UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended December 31, 2005
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Transition Period from _________ to _________
Commission file number: 000-15066
CAPE SYSTEMS GROUP, INC.
(Exact name of registrant as specified on its charter)
New Jersey 22-2050350
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
3619 Kennedy Road
South Plainfield, New Jersey 07080
(Address of principle executive offices)
(908) 756-2000
(Registrant's telephone number, including area code)
Indicate by check mark whether the issuer (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ x ] No [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes [ ] No [ x ]
Common stock, par value $.005 per share: 99,235,053 shares outstanding as of
January 31, 2006.
Preferred stock, Series "A", par value $.01 per share: 1,356,852 shares
outstanding as of January 31, 2006.
Preferred stock, Series "B", par value $.01 per share: 1,000 shares outstanding
as of January 31, 2006.
Preferred stock, Series "C-1", par value $.01 per share: 997 shares outstanding
as of January 31, 2006.
Preferred stock, Series "D", par value $.01 per share: 7,615 shares outstanding
as of January 31, 2006.
INDEX
PART I FINANCIAL INFORMATION
ITEM 1 Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheet as of December 31, 2005 (Unaudited) 3-4
Condensed Consolidated Statements of Operations for the three months Ended
December 31, 2005 and 2004 (Unaudited) 5
Condensed Consolidated Statement of Changes in Stockholders' Deficiency
for the three months ended December 31, 2005 (Unaudited) 6-7
Condensed Consolidated Statements of Cash Flows for the three months ended
December 31, 2005 and 2004 (Unaudited) 8
Notes to Condensed Consolidated Financial Statements (Unaudited) 9-17
ITEM 2 Management's Discussion and Analysis of Financial Condition and Results of
Operations 18-22
ITEM 3 Controls and Procedures 23
PART II OTHER INFORMATION
ITEM 1 Legal proceedings 23-24
ITEM 2 Unregistered sales of equity securities and use of proceeds 24
ITEM 3 Defaults upon senior securities 24
ITEM 4 Submission of matters to a vote of security holders 24
ITEM 5 Other information 25
ITEM 6 Exhibits 25
SIGNATURES 25
2
PART 1 - FINANCIAL INFORMATION
ITEM 1 - CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
December 31, 2005 (Unaudited)
(In thousands except share and per share data)
ASSETS
December 31, 2005
----------------
CURRENT ASSETS:
Cash $ 321
Accounts receivable, less
allowance for doubtful accounts of $5 602
Inventories, net of valuation allowance 161
Prepaid expenses and other current assets 381
------
Total current assets 1,465
Equipment and improvements, net of
accumulated depreciation and
amortization of $665 42
Deferred financing costs,
net of accumulated amortization of $217 159
Goodwill 342
Other intangible assets, net of accumulated
amortization of $500 1,044
Other assets 194
------
Total assets $3,246
======
See notes to unaudited condensed consolidated financial statements.
3
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
December 31, 2005 (Unaudited)
(In thousands except share and per share data)
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
December 31, 2005
--------------------
CURRENT LIABILITIES:
Notes payable $ 1,227
Mandatory redeemable Series D preferred stock -
504 shares at redemption value 505
Accounts payable 4,152
Payroll and related benefits accruals 1,474
Litigation related accruals 3,655
Other accrued expenses and liabilities 3,729
Deferred revenue 566
Long-term convertible notes payable 4,949
Estimated remaining net liabilities associated
with subsidiaries in liquidation 7,166
---------
Total current liabilities 27,423
---------
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) 14
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)
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)
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)
Common stock, par value $.005 per share; 1,000,000,000 shares authorized;
96,685,053 shares issued 483
Additional paid-in capital 170,594
Subscriptions receivable (66)
Accumulated deficit (193,686)
Accumulated other comprehensive loss (1,449)
Less: Treasury stock, 87,712 shares of
common stock (at cost) (67)
---------
Total stockholders' deficiency (24,177)
---------
Total liabilities and stockholders' deficiency $ 3,246
=========
See notes to unaudited condensed consolidated financial statements.
