As filed with the Securities and Exchange Commission on April 21, 2006
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. 3
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
- ------------------------------------------------ --------------------- ------------------ -------------------- --------------
PROPOSED
MAXIMUM PROPOSED MAXIMUM AMOUNT OF
TITLE OF EACH CLASS OF SECURITIES TO BE AMOUNT TO BE OFFERING PRICE AGGREGATE REGISTRATION
REGISTERED REGISTERED (1) PER SHARE (2) OFFERING PRICE FEE
- ------------------------------------------------ --------------------- ------------------ -------------------- --------------
Common stock, $.005 par value issuable upon 370,000,000 (3) $.085 $31,450,000 $3,701.67
conversion of the secured convertible notes (7)
- ------------------------------------------------ --------------------- ------------------ -------------------- --------------
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 $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.
(7) Issuable pursuant to the securities purchase agreements dated April 28, 2004
and January 11, 2005, as amended.
--------------------------------
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 APRIL 21, 2006
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
$4,387,526, 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. $2,537,526 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 April 19, 2006, was $.03.
INVESTING IN THESE SECURITIES INVOLVES SIGNIFICANT RISKS. SEE "RISK
FACTORS" BEGINNING ON PAGE 7.
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 ________, 2006.
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 14
Market For Common Equity And Related Stockholder Matters 21
Management's Discussion And Analysis Of Financial Condition And
Results Of Operations 22
Description Of Business 31
Description Of Properties 38
Legal Proceedings 39
Management 41
Executive Compensation 42
Certain Relationships And Related Transactions 44
Security Ownership Of Certain Beneficial Owners And Management 45
Description Of Securities 47
Commission's Position On Indemnification For Securities Act
Liabilities 49
Plan Of Distribution 50
Selling Stockholders 52
Legal Matters 59
Experts 59
Available Information 59
Index to Consolidated Financial Statements 60
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, 2005 and 2004, we generated revenues in
the amount of approximately $3,779,000 and $2,566,000 and net losses of
approximately $6,795,000 and $2,185,000, respectively. 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 January 13, 2006, have expressed substantial doubt about our
ability to continue as going concern. Based upon our current capital resources,
we believe we can only continue to operate at our current level of operations
until September 2006. We anticipate that we will need an additional $2 million
to fund our continued operations for the next 12 months, depending on revenues
from our operations. Additionally, as of December 31, 2005, we had current
assets of approximately $1.5 million and a working capital deficit of
approximately $26 million. Although a significant portion of our current
liabilities relate to accruals for potential litigation, European subsidiaries
in liquidation and outstanding debt owned by the selling stockholders, the
remaining current liabilities still exceed our current assets. As a result, we
may not have adaquate funds to pay our liabilities on a timely basis or we may
be unable to provide enough capital to grow our operations. In addition, we have
granted a first priority security interest in substantially all of our assets in
connection with the issuance of secured convertible notes to certain selling
stockholders. See "Risk Factors" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" herein for more information.
We are currently in default under the terms of the secured convertible
notes outstanding. The investors have waived in writing all default provisions
and liquidated damages as of December 31, 2005. The investors have indicated
that they do not intend to exercise their rights under the various default
provisions in our transaction documents, however, they have not committed that
to writing for any period after December 31, 2005 nor have they waived their
right to do so.
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. We maintain a website at www.capesystems.com. The
information contained on that website is not deemed to be a part of this
prospectus.
The Offering
Common stock offered by selling Up to 858,200,000 shares, including up to
stockholders........................ 370,000,000 shares of common stock
underlying secured convertible notes in
the principal amount of $4,387,526,
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).
4
This number represents 89.07% of our
current outstanding common stock.
Common stock to be outstanding
after the offering.................. Up to 963,494,456 shares
Use of We will not receive any proceeds from the
proceeds............................ 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 105,294,456 shares of common stock outstanding as of April
20, 2006 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 April 20, 2006, $462,474 of the convertible
debentures has been converted and $2,537,526 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 April 20, 2006, 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 $.02 and, therefore,
the conversion price for the secured convertible notes was $.008. Based on this
conversion price, the $2,537,526 remaining of the secured convertible notes,
excluding interest, are convertible into 317,190,625 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 April
20, 2006, 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 $.02 and, therefore, the conversion price for the class C-1
and D convertible preferred stock was $.012. Based on this conversion price, the
997 shares of class C-1 convertible preferred stock were convertible into
83,083,334 shares of our common stock and the 7,615 shares of class D
convertible preferred stock were convertible into 634,583,334 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 April 20, 2006, 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 $.02 and, therefore,
the conversion price for the secured convertible notes was $.008. Based on this
conversion price, the $1,850,000 secured convertible notes, excluding interest,
is convertible into 231,250,000 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 approximately $6,795,000 and $2,185,000 for the
years ended September 30, 2005 and 2004, respectively. For the three months
ended December 31, 2005, we incurred a net loss of approximately $374,000. 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 January 13, 2006 on our consolidated financial
statements as of and for the year ended September 30, 2005, our independent
registered public accounting firm stated that our recurring losses and our
working capital and stockholders' deficiencies as of September 30, 2005 raised
substantial doubt about the Company's ability to continue as a going concern.
Since September 30, 2005, 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 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.
7
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.
WE HAVE IDENTIFIED MATERIAL WEAKNESSES IN OUR DISCLOSURE CONTROLS AND PROCEDURES
AND INTERNAL CONTROL OVER FINANCIAL REPORTING THAT MAY PREVENT US FROM BEING
ABLE TO REPORT ACCURATELY OUR FINANCIAL RESULTS OR PREVENT FRAUD, WHICH COULD
HARM OUR BUSINESS AND OPERATING RESULTS AND THE TRADING PRICE OF OUR STOCK.
Effective disclosure controls and procedures and internal controls are
necessary for us to provide reliable and accurate financial reports and prevent
fraud. If we cannot provide reliable and accurate financial reports and prevent
fraud, our business and operating results could be harmed. In connection with
our evaluation of our disclosure controls and procedures and internal control
over financial reporting, we have identified material weakness in for each
period starting with the fiscal year ended September 30, 2004. See "Liquidity
and Capital Resources - Internal Controls and Procedures" We may in the future
discover additional areas of our disclosure controls or internal control over
financial reporting that need improvement. Any remedial measures we take may not
succeed in designing, implementing and maintaining adequate controls over our
financial processes and reporting in the future and may not be sufficient to
address and eliminate the material weakness. Remedying the material weakness
that has been identified, or material weaknesses that we or our independent
registered public accounting firm may identify in the future, could require us
to incur additional costs or divert management resources which could reduce our
profitability.
We have not yet fully remediated the material weaknesses that we have
identified. If we do not remedy these material weaknesses, we may be required to
report in subsequent reports that we file with the Securities and Exchange
Commission that a material weakness in our disclosure controls and procedures
and internal controls over financial reporting continues to exist. Any delay or
failure to design and implement new or improved controls, or difficulties
encountered in their implementation or operation, could harm our operating
results, cause us to fail to meet our financial reporting obligations, or
prevent us from providing reliable and accurate financial reports or avoiding or
detecting fraud. Disclosure of material weaknesses, any failure to remediate
such material weaknesses in a timely fashion or having or maintaining
ineffective internal controls could cause investors to lose confidence in our
reported financial information, which could have a negative effect on the
trading price of our stock and our access to capital.
8
WE HAVE ENTERED INTO A CONSENT ORDER AND AGREEMENT RELATED TO OVERDUE PAYROLL
OBLIGATIONS.
We have outstanding payroll obligation under a Consent Order and Agreement
with the New Jersey Department of Labor of $282,000. We believe, although there
can be no assurances, that the payroll obligations including penalties will be
satisfied by the calendar year ending December 31, 2006. If, however, sufficient
cash is not available to meet this obligation, the New Jersey Department of
Labor pursuant to Title 34, Chapter 11, of the New Jersey Statutes Annotated,
through the Commissioner of Labor, is authorized to supervise the payment of
amounts due employees by requiring that the payments be paid to the Commissioner
to be paid over by the Commissioner to the employees. The Consent Order and
Agreement provided for precisely that, including administrative fees and
penalties, to be paid over a period of time. Under Title 34, each of the
individuals named in the Consent Order and Agreement are deemed to be
"Employers". Pursuant to the Consent Order and Agreement, the Department of
Labor agreed not to pursue the individuals as long as we made the required
payments, and agreed not to pursue us further for failure to make the
installment payments without providing notice and a 15 day period to cure such
failure. We have not received such a notice.
In the event such notice is received and we fail to cure, the Commissioner
can pursue all available remedies under Title 34. This would be further
administrative fees of 25% of the unpaid wages and penalties of 5%.
Additionally, failure to pay wages due is a disorderly persons offense
providing, at a court's discretion, the option of imprisonment for not less than
10 days nor more than 100 days.
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 April 20, 2006, we had 105,294,456 shares of common stock issued and
outstanding, secured convertible notes outstanding that may be converted into an
estimated 548,440,625 shares of common stock at current market prices, class C-1
convertible preferred stock outstanding that may be converted into an estimated
83,083,334 shares of common stock at current market prices, class D convertible
preferred stock outstanding that may be converted into an estimated 634,583,334
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 April 19, 2006 of $0.03 per share.
9
Secured Convertible Notes
Number % of
% Below Price Per With Discount of Shares Outstanding
Market Share at 60% Issuable Stock
- ------ ----- ------ -------- -----
25% $.0225 $.009 487,502,778 82.24%
50% $.015 $.006 731,254,167 87.41%
75% $.0075 $.003 1,462,508,334 93.28%
Class C-1 Convertible Preferred Stock
Number % of
% Below Price Per With Discount of Shares Outstanding
Market Share at 40% Issuable Stock
- ------ ----- ------ -------- -----
25% $.0225 $.0135 73,851,852 41.22%
50% $.015 $.009 110,777,778 51.27%
75% $.0075 $.0045 221,555,556 67.79%
Class D Convertible Preferred Stock
Number % of
% Below Price Per With Discount of Shares Outstanding
Market Share at 40% Issuable Stock
- ------ ----- ------ -------- -----
25% $.025 $.0135 564,074,075 84.27%
50% $.015 $.009 846,111,112 88.93%
75% $.0075 $.0045 1,692,222,223 94.14%
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 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.
10
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.
WE ARE CURRENTLY IN DEFAULT UNDER THE SECURITIES PURCHASE AGREEMENTS AND SECURED
CONVERTIBLE NOTES AND THE INVESTORS HAVE THE RIGHT TO TAKE POSSESSION OF ALL OUR
GOODS, INVENTORY, CONTRACTUAL RIGHTS AND GENERAL INTANGIBLES, RECEIVABLES,
DOCUMENTS, INSTRUMENTS, CHATTEL PAPER, AND INTELLECTUAL PROPERTY.
11
In connection with the Securities Purchase Agreements we entered into in
April 2004, January 2005 and August 2005, we granted in favor of the investors a
first priority security interest in all of our goods, inventory, contractual
rights and general intangibles, receivables, documents, instruments, chattel
paper, and intellectual property. Pursuant to the terms of the Securities
Purchase Agreements, an event of default has occurred. We currently owed the
investors $4,937,526 in face amount of secured convertible notes, plus interest
and default payments. As a result of the events of a default, 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. As of the date of
this filing, the Investors have not declared a default by the Company, although
there can be no assurance that they will not declare a default in the future. If
the investors declare an event of default and take possession of our property,
we will lose all of our assets and may have to file for bankruptcy protection.
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.
12
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.
13
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;
14
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.
15
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.
16
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
17
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 $4,387,526 of secured convertible
notes issued and outstanding on April 20, 2006, at a conversion price of $0.008,
the number of shares issuable upon conversion would be:
$4,387,526/$0.008 = 548,440,625 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 April 19, 2006 of $0.03.
