, and 75,000 shares held in a trust
for the benefit of his daughter, Catherine Toms, of which Mr. Toms is the
trustee. Mr. Toms, however, disclaims such beneficial ownership of the shares
owned by his wife and in the trust.
(6) Includes 50,000 shares issuable pursuant to presently exercisable options.
(7) Includes 19,000 shares issuable pursuant to presently exercisable options.
(8) Includes 1,019,000 shares issuable pursuant to presently exercisable options
and 388,010 shares held by a company for which by Mr. Biermann disclaims
beneficial ownership.
(9) Includes 1,214,199 shares issuable upon conversion of class C-1 convertible
preferred stock.
(10) Includes 271,944,862 shares issuable upon conversion of class D convertible
preferred stock, and 28,747,947 shares issuable upon conversion of class C-1
convertible preferred stock.
41
DESCRIPTION OF SECURITIES
COMMON STOCK
We are authorized to issue up to 1,000,000,000 shares of common stock,
par value $.005. As of October 7, 2005, there were 92,186,066 shares of common
stock outstanding. Holders of the common stock are entitled to one vote per
share on all matters to be voted upon by the stockholders. Holders of common
stock are entitled to receive ratably such dividends, if any, as may be declared
by the Board of Directors out of funds legally available therefor. Upon the
liquidation, dissolution, or winding up of our company, the holders of common
stock are entitled to share ratably in all of our assets which are legally
available for distribution after payment of all debts and other liabilities and
liquidation preference of any outstanding common stock. Holders of common stock
have no preemptive, subscription, redemption or conversion rights. The
outstanding shares of common stock are validly issued, fully paid and
nonassessable.
We have engaged Continental Stock Transfer & Trust Company, located in
New York, New York, as independent transfer agent or registrar.
PREFERRED STOCK
We are authorized to issue up to 2,000,000 shares of Preferred Stock,
par value $.01. As of October 7, 2005, there were 1,356,852 shares of Class A
Preferred Stock outstanding, 1,000 shares of Class B Preferred Stock
outstanding, 997 shares of Class C-1 Preferred Stock outstanding and 7,615
shares of Class D Preferred Stock outstanding. Each share of Class A Preferred
is convertible into 1 share of our common stock. Each share of Class B Preferred
is convertible into 1,190 shares of our common stock. Each share of the Class
C-1 and Class D Convertible Preferred is convertible into $1,000 worth of our
common stock, at the selling stockholders' option, at the lower of (i) $0.30 or
(ii) 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.
OPTIONS
There are currently outstanding options to purchase 10,228,514 shares
of our common stock consisting of the following: (i) 5,618,014 options granted
under our non-qualified plan; and (ii) 4,610,500 options granted under our
qualified plan.
WARRANTS
In connection with a Securities Purchase Agreement dated April 28,
2004, we have issued 3,000,000 warrants to purchase shares of common stock
exercisable until five years from the date of issuance at a purchase price of
$0.11 per share. In connection with a Securities Purchase Agreement dated
January 11, 2005, we have issued 1,850,000 warrants to purchase shares of common
stock exercisable until five years from the date of issuance at a purchase price
of $0.09 per share. In connection with a Securities Purchase Agreement dated
August 10, 2005, we have issued 250,000 warrants to purchase shares of common
stock and are obligated to issue 600,000 additional warrants. The warrants are
exercisable until five years from the date of issuance at a purchase price of
$0.09 per share.
CONVERTIBLE SECURITIES
Not including approximately 14,879,114 shares of common stock issuable
upon exercise of outstanding options and warrants, approximately 236,521,428
shares of common stock are issuable upon conversion of outstanding promissory
notes, which includes 137,421,363 shares of common stock issuable upon
conversion of the secured convertible notes issued pursuant to the Securities
Purchase Agreement dated April 28, 2004 and 99,100,065 shares of common stock
issuable upon conversion of the secured convertible notes issued pursuant to the
Securities Purchase Agreement dated January 11, 2005.
To obtain funding for our ongoing operations, we entered into a
Securities Purchase Agreement with four accredited investors on April 28, 2004,
and amended on December 30, 2004, for the sale of (i) $3,000,000 in secured
convertible notes and (ii) warrants to buy 3,000,000 shares of our common stock.
Pursuant to a registration statement on Form S-1 (333-116714) declared effective
42
with the SEC on August 9, 2004, we previously registered 10,000,000 shares of
common stock underlying the convertible debentures and 3,000,000 shares of
common stock underlying the warrants. We are registering 130,000,000 shares in
this offering underlying the convertibles debentures and we are registering
6,000,000 shares underlying the warrants. As of October 7, 2005, $434,618 of the
convertible debentures has been converted and $2,565,382 remains outstanding.
This prospectus relates to the resale of the common stock underlying
these secured convertible notes and warrants. The investors provided us with an
aggregate of $3,000,000 as follows:
o $1,500,000 was disbursed on April 28, 2004;
o $750,000 was disbursed on May 28, 2004; and
o $750,000 was disbursed on August 12, 2004.
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:
o $0.30; or
o 40% 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.
The full principal amount of the secured convertible notes is due upon
default under the terms of secured convertible notes. The 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.
To obtain funding for our ongoing operations, we entered into a
Securities Purchase Agreement with four accredited investors on January 11, 2005
for the sale of (i) $1,850,000 in secured convertible notes and (ii) warrants to
buy 1,850,000 shares of our common stock.
This prospectus relates to the resale of the common stock underlying
these secured convertible notes and warrants. The investors purchased all the
secured convertible notes on January 11, 2005.
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:
o $0.09; or
o 40% 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.
43
The full principal amount of the secured convertible notes is due upon
default under the terms of secured convertible notes. The 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.
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.
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.
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.
COMMISSION'S POSITION ON INDEMNIFICATION FOR SECURITIES ACT LIABILITIES
Our Articles of Incorporation, as amended, provide to the fullest
extent permitted by New Jersey law, our directors or officers shall not be
personally liable to us or our shareholders for damages for breach of such
director's or officer's fiduciary duty. The effect of this provision of our
Articles of Incorporation, as amended, is to eliminate our rights and our
shareholders (through shareholders' derivative suits on behalf of our company)
to recover damages against a director or officer for breach of the fiduciary
duty of care as a director or officer (including breaches resulting from
negligent or grossly negligent behavior), except under certain situations
defined by statute. We believe that the indemnification provisions in our
Articles of Incorporation, as amended, are necessary to attract and retain
qualified persons as directors and officers.
44
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 (the "Act" or "Securities Act") may be permitted to directors,
officers or persons controlling us pursuant to the foregoing provisions, or
otherwise, we have been advised that in the opinion of the Securities and
Exchange Commission, such indemnification is against public policy as expressed
in the Act and is, therefore, unenforceable.
PLAN OF DISTRIBUTION
The selling stockholders and any of their respective pledgees, donees,
assignees and other successors-in-interest may, from time to time, sell any or
all of their shares of common stock on any stock exchange, market or trading
facility on which the shares are traded or in private transactions. These sales
may be at fixed or negotiated prices. The selling stockholders may use any one
or more of the following methods when selling shares:
o ordinary brokerage transactions and transactions in which the
broker-dealer solicits the purchaser;
o block trades in which the broker-dealer will attempt to sell
the shares as agent but may position and resell a portion of
the block as principal to facilitate the transaction;
o purchases by a broker-dealer as principal and resale by the
broker-dealer for its account;
o an exchange distribution in accordance with the rules of the
applicable exchange;
o privately-negotiated transactions;
o short sales that are not violations of the laws and
regulations of any state or the United States;
o broker-dealers may agree with the selling stockholders to sell
a specified number of such shares at a stipulated price per
share;
o through the writing of options on the shares
o a combination of any such methods of sale; and
o any other method permitted pursuant to applicable law.
The selling stockholders may also sell shares under Rule 144 under the
Securities Act, if available, or Regulation S, rather than under this
prospectus. The selling stockholders shall have the sole and absolute discretion
not to accept any purchase offer or make any sale of shares if they deem the
purchase price to be unsatisfactory at any particular time.
The selling stockholders may also engage in short sales against the
box, puts and calls and other transactions in our securities or derivatives of
our securities and may sell or deliver shares in connection with these trades.
The selling stockholders or their respective pledgees, donees,
transferees or other successors in interest, may also sell the shares directly
to market makers acting as principals and/or broker-dealers acting as agents for
themselves or their customers. Such broker-dealers may receive compensation in
the form of discounts, concessions or commissions from the selling stockholders
and/or the purchasers of shares for whom such broker-dealers may act as agents
or to whom they sell as principal or both, which compensation as to a particular
broker-dealer might be in excess of customary commissions. Market makers and
block purchasers purchasing the shares will do so for their own account and at
their own risk. It is possible that a selling stockholder will attempt to sell
shares of common stock in block transactions to market makers or other
purchasers at a price per share which may be below the then market price. The
selling stockholders cannot assure that all or any of the shares offered in this
prospectus will be issued to, or sold by, the selling stockholders. The selling
stockholders and any brokers, dealers or agents, upon effecting the sale of any
of the shares offered in this prospectus, may be deemed to be "underwriters" as
that term is defined under the Securities Act of 1933, as amended, or the
Securities Exchange Act of 1934, as amended, or the rules and regulations under
such acts. In such event, any commissions received by such broker-dealers or
agents and any profit on the resale of the shares purchased by them may be
deemed to be underwriting commissions or discounts under the Securities Act.
We are required to pay all fees and expenses incident to the
registration of the shares, including fees and disbursements of counsel to the
selling stockholders, but excluding brokerage commissions or underwriter
discounts.
The selling stockholders, alternatively, may sell all or any part of
the shares offered in this prospectus through an underwriter. No selling
stockholder has entered into any agreement with a prospective underwriter and
there is no assurance that any such agreement will be entered into.
45
The selling stockholders may pledge their shares to their brokers under
the margin provisions of customer agreements. If a selling stockholders defaults
on a margin loan, the broker may, from time to time, offer and sell the pledged
shares. The selling stockholders and any other persons participating in the sale
or distribution of the shares will be subject to applicable provisions of the
Securities Exchange Act of 1934, as amended, and the rules and regulations under
such act, including, without limitation, Regulation M. These provisions may
restrict certain activities of, and limit the timing of purchases and sales of
any of the shares by, the selling stockholders or any other such person. In the
event that the selling stockholders are deemed affiliated purchasers or
distribution participants within the meaning of Regulation M, then the selling
stockholders will not be permitted to engage in short sales of common stock.
Furthermore, under Regulation M, persons engaged in a distribution of securities
are prohibited from simultaneously engaging in market making and certain other
activities with respect to such securities for a specified period of time prior
to the commencement of such distributions, subject to specified exceptions or
exemptions. In regards to short sales, the selling stockholder can only cover
its short position with the securities they receive from us upon conversion. In
addition, if such short sale is deemed to be a stabilizing activity, then the
selling stockholder will not be permitted to engage in a short sale of our
common stock. All of these limitations may affect the marketability of the
shares.
We have agreed to indemnify the selling stockholders, or their
transferees or assignees, against certain liabilities, including liabilities
under the Securities Act of 1933, as amended, or to contribute to payments the
selling stockholders or their respective pledgees, donees, transferees or other
successors in interest, may be required to make in respect of such liabilities.
If the selling stockholders notify us that they have a material
arrangement with a broker-dealer for the resale of the common stock, then we
would be required to amend the registration statement of which this prospectus
is a part, and file a prospectus supplement to describe the agreements between
the selling stockholders and the broker-dealer.
PENNY STOCK
The Securities and Exchange Commission has adopted Rule 15g-9 which
establishes the definition of a "penny stock," for the purposes relevant to us,
as any equity security that has a market price of less than $5.00 per share or
with an exercise price of less than $5.00 per share, subject to certain
exceptions. For any transaction involving a penny stock, unless exempt, the
rules require:
o that a broker or dealer approve a person's account for
transactions in penny stocks; and
o the broker or dealer receive from the investor a written
agreement to the transaction, setting forth the identity and
quantity of the penny stock to be purchased.
In order to approve a person's account for transactions in penny
stocks, the broker or dealer must
o obtain financial information and investment experience
objectives of the person; and
o make a reasonable determination that the transactions in penny
stocks are suitable for that person and the person has
sufficient knowledge and experience in financial matters to be
capable of evaluating the risks of transactions in penny
stocks.
The broker or dealer must also deliver, prior to any transaction in a
penny stock, a disclosure schedule prescribed by the Commission relating to the
penny stock market, which, in highlight form:
o sets forth the basis on which the broker or dealer made the
suitability determination; and
o that the broker or dealer received a signed, written agreement
from the investor prior to the transaction.
Disclosure also has to be made about the risks of investing in penny
stocks in both public offerings and in secondary trading and about the
commissions payable to both the broker-dealer and the registered representative,
current quotations for the securities and the rights and remedies available to
an investor in cases of fraud in penny stock transactions. Finally, monthly
statements have to be sent disclosing recent price information for the penny
stock held in the account and information on the limited market in penny stocks.
46
SELLING STOCKHOLDERS
The table below sets forth information concerning the resale of the
shares of common stock by the selling stockholders. We will not receive any
proceeds from the resale of the common stock by the selling stockholders. We
will receive proceeds from the exercise of the warrants. Assuming all the shares
registered below are sold by the selling stockholders, none of the selling
stockholders will continue to own any shares of our common stock.
The following table also sets forth the name of each person who is
offering the resale of shares of common stock by this prospectus, the number of
shares of common stock beneficially owned by each person, the number of shares
of common stock that may be sold in this offering and the number of shares of
common stock each person will own after the offering, assuming they sell all of
the shares offered.
- ------------------- ----------------- ------------- ------------- ------------ -------------- ------------ -------------
Total
Total Shares of Percentage Percentage
Common Stock of Common Shares of Beneficial of Common
Issuable Upon Stock, Common Stock Beneficial Percentage of Ownership Stock Owned
Conversion of Assuming Included in Ownership Common Stock After the After
Name Notes, Preferred Full Prospectus Before the Owned Before Offering Offering
Stock and/or Conversion (1) Offering** Offering** (3) (3)
Warrants*
- ------------------- ----------------- ------------- ------------- ------------ -------------- ------------ -------------
AJW Offshore, Ltd. 95,249,029 50.82% Up to 4,749,860 4.90% -- --
(2) 149,749,640
shares of
common stock
- ------------------- ----------------- ------------- ------------- ------------ -------------- ------------ -------------
AJW Qualified 94,070,066 50.51% Up to 4,749,860 4.90% -- --
Partners, LLC (2) 149,720,100
shares of
common stock
- ------------------- ----------------- ------------- ------------- ------------ -------------- ------------ -------------
AJW Partners, LLC 43,226,783 31.92% Up to 4,749,860 4.90% -- --
(2) 68,045,000
shares of
common stock
- ------------------- ----------------- ------------- ------------- ------------ -------------- ------------ -------------
New Millennium 8,825,551 8.74% Up to 4,749,860 4.90% -- --
Capital Partners 12,185,260
II, LLC (2) shares of
common stock
- ------------------- ----------------- ------------- ------------- ------------ -------------- ------------ -------------
MidMark Capital, 1,214,199 1.30% Up to 4,749,860 4.90% 5,928,330 0.62%
L.P. (4) 1,889,268
shares of
common stock
- ------------------- ----------------- ------------- ------------- ------------ -------------- ------------ -------------
MidMark Capital II, 300,692,809 76.54% Up to 4,749,860 4.90% -- --
L.P. (4) 467,831,193
shares of
common stock
- ------------------- ----------------- ------------- ------------- ------------ -------------- ------------ -------------
Paine Webber 1,785,587 1.90% Up to 1,785,587 1.90% -- --
Custodian F/B/O 2,778,335
Wayne Clevenger shares of
common stock
- ------------------- ----------------- ------------- ------------- ------------ -------------- ------------ -------------
Joseph Robinson 1,785,587 1.90% Up to 1,785,587 1.90% -- --
2,778,335
shares of
common stock
- ------------------- ----------------- ------------- ------------- ------------ -------------- ------------ -------------
O'Brien Ltd 1,785,587 1.90% Up to 1,785,587 1.90% -- --
Partnership (5) 2,778,335
shares of
common stock
- ------------------- ----------------- ------------- ------------- ------------ -------------- ------------ -------------
Matthew Finlay & 285,694 0.31% Up to 285,694 0.31% -- --
Teresa Finlay 444,534
JTWROS shares of
common stock
- ------------------- ----------------- ------------- ------------- ------------ -------------- ------------ -------------
47
* This column represents an estimated number based on conversion prices as of a
recent date of October 7, 2005 of $.018668 and $.028002, divided into the
principal amounts of the convertible notes and preferred stock, respectively.
** These columns represent the aggregate maximum number and percentage of shares
that the selling stockholders can own at one time (and therefore, offer for
resale at any one time) due to their 4.9% limitation.
The number and percentage of shares beneficially owned is determined in
accordance with Rule 13d-3 of the Securities Exchange Act of 1934, and the
information is not necessarily indicative of beneficial ownership for any other
purpose. Under such rule, beneficial ownership includes any shares as to which
the selling stockholders has sole or shared voting power or investment power and
also any shares, which the selling stockholders has the right to acquire within
60 days. The actual number of shares of common stock issuable upon the
conversion of the secured convertible notes is subject to adjustment depending
on, among other factors, the future market price of the common stock, and could
be materially less or more than the number estimated in the table.
(1) Includes a good faith estimate of the shares issuable upon conversion of
the secured convertible notes and exercise of warrants, based on current market
prices. Because the number of shares of common stock issuable upon conversion of
the secured convertible notes is dependent in part upon the market price of the
common stock prior to a conversion, the actual number of shares of common stock
that will be issued upon conversion will fluctuate daily and cannot be
determined at this time. Under the terms of the secured convertible notes, if
the secured convertible notes had actually been converted on October 7, 2005,
the secured convertible notes would have had a conversion price of $.018668. The
actual number of shares of common stock offered in this prospectus, and included
in the registration statement of which this prospectus is a part, includes such
additional number of shares of common stock as may be issued or issuable upon
conversion of the secured convertible notes and exercise of the related warrants
by reason of any stock split, stock dividend or similar transaction involving
the common stock, in accordance with Rule 416 under the Securities Act of 1933.
However the selling stockholders have contractually 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
common stock as determined in accordance with Section 13(d) of the Exchange Act.
Accordingly, the number of shares of common stock set forth in the table for the
selling stockholders exceeds the number of shares of common stock that the
selling stockholders could own beneficially at any given time through their
ownership of the secured convertible notes and the warrants. In that regard, the
beneficial ownership of the common stock by the selling stockholder set forth in
the table is not determined in accordance with Rule 13d-3 under the Securities
Exchange Act of 1934, as amended.
(2) The selling stockholders are affiliates of each other because they are under
common control. AJW Partners, LLC is a private investment fund that is owned by
its investors and managed by SMS Group, LLC. SMS Group, LLC, of which Mr. Corey
S. Ribotsky is the fund manager, has voting and investment control over the
shares listed below owned by AJW Partners, LLC. AJW Offshore, Ltd., formerly
known as AJW/New Millennium Offshore, Ltd., is a private investment fund that is
owned by its investors and managed by First Street Manager II, LLC. First Street
Manager II, LLC, of which Corey S. Ribotsky is the fund manager, has voting and
investment control over the shares owned by AJW Offshore, Ltd. AJW Qualified
Partners, LLC, formerly known as Pegasus Capital Partners, LLC, is a private
investment fund that is owned by its investors and managed by AJW Manager, LLC,
of which Corey S. Ribotsky and Lloyd A. Groveman are the fund managers, have
voting and investment control over the shares listed below owned by AJW
Qualified Partners, LLC. New Millennium Capital Partners II, LLC, is a private
investment fund that is owned by its investors and managed by First Street
Manager II, LLC. First Street Manager II, LLC, of which Corey S. Ribotsky is the
fund manager, has voting and investment control over the shares owned by New
Millennium Capital Partners II, LLC. We have been notified by the selling
stockholders that they are not broker-dealers or affiliates of broker-dealers
and that they believe they are not required to be broker-dealers.
(3) Assumes that all securities registered will be sold.
48
(4) The selling stockholders are affiliates of each other because they are under
common control. MidMark Capital, L.P., is a private investment fund that is
owned by its partners and managed by its General Partner, MidMark Associates
Inc. MidMark Associates Inc., of which Messrs. Wayne Clevenger, Joseph Robinson
and Denis Newman are the owners, have equal voting and investment control over
the shares listed below owned by MidMark Capital, L.P. MidMark Capital II, L.P.,
is a private investment fund that is owned by its partners and managed by its
General Partner, MidMark Associates II LLC. MidMark Associates II LLC, of which
Messrs. Wayne Clevenger, Joseph Robinson and Denis Newman are the owners, have
equal voting and investment control over the shares listed below owned by
MidMark Capital, L.P. We have been notified by the selling stockholders that
they are not broker-dealers or affiliates of broker-dealers and that they
believe they are not required to be broker-dealers.
(5) O'Brien Ltd Partnership is controlled by its two General Partners, Denis
Newman and Mary Newman.
TERMS OF SECURED CONVERTIBLE NOTES
April 2004 Securities Purchase Agreement
To obtain funding for our ongoing operations, we entered into a
Securities Purchase Agreement with four accredited investors on April 28, 2004,
and amended on December 30, 2004, for the sale of (i) $3,000,000 in secured
convertible notes and (ii) a warrants to buy 3,000,000 shares of our common
stock.
The investors provided us with the funds as follows:
o $1,500,000 was disbursed on April 28, 2004;
o $750,000 was disbursed on May 28, 2004; and
o $750,000 was disbursed on August 12, 2004.
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:
o $0.30; or
o 40% 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.
The full principal amount of the secured convertible notes is due upon
default under the terms of secured convertible notes. In addition, we have
granted the investors a security interest in substantially all of our assets and
intellectual property and registration rights. We are liable for breach of any
covenant, representation or warranty contained in the Securities Purchase
Agreement for a period of two years from the date that the investors distribute
the final $750,000. In the event that we breach any representation or warranty
regarding the condition of our company as set forth in the Securities Purchase
Agreement, we are liable to pay liquidated damages in shares or cash, at the
election of the investors, equal to three percent of the outstanding amount of
the secured convertible notes per month plus accrued and unpaid interest. In the
event that we breach any covenant as set forth in the Securities Purchase
Agreement, including the failure to comply with blue sky laws, timely file all
public reports, use the proceeds from the sale of the secured convertible notes
in the agreed upon manner, obtain written consent from the investors to
negotiate or contract with a party to for additional financing, reserve and have
authorized the required number of shares of common stock or the maintenance of
our shares of common stock on an exchange or automated quotation system, then we
are liable to pay liquidated damages in shares or cash, at the election of the
investors, equal to three percent of the outstanding amount of the secured
convertible notes per month plus accrued and unpaid interest.
In connection with the Securities Purchase Agreement, we executed a
Security Agreement and an Intellectual Property Security Agreement in favor of
the investors granting them a first priority security interest in all of our
goods, inventory, contractual rights and general intangibles, receivables,
documents, instruments, chattel paper, and intellectual property. Under the
Security Agreement and Intellectual Property Security Agreement, events of
default occur upon:
49
o The occurrence of an event of default (as defined in the
secured convertible notes) under the secured convertible
notes;
o Any representation or warranty we made in the Security
Agreement or in the Intellectual Property Security Agreement
shall prove to have been incorrect in any material respect
when made;
o The failure by us to observe or perform any of our obligations
under the Security Agreement or in the Intellectual Property
Security Agreement for ten (10) days after receipt of notice
of such failure from the investors; and
o Any breach of, or default under, the Warrants.