4
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands except share and per share data)
For the Three Months
Ended December 31,
-----------------------------
2005 2004
------------ ------------
Revenues $ 901 $ 665
Cost of sales 427 249
------------ ------------
Gross profit 474 416
------------ ------------
Operating expenses:
Selling and administrative 956 706
Depreciation and amortization 133 3
------------ ------------
Total operating expenses 1,089 709
------------ ------------
Operating loss (615) (293)
------------ ------------
Other income(expense):
Interest expense - including beneficial
conversion charge of $200 in 2005 (465) (283)
Gain on settlements of
liabilities 300 29
Other 5 13
------------ ------------
Net other expense (160) (241)
------------ ------------
Loss before credit for income taxes (775) (534)
Credit for sale of state tax benefits (401) (457)
------------ ------------
Net loss $ (374) $ (77)
============ ============
Net loss per share of common stock:
Basic and Diluted ($.00) ($.00)
============ ============
Weighted Average number of shares outstanding:
Basic and Diluted 94,519,559 65,385,517
============ ============
See notes to unaudited condensed consolidated financial statements.
5
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' DEFICIENCY
FOR THE THREE MONTHS ENDED DECEMBER 31, 2005
(UNAUDITED)
(In thousands except share and per share data)
Preferred Stock Common Stock Additional
----------------------- ----------------------- Paid-In
Shares Amount Shares Amount Capital
---------- ---------- ---------- ---------- ----------
Balance September 30, 2005 1,365,960 $ 14 92,273,778 $ 461 $ 170,222
Conversion of notes payable -
into common stock 911,275 5 11
Common stock issued for accrued
liabilities 500,000 2 18
Common stock issued in
exchange for services 3,000,000 15 105
Stock options issued in exchange for services 38
Beneficial conversion feature
related to convertible notes 200
Net loss
Change in unrealized foreign
exchange translation gains (A) -- --
---------- ---------- ---------- ---------- ----------
Balance December 31, 2005 1,365,960 $ 14 96,685,053 $ 483 $ 170,594
========== ========== ========== ========== ==========
(A) Comprehensive loss for the three months ended December 31, 2005 and 2004
was $261 and $759, respectively.
See notes to unaudited condensed consolidated financial statements.
6
CAPE SYSTEMS GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' DEFICIENCY
FOR THE THREE MONTHS ENDED DECEMBER 31, 2005
(UNAUDITED)
(CONTINUED)
(In thousands except share and per share data)
Accumulated
Other
Accumulated Subscriptions Comprehensive Treasury
Deficit Receivable Loss Stock Total
----------- ------------- ------------- -------- ---------
Balance September 30, 2005 $ (193,312) $ (66) $ (1,562) $ (67) $ (24,310)
Conversion of notes payable -
into common stock 16
Common stock issued for accrued
liabilities 20
Common stock issued in exchange
for services 120
Stock options issued in exchange for services 38
Beneficial conversion feature
related to convertible notes 200
Net Loss (374) (374)
Change in unrealized foreign
exchange translation
gains (A) 113 113
----------- ------------- ------------- -------- ---------
Balance December 31, 2005 $ (193,686) $ (66) $ ( 1,449) $ (67) $ (24,177)
=========== ============= ============= ======== =========
(A) Comprehensive loss for the three months ended December 31, 2005 and 2004
was $261 and $759, respectively.
See notes to unaudited condensed consolidated financial statements.
7
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands except share and per share data)
For the Three Months Ended
December 31,
--------------------------
2005 2004
------ ------
Cash Flows from Operating Activities:
- ------------------------------------
Net loss ($374) ($ 77)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization 133 4
Common stock issued in exchange for services 120 100
Amortization of deferred financing costs and
debt discount 42 168
Variable stock option charge 41 --
Charges to interest expense for beneficial
conversion features of note payables 200 --
Gain on settlements of liabilities (300) --
Changes in operating assets and liabilities:
Accounts receivable (30) (55)
Inventories 24 (18)
Prepaid expenses and other current assets 96 27
Restricted cash and other assets -- 31
Accounts payable (163) (136)
Accrued expenses and other liabilities 97 (81)
Deferred revenue 17 (13)
----- -----
Net cash used in operating activities (97) (50)
Cash Flows from Investing Activities:
Additions to equipment and improvements -- (1)
----- -----
Cash Flows from Financing Activities:
Proceeds from notes and convertible notes payable 200 --
Deferred financing costs (21) --
----- -----
Net cash flows from financing activities 179 --
----- -----
Net increase (decrease) in cash 82 (51)
Cash at beginning of period 239 101
----- -----
Cash at end of period $ 321 $ 50
===== =====
Noncash investing and financing activities:
Long-term convertible notes payable -
converted into common stock $ 16 $ 313
Common stock issued for payment of liabilities $ 20 $ 317
See notes to unaudited condensed consolidated financial statements.
8
CAPE SYSTEMS GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. NATURE OF BUSINESS AND BASIS FOR PRESENTATION
(In thousands except share and per share data)
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, 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.