18
Secured Convertible Notes
Number % of
% Below Price Per With Discount of Shares Outstanding
Market Share at 60% Issuable Stock
- ------ ----- ------ -------- -----
25% $.0225 $.009 487,502,778 82.24%
50% $.015 $.006 731,254,167 87.41%
75% $.0075 $.003 1,462,508,334 93.28%
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 April 20, 2006, a conversion price of $0.012 per
share, the number of shares issuable upon conversion would be:
(997+7,615) * 1,000/$.012 = 717,666,667 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 April 19, 2006 of $0.03.
19
Class C-1 Convertible Preferred Stock
Number % of
% Below Price Per With Discount of Shares Outstanding
Market Share at 40% Issuable Stock
- ------ ----- ------ -------- -----
25% $.0225 $.0135 73,851,852 41.22%
50% $.015 $.009 110,777,778 51.27%
75% $.0075 $.0045 221,555,556 67.79%
Class D Convertible Preferred Stock
Number % of
% Below Price Per With Discount of Shares Outstanding
Market Share at 40% Issuable Stock
- ------ ----- ------ -------- -----
25% $.025 $.0135 564,074,075 84.27%
50% $.015 $.009 846,111,112 88.93%
75% $.0075 $.0045 1,692,222,223 94.14%
20
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is quoted on the OTC Bulletin Board under the symbol
"CYSG". Prior to August 20, 2002, our common stock was quoted on the Nasdaq
National Market. From August 21, 2002 until February 17, 2003 our Common Stock
was traded on the NASDAQ Bulletin Board. From February 18, 2003 until March 28,
2004 our common stock traded on the Pink Sheets under the symbol VETXE. Prior to
April 8, 2005, our common stock traded under the symbol "VETX."
For the periods indicated, the following table sets forth the high and low
bid prices per share of common stock. These prices represent inter-dealer
quotations without retail markup, markdown, or commission and may not
necessarily represent actual transactions.
High($) 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 0.05 0.03
Second Quarter 0.05 0.01
Third Quarter (1) 0.03 0.02
(1) As of April 20, 2006
HOLDERS
As of April 20, 2006, 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.
21
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
On January 12, 2005, we acquired Cape Systems, Inc., which was comprised
of two operating units of the same company. These operating units were the
Dallas, Texas unit and the London, United Kingdom unit. For financial reporting
purposes, these units are consolidated into one financial unit. All references
to London and Dallas refer to segments of one reporting unit.
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 remaining 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) In 2005 and 2004 we have recorded no 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. Impairment losses are recorded on
long-lived assets used in operations when indicators of impairment are present
and the undiscounted cash flows estimated to be generated by those assets are
less than the net carrying amount of the assets. The Company has evaluated the
value of its long-lived assets for impairment in accordance with Statement of
Financial Accounting Standards No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." As a result of its review, the Company does not
believe that any change has occurred. If such changes in circumstances are
present, a loss is recognized to the extent the carrying value of the asset is
in excess of the sum of the discounted cash flows expected to result from the
use of the asset and amounts expected to be realized upon its eventual
disposition.
22
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, 2005 and 2004.
e) As described in Note 3 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.
During the year ended September 30, 2005, we recognized a non-cash gain of
$177,000 from the approval of creditors of the liquidation of the net
liabilities of our Ireland subsidiaries. Upon legal resolution of the
approximately $7,296,000 of net liabilities of our remaining European entities
as of September 30, 2005, we may 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, 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. None of our revenue related to software license sales is recorded by
percentage-of-completion accounting.
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 the 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.
23
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs, an
amendment of Accounting Research Bulletin No. 43, Chapter 4" ("SFAS 151"). This
SFAS 151 amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing," to
clarify the accounting for abnormal amounts of idle facility expense, freight,
handling costs, and wasted material (spoilage). Paragraph 5 of ARB No. 43,
Chapter 4, previously stated that "...under some circumstances, items such as
idle facility expense, excessive spoilage, double freight, and rehandling costs
may be so abnormal as to require treatment as current period charges ..." SFAS
151 requires that those items be recognized as current-period charges regardless
of whether they meet the criterion of "so abnormal." In addition, this SFAS 151
requires that allocation of fixed production overheads to the costs of
conversion be based on the normal capacity of the production facilities. The
provisions of SFAS 151 shall be applied prospectively and are effective for
inventory costs incurred during fiscal years beginning after June 15, 2005, with
earlier application permitted for inventory costs incurred during fiscal years
beginning after the date this SFAS 151 was issued. The adoption of SFAS 151 is
not expected to have a material impact on our financial position and results of
operations.
RESULTS OF OPERATIONS
YEAR ENDED SEPTEMBER 30, 2005 COMPARED TO YEAR ENDED SEPTEMBER 30, 2004.
OPERATING REVENUES:
Operating revenues increased by approximately $1,212,000 (or 47.3%) to
approximately $3,779,000 in 2005.
PRODUCTS AND SERVICES
Sales to customers by the two significant product and service line
groupings for the years ended September 30, 2005 and 2004 (in thousands) are as
follows:
September 30
---------------
2005 2004
------ ------
Enterprise Solutions $1,279 $ 83
Service, Maintenance and Other 2,500 2,483
------ ------
$3,779 $2,566
====== ======
Enterprise solutions revenues increased to $1,279,000 in 2005 from $83,000
in 2004. The increase was a result of three warehouse expansions in our customer
base. Service, maintenance and other revenues have increased approximately
$17,000 from 2004. The increase was a result of the acquisition of operations in
London ($428,000) and Dallas ($612,000) which were not owned by us in 2004
offset by a decrease 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 $652,000 (or 51.0%) to $1,931,000
in 2005. The addition of the London and Dallas operation accounted for virtually
the entire increase ($692,000) as the core business remained flat year-to-year.
As a percent of operating revenues, gross profit was 51.1% in 2005 as compared
to 49.8% in 2004.
OPERATING EXPENSES:
Selling and administrative expenses increased approximately $1,209,000 (or
41.3%) to $4,136,000 in 2005. Approximately $479,000 of the increase is due to
the addition of the London and Dallas operations with the balance of $730,000
due primarily to professional fees resulting from numerous regulatory filings
and contractual obligations.
24
There were no research and development ("R&D") expenses in 2005 or in
2004. 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 2006.
The $241,000 increase in depreciation and amortization to $396,000 in
2005, as compared to $155,000 in 2004, is due primarily to the amortization of
the intangible assets in connection with the acquisition of the London and
Dallas operations.
As a result of the aforementioned, our operating loss increased by
approximately $798,000 to approximately $2,601,000 for fiscal 2005 as compared
to our operating loss of approximately $1,803,000 for fiscal 2004.
Interest expense increased by approximately $3,036,000 to $5,005,000 in
2005. This increase is due to new financing obtained in 2005, non-cash charges
for the beneficial conversion feature for long-term convertible debt as well as
penalties, default interest on the convertible notes, and interest of $113,000
in connection delinquent filings of the Company's Form 5500 annual report offset
by lower amortization of deferred financing fees.
During 2005 we settled certain of our liabilities and recognized a gain of
$164,000, mainly due to our ability to settle $517,000 in debts and obligations
for $353,000 in cash.
Gain on liquidation of foreign subsidiaries increased due to a $177,000
gain on liquidation of the Ireland operations.
The income tax provision is negligible in both years due primarily to
operating losses.
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.
25
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.
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 & 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 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.
As of December 31, 2005, our current liabilities exceeded our current
assets by approximately $26 million. As described below, a substantial portion
of the current liabilities relates to reserves for convertible debt, reserves
for pending litigation and reserves for subsidiaries in liquidiation. Although
there are no assurances, we anticipate that all of our convertible debt will be
converted into shares of common stock. In addition, we have and continue to
negotiate pending litigation claims for small portions of the estimated claims
in cash or for shares of our common stock. Except for an inchoate claim relating
to one subsidiary in Italy, there have been no claims and our other subsidiaries
in liquidation are proceeding in accordance with the laws of jurisdictions in
which they were incorporated. We anticipate that we will need to address a
significant portion less than our current liabilities in order to continue our
operations, however, there can be no assurances that we will not be required to
settle our current liabilities for a higher, and potentially substantially
higher, amount. We have had negotiations with creditors to settle their claims
for partial payment, in cash and/or shares of common stock, although we do not
have any definitive settlement agreements nor can there be any assurance that we
will be able to settle any current liabilities for less than their carrying
value. As a result, we may not have adequate funds to pay our liabilities on a
timely basis or we may be unable to provide enough capital to grow or continue
our operations. In addition, we have granted a first priority security interest
in substantially all of our assets in connection with the issuance of secured
convertible notes to certain selling stockholders. As a result, we do not
believe that our current liabilities present a serious impact on a timing basis
in order to continue our operations.
26
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, us
to raise substantial funds to finance (i) continuing operations, (ii) the
further development of our enterprise software technologies, (iii) the
settlement of exist ing 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 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.
Due to our working capital deficiency, and if we do not receive adequate
financing, we will be unable to pay our vendors, lenders and other creditors if
we cease our operations, since the net realizable value of our non-current
assets will not generate adequate cash. We currently do not have any commitments
for financing. There is no guarantee that we will be successful in raising the
funds required.
Until such time, if at all, as we receive adequate funding, we intend to
continue to defer payment of all of our obligations which are capable of being
deferred, which actions have resulted in some vendors demanding cash payment for
their goods and services in advance, and other vendors refusing to continue to
do business with us. In the event that we are successful in obtaining
third-party funding, we do not expect to generate a positive cash flow from our
operations for at least several years, if at all, due to anticipated
expenditures for research and development activities, administrative and
marketing activities, and working capital requirements and expect to continue to
attempt to raise further capital through one or more further private placements.
Depending on revenues from operations and our cash on hand of
approximately $400,000 as of March 31, 2006, we should be able to continue
operations at the current level through September 30, 2006 at a minimum. We will
require additional funds of approximately $2,000,000 to sustain and expand our
sales and marketing activities and to fund our continued operations for the next
twelve months. 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.
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.
As reported elsewhere, we have outstanding payroll obligation under a
Consent Order and Agreement with the New Jersey Department of Labor of $282,000.
We believe, although there can be no assurances, that the payroll obligations
including penalties will be satisfied by the calendar year ending December 31,
2006. If, however, sufficient cash is not available to meet this obligation, the
New Jersey Department of Labor pursuant to Title 34, Chapter 11, of the New
Jersey Statutes Annotated, through the Commissioner of Labor, is authorized to
supervise the payment of amounts due employees by requiring that the payments be
paid to the Commissioner to be paid over by the Commissioner to the employees.
The Consent Order and Agreement provided for precisely that, including
administrative fees and penalties, to be paid over a period of time. Under Title
34, each of the individuals named in the Consent Order and Agreement are deemed
to be "Employers". Pursuant to the Consent Order and Agreement, the Department
of Labor agreed not to pursue the individuals as long as we made the required
payments, and agreed not to pursue us further for failure to make the
installment payments without providing notice and a 15 day period to cure such
failure. We have not received such a notice.
27
In the event such notice is received and we fail to cure, the Commissioner
can pursue all available remedies under Title 34. This would be further
administrative fees of 25% of the unpaid wages and penalties of 5%.
Additionally, failure to pay wages due is a disorderly persons offense
providing, at a court's discretion, the option of imprisonment for not less than
10 days nor more than 100 days.
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.
(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.
28
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
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.