An event of default under the secured convertible notes occurs if we:
o Fail to pay the principal or interest when due;
o Do not issue shares of common stock upon receipt of a
conversion notice;
o Fail to file a registration statement within 60 days after
April 28, 2004 or fail to have the registration statement
effective within 115 days after April 28, 2004;
o Breach any material covenant or other material term or
condition in the secured convertible notes or the Securities
Purchase Agreement;
o Breach any representation or warranty made in the Securities
Purchase Agreement or other document executed in connection
therewith;
o Apply for or consent to the appointment of a receiver or
trustee for us or any of our subsidiaries or for a substantial
part of our of our subsidiaries' property or business, or such
a receiver or trustee shall otherwise be appointed;
o Have any money judgment, writ or similar process shall be
entered or filed against us or any of our subsidiaries or any
of our property or other assets for more than $50,000, and
shall remain unvacated, unbonded or unstayed for a period of
twenty (20) days unless otherwise consented to by the
investors;
o Institute or have instituted against us or any of our
subsidiaries any bankruptcy, insolvency, reorganization or
liquidation proceedings or other proceedings for relief under
any bankruptcy law or any law for the relief of debtors;
o Fail to maintain the listing of our common stock on one of the
OTCBB or an equivalent replacement exchange, the Nasdaq
National Market, the Nasdaq SmallCap Market, the New York
Stock Exchange, or the American Stock Exchange; or
o Default under any other secured convertible note issued
pursuant to the Securities Purchase Agreement.
Upon occurrence of any event of default under either the Security
Agreement or the Intellectual Property Security Agreement, the investors shall
have the right to exercise all of the remedies conferred under the Security
Agreement, the Intellectual Property and under the secured convertible notes,
and the investors shall have all the rights and remedies of a secured party
under the Uniform Commercial Code and/or any other applicable law (including the
Uniform Commercial Code of any jurisdiction in which any collateral is then
located). The investors shall have the following rights and powers:
o To take possession of the collateral and, for that purpose,
enter, with the aid and assistance of any person, any premises
where the collateral, or any part thereof, is or may be placed
and remove the same, and we shall assemble the collateral and
make it available to the investors at places which the
investors shall reasonably select, whether at our premises or
elsewhere, and make available to the investors, without rent,
all of our respective premises and facilities for the purpose
of the investors taking possession of, removing or putting the
collateral in saleable or disposable form; and
o To operate our business using the collateral and shall have
the right to assign, sell, lease or otherwise dispose of and
deliver all or any part of the collateral, at public or
private sale or otherwise, either with or without special
conditions or stipulations, for cash or on credit or for
future delivery, in such parcel or parcels and at such time or
times and at such place or places, and upon such terms and
conditions as the investors may deem commercially reasonable,
all without (except as shall be required by applicable statute
and cannot be waived) advertisement or demand upon or notice
to us or our right of redemption, which we expressly waived.
Upon each such sale, lease, assignment or other transfer of
collateral, the investors may, unless prohibited by applicable
law which cannot be waived, purchase all or any part of the
collateral being sold, free from and discharged of all trusts,
claims, right of redemption and equities by us, which we
waived and released.
50
The warrants are exercisable until five years from the date of issuance
at a purchase price of $0.11 per share. The selling stockholders will be
entitled to 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 that the selling stockholder exercises 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 this warrant or issued in connection with the secured
convertible notes issued pursuant to the Securities Purchase Agreement, dated
April 28, 2004.
Upon the 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.
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 selling stockholders have contractually 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 and their affiliates in the aggregate after such conversion
or exercise does not exceed 4.9% of the then issued and outstanding shares of
common stock.
JANUARY 2005 SECURITIES PURCHASE AGREEMENT
To obtain funding for our ongoing operations, we entered into a
Securities Purchase Agreement with four accredited investors on January 11, 2005
for the sale of (i) $1,850,000 in secured convertible notes and (ii) a warrants
to buy 1,850,000 shares of our common stock. The investors provided us with
$1,850,000 on January 11, 2005.
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:
o $0.09; or
o 40% 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.
The full principal amount of the secured convertible notes is due upon
default under the terms of secured convertible notes. In addition, we have
granted the investors a security interest in substantially all of our assets and
intellectual property and registration rights. We are liable for breach of any
covenant, representation or warranty contained in the Securities Purchase
Agreement for a period of two years from January 11, 2005. In the event that we
breach any representation or warranty regarding the condition of our company as
set forth in the Securities Purchase Agreement, we are liable to pay liquidated
damages in shares or cash, at the election of the investors, equal to three
percent of the outstanding amount of the secured convertible notes per month
plus accrued and unpaid interest. In the event that we breach any covenant as
set forth in the Securities Purchase Agreement, including the failure to comply
with blue sky laws, timely file all public reports, use the proceeds from the
sale of the secured convertible notes in the agreed upon manner, obtain written
51
consent from the investors to negotiate or contract with a party to for
additional financing, reserve and have authorized the required number of shares
of common stock or the maintenance of our shares of common stock on an exchange
or automated quotation system, then we are liable to pay liquidated damages in
shares or cash, at the election of the investors, equal to three percent of the
outstanding amount of the secured convertible notes per month plus accrued and
unpaid interest.
In connection with the Securities Purchase Agreement, we executed a
Security Agreement and an Intellectual Property Security Agreement in favor of
the investors granting them a first priority security interest in all of our
goods, inventory, contractual rights and general intangibles, receivables,
documents, instruments, chattel paper, and intellectual property. Under the
Security Agreement and Intellectual Property Security Agreement, events of
default occur upon:
o The occurrence of an event of default (as defined in the
secured convertible notes) under the secured convertible
notes;
o Any representation or warranty we made in the Security
Agreement or in the Intellectual Property Security Agreement
shall prove to have been incorrect in any material respect
when made;
o The failure by us to observe or perform any of our obligations
under the Security Agreement or in the Intellectual Property
Security Agreement for ten (10) days after receipt of notice
of such failure from the investors; and
o Any breach of, or default under, the Warrants.
An event of default under the secured convertible notes occurs if we:
o Fail to pay the principal or interest when due;
o Do not issue shares of common stock upon receipt of a
conversion notice;
o Fail to file a registration statement within 30 days after
January 11, 2005 or fail to have the registration statement
effective within 60 days after January 11, 2005;
o Breach any material covenant or other material term or
condition in the secured convertible notes or the Securities
Purchase Agreement;
o Breach any representation or warranty made in the Securities
Purchase Agreement or other document executed in connection
therewith;
o Apply for or consent to the appointment of a receiver or
trustee for us or any of our subsidiaries or for a substantial
part of our of our subsidiaries' property or business, or such
a receiver or trustee shall otherwise be appointed;
o Have any money judgment, writ or similar process shall be
entered or filed against us or any of our subsidiaries or any
of our property or other assets for more than $50,000, and
shall remain unvacated, unbonded or unstayed for a period of
twenty (20) days unless otherwise consented to by the
investors;
o Institute or have instituted against us or any of our
subsidiaries any bankruptcy, insolvency, reorganization or
liquidation proceedings or other proceedings for relief under
any bankruptcy law or any law for the relief of debtors;
o Fail to maintain the listing of our common stock on one of the
OTCBB or an equivalent replacement exchange, the Nasdaq
National Market, the Nasdaq SmallCap Market, the New York
Stock Exchange, or the American Stock Exchange; or
o Default under any other secured convertible note issued
pursuant to the Securities Purchase Agreement.
Upon occurrence of any event of default under either the Security
Agreement or the Intellectual Property Security Agreement, the investors shall
have the right to exercise all of the remedies conferred under the Security
Agreement, the Intellectual Property and under the secured convertible notes,
and the investors shall have all the rights and remedies of a secured party
under the Uniform Commercial Code and/or any other applicable law (including the
Uniform Commercial Code of any jurisdiction in which any collateral is then
located). The investors shall have the following rights and powers:
o To take possession of the collateral and, for that purpose,
enter, with the aid and assistance of any person, any premises
where the collateral, or any part thereof, is or may be placed
and remove the same, and we shall assemble the collateral and
make it available to the investors at places which the
investors shall reasonably select, whether at our premises or
elsewhere, and make available to the investors, without rent,
all of our respective premises and facilities for the purpose
of the investors taking possession of, removing or putting the
collateral in saleable or disposable form; and
52
o To operate our business using the collateral and shall have
the right to assign, sell, lease or otherwise dispose of and
deliver all or any part of the collateral, at public or
private sale or otherwise, either with or without special
conditions or stipulations, for cash or on credit or for
future delivery, in such parcel or parcels and at such time or
times and at such place or places, and upon such terms and
conditions as the investors may deem commercially reasonable,
all without (except as shall be required by applicable statute
and cannot be waived) advertisement or demand upon or notice
to us or our right of redemption, which we expressly waived.
Upon each such sale, lease, assignment or other transfer of
collateral, the investors may, unless prohibited by applicable
law which cannot be waived, purchase all or any part of the
collateral being sold, free from and discharged of all trusts,
claims, right of redemption and equities by us, which we
waived and released.
The warrants are exercisable until five years from the date of issuance
at a purchase price of $0.09 per share. The selling stockholders will be
entitled to 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 that the selling stockholder exercises 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 this warrant or issued in connection with the secured
convertible notes issued pursuant to the Securities Purchase Agreement, dated
January 11, 2005.
Upon the 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.
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 selling stockholders have contractually 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 and their affiliates in the aggregate after such conversion
or exercise does not exceed 4.9% of the then issued and outstanding shares of
common stock.
A complete copy of the April 2004 and January 2005 Securities Purchase
Agreements and related documents are incorporated by reference as exhibits to
our amended Form SB-2 registration statement relating to this prospectus.
Sample Conversion Calculation
The number of shares of common stock issuable upon conversion of the
secured convertible notes is determined by dividing that portion of the
principal of the notes to be converted and interest, if any, by the conversion
price. For example, assuming conversion of the $4,415,382 of secured convertible
notes issued and outstanding on October 7, 2005, at a conversion price of
$0.018668, the number of shares issuable upon conversion would be:
$4,415,382/$0.018668 = 236,521,428 shares
The following is an example of the amount of shares of our common stock
that are issuable, upon conversion of the principal amount of our secured
convertible notes, based on market prices 25%, 50% and 75% below the market
price as of October 7, 2005 of $0.05.
53
Secured Convertible Notes
Number % of
% Below Price Per With Discount of Shares Outstanding
Market Share at 60% Issuable Stock
- ------ ----- ------ -------- -----
25% $.0375 $.015 294,225,467 76.14%
50% $.025 $.01 441,338,200 82.72%
75% $.0125 $.005 882,676,400 90.54%
LEGAL MATTERS
Sichenzia Ross Friedman Ference LLP, New York, New York will issue an
opinion with respect to the validity of the shares of common stock being offered
hereby.
EXPERTS
The consolidated financial statements of Cape Systems Group, Inc.
(formerly Vertex Interactive, Inc.) and subsidiaries as of and for the years
ended September 30, 2004 and 2003 included in this prospectus have been audited
by J.H. Cohn LLP, independent registered public accounting firm, as stated in
their report dated December 10, 2004, except for Notes 15 and 16 as to which the
date is December 21, 2004 and Note 18 as to which the date is April 8, 2005,
which report includes an explanatory paragraph relating to our ability to
continue as a going concern. Such consolidated financial statements have been so
included in reliance upon such report given on the authority of such firm as
experts in accounting and auditing.
AVAILABLE INFORMATION
We have filed a registration statement on Form SB-2 under the
Securities Act of 1933, as amended, relating to the shares of common stock being
offered by this prospectus, and reference is made to such registration
statement. This prospectus constitutes the prospectus of Cape Systems Group,
Inc., filed as part of the registration statement, and it does not contain all
information in the registration statement, as certain portions have been omitted
in accordance with the rules and regulations of the Securities and Exchange
Commission.
We are subject to the informational requirements of the Securities
Exchange Act of 1934 which requires us to file reports, proxy statements and
other information with the Securities and Exchange Commission. Such reports,
proxy statements and other information may be inspected at public reference
facilities of the SEC at 100 F Street, N.E., Washington D.C. 20549. Copies of
such material can be obtained from the Public Reference Section of the SEC at
100 F Street, N.E., Washington, D.C. 20549 at prescribed rates. Because we file
documents electronically with the SEC, you may also obtain this information by
visiting the SEC's Internet website at http://www.sec.gov.
54
INDEX TO FINANCIAL STATEMENTS
CAPE SYSTEMS GROUP, INC. (FORMERLY VERTEX INTERACTIVE, INC.)
AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm F-1
Consolidated Balance Sheets as of September 30, 2004 and 2003 F-2
Consolidated Statements of Operations for the years ended September 30,
2004 and 2003 F-5
Consolidated Statements of Changes in Stockholders' Deficiency
for the years ended September 30, 2004 and 2003 F-7
Consolidated Statements of Cash Flows for the years ended September 30,
2004 and 2003 F-9
Notes to Consolidated Financial Statements F-11 to
F-43
Condensed Consolidated Balance Sheets as of June 30, 2005 (Unaudited)
and September 30, 2004 F-44
Condensed Consolidated Statements of Operations for the three and nine
months ended June 30, 2005 and 2004 (Unaudited) F-46
Condensed Consolidated Statement of Changes in Stockholders' Deficiency
for the nine months ended June 30, 2005 (Unaudited) F-47
Condensed Consolidated Statements of Cash Flows for the nine months
ended June 30, 2005 and 2004 (Unaudited) F-49
Notes to the Condensed Consolidated Financial Statements (Unaudited) F-50 to F-62
Audited Financial Statements of Cape Systems and Consulting Services Ltd.
for the years ended December 31, 2003 and 2002 F-63
Audited Financial Statements of Cape Systems, Inc, for the years ended
December 31, 2003 and 2002 F-83
Unaudited pro forma condensed combined financial statements for Cape
Systems Group, Inc. (formerly Vertex Interactive, Inc.), Cape
Systems and Consulting Services Ltd. and Cape Systems, Inc. F-92
55
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Cape Systems Group, Inc.:
We have audited the accompanying consolidated balance sheets of Cape Systems
Group, Inc. (formerly Vertex Interactive, Inc.) and Subsidiaries as of September
30, 2004 and 2003, and the related consolidated statements of operations,
changes in stockholders' deficiency and cash flows for the years then ended.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Cape Systems Group,
Inc. and Subsidiaries as of September 30, 2004 and 2003, and their results of
operations and cash flows for the years then ended, in conformity with United
States generally accepted accounting principles.
The consolidated financial statements referred to above have been prepared
assuming that the Company will continue as a going concern. As further discussed
in Note 1 to the consolidated financial statements, among other things, the
Company's operations have generated recurring losses and it had working capital
and stockholders' deficiencies as of September 30, 2004. Such matters raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plans concerning these matters are also described in Note 1. The
accompanying consolidated financial statements as of and for the year ended
September 30, 2004 do not include any adjustments that might result from the
outcome of this uncertainty.
/s/ J.H. Cohn LLP
Roseland, New Jersey
December 10, 2004
except for Notes 15 and 16
as to which the date is
December 21, 2004 and
Note 18 as to
which the date is
April 8, 2005
F-1
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, 2004 and 2003
ASSETS 2004 2003
---------- ----------
CURRENT ASSETS:
Cash $ 101,390 $ 25,265
Restricted cash - short term 300,000
Accounts receivable, less allowance for
doubtful accounts of $456,358 350,935 639,208
Inventories, net of valuation allowances 368,086 537,337
Prepaid expenses and other current assets 71,696 20,103
---------- ----------
Total current assets 1,192,107 1,221,913
Equipment and improvements, net of accumulated
depreciation and amortization of $1,359,090
and $1,320,152 33,748 70,249
Capitalized software costs, net of accumulated
amortization of $347,269 and $231,513 -- 115,756
Restricted cash - long-term 150,000 --
Deferred financing costs, net of accumulated
amortization of $54,189 260,926 --
Other assets 111,273 111,273
---------- ----------
Total assets $1,748,054 $1,519,191
========== ==========
See notes to consolidated financial statements.
F-2
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, 2004 and 2003
LIABILITIES AND STOCKHOLDERS' DEFICIENCY 2004 2003
------------- -------------
CURRENT LIABILITIES:
Notes payable - unrelated parties $ 1,227,500 $ 1,869,236
Notes payable - related parties -- 4,095,848
Convertible notes payable - related parties -- 2,294,324
Mandatory redeemable Series D preferred stock -
504 shares at redemption value 504,713 --
Accounts payable 3,653,751 4,533,875
Net liabilities associated with subsidiaries in
liquidation 7,714,783 8,511,077
Payroll and related benefits accrual 1,994,852 2,622,354
Litigation related accruals 3,655,323 4,077,665
Other accrued expenses and liabilities 3,749,685 4,870,759
Deferred revenue 354,203 305,243
------------- -------------
Total current liabilities 22,854,810 33,180,381
Long-term convertible notes payable - unrelated parties,
net of unamortized debt discount 2,549,724 --
------------- -------------
Total Liabilities 25,404,534 33,180,381
------------- -------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' DEFICIENCY:
Series A preferred stock, par value $0.01 per share;
2,000,000 shares authorized, 1,356,852 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 issued and outstanding
($1,000,000 aggregate liquidation preference) 10 10
Series C preferred stock, par value $0.01 per share;
10,000 shares authorized, 997 issued and outstanding at
September 30, 2003 ($997,000 aggregate liquidation preference) 10
Series C-1 preferred stock, par value $0.01 per share;
10,000 shares authorized, 997 issued and outstanding at
September 30, 2004 ($997,000 aggregate liquidation preference) 10 --
Series D preferred stock, par value $0.01 per share;
10,000 shares authorized, 7,111 issued and outstanding
($7,109,995 aggregate liquidation preferences) 71 --
Common stock, par value $0.005 per share; 400,000,000 shares
authorized and 56,116,342 shares issued at
September 30, 2004; 75,000,000 shares authorized and
48,201,978 shares issued at September 30, 2003, 280,583 241,011
Additional paid-in capital 164,442,227 155,364,295
Unearned income (400,000)
Accumulated deficit (186,517,047) (184,332,055)
Accumulated other comprehensive loss (1,808,663) (2,480,790)
F-3
Less: Treasury stock, 87,712 shares of common stock (at cost) (67,240) (67,240)
------------- -------------
Total stockholders' deficiency (23,656,480) (31,661,190)
------------- -------------
Total liabilities and stockholders' deficiency $ 1,748,054 $ 1,519,191
============= =============
See notes to consolidated financial statements.
F-4
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED SEPTEMBER 30, 2004 AND 2003
2004 2003
------------ ------------
REVENUES $ 2,566,520 $ 4,226,187
COST OF SALES 1,287,435 2,138,883
------------ ------------
GROSS PROFIT 1,279,085 2,087,304
------------ ------------
OPERATING EXPENSES:
Selling and administrative 2,925,051 4,642,123
Depreciation of equipment
and improvements 38,938 119,606
Amortization of intangible assets 115,756 115,757
------------ ------------
Total operating expenses 3,079,745 4,877,486
------------ ------------
OPERATING LOSS (1,800,660) (2,790,182)
------------ ------------
OTHER INCOME (EXPENSES):
Interest income -- 2,703
Interest expense (1,969,074) (851,933)
Gain on liquidation of
foreign subsidiaries 320,951 --
Gain on settlements of liabilities 1,072,247 --
Other 193,279 (10,941)
------------ ------------
Net other income (expense) (382,597) (860,171)
------------ ------------
LOSS BEFORE PROVISION FOR
INCOME TAXES (2,183,257) (3,650,353)
Provision for income taxes 1,735 --
------------ ------------
NET LOSS (2,184,992) (3,650,353)
Charge for preferred stock
beneficial conversion feature 3,444,683 --
------------ ------------
F-5
NET LOSS ATTRIBUTABLE TO COMMON
STOCKHOLDERS ($ 5,629,675) ($ 3,650,353)
============ ============
Net loss per common share:
Basic and diluted $ (0.12) $ (0.09)
============ ============
Weighted average number of shares outstanding:
Basic and diluted 48,469,039 39,671,923
============ ============
See notes to consolidated financial statements.
F-6
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIENCY
For the Years ended September 30, 2004 and 2003
Preferred Stock Common Stock
--------------------- ---------------------- Additional Deferred
Paid-In Compensation/
Shares Amount Shares Amount Capital Unearned Income
--------- -------- ---------- -------- ------------ ---------
Balance October 1, 2002 1,358,849 13,589 37,201,978 186,011 154,979,295 --
Common stock issued in
exchange for services 1,000,000 5,000 35,000
Common stock issued for
trade credits 10,000,000 50,000 350,000 (400,000)
Other comprehensive income
(loss), net of tax:
Comprehensive loss:
Net loss
Change in unrealized
foreign exchange
translation gains/losses
Comprehensive loss
--------- -------- ---------- -------- ------------ ---------
Balance September 30, 2003 1,358,849 13,589 48,201,978 241,011 155,364,295 (400,000)
Effects of issuance of
warrants with notes payable:
Related parties 54,000
Unrelated parties 427,500
Conversion of notes
payable - related parties
into non-redeemable
Series D preferred stock 7,111 71 7,109,924
Exercise of warrants 5,809,980 29,050 288,659
Conversion of long-term
notes payable - unrelated
parties 1,754,384 8,772 89,474
Common stock issued in exchange
for services 350,000 1,750 12,250
Issuance of Series C-1
preferred stock for Series C -- --
Write off of unearned income 400,000
Beneficial conversion
feature related to
Long-term convertible debt 1,096,125
Comprehensive loss:
Net loss
Change in unrealized
foreign exchange
translation gains/losses
Reclassification into
current period earnings
Comprehensive loss
---------- -------- ---------- -------- ------------ --------
Balance September 30, 2004 1,365,960 $ 13,660 56,116,342 $280,583 $164,442,227 $ --
========== ======== ========== ======== ============ ========
F-7
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIENCY
For the Years Ended September 30, 2004 and 2003
(continued)
Accumulated
Other
Accumulated Comprehensive Comprehensive Treasury
Deficit Loss Income/(Loss) Stock Total
----------- ============ --------- ---------- -------------
Balance October 1, 2002 (180,681,702) (1,265,478) (67,240) (26,835,525)
Common stock issued in exchange
for services 40,000
Common stock issued for trade credits
Other comprehensive income (loss),
net of tax:
Comprehensive loss:
Net loss (3,650,353) $ (3,650,353) (3,650,353)
Change in unrealized foreign
exchange translation
gains/losses (1,215,312) (1,215,312) (1,215,312)
------------
Comprehensive loss $(4,865,665)
----------- ============ --------- ------- ------------
Balance September 30, 2003 (184,332,055) (2,480,790) (67,240) (31,661,190)
Effects of issuance of warrants
with notes payable:
Related parties 54,000
Unrelated parties 427,500
Conversion of notes payable
related parties into non-redeemable
Series D preferred stock 7,109,995
Exercise of warrants 317,709
Conversion of long-term notes payable -
unrelated parties 98,246
Common stock issued in exchange
for services 14,000
Issuance of Series C-1 Preferred
Stock for Series C
Write off of unearned income 400,000
Beneficial conversion feature related to
Long-term convertible debt 1,096,125
Comprehensive loss:
Net loss (2,184,992) $(2,184,992) (2,184,992)
Change in unrealized foreign
exchange translation
gains/losses (401,081) (401,081) (401,081)
Reclassification into current -----------
period earnings 1,073,208 1,073,208
Comprehensive loss $(2,586,073)
-------------- =========== ----------- -------- ------------
Balance September 30, 2004 $ (186,517,047) $(1,808,663) $(67,240) $(23,656,480)
============== =========== ======== ============
See notes to consolidated financial statements.