Going Concern Matters
Based upon our substantial working capital deficiency ($25,958) and
stockholders' deficiency ($24,177) at December 31, 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.
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 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.
Outlook:
We had current obligations at December 31, 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.
9
CAPE SYSTEMS GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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, 2005, we recognized a noncash
gain of $177 from the approval by creditors of the liquidation of the net
liabilities of the Company's Ireland subsidiaries. Upon legal resolution of the
approximately $7,166 of estimated remaining liabilities of these remaining
European entities as of December 31, 2005, we may 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) During the three months ended December 31, 2005, we realized net gains of
approximately $300 from settlements of liabilities totaling $310 through the
payments of approximately $10 in cash.
(iii) During the three months ended December 31, 2005, convertible notes payable
in the principal amount of $16 were converted into 911,275 shares of common
stock.
(iv) On January 11, 2005, we entered into a Securities Purchase Agreement and
sold (i) $1,850 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.
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.
The Company has filed a registration statement which has not yet been declared
effective and, as a result, has recorded interest at the rate of 15% per annum
for the period from October 1, 2005 through December 31, 2005. Consequently,
interest expense has been increased from $122 at the 10% rate to $182 at the 15%
rate. 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.
10
CAPE SYSTEMS GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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.
(v) On August 10, 2005, we entered into a Securities Purchase Agreement for the
sale of (i) $850 in secured convertible notes and (ii) warrants to purchase
850,000 shares of our common stock to accredited investors.
The investors have provided or are obligated to provide us with the funds as
follows:
Amount Disbursement Date
------ -----------------
$250 August 10, 2005
$100 September 19, 2005
$100 October 19, 2005
$100 November 16, 2005
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 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. Pursuant to the Stock Purchase Agreement, the parties
executed an escrow agreement pursuant to which $200 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" ("SFAS 141") effective as of January
12, 2005.
Basis of Presentation
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 and Article 10 of Regulation S-X. Accordingly, they do not include
all of the information and footnotes 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 for a fair presentation have been included. Operating
results for the three months ended December 31, 2005 are not necessarily
indicative of the results that may be expected for the fiscal year ending
September 30, 2006.
11
CAPE SYSTEMS GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
For further information, refer to the consolidated financial statements and
notes thereto included in the Company's Annual Report on Form 10-KSB for the
year ended September 30, 2005 (the "2005 Form 10-KSB).
2. SIGNIFICANT ACCOUNTING POLICIES
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 (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 December 31, 2005, there were 906,270,767 shares of common stock
potentially issuable upon the exercise of stock options (7,434,221 shares),
warrants (5,400,000 shares) and the conversion of convertible securities
(893,436,546 shares). However, diluted per share amounts have not been presented
in the accompanying condensed consolidated statements of operations for the
three months ended December 31, 2005 and 2004 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.
Pro Forma and Other Disclosures Related to Stock Options
As of December 31, 2005, the Company had granted options to purchase a total of
7,434,221 shares of common stock. No options were granted and no options were
cancelled during the three months ended December 31, 2005. Approximately 636,000
options expired during the three months ended December 31, 2005. As further
explained in Note 4 in the 2005 Form 10-KSB, as permitted by Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation" the Company accounts for its 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. If
the Company had elected to recognize compensation cost based on the fair value
of the options granted at the grant date 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:
12
CAPE SYSTEMS GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Three Months Ended December 31,
-------------------------------
2005 2004
--------- ---------
Net loss-as reported $ (374) $ (77)
Deduct total stock -
based employee compensation
expense determined under a
fair value based method for
all awards (134) (240)
--------- ---------
Net loss - pro-forma $ (508) $ (317)
========= =========
Basic and diluted
loss per common share
- as reported $ (.00) $ (.00)
Basic and diluted
loss per common share
- pro-forma $ (.01) $ (.00)
The fair value of each option granted is estimated on the date of grant using
the Black-Scholes option-pricing model.
As a result of amendments to SFAS 123, the Company will be required to expense
the fair value of employee stock options beginning with its fiscal quarter
ending December 31, 2006.
3. ESTIMATED REMAINING LIABILITIES OF SUBSIDIARIES IN LIQUIDATION
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. 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 fourth quarter of fiscal 2005, the Company
recognized a noncash gain from the approval by creditors of the liquidation of
the net liabilities of the Company's Ireland subsidiaries, as explained below.
Accordingly, the remaining estimated liabilities of these businesses are
classified as estimated remaining liabilities associated with subsidiaries in
liquidation in the accompanying December 31, 2005 consolidated balance sheet.