29
DEFAULT UNDER SECURED CONVERTIBLE NOTES
In connection with the securities purchase agreements entered into in
April 2004, January 2005 and August 2005, we granted the investors registration
rights and security interests in all of our assets. Several events of default
have occurred regarding all of the secured convertible notes, including failure
to have a sufficient number of shares reserved for issuance upon conversion of
the secured convertible notes and warrants and failure to have an effective
registration statement for the shares underlying secured convertible the notes
and warrants. As a result of these defaults, we are obligated to pay the note
holders the principal amount of the notes together with interest and certain
other amounts. We do not have the capital resources to pay the amounts required
under these agreements. The secured convertible note holders have informed us
that they do not intend to take any action at this time due to the default. The
investors have waived as of and through December 31, 2005, all events of default
and all liquidated damages under the various securities purchase agreements and
convertible notes. However, since January 1, 2006, we are in default again under
these securities purchase agreements and secured convertible notes. We do not
have any written commitment from the note holders that they will continue to
waive events of default and liquidated damages thereunder. These events of
default, taken as a whole, are reasonably likely to have a material impact on
our short-term and long-term liquidity. The investors have been willing in the
past to provide us with capital as needed to sustain our day-to-day operations
and to forego enforcing default provisions, however, no assurance can be given
that they will provide such capital in the future or continue to forego
enforcing default provisions, which they are under no obligation to do so. In
the event that we need additional capital in the future for our day-to-day
operations, and the investors do not provide such funds, we will have to seek
capital from new investors. As a result of these events of default and that all
of our assets are secured by the current investors, it is highly unlikely that
we would be able to obtain additional capital from other investors. If we are
unable to obtain additional capital, we would likely be required to curtail or
cease our operations. As all of our assets are secured by our existing lendors,
of which we are currently in default, we do not anticipate filing for bankruptcy
protection, as all of our assets would be transferred to our lendors pursuant to
our existing security agreements.
INTERNAL CONTROLS AND PROCEDURES
Since the quarter ended September 30, 2004, we have had significant
deficiencies and/or material weaknesses in our internal controls and procedures.
These significant deficiencies and material weaknesses have included:
o Failure to timely consider certain issuances of equity securities
and the beneficial conversion features imbedded within the
convertible debt instruments and preferred stock;
o Inadaquate staffing in our accounting department and the lack of a
full-time senior accounting person;
o Failure to timely consider the beneficial conversation charges
resulting from modification of the terms of convertible debt
instruments;
o Stock options that we had granted to non-employee consultants should
have been accounted for under variable accounting;
o Revenue recognized for a particular contract during one quarter
should have been deferred to the next quarter;
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;
o During the financial reporting process including footnote disclosure
requirements, our independent registered public accounting firm
identified that we were missing some of the required generally
accepted accounting principles disclosures; and
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.
We have implemented numerous changes to our internal controls and
procedures to correct these significant deficiencies and/or material weaknesses.
Most recently, we have retained an outside, independent certified public
accountant to oversee and assist us in our closing procedures. To date, the
costs involved in remediating our controls and procedures issues have been
minimal. However, we cannot be certain that the corrective measures taken to
date have corrected all deficiencies and weaknesses.
Additionally, we may in the future discover additional areas of our
disclosure controls or internal control over financial reporting that need
improvement. Any remedial measures we take may not succeed in designing,
implementing and maintaining adequate controls over our financial processes and
reporting in the future and may not be sufficient to address and eliminate the
material weakness. Remedying the material weakness that has been identified, or
material weaknesses that we or our independent registered public accounting firm
may identify in the future, could require us to incur additional costs or divert
management resources which could reduce our profitability.
Any delay or failure to design and implement new or improved controls, or
difficulties encountered in their implementation or operation, could harm our
operating results, cause us to fail to meet our financial reporting obligations,
or prevent us from providing reliable and accurate financial reports or avoiding
or detecting fraud. Disclosure of material weaknesses, any failure to remediate
such material weaknesses in a timely fashion or having or maintaining
ineffective internal controls could cause investors to lose confidence in our
reported financial information, which could have a negative effect on the
trading price of our stock and our ability to raise additional capital.
30
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 are also 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. Our 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. Our customer base, numbering approximately 3,700,
includes, among others, some fortune 500 companies such as Wal-Mart, Sam's Club,
Nestle, Procter & Gamble, Smurfit-Stone and Coca-Cola.
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 and the United Kingdom, 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.
In fiscal 2005, we had one customer, Regis Corporation, whose sales were
approximately 10% of total revenue. At September 30, 2005 the customer accounted
for approximately 14% of total accounts receivable. In fiscal 2004, we had two
customers whose sales were approximately 30% of total revenue (IBM China 20% and
Rite Aid Corp 10%). At September 30, 2004 the two customers accounted for
approximately 30% of total accounts receivable.
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.
31
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
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.
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.
Throughout 2005, 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.
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
The industry opportunity is being defined by three worldwide trends:
Two Major Catalysts: Global Competition and the Internet
- --------------------------------------------------------
32
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 returnt 6 0 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.
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
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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 of some 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:
1. Warehouse Management Systems (WMS)
eWMS is designed to fully automate a warehouse. The system is a fully
integrated, scalable product designed to address day-to-day "operational"
functions and inventory availability. It operates on platforms such as Linux or
Unix utilizing industry standard Relational Database Management Systems (RDBMS).
The system includes integral RF support to facilitate product movement processes
within the warehouse. Receiving, inventory control, replenishment, and picking
are automated. The system includes comprehensive inventory control functions
such as receiving, system-directed, automatic replenishment, consolidation and
cycle counting. The product includes a number of standard functions that can be
custom configured to suit the physical warehouse and inventory control
requirements of the customer. It can control and record all material movements
including: planned and unplanned receipts, adjustments, and order processing.
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.
34
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.
3. Packaging and Transportation Software
We also offer a full range of software solutions for all packaging design,
palletizing and truck or container loading needs. The CAPE PACK and TRUCKFILL
programs can be fully integrated with other systems and offer simple import and
export features. Sharing pallet specifications and container load diagrams is
easy with the email feature and the Web Page Publisher program. Companies using
CAPE PACK, palletizing and packaging design software, can increase profitability
without having to sell more products, raise prices or increase market share.
CAPE PACK palletizing and package design software calculates efficient
pallet loads, enables users to design custom packages, evaluate alternative
product dimensions, review optional pack arrangements and test package integrity
using the compression strength testing feature. CAPE PACK also includes
extensive import and exporting capabilities, making integration with other
systems, such as SAP, much easier for customers. Product data can be imported
into CAPE PACK and stored in product, bundle and case size databases.
The Pallet Group allows the improvement of pallet utilization and load
stability by entering in a product size, basic pallet restrictions and letting
the program calculate the most efficient pallet stacking patterns. The program
will also allow evaluation of the efficiencies of the product on up to 3
different sets of pallet criteria at one time.
The Arrange Group takes the design process a step further and helps to
design improved case sizes, better product arrangements, or bundles, within the
case and get more product on a pallet. Beginning with a fixed product size, the
user can set a range of desired product quantities and the program would
calculate alternative bundles, secondary packaging sizes and arrangements, while
also calculating the most efficient pallet pattern.
The Design Group is used to evaluate alternative product dimensions so
more product will fit in the case, on the store shelf, and on the pallet. This
group builds on Pallet and Arrange so beginning with a variable product
dimension, the user can specify how much each dimension can vary up or down and
in certain increments. The program then calculates alternative product
dimensions, bundles, cases and the resulting pallet load.
CAPE PACK's graphics technology enables users to view true to life
representations of solutions and the power to share the results with other
people. The program generates three dimensional, color displays of full, quarter
and club-store pallet loads.
CASEFILL, DISPLAY PALLET, AND KDF are utilities which can aid in the
consolidation of cases, automatically calculate mixed product pallets for
club-stores, and to generate pallet loads using bundles of KDF's/flat glued
cases. All of these features are includes with any of the above program groups
within CAPE PACK.
35
DISPLAY PALLET PROGRAM accesses a customer's product database to help
manufacturers and retailers build 3-dimensional displays of single and mixed
sized products for club stores. By setting load restrictions and using the very
powerful multiple product calculation algorithms, pallet loads that are
shoppable as well as efficient.
TRUCKFILL software specializes in the organization and priority loading of
products into trucks and containers. TRUCKFILL helps users reduce shipping costs
by planning, creating, editing, printing and maintaining multi-product load
plans, while avoiding the shipment of empty space or wasted time manually
calculating how many products can be loaded onto containers and trucks. For
existing CAPE software users, importing previously saved pallet loads from CAPE
PACK can be accomplished quickly and easily.
The customer can enter the details for the products, pallet loads and
truck/container sizes into the appropriate database then the software will
calculate the load configurations. Sharing the results is made easy with the
email, custom reports and exporting capabilities. Creating export documentation
in advance and communicating results via the Internet can improve customer
relations, help create shipment quotes and reduce refused shipments.
4. RFID
Apply and Comply is a simple, low cost, turnkey Radio Frequency
Identification (RFID) labeling solution that gives users the capability to be
compliant with Wal-Mart, Target, Gillette, Best Buy and Department of Defense
mandates, among others. Designed for companies that are facing RFID compliance
mandates on low to mid volume products, the Apply and Comply(TM) product offers
a complete portable solution containing all of the hardware, software, and
equipment necessary to provide an out-of-the-box RFID compliance label tagging
solution.
The RFID Tag Locator uses commercially available RFID tags and readers to
measure RFID performance at the case and pallet level under real-world
conditions. Results from these measurements are displayed using interactive
color-coded 3D models to show RF properties. This unique and intuitive
visualization system conveys an immediate understanding of the RF behavior of a
product. This in turn leads to optimal tag placement and significantly improved
case and pallet reading.
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 approximately $3 billion. We
believe that PeopleSoft has a Java-based product offering which is very
competitive with that offered by us. PeopleSoft recently acquiredJD Edwards & Co
Inc, an ERP vendor 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
- --------------------
36
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 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.
Packaging and Transportation Systems
- ------------------------------------
Within the packaging industry there are only a few companies that provide
packaging design, palletization or container loading software in some format.
There is only one major competitor within this market segment. CAPE Systems has
been the innovator in bringing new features and functionality to market, based
on customer requests and industry demands. The abilities to import / export data
and integrate with other systems, are some of the reasons why CAPE Systems has
been named a Top 100 IT Logistics Provider for the past two years.
TOPS Engineering, a privately held company, with revenues believed to be
approximately $2 million, competes most directly with us in packaging,
palletizing and container loading software, in our main vertical markets.
RFID
- ----
The science of best tag placement has usually been conducted at private
labs and certain universities. Only over the last couple of years have companies
decided to take this science and commercialize it. We have identified two
companies that we feel come closest to provided competitive solutions to our
RFID Tag Locator. We also feel that as companies like Wal-Mart start mandating
that not only must RFID tags be placed on pallets and individual cases, but that
the tags must be readable as well, we will see tremendous interest and need in
tag readability and placement software, including our RFID Tag Locator.
ODIN Technologies, a privately held company, based in Virginia, competes
in the RFID tag location business with a product called Trifecta. Our research
indicates that the results from ODIN's product are based on simulation models,
while our RFID Tag Locator product gathers scientific RFID data and displays
results in 3D and most importantly in real-time. We believe the real-time
aspects of RFID Tag Locator is an important competitive differentiator.
Venture Research, a privately held company, based in Texas, provides
non-graphical analysis of RFID best tag placement through the use of RFID portal
and tunnels. Because of the real-time 3D graphical analysis of our RFID Tag
Locator product, we see Venture Research as a competitor and as a potential
partner.
37
There are many companies that are promoting RFID "slap-and-ship"
compliance software, including Manhattan Associates and Venture Research. We
feel our differentiator is that we can also bundle in other supply chain
functionality at a modular level to enhance and speed up RFID compliance
mandates, as well as bundle in best tag placement software. These additional
features combined with a quick and easy to setup procedure and a user-friendly
touch screen interface provides us with the necessary tools to remain
competitive in the RFID compliance space.
RESEARCH AND DEVELOPMENT
For the years ended September 30, 2005 and 2004, there was no research and
development spending as we suspended research and development to focus our
resources on customer support.