F-8
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended September 30, 2004 and 2003
2004 2003
----------- -----------
Cash Flows from Operating Activities:
Net Loss $(2,184,992) $(3,650,353)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 154,693 235,363
Write-off of unearned income 400,000 --
Common stock issued in exchange for services 14,000 40,000
Amortization of deferred financing costs 54,189 --
Charges to interest expense for beneficial
conversion feature and warrants issued
with notes payable:
Related parties 54,000 --
Unrelated parties 1,171,594 --
Gain on liquidation of foreign subsidiaries (320,951) --
Gain on settlements of liabilities (1,072,247) --
Changes in assets and liabilities, net of
effects of acquisitions and disposals:
Restricted cash (450,000)
Accounts receivable, net 288,273 297,038
Inventories, net 169,251 404,020
Prepaid expenses and other current assets (51,593) 243,157
Other assets -- 55,692
Accounts payable (57,877) 104,810
Accrued expenses and other liabilities (569,229) 1,472,099
Advances from customers -- (343,547)
Deferred revenue 48,960 (1,012,197)
----------- -----------
Net cash used in operating activities (2,351,929) (2,153,918)
----------- -----------
Cash Flows from Investing Activities:
Additions to equipment and improvements (2,436) (2,781)
----------- -----------
Cash Flows from Financing Activities:
Deferred financing costs (315,114) --
Proceeds from senior credit facility and
notes payable -- 250,000
Payments of senior credit facility and
notes payable -- (145,736)
F-9
Proceeds from convertible notes
payable - unrelated parties 3,000,000 --
Proceeds from notes and convertible notes
payable - related parties 137,339 1,986,948
Repayment of notes payable - unrelated parties (391,735) --
----------- -----------
Net cash provided by financing activities 2,430,490 2,091,212
----------- -----------
Effect of exchange rate changes on cash -- 16,736
----------- -----------
Net increase (decrease) in cash 76,125 (48,751)
Cash at Beginning of year 25,265 74,016
----------- -----------
Cash at End of year $ 101,390 $ 25,265
=========== ===========
Cash paid for:
Interest $ 154,575 $ 72,000
Noncash investing and financing activities:
Notes payable and accrued interest - related
parties converted into nonredeemable and
mandatory redeemable preferred stock $ 7,109,995 --
Long-term convertible notes payable -
unrelated parties converted into common stock $ 98,246 --
See notes to consolidated financial statements.
F-10
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. RECENT DEVELOPMENTS AND NATURE OF PRESENTATION
BACKGROUND AND DESCRIPTION OF BUSINESS
Cape Systems Group, Inc. ("Cape Systems Group" or "we" or "our" or the
"Company") is a global provider of supply chain management ("SCM") technologies,
including enterprise software systems and applications, that enable our
customers to manage their orders, inventory and warehouse needs, consultative
services, and software and hardware service and maintenance. We serve our
clients through three general product and service lines: (1) enterprise
solutions; (2) point solutions; and, (3) 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'TM'-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. Our point solutions
provide an array of products and services designed to solve more specific
customer needs from managing a mobile field workforce, mobile data collection,
distributed bar code printing capabilities, compliance labeling applications,
automated card devices, software development tools and proprietary software
serving SAP R/3 users. We provide a full range of software and hardware support
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 August 2002, Cape Systems Group 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
Cape Systems Group 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 Cape Systems
Group. 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
Cape Systems Group.
In August 2002, the Company was notified that the NASDAQ Listing Qualifications
Panel had determined that the Company had failed to comply with the $1.00
minimum closing bid price and the minimum stockholders' equity or the market
value of publicly held shares requirements for continued listing and it delisted
the Company's securities from the NASDAQ National Stock Market effective with
the open of business on August 21, 2002 and listed them on the NASDAQ Bulletin
Board. From February 17, 2003 to March 30, 2004, the Company's securities were
quoted on the Pink Sheets, under the symbol "VETXE". The Company's securities
received approval to return to the bulletin board for trading as of March 31,
2004.
Prior to April 8, 2005, Cape Systems Group, Inc. was named Vertex Interactive,
Inc. (See Note 18).
EXPIRATION OF ACQUISITION AGREEMENT
As previously reported on Form 8-K which was filed with the Securities and
Exchange Commission on August 12, 2003, the Company entered into an asset
purchase agreement with Jag Media Holdings, Inc. ("JAG Media") pursuant to which
it would sell all of the assets and certain liabilities of XeQute, the Company's
wholly-owned subsidiary, to JAG Media, in exchange for approximately 54% of JAG
Media's common stock. The agreement was subject to certain terms and conditions,
one of which was closing on or before October 31, 2003 and the Company's ability
to arrange $8,000,000 of financing upon terms and conditions satisfactory to JAG
Media, XeQute and Cape Systems Group. On October 31, 2003, the agreement expired
by its terms.
GOING CONCERN MATTERS
Based upon our substantial working capital deficiency and stockholders'
deficiency, of approximately $21,663,000 and $23,656,000 at September 30, 2004,
respectively, our recurring losses, our historic rate of cash consumption, the
uncertainty arising from our default on a note payable with a balance of
$1,227,500 as of September 30, 2004 (see Note 9), 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.
F-11
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 (iv) possible selective acquisitions to
achieve the scale we believe will be necessary to enable us to remain
competitive in the global SCM industry. There can be no assurance that we will
be successful in raising the necessary funds.
FISCAL 2004:
In fiscal 2004, the previous decline in the enterprise applications software and
telecommunications industries continued to have a substantial negative impact on
our results of operations. These factors, in combination with our continuing
negative operating cash flows, placed significant pressures on our financial
condition and liquidity and negatively impacted our operations. Operating
activities resulted in cash consumption of approximately $2,352,000 in 2004.
During fiscal 2004 we raised approximately $3,100,000 including cash transaction
costs through the issuance of notes payable and notes and convertible notes
payable from unrelated parties, restructured notes, converted debt into equity,
and paid a loan in default. At September 30, 2004, we had a net cash balance of
approximately $101,000.
OUTLOOK:
In light of current economic conditions, we now anticipate, but cannot assure,
reaching the point at which we will generate cash in excess of our operating
expenses in the quarter ending June 30, 2005. However, we had current
obligations at September 30, 2004 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, Cape Systems Group 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.
INITIATIVE 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) As of September 27, 2004, the Company had approximately $7,614,000 of
borrowings from and accrued interest payable to 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". Midmark owns
shares of Cape Systems Group's preferred and common stock and has the ability to
purchase a majority interest in Cape Systems Group (see Note 11). As explained
below, this debt was exchanged for Series D nonredeemable and mandatory
redeemable preferred stock on that date.
F-12
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(ii) 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 (see Note 2). Upon legal resolution
of the approximately $7,715,000 of net liabilities of these remaining European
entities as of September 30, 2004, 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 (See Note 2 as to the approval of the
liquidation of the U.K. subsidiaries in January 2004).
(iii) We have continued to reduce headcount (to approximately 17 employees in
our continuing North American business at September 30, 2004 and December 10,
2004, of whom 3 were furloughed until additional funds are raised), consolidate
facilities and generally reduce costs.
(iv) To obtain funding for our ongoing operations, we entered into a Securities
Purchase Agreement with four accredited investors on April 28, 2004 pursuant to
which we sold (i) $3,000,000 in secured convertible notes and (ii) warrants to
buy 3,000,000 shares of our common stock (see Note 10).
(v) 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 either Cape Systems Group or XeQute.
(vi) During the year ended September 30, 2004, we realized net gains of
$1,072,000 from settlements of liabilities totaling $1,564,500 through the
payments of $492,500 in cash.
(vii) On September 27, 2004, we completed the terms and conditions of an
Investment Restructuring Agreement that we entered into on May 26, 2004 with six
accredited investors: MidMark Capital L.P., MidMark Capital II, L.P., Paine
Webber Custodian F/B/O Wayne Clevenger, Joseph Robinson, O'Brien Ltd.
Partnership and Matthew Finlay and Teresa Finlay JTWROS, who are also our
principal stockholders.
On June 25, 2004, as part of the Investment Restructuring Agreement, we
exchanged Series C preferred stock for Series C-1 convertible preferred stock on
a 1:1 basis. On September 27, 2004, we issued 7,615 shares of Series D non
redeemable and mandatory redeemable convertible preferred stock to MidMark
Capital, L.P. in exchange for $7,614,708 of debt owed by our subsidiaries and us
to MidMark Capital II, L.P. In addition, on September 27, 2004, we issued
5,569,980 shares of common stock to MidMark Capital, L.P. upon exercise of
warrants by MidMark Capital, L.P. The exercise price for the warrants was
exchanged for the retirement of $315,309 in debt owed by us to MidMark Capital,
L.P. As well, on September 27, 2004, we issued 240,000 shares of common stock to
MidMark Capital II, L.P. upon exercise of warrants by MidMark Capital II, L.P.
The exercise price for the warrants was exchanged for the retirement of $2,400
in debt owed by us to MidMark Capital II, L.P.
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.
F-13
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
BASIS OF PRESENTATION:
The accompanying consolidated financial statements have been prepared on a basis
that contemplates Cape Systems Group's continuation as a going concern and the
realization of its assets and liquidation of its liabilities in the ordinary
course of business. The accompanying consolidated financial statements do not
include any adjustments, with the exception of the provision to reduce 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 Systems Group fails to raise capital when needed, the lack of
capital will have a material adverse effect on Cape Systems Group's business,
operating results, financial condition and ability to continue as a going
concern.
F-14
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
However, 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 of $321,000 from the approval by
creditors of the liquidation of the net liabilities of the Company's U.K.
subsidiary, as explained below. The remaining assets and liabilities of these
businesses are classified as net liabilities associated with subsidiaries in
liquidation in the accompanying September 30, 2004 and 2003 consolidated balance
sheets. The remaining assets have been reduced to their estimated net realizable
values. Estimated transaction and closing costs have been recorded. 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 proceedings.
September 30, 2004 and 2003:
2004 2003
----------- -----------
Cash $ 200,504 $ 654,068
Receivables, net 1,181,413 990,468
Inventories, net 652,053 608,993
Accounts payable (2,288,560) (2,959,933)
Accrued liabilities (5,065,009) (5,207,546)
Deferred revenue (1,245,093) (1,186,486)
Loans payable - banks (1,150,091) (1,074,142)
Other liabilities -- (336,499)
----------- -----------
Net liabilities associated with
subsidiaries in liquidation $(7,714,783) (8,511,077)
=========== ===========
F-15
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company received notice that the liquidation of the UK companies, which were
under liquidation as of September 30, 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 recognize a gain of approximately $320,000 in fiscal 2004.
The results of these businesses' operations for the years ended September 30,
2004 and 2003 are not segregated from other businesses in the accompanying
statements of operations as they were not considered distinct segments or
discontinued operations.
Except for the gain from the liquidation of the U.K. subsidiary, the results of
operations of these businesses for the years ended September 30, 2004 and 2003
were not significant.
F-16
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. The more significant estimates are those used by management to
measure net liabilities associated with subsidiaries in liquidation, litigation
accruals, the recoverability of intangible assets, the allowances for doubtful
accounts and inventory reserves and the value of shares, options or warrants
issued for services or in connection with financing transactions. Actual results
could differ from those estimates.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany accounts
and transactions have been eliminated in consolidation.
REVENUE RECOGNITION
EQUIPMENT SALES:
Revenue related to sales of equipment is recognized when the products are
delivered, title has passed, the collection of the related receivable is deemed
probable by management and no obligations to the customer remain outstanding.
SOFTWARE LICENSE SALES:
Revenue related to software license sales is recorded at the time of shipment
provided that (i) no significant vendor obligations remain outstanding at the
time of sale; (ii) the collection of the related receivable is deemed probable
by management; and (iii) vendor specific objective evidence ("V.S.O.E.") of fair
value exists for all significant elements, including post contract customer
support ("PCS") in multiple element arrangements.
F-17
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Where the services relate to arrangements requiring significant production,
modification or customization of software, and the service element does not meet
the criteria for separate accounting, the entire arrangement, including the
software element, is accounted for in conformity with either the
percentage-of-completion or completed contract accounting method.
Percentage-of-completion generally uses input measures, primarily labor costs,
where such measures indicate progress to date and provide a basis to estimate
completion.
PROFESSIONAL SERVICES:
The Company provides consulting and other services on a per-diem billing basis
and recognizes such revenues as the services are performed.
SUPPORT AND SERVICE:
The Company accounts for revenue related to service contracts and post contract
customer support over the life of the arrangements, usually twelve months,
pursuant to the service and/or licensing agreement between the customers and the
Company.
DEFERRED REVENUE
Deferred revenue represents the unearned portion of revenue related to PCS and
other service arrangements not yet completed and revenue related to multiple
element arrangements that could not be unbundled pursuant to Statement of
Position ("SOP") 97-2 "Software Revenue Recognition" or, in the case of projects
accounted for using percentage of completion or completed contract accounting in
accordance with SOP 81-1 "Accounting for Performance of Construction - Type and
Certain Production -Type Contracts".
INVENTORIES
Inventories are valued at the lower of cost (first-in, first-out basis) or
market.
EQUIPMENT AND IMPROVEMENTS
Equipment and improvements are stated at cost, less accumulated depreciation and
amortization. Depreciation is computed on the straight-line basis over the
estimated useful lives of individual assets or classes of assets. Improvements
to leased properties or fixtures are amortized over the shorter of their
estimated useful lives or the related lease terms.
The estimated useful lives of depreciable assets are as follows:
Category Years
-------- -----
Office furniture and equipment 3-10
Computer equipment 3-7
Other 3-10
SOFTWARE DEVELOPMENT COSTS AND OTHER INTANGIBLE ASSETS
Pursuant to SFAS 86 "Accounting for the Costs of Computer Software to be Sold,
Leased or Otherwise Marketed, " the Company is required to charge the costs of
creating a computer software product to research and development expense as
incurred until the technological feasibility of the product has been
established; thereafter, all related software development and production costs
are required to be capitalized.
F-18
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Commencing upon the initial release of a product, capitalized software costs and
any costs of related purchased software are generally required to be amortized
over the estimated economic life of the product or based on current and
estimated future revenues. Thereafter, capitalized software costs and costs of
purchased software are reported at the lower of amortized cost or estimated net
realizable value. Due to the inherent technological changes in the software
development industry, estimated net realizable values or economic lives may
decline and, accordingly, the amortization period may have to be accelerated or
impaired balances may have to be written off.
Impairment of long-lived assets
Under the provisions of SFAS 144, "Accounting for the Impairment of Long-Lived
Assets," which became effective for the Company as of October 31, 2002, and SFAS
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of" which was effective prior to that date, impairment
losses on long-lived tangible and intangible assets that do not have indefinite
lives, such as equipment and software licenses, are generally recognized when
events or changes in circumstances, such as the occurrence of significant
adverse changes in the environment in which the Company's business operates,
indicate that the undiscounted cash flows estimated to be generated by such
assets are less than their carrying value and, accordingly, all or a portion of
such carrying value may not be recoverable. Impairment losses are then measured
by comparing the fair value of assets to their carrying amounts. However,
impairment losses for capitalized software costs are determined pursuant to SFAS
86 and impairment losses for goodwill and other intangible assets with
indefinite useful lives are now determined pursuant to SFAS 142 as described
above.
NET 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 shares is calculated by dividing net
income or loss applicable to common stock (which reflects a charge for a
preferred beneficial conversion feature in 2004) 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.
F-19
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of September 30, 2004, there were 225,718,736 shares of common stock
potentially issuable upon the exercise of stock options and warrants (9,959,606
shares) and the conversion of convertible securities (215,759,130 shares).
However, diluted per share amounts have not been presented in the accompanying
consolidated statements of operations because the Company had a net loss in
fiscal 2004 and 2003 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.
COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is defined to include all changes in equity except
those resulting from investments by stockholders and distributions to
stockholders and is reported in the Statements of Changes in Stockholders'
Deficiency. Included in the Company's comprehensive loss are net loss and
foreign exchange translation adjustments.
STOCK-BASED COMPENSATION
SFAS 123, "Accounting for Stock-Based Compensation" provides for the use of a
fair value based method of accounting for employee stock compensation. However
SFAS 123 also allows an entity to continue to measure compensation cost for
stock options granted to employees using the intrinsic value method of
accounting prescribed by APB 25, "Accounting for Stock Issued to Employees"
which requires charges to compensation expense based on the excess, if any, of
the fair value of the underlying stock at the date a stock option is granted
over the amount the employee must pay to acquire the stock. The Company has
elected to continue to account for employee stock options under APB 25.
Accordingly, 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 had been applied.
The Company did not grant any stock options to employees and did not record any
compensation expense in connection with employee stock options during the years
ended September 30, 2004 and 2003; however, it did grant options to employees in
prior periods. If the Company had elected to recognize compensation cost based
on the fair value of the options granted at the grant date using the
Black-Scholes option-pricing model 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:
2004 2003
----------- -----------
Net loss-as reported $(2,184,992) $(3,650,353)
Deduct total stock - based
employee compensation
expense determined under
a fair value based method
for all awards net of
related tax effects 985,648 1,502,005
----------- -----------
Net loss pro-forma $(3,170,640) $(5,152,358)
=========== ===========
Loss applicable to common
stock pro-forma $(6,615,323) $(5,152,358)
=========== ===========
Loss per common
share--as reported $ (.12) $ (0.09)
Loss per common
share--pro-forma (.14) (0.13)
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 March 31, 2006.
F-20
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In accordance with the provisions of SFAS 123 and related interpretations of the
Emerging Issues Task Force (the "EITF") of the Financial Accounting Standards
Board (the "FASB"), all other issuances of common stock, stock options or other
equity instruments to employees and non employees as the consideration for goods
or services received by the Company are accounted for based on the fair value of
the equity instruments issued (unless the fair value of the consideration
received can be more reliably measured). Generally, the fair value of any
options, warrants or similar equity instruments issued will be estimated based
on the Black-Scholes option-pricing model. Such fair value is measured as of an
appropriate date pursuant to the guidance in the consensus of the Emerging
Issues Task Force ("EITF") for EITF Issue No. 96-18 (generally, the earlier of
the date the other party becomes committed to provide goods or services or the
date performances by the other party is complete) and capitalized or expensed as
if the Company had paid cash for the goods or services.
The Company accounts for the intrinsic value of beneficial conversion features
arising from the issuance of convertible debt and preferred stock with
conversion rights that are in-the-money at the commitment date pursuant to the
consensuses for EITF Issue No. 98-5 and EITF Issue No. 00-27. The resulting
charge arising from the issuance of convertible debt is recorded as interest
expense if the related debt is convertible immediately or as debt discount which
is amortized to interest expense using the effective yield method over the
period to the debt instrument's earliest conversion date. The resulting charge
arising from the issuance of preferred stock is included as an adjustment to net
income or loss in computing net income or loss applicable to common stock at the
commitment date if the preferred stock is convertible immediately or over the
period to the earliest conversion date of the preferred stock. The intrinsic
value of a beneficial conversion feature is determined after initially
allocating an appropriate portion of the proceeds received from the sale of the
related debt instrument or preferred stock to any detachable instruments (such
as warrants) included in the sale or exchange based on relative fair values.
CONCENTRATION OF CREDIT RISK
The Company's financial instruments that are exposed to concentration of credit
risk consist primarily of cash and accounts receivable. The Company maintains
its cash in bank accounts that, at times, have balances that exceed the
federally insured limit of $100,000 (there was a balance of $61,000 in excess of
the limit at September 30, 2004). The Company reduces its exposure to credit
risk by maintaining its cash deposits with major financial institutions and
monitoring their credit ratings.
Concentrations of credit risk with respect to trade receivables are limited due
to the large number of customers comprising the Company's customer base, their
dispersion across different geographic areas, and generally short payment terms.
In addition, the Company closely monitors the extension of credit to its
customers while maintaining allowances for potential credit losses. On a
periodic basis, the Company evaluates its trade accounts receivable and
establishes an allowance for doubtful accounts, based on a history of past
write-offs and collections and current credit considerations.
F-21
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In fiscal 2004, the Company had two customers whose sales were approximately 35%
of total revenue. At September 30, 2004, the two customers accounted for
approximately 30% of total accounts receivable.
There were no such concentrations in fiscal 2003.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's material financial instruments for which disclosure of estimated
fair value is required by certain accounting standards consisted of cash,
accounts receivable, notes payable, accounts payable and net liabilities
associated with subsidiaries in liquidation. In the opinion of management, cash
and accounts receivable were carried at values that approximated their fair
values because of their liquidity and/or their short-term maturities. Due to the
financial condition of the Company, management believes that the Company's notes
payable, accounts payable, and net liabilities associated with companies in
liquidation could be settled at less than their carrying values. However, such
fair values cannot be reasonably estimated.
FOREIGN CURRENCY TRANSLATION
Assets and liabilities of the Company's foreign affiliates are translated at
current exchange rates, while revenue and expenses are translated at average
rates prevailing during the respective period. Translation adjustments are
reported as a component of comprehensive income (loss).
ADVERTISING COSTS
Advertising costs are expensed as incurred. Advertising expense was
approximately $19,000 and $26,000 in fiscal 2004 and 2003, respectively.
RESEARCH AND DEVELOPMENT
Research and development expenditures are charged to expense as incurred and no
research and development expenses were incurred in 2004 and 2003.
INCOME TAXES
The Company accounts for income taxes pursuant to the asset and liability method
which requires deferred income tax assets and liabilities to be computed for
temporary differences between the financial statement and tax bases of assets
and liabilities that will result in taxable or deductible amounts in the future
based on enacted tax laws and rates applicable to the periods in which the
differences are expected to affect taxable income. Valuation allowances are
established when necessary to reduce deferred tax assets to the amount expected
to be realized. The income tax provision or credit is the tax payable or
refundable for the period plus or minus the change during the period in deferred
tax assets and liabilities.
NEW ACCOUNTING PRONOUNCEMENTS
In November 2002, the EITF reached a consensus on Issue No. 00-21, "Accounting
for Revenue Arrangements with Multiple Deliverables." This consensus provides
guidance on when and how to separate elements of an arrangement that may involve
the delivery or performance of multiple products, services and rights to use
assets into separate units of accounting. The guidance in the consensus is
effective for revenue arrangements entered into in fiscal periods beginning
after June 15, 2003. The Company adopted this consensus in the quarter beginning
July 1, 2003. The transition provision allows either prospective application or
a cumulative effect adjustment upon adoption. The adoption of this consensus did
not have a material effect on the Company's results of operations.
F-22
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In April 2003, the FASB issued Statement of Financial Accounting Standards No.
149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities." The Company does not hold any material derivative instruments and
does not conduct any significant hedging activities.
In May 2003, the FASB issued SFAS 150 "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity". This statement
requires that an issuer classify financial instruments that are within its scope
as a liability. Many of those instruments were classified as equity under
previous guidance. Most of the guidance in SFAS 150 was effective for all
financial instruments entered into or modified after May 31, 2003, and otherwise
was effective at the beginning of the first interim period beginning after June
15, 2003. The adoption of the provision of SFAS 150 did not have any impact on
the Company's consolidated financial statements.
In December 2003, the FASB issued revised Interpretation No. 46R, "Consolidation
of Variable Interest Entities". Interpretation No. 46R requires companies with a
variable interest in a variable interest entity to apply this guidance as of the
first reporting period ending after December 15, 2003. The application of the
guidance could result in the consolidation of a variable interest entity. The
adoption of the provision of FIN 46R did not have any impact on the Company's
consolidated financial statements.
In December 2004, the FASB issued SFAS No. 123(R), "Accounting for Stock-Based
Compensation". SFAS 123(R) establishes standards for the accounting for
transactions in which an entity exchanges its equity instruments for goods or
services. This Statement focuses primarily on accounting for transactions in
which an entity obtains employee services in share-based payment transactions.
SFAS 123(R) requires that the fair value of such equity instruments, including
all employee stock options, be recognized as expense in the historical financial
statements as services are performed. Prior to SFAS 123(R), only certain
pro-forma disclosures of fair value were required. SFAS 123(R) shall be
effective for the Company as of the beginning of the first interim or annual
reporting period that begins after December 15, 2005. The adoption of this new
accounting pronouncement is expected to have a material impact on the financial
statements of the Company commencing with the quarter ending March 31, 2006.