When the liquidation process is completed, significant variations may occur
based on the complexity of the entity and requirements of the respective
country.
Estimated remaining 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.
Estimated remaining net liabilities as of December 31, 2005 were $7,166.
Except for the changes in the unrealized foreign translation gain, there were no
results of operations of these businesses for the three months ended December
31, 2005.
4. 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, excluding acquisition costs of $198. The
acquisition was financed primarily through the sale of $1,850 of secured
convertible notes and warrants to purchase 1,850,000 shares of the Company's
common stock.
13
CAPE SYSTEMS GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The following table presents unaudited pro forma results of operations of the
Company as if the above described acquisition had occurred at October 1, 2004:
Three Months Ended
December 31, 2004
-----------------
Revenues $ 1,200
Net loss (1,000)
Net loss per share ($.02)
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.
5. NOTES PAYABLE
Notes payable consist of past due notes payable to Renaissance Software, Inc.
("Renaissance") in the amount of $1,227 as of December 31, 2005. The Company
issued approximately $1,500 in promissory notes payable, bearing interest at 8%,
in connection with the purchase of 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) the notes became payable as follows: $250
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
February 14, 2006.
6. CONVERTIBLE NOTES PAYABLE
Convertible notes payable of $4,949 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 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 in
convertible notes (the "2005 Convertible Notes") and (ii) warrants (the "2005
Warrants") to purchase 1,850,000 shares of common stock, and (c) $550 in
convertible notes (the "2005 Working Capital Facility") and warrants to purchase
550,000 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 2004 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 to the fair
value of the warrants and the remaining $2,573 to the fair value of the 2004
Convertible Notes. 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 additional charges for the
beneficial conversion which the Company recorded in the year ended September 30,
2005, and an increase in additional paid-in capital and interest expense in the
year ended September 30, 2005.
14
CAPE SYSTEMS GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
On October 5, 2005, the Company issued 911,275 common shares upon the conversion
of 10% Convertible Notes with an approximate principal balance of $16 at a
conversion price of $0.0176 per share.
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.
2005 Working Capital Facility
- -----------------------------
On August 10, 2005, we entered into a Securities Purchase Agreement for the sale
of (i) $850 in secured convertible notes and (ii) warrants to purchase 850,000
shares of our common stock to accredited investors. The investors have provided
or are obligated to provide us with the funds as follows:
Amount Disbursement Date
------ -----------------
$250 August 10, 2005
$100 September 19, 2005
$100 October 19, 2005
$100 November 16, 2005
We believe, although there can be no assurances that $100 will be disbursed on
the final business day of each month beginning March 2006 and ending in May
2006.
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.
Based on the excess of the aggregate fair value of the common shares that would
have been issued if the 2005 Working Capital Facility had been converted
immediately over the proceeds allocated to the 2005 Working Capital Facility,
the investors received a beneficial conversion feature which the Company
recorded an increase in additional paid-in capital and interest expense totaling
$200 in the three months ended December 31, 2005.
7. STOCKHOLDERS' DEFICIENCY
Shares Issued for Services and Accrued Liabilities
During the three months ended December 31, 2005, the Company issued 3,000,000
shares of common stock for various consulting and professional services rendered
and recorded a charge of approximately $120 based on the fair value of the
shares issued, and 500,000 shares of common stock in satisfaction of other
liabilities of $20.
Subsequent to December 31, 2005, the Company issued 2,350,000 shares of common
stock for various consulting and professional services rendered and 200,000
shares of common stock in satisfaction of other liabilities.
15
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, or tax benefits. The Company was originally permitted
to sell tax benefits in the amount of $518. On December 17, 2004, the Company
received approximately $456 from the sale of the $518 of tax benefits which was
recognized as a tax benefit in the first quarter of fiscal 2005. For the state
fiscal years through 2005 (July 1, 2004 to June 30, 2005) the Company had
approximately $7,976 of total available net operating loss carryforwards that
were saleable, of which New Jersey permitted the Company to sell approximately
$6,297. On December 19, 2005, the Company received approximately $401 from the
sale of these benefits which is recognized as a tax benefit in the three months
ended December 31, 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
$1,679 between July 1, 2005 and June 30, 2006. 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 2006. 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
- ------------------
From time to time, we may become involved in various lawsuits and legal
proceedings, which arise in the ordinary course of business. However, litigation
is subject to inherent uncertainties, and an adverse result in these or other
matters may arise from time to time that may harm our business.
We are party to a number of claims, which have been previously disclosed by us.