INTELLECTUAL PROPERTY
We have 11 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)
CAPE Reg. No. 920,742 September 21, 1971 (renewed June 13, 2001)
CAPE PACK Reg. No. 1,948,709 January 16, 1996 (renewed September 30, 2005)
Truckfill Reg. No. 2,480,542 August 21, 2001
CAPE Reg. No. TMA 210,349 October 31, 1975 (renewed October 31, 2005)
(Canada)
EMPLOYEES
At April 1, 2006, we had approximately 27 employees. 20 of our employees
are in North America and seven are in the United Kingdom. Approximately 52% are
in Installation and Implementation, 30% 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 we can retain existing
employees or attract and hire capable technical employees we 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. Our Dallas office is located at 100
Allentown Parkway, #218, Allen, Texas 75002, and our telephone number is (972)
359-1100. This office occupies approximately 3,000 square feet of office space
under a lease that expires April 2006. The monthly rent is $2,963. Our London
office are located at The Perfume Factory, 140, Wales Farm Road, London W3 6UG
and our telephone number is 020-8752-8610. This office occupies approximately
1,803 square feet of office space under a lease that expires March 2008. The
monthly rent is approximately 3,250 GBP (approximately $5,737 based on current
exchange rates).
38
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 and expense $4,100 a month and receive an offset $3,100 per month
from the subleasee against rent expense. 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. We maintain a website at www.capesystems.com. The
information contained on that website is not deemed to be a part of this
prospectus.
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.
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
our stockholders' deficiency. However, they could lead to involuntary bankruptcy
proceedings. Those are the following.
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 demanded $394,000, was
brought by a former employee claiming breach of his employment agreement. On
March 29, 2004, a judgment was granted against us in the amount of $350,482. As
of the date of this filing, 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 ours, and us, alleged the
default by Renaissance Software, Inc. in payment of certain promissory notes in
the principal aggregate sum of $1,227,500. We 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. As of the date of this filing, the judgment has not been paid.
c) As part of the settlement entered into between us and three former
principals of a company we acquired in 2000, consent judgments in the amount of
approximately $1,000,000 each were entered against us on July 19, 2002. We are
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. As of the date of this filing, the judgments have not been paid.
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 us for computer hardware. As of the date of this filing, the
judgment has not been paid.
e) In connection with the liquidation of our European operations,
specifically VSM Italia s.r.l. ("VSM"), our wholly owned subsidiary, on July 25,
2005 an action was commenced against us, the Board of Directors of VSM, its
auditing committee, and its auditors, in the Civil Court of Milan, Italy,
captioned Bankrupt V.S.M. Italia s.r.l. in liquidation- n. 559/02. The complaint
alleges that at the end of calendar year 2000 and beginning of 2001, VSM lacked
liquidity", had incurred large liabilities, and was undercapitalized. As a
result, the complaint alleges, among other things, that liquidation proceedings
should have started at the end of year 2000, and continuing to run the business
until June 30, 2002 damaged VSM in the amount of Euro 2,600,000, such amount has
been accrued by us. We have only recently received the complaint and have
requested additional information with respect to its contents so that we may
respond accordingly.
39
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. Certain individuals who are owed payroll
obligations have agreed in principle to accept shares of our common stock in
lieu of cash. We are continuing to negotiate to reduce the total cash
obligations due so that a combination of stock and cash will allow us to pay off
these obligations.
40
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
NAMES: AGES TITLES: BOARD OF DIRECTORS
Hugo H. Biermann 56 Executive Chairman Director
Nicholas R. H. Toms 57 Chief Executive Officer and Chief Financial Officer Director
Otto Leistner 61 Director
David Sasson 36 Chief Operating Officer and Chief Technical Officer
Peter Ayling 61 V.P. - Worldwide Group Marketing;
President, Cape Systems
Brad Leonard 49 V.P. - Worldwide Group Sales
Barbara H. Martorano 49 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.
40
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.
DAVID SASSON has served as our Chief Operating Officer and Chief Technical
Officer since October 2005. Mr. Sasson held various positions within the Company
primarily as director of software operations for the Pick-to-Light product
division of XeQute Solutions, Inc., our wholly-owned subsidiary, from 2002 until
2005. Mr. Sasson previously worked for Data Control Systems, which we acquired
in 2000. Mr. Sasson is a member of the board of directors of Open Terra, Inc.
Mr. Sasson serves on the board of directors for the Warehousing Education and
Research Council for NJ/NY/CT and is a member of the NJ Material Handling
Society and the NJ Technology Council. Mr. Sasson has a Bachelor of Science in
Business Administration from Ramapo College of New Jersey.
PETER AYLING has served as our V.P. Worldwide Group Marketing, and
Managing Director of Cape Systems and Consulting Services Ltd, in the United
Kingdom since January 2005. Prior to that, Mr. Ayling was the Managing Director
of Cape Systems and Consulting Services Ltd. in the United Kingdom and the
President of Cape Systems, Inc., the U.S. subsidiary.
BRAD LEONARD has served as our V.P. - Worldwide Group Sales since January
2005. Prior to the time, Mr. Leonard served as the VP of Business Development
with Cape Systems, Inc. since 1984. Prior to joining Cape Systems, Inc. Mr.
Leonard was a Packaging Engineering with General Dynamics, Miles Laboratories
and Frito-Lay. Mr. Leonard has a BA from the University of Wisconsin and an MBA
from Indiana University.
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.
41
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, 2005, 2004 and 2003 exceeded
$100,000:
SUMMARY COMPENSATION TABLE
Long-Term Compensation
-------------------------------------
Annual Compensation Awards Payouts
---------------------------------- --------------------------- -------
Other Securities
Annual Annual Annual Restricted Underlying LTIP All Other
Name and Fiscal Salary Bonus Compensation Stock Awards Options/SARs Payouts Compensation
Principal Position Year ($) ($) ($) ($) (#) ($) ($)
- ---------------------- ------ ------- ------ ------------ ------------ ------------ ------- ------------
Nicholas R. H. Toms, 2005 62,518
CEO and CFO 2004 91,667 0 0 0 0 0 0
2003 300,000 0 0 0 0 0 0
Mark A. Flint, CFO 2005 0 0 0 0 0 0 0
2004 0 0 0 0 0 0 0
2003 218,589(1) 0 0 0 0 0 0
Donald W. Rowley, 2005 0 0 0 0 0 0 0
Executive VP - 2004 0 0 0 0 0 0 0
Strategic Development 2003 101,667(2) 0 0 0 0 0 0
Brad Leonard, Vice 2005 120,312 0 0 0 0 0 0
President, Worldwide 2004 0 0 0 0 0 0 0
Sales 2003 0 0 0 0 0 0 0
Peter Ayling, Vice 2005 119,700 0 0 0 0 0 0
President, Worldwide 2004 0 0 0 0 0 0 0
Marketing 2003 0 0 0 0 0 0 0
Robert Schilt, Chief 2005 172,134 0 0 0 0 0 0
Technology Officer 2004 100,000 0 0 0 0 0 0
XeQute Solutions, Inc. 2003 214,475 0 0 0 0 0 0
Timothy Callahan, 2005 0 0 0 0 0 0 0
Vice President Sales 2004 50,000 0 0 0 0 0 0
and Marketing 2003 198,750 0 0 0 0 0 0
(1) Mr. Flint was laid off in August, 2003.
(2) Mr. Rowley resigned as an officer in February, 2003, and was laid off in
June, 2003.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
On January 12, 2005, we issued options to acquire 3,420,000 shares of our
common stock at an exercise price of $0.10 per share to principals in connection
with the acquisition of Cape Systems.
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.
42
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 April 1, 2006, there were 4,160,500 stock options granted under the
1985 plan that were outstanding.
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
The following table describes for the named executive officers, the
exercisable and unexercised options held by them as of September 30, 2005. No
options were exercised by the named executive officers in fiscal 2005. The
"Value of Unexercised In-the-Money Options at Fiscal Year End" is based on a
value of $.05 per share, the closing price of Vertex's common stock on The
Nasdaq Stock Market's National Market, on September 30, 2005, less the per share
exercise price, multiplied by the number of shares to be issued upon exercise of
the options.
Number of Securities Value of unexercised
Underlying unexercised in-the-money options
Options at fiscal year end at fiscal year end
--------------------------- ---------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- ------------- ----------- ------------- ----------- -------------
Hugo Biermann 475,000 -- n/a n/a
Nicholas Toms 475,000 -- n/a n/a
Brad Leonard 200,000 -- n/a n/a
Peter Ayling 300,000 -- n/a n/a
43
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.
We have no policy regarding entering into transactions with affiliated
parties.
44
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding beneficial
ownership of our common stock as of April 20, 2006
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) 2.71% *
3619 Kennedy Road
South Plainfield, NJ 07080
Nicholas R. H. Toms Common Stock 3,986,293 (5) 3.77% *
3619 Kennedy Road
South Plainfield, NJ 07080
Otto Leistner Common Stock 2,672,875 (6) 2.54% *
3619 Kennedy Road
South Plainfield, NJ 07080
Barbara Martorano Common Stock 27,000 (7) * *
3619 Kennedy Road
South Plainfield, NJ 07080
David Sasson Common Stock 1,500,000 * *
3619 Kennedy Road
South Plainfield, NJ 07080
Peter Ayling Common Stock 675,000 (7) * *
3619 Kennedy Road
South Plainfield, NJ 07080
Brad Leonard Common Stock 400,000 (7) * *
3619 Kennedy Road
South Plainfield, NJ 07080
All Officers and Directors Common Stock 11,701,303 (8) 10.90% *
As a Group (7 persons)
- ----------------------------
American Marketing Complex Common Stock 9,455,000 8.98% *
330 East 33rd Street, Suite 15M
New York, NY 10016
MidMark Capital L.P. Common Stock 8,761,664 (9) 8.10% *
177 Madison Avenue
Morristown, NJ 07960
MidMark Capital II L.P. Common Stock 701,906,668 (10) 86.98% *
177 Madison Avenue
Morristown, NJ 07960
=======================================================================================================
Pitney Bowes, Inc. Preferred A 1,356,852 100% 100%
One Elmcroft Road
Stamford, CT 06926
=======================================================================================================
45
=======================================================================================================
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
(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 April 20, 2006 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
105,294,456 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 April 20, 2006.
(3) Percentage based on 963,494,456 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 and 82,000 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 the trust.
(6) Includes 50,000 shares issuable pursuant to presently exercisable
options.
(7) Represents shares issuable pursuant to presently exercisable options.
(8) Includes 1,519,000 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 2,833,334 shares issuable upon conversion of class C-1
convertible preferred stock.
(10) Includes 634,583,334 shares issuable upon conversion of class D
convertible preferred stock, and 67,083,334 shares issuable upon
conversion of class C-1 convertible preferred stock.
46
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 April 20, 2006, there were 105,294,456 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 April 20, 2006, 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 7,434,221 shares of
our common stock consisting of the following: (i) 5,172,221 options granted
under our non-qualified plan; and (ii) 2,262,000 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 550,000 warrants to purchase shares of common stock and
are obligated to issue 300,000 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 12,834,221 shares of common stock issuable
upon exercise of outstanding options and warrants, approximately 365,627,167
shares of common stock are issuable upon conversion of outstanding promissory
notes, which includes 211,460,417 shares of common stock issuable upon
conversion of the $2,537,526 in outstanding secured convertible notes issued
pursuant to the Securities Purchase Agreement dated April 28, 2004 and
154,166,667 shares of common stock issuable upon conversion of the secured
convertible notes issued pursuant to the Securities Purchase Agreement dated
January 11, 2005.
47
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 convertibles debentures and we are registering 6,000,000 shares
underlying the warrants. As of April 20, 2006, $462,474 of the convertible
debentures has been converted and $2,537,526 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.