4. INTANGIBLE ASSETS
As of September 30, 2004, the only intangible asset of the Company was
capitalized software costs, which has been fully amortized. Information related
to changes in the Company's intangible assets during the years ended September
30, 2004 and 2003 is presented separately below for intangible assets that are
or were subject to amortization and intangible assets that were not subject to
amortization.
Intangible assets subject to amortization as of September 30, 2004 and related
changes during fiscal 2004 and 2003 were as follows:
F-23
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, Amortization September 30, Amortization September 30,
2002 Expense 2003 Expense 2004
-------- -------- -------- -------- --------
Gross Cost $347,269 $ -- $347,269 $ -- $347,269
Accumulated amortization-
based upon estimated life
of 3 years 115,756 115,757 231,513 115,756 347,269
-------- -------- -------- -------- --------
Net book value $231,513 $115,757 $115,756 $115,756 $ --
======== ======== ======== ======== ========
F-24
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. INVENTORIES
Inventories consist of the following:
September 30,
2004 2003
-------- --------
Raw materials $308,844 $537,337
Work in process 59,242 0
-------- --------
Totals $368,086 $537,337
======== ========
Total inventories were net of valuation allowances of $50,504 at both September
30, 2004 and 2003.
At September 30, 2004 and 2003, inventories of the European operations in
liquidation amounted to approximately $652,053 and $609,000 at September 30,
2004 and 2003, respectively, and are presented on the balance sheet in net
liabilities associated with subsidiaries in liquidation.
6. EQUIPMENT AND IMPROVEMENTS
September 30,
2004 2003
----------- -----------
Office furniture and equipment $ 728,568 $ 728,568
Computer equipment 540,785 538,349
Other equipment 123,484 123,484
----------- -----------
Totals 1,392,837 1,390,401
Accumulated depreciation and amortization (1,359,089) (1,320,152)
----------- -----------
Net equipment and improvements $ 33,748 $ 70,249
=========== ===========
7. OTHER ASSETS
Other assets consist of the following:
September 30,
2004 2003
-------- --------
Security deposits $111,273 $111,273
-------- --------
Totals $111,273 $111,273
======== ========
F-25
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. BANK LINES OF CREDIT
The Company had several foreign lines of credit, which allowed it to borrow in
the applicable local currency. These lines of credit were concentrated in
Germany, Italy and the United Kingdom. The Company's lines of credit generally
were collateralized by the accounts receivable of the borrowing subsidiary. None
of these lines of credit were available as of September 30, 2003 as the
subsidiaries have either been sold or placed in liquidation (See Note 2).
Amounts outstanding at September 30, 2004 are classified in net liabilities
associated with subsidiaries in liquidation.
9. NOTES PAYABLE TO UNRELATED PARTIES
Notes payable to unrelated parties consist of past due notes payable to the
following:
September 30,
2004 2003
---------- ----------
Renaissance Software, Inc. $1,227,500 $1,227,500
Divisions of Genicom International -- 375,000
Aryeh Trust -- 266,736
---------- ----------
$1,227,500 $1,869,236
========== ==========
F-26
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company issued approximately $1,500,000 in promissory notes payable, bearing
interest at 8%, in connection with the purchase of Renaissance Software, Inc.
("Renaissance") in fiscal 2000 which were originally due on June 30, 2001. On
August 9, 2001, the Company renegotiated the terms of these notes and, in return
for 147,000 shares of stock (with a fair market value of approximately $162,000)
the notes became payable as follows: $250,000 was due on August 15, 2001, and
the remaining balance, plus accrued interest from June 30, 2001, was due on
September 30, 2001. The Company paid the August 15, 2001 installment and, has
not paid the remaining past due balance as of December 10, 2004.
In connection with the purchase of the assets and business of three former
European service and maintenance divisions of Genicom International in October
2000, the Company paid approximately $2,000,000 in cash at closing and agreed to
make a deferred cash payment of $500,000 that was due on September 1, 2001. The
Company paid $125,000 in December 2001 and had not paid the remaining $375,000
balance as of September 30, 2003. On March 3, 2004, the balance was settled for
the sum of $125,000 which was paid on April 30, 2004. The gain of $250,000 is
included in other income in fiscal 2004.
In December 2002, Cape Systems Group, through XeQute PLC, closed a $500,000
Bridge Loan arranged by CSS whereby it borrowed $250,000 from both Aryeh Trust,
an unrelated party, and Midmark, a related party. The terms of the Bridge Loan
are described in Note 10. This Bridge Loan had been repaid in full in May, 2004.
10. CONVERTIBLE NOTES PAYABLE - UNRELATED PARTIES
Non-current convertible notes payable to unrelated parties, net of unamortized
debt discount of $2,549,724 at September 30, 2004 arose from loans under a
Securities Purchase Agreement with four accredited investors on April 28, 2004
for the private placement (the "Private Placement") of (i) $3,000,000 in
convertible notes (the "Convertible Notes") and (ii) warrants (the "Warrants")
to purchase 3,000,000 shares of our common stock. The investors were obligated
to provide us with an aggregate of $3,000,000 as follows: $1,500,000 which was
provided to us on April 28, 2004; $750,000 which was provided to us on May 28,
2004 ; and $750,000 was provided to us on August 12, 2004.
F-27
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Convertible Notes bear interest at 10% and mature two years from the date of
issuance. At the investors' option, 50% of the 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
(see Note 18). The full principal amount of the Convertible Notes would become
due upon any default under the terms of the Convertible Notes. The 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 Convertible
Notes. Based on the excess of the aggregate fair value of the common shares that
would have been issued if the Convertible Notes had been converted immediately
over the proceeds allocated to the 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 Convertible Notes and
warrants, of which $1,171,000 was amortized to interest expense during the year
ended September 30, 2004.
A portion of the proceeds of the Private Placement was used to repay the balance
of the $294,400 note payable to Aryeh Trust.
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. In
addition, during the period from October 1, 2004 to December 10, 2004, the
Company issued 10,368,424 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 $0.04 per share.
11. RELATED PARTY TRANSACTIONS
NOTES AND CONVERTIBLE NOTES PAYABLE
Notes and convertible notes payable to related parties at September 30, 2003
consisted of past due or demand notes payable to Midmark as follows:
10% convertible notes $1,814,324
Convertible loan note 480,000
Demand notes 3,701,900
Grid note 143,948
Bridge loan 250,000
----------
$6,390,172
==========
F-28
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Midmark is a shareholder of the Company and has the ability to purchase a
majority interest in the Company through the conversion of convertible preferred
stock and the exercise of warrants (see Note 13). Certain Midmark Managing
Directors have served as directors of the Company. In June 2001, November 2001
and again in January 2002, the Company issued in the aggregate $5,500,000 of
convertible notes payable to Midmark. These notes were to automatically convert
into shares of Cape Systems Group common stock on the day that the Company
obtained the requisite shareholder approval for the issuance of shares upon
conversion to Midmark. In the event that shareholder approval was not obtained
by September 30, 2003, the principal amount plus any accrued interest (at the
prime rate) would become immediately due and payable. The notes were to convert,
subject to future events, into (i) Cape Systems Group common stock at a future
market price no higher than $1.31 per share or (ii) 5,500 shares of Series "C"
Preferred Stock, which were convertible into 6,545,000 common shares at $0.84
per share. The Company was required to register the underlying common shares. In
the event of a shareholder rejection, or prepayment prior to shareholder
approval, the interest rate on the notes would have increased retroactively to
14%.
In March 2002, the Company agreed to amend the agreement related to the
$5,500,000 of convertible notes payable issued in June 2001. The amendment
removed both the requirement for shareholder approval and the automatic
conversion feature, and set the maturity date for September 30, 2003. Concurrent
with the amendment of these notes, Midmark elected to convert approximately
$782,000 of principal and $218,000 of accrued interest into 997 shares of Series
"C" preferred stock. The remaining principal balance of the convertible notes
payable of $4,718,717 and accrued interest at prime were convertible into Series
"C" preferred shares at a conversion price of $1,000 per share. The Series "C"
preferred shares in turn were convertible into shares of common stock at $0.84
per share.
In November 2001, the Company issued $3,000,000 of 10% convertible notes
payable, with an original maturity date of September 30, 2003, to Midmark that
would have been convertible into 3,000 shares of Cape Systems Group Series "C"
Preferred Stock at the option of Midmark on the day that the Company obtained
the requisite shareholder approval for the issuance of Series "C" Preferred
Stock upon conversion to Midmark. Midmark could have converted the Series "C"
Preferred Shares into 3,570,026 shares of Cape Systems Group common stock at
$0.84 per share. The Company was required to register the underlying common
shares. In the event of a shareholder rejection, or prepayment prior to
shareholder approval, the interest rate on the notes would have increased
retroactively to 14%. On August 9, 2002, the remaining principal balance of
$4,718,717 of the convertible notes and $1,185,176 of the $3,000,000 of 10%
convertible notes were fully settled in connection with the sale of the
Company's French based advanced planning software business to Midmark. The
remaining $1,814,324 of past due 10% convertible notes payable at September 30,
2003 were collateralized by all tangible and intangible property of the Company,
except that the holders had executed in favor of certain senior lenders a
subordination of their right of payment under the convertible notes and the
priority of any liens on certain assets, primarily accounts receivable.
In December 2002, XeQute received an additional $480,000 from Midmark under a
Convertible Loan Note with terms similar to the 10% convertible note payable
described above. The Convertible Loan Note would have automatically converted
into Non-Voting Shares of XeQute PLC at $0.672 per share when a minimum
subscription of $480,000 of a proposed but now aborted Private Placement had
been reached.
The conversion rates of all of the above Midmark notes were subject to certain
antidilution provisions.
The Company borrowed an additional $2,588,900 during the year ended September
30, 2002, and an additional $1,113,000 (including $425,000 restricted for usage
on XeQute obligations) during the year ended September 30, 2003, from Midmark
under nonconvertible notes that were payable on demand, bore interest at 10% per
annum and were secured by the same collateral in which the Company previously
granted a security interest to Midmark under the agreement related to the
convertible notes payable described above.
F-29
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
During October, 2002, Cape Systems Group also executed a Grid Note which
provided for up to $1,000,000 of availability from Midmark, This note was to be
funded by the proceeds, if any, from the sale of any shares of Cape Systems
Group common stock held by Midmark. This note was payable on demand, carried
interest at the rate of 10% per annum and was secured by the same collateral in
which the Company previously granted a security interest to Midmark under an
agreement related to the convertible notes payable described above. In
consideration of Midmark providing this facility, the Company agreed to issue
warrants to purchase a number of unregistered shares equal to 120% of the number
of tradeable shares sold by Midmark to fund such note, at a purchase price per
share equal to 80% of the price per share realized in the sale of shares to fund
the Grid Note. As of September 1, 2004, the Company had borrowed $281,287 under
this arrangement, of which $143,900 had been borrowed as of September 30, 2003.
As a result of the borrowings through September 1, 2004, the Company was
obligated to issue to Midmark warrants to purchase 5,569,980 shares of common
stock at an exercise price of $0.05 per share. The aggregate estimated fair
value of the warrants at the respective dates of issuance was $54,000, which was
determined using the Black-Scholes option pricing model and recorded as a charge
to interest expense with an offsetting increase in additional paid-in capital,
during the year ended September 30, 2004. In applying the Black-Scholes option
pricing model, the Company used the following assumptions: expected dividend
yield - 0%; expected stock price volatility - 142%; risk free interest rate -
3.50%; and expected life of the warrants - three months.
In December 2002, Cape Systems Group, through XeQute PLC, closed a $500,000
Bridge Loan arranged by CSS whereby it borrowed $250,000 from both Midmark and
Aryeh Trust, an unrelated party. The Bridge Loans were to be repaid with
proceeds from a proposed private placement funding. The Bridge Loans matured on
June 9, 2003. The Company agreed to continue paying interest at the original
rate of 3% per month, with the principal to be repaid when funds became
available. The Bridge Loans were secured by a first security interest in all of
the assets of XeQute. The lenders were each granted warrants to purchase shares
of XeQute PLC as part of the consideration for this loan. The interest charge
relating to the fair value of these warrants was not material and was recognized
over the original term of the Loan. Upon the receipt of the minimum subscription
amount for a private placement by XeQute PLC, Midmark had agreed to relinquish
its security interest in the assets of XeQute, in exchange for warrants to
purchase 250,000 common shares of XeQute PLC which were then owned by Cape
Systems Group. Midmark had agreed that it would vote any shares which it
acquired through the exercise of the warrant in accordance with the directions
of Cape Systems Group. However, it was to retain its security interest in the
shares of XeQute PLC owned by Cape Systems Group and in all of the assets of
Cape Systems Group. The loan from Areyh Trust was repaid in April 2004 (see Note
9).
On September 27, 2004, we completed the terms and conditions of an Investment
Restructuring Agreement that we entered into on May 26, 2004 with six accredited
investors: MidMark Capital L.P., MidMark Capital II, L.P., Paine Webber
Custodian F/B/O Wayne Clevenger, Joseph Robinson, O'Brien Ltd. Partnership and
Matthew Finlay and Teresa Finlay JTWROS, who are also our principal
stockholders.
As further explained in Note 13, on June 25, 2004, as part of the Investment
Restructuring Agreement, we exchanged Series C preferred stock for newly
authorized Series C-1 convertible preferred stock on a 1:1 basis. On September
27, 2004, we issued 7,615 shares of newly authorized Series D convertible
preferred stock to MidMark Capital, L.P. in exchange for $7,614,708 of debt,
including accrued interest, owed by our subsidiaries and us to MidMark Capital
II, L.P. In addition, on September 27, 2004, we issued 5,569,980 shares of
common stock to MidMark Capital, L.P. upon exercise of warrants by MidMark
Capital, L.P. The exercise price for the warrants was exchanged for the
retirement of $315,309 in debt owed by us to MidMark Capital, L.P. As well, on
September 27, 2004, we issued 240,000 shares of common stock to MidMark Capital
II, L.P. upon exercise of warrants by MidMark Capital II, L.P. The exercise
price for the warrants was exchanged for the retirement of $2,400 in debt owed
by us to MidMark Capital II, L.P.
F-30
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Cape Systems Group provided registration rights to MidMark with respect to any
unregistered shares of common stock of Cape Systems Group. In furtherance of
this, MidMark has, under the terms of a customary lock-up agreement, agreed not
to sell any shares of common stock until the earlier of (x) August 9, 2005 or
(y) the sale by the Private Placement investors of common stock which in the
aggregate exceeds two thirds (as determined by value) of the common stock
received by the Private Placement investors in connection with the exercise of
their conversion rights under the Convertible Notes (see Note 10).
OTHER RELATED PARTY TRANSACTIONS
In March 2003, the Company's subsidiary XeQute entered into an "Authorized
Marketing Program Partnership Agreement" with Core eBusiness Solutions LLC
("Core"), a company that employs certain former employees of the Company. This
agreement provided Core with the exclusive rights to market and sell certain of
XeQute's warehouse management software in the United States and Canada.
However, in June 2003, XeQute and Core mutually agreed to rescind this agreement
and renegotiate a non-exclusive marketing agreement, which had not been
finalized as of December 10, 2004.
12. OTHER ACCRUED EXPENSES AND LIABILITIES
The components of other accrued expenses and liabilities consist of the
following:
September 30,
2004 2003
---------- ----------
Professional fees $ 382,631 $1,088,055
Remaining obligations on terminated leases 1,436,676 1,402,984
Sales and other taxes, excluding income
and payroll 53,582 57,379
Income taxes 270,863 270,863
Accrued interest 336,506 1,238,936
Other 1,269,427 812,542
---------- ----------
$3,749,685 $4,870,759
========== ==========
F-31
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. STOCKHOLDERS' DEFICIENCY
Also in January 2002, the Company granted options to purchase an aggregate
1,800,000 shares of common stock at $0.80 per share in connection with the
settlement of certain litigation with three former principals of the Company.
The Company also placed an equivalent number of common shares into escrow to be
available upon exercise of these options. Of the 1,800,000 shares placed into
escrow, 1,500,000 were unregistered shares. The settlement agreement also
required the Company to register these shares by April 30, 2002, or an
additional monthly cash payment would be required until the shares are
registered. The Company has not registered these shares and has not made
additional monthly cash payments and, as part of the settlement agreement, three
consent judgments have been entered against Cape Systems Group (see Note 16 -
Settled Litigation).
In May 2003 the Company issued 1,000,000 common shares, which had a fair market
value of approximately $40,000, to an investment advisor to assist in the
Company's fund raising efforts.
Effective July 31, 2003, the Company completed the sale of 10,000,000 shares of
its common stock, which had a fair market value at that time of approximately
$400,000, to American Marketing Complex, Inc. ("AMC"). Payment for this purchase
by AMC was in the form of cash equivalent trade credits with a face value of
$4,000,000, which the Company can use or sell to others for the purchase of
merchandise and services. The face value is not necessarily indicative of the
ultimate fair value or settlement value of the trade credits. Any trade credits
not utilized by June 30, 2008 shall expire, unless the Company exercises an
option to extend the agreement for one year. The trade credits were valued at
the fair market value of the shares issued by the Company of $400,000 and
classified as unearned income, which is a separate component of stockholders'
deficiency in the accompanying consolidated balance sheets as of September 30,
2003. The unearned credits were to be offset as the trade credits were used.
In addition, the Company agreed to loan AMC $150,000 of which $10,000 was
delivered at closing; $40,000 was delivered in August 2003; $50,000 was to be
delivered by September 10, 2003 and $50,000 was to be delivered by October 10,
2003. The Company did not make the September or October payments. This loan will
be repaid exclusively from funds received from the sale by AMC of its 10,000,000
shares of the Company's Common Stock. The Company was required to, but did not,
register these shares within six months of the closing. In 2004, AMC declared
that the Company is in default. The Company is in negotiations for the
termination of this agreement with AMC. Hence, during 2004, the Company wrote
off the balance of unearned income and recorded a charge of $400,000 in the
statement of operations.
In addition, the Company issued 5,809,980 shares of common stock on June 25,
2004 upon exercise of warrants (see Note 11) and 1,754,384 shares of common
stock in August and September 2004 upon the conversion of 10% Convertible Notes
(see Note 10).
On September 21, 2004, the Company increased the common shares authorized from
75,000,000 to 400,000,000.
SHARES ISSUED FOR SERVICES
In July, 2004, the Company issued 350,000 shares of common stock with a fair
value of $14,000 for consulting services rendered.
F-32
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PREFERRED STOCK
Series "A"
In connection with an acquisition in February 2001, the Company issued 1,356,852
shares of Series "A" Preferred Stock. Each outstanding share of Series "A"
Preferred Stock is convertible at any time, at the option of the holder, into
common stock on a one for one basis. All of the common shares issuable on
conversion of the Series "A" Preferred Stock must be registered by the Company.
Series "B"
In October 2001, the Company raised $1,000,000 in cash through the issuance and
sale of 1,000 shares of Series "B" Convertible Preferred Stock to Pitney Bowes,
with each share of Series "B" Preferred being convertible at any time into 1,190
shares of common stock at a price of $0.84 per share. The Company must register
all of the common shares issuable on conversion of the Series "B" Preferred
Stock.
Series "C", Series "C-1" and Series "D"
In March 2002, the Company issued 997 shares of Series "C" Convertible Preferred
Stock to Midmark upon conversion of approximately $997,000 of convertible notes
payable and accrued interest (See Note 11). Each outstanding share of Series "C"
Preferred was convertible at any time into 1,190 shares of common stock at a
price of $0.84 per share. The Company was required to register all of the common
shares issuable on conversion of the Series "C" Preferred Stock.
On June 25, 2004, in connection with the Investment Restructuring Agreement, the
holders of Series C convertible preferred stock exchanged their Series C
convertible preferred stock for Series C-1 convertible preferred stock on a 1:1
basis. The Series C-1 preferred stock was recorded at $997,000 which was the
carrying value of the Series C preferred stock and the aggregate liquidation
value of the Series C-1 preferred stock.
In September 2004, the Company issued 7,615 shares of Series "D" convertible
preferred stock to Midmark upon conversion of approximately $7,615,000 of
convertible and demand notes payable and accrued interest (See Note 11). The
Series D preferred stock was recorded at approximately $7,615,000 which was the
carrying value of the notes and accrued interest payable and the aggregate
liquidation value of the Series D preferred stock.
Cape Systems Group 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 upon the earlier of (x) December 31, 2004, or (y) the receipt
by Cape Systems Group of a tax refund which was expected in the fourth quarter
of calendar year 2004. Accordingly, a total of 504 shares of Series D preferred
stock with an aggregate liquidation value of $504,713 was included in current
liabilities as mandatory redeemable Series D preferred stock in the accompanying
consolidated balance sheet as of September 30, 2004. As of December 10, 2004,
Cape Systems Group had not made the payment.
Each share of Series C-1 and Series D preferred stock is convertible into $1,000
worth of our common stock, at the selling stockholders' option, at the lower of
(i) $0.30 or (ii) 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. Accordingly, there is in fact no limit on the
number of shares into which the Series C-1 and Series D preferred stock may be
converted. As of September 27, 2004, the average of the three lowest intraday
trading prices for our common stock during the preceding 20 trading days as
reported on the Over-The-Counter Bulletin Board was $.07 and, therefore, the
conversion price for the Series C-1 and Series D preferred stock was $.042.
Based on this conversion price, 997 shares of Series C-1 preferred stock and
7,615 shares of Series D preferred stock (including the 504 shares classified as
subject to mandatory redemption) were convertible into 205,040,666 shares of
common stock.
F-33
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Based on the excess of the aggregate fair value of the common shares that would
have been issued if the Series C-1 and Series D preferred stock had been
converted immediately over the aggregate carrying value of the Series C-1 and
Series D preferred stock the investors received a beneficial conversion feature
that had an aggregate intrinsic value of approximately $3,445,000 as of the
commitment date. Accordingly, the Company recorded a charge for the preferred
stock beneficial conversion feature in the accompanying 2004 consolidated
statement of operations resulting in an increase in the loss applicable to
common stock.
VOTING RIGHTS AND DIVIDENDS
All of the preferred stockholders are entitled to vote their shares as though
such conversion had taken place. In addition, preferred stockholders are not
entitled to preferred dividends, but are entitled to their pro rata share of
dividends, if any, declared on common stock under the assumption that a
conversion to common stock had occurred.
STOCK OPTION PLAN
The Company has an Incentive Stock Option Plan (the "Plan") that provides for
the granting of options to employees, directors, and consultants to purchase
shares of the Company's common stock. During fiscal 2001, the Company's Board of
Directors approved an increase in the number of shares available for issuance
from 4,000,000 to 8,000,000. The Company is required to register the additional
4,000,000 shares issuable pursuant to options exercised. The Company intends to
register the shares as soon as possible. Options granted under the Plan
generally vest over five years and expire after ten years. The exercise price
per share may not be less than the fair market value of the stock on the date
the option is granted. Options granted to persons owning more than 10% of the
voting shares of the Company may not have a term of more than five years and may
not be granted at less than 110% of fair market value.