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. However, they could lead to involuntary bankruptcy
proceedings.
Recently Settled Litigation
- ---------------------------
On or about November 30, 2005, we settled for $10 for an action previously
disclosed by us which was commenced in New York State Supreme Court, Nassau
County, captioned Great Oak LLC vs. Vertex Interactive, Inc. et. al. The action
had demanded $328 to be due Great Oak LLC, the landlord of premises leased to
Renaissance Software LLC.
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. As a result, we entered into a Consent Order
and Agreement with the New Jersey Department of Labor which provides for monthly
payments of $30 which commenced on June 1, 2004 and payments were made through
August 31, 2005 and we have made no subsequent payments. We shall reduce the
balance of the payroll obligations, including penalty, as cash becomes available
until the total outstanding balance of approximately $282 is paid.
We believe, although there can be no assurances, that the payroll obligations
including penalties as of December 31, 2005 will be satisfied by the calendar
year ending December 31, 2006.
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. He was granted options to purchase 1,000,000 shares of
common stock upon execution, of which 200,000 vest immediately and the balance
of 800,000 options vest over a period of five years. 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.
16
CAPE SYSTEMS GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 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. RELATED PARTY TRANSACTIONS
The Company hired Mr. David Sasson as acting 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 months ended December 31, 2005, the Company incurred costs of
$25 for these services of which $2 is due and payable as of December 31, 2005.
In addition, in connection with the acquisition, we entered into a consulting
agreement with IMC Development Group ("IMC"), which is owned by Peter Ayling,
for which we paid $42 for these services.
11. GEOGRAPHIC AREA DATA
The Company operated in one business segment in North America in 2004 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 and identifiable
assets as of and for the three months ended December 31, 2005:
2005
----
Revenues
North America $702
United Kingdom 199
----
$901
====
Identifiable assets
North America $ 26
United Kingdom 16
----
$ 42
====
17
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
- -------------
This Quarterly Report on Form 10-QSB contains, in addition to historical
information, certain forward-looking statements that involve significant risks
and uncertainties. Such forward-looking statements are based on management's
belief, as well as assumptions made by and information currently available to,
management pursuant to the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995. Our actual results could differ materially from
those expressed in or implied by the forward-looking statements contained
herein. Factors that could cause or contribute to such differences include, but
are not limited to, those discussed herein and in Item 1: "Business", included
in our Annual Report on Form 10-KSB for the year ended September 30, 2005. Cape
undertakes no obligation to release publicly the result of any revisions to
these forward-looking statements that may be made to reflect events or
circumstances after the date of this Quarterly Report or to reflect the
occurrence of other unanticipated events.
This discussion and analysis should be read in conjunction with the unaudited
condensed consolidated financial statements and related notes of the Company
contained elsewhere in this report. In this discussion, the years "2006" and
"2005" refer to the three months ended December 31, 2005 and 2004, respectively.
Critical Accounting Policies and Estimates
The preparation of the unaudited condensed consolidated financial statements
requires management to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and the related
disclosure of contingent assets and liabilities. Management bases its estimates
and judgments on historical experience and on various other factors that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Management continuously
evaluates its estimates and judgments, and actual results may differ from these
estimates under different assumptions or conditions.
Those estimates and judgments that were most critical to the preparation of the
financial statements involved the allowance for doubtful accounts, inventory
reserves, recoverability of intangible assets and the estimation of the net
liabilities associated with subsidiaries in liquidation as further explained in
the Company's Form 10-KSB for the year ended September 30, 2005.
RECENT ACCOUNTING PRONOUNCEMENTS:
In December 2004, the Financial Accounting Standards Board (the "FASB") issued
SFAS No. 123(R) "Share-Based Payment" ("SFAS 123(R)"), which amends SFAS 123 and
will be effective for public companies that are small business issuers for
annual periods beginning after December 15, 2005. SFAS 123(R) will require us to
expense all employee stock options and other share-based payments over the
service period. The FASB believes the use of a binomial lattice model for option
valuation is capable of more fully reflecting certain characteristics of
employee share options compared to the Black-Scholes options pricing model. SFAS
123(R) may be adopted in one of three ways - the modified prospective transition
method, a variation of the modified prospective transition method or the
modified retrospective transition method. We are currently evaluating how we
will adopt SFAS 123(R) and evaluating the effect that the adoption will have on
our financial position and results of operations. Since we have used the
intrinsic value method for employee stock options and, generally, have not
recorded any related expense, the adoption of a fair value method for employee
stock options is likely to generate additional compensation expense.