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 provided us with the funds as follows:
o $250,000 was disbursed on August 10, 2005;
o $100,000 was disbursed on September 19, 2005;
48
o $100,000 was disbursed on October 19, 2005;
o $100,000 was disbursed on November 16, 2005; and
o $300,000 was disbursed on March 31, 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:
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.
49
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.
50
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.
We are registering shares of common stock for resale upon conversion of
outstanding debt pursuant to securities purchase agreements dated April 28, 2004
and January 11, 2005 among us, AJW Offshore, Ltd., AJW Qualified Partners, LLC,
AJW Partners, LLC and New Millennium Capital Partners II, LLC We have entered
into another securities purchase agreement with AJW Offshore, Ltd., AJW
Qualified Partners, LLC, AJW Partners, LLC and New Millennium Capital Partners
II, LLC in August 2005. Shares of common stock issuable upon conversion of
secured convertible debentures issuable upon conversion of the secured
convertible debentures issued pursuant to the August 2005 securities purchase
agreement are not registered hereunder and the investors may not rely upon this
registration statement to make resales of such shares.
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.
51
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 Shares of Total
Common Stock Percentage Percentage
Issuable Upon of Common Shares of Beneficial of Common
Conversion of Stock, Common Stock Beneficial Percentage of Ownership Stock Owned
Notes, Preferred Assuming Included in Ownership Common Stock After the After
Stock and/or Full Prospectus Before the Owned Before Offering Offering
Name Warrants* Conversion (1) Offering** Offering** (3) (3)
- ------------------- ----------------- ------------- ------------- ------------ -------------- ------------ -------------
AJW Offshore, Ltd. 218,389,025 67.47% Up to 5,425,266 4.90% -- --
(2) 149,749,640
shares of
common stock
- ------------------- ----------------- ------------- ------------- ------------ -------------- ------------ -------------
AJW Qualified 217,098,600 67.34% Up to 5,425,266 4.90% -- --
Partners, LLC (2) 149,720,100
shares of
common stock
- ------------------- ----------------- ------------- ------------- ------------ -------------- ------------ -------------
AJW Partners, LLC 99,003,125 48.46% Up to 5,425,266 4.90% -- --
(2) 68,045,000
shares of
common stock
- ------------------- ----------------- ------------- ------------- ------------ -------------- ------------ -------------
New Millennium 18,799,875 15.15% Up to 5,425,266 4.90% -- --
Capital Partners 12,185,260
II, LLC (2) shares of
common stock
- ------------------- ----------------- ------------- ------------- ------------ -------------- ------------ -------------
MidMark Capital, 2,833,334 2.62% Up to 5,425,266 4.90% 5,928,330 0.62%
L.P. (4) 1,889,268
shares of
common stock
- ------------------- ----------------- ------------- ------------- ------------ -------------- ------------ -------------
MidMark Capital II, 701,666,667 86.95% Up to 5,425,266 4.90% -- --
L.P. (4) 467,831,193
shares of
common stock
- ------------------- ----------------- ------------- ------------- ------------ -------------- ------------ -------------
Paine Webber 4,166,667 3.81% Up to 4,166,667 3.81% -- --
Custodian F/B/O 2,778,335
Wayne Clevenger shares of
common stock
- ------------------- ----------------- ------------- ------------- ------------ -------------- ------------ -------------
Joseph Robinson 4,166,667 3.81% Up to 4,166,667 3.81% -- --
2,778,335
shares of
common stock
- ------------------- ----------------- ------------- ------------- ------------ -------------- ------------ -------------
O'Brien Ltd 4,166,667 3.81% Up to 4,166,667 3.81% -- --
Partnership (5) 2,778,335
shares of
common stock
- ------------------- ----------------- ------------- ------------- ------------ -------------- ------------ -------------
Matthew Finlay & 666,667 0.63% Up to 666,667 0.63% -- --
Teresa Finlay 444,534
JTWROS shares of
common stock
- ------------------- ----------------- ------------- ------------- ------------ -------------- ------------ -------------
52
* This column represents an estimated number based on conversion prices as of a
recent date of April 20, 2006 of $.008 and $.012, 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 April 20, 2006, the
secured convertible notes would have had a conversion price of $.008. 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.
53
(3) Assumes that all securities registered will be sold.
(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:
54
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.
55
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.
56
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:
57
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.
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 $4,387,526 of secured convertible
notes issued and outstanding on April 20, 2006, at a conversion price of $0.008,
the number of shares issuable upon conversion would be:
$4,387,526/$0.008 = 548,440,750 shares
58
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 April 19, 2006 of $0.03.
% Below Price Per With Discount of Shares Outstanding
Market Share at 60% Issuable Stock
- ------ ----- ------ -------- -----
25% $.0225 $.009 487,502,778 82.24%
50% $.015 $.006 731,254,167 87.41%
75% $.0075 $.003 1,462,508,334 93.28%
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, 2005 and 2004 included in this prospectus have been audited
by J.H. Cohn LLP, independent registered public accounting firm, as stated in
their report dated January 13, 2006, 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.
The financial statements of Cape Systems, Inc. as of and for the year
ended December 31, 2003 included in this prospectus have been audited by J.H.
Cohn LLP, independent registered public accounting firm, as stated in their
report dated March 24, 2005. Such 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.
59
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, 2005 and 2004 F-2
Consolidated Statements of Operations for the years ended September 30,
2005 and 2004 F-5
Consolidated Statements of Changes in Stockholders' Deficiency
for the years ended September 30, 2005 and 2004 F-6
Consolidated Statements of Cash Flows for the years ended September 30,
2005 and 2004 F-9
Notes to Consolidated Financial Statements F-11 to
F-37
Condensed Consolidated Balance Sheets as of December 31, 2005 (Unaudited) F-38
Condensed Consolidated Statements of Operations for the three
months ended December 31, 2005 and 2004 (Unaudited) F-40
Condensed Consolidated Statement of Changes in Stockholders' Deficiency
for the three months ended December 31, 2005 (Unaudited) F-41
Condensed Consolidated Statements of Cash Flows for the three months
ended December 31, 2005 and 2004 (Unaudited) F-43
Notes to the Condensed Consolidated Financial Statements (Unaudited) F-45 to
F-54
Audited Financial Statements of Cape Systems and Consulting Services Ltd.
for the year ended December 31, 2003 F-55
Audited Financial Statements of Cape Systems, Inc, for the year ended
December 31, 2003 F-74
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, 2005 and 2004, 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, 2005 and 2004, and their results of
operations and cash flows for the years then ended, in conformity with
accounting principles generally accepted in the United States of America.
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, 2005. 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, 2005 do not include any adjustments that might result from the
outcome of this uncertainty.
/s/ J. H. COHN LLP
- ------------------
Roseland, New Jersey
January 13, 2006
F-1
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2005 AND 2004
(in thousands except share and per share data)
ASSETS
September 30,
2005 2004
------ ------
CURRENT ASSETS:
Cash $ 239 $ 101
Restricted cash - short-term -- 300
Accounts receivable, less
allowance for doubtful accounts of $9 and $456 572 351
Inventories, net of valuation allowance 185 369
Prepaid expenses and other current assets 480 71
------ ------
Total current assets 1,476 1,192
Equipment and improvements, net of
accumulated depreciation and
amortization of $670 and $1,359 45 34
Restricted cash - long-term -- 150
Deferred financing costs,
net of accumulated amortization of $175 and $54 180 261
Goodwill 342 --
Other intangible assets, net of accumulated
amortization of $370 1,175 --
Other assets 194 111
------ ------
Total assets $3,412 $1,748
====== ======
See notes to consolidated financial statements.
F-2
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2005 AND 2004
(in thousands except share and per share data)
2005 2004
--------- ---------
CURRENT LIABILITIES:
Notes payable $ 1,227 $ 1,227
Mandatory redeemable Series D preferred stock -
504 shares at redemption value 505 505
Accounts payable 4,315 3,654
Payroll and related benefits accrual 1,576 1,995
Litigation related accruals 3,655 3,655
Other accrued expenses and liabilities 3,834 3,750
Deferred revenue 549 354
Long-term convertible notes payable 4,765 --
Estimated remaining net liabilities associated
with subsidiaries in liquidation 7,296 7,715
--------- ---------
Total current liabilities 27,722 22,855
Long-term convertible notes payable -- 2,549
--------- ---------
Total Liabilities 27,722 25,404
--------- ---------
F-3
2005 2004
--------- ---------
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 aggregate liquidation preference) 14 14
Series B preferred stock, par value $0.01 per
share; 1,000 shares authorized, 1,000 shares
issued and outstanding($1,000 aggregate
liquidation preference) -- --
Series C-1 preferred stock, par value
$0.01 per share; 10,000 shares authorized,
997 shares issued and outstanding ($997
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)($7,110 aggregate
liquidated preference) -- --
Common stock, par value $.005 per share;
1,000,000,000 shares authorized;
92,273,778 and 56,116,342 shares issued 461 281
Additional paid-in capital 170,222 164,442
Subscription receivable (66) --
Accumulated deficit (193,312) (186,517)
Accumulated other comprehensive loss (1,562) (1,809)
Less: Treasury stock, 87,712 shares of
common stock (at cost) (67) (67)
--------- ---------
Total stockholders' deficiency (24,310) (23,656)
--------- ---------
Total liabilities and stockholders' deficiency $ 3,412 $ 1,748
========= =========
See notes to consolidated financial statements.
F-4
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended September 30, 2005 and 2004
(in thousands except share and per share data)
2005 2004
------------ ------------
REVENUES $ 3,779 $ 2,566
COST OF SALES 1,848 1,287
------------ ------------
GROSS PROFIT 1,931 1,279
------------ ------------
OPERATING EXPENSES:
Selling and administrative 4,136 2,927
Depreciation and amortization 396 155
------------ ------------
Total operating expenses 4,532 3,082
------------ ------------
OPERATING LOSS (2,601) (1,803)
------------ ------------
OTHER INCOME (EXPENSE):
Interest expense (includes beneficial
conversion charge of $3,540 and $1,096
in 2005 and 2004, respectively) (5,005) (1,969)
Gain on settlements of liabilities 164 1,072
Gain on liquidation of foreign subsidiaries 177 321
Other 13 194
------------ ------------
Net other expense (4,651) (382)
------------ ------------
LOSS BEFORE(CREDIT) FOR INCOME TAXES (7,252) (2,185)
Credit for sale of state tax benefits (457) --
------------ ------------
NET LOSS (6,795) (2,185)
Charge for preferred stock
beneficial conversion feature -- 3,445
------------ ------------
NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS $ (6,795) $ (5,630)
============ ============
Net loss per share of common stock:
Basic and Diluted $ (.09) $ (0.12)
Weighted average number of shares outstanding:
Basic and Diluted 77,305,980 48,469,039
See notes to consolidated financial statements.