The following table summarizes the common stock options granted, cancelled or
exercised under the Plan:
2004 2003
--------------------------------- --------------------------------
Common Weighted Common Weighted
Stock Average Stock Average
Options Exercise Options Exercise
Price Price
----------- ------------- ----------- ------------
Outstanding at
beginning of year 1,828,000 $ 3.14 3,269,000 $ 3.72
Granted --
Exercised --
Cancelled (637,500) 5.59 (1,441,000) 4.04
----------- -----------
Outstanding at
end of year 1,190,500 2.49 1,828,000 3.37
=========== ===========
Exercisable at
end of year 1,008,500 2.5 1,359,500 3.14
=========== ===========
Weighted average
fair value of
options granted
during the year $ -- $ --
F-34
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes information on stock options outstanding under
the Plan at September 30, 2004:
Options Outstanding Options Exercisable
--------------------------------- ----------------------
Options Weighted
Outstanding Weighted Average Options Weighted
at Average Remaining Exercisable Average
Range of Exercise September Exercise Contractual at September Exercise
Prices 30, 2004 Price Life 30, 2004 Price
- ------------------ --------- -------- ---------- ----------- -------
$.27 to $1.50 740,000 $ .97 6.79 620,000 $ .94
1.51 to 2.25 43,500 1.77 3.39 37,500 1.81
2.26 to 3.40 90,000 2.42 6.61 54,000 2.42
3.41 to 5.00 212,000 3.85 4.44 210,000 3.85
5.01 to 7.65 -- -- -- -- --
7.66 to 11.50 50,000 8.70 6.27 43,000 8.69
11.51 to 15.88 55,000 12.69 5.51 44,000 12.69
------- --------
1,190,500 2.49 1,008,500 2.50
========= =========
In September 2004, the Board approved the 2004 Incentive Stock Option Plan (the
"2004 Plan") pending stockholders' approval that provides for the granting of
options to employees, directors and consultants to purchase shares of the
Company's common stock. The number of shares available for issuance under the
2004 Plan is 10,000,000. Options granted under the Plan generally vest over five
years and expire after ten years. The exercise price per share may not be less
than the fair market value of the stock on the date the option is granted.
Options granted to persons owning more than 10% of the voting shares of the
Company may not have a term of more than five years and may not be granted at
less than 110% of fair market value. As of September 30, 2004, no shares were
issued from the 2004 Plan.
OTHER STOCK OPTIONS
In addition to the stock options granted under the "Plan" discussed above, the
Company periodically grants stock options to non-employees in consideration for
services rendered, as well as for services to be rendered. Options issued for
services rendered were accounted for under SFAS 123 and EITF Issue 96-18, using
the Black-Scholes option pricing model to determine their fair value.
F-35
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes common stock options granted, cancelled and
exercised in addition to those in the Plan:
2004 2003
----------------------------------- -----------------------------------
Weighted Weighted
Common Average Common Average
Stock Exercise Stock Exercise
Options Price Options Price
------------- ------------- ------------- -------------
Outstanding at
beginning of year 5,890,556 $ 3.45 6,130,673 $ 3.37
Granted --
Cancelled (272,542) 7.67 (240,117) 1.32
------------- -------------
Outstanding at
end of year 5,618,014 3.24 5,890,556 3.45
============= =============
Options exercisable 5,616,014 5,769,106 $ 3.33
============= =============
REGISTRATION REQUIREMENTS
The Company is obligated to register under the Securities Act of 1933 certain
common shares issued or issuable in connection with acquisition agreements,
private placements, the exercise of options and warrants and the conversion of
notes payable and preferred stock. At September 30, 2004, the Company was
obligated to but had been unable to register approximately 12,646,000 common
shares then outstanding. The Company intends to register the shares as soon as
possible.
WARRANTS ISSUED WITH CONVERTIBLE NOTES PAYABLE - UNRELATED PARTIES
As of September 30, 2004, the Company had issued 3,000,000 warrants for the
purchase of shares of its common stock in connection with raising $3,000,000
through convertible notes payable (see Note 10). The warrants are exercisable
until five years from the date of issuance at a purchase price of $0.11 per
share. All of these warrants were outstanding as of September 30, 2004.
WARRANTS ISSUED BY XEQUTE PLC
As of December 31, 2003, XeQute PLC had issued warrants for the purchase of
shares of its common stock to Midmark, Aryeh Trust and CSS in connection with
certain financing agreements. The total of the fair value of the warrants at the
respective dates of issuance was not material. If all of the warrants had been
exercised as of September 30, 2003, the Company's ownership interest in XeQute
PLC would have decreased from 100% to approximately 90%. During fiscal 2004, the
warrants issued to Midmark were converted into common shares (see Note 11).
F-36
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SHARES ISSUED SUBSEQUENT TO SEPTEMBER 30, 2004
During the period from October 1, 2004 to December 10, 2004, in addition to
shares issued upon conversion of 10% convertible notes (see Note 11), the
Company issued 1,500,000 shares for various consulting and professional services
rendered and 3,034,404 shares for accrued directors' fees.
14. RETIREMENT PLANS
The Company and certain of its subsidiaries maintain a 401(k) retirement plan,
which is a defined contribution plan covering substantially all employees in the
United States. Eligible employees can contribute up to 17% of their compensation
not to exceed Internal Revenue Code limits. The Company is required to make
matching contributions of 50% of the employees' contribution up to 3% of gross
pay. The Company's contribution will be funded after each calendar year end in
either cash or in Cape Systems Group stock, at the Company's option. The Company
accrued contributions for the years ended September 30, 2004 and 2003 of
approximately $59,000 and $80,000, respectively.
During October 2004, the Company issued 1,951,452 shares to the plan to fund its
required contributions for the calendar years ended December 31, 2002 and 2003.
15. INCOME TAXES
The components of the income tax provision included in the accompanying
consolidated statements of operations for the years ended September 30, 2004 and
2003 consist of the following:
2004 2003
------ ------
Current:
Federal $ -- $ --
Foreign -- --
State 1,735 --
------ ------
Total Current 1,735 --
------ ------
Deferred:
Federal -- --
Foreign -- --
State -- --
------ ------
Total Deferred -- --
------ ------
Total income tax provision $1,735 $ --
====== ======
F-37
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The net deferred tax assets in the accompanying consolidated balance sheets as
of September 30, 2004 and 2003 consist of temporary differences related to the
following:
September 30,
---------------------------------
2004 2003
------------ ------------
Deferred tax assets:
Allowance for doubtful accounts $ 196,234 $ 196,234
Inventory 179,155 179,155
Net operating loss carryforwards 22,649,800 21,695,108
Capital loss carryforwards 1,850,296 1,850,296
Accrued expenses 1,059,067 1,055,638
------------ ------------
Total deferred tax assets 25,934,552 24,976,431
------------ ------------
Deferred tax liabilities:
Depreciation (18,633) (18,633)
Capitalized software costs -- (49,775)
------------ ------------
Total deferred tax liabilities (18,633) (68,408)
------------ ------------
Valuation allowance (25,915,919) (24,908,023)
------------ ------------
Net deferred tax assets $ -- $ --
============ ============
Deferred tax assets arise from the tax benefit of net operating and capital loss
carryforwards which are expected to be utilized to offset taxable income and
from temporary differences between the recognition in financial statements and
tax returns of certain inventory costs, bad debt allowances on receivables,
depreciation on fixed assets and amortization of certain intangible assets.
A valuation allowance on the net deferred tax assets has been provided based on
the Company's assessment of its ability to realize such assets in the future.
For the years ended September 30, 2004 and 2003 the valuation allowance for net
deferred tax assets increased by $1,007,896 and $1,206,957, respectively, as a
result of net changes in temporary differences.
The Company believes that as of September 30, 1999, an ownership change under
Section 382 of the Internal Revenue Code occurred. The effect of the ownership
change would be the imposition of annual limitations on the use of the net
operating loss carryforwards attributable to the periods before the change.
At September 30, 2004, the net operating loss carryforwards available to offset
future taxable income consist of approximately $55,200,000 in Federal net
operating losses, which will expire in various amounts through 2023, and state
net operating losses of approximately $43,100,000 which will expire in various
amounts through 2010. These net operating losses also may be limited due to
ownership changes, the effect of which has not yet been determined by the
Company. Total net operating losses available in foreign jurisdictions are
approximately $3,800,000, none of which relate to periods prior to the
acquisition of certain subsidiaries by Cape Systems Group. No pre-acquisition
net operating losses were utilized during fiscal 2004 and 2003. Based on the
fact that the remaining European subsidiaries are in liquidation, the Company
does not anticipate utilizing the European net operating losses. The capital
loss carryforward at September 30, 2004 of $4,600,000 has no expiration date,
but utilization is limited to the extent of capital gains generated by the
Company.
F-38
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, or tax benefits. The Company was permitted to sell tax
benefits in the amount of $518,000. On December 17, 2004, the Company received
approximately $456,000 from the sale of the $518,000 of tax benefits which will
be recognized as a tax benefit in the first quarter of fiscal 2005.
A reconciliation of income tax at the statutory rate to the Company's effective
rate is as follows:
2004 2003
------ ------
Statutory rate 34.0% 34.0%
Effect of Valuation allowances (34.0) (34.0)
------ ------
Effective income tax rate 0% 0%
====== ======
There are no undistributed earnings of the Company's foreign subsidiaries at
September 30, 2004 and 2003. In the event of a distribution of foreign earnings
in the form of dividends or otherwise, the Company would be subject to both U.S.
income taxes (subject to an adjustment for foreign tax credits) and withholding
taxes payable to the various foreign countries.
16. COMMITMENTS AND CONTINGENT LIABILITIES
LEASES
The Company and its subsidiaries lease office facilities and certain office
equipment under operating leases that expire at various dates through 2008.
Rent expense for the years ended September 30, 2004 and 2003 was approximately
$200,000 and $275,000, respectively.
During the year ended September 30, 2002, the Company sold and closed down
various businesses. In connection with these dispositions, the Company abandoned
certain facilities, terminated certain leases and accrued the remaining
terminated lease obligations. The minimum lease payments (including common area
maintenance charges) under all of the other remaining non-cancellable operating
leases as of September 30, 2004, that have initial terms in excess of one year
are as follows: 2005 - $176,000; 2006 - 181,625; 2007 - 183,500; 2008 - 65,208;
and 2009 - $606,333.
In October 2003, the Company consolidated its offices into one building in South
Plainfield, and subleased a portion of its office space in Paramus commencing
December 1, 2003. The sublease, which requires rental payments of approximately
$37,000 per year, expires in May 2008. The Company was able to cancel the
remaining portion of the Paramus lease effective January 1, 2004.
F-39
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 or about March 22, 2004, an action against the Company and its subsidiary
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 $303,929 to be due Great Oak LLC, the landlord of premises
leased to Renaissance Software LLC. The Company is vigorously defending the
action.
b) 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, was 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 beed paid.
c) 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. and the Company, alleged the default by Renaissance
Software, Inc. in payment of certain promissory notes in the principal aggregate
sum of $1,227,500. The Company 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.
d) As part of the settlement entered into between the Company and three former
principals of a company acquired by the Company in 2000, consent judgments in
the amount of approximately $1,000,000 each were entered against the Company on
July 19, 2002. The incremental liability has been included in other expense
(provision for litigation) for the year ended September 30, 2003. 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. However, given the Company's current cash position, the judgment
has not beed paid.
e) 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, the judgment has not beed paid.
SETTLED LITIGATION
a) On June 25, 2003, an action was commenced in the United States District
Court, District of New Jersey, entitled CPG International, N.V. vs. Vertex
Interactive, Inc. The action, which demands $406,342, alleges the Company's
breach of an Asset Sale and Purchase Agreement. On March 3, 2004, the action was
settled for the sum of $125,000 which was paid on April 30, 2004. The gain on
settlement is included in the consolidated statement of operations for the year
ended September 30, 2004.
F-40
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
b) On or about October 29, 2004, an action against the Company was commenced in
New York State Supreme Court, New York County, captioned NautaDutilh vs Vertex
Interactive, Inc. The action, which demands $434,189, alleges nonpayment by
Vertex of attorneys' fees allegedly incurred by the Company in connection with a
potential acquisition transaction and the reorganization of the Company's
foreign business operations. In December 2004, this action was settled for
$300,000 and the gain on settlement of approximately $134,000 will be recognized
in the three months ended December 31, 2004.
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 September 30, 2004, were granted to these former
employees.
EMPLOYMENT AGREEMENTS AND OTHER COMMITMENTS
The Company has employment agreements with certain key employees, which
automatically renew on an annual basis, unless otherwise terminated by either
party. Such agreements provide for minimum salary levels (approximately $495,000
as of September 30, 2004) as well as for incentive bonuses. As of September 30,
2004, two employees who have employment agreements, are on furlough from the
Company, and are not receiving salaries while on furlough, but are receiving
Company benefits, with the expectation that they can return when the Company has
the financial capability for them to do so. One employee has verbally agreed to
accept a lower salary until such time that the Company has the financial
capability to increase their salary.
On April 24, 2001 the Company entered into an investment banking agreement with
Harris, Hoover and Lewis, LLC to provide financial advisory and consulting
services with respect to the acquisition of Plus Integration. This agreement
provided for a transaction fee of 2% of the value of the acquisition, together
with related options, with a minimum transaction fee of $500,000. This agreement
was terminated on November 25, 2002 in connection with the general release of
all claims in the litigation settlement discussed above.
F-41
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On September 23, 2002, the Company entered into a business advisory and
consulting services agreement with Jeffrey Firestone to assist the Company in
raising funds. The Company paid an initial retainer of $5,000. When Mr.
Firestone raises $1,000,000 on behalf of Cape Systems Group, he will be entitled
to a monthly retainer of $5,000 for an additional five months. If Mr. Firestone
is successful within a three year period in raising $1,000,000 of funds through
a private equity offering for Cape Systems Group, he is entitled to a cash fee
equal to 10% of the proceeds and five year warrants to purchase 10% of the
shares and other equity instruments sold through the private equity offering
with an exercise price equal to the per share price at which shares were sold in
the private equity offering. Mr. Firestone is also entitled to a 3% commission
if he introduces Cape Systems Group to an entity that in turn raises money for
Cape Systems Group on a commission basis.
On September 30, 2002, Cape Systems Group entered into an agreement with
Tarshish Capital Markets ("TCM"), an Israel based corporation to provide
financial advisory and fund raising services. An initial non-refundable retainer
fee was accrued by the Company at September 30, 2002 and was paid in October
2002 in the form of 800,000 shares of Cape Systems Group registered common
stock, which had an aggregate fair market value of $56,000. The agreement
provides for TCM to use its best efforts to raise in excess of $5,000,000 in a
private stock offering. If TCM is successful within a three year period, it is
entitled to a cash fee equal to 10% of the amount invested in Cape Systems Group
and five year warrants to purchase 10% of the shares and other equity
instruments sold through the private placement with an exercise price equal to
the per share price at which shares are sold in the private stock offering.
17. SEGMENT INFORMATION AND INTERNATIONAL OPERATIONS
The Company operates in one business segment, which is the design, development,
marketing and support of supply chain management solutions.
GEOGRAPHIC AREA DATA
The following geographic information presents total revenues, gross profit and
identifiable assets for the years ended September 30, 2004 and 2003 (in
thousands):
2004 2003
-------- --------
Revenues
North America $ 2,566 $ 4,226
Europe(1) -- --
-------- --------
$ 2,566 $ 4,226
======== ========
Gross Profit
North America $ 1,279 $ 2,087
Europe(1) -- --
-------- --------
$ 1,279 $ 2,087
======== ========
Identifiable assets
North America $ 17,400 $ 17,171
Europe(1) -- --
Eliminations (15,652) (15,652)
-------- --------
$ 1,748 $ 1,519
======== ========
F-42
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) The Company had operated throughout Europe, but principally in the United
Kingdom, Germany and Italy. All European operations had either been sold or
placed into liquidation by September 30, 2002.
PRODUCTS AND SERVICES
Sales to external customers by the three significant product and service line
groupings for the years ended September 30, 2004 and 2003 (in thousands) are as
follows:
2004 2003
------- -------
Point Solutions $ 0 $ 0
Enterprise Solutions 84 889
Service, Maintenance and Other 2,483 3,337
------- -------
$ 2,567 $ 4,226
======= =======
MAJOR CUSTOMERS
The Company had no customers that accounted for more than 10% of revenue for the
fiscal year 2003. In 2004, the Company had two customers that
accounted for 35% of revenue.
18. SUBSEQUENT EVENTS
On January 12, 2005, the Company 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 it
purchased all of the issued and outstanding shares of common stock of Cape
Systems and Consulting Services Ltd. 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, excluding acquisition costs. 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. Cape
Systems and Consulting Services Ltd. together with its subsidiary, Cape Systems,
Inc., is a provider of palletizing and packaging configuration, and
truck/container loading software that improves pallet and truck utilization, and
reduces packaging, storage and transportation costs.
The acquisition 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. 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
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 warrants are exercisable
until five years from the date of issuance at a purchase price of $0.09 per
share.
As of September 30, 2004, the Company had Convertible Notes outstanding with a
carrying value of $2,549,724, net of unamortized discount. As explained in Note
10, at the investors' option, 50% of the Convertible Notes were 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 were convertible into our common stock at the lower of
$0.30 or 55% of the same average over the same trading period. In connection
with the acquisition and the related financing transactions, the Convertible
Notes became convertible at the lower of $0.30 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 acquisition will be accounted for as a purchase pursuant to Statement of
Financial Accounting Standards No. 141, "Business Combinations" and,
accordingly, the assets and liabilities of the acquired companies will be
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
allocated to goodwill. The results of operations of the acquired companies will
be consolidated with the Company's results subsequent to the date of
acquisition.
In connection with the acquisition, 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.
F-43
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.
F-44
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.
F-45
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.
F-46
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.
F-47
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.
F-48
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.
F-49
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.
F-50
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.
F-51
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.
F-52
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.
F-53
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.
F-54
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.
F-55
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.
F-56
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.
F-57
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
F-58
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.
F-59
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.
F-60
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:
F-61
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.
F-62
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
PROFIT AND LOSS ACCOUNT 01.01.02 - 31.12.02
Note 2002 2001
----------- ----------- -----------
(pound) (pound)
----------- -----------
Turnover (see footnote) 498037 391692
Cost of sales 336921 251098
----------- -----------
Gross Profit 161116 140594
Net Operating Expenses 157415 130316
----------- -----------
3701 10278
Interest Payable and Similar Payments 3305 4869
----------- -----------
Profit on Ordinary Activities 1 396 5409
Taxation 3 (506) 390
----------- -----------
Profit after taxation 902 5019
Dividends 0 0
----------- -----------
Retained Profit for the year 9 902 5019
----------- -----------
FOOTNOTES
1. Turnover reflects the absorption of operations from Cape Systems Limited, a
subsidiary made dormant from 31.12.91. These activities are streamed with that
of the parent company and continue to be conducted.
2. The company had no recognised gains or losses other than those included in
profit and loss. No separate primary statement is required.
3. The profit for the year is the only movement on reserves.
F-63
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
BALANCE SHEET 31.12.02
Note 2002 2001
----------- ----------- -----------
(pound) (pound)
----------- -----------
Fixed Assets
Tangible Fixed Assets 4 8969 17934
Investment in Subsidiaries 5 40500 40500
----------- -----------
49469 58434
----------- -----------
Current Assets
Stocks 4500 3850
Debtors 6 71300 71670
Bank Balances and Cash 59403 42397
----------- -----------
135203 117917
Creditors due within one year 7 46422 39003
----------- -----------
Net Current Assets 88781 78914
----------- -----------
Total Assets less Current Liabilities 138250 137348
----------- -----------
Net assets 138250 137348
=========== ===========
Capital and Reserves
Called up Share Capital 8 25500 25500
Reserves 9 112750 111848
----------- -----------
138250 137348
=========== ===========
The accounts are prepared in accordance with the special provisions of Part VII
of the CA1985 relating to small companies.
The accounts shown on pages 5 to 9 were approved by the Board of Directors on
06.11.03 and were signed on its behalf by
PB AYLING
DIRECTOR
F-64
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
EXPLANATORY NOTES TO THE ACCOUNTS - 01.01.02 - 31.12.02
2002 2001
---- ----
(pound) (pound)
------- -------
NOTE 1: Profit/(loss) on ordinary activities before tax stated after charging:-
Depreciation and loss on disposal 10221 2911
Auditor's Remuneration 1532 1532
Operating Leases - Equipment 2567 4039
----------- -----------
NOTE 2: Directors' Emoluments Nil Nil
----------- -----------
Consultants fees include payments to a
business in which the directors have
an interest 93200 87200
----------- -----------
NOTE 3: Taxation
Based on chargeable profits at small company rate 0 300
Tax repayment (506) 90
----------- -----------
(506) 390
----------- -----------
NOTE 4: TANGIBLE FIXED ASSETS
Office Computer
Euipment Equipment Software Total
-------- --------- --------- ---------
Cost
01.01.02 16515 31100 143251 190866
Additions 425 831 0 1256
Disposals 0
----- ----- ------ ------
31.12.02 16940 31931 143251 192122
----- ----- ------ ------
Depreciation
01.01.02 15865 26316 130751 172932
Charges 325 2946 6950 10221
Disposals 0
----- ----- ------ ------
31.12.02 16190 29262 137701 183153
----- ----- ------ ------
Net Values
31.12.02 750 2669 5550 8969
===== ===== ====== ======
31.12.01 650 4784 12500 17934
===== ===== ====== ======
F-65
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
EXPLANATORY NOTES TO THE ACCOUNTS - 01.01.02 - 31.12.02
2002 2001
------- -------
(pound) (pound)
------- -------
NOTE 5: INVESTMENT IN SUBSIDIARIES AND ASSOCIATES AT COST
Cape Systems Limited 100 100
Cape Systems Incorp. (Formerly Techelm) 40400 40400
----- -----
40500 40500
----- -----
NOTE 6: Debtors
Trade Debtors 66752 66025
Other debtors and prepayments 4548 5645
----- -----
71300 71670
----- -----
NOTE 7: Creditors - due within one year
Trade Creditors 8647 10891
Other creditors and accruals 16141 6540
Bank Loan 3977 8856
Corporation Tax - -
Service and upgrade in advance 17657 12716
----- -----
46422 39003
----- -----
NOTE 8: Called up Share Capital
Authorised 50000 ordinary (pound)1 shares
Called up and fully paid (pound)1 shares 25500 25500
----- -----
NOTE 9: Reserves Capital
Redemption Profit &
Reserve Loss Total
---------- -------- -----
Balance 01.01.02 24500 87348 111848
Retained profit for the year - 902 902
----- ----- ------
24500 88250 112750
----- ----- ------
F-66
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
The following pages are prepared for the directors use only.
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
DETAILED PROFIT AND LOSS ACCOUNT 01.01.02 - 31.12.02
2002 2001
------ ------
(pound) (pound)
------- -------
Turnover 498037 391692
------ ------
Cost of Sales
Consulting and System Design 251581 172437
Salaries 82971 77453
Computer Consumables 2369 1208
------ ------
336921 251098
------ ------
Gross Profit 161116 140594
------ ------
Operating Costs
Freight and Packaging 17647 34920
Office Rent and Services 26594 22448
Euro and International Travel 24254 18923
Marketing and Promotions 26144 14322
Office Costs 22709 21420
Equipment Hire/Lease 2567 4040
Equipment Maintenance and General 4355 3559
Accounts and Legal 22924 7772
------ ------
147194 127404
------ ------
Operating Profit 13922 13190
------ ------
Other Income (132) (126)
Bank Interest and Charges 4122 3934
(Profit) / Loss on Exchange (685) 839
Bad Debts 222
------ ------
3305 4869
------ ------
Depreciation and Loss on Disposal
of Fixed Assets 10221 2912
------ ------
Profit for the Year before Taxation 396 5409
------ ------
F-67
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
COMPANY NO. 01770912
Registered Office
Suite 9.03
The Perfume Factory
140 Wales Farm Road
London W3 6XL
REPORTS AND ACCOUNTS
01.01.02 - 31.12.02
F-68
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
DIRECTORS REPORT
Activities
The principal activity of the company is to provide consulting services in
evaluating computer assisted packaging (Cape Systems). The Cape System is
designed to explore quicker ways of improving package design and space
utilisation through modular programmes. Users include leading companies
throughout the world.
DIRECTORS - AND DIRECTORS INTERESTS 01.01.02 - 31.12.02
PB Ayling 13000 Shares
EM Ayling 12500 Shares
VK Ayling --
The total directors' interests remained the same. The holdings were split in
October 1999 by transfer between PBA and EMA.
STATUS OF COMPANY
Advantage has been taken of the special provisions of Part VII CA1985 relating
to small companies.