18
Results of Operations
Three months ended December 31, 2005 ("2006") compared to the three months ended
December 31, 2004 ("2005").
Operating Revenues:
- -------------------
Operating revenues increased by approximately $236,000 (or 35.4%) from
approximately $665,000 in 2005 to approximately $901,000 in 2006.
Products and Services
- ---------------------
Sales to customers by the two significant product and service line groupings for
the three months ended December 31, 2005 and 2004 are approximately as follows:
2006 2005
----------- -----------
Enterprise Solutions $ 241,000 $ 169,000
Service, Maintenance and Other 660,000 496,000
----------- -----------
$ 901,000 $ 665,000
=========== ===========
Enterprise solutions revenues increased to approximately $241,000 in 2006 from
approximately $169,000 in 2005. The increase was a result of one warehouse
expansion in our customer base. Service, maintenance and other revenues have
increased approximately $164,000 from $496,000 in 2005 to approximately $660,000
in 2006. The increase was a result of the acquisition of operations in London
($199,000) and Dallas ($367,000) which were not owned by us in 2005 offset by a
decrease of $402,000 in the service and maintenance contracts in our core
business.
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 $58,000 (or 13.9%) from $416,000 in 2005
to $474,000 in 2006. The addition of the London and Dallas operations accounted
for an increase of $340,000 offset by a decrease of $282,000 in our core
business.
Operating Expenses:
- -------------------
Selling and administrative expenses increased approximately $250,000 (or 35.4%)
from approximately $706,000 in 2005 to $956,000 in 2006. Approximately $290,000
of the increase is due to the London and Dallas operations partially offset by
reductions in professional fees incurred resulting from numerous regulatory
filings in the prior period.
There were no research and development expenses ("R&D") expenses in 2006 or
2005. As a result of 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 later
in 2006.
The $130,000 increase in depreciation to $133,000 in 2006, as compared to $3,000
in 2005, is due primarily to the amortization of the intangible assets in
connection with the acquisition of the London and Dallas operations.
Interest expense increased by approximately $182,000 from $283,000 in 2005 to
$465,000 in 2006. This increase is due to non-cash charges for the beneficial
conversion feature in connection with the proceeds from the working capital
facility.
19
Gain on settlements increased approximately $271,000 mainly due to our ability
to settle certain debts and obligations for less than their book value.
We realized a tax credit of approximately $401,000 by selling New Jersey State
net operating loss carryforwards during the three months ended December 31,
2005, which is slightly less than the amount realized in the three months ended
December 31, 2004.
The current income tax provision in both years was negligible due primarily to
the net operating loss carryforwards.
The net loss for the period increased by approximately $297,000 or 385.7% to
approximately $374,000 in 2006 from a loss of $77,000 in 2005, mainly due to the
factors mentioned above.
Liquidity and Capital Resources
Based upon our substantial working capital deficiency ($25,958,000) and
stockholders' deficiency ($24,177,000) at December 31, 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, 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 or integrate the recently completed
acquisition.
Outlook
We had current obligations at December 31, 2005 accumulated during the past
several years that substantially exceeded our current assets and, to the extent
we cannot settle existing obligations in stock or defer payment of our
obligations until we generate sufficient operating cash, we will require
significant additional funds to meet accrued non-operating obligations, to fund
operating losses, if required, short-term debt and related interest, capital
expenditures and expenses related to cost-reduction initiatives, and to pay
liabilities that could arise from litigation claims and judgments.
Our sources of ongoing liquidity include the cash flows from our operations,
potential new credit facilities and potential additional equity investments.
Consequently, we continue to aggressively pursue obtaining additional debt and
equity financing, the restructuring of certain existing debt obligations, and
the reduction of our operating expenses. In addition, we have structured our
overall operations and resources around high margin enterprise products and
services. However, in order to remain in business, we must raise additional cash
in a timely fashion.
Initiatives Completed or in Process:
- ------------------------------------
The following initiatives related to raising required funds, settling
liabilities and/or reducing expenses have been completed or are in process:
(i) 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, 2005, we recognized a noncash
gain of $177,000 from the approval by creditors of the liquidation of the net
liabilities of our Ireland subsidiaries. Upon legal resolution of the
approximately $7,166,000 of estimated remaining liabilities of these remaining
European entities as of December 31, 2005, we may 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.
20
(ii) During the three months ended December 31, 2005, we realized net gains of
approximately $300,000 from settlements of liabilities totaling $310,000 through
the payments of approximately $10,000 in cash.