F-5
CAPE SYSTEMS GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIENCY
FOR THE YEARS ENDED SEPTEMBER 30, 2005 AND 2004
(In thousands except share and per share data)
Preferred Stock Common Stock Additional Deferred
-------------------- --------------------- Paid-In Compensation
Shares Amount Shares Amount Capital Unearned Income
--------- -------- ---------- -------- ---------- ----------------
Balance September 30, 2003 1,358,849 $ 13 48,201,978 $ 241 $ 155,364 $ (400)
Effects of issuance of
warrants with notes payable:
Related parties 54
Unrelated parties 428
Conversion of notes payable -
related parties into non-redeemable
Series D preferred stock 7,111 1 7,110
Exercise of warrants 5,809,980 29 289
Conversion of long-term
notes payable - unrelated parties 1,754,384 9 89
Common stock issued in exchange
for services 350,000 2 12
Issuance of Series C-1 preferred
stock for Series C -- --
Write off of unearned income 400
Beneficial conversion feature related to
long-term convertible debt 1,096
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 14 56,116,342 281 164,442 --
Conversion of notes payable -
into common stock 12,031,915 61 275
Common stock issued for accrued
401(k) plan contribution and
other liabilities 13,252,899 66 854
Common stock issued in
exchange for services 9,622,622 47 761
Beneficial conversion feature
related to long-term convertible debt 3,540
Common stock issued related to
subscription agreement 1,250,000 6 94
Effects of issuance of warrants
with notes payable 136
Stock options issued in exchange
for services 120
Net loss
Change in unrealized foreign
exchange translation gains/
(losses)
--------- -------- ---------- -------- ---------- ----------------
Balance September 30, 2005 1,365,960 $ 14 92,273,778 $ 461 $ 170,222 $ --
========= ======== ========== ======== ========== ================
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, 2005 AND 2004
(In thousands except share and per share data)
(CONTINUED)
Accumulated
Other
Accumulated Subscription Comprehensive Treasury
Deficit Receivable Loss Stock Total
----------- ------------ ------------- -------- --------
Balance September 30, 2003 $ (184,332) $ -- $ (2,481) $ (67) $(31,662)
Effects of issuance of
warrants with notes payable:
Related parties 54
Unrelated parties 428
Conversion of notes payable
related parties into non-redeemable
Series D preferred stock 7,111
Exercise of warrants 318
Conversion of long-term notes payable -
unrelated parties 98
Common stock issued in exchange
for services 14
Issuance of Series C-1 Preferred
Stock for Series C
Write off of unearned income 400
Beneficial conversion feature related to
long-term convertible debt 1,096
Comprehensive loss:
Net loss (2,185) (2,185)
Change in unrealized foreign
exchange translation gains/losses 672 672
----------- ------------ ------------- -------- --------
Balance September 30, 2004 (186,517) -- (1,809) (67) (23,656)
Conversion of notes payable -
into common stock 336
Common stock issued for accrued
401(k) Plan contribution
and other liabilities 920
Common stock issued in exchange
for services 808
Beneficial conversion feature
related to additional long-term
convertible debt 3,540
Common stock issued related to
subscription agreement -425,000 purchased
as of September 30, 2005 (66) 34
Effects of issuance of warrants
with notes payable 136
Stock options issued in exchange
for services 120
Net loss (6,795) (6,795)
Change in unrealized foreign
exchange translation gains/(losses) 247 247
----------- ------------ ------------- -------- --------
Balance September 30, 2005 $ (193,312) $ (66) $ (1,562) $ (67) $(24,310)
=========== ============ ============= ======== ========
F-7
(a) Comprehensive (loss) for the years ended September 30, 2005 and 2004 totaled
$(6,571) and $(2,586) respectively. The Company reclassified $23 and $1,073 from
other comprehensive loss into current year loss for the years ended September
30, 2005 and 2004 respectively.
See notes to consolidated financial statements.
F-8
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
For the Years Ended
September 30,
------------------
2005 2004
------- -------
Cash Flows from Operating Activities:
Net loss $(6,795) $(2,185)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization 396 155
Write-off unearned income -- 400
Common stock issued in exchange for services 808 14
Amortization of deferred financing costs and
debt discount 579 54
Variable stock option charge 43 --
Charges to interest expense for warrants
issued with note payable - related parties -- 54
Charges to interest expense for beneficial
conversion features of notes payable - unrelated parties 3,540 1,172
Gain on liquidation of foreign subsidiaries: (177) (321)
Gain on settlement of liabilities (164) (1,072)
Changes in operating assets and liabilities:
net of effects of acquisitions
Restricted cash -- (450)
Accounts receivable, net (6) 288
Inventory 219 169
Prepaid expenses and other current assets (225) (52)
Other assets 399 --
Accounts payable 800 (58)
Accrued expenses and other liabilities 591 (569)
Deferred revenue (20) 49
------- -------
Net cash used in operating activities (12) (2,352)
------- -------
Cash Flows from Investing Activities:
Additions to equipment and improvements -- (2)
Acquisition of business - net of cash acquired (1,990) --
------- -------
Net cash used in investing activities (1,990) (2)
------- -------
F-9
For the Years Ended
September 30,
------------------
2005 2004
------- -------
Cash Flows from Financing Activities:
Proceeds from notes and convertible notes payable:
Related parties -- 137
Unrelated parties 2,200 3,000
Repayment of notes payable - unrelated parties -- (392)
Deferred financing costs (94) (315)
Cash received - common stock issuance 34 --
------- -------
Net cash provided by Financing Activities 2,140 2,430
------- -------
Net increase in cash 138 76
Cash at beginning of year 101 25
------- -------
Cash at end of year $ 239 $ 101
======= =======
Cash paid for interest -- 155
Noncash investing and financing activities:
Long-term convertible notes payable -
converted into common stock $ 336 98
Notes payable and accrued interest -
related parties converted into nonredeemable
and mandatory redeemable preferred stock -- 7,110
Common stock issued for payment of liabilities $ 920 --
Stock options issued for future services $ 120 --
See notes to consolidated financial statements.
F-10
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BUSINESS AND BASIS OF 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.
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.
GOING CONCERN MATTERS
Based upon our substantial working capital deficiency ($26,246) and
stockholders' deficiency ($24,310) at September 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.
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 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.
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 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 September 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, 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 $7,296 of estimated remaining liabilities of these remaining
European entities as of September 30, 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 year ended September 30, 2005, we realized net gains of
approximately $164 from settlements of liabilities totaling $517 through the
payments of approximately $353 in cash.
(iii) During the year ended September 30, 2005 convertible notes payable to
unrelated parties in the principal amount of $336 were converted into 12,031,915
shares of common stock.
F-12
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(iv) On January 11, 2005, we entered into a Securities Purchase Agreement (the
"SPA") 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 default rate
of 15% per annum for the period from March 12, 2005 through September 30, 2005.
Interest expense has been increased from $360 at the 10% rate to $482 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 2005 and 2004 (the "SPA"). 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 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
$100 will be disbursed on the final business day of each month beginning January
2006 and ending in March 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.
F-13
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
2. 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 (see Note 10). The acquisition was completed in order to expand our
customer base.
In addition, prior to January 12, 2005, the Company had made restricted cash
deposits of $418 that were held by the purchasers of the secured convertible
notes and had made prepayments of interest of $31 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.
The acquisition was accounted for as a purchase pursuant to SFAS 141.
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 allocated to
goodwill. The cost of the acquisition of $2,198 allocated to the estimated fair
values of the assets and liabilities of the Acquired Companies as follows:
Cash $ 208
Accounts receivable 214
Inventories 35
Prepaid expenses and other assets 95
Equipment, furniture and fixtures 42
Accrued expenses (42)
Deferred revenue (214)
Notes payable (6)
Accounts payable (24)
Other intangible assets 1,548
Goodwill 342
-------
Total cost allocated $ 2,198
=======
F-14
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The acquisition closed effective January 12, 2005 and, accordingly, included the
results of operations of the Acquired Companies from January 12, 2005.
Purchased goodwill is normally deductible for tax purposes. However, since this
acquisition was a stock puchase goodwill is not deductible for tax purposes.
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)
Years Ended
September 30,
2005 2004
------- -------
Revenues $ 4,100 $ 3,900
Net loss (6,825) (2,300)
Net loss per share* (.09) (.05)
* Includes a nonrecurring charge of $1,850 ($.02 per share) for the year ended
September 30, 2005 for the beneficial conversion feature given to the investors
that provided financing for the acquisition.
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.
3. ESTIMATED REMAINING LIABILITIES ASSOCIATED WITH 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 September 30, 2005 and 2004 consolidated balance
sheets. While the Company expects the liquidation process to take through at
least June 30, 2006, 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 September 30, 2005 and 2004 was $7,296
and $7,715, respectively:
F-15
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company received notice that the liquidation of Vertex Ireland subsidiaries
had been approved and finalized by the Ireland creditors as of September 30,
2005. Based on such notice, management reduced the Company's estimated remaining
liabilities associated with subsidiaries in liquidation by approximately $200,
reclassed approximately $23 of translation loss from accumulated other
comprehensive loss to the consolidated statement of operations and recognized a
gain of approximately $177 in the fourth quarter of fiscal 2005.
The Company received notice that the liquidation of the UK companies was
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, reclassed approximately
$1,073 of translation loss from accumulated other comprehensive loss to the
consolidated statement of operations, and recognized a gain of approximately
$320 in fiscal 2004.
Except for the gain from the liquidation of the Ireland subsidiaries and changes
in the unrealized foreign translation loss, there were no results of operations
of these businesses for the years ended September 30, 2005 and 2004.
4. 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 of America 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 record 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.
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.
F-16
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, " ("SFAS 86") 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.
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. The capitalized software costs
were fully amortized as of September 30, 2004.
F-17
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Pursuant to SFAS 142, "Goodwill and Other Intangible Assets" ("SFAS 142"),
goodwill and other intangible assets with indefinite lives are no longer
amortized and are subject to reduction only when their carrying amounts exceed
their estimated fair values based on impairment tests that are required to be
made annually or more frequently under certain circumstances. Fair values are
determined based on models that incorporate estimates of future profitability
and cash flows.
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, customer lists 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.
As of September 30, 2005 and 2004, there were 540,963,700 and 225,718,736 shares
of common stock respectively potentially issuable upon the exercise of stock
options (7,890,815 and 6,959,606 shares), warrants (5,200,000 and 3,000,000) and
the conversion of convertible securities (527,872,885 and 215,759,130 shares).
However, diluted per share amounts have not been presented in the accompanying
consolidated statements of operations for the years ended September 30, 2005 and
2004 because the Company had a 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.
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.
F-18
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
STOCK-BASED COMPENSATION
SFAS 123, "Accounting for Stock-Based Compensation" ("SFAS 123") 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" ("APB 25") 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" ("SFAS 148") 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.
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:
Year Ended
September 30,
------------------
2005 2004
------- -------
Net loss-as reported $(6,795) $(2,185)
Deduct total stock - based employee
compensation expense determined under a
fair value based method for all awards,
net of related tax effects 663 986
------- -------
Net loss - pro-forma $(7,458) $(3,171)
======= =======
Net loss applicable to common stock pro-forma $(7,458) (6,616)
======= =======
Basic and diluted
loss per common share - as reported $ (.09) $ (.12)
Basic and diluted
loss per common share - pro-forma $ (.10) $ (.14)
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.
F-19
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The effects of applying SFAS 123 and the results obtained through the use of the
Black-Scholes option-pricing model used are not necessarily indicative of future
values.
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 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 of 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 over the term of the debt or as debt discount which is amortized to
interest expense using the effective yield method. 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 (there was a balance of $157 in excess of the
limit at September 30, 2005). 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 does not require collateral and 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.
In fiscal 2005, we had one customer, Regis Corporation, whose sales were
approximately 10% of total revenue. At September 30, 2005 the customer accounted
for approximately 14% of total accounts receivable. In fiscal 2004, we had two
customers whose sales were approximately 30% of total revenue (IBM China 20% and
Rite Aid Corp 10%). At September 30, 2004 the two customers accounted for
approximately 30% of total accounts receivable.
F-20
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 $101 and $19 in fiscal 2005 and 2004, respectively.
RESEARCH AND DEVELOPMENT
There were no research and development expenses ("R&D") as we suspended all R&D,
focusing our resources on customer support services.
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 December 2004, 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.
F-21
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs, an amendment
of Accounting Research Bulletin No. 43, Chapter 4" ("SFAS 151"). SFAS 151 amends
the guidance in ARB No. 43, Chapter 4, "Inventory Pricing," to clarify the
accounting for abnormal amounts of idle facility expense, freight, handling
costs, and wasted material (spoilage). Paragraph 5 of ARB No. 43, Chapter 4,
previously stated that "...under some circumstances, items such as idle facility
expense, excessive spoilage, double freight, and rehandling costs may be so
abnormal as to require treatment as current period charges ..." SFAS 151
requires that those items be recognized as current-period charges regardless of
whether they meet the criterion of "so abnormal." In addition, SFAS 151 requires
that allocation of fixed production overheads to the costs of conversion be
based on the normal capacity of the production facilities. The provisions of
SFAS 151 shall be applied prospectively and are effective for inventory costs
incurred during fiscal years beginning after June 15, 2005, with earlier
application permitted for inventory costs incurred during fiscal years beginning
after the date SFAS 151 was issued. The adoption of SFAS 151 is not expected to
have a material impact on our financial position and results of operations.