PB AYLING
DIRECTOR
06.11.03
F-69
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
Statement of directors responsibilities
Company law requires the directors to prepare financial statements which give a
true and fair view of the state of affairs of the company and of the profit of
the company for that period. In preparing those financial statements the
directors are required to:
(i) apply accounting policies consistently,
(ii) make judgements and estimates that are reasonable and prudent,
(iii) prepare the accounts on a going concern basis unless this is a wrong
assumption.
The directors are responsible for keeping proper accounting records which
disclose with reasonable accuracy at any time the financial position of the
company and comply with Companies Act 1985.
The directors have a general responsibility for safeguarding the assets of the
company and for taking reasonable steps for the prevention and detection of
fraud and other irregularities.
This statement should be read in conjunction with the auditors statement of
their responsibilities in order to underline and distinguish the respective
responsibilities of directors and auditors in relation to the accounts.
In approving the accounts on page 7 the directors acknowledge these
responsibilities.
F-70
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
INDEPENDENT AUDITORS REPORT TO THE MEMBERS OF CAPE SYSTEMS & CONSULTING SERVICES
LIMITED
We have audited the accounts on pages 5 to 9 which have been prepared in
accordance with the Financial Reporting Standard for smaller entities under the
accounting policies set out on page 5.
Respective responsibilities of directors and auditors.
As described on page 3 the company's directors are responsible for the
preparation of the financial statements. It is our responsibility to form an
independent opinion, based on our audit, on those accounts and to report our
opinion to you.
Basis of opinion
We conducted our audit in accordance with auditing standards issued by the
Auditing Practices Board. An audit includes examination, on a test basis, of
evidence relevant to the amounts and disclosures in the financial statements. It
also includes an assessment of the significant estimates and judgements made by
the directors in preparation of the financial statements, and of whether the
accounting policies are appropriate to the company's circumstances, consistently
applied and adequately disclosed.
We planned and performed the audit so as to obtain all the information and
explanations which we considered necessary in order to provide us with
sufficient evidence to give reasonable assurance that the financial statements
are free from material misstatement, whether caused by fraud or other
irregularity or error. In forming our opinion we also evaluated the overall
adequacy of the presentation of information in the financial statements.
Opinion
In our opinion the financial statements give a true and fair view of the state
of the company's affairs as at 31 December 2002 and of the profit for the year
then ended and have been properly prepared in accordance with the provisions of
the Companies Act 1985.
/s/ LESLIE, WARD & DREW
- -----------------------
Leslie, Ward and Drew
Chartered Accountants
Registered Auditors
Bath
06.11.03
F-71
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
STATEMENT OF ACCOUNTING POLICIES
Basis of Accounting
The accounts are prepared in accordance with the provisions of the Companies Act
1985 applicable to small companies and the generally accepted accounting
standards on a basis of historical cost.
Tangible Fixed Assets
Tangible fixed assets are recorded at cost. Depreciation is calculated to write
off the cost over the period of the life of the asset.
Turnover
Represents the invoiced value of software sold exclusive of VAT.
System Users Support Package
Service and upgrade fees relating to commitments beyond the year end are treated
as prepaid income in order to match the costs to be incurred in the period of
that commitment.
Foreign Currencies
Assets and liabilities are translated at the rate operative at the balance sheet
date. Transactions are converted at the rate ruling at the time of the
transaction. Profits and losses are written off to the profit and loss account.
Leases - Equipment
Operating lease rentals are written off to profit and loss. Instalments under
finance leases are split between capital and interest elements. The capital
value of the obligation is treated as a fixed asset.
Consolidation
The company and its subsidiaries are a small group. The company takes advantage
of the exemption provided by section 248 of the CA 1985 not to prepare group
accounts.
F-72
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
PROFIT AND LOSS ACCOUNT 01.01.03 - 31.12.03
Note 2003 2002
----------- ----------- -----------
(pound) (pound)
----------- -----------
Turnover (see footnote) 450370 498037
Cost of sales 281261 336921
----------- -----------
Gross Profit 169109 161116
Net Operating Expenses 142916 157415
----------- -----------
26193 3701
Interest Payable and Similar Payments 3651 3305
----------- -----------
Profit on Ordinary Activities 1 22542 396
Taxation 3 1811 (506)
----------- -----------
Profit after taxation 20731 902
Dividends 0 0
----------- -----------
Retained Profit for the year 9 20731 902
----------- -----------
FOOTNOTES
1. Turnover reflects the absorption of operations from Cape Systems Limited, a
subsidiary made dormant from 31.12.91. These activities are streamed with that
of the parent company and continue to be conducted.
2. The company had no recognised gains or losses other than those included in
profit and loss. No separate primary statement is required.
3. The profit for the year is the only movement on reserves.
F-73
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
BALANCE SHEET 31.12.03
Note 2003 2002
----------- ----------- -----------
(pound) (pound)
----------- -----------
Fixed Assets
Tangible Fixed Assets 4 18750 8969
Investment in Subsidiaries and Associates at cost 5 40500 40500
----------- -----------
59250 49469
----------- -----------
Current Assets
Stocks 3300 4500
Debtors 6 110314 71300
Bank Balances and Cash 51144 59403
----------- -----------
164758 135203
Creditors due within one year 7 65027 46422
----------- -----------
Net Current Assets 99731 88781
----------- -----------
Total Assets less Current Liabilities 158981 138250
----------- -----------
Net assets 158981 138250
=========== ===========
Capital and Reserves
Called up Share Capital 8 25500 25500
Reserves 9 133481 112750
----------- -----------
158981 138250
=========== ===========
The accounts are prepared in accordance with the special provisions of Part VII
of the CA1985 relating to small companies.
The accounts shown on pages 5 to 9 were approved by the Board of Directors on
29.07.04 and were signed on its behalf by
PB AYLING
DIRECTOR
F-74
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
EXPLANATORY NOTES TO THE ACCOUNTS - 01.01.03 - 31.12.03
2003 2002
------- -------
(pound) (pound)
------- -------
NOTE 1: Profit/(loss) on ordinary activities before tax
stated after charging:-
Depreciation and loss on disposal 10249 10221
Auditor's Remuneration 1532 1532
Operating Leases - Equipment 2184 2567
----- -----
NOTE 2: Directors' Emoluments Nil Nil
----- -----
Consultants fees include payments to a
business in which the directors have
an interest 93250 93200
----- -----
NOTE 3: Taxation
Based on chargeable profits at small company rate 1811 0
Tax repayment - (506)
----- -----
1811 (506)
----- -----
NOTE 4: TANGIBLE FIXED ASSETS
Office Computer
Equipment Equipment Software Total
--------- --------- -------- -----
Cost
01.01.03 16940 31931 143251 192122
Leased Equipment 6266 0 0 6266
Additions 12973 791 13764
Disposals (16516) (30267) 0 (46783)
------ ------ ------ ------
31.12.03 19663 2455 143251 165369
------ ------ ------ ------
Depreciation
01.01.03 16190 29262 137701 183153
Charges 4389 2090 3770 10249
Disposals (16516) (30267) 0 (46783)
------ ------ ------ ------
31.12.03 4063 1085 141471 146619
------ ------ ------ ------
Net Values
31.12.03 15600 1370 1780 18750
====== ====== ====== ======
31.12.02 750 2669 5550 8969
====== ====== ====== ======
F-75
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
EXPLANATORY NOTES TO THE ACCOUNTS - 01.01.03 - 31.12.03
2003 2002
------- -------
(pound) (pound)
------- -------
NOTE 5: INVESTMENT IN SUBSIDIARIES AND ASSOCIATES AT COST
Cape Systems Limited 100 100
Cape Systems Incorp. (Formerly Techelm) 40400 40400
----------- -----------
40500 40500
----------- -----------
NOTE 6: Debtors
Trade Debtors 90245 66752
Other debtors and prepayments 20069 4548
----------- -----------
110314 71300
----------- -----------
NOTE 7: Creditors - due within one year
Trade Creditors 15684 8647
Other creditors and accruals 18048 16141
Bank Loan 6013 3977
Corporation Tax 1811 --
Lease Creditor 4917 --
Service and upgrade in advance 18554 17657
----------- -----------
65027 46422
----------- -----------
NOTE 8: Called up Share Capital
Authorised 50000 ordinary (pound)1 shares
Called up and fully paid (pound)1 shares 25500 25500
----------- -----------
NOTE 9: Reserves Capital
Redemption Profit &
Reserve Loss Total
----------- ----------- -----------
Balance 01.01.03 24500 88250 112750
Retained profit for the year -- 20731 20731
----------- ----------- -----------
24500 108981 133481
----------- ----------- -----------
F-76
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
The following pages are prepared for the directors use only.
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
DETAILED PROFIT AND LOSS ACCOUNT 01.01.03 - 31.12.03
2003 2002
----------- -----------
(pound) (pound)
----------- -----------
Turnover 450370 498037
----------- -----------
Cost of Sales
Consulting and System Design 195640 251581
Salaries 82678 82971
Computer Consumables 2943 2369
----------- -----------
281261 336921
----------- -----------
Gross Profit 169109 161116
----------- -----------
Operating Costs
Freight and Packaging 24882 17647
Office Rent and Services 27498 26594
Euro and International Travel 20232 24254
Marketing and Promotions 22982 26144
Office Costs 11758 22709
Equipment Hire/Lease 2185 2567
Equipment Maintenance and General 6471 4355
Accounts and Legal 16659 22924
----------- -----------
132667 147194
----------- -----------
Operating Profit 36442 13922
----------- -----------
Other Income (412) (132)
Bank Interest and Charges 3732 4122
Other Interest 1261 --
(Profit) / Loss on Exchange (1555) (685)
Bad Debts 625
----------- -----------
3651 3305
----------- -----------
Depreciation and Loss on Disposal
of Fixed Assets 10249 10221
----------- -----------
Profit for the Year before Taxation 22542 396
----------- -----------
F-77
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
COMPANY NO. 01770912
Registered Office
Suite 9.03
The Perfume Factory
140 Wales Farm Road
London W3 6XL
REPORTS AND ACCOUNTS
01.01.03 - 31.12.03
F-78
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
DIRECTORS REPORT
Activities
The principal activity of the company is to provide consulting services in
evaluating computer assisted packaging (Cape Systems). The Cape System is
designed to explore quicker ways of improving package design and space
utilisation through modular programmes. Users include leading companies
throughout the world.
DIRECTORS - AND DIRECTORS INTERESTS 01.01.03 - 31.12.03
PB Ayling 13000 Shares
EM Ayling 12500 Shares
VK Ayling --
The total directors' interests remained the same. The holdings were split in
October 1999 by transfer between PBA and EMA.
STATUS OF COMPANY
Advantage has been taken of the special provisions of Part VII CA1985 relating
to small companies.
PB AYLING
DIRECTOR
29.07.04
F-79
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
Statement of directors responsibilities
Company law requires the directors to prepare financial statements which give a
true and fair view of the state of affairs of the company and of the profit of
the company for that period. In preparing those financial statements the
directors are required to:
(i) apply accounting policies consistently,
(ii) make judgements and estimates that are reasonable and prudent, (iii)
prepare the accounts on a going concern basis unless this is a wrong assumption.
The directors are responsible for keeping proper accounting records which
disclose with reasonable accuracy at any time the financial position of the
company and comply with Companies Act 1985.
The directors have a general responsibility for safeguarding the assets of the
company and for taking reasonable steps for the prevention and detection of
fraud and other irregularities.
This statement should be read in conjunction with the auditors statement of
their responsibilities in order to underline and distinguish the respective
responsibilities of directors and auditors in relation to the accounts.
In approving the accounts on page 7 the directors acknowledge these
responsibilities.
F-80
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
INDEPENDENT AUDITORS REPORT TO THE MEMBERS OF CAPE SYSTEMS & CONSULTING SERVICES
LIMITED
We have audited the accounts on pages 5 to 9 which have been prepared in
accordance with the Financial Reporting Standard for smaller entities under the
accounting policies set out on page 5.
Respective responsibilities of directors and auditors.
As described on page 3 the company's directors are responsible for the
preparation of the financial statements. It is our responsibility to form an
independent opinion, based on our audit, on those accounts and to report our
opinion to you.
Basis of opinion
We conducted our audit in accordance with auditing standards issued by the
Auditing Practices Board. An audit includes examination, on a test basis, of
evidence relevant to the amounts and disclosures in the financial statements. It
also includes an assessment of the significant estimates and judgements made by
the directors in preparation of the financial statements, and of whether the
accounting policies are appropriate to the company's circumstances, consistently
applied and adequately disclosed.
We planned and performed the audit so as to obtain all the information and
explanations which we considered necessary in order to provide us with
sufficient evidence to give reasonable assurance that the financial statements
are free from material misstatement, whether caused by fraud or other
irregularity or error. In forming our opinion we also evaluated the overall
adequacy of the presentation of information in the financial statements.
Opinion
In our opinion the financial statements give a true and fair view of the state
of the company's affairs as at 31 December 2003 and of the profit for the year
then ended and have been properly prepared in accordance with the provisions of
the Companies Act 1985.
/s/ LESLIE, WARD & DREW
- -----------------------
Leslie, Ward and Drew
Chartered Accountants
Registered Auditors
Bath
29.07.04
F-81
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
STATEMENT OF ACCOUNTING POLICIES
Basis of Accounting
The accounts are prepared in accordance with the provisions of the Companies Act
1985 applicable to small companies and the generally accepted accounting
standards on a basis of historical cost.
Tangible Fixed Assets
Tangible fixed assets are recorded at cost. Depreciation is calculated to write
off the cost over the period of the life of the asset.
Turnover
Represents the invoiced value of software sold exclusive of VAT.
System Users Support Package
Service and upgrade fees relating to commitments beyond the year end are treated
as prepaid income in order to match the costs to be incurred in the period of
that commitment.
Foreign Currencies
Assets and liabilities are translated at the rate operative at the balance sheet
date. Transactions are converted at the rate ruling at the time of the
transaction. Profits and losses are written off to the profit and loss account.
Leases - Equipment
Operating lease rentals are written off to profit and loss. Instalments under
finance leases are split between capital and interest elements. The capital
value of the obligation is treated as a fixed asset.
Consolidation
The company and its subsidiaries are a small group. The company takes advantage
of the exemption provided by section 248 of the CA 1985 not to prepare group
accounts.
F-82
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Cape Systems, Inc.
We have audited the accompanying balance sheets of Cape Systems, Inc. (A
Subsidiary of Cape Systems and Consulting Services Ltd) as of December 31, 2003
and 2002, and the related statements of operations and retained earnings and
cash flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Cape Systems, Inc. as of
December 31, 2003 and 2002, and its results of operations and cash flows for the
years then ended, in conformity with United States generally accepted accounting
principles.
/s/ J.H. COHN LLP
-----------------
Roseland, New Jersey
March 24, 2005
F-83
CAPE SYSTEMS, INC.
(A Subsidiary of Cape Systems and Consulting Services Ltd.)
Cape Systems, Inc.
Balance Sheets
December 31, 2003 and 2002
ASSETS 2003 2002
--------- ---------
CURRENT ASSETS
Cash $ 153,000 $ 34,830
Accounts receivables net of allowance for
doubtful accounts of $2,554 and $1,000 83,083 157,231
Prepaid expenses and other current assets 18,619 34,204
Deferred tax assets 67,800 67,400
--------- ---------
Total current assets 322,502 293,665
Equipment, furniture and fixtures, net of accumulated
depreciation of $42,330 and $38,400 12,054 18,294
Other assets 3,704 3,704
--------- ---------
Total assets $ 338,260 $ 315,663
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Current portion of long-term debt $ 6,613 $ 7,786
Accounts payable 24,960 34,060
Accrued expenses and other liabilities 17,399 3,836
Deferred revenue 166,890 168,476
--------- ---------
Total current liabilities 215,862 214,158
Long-term debt, net of current portion 9,493 19,054
Deferred tax liabilities 4,200 5,600
--------- ---------
Total liabilities 229,555 238,812
--------- ---------
Commitments
- -----------
STOCKHOLDERS' EQUITY
Common stock par value $1 per share;
100,000 shares authorized, 28,690 issued and outstanding 28,690 28,690
Additional paid-in capital 106,911 106,911
Retained earnings 34,103 2,249
Less: Treasury stock, 11,813 shares of common stock, at cost (60,999) (60,999)
--------- ---------
Total stockholders' equity 108,705 76,851
--------- ---------
Total liabilities and stockholders' equity $ 338,260 $ 315,663
========= =========
See notes to the financial statements
F-84
CAPE SYSTEMS, INC.
(A Subsidiary of Cape Systems and Consulting Services Ltd.)
Cape Systems, Inc.
Statements of Operations and Retained Earnings For the Years Ended December 31,
2003 and 2002
2003 2002
--------- ---------
REVENUE $ 769,172 $ 756,777
COST OF SALES 134,233 172,409
--------- ---------
GROSS PROFIT 634,939 584,368
OPERATING EXPENSES
Selling, general and administrative 561,802 538,310
Depreciation 8,236 14,165
Research and development 24,132 38,912
--------- ---------
Total operating expenses 594,170 591,387
--------- ---------
Operating income (loss) 40,769 (7,019)
OTHER EXPENSE
Interest expense (2,565) (3,863)
Other (3,937) 0
--------- ---------
Other expense (6,502) (3,863)
--------- ---------
INCOME (LOSS) BEFORE
PROVISION FOR INCOME TAXES 34,267 (10,882)
Provision (credit) for income taxes 2,413 (3,763)
--------- ---------
NET INCOME (LOSS) 31,854 (7,119)
Retained earnings beginning of year 2,249 9,368
--------- ---------
Retained earnings end of year $ 34,103 $ 2,249
========= =========
See notes to financial statements
F-85
CAPE SYSTEMS, INC.
(A Subsidiary of Cape Systems and Consulting Services Ltd.)
Cape Systems, Inc.
Statements of Cash Flows
For the Years Ended December 31, 2003 and 2002
2003 2002
--------- ---------
Cash Flows from Operating Activities
Net Income (loss) $ 31,854 ($ 7,119)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation 8,236 14,165
Bad debts 2,554 5,108
Change in operating assets and liabilities
Accounts receivable 71,594 (39,550)
Deferred taxes (1,800) (4,600)
Prepaid expense and other current assets 15,585 (3,005)
Accounts payable (9,100) 27,670
Accrued expenses and other liabilities 11,977 7,526
--------- ---------
Net cash provided by operating activities 130,900 195
--------- ---------
Cash flows from investing activities -
additions to equipment, furniture and fixtures (1,996) (6,276)
--------- ---------
Cash flows from financing activities
Proceeds from notes payable -- 20,000
Repayment of notes payable (10,734) (7,691)
--------- ---------
Net cash provided by (used in) financing activities (10,734) 12,309
Net increase in cash 118,170 6,228
Cash at beginning of year 34,830 28,602
--------- ---------
Cash at end of year $ 153,000 $ 34,830
========= =========
Supplemental Disclosures of Cash Flow Information
Cash paid for:
Income taxes $ 4,314 $ 837
Interest $ 2,565 $ 3,863
See notes to financial statements
F-86
CAPE SYSTEMS, INC.
(A Subsidiary of Cape Systems and Consulting Services Ltd.)
NOTES TO THE FINANCIAL STATEMENTS
NOTE 1: ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION:
Cape Systems, Inc (the "Company") was incorporated in Texas on July 27, 1987.
The Company is a 60% owned subsidiary of Cape Systems and Consulting Services
Ltd. (the "Parent"). The Company is a provider of palletizing and packaging
configuration, and truck and container loading software that improves pallet and
truck utilization, and reduces packaging, storage and transportation costs. Its
programs optimize pallet patterns, create new case sizes and product packaging,
create efficient bundles of corrugated flat packs, build display pallet loads
and test the strength of corrugated board.
USE OF ESTIMATES:
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Accordingly, actual results could differ from those estimates.
REVENUE RECOGNITION:
Software sales:
Revenue related to software license sales is recorded at the time of shipment
provided that (i) no significant vendor obligations remain outstanding at the
time of sale; (ii) the collection of the related receivable is reasonably
assured by management; and (iii) vendor specific objective evidence ("V.S.O.E.")
of fair value exists for all significant elements, including post contract
customer support ("PCS") in multiple element arrangements.
Professional services:
The Company provides consulting and other services on a per-diem billing basis
and recognizes such revenues as the services are performed.
SUPPORT AND SERVICE:
The Company accounts for revenue related to service contracts and post contract
customer support over the life of the arrangements, usually twelve months,
pursuant to the service and/or licensing agreement between the customers and the
Company.
DEFERRED REVENUE:
Deferred revenue represents the unearned portion of revenue related to PCS.
Equipment, furniture and fixtures:
Equipment, furniture and fixtures are stated at cost, less accumulated
depreciation and amortization. Depreciation is computed on the straight-line
basis over the estimated useful lives of individual assets or classes of assets.
Improvements to leased properties or fixtures are amortized over the shorter of
their estimated useful lives or the related lease terms.
F-87
CAPE SYSTEMS, INC.
(A Subsidiary of Cape Systems and Consulting Services Ltd.)
NOTES TO THE FINANCIAL STATEMENTS
CONCENTRATION OF CREDIT RISK:
The Company's financial instruments that are exposed to concentration of credit
risk consist primarily of cash and accounts receivable. The Company maintains
its cash in bank accounts that, at times, have balances that exceed the
federally insured limit of $100,000 (there was a balance of $7,000 in excess of
the limit at December 31, 2003). The Company reduces its exposure to credit risk
by maintaining its cash deposits with major financial institutions and
monitoring their credit ratings.
Concentrations of credit risk with respect to trade receivables are limited due
to the large number of customers comprising the Company's customer base, their
dispersion across different geographic areas, and generally short payment terms.
There were no significant concentrations in 2003 and 2002. In addition, the
Company closely monitors the extension of credit to its customers while
maintaining allowances for potential credit losses. On a periodic basis, the
Company evaluates its trade accounts receivable and will establish an allowance
for doubtful accounts, based on a history of past write-offs and collections and
current credit considerations if necessary.
INCOME TAXES:
The Company accounts for income taxes pursuant to the asset and liability method
that requires deferred income tax assets and liabilities to be computed for
temporary differences between the financial statement and tax bases of assets
and liabilities that will result in taxable or deductible amounts in the future
based on enacted tax laws and rates applicable to the periods in which the
differences are expected to affect taxable income. Valuation allowances are
established when necessary to reduce deferred tax assets to the amount expected
to be realized. The income tax provision or credit is the tax payable or
refundable for the period plus or minus the change during the period in deferred
tax assets and liabilities.
ADVERTISING:
The Company expenses the cost of advertising and promotions as incurred.
Advertising cost charges to operations amounted to approximately $26,900 and
$28,600 in 2003 and 2002 respectively.
Research and development:
Research and development expenditures are charged to expense as incurred.
NOTE 2: EQUIPMENT, FURNITURE AND FIXTURES:
Equipment, furniture and fixtures, consist of the following:
Range of
Estimated
Useful Lives 2003 2002
------------ --------- ----------
Equipment, furniture and fixtures 3 - 10 years $ 42,777 $ 202,810
Computer equipment 3 - 5 years 7,677 54,837
--------- ----------
50,454 257,647
Less: accumulated depreciation 38,400 239,353
--------- ----------
Totals $ 12,054 $ 18,294
========= ==========
F-88
CAPE SYSTEMS, INC.
(A Subsidiary of Cape Systems and Consulting Services Ltd.)
NOTES TO THE FINANCIAL STATEMENTS
NOTE 3: LINE OF CREDIT BORROWINGS:
At December 31, 2003, the Company had no outstanding borrowings under its
$25,000 line of credit. Any outstanding borrowings bear interest at 1.25% above
the prime rate, are collateralized by all of the Company's assets and guaranteed
by certain stockholders of the Company. The line of credit expires on December
31, 2005.