(iii) During the three months ended December 31, 2005 convertible notes payable
in the principal amount of $16,000 were converted into 911,275 shares of common
stock.
(iv) 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.
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.
The Company has filed a registration statement which has not yet been declared
effective and, as a result, has recorded interest at the rate of 15% per annum
for the period from October 1, 2005 through December 31, 2005. Consequently,
interest expense has been increased from $122,000 at the 10% rate to $182,000 at
the 15% rate. 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.
(v) 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 have provided or are obligated to provide us with the funds as
follows:
Amount Disbursement Date
------ -----------------
$250,000 August 10, 2005
$100,000 September 19, 2005
$100,000 October 19, 2005
$100,000 November 16, 2005
21
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 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 our 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" ("SFAS 141") effective as
of January 12, 2005.
22
ITEM 3. CONTROLS AND PROCEDURES
- -------------------------------
a) Evaluation of Disclosure Controls and Procedures: As of December 31,
2005, our management carried out an evaluation, under the
supervision of our Chief Executive Officer and Chief Financial
Officer of the effectiveness of the design and operation of our
system of disclosure controls and procedures pursuant to the
Securities and Exchange Act, Rule 13a-15(e) and 15d-15(e) under the
Exchange Act). Based on that evaluation, our chief executive officer
and chief financial officer concluded that our disclosure controls
and procedures are not effective to provide reasonable assurance
that information we are required to disclose in reports that we file
or submit under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in Securities and
Exchange Commission rules and forms, and that such information is
accumulated and communicated to our management, including our chief
executive officer and chief financial officer, as appropriate, to
allow timely decisions regarding required disclosure.
b) Changes in internal controls: Except as described below, there were
no changes in internal controls over financial reporting that
occurred during the period covered by this report that have
materially affected, or are reasonably likely to materially effect,
our internal control over financial reporting.
SIGNIFICANT DEFICIENCIES IN DISCLOSURE CONTROLS AND PROCEDURES OR INTERNAL
CONTROLS
During our preparation of our Form 10-KSB for the year ended September 30, 2005,
which did not occur until the quarter ended December 31, 2005, we identified
certain material weaknesses. These material weaknesses did result in the
restatement of previously reported financial statements. As defined by the
Public Company Accounting Oversight Board Auditing Standard No.2, a material
weakness is a significant control deficiency or a combination of significant
control deficiencies that result in there being more than a remote likelihood
that a material misstatement in the annual or interim financial statements will
not be prevented or detected. These deficiencies and issues include:
o Revenue recognized for certain contracts during the year ended
September 30, 2005 were initially not recognized properly per
Statement of Position (SOP) 97-2 "Software Revenue Recognition".
Under SOP 97-2, in certain circumstances, all revenues from an
entire contract should be deferred until all the elements of the
contracts have been delivered. In these cases, all the elements of
the contracts were not delivered as of the end of respective
quarters and hence, revenue should be deferred until all the
elements of the contracts have been delivered. Our internal control
over reviewing and recording revenue recognition did not detect this
matter, and therefore, was not effective at preventing or detecting
misstatements of the financial statements.
o During the financial reporting process including footnote disclosure
requirements, our independent registered public accounting firm
identified that our Form 10-KSB was missing some of the required
generally accepted accounting principles disclosures. These
deficiencies could impact the timeliness and accuracy of financial
reporting. These deficiencies were corrected by management prior to
the issuance of the Form 10-KSB. Our disclosure control over
financial reporting did not detect these matters and therefore was
not effective at detecting these disclosure deficiencies in the
financial statements.
o Our closing process did not identify all the journal entries that
needed to be recorded as part of the closing process. As part of the
audit, our auditors proposed certain entries that should have been
recorded as part of the normal closing process. Our internal control
over reviewing the closing process did not detect this matter and
therefore was not effective in detecting misstatements of the
financial statements.
23
o Failure to properly calculate the beneficial conversion charges
resulting from issuance and modification of terms of its convertible
debt instruments during the quarter ended March 31, 2005. Such
weakness resulted in restatement to the Company's financial
statements for the quarter ended March 31, 2005 to increase by
$1,200,000 the amount of beneficial conversion charges recorded in
the statement of operations.
Management is aware that there is a lack of segregation of duties at the Company
due to the small number of employees dealing with general administrative and
financial matters. However, at this time management has decided that considering
the employees involved and the control procedures in place, the risks associated
with such lack of segregation are insignificant and the potential benefits of
adding employees to clearly segregate duties do not justify the expenses
associated with such increases. Management will periodically reevaluate this
situation.