5. INTANGIBLE ASSETS
As of September 30, 2005, the only intangible asset of the Company was the value
of a customer list in connection with the acquisition of Cape Systems in January
2005. Information related to changes in the Company's intangible assets during
the years ended September 30, 2005 and 2004 is presented below.
Intangible assets subject to amortization as of September 30, 2005 and related
changes during fiscal 2005 and 2004 were as follows:
Additions/
September 30, Amortization September 30, Amortization September 30,
2003 Expense 2004 Expense 2005
------------- ------------ ------------- ------------ -------------
Gross Cost $ 347 $ -- $ 347 $ 1,548 $ 1,548
Accumulated amortization-
based upon estimated life of 3 years 232 115 347 370 370
------------- ------------ ------------- ------------ -------------
Net book value $ 115 $ 115 $ -- $ 1,178 $ 1,178
============= ============ ============= ============ =============
F-22
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Intangible assets subject to amortization as of September 30, 2005 and related
changes during fiscal 2005 were as follows:
Additions/
Estimated September 30, Amortization September 30,
Life 2004 Expense Disposals 2005
--------- ------------- ------------ --------- -------------
Gross Cost
Capitalized Software 3 yrs $ 347 $ -- $ (347)(1) $ --
Customer List 3 yrs -- 1,548 -- 1,548
------------- ------------ --------- -------------
$ 347 $ 1,548 $ (347) $ 1,548
============= ============ ========= =============
Accumulated Amortization
Capitalized Software 347 -- (347)(1) $ --
Customer List -- 373 -- 373
------------- ------------ --------- -------------
$ 347 $ 373 $ (347) $ 373
============= ============ ========= =============
Net Book Value
Capitalized Software -- -- --
Customer List -- 1,175 -- 1,175
------------- ------------ --------- -------------
$ -- $ 1,175 $ -- $ 1,175
============= ============ ========= =============
(1) Capitalized software became fully amortized in 2004.
Amortization expenses in each of the years subsequent to September 30, 2005 will
be approximately $516 in 2006 and 2007 and $143 in 2008.
Intangible assets not subject to amortization as of September 30, 2005 and the
related changes during 2005 were are follows:
September 30, Additions September 30,
2004 Reductions 2005
------------- --------- ---------- -------------
Cost
Goodwill -- $ 342(1) -- $ 342
------------- --------- ---------- -------------
Total -- $ 342 -- $ 342
============= ========= ========== =============
No impairment required for the year ended September 30, 2005
(1) The additions to goodwill during the year ended September 30, 2005 relate to
the acquisition of Cape Systems on January 12, 2005 .
F-23
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. INVENTORIES
Inventories consist of the following:
September 30,
2005 2004
---- ----
Raw materials $185 $310
Work in process -- 59
---- ----
Totals $185 $369
==== ====
7. EQUIPMENT AND IMPROVEMENTS
September 30,
2005 2004
----- -------
Office furniture and equipment $ 166 $ 728
Computer equipment 510 541
Other equipment 39 124
----- -------
Totals 715 1,393
Less accumulated depreciation and amortization (670) (1,359)
----- -------
Net equipment and improvements $ 45 $ 34
===== =======
8. OTHER ASSETS
Other assets consist of the following:
September 30,
2005 2004
----- -----
Security deposits $ 120 $ 111
Deferred acquisition fees 74 --
----- -----
Totals $ 194 $ 111
===== =====
9. NOTES PAYABLE
Notes payable classified as current liabilities consist of past due notes
payable to Renaissance Software, Inc. ("Renaissance") in the amount of $1,227 as
of September 30, 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 January 13, 2006.
F-24
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. CONVERTIBLE NOTES PAYABLE
Convertible notes payable of $4,765 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) $350 in
convertible notes (the "2005 Working Capital Facility") and warrants to purchase
350,000 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. 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 as of the commitment date. Accordingly,
the Company recorded an increase in additional paid-in capital and debt discount
of $1,524 in connection with the issuance of the 2004 Convertible Notes and 2004
Warrants, of which $1,171 was amortized to interest expense during the year
ended September 30, 2004 and $352 during the year ended September 30, 2005.
In connection with the 2005 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 $1,469 as of the
modification date. Accordingly, the Company recorded an increase in additional
paid-in capital and the additional debt discount of $1,469 which was amortized
to interest expense in 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 at conversion prices of $0.054 and $0.055 per share. During
October 2004 through December 2004, the Company issued 11,245,615 common shares
upon the conversion of 10% Convertible Notes with an approximate principal
balance of $313 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 $23
at a conversion price of $0.03 per share.
F-25
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 Over-the-Counter
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 $1,720 as of the commitment date. Accordingly, the Company
recorded an increase in additional paid-in capital and the additional debt
discount of $1,720 which was amortized to interest expense since the Company is
currently in default. In addition the aggregate intrinsic value of the 2005
Warrants was $129 which was recorded as additional paid-in capital and debt
discount, $129 of which was amortized to interest expense during the year ended
September 30, 2005.
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
$100 will be disbursed on the final business day of each month beginning January
2006 and ending in March 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.
11. STOCKHOLDERS' DEFICIENCY
SHARES ISSUED FOR SERVICES AND DIRECTORS' FEES AND ACCRUED LIABILITIES
During the year ended September 30, 2005, the Company issued 9,622,622 shares of
common stock for various consulting and professional services rendered and
recorded charges of approximately $808, based on the fair value of the shares
issued.
During the year ended September 30, 2005, the Company issued: 6,767,043 shares
of common stock to settle various outstanding payroll obligations and other
liabilities totaling approximately $558; 1,951,452 shares to its 401K Retirement
Plan in satisfaction of its accrued calendar 2002 and 2003 matching contribution
obligation of approximately $137; and 4,534,404 shares in satisfaction of
accrued Director's Fees of $225.
F-26
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
During the year ended September 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. As of September 30, 2005, 425,000
shares of common stock were purchased and the Company received $34 and recorded
a subscription receivable of $66.
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.
Series "A"
In connection with the Transcape 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 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. In connection with this transaction Pitney Bowes had nominated Michael
Monahan to the Company's Board of Directors. He served as a Director from
November 15, 2001 until his resignation on February 21, 2002.
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 of convertible notes
payable and accrued interest. 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 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 of
convertible and demand notes payable and accrued interest. The Series D
preferred stock was recorded at approximately $7,615 which was the liquidation
value of the Series D preferred stock.
F-27
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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
$505 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 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 $505 was included in current liabilities as mandatory
redeemable Series D preferred stock in the accompanying consolidated balance
sheet. However, the payment was not made and, accordingly, a total of 504 shares
of Series D preferred stock with an aggregate liquidation value of $505 remains
in current liabilities as mandatory redeemable Series D preferred stock in the
accompanying consolidated balance sheet as of September 30, 2005.
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 30, 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 $.05 and, therefore, the
conversion price for the Series C-1 and Series D preferred stock was $.03. 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 287,056,933 shares of
common stock.
Based on the excess of the aggregate fair value of the common shares that would
be 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 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. 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.
In September 2004, the Board approved the 2004 Incentive Stock Option Plan (the
"2004 Plan") 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, 2005, 3,420,000 shares were issued from the 2004 Plan, 1,200,000
shares were issued to employees and 2,200,000 shares were issued to
non-employees for which an expense of $120 was recognized during the year ended
September 30, 2005.
F-28
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the common stock options granted, cancelled or
exercised under the Plan:
2005 2004
Weighted Weighted
Common Average Common Average
Stock Exercise Stock Exercise
Options Price Options Price
--------- -------- --------- --------
Outstanding at beginning of year 1,190,500 $ 2.49 1,828,000 $ 3.14
Granted 1,220,000 .10 --
Exercised --
Cancelled (90,000) 1.28 (637,500) 5.59
--------- ---------
Outstanding at end of year 2,320,500 1.20 1,190,500 2.49
========= =========
Exercisable at end of year 1,259,500 2.50 1,008,500 2.50
========= =========
Weighted average
fair value of
options granted
during the year $ .08 $ --
The following table summarizes information on stock options outstanding under
the Plan at September 30, 2005:
Options Outstanding Options Exercisable
---------------------- -----------------------
Options Weighted
Outstanding Weighted Average Options Weighted
at Average Remaining Exercisable Average
Range of September Exercise Contractual at September Exercise
Exercise Prices 30, 2005 Price Life 30, 2005 Price
- --------------- ----------- -------- ----------- ------------ --------
$.27 to $1.50 1,935,000 $ .42 7.45 865,000 $ 0.75
1.51 to 2.25 43,500 1.77 2.39 40,500 1.79
2.26 to 3.40 90,000 2.42 5.61 75,000 2.42
3.41 to 5.00 147,000 3.79 5.28 177,000 3.82
7.66 to 11.50 50,000 8.70 5.28 47,000 8.71
11.51 to 15.88 55,000 12.69 4.51 55,000 12.69
----------- ------------
2,320,500 1.20 1,259,500 2.49
=========== ============
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 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-29
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:
2005 2004
--------------------- --------------------
Weighted Weighted
Common Average Common Average
Stock Exercise Stock Exercise
Options Price Options Price
---------- -------- --------- --------
Outstanding at
beginning of year 5,618,014 $ 3.24 5,890,556 $ 3.45
Granted 2,200,000 .10 --
Cancelled (2,067,699) 2.42 (272,542) 7.67
---------- ---------
Outstanding at
end of year 5,750,315 $ 1.73 5,618,014 $ 3.24
========== =========
Options exercisable 4,586,513 5,616,014
========== =========
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, 2005, the Company was
obligated to but had been unable to register approximately 21,703,000 common
shares then outstanding. The Company intends to register the shares as soon as
possible.
WARRANTS ISSUED WITH CONVERTIBLE NOTES PAYABLE
As of September 30, 2005, the Company had issued 5,200,000 warrants for the
purchase of shares of its common stock in connection with raising $5,200 through
convertible notes payable (see Note 11). The warrants are exercisable until five
years from the date of issuance at a purchase price of $0.09 to $0.11 per share.
All of these warrants were outstanding as of September 30, 2005.
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 of the Company.
SHARES ISSUED SUBSEQUENT TO SEPTEMBER 30, 2005
During the period from October 1, 2005 to December 31, 2005, the Company issued
911,275 shares issued upon conversion of 10% convertible notes, and issued
3,500,000 shares for various consulting and professional services rendered.
F-30
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. 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. In fiscal 2001, the Company amended
its plan to require 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 Company stock, at the Company's option.
The Company accrued contributions for the years ended September 30, 2005 and
2004 of $113 and $59, respectively. For the year ended September 30, 2005, the
Company recorded a charge of approximately $113 in penalties and interest in
connection with deficient filings of the Company's Form 5500 annual reports.