NOTE 4: LONG-TERM DEBT:
Long-term debt consists of the following:
2003 2002
---- ----
Unsecured note payable in monthly installments of $306,
including interest at 7.5% through May 2009 $12,034 $16,999
Note payable in monthly installments of $523 including interest at 11.49%,
through September 2004; collateralized by all of the Company's assets:
4,072 9,841
------- -------
16,106 26,840
Less current portion 6,613 7,786
------- -------
Long-term portion $ 9,493 $19,054
------- -------
The principal payments due under the notes payable for each of the subsequent
years after December 31, 2003 were as follows
Year Ending
December 31 Amount
----------- ------
2004 $6,613
2005 2,738
2006 2,952
2007 3,180
2008 623
F-89
CAPE SYSTEMS, INC.
(A Subsidiary of Cape Systems and Consulting Services Ltd.)
NOTES TO THE FINANCIAL STATEMENTS
NOTE 5: INCOME TAXES
Provision (credit) for income taxes consist of the following:
2003 2002
------- -------
Current:
Federal $ 4,213 $ 837
------- -------
Total Current $ 4,213 $ 837
------- -------
Deferred:
Federal $(1,800) $(4,600)
------- -------
Total Deferred $(1,800) $(4,600)
------- -------
Totals $ 2,413 $(3,763)
======= =======
The provision for income taxes differs from the amount which would have been
reported by applying the statutory rates. These differences are due primarily to
certain nondeductible expenses.
At December 31, 2003 and 2002, the deferred tax asset relates to the allowance
for doubtful accounts and deferred revenue. At December 31, 2003 and 2002, the
deferred tax liability relates to depreciation.
In assessing the realizability of the deferred tax asset, management considers
whether it is more likely that some portion or all of the deferred tax asset
will not be realized. The ultimate realization of the deferred tax asset is
dependent upon the generation of future taxable income during the periods in
which the temporary differences become deductible. Management has determined
that the realization of the recorded deferred tax asset is reasonably assured;
accordingly, no valuation allowance has been recorded.
NOTE 6: COMMITMENT:
LEASES:
The Company has a lease for its office facility which expires in April 2006. The
minimum annual lease payment under the operating lease is $35,556.
Rent expense for 2003 and 2002 was approximately $44,000 and $36,000
respectively.
Royalty payments:
A royalty agreement was entered into in June 1998 as part of software license
for its Truckfill Software Product. As part of the agreement, the Company is
required to make a royalty payment of $450 for each Truckfill software license
sold. During 2003, the Company incurred royalty expenses of approximately
$19,350.
NOTE 7: RELATED PARTY TRANSACTIONS:
The Company receives certain administrative and management services from the
Parent. The Company paid $8,500 in 2003 and $33,000 in 2002 for such services
performed.
In addition, the Company paid approximately $24,000 during 2003 and 2002 to a
corporation owned by an Officer of the Company for various consulting services.
F-90
CAPE SYSTEMS, INC.
(A Subsidiary of Cape Systems and Consulting Services Ltd.)
NOTES TO THE FINANCIAL STATEMENTS
Accounts receivable at December 31, 2003 includes amount receivable from Parent
for reimbursement of expenses of $3,890.
NOTE 8: SUBSEQUENT EVENTS:
On January 12, 2005, the Company and the stockholders of the Company entered
into a Stock Purchase Agreement with Cape Systems Group, Inc ("Cape Systems
Group") pursuant to which Cape Systems Group purchased all of the issued and
outstanding shares of the Company.
F-91
INTRODUCTION TO THE UNAUDITED PRO FORMA
CONDENSED COMBINED FINANCIAL STATEMENTS
On January 12, 2005, Cape Systems Group, Inc. entered into a stock purchase
agreement pursuant to which it acquired all of the issued and outstanding shares
of common stock of Cape Systems and Consulting Services Ltd. ("CSCS Ltd") and
its, subsidiary, Cape Systems, Inc. ("CSI"), for an aggregate purchase price of
$2,000,000, excluding acquisition costs (the "Acquisition"). As used herein, the
"Company" refers to Cape Systems Group, Inc. or Cape Systems Group, Inc.
together with its subsidiaries prior to the acquisition, and the "Acquired
Companies" refers to CSCS Ltd together with CSI. The Acquisition 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. 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 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 warrants are exercisable until five years
from the date of issuance at a purchase price of $0.09 per share.
The accompanying unaudited pro forma condensed combined balance sheet combines
the historical consolidated balance sheet of the Company and the historical
balance sheets of the Acquired Companies assuming the financing had been
obtained and the Acquisition had been consummated on December 31, 2004 and
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 will be 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 allocated to goodwill. The
accompanying unaudited pro forma condensed combined statements of operations
combine the historical results of operations of the Company and the Acquired
Companies for the three months ended December 31, 2004 and the historical
results of operations of the Company for the year ended September 30, 2004 and
the historical results of operations of the Acquired Companies for the year
ended December 31, 2003 assuming the financing had been obtained and the
Acquisition had been consummated on October 1, 2003.
You should read this information in conjunction with:
o the accompanying notes to the unaudited pro forma condensed
combined financial statements;
o the separate audited historical financial statements of the
Company as of and for the years ended September 30, 2004 and
2003 included herein;
o the unaudited historical financial statements of the Company
as of December 31, 2004 and for the three months ended
December 31, 2004 and 2003 included in the quarterly report on
Form 10-QSB, as amended, for the quarter ended December 31,
2004;
F-92
o the separate audited historical financial statements of CSCS Ltd as
of and for the years ended December 31, 2003 and 2002, which are
included herein; and
o the separate audited historical financial statements of CSI as of
December 31, 2003 and 2002, which are included herein.
We have presented the accompanying unaudited pro forma condensed combined
financial statements for informational purposes only. The accompanying unaudited
pro forma condensed combined financial statements are not necessarily indicative
of what our financial position or results of operations actually would have been
had we completed the Acquisitions on the dates set forth above. In addition, the
unaudited pro forma condensed combined financial statements do not purport to
project the future financial position or operating results of the combined
companies.
F-93
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
PRO FORMA CONDENSED COMBINED BALANCE SHEET
DECEMBER 31, 2004
Historical
--------------------------------------------------------------------
The Acquired Companies
------------------------------------------------- Pro forma
The Company CSCS Ltd. CSI Total Adjustments Total
------------------ ----------------- ------------------ ------------ ------------- -------------
ASSETS
CURRENT ASSETS
Cash $ 50,698 $ 137,067 $ 71,698 $ 208,765 $ 0 $ 259,463
Restricted cash, short
term 300,000 0 0 0 (300,000) 0
Accounts receivable,
net 406,178 120,141 118,483 238,624 (23,862) 620,940
Inventories, net 386,295 7,089 32,340 39,429 (3,943) 421,781
Prepaid expenses and
other assets 43,973 35,252 71,000 106,252 (41,875) 108,350
Deferred tax assets
------------- ------------- ------------- ------------- ------------- -------------
Total current assets 1,187,144 299,549 293,521 593,070 (369,680) 1,410,534
0
Equipment and fixtures,
net 30,541 25,854 12,044 37,898 (3,790) 64,649
Other intangible assets 1,548,451 1,548,451
Restricted cash - long
term 118,750 0 0 0 (118,750) 0
Deferred financing, net 194,355 0 0 0 194,355
Other assets 111,273 77,885 3,704 81,589 (81,589) 111,273
Goodwill 350,000 350,000
------------- ------------- ------------- ------------- ------------- -------------
Total assets $ 1,642,063 $ 403,288 $ 309,269 $ 712,557 $ 1,324,642 $ 3,679,262
============= ============= ============= ============= ============= =============
LIABILITIES AND
STOCKHOLDERS' EQUITY/
(DEFICIENCY)
CURRENT LIABILITIES
Notes payable $ 1,227,500 $ 0 $ 6,723 $ 6,723 1,234,223
Mandatorily redeemable
preferred stock 504,713 0 0 0 504,713
Accounts payable 3,518,291 9,165 15,427 24,592 (101,300) 3,441,583
Net liabilities -
subsidiaries in
liquidation 8,397,181 0 0 0 8,397,181
Payroll and related
benefits accrual 1,764,974 0 0 0 1,764,974
Accrued litigation 3,655,323 0 0 0 3,655,323
Other accrued expenses
and liabilities 3,580,975 27,010 15,396 42,406 0 3,623,381
Deferred revenue 340,377 38,320 176,458 214,778 555,155
Deferred tax liabilities 0 0 4,600 4,600 (4,600) 0
0 0
------------- ------------- ------------- ------------- ------------- -------------
Total current
liabilities 22,989,334 74,495 218,604 293,099 (105,900) 23,176,533
Long-term convertible
notes payable 2,338,662 0 0 0 1,850,000 4,188,662
------------- ------------- ------------- ------------- ------------- -------------
Total liabilities 25,327,996 74,495 218,604 293,099 1,774,100 27,365,195
------------- ------------- ------------- ------------- ------------- -------------
STOCKHOLDERS' EQUITY
(DEFICIENCY)
Common stock 369,240 48,858 28,690 77,548 (77,548) 369,240
Preferred stock 13,660 0 0 0 13,660
Additional paid-in
capital 165,083,708 0 106,911 106,911 (106,911) 165,083,708
Accumulated equity
(deficit) (186,594,240) 279,935 16,063 295,998 (295,998) (186,594,240)
Accumulated other
comprehensive loss (2,491,061) 0 0 0 (2,491,061)
Treasury stock (67,240) 0 (60,999) (60,999) 60,999 (67,240)
------------- ------------- ------------- ------------- ------------- -------------
Total Stockholders'
deficiency (23,685,933) 328,793 90,665 419,458 (419,458) (23,685,933)
------------- ------------- ------------- ------------- ------------- -------------
Total liabilities and
stockholders' equity $ 1,642,063 $ 403,288 $ 309,269 $ 712,557 $ 1,324,642 $ 3,679,262
============= ============= ============= ============= ============= =============
F-94
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED DECEMBER 31, 2004
Historical
--------------------------------------------------------------------
The Acquired Companies
------------------------------------------------- Pro forma Total
The Company CSCS Ltd. CSI Total Adjustments Combined
------------------ ----------------- ---------------- ----------- ----------- -----------
REVENUE $ 665,340 $ 205,823 179,608 $ 385,431 $ 1,050,771
COST OF SALES 249,338 145,000 25,233 170,233 419,571
----------- ----------- ----------- ----------- ----------- -----------
GROSS PROFIT 416,002 60,823 154,375 215,198 $ 0 631,200
----------- ----------- ----------- ----------- -----------
OPERATING EXPENSES
Selling and administrative 704,898 122,759 156,738 279,497 0 984,395
Depreciation and
amortization 3,572 4,740 983 5,723 9,295
Amortization of
intangible assets 129,000 129,000
----------- ----------- ----------- ----------- ----------- -----------
Total operating expenses 708,470 127,499 157,721 285,220 129,000 1,122,690
----------- ----------- ----------- ----------- ----------- -----------
Operating income/(loss) (292,468) (66,676) (3,346) (70,022) (129,000) (491,490)
----------- ----------- ----------- ----------- ----------- -----------
OTHER INCOME (EXPENSE)
Interest income 0 0 89 89 89
Interest expense (282,640) 0 (224) (224) (186,650) (469,514)
Gain on settlement of
liabilities 29,712 0 (38) (38) 29,674
Other 13,221 0 0 13,221
----------- ----------- ----------- ----------- ----------- -----------
Net other income (expense) (239,707) 0 (173) (173) (186,650) (426,530)
----------- ----------- ----------- ----------- ----------- -----------
INCOME/(LOSS) BEFORE
PROVISION FOR INCOME TAXES (532,175) (66,676) (3,519) (70,195) (315,650) (918,020)
----------- ----------- ----------- ----------- ----------- -----------
Provision for state income
taxes 1,881 0 0 0 1,881
Credit for sale of state
tax benefits (456,863) 0 0 0 (456,863)
----------- ----------- ----------- ----------- ----------- -----------
Net income tax credit (454,982) 0 0 0 0 (454,982)
----------- ----------- ----------- ----------- ----------- -----------
NET LOSS ($77,193) ($66,676) ($3,519) ($70,195) $(315,650) ($463,038)
=========== =========== =========== =========== =========== ===========
Net loss per share
of common stock:
Basic and Diluted $ -- $ (.01)
=========== ===========
Weighted average number
of shares outstanding:
Basic and Diluted 65,385,517 65,385,517
=========== ===========
F-95
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED SEPTEMBER 30, 2004
Historical
--------------------------------------------------------------------
The Acquired Companies
------------------------------------------------- Pro forma Total
The Company CSCS Ltd. CSI Total Adjustments Combined
------------------ ----------------- ---------------- ----------- ----------- -----------
REVENUE $ 2,566,520 $ 833,185 $ 769,172 $ 1,602,357 $ 4,168,877
COST OF SALES 1,287,435 520,333 134,233 654,566 1,942,001
----------- ----------- ----------- ----------- ----------- -----------
GROSS PROFIT 1,279,085 312,852 634,939 947,791 $ 0 2,226,876
----------- ----------- ----------- ----------- -----------
OPERATING EXPENSES
Selling and administrative 2,925,051 245,434 585,934 831,368 15,200 3,771,619
Depreciation and
amortization 38,938 18,961 8,236 27,197 66,135
Amortization of
intangible assets 115,756 516,000 631,756
----------- ----------- ----------- ----------- ----------- -----------
Total operating expenses 3,079,745 264,395 594,170 858,565 531,200 4,469,510
----------- ----------- ----------- ----------- ----------- -----------
Operating income/(loss) (1,800,660) 48,457 40,769 89,226 (531,200) (2,242,634)
----------- ----------- ----------- ----------- ----------- -----------
OTHER INCOME (EXPENSE)
Interest income 0 0 0 0 0
Interest expense (1,969,074) (6,754) (2,565) (9,319) (740,000) (2,718,393)
Other gain/(loss) 1,586,477 0 (3,937) (3,937) 1,582,540
0 0
----------- ----------- ----------- ----------- ----------- -----------
Net other income (expense) (382,597) (6,754) (6,502) (13,256) (740,000) (1,135,853)
----------- ----------- ----------- ----------- ----------- -----------
INCOME/(LOSS) BEFORE
PROVISION FOR INCOME TAXES (2,183,257) 41,703 34,267 75,970 (1,271,200) (3,378,487)
Provision for income taxes 1,735 3,350 2,413 5,763 7,498
----------- ----------- ----------- ----------- ----------- -----------
NET INCOME (LOSS) (2,184,992) $ 38,353 $ 31,854 $ 70,207 $(1,271,200) (3,385,985)
=========== =========== =========== ===========
Charge for preferred stock
beneficial conversion
feature 3,444,683 -- -- -- -- 3,444,683
----------- -----------
Net loss attributable to
common stockholders $(5,629,675) $(6,830,668)
=========== ===========
Net loss per common share:
Basic and diluted $ (0.12) $ (0.14)
=========== ===========
Weighted average number of
shares outstanding:
Basic and diluted 48,469,039 48,469,039
=========== ===========
F-96
NOTES TO THE UNAUDITED PRO FORMA
CONDENSED COMBINED FINANCIAL STATEMENTS
Description of the Transactions and Basis of Presentation
As explained in the Introduction to the Unaudited Pro Forma Condensed Combined
Financial Statements, 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 estimated acquisition costs of
$200,000. The Acquisition 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. 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 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 warrants
are exercisable until five years from the date of issuance at a purchase price
of $0.09 per share.
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
agreed to release the restricted deposits and return the prepaid interest.
The Acquisition will be 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 will be 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 allocated to goodwill. The
Company expects the costs of the Acquisition that it estimates will total
$2,198,700 will be allocated to the estimated fair values of the assets and
liabilities of the Acquired Companies and to goodwill as follows:
F-97
Cash $ 208,765
Accounts receivable 214,762
Inventories 35,486
Prepaid expenses 95,627
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 1,548,451
Goodwill 350,000
----------
Total cost allocated $2,198,700
==========
Pro Forma Balance Sheet Adjustments
The accompanying unaudited pro forma condensed combined balance sheet combines
the historical consolidated balance sheet of the Company and the historical
balance sheets of the Acquired Companies assuming the financing had been
obtained and the Acquisition had been consummated on December 31, 2004 and
reflects pro forma adjustments as follows:
(1) To record the receipt of proceeds of $2,300,000, of which $1,850,000 is
attributable to the sale of the secured convertible notes, $418,750 is
attributable to the release of short- and long-term restricted cash deposits and
$31,250 is attributable to the return of prepaid interest, and the use of those
proceeds to pay $2,000,000 to the stockholders of the Acquired Companies,
$198,700 is for the payment of acquisition costs, and $101,300 is for the
payment of accounts payable.
(2) To record the effects on debt discount and additional paid-in capital of the
beneficial conversion feature attributable to the secured convertible notes of
approximately $1,100,000 based on the excess of the aggregate fair value of the
common shares that would have been issued if the secured convertible notes had
been converted immediately over the proceeds received from their sale. The debt
discount will be amortized to interest expense over the two year term of the
related notes.
F-98
(3) To record increases in the historical carrying values of the assets of the
Acquired Companies and goodwill as follows:
Accounts receivable $ 23,862
Inventories 3,943
Prepaid expenses 10,625
Equipment, furniture and fixtures 3,790
Other assets 81,589
Deferred tax 4,600
Other intangible assets 1,548,451
Goodwill 350,000
(4) To eliminate the historical equity accounts of the Acquired Companies.
F-99
Pro Forma Statement of Operations Adjustments
The accompanying unaudited pro forma condensed combined statements of operations
combine the historical results of operations of the Company and the Acquired
Companies for the three months ended December 31, 2004 and the historical
results of operations of the Company for the year ended September 30, 2004 and
the historical results of operations of the Acquired Companies for the year
ended December 31, 2003 assuming the financing had been obtained and the
Acquisition had been consummated on October 1, 2003 and reflects pro forma
adjustments as follows:
(5) To record bank and insurance charges of approximately $15,200 for the year
ended September 30, 2004.
(6) To record approximately $129,000 for the three months ended December 31,
2004 and $516,000 for the year ended September 30, 2004 of the amortization of
other intangible assets, comprised primarily of customer lists, over an
estimated useful life of three years.
(7) To record approximately $47,900 for the three months ended December 31, 2004
and $185,000 for the year ended September 30, 2004 of interest expense on the
10% secured convertible notes issued to finance the Acquisition.
(8) To record approximately $555,000 for the three months ended December 31,
2004 and $138,750 for the year ended September 30, 2004 of amortization of the
debt discount attributable to the sale of the secured convertible notes.
F-100
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Our Articles of Incorporation, as amended, provide to the fullest
extent permitted by New Jersey law, our directors or officers shall not be
personally liable to us or our shareholders for damages for breach of such
director's or officer's fiduciary duty. The effect of this provision of our
Articles of Incorporation, as amended, is to eliminate our right and our
shareholders (through shareholders' derivative suits on behalf of our company)
to recover damages against a director or officer for breach of the fiduciary
duty of care as a director or officer (including breaches resulting from
negligent or grossly negligent behavior), except under certain situations
defined by statute. We believe that the indemnification provisions in its
Articles of Incorporation, as amended, are necessary to attract and retain
qualified persons as directors and officers.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act and will be governed by the final adjudication of such issue.
ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth an itemization of all estimated
expenses, all of which we will pay, in connection with the issuance and
distribution of the securities being registered:
NATURE OF EXPENSE AMOUNT
SEC Registration fee $ 8,605.69
Accounting fees and expenses 10,000.00*
Legal fees and expenses 35,000.00*
Miscellaneous 1,394.31
------------
TOTAL $55,000.00*
===========
* Estimated.
II-1
ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES.
In May 2003, we issued 1,000,000 shares of restricted common stock to
Max Communications Inc. in lieu of a cash payment of $20,000 for services
rendered. The shares were issued within the meaning of Rule 501 and pursuant to
Rule 506 of Regulation D under the Securities Act of 1933.
In July 2003, pursuant to a stock agreement, we issued 10,000,000
shares of common Stock pursuant to an agreement with American Marketing Complex.
The shares were issued within the meaning of Rule 501 and pursuant to Rule 506
of Regulation D under the Securities Act of 1933.
To obtain funding for our ongoing operations, we entered into a
Securities Purchase Agreement with the selling stockholders on April 28, 2004,
and amended on December 30, 2004, for the sale of (i) $3,000,000 in secured
convertible notes and (ii) a warrants to buy 3,000,000 shares of our common
stock.
The investors provided us with the funds as follows:
o $1,500,000 was disbursed on April 28, 2004;
o $750,000 was disbursed on May 28, 2004; and
o $750,000 was disbursed on August 12, 2004.
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 (i) $0.30 or (ii) 40% 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. The full
principal amount of the secured convertible notes are due upon default under the
terms of secured convertible notes. In addition, we have granted the investors a
security interest in substantially all of our assets and intellectual property
and registration rights. The warrants are exercisable until five years from the
date of issuance at a purchase price of $0.11 per share. In addition the
warrants exercise price gets 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 this warrant.
On May 26, 2004, we entered into an Investment Restructuring Agreement
with six accredited investors. In connection with this transaction, we will
exchange class C preferred stock for class C-1 convertible preferred stock on a
1:1 basis and shall issue, on the date that the amendment to the certificate of
incorporation increasing the authorized number of shares of common stock is
filed and approved with the New Jersey Secretary of State, approximately 7,391
shares of class D convertible preferred stock to MidMark Capital, L.P. in
exchange for approximately $7,500,000 of debt and accrued interest owed by us
and our subsidiaries to MidMark Capital II, L.P. As part of the transaction, we
issued 5,569,980 shares of common stock to MidMark Capital, L.P.in exchange for
the conversion of $306,793 of debt owed to MidMark Capital, L.P. In addition, we
issued 240,000 shares of common stock to MidMark Capital II, L.P.in exchange for
the conversion of $2,400 of debt owed to MidMark Capital II, L.P.
On June 25, 2004, as part of an Investment Restructuring Agreement, we
exchanged class C preferred stock for class C-1 convertible preferred stock on a
1:1 basis. Each share of Series C-1 convertible preferred stock is convertible
into $1,000 worth of our common stock, at the selling stockholders' option, at
the lower of (i) $0.30 or (ii) 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.
On July 28, 2004, we issued 350,000 shares of common stock to Sloan
Securities pursuant to a consulting agreement. This issuance is considered
exempt from registration under Section 4(2) of the Securities Act of 1933.
II-2
On September 27, 2004, we issued 7,615 shares of class D convertible
preferred stock to MidMark Capital, L.P. in exchange for $7,614,708 of debt owed
by our subsidiaries and us to MidMark Capital II, L.P. In addition, on September
27, 2004, we issued 5,569,980 shares of common stock to MidMark Capital, L.P.
upon exercise of warrants by MidMark Capital, L.P. The exercise price for the
warrants was exchanged for the retirement of $315,309 in debt owed by us to
MidMark Capital, L.P. As well, on September 27, 2004, we issued 240,000 shares
of common stock to MidMark Capital II, L.P. upon exercise of warrants by MidMark
Capital II, L.P. The exercise price for the warrants was exchanged for the
retirement of $2,400 in debt owed by us to MidMark Capital II, L.P. Each share
of the class D convertible preferred stock is convertible into $1,000 worth of
our common stock, at MidMark Capital's option, at the lower of (i) $0.30 or (ii)
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.
To obtain funding for our ongoing operations, we entered into a
Securities Purchase Agreement with the selling stockholders on January 11, 2005
for the sale of (i) $1,850,000 in secured convertible notes and (ii) a warrants
to buy 1,850,000 shares of our common stock. The investors purchased all the
secured convertible notes on January 11, 2005.
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 (i) $0.09 or (ii) 40% 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. The full
principal amount of the secured convertible notes are due upon default under the
terms of secured convertible notes. In addition, we have granted the investors a
security interest in substantially all of our assets and intellectual property
and registration rights. The warrants are exercisable until five years from the
date of issuance at a purchase price of $0.09 per share. In addition the
warrants exercise price gets 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 this warrant.
During the quarter ended March 31, 2005, we issued 4,175,530 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 March 31, 2005, we issued 697,059 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.