In order to remediate the revenue recognition issue, we have instituted a policy
requiring at least two accounting personnel, one of which must be the Chief
Financial Officer, to review all contracts and provide independent assessment of
how revenue should be accounted for. In the event that such personnel have
conflicting opinions on the recognition of revenue, we will seek outside,
independent advice to determine the method of revenue recognition to be
utilized. In addition, we have modified our accounting software system to
automatically classify contract revenue as deferred revenue until all elements
of the contract have been delivered.
In order to remediate the weakness in our closing process and financial
reporting process and recording of beneficial conversion charges, we have
retained an outside, independent Certified Public Accountant, who will review
the closing procedures, financial statement preparation and identify all entries
and disclosures in order to mitigate any misstatements in our financial
statements.
As these changes to our internal controls and procedures did not occur until
after December 31, 2005, we believe these changes will be effective for the
quarter ended March 31, 2006, however, we will be unsure until they are tested
at that time.
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PART II - OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
From time to time, we may become involved in various lawsuits and legal
proceedings, which arise in the ordinary course of business. However, litigation
is subject to inherent uncertainties, and an adverse result in these or other
matters may arise from time to time that may harm our business. We have
previously disclosed in our annual and quarterly filings all legal proceedings
or claims, of which we are aware, that we believe will have, individually or in
the aggregate, a material adverse affect on our business, financial condition or
operating results. There have been no material developments during the period
covered by this report.
Recently Settled Litigation
- ---------------------------
On or about November 30, 2005, we settled for $10,000 an action previously
disclosed by us which was commenced in New York State Supreme Court, Nassau
County, captioned Great Oak LLC vs. Vertex Interactive, Inc. et. al. The action
had demanded approximately $328,000 to be due Great Oak LLC, the landlord of
premises leased to Renaissance Software LLC.
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. As a result, we entered into a Consent Order
and Agreement with the New Jersey Department of Labor which provides for monthly
payments of $30,000 which commenced on June 1, 2004 and payments were made
through August 31, 2005 and we have made no subsequent payments. We shall reduce
the balance of the payroll obligations, including penalty, as cash becomes
available until the total outstanding balance of approximately $282,000 is paid.
We believe, although there can be no assurances, that the payroll
obligations including penalties as of December 31, 2005 will be satisfied by the
calendar year ending December 31, 2006.
ITEM 2 UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the quarter ended December 31, 2005, we issued 500,000 shares of
our common stock to one consultant 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 December 31, 2005, we issued 1,500,000 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 December 31, 2005, we issued 1,500,000 shares of
our common stock to David Sasson for services rendered. This issuance is
considered exempt under Regulation D of the Securities Act of 1933 and Rule 506
promulgated thereunder.
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ITEM 3 DEFAULTS UPON SENIOR SECURITIES
We are currently in default pursuant to secured convertible notes issued
pursuant to a securities purchase agreement dated April 28, 2004 (the "2004
SPA"). Pursuant to the 2004 SPA, we are obligated to have two times the number
of shares that the secured convertible notes are convertible into registered
pursuant to an effective registration statement. We filed a registration
statement on Form S-1, as amended, that was declared effective by the Securities
and Exchange Commission on August 9, 2004. All of the shares of common stock
underlying the secured convertible notes that were registered on the S-1 have
been issued.
On January 11, 2005, we entered into a securities purchase agreement (the
"2005 SPA") pursuant to which we issued secured convertible notes and warrants.
The terms of the 2005 SPA required us to have a registration statement
registering the shares underlying the secured convertible notes and warrants
effective within 60 days of closing. We are currently in default under the 2005
SPA and the 2005 Working Capital Facility. On April 26, 2005, we filed a
registration statement on Form SB-2 registering shares to be issued upon
conversion of the secured convertible notes pursuant to the 2005 SPA however,
the SB-2 registration statement is currently being review and has not been
declared effective.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5 OTHER INFORMATION
None.
ITEM 6 EXHIBITS
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14 and
Rule 15d-14(a), promulgated under the Securities and Exchange Act of
1934, as amended
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14 and
Rule 15d 14(a), promulgated under the Securities and Exchange Act of
1934, as amended
32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Executive
Officer)
32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Financial
Officer)
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SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
CAPE SYSTEMS GROUP, INC.
Date: February 16, 2006 By: /s/ NICHOLAS R. TOMS
---------------------
Nicholas R. Toms
Chief Executive Officer
(Principal Executive Officer)
and Chief Financial Officer
(Principal Financial Officer
and Principal Accounting Officer)
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