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.
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.
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.
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.
II-3
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 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 (i) $0.09 or (ii) 40% 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. The full
principal amount of the secured convertible notes are due upon default under the
terms of secured convertible notes. In addition, we have granted the investors a
security interest in substantially all of our assets and intellectual property
and registration rights. The warrants are exercisable until five years from the
date of issuance at a purchase price of $0.09 per share. In addition the
warrants exercise price gets 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 this warrant.
On September 20, 2005, we issued 3,000,000 shares of our common stock
to our three directors for services provided. This issuance is considered exempt
under Regulation D of the Securities Act of 1933 and Rule 506 promulgated
thereunder.
* All of the above offerings and sales were deemed to be exempt under
rule 506 of Regulation D and Section 4(2) of the Securities Act of 1933, as
amended. No advertising or general solicitation was employed in offering the
securities. The offerings and sales were made to a limited number of persons,
all of whom were accredited investors, business associates of Cape Systems Group
or executive officers of Cape Systems Group, and transfer was restricted by Cape
Systems Group in accordance with the requirements of the Securities Act of 1933.
In addition to representations by the above-referenced persons, we have made
independent determinations that all of the above-referenced persons were
accredited or sophisticated investors, and that they were capable of analyzing
the merits and risks of their investment, and that they understood the
speculative nature of their investment. Furthermore, all of the above-referenced
persons were provided with access to our Securities and Exchange Commission
filings.
Except as expressly set forth above, the individuals and entities to
whom we issued securities as indicated in this section of the registration
statement are unaffiliated with us.
II-4
ITEM 27. EXHIBITS.
The following exhibits are included as part of this amended Form SB-2.
References to "the Company" in this Exhibit List mean Cape Systems Group, Inc.,
a New Jersey corporation.
Exhibit No. Description
2.1 Form of Common Stock Certificate (incorporated by reference to
the Registration Statement on Form S-18 filed under the
Securities Act of 1933, as amended and effective June 2, 1986
(File No. 33-897-NY)).
3.1 Certificate of Amendment to the Certificate of Incorporation
of Vertex Interactive, Inc. filed with the Secretary of State,
State of New Jersey on February 7, 2001, on October 18, 2001
and November 2, 2001 (incorporated by reference to the Form
10-Q filed May 20, 2002).
3.2 Certificate of Amendment to the Certificate of Incorporation
of Vertex Interactive, Inc., filed with the Secretary of
State, State of New Jersey on March 30, 2005 (incorporated by
reference to the registration statement on Form SB-2 filed
April 16, 2005).
3.3 Amended By-laws, amended as of August 9, 2001 (incorporated by
reference to the Form 10-K filed January 25, 2002).
4.1 Common Stock Purchase Warrant with AJW Offshore, Ltd., dated
April 28, 2004 (incorporated by reference to the registration
statement on Form S-1 filed June 22, 2004).
4.2 Common Stock Purchase Warrant with AJW Partners, LLC, dated
April 28, 2004 (incorporated by reference to the registration
statement on Form S-1 filed June 22, 2004).
4.3 Common Stock Purchase Warrant with AJW Qualified Partners,
LLC, dated April 28, 2004 (incorporated by reference to the
registration statement on Form S-1 filed June 22, 2004).
4.4 Common Stock Purchase Warrant with New Millennium Capital
Partners II, LLC, dated April 28, 2004 (incorporated by
reference to the registration statement on Form S-1 filed June
22, 2004).
4.5 Convertible Note with AJW Offshore, Ltd., dated April 28, 2004
(incorporated by reference to the registration statement on
Form S-1 filed June 22, 2004).
4.6 Convertible Note with AJW Partners, LLC, dated April 28, 2004
(incorporated by reference to the registration statement on
Form S-1 filed June 22, 2004).
4.7 Convertible Note with AJW Qualified Partners, LLC, dated April
28, 2004 (incorporated by reference to the registration
statement on Form S-1 filed June 22, 2004).
4.8 Convertible Note with New Millennium Capital Partners II, LLC,
dated April 28, 2004 (incorporated by reference to the
registration statement on Form S-1 filed June 22, 2004).
4.9 Securities Purchase Agreement, dated as of April 28, 2004, by
and among Vertex Interactive, Inc., AJW Partners, LLC, AJW
Qualified Partners, LLC, AJW Offshore, Ltd. and New Millennium
Capital Partners II, LLC (incorporated by reference to the
registration statement on Form S-1 filed June 22, 2004).
4.10 Security Agreement, dated as of April 28, 2004, by and among
Vertex Interactive, Inc., AJW Partners, LLC, AJW Qualified
Partners, LLC, AJW Offshore, Ltd. and New Millennium Capital
Partners II, LLC (incorporated by reference to the
registration statement on Form S-1 filed June 22, 2004).
II-5
4.11 Intellectual Property Security Agreement, dated as of April
28, 2004, by and among Vertex Interactive, Inc., AJW Partners,
LLC, AJW Qualified Partners, LLC, AJW Offshore, Ltd. and New
Millennium Capital Partners II, LLC (incorporated by reference
to the registration statement on Form S-1 filed June 22,
2004).
4.12 Registration Rights Agreement, dated as of April 28, 2004, by
and among Vertex Interactive, Inc., AJW Partners, LLC, AJW
Qualified Partners, LLC, AJW Offshore, Ltd. and New Millennium
Capital Partners II, LLC (incorporated by reference to the
registration statement on Form S-1 filed June 22, 2004).
4.13 Escrow Agreement, dated as of April 28, 2004, by and among
Vertex Interactive, Inc., AJW Partners, LLC, AJW Qualified
Partners, LLC, AJW Offshore, Ltd., New Millennium Capital
Partners II, LLC and Owen Naccarato (incorporated by reference
to the registration statement on Form S-1 filed June 22,
2004).
4.14 Guaranty and Pledge Agreement, dated as of April 28, 2004, by
and among Vertex Interactive, Inc., AJW Partners, LLC, AJW
Qualified Partners, LLC, AJW Offshore, Ltd., New Millennium
Capital Partners II, LLC and Nicholas Toms (incorporated by
reference to the registration statement on Form S-1 filed June
22, 2004).
4.15 Common Stock Purchase Warrant with AJW Offshore, Ltd., dated
May 28, 2004 (incorporated by reference to the registration
statement on Form S-1 filed June 22, 2004).
4.16 Common Stock Purchase Warrant with AJW Partners, LLC, dated
May 28, 2004 (incorporated by reference to the registration
statement on Form S-1 filed June 22, 2004).
4.17 Common Stock Purchase Warrant with AJW Qualified Partners,
LLC, dated May 28, 2004 (incorporated by reference to the
registration statement on Form S-1 filed June 22, 2004).
4.18 Common Stock Purchase Warrant with New Millennium Capital
Partners II, LLC, dated May 28, 2004 (incorporated by
reference to the registration statement on Form S-1 filed June
22, 2004).
4.19 Convertible Note with AJW Offshore, Ltd., dated May 28, 2004
(incorporated by reference to the registration statement on
Form S-1 filed June 22, 2004).
4.20 Convertible Note with AJW Partners, LLC, dated May 28, 2004
(incorporated by reference to the registration statement on
Form S-1 filed June 22, 2004).
4.21 Convertible Note with AJW Qualified Partners, LLC, dated May
28, 2004 (incorporated by reference to the registration
statement on Form S-1 filed June 22, 2004).
4.22 Convertible Note with New Millennium Capital Partners II, LLC,
dated May 28, 2004 (incorporated by reference to the
registration statement on Form S-1 filed June 22, 2004).
4.23 Escrow Agreement, dated as of May 28, 2004, by and among
Vertex Interactive, Inc., AJW Partners, LLC, AJW Qualified
Partners, LLC, AJW Offshore, Ltd., New Millennium Capital
Partners II, LLC and Owen Naccarato (incorporated by reference
to the registration statement on Form S-1 filed June 22,
2004).
4.24 Common Stock Purchase Warrant with AJW Offshore, Ltd., dated
August 12, 2004 (incorporated by reference to the registration
statement on Form SB-2 filed April 16, 2005).
4.25 Common Stock Purchase Warrant with AJW Partners, LLC, dated
August 12, 2004 (incorporated by reference to the registration
statement on Form SB-2 filed April 16, 2005).
4.26 Common Stock Purchase Warrant with AJW Qualified Partners,
LLC, dated August 12, 2004 (incorporated by reference to the
registration statement on Form SB-2 filed April 16, 2005).
II-6
4.27 Common Stock Purchase Warrant with New Millennium Capital
Partners II, LLC, dated August 12, 2004 (incorporated by
reference to the registration statement on Form SB-2 filed
April 16, 2005).
4.28 Convertible Note with AJW Offshore, Ltd., dated August 12,
2004 (incorporated by reference to the registration statement
on Form SB-2 filed April 16, 2005).
4.29 Convertible Note with AJW Partners, LLC, dated August 12, 2004
(incorporated by reference to the registration statement on
Form SB-2 filed April 16, 2005).
4.30 Convertible Note with AJW Qualified Partners, LLC, dated
August 12, 2004 (incorporated by reference to the registration
statement on Form SB-2 filed April 16, 2005).
4.31 Convertible Note with New Millennium Capital Partners II, LLC,
dated August 12, 2004 (incorporated by reference to the
registration statement on Form SB-2 filed April 16, 2005).
4.32 Escrow Agreement, dated as of August 12, 2004, by and among
Vertex Interactive, Inc., AJW Partners, LLC, AJW Qualified
Partners, LLC, AJW Offshore, Ltd., New Millennium Capital
Partners II, LLC and Owen Naccarato (incorporated by reference
to the registration statement on Form SB-2 filed April 16,
2005).
4.33 Common Stock Purchase Warrant with AJW Offshore, Ltd., dated
January 11, 2005 (incorporated by reference to the current
report on Form 8-K filed January 18, 2005).
4.34 Common Stock Purchase Warrant with AJW Partners, LLC, dated
January 11, 2005 (incorporated by reference to the current
report on Form 8-K filed January 18, 2005).
4.35 Common Stock Purchase Warrant with AJW Qualified Partners,
LLC, dated January 11, 2005 (incorporated by reference to the
current report on Form 8-K filed January 18, 2005).
4.36 Common Stock Purchase Warrant with New Millennium Capital
Partners II, LLC, dated January 11, 2005 (incorporated by
reference to the current report on Form 8-K filed January 18,
2005).
4.37 Convertible Note with AJW Offshore, Ltd., dated January 11,
2005 (incorporated by reference to the current report on Form
8-K filed January 18, 2005).
4.38 Convertible Note with AJW Partners, LLC, dated January 11,
2005 (incorporated by reference to the current report on Form
8-K filed January 18, 2005).
4.39 Convertible Note with AJW Qualified Partners, LLC, dated
January 11, 2005 (incorporated by reference to the current
report on Form 8-K filed January 18, 2005).
4.40 Convertible Note with New Millennium Capital Partners II, LLC,
dated January 11, 2005 (incorporated by reference to the
current report on Form 8-K filed January 18, 2005).
4.41 Securities Purchase Agreement, dated as of January 11, 2005,
by and among Vertex Interactive, Inc., AJW Partners, LLC, AJW
Qualified Partners, LLC, AJW Offshore, Ltd. and New Millennium
Capital Partners II, LLC (incorporated by reference to the
current report on Form 8-K filed January 18, 2005).
4.42 Security Agreement, dated as of January 11, 2005, by and among
Vertex Interactive, Inc., Data Control Systems, Inc.,
Renaissance Software, Inc., Xequte Solutions PLC, Xequte
Solutions, Inc., Vertex Interactive (UK), Ltd., Vertex
Interactive (Ireland) Ltd., Vertex Interactive (Mfg) Ltd.,
Trend Investments Ltd., ICS France Indentcode-System S.A..,
Vertex Support And Maintenance Italia SRL, Vertex Interactive
Italia SRL, Euronet Consulting SRL, AJW Offshore, Ltd., AJW
Qualified Partners, LLC, AJW Partners, LLC and New Millennium
Capital Partners II, LLC (incorporated by reference to the
current report on Form 8-K filed January 18, 2005).
II-7
4.43 Intellectual Property Security Agreement, dated January 11,
2005, by and among Vertex Interactive, Inc., Data Control
Systems, Inc., Renaissance Software, Inc., Xequte Solutions
PLC, Xequte Solutions, Inc., Vertex Interactive (UK), Ltd.,
Vertex Interactive (Ireland) Ltd., Vertex Interactive (Mfg)
Ltd., Trend Investments Ltd., ICS France Indentcode-System
S.A.., Vertex Support And Maintenance Italia SRL, Vertex
Interactive Italia SRL, Euronet Consulting SRL, AJW Offshore,
Ltd., AJW Qualified Partners, LLC, AJW Partners, LLC and New
Millennium Capital Partners II, LLC (incorporated by reference
to the current report on Form 8-K filed January 18, 2005).
4.44 Registration Rights Agreement, dated as of January 11, 2005,
by and among Vertex Interactive, Inc., AJW Partners, LLC, AJW
Qualified Partners, LLC, AJW Offshore, Ltd. and New Millennium
Capital Partners II, LLC (incorporated by reference to the
current report on Form 8-K filed January 18, 2005).
4.45 Guaranty and Pledge Agreement, dated January 11, 2005, by and
among Vertex Interactive, Inc., Nicholas Toms, AJW Offshore,
Ltd., AJW Qualified Partners, LLC, AJW Partners, LLC and New
Millennium Capital Partners II, LLC (incorporated by reference
to the current report on Form 8-K filed January 18, 2005).
4.46 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 (incorporated by reference to the
quarterly report on Form 10-QSB filed August 19, 2005).
4.47 Callable Secured Convertible Note issued to AJW Offshore,
Ltd., dated August 10, 2005 (incorporated by reference to the
quarterly report on Form 10-QSB filed August 19, 2005).
4.48 Callable Secured Convertible Note issued to AJW Qualified
Partners, LLC, dated August 10, 2005 (incorporated by
reference to the quarterly report on Form 10-QSB filed August
19, 2005).
4.49 Callable Secured Convertible Note issued to AJW Partners, LLC,
dated August 10, 2005 (incorporated by reference to the
quarterly report on Form 10-QSB filed August 19, 2005).
4.50 Callable Secured Convertible Note issued to New Millennium
Capital Partners II, LLC, dated August 10, 2005 (incorporated
by reference to the quarterly report on Form 10-QSB filed
August 19, 2005).
4.51 Stock Purchase Warrant issued to to AJW Offshore, Ltd., dated
August 10, 2005 (incorporated by reference to the quarterly
report on Form 10-QSB filed August 19, 2005).
4.52 Stock Purchase Warrant issued to AJW Qualified Partners, LLC,
dated August 10, 2005 (incorporated by reference to the
quarterly report on Form 10-QSB filed August 19, 2005).
4.53 Stock Purchase Warrant issued to AJW Partners, LLC, dated
August 10, 2005 (incorporated by reference to the quarterly
report on Form 10-QSB filed August 19, 2005).
4.54 Stock Purchase Warrant issued to New Millennium Capital
Partners II, LLC, dated August 10, 2005 (incorporated by
reference to the quarterly report on Form 10-QSB filed August
19, 2005).
4.55 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 (incorporated by reference to the
quarterly report on Form 10-QSB filed August 19, 2005).
II-8
4.56 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 (incorporated by reference to the quarterly
report on Form 10-QSB filed August 19, 2005).
4.57 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 (incorporated by reference
to the quarterly report on Form 10-QSB filed August 19, 2005).
5.1 Sichenzia Ross Friedman Ference LLP Opinion and Consent
(incorporated by reference to the registration statement on
Form SB-2 filed April 16, 2005).
10.1 Incentive Stock Option Plan dated October 10, 1985, and
amended February 14, 2000 (incorporated by reference to the
Form 10-K filed on December 18, 2000).
10.2 Share Purchase Agreement, by and among Vertex Industries,
Inc., St. Georges Trustees Limited, as trustee on behalf of
the John Kenny Settlement and the Godfrey Smith Settlement,
John Kenny and Bryan J. Maguire and Godfrey Smith dated June
21, 1999, as amended September 27, 1999, (incorporated by
reference to the Form 8-K filed October 7, 1999).
10.3 Stock Purchase Agreement by and among Vertex Interactive, Data
Control Systems and The Stockholders of Data Control Systems,
Inc. dated March 31, 2000 (incorporated by reference to the
Form 8-K filed April 12, 2000).
10.4 Agreement and Plan of Merger, dated September 18, 2000, by and
among Vertex Interactive, Rensoft Acquisition Corp. and
Renaissance Software, Inc. (incorporated by reference to the
Form 8-K filed October 2, 2000).
10.5 Form of Note Purchase Agreement dated June 19, 2001 between
Vertex Interactive, Inc. and MidMark Capital II, LP with
respect to the Convertible Notes Payable (incorporated by
reference to the Form 10-Q filed August 14, 2001).
10.6 Agreement and Plan of Merger, dated December 29, 2000, between
Vertex Interactive and Applied Tactical Systems, Inc.
(incorporated by reference to the Form 8-K filed March 2, 2001
and Form 8-K filed March 14, 2001.)
10.7 Asset Purchase Agreement and Ancillary Agreements between
Vertex Interactive, Inc. and Finmek Holding N. V.-Genicom
S.p.A., Genicom Ltd., Genicom S.A. dated October 6, 2000
(incorporated by reference to the Form 10-K filed on January
25, 2002).
10.8 Stock Purchase Agreement by and between Pitney Bowes Inc. and
Vertex Interactive, Inc. dated October 18, 2001 for the
purchase of Series "B" Preferred Stock (incorporated by
reference to the Form 10-Q filed February 20, 2002).
10.9 Note Purchase Agreement by and among MidMark Capital II, L.P.
and Vertex Interactive, Inc. dated as of November 1, 2001 for
the purchase of 10% Convertible Notes Payable (incorporated by
reference to the Form 10-Q filed February 20,2002).
10.10 Form of Conversion Agreement between Vertex Interactive, Inc.
and MidMark dated March 7, 2002 and the Amended and Restated
Convertible Promissory Note dated March 7, 2002 (incorporated
by reference to the Form 10-Q filed May 20, 2002).
10.11 Asset Purchase Agreement between Vertex, Renaissance and
Pitney Bowes dated April 19, 2002 (incorporated by reference
to the Form 10-Q filed May 20, 2002).
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10.12 Stock and Debt Purchase Agreement between MidMark Capital II,
L.P., MidMark Capital, L.P., DynaSys, S.A. and Vertex
Interactive, Inc. dated August 9, 2002 (incorporated by
reference to the Form 10-K filed August 4, 2003).
10.13 Stock Purchase Agreement, dated January 12, 2005, by and among
Vertex Interactive, Inc., Peter B. Ayling, Elizabeth M.
Ayling, Brad L. Leonard, Michael C. Moore, Cape Systems and
Consulting Services Ltd. and Cape Systems, Inc. (incorporated
by reference to the current report on Form 8-K filed January
18, 2005).
10.14 Escrow Agreement, dated as of January 12, 2005, by and among
Vertex Interactive, Inc., Peter B. Ayling, Elizabeth M.
Ayling, Brad L. Leonard, Michael C. Moore and Law Office of
Jeffrey D. Marks P.C. (incorporated by reference to the
current report on Form 8-K filed January 18, 2005).
10.15 Employment Agreement, dated as of January 12, 2005, by and
between Vertex Interactive, Inc. and Brad L. Leonard
(incorporated by reference to the current report on Form 8-K
filed January 18, 2005).
10.16 Consulting Agreement, dated as of January 12, 2005, by and
between Vertex Interactive, Inc. and IMC Development Group
(incorporated by reference to the current report on Form 8-K
filed January 18, 2005).
21.1 Subsidiaries of Vertex Interactive, Inc. (incorporated by
reference to the registration statement on Form S-1 filed June
22, 2004).
23.1 Consent of J.H. Cohn LLP (filed herewith).
23.2 Consent of Leslie, Ward & Drew (filed herewith).
23.3 Consent of legal counsel (see Exhibit 5.1).
ITEM 28. UNDERTAKINGS.
The undersigned registrant hereby undertakes to:
(1) File, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement to:
(i) Include any prospectus required by Section 10(a)(3) of the Securities Act of
1933, as amended (the "Securities Act");
(ii) Reflect in the prospectus any facts or events which, individually or
together, represent a fundamental change in the information in the registration
statement. Notwithstanding the foregoing, any increase or decrease in volume of
securities offered (if the total dollar value of the securities offered would
not exceed that which was registered) and any deviation from the low or high end
of the estimated maximum offering range may be reflected in the form of
prospectus filed with the Commission pursuant to Rule 424(b) under the
Securities Act if, in the aggregate, the changes in volume and price represent
no more than a 20% change in the maximum aggregate offering price set forth in
the "Calculation of Registration Fee" table in the effective registration
statement, and
(iii) Include any additional or changed material information on the plan of
distribution.
(2) For determining liability under the Securities Act, treat each
post-effective amendment as a new registration statement of the securities
offered, and the offering of the securities at that time to be the initial bona
fide offering.
(3) File a post-effective amendment to remove from registration any of the
securities that remain unsold at the end of the offering.
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(4) For purposes of determining any liability under the Securities Act, treat
the information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Securities Act as part of this registration statement as of the time
it was declared effective.
(5) For determining any liability under the Securities Act, treat each
post-effective amendment that contains a form of prospectus as a new
registration statement for the securities offered in the registration statement,
and that offering of the securities at that time as the initial bona fide
offering of those securities.
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
and is, therefore, unenforceable.
In the event that a claim for indemnification against such liabilities
(other than the payment by the registrant of expenses incurred or paid by a
director, officer or controlling person of the registrant in the successful
defense of any action, suit or proceeding) is asserted by such director, officer
or controlling person in connection with the securities being registered, the
registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate jurisdiction
the question whether such indemnification by it is against public policy as
expressed in the Securities Act and will be governed by the final adjudication
of such issue.
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SIGNATURES
In accordance with the requirements of the Securities Act of 1933, as
amended, the registrant, Cape Systems Group, Inc., certifies that it has
reasonable grounds to believe that it meets all of the requirements of filing on
Form SB-2 and has duly caused this registration statement on Form SB-2 to be
signed on its behalf by the undersigned, in the City of South Plainfield, State
of New Jersey, on October 11, 2005.
CAPE SYSTEMS GROUP, INC.
By: /s/ Nicholas R. H. Toms
---------------------------------------
Nicholas R. H. Toms, Chief Executive Officer (Principal
Executive Officer), Chief Financial Officer (Principal
Financial Officer) and Principal Accounting Officer
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POWER OF ATTORNEY
Each person whose signature appears below constitutes and appoints
Nicholas R. Toms his or her true and lawful attorney in fact and agent, with
full power of substitution and resubstitution, for him or her and in his or her
name, place and stead, in any and all capacities, to sign any or all amendments
(including post effective amendments) to the Registration Statement, and to sign
any registration statement for the same offering covered by this Registration
Statement that is to be effective upon filing pursuant to Rule 462(b) under the
Securities Act of 1933, as amended, and all post effective amendments thereto,
and to file the same, with all exhibits thereto, and all documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorney-in-fact and agent, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in and about the
premises, as fully to all intents and purposes as he or she might or could do in
person, hereby ratifying and confirming all that said attorney-in-fact and
agent, each acting alone, or his or her substitute or substitutes, may lawfully
do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement on Form SB-2 has been signed below by the following
persons in the capacities and on the dates indicated:
SIGNATURE TITLE DATE
/s/ Hugo H. Biermann Executive Chairman of October 11, 2005
- -------------------------------- the Board of Directors
Hugo H. Biermann
/s/ Nicholas R. H. Toms Chief Executive Officer, October 11, 2005
- -------------------------------- Chief Financial Officer and Director
Nicholas R. H. Toms
/s/ Otto Leistner Director October 11, 2005
- --------------------------------
Otto Leistner
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