13. INCOME TAXES
The components of the income tax provision included in the accompanying
consolidated statements of operations for the years ended September 30, 2005 and
2004 consist of the following:
2005 2004
----- -----
Current:
Federal $ -- $ --
Foreign -- --
State (457) --
----- -----
Total Current (457) --
----- -----
Deferred:
Federal -- --
Foreign -- --
State -- --
----- -----
Total Deferred -- --
----- -----
Total income tax provision $(457) $ --
===== =====
The net deferred tax assets in the accompanying consolidated balance sheets as
of September 30, 2005 and 2004 consist of temporary differences related to the
following:
F-31
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30,
--------------------
2005 2004
-------- --------
Deferred tax assets:
Allowance for doubtful accounts $ 3 $ 196
Inventory 179 179
Net operating loss carryforwards 20,722 22,650
Capital loss carryforwards 1,850 1,850
Accrued expenses 951 1,059
-------- --------
Total deferred tax assets 23,705 25,934
-------- --------
Deferred tax liabilities:
Depreciation (15) (19)
-------- --------
Total deferred tax liabilities (15) (19)
-------- --------
Valuation allowance (23,690) (25,915)
-------- --------
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, 2005 and 2004 the valuation allowance for net
deferred tax assets decreased by $2,225 and increased by $1,008, 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, 2005, the net operating loss carryforwards available to offset
future taxable income consist of approximately $54,960 in Federal net operating
losses, which will expire in various amounts through 2024, and state net
operating losses of approximately $33,927 which will expire in various amounts
through 2011. 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
none of which relate to periods prior to the acquisition of certain subsidiaries
by Cape. No pre-acquisition net operating losses were utilized during fiscal
2005 and 2004. 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, 2005 of $4,300
has no expiration date, but utilization is limited to the extent of capital
gains generated by the Company.
F-32
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. On December 17, 2004, the Company received
approximately $457 from the sale of the $518 of tax benefits which were
recognized as a tax benefit in 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 will be recognized as a tax benefit in the first quarter of fiscal 2006.
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.
A reconciliation of income tax at the statutory rate to the Company's effective
rate is as follows:
2005 2004
----- -----
Statutory rate 34.0% 34.0%
Effect of:
Valuation allowances (34.0) (34.0)
Permanent differences --
State income taxes, net (8.0) --
----- ----
Effective income tax rate (8.0) 0%
===== ====
There are no undistributed earnings of the Company's foreign subsidiaries at
September 30, 2005 and 2004. 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.
13. 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, 2005 and 2004 was approximately
$340 and $200, respectively.
During the year ended September 30, 2002, the Company sold and closed down
various businesses. In connection with these dispositions of non-core
businesses, the Company abandoned certain facilities and terminated leases at a
cost of approximately $1,100. As a result of these sales and the accrual of the
remaining terminated lease obligations, the minimum lease payments (including
common area maintenance charges) under non-cancellable operating leases as of
September 30, 2005, that have initial or remaining terms in excess of one year
are as follows:
F-33
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2006 264
2007 239
2008 88
---
$591
====
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 and expense $4,100 a month and receive an offset $3,100 per month
from the subleasee against rent expense.
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. 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 our business, financial condition or operating results.
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. Those are the following.
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 demanded $394 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. As of the date
of this filing, 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 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. The Company
guaranteed the notes. The noteholders demanded $1,227, 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 including interest, late
charges and attorneys' fees. As of the date of this filing, the judgment has not
been paid.
c) 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 each were entered against the Company on July
19, 2002. 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. As of the date of this filing, the
judgments have not been paid.
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. The action alleged
non-payment by the Company for computer hardware. As of the date of this filing,
the judgment has not been paid.
F-34
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
e) In connection with the liquidation of our European operations, specifically
VSM Italia s.r.l. ("VSM"), our wholly owned subsidiary, on July 25, 2005 an
action was commenced against us, the Board of Directors of VSM, its audit
committee, and its auditors, in the Civil Court of Milan, Italy, captioned
Bankrupt V.S.M. Italia s.r.l. in liquidation- n. 559/02. The complaint alleges
that at the end of calendar year 2000 and beginning of 2001, VSM lacked
liquidity", had incurred large liabilities, and was undercapitalized. As a
result, the complaint alleges, among other things, that liquidation proceedings
should have started at the end of year 2000, and continuing to run the business
until June 30, 2002 damaged VSM in the amount of Euro 2,600 which is accounted
for in the liabilities associated with subsidiaries in liquidation. We have only
recently received the complaint and have requested additional information with
respect to its contents so that we may respond accordingly.
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 is paid.
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. In July 2003, these claims were heard by the California
Department of Labor, which awarded the amounts claimed, together with interest
and penalties aggregating approximately $100,000. This payroll obligation is
included in the New Jersey Department of Labor Consent Order and Agreement.
We believe, although there can be no assurances, that the payroll obligations
including penalties as of September 30, 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 options 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.
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.
14. 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 year ended September 30, 2005, the Company incurred cost of $171 for
these services of which $50 is due and payable as of September 30, 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 $120 for these services.
F-35
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. 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 year ended September 30, 2005:
2005
------
Revenues
North America $3,351
United Kingdom 428
------
$3,779
======
Identifiable assets
North America $ 30
United Kingdom 15
------
$ 45
======
RESTATEMENT OF QUARTERLY DATA (UNAUDITED)
In connection with the preparation of the Annual Report on Form 10-KSB of the
Company for the year ended September 30, 2005, the Company's current independent
registered public accounting firm brought to the attention of the Company that
the beneficial conversion charge previously recorded in the Company's financial
statements for the quarter ended March 31, 2005 was not appropriate. The Company
has identified certain non-cash adjustments that necessitated the restatement of
its financial statements for the quarter ended March 31, 2005 and determined
that adjustments to all other periods are insignificant.
The following table shows the effect of the restatement on the Company's
quarterly results of operations for the quarter ended March 31, 2005. In the
table that follows, the column labeled "Restatement Adjustment" represents
adjustments for additional interest expense.
F-36
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CAPE SYSTEMS, INC. AND SUBSIDIARIES
RESTATED STATEMENT OF OPERATIONS
FOR THE QUARTER ENDED MARCH 31, 2005
Three Months Ended
As Previously March 31, 2005
Reported Restatement Adjustment As Restated
---------------------- ---------------------- ----------------------
REVENUES $ 1,349 $ 1,349
COST OF SALES 647 647
---------------------- ---------------------- ----------------------
GROSS PROFIT 702 702
---------------------- ---------------------- ----------------------
OPERATING EXPENSES:
Selling and administrative 1,266 1,266
Depreciation and
amortization of intangibles 119 119
---------------------- ---------------------- ----------------------
Total operating expenses 1,385 1,385
---------------------- ---------------------- ----------------------
OPERATING LOSS (683) (683)
---------------------- ---------------------- ----------------------
OTHER INCOME (EXPENSE):
Interest expense (1,655) $ (1,761) (3,416)
Gain on settlements of
liabilities 137 137
---------------------- ---------------------- ----------------------
Net other expense (1,518) (1,761) (3,279)
---------------------- ---------------------- ----------------------
NET LOSS $ (2,201) $ (1,761) $ (3,962)
====================== ====================== ======================
Net loss per share of common stock:
Basic and Diluted $ (.03) $ (.02) $ (.05)
Weighted average number of shares outstanding:
Basic and Diluted 75,786,575 75,786,575 75,786,575
F-37
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.
F-38
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.
F-39
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.
F-40
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.
F-41
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.
F-42
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
F-43
See notes to unaudited condensed consolidated financial statements.
F-44
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.
F-45
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.
F-46
CAPE SYSTEMS GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 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.
F-47
CAPE SYSTEMS GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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.
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.
F-48
CAPE SYSTEMS GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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:
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.
F-49
CAPE SYSTEMS GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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.
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.
F-50
CAPE SYSTEMS GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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.
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.
F-51
CAPE SYSTEMS GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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.
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.
F-52
CAPE SYSTEMS GROUP INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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.
F-53
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
====
F-54
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
PROFIT AND LOSS ACCOUNT 01.01.03 - 31.12.03
Note 2003
----------- -----------
(pound)
-----------
Turnover (see footnote) 450370
Cost of sales 281261
-----------
Gross Profit 169109
Net Operating Expenses 142916
-----------
26193
Interest Payable and Similar Payments 3651
-----------
Profit on Ordinary Activities 1 22542
Taxation 3 1811
-----------
Profit after taxation 20731
Dividends 0
-----------
Retained Profit for the year 9 20731
-----------
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-55
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
BALANCE SHEET 31.12.03
Note 2003
----------- -----------
(pound)
-----------
Fixed Assets
Tangible Fixed Assets 4 18750
Investment in Subsidiaries and Associates at cost 5 40500
-----------
59250
-----------
Current Assets
Stocks 3300
Debtors 6 110314
Bank Balances and Cash 51144
-----------
164758
Creditors due within one year 7 65027
-----------
Net Current Assets 99731
-----------
Total Assets less Current Liabilities 158981
-----------
Net assets 158981
===========
Capital and Reserves
Called up Share Capital 8 25500
Reserves 9 133481
-----------
158981
===========
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-56
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
EXPLANATORY NOTES TO THE ACCOUNTS - 01.01.03 - 31.12.03
2003
----
(pound)
-------
NOTE 1: Profit/(loss) on ordinary activities before tax stated after charging:-
Depreciation and loss on disposal 10249
Auditor's Remuneration 1532
Operating Leases - Equipment 2184
-----
NOTE 2: Directors' Emoluments Nil
-----
Consultants fees include payments to a
business in which the directors have
an interest 93250
-----
NOTE 3: Taxation
Based on chargeable profits at small company rate 1811
Tax repayment -
-----
1811
-----
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-57
CAPE SYSTEMS AND CONSULTING SERVICES LIMITED
EXPLANATORY NOTES TO THE ACCOUNTS - 01.01.03 - 31.12.03
2003
----
(pound)
-------
NOTE 5: INVESTMENT IN SUBSIDIARIES AND ASSOCIATES AT COST
Cape Systems Limited 100
Cape Systems Incorp. (Formerly Techelm) 40400
-----------
40500
-----------
NOTE 6: Debtors
Trade Debtors 90245
Other debtors and prepayments 20069
-----------
110314
-----------
NOTE 7: Creditors - due within one year
Trade Creditors 15684
Other creditors and accruals 18048
Bank Loan 6013
Corporation Tax 1811
Lease Creditor 4917
Service and upgrade in advance 18554
-----------
65027
-----------
NOTE 8: Called up Share Capital
Authorised 50000 ordinary (pound)1 shares
Called up and fully paid (pound)1 shares 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-58
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
-----------
(pound)
-----------
Turnover 450370
-----------
Cost of Sales
Consulting and System Design 195640
Salaries 82678
Computer Consumables 2943
-----------
281261
-----------
Gross Profit 169109
-----------
Operating Costs
Freight and Packaging 24882
Office Rent and Services 27498
Euro and International Travel 20232
Marketing and Promotions 22982
Office Costs 11758
Equipment Hire/Lease 2185
Equipment Maintenance and General 6471
Accounts and Legal 16659
-----------
132667
-----------
Operating Profit 36442
-----------
Other Income (412)
Bank Interest and Charges 3732
Other Interest 1261
(Profit) / Loss on Exchange (1555)
Bad Debts 625
-----------
3651
-----------
Depreciation and Loss on Disposal
of Fixed Assets 10249
-----------
Profit for the Year before Taxation 22542
-----------
F-59
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
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-60
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-61
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.
F-62
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-63
F-64
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Cape Systems, Inc.
We have audited the accompanying balance sheet of Cape Systems, Inc. (A
Subsidiary of Cape Systems and Consulting Services Ltd) as of December 31, 2003,
and the related statements of operations and retained earnings and cash flows
for the year 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 audit.
We conducted our audit 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 audit 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 its results of operations and cash flows for the year
then ended, in conformity with United States generally accepted accounting
principles.
/s/ J.H. COHN LLP
-----------------
Roseland, New Jersey
March 24, 2005
F-65
CAPE SYSTEMS, INC.
(A Subsidiary of Cape Systems and Consulting Services Ltd.)
Cape Systems, Inc.
Balance Sheet
December 31, 2003
ASSETS
CURRENT ASSETS
Cash $ 153,000
Accounts receivables net of allowance for
doubtful accounts of $2,554 83,083
Prepaid expenses and other current assets 18,619
Deferred tax assets 67,800
---------
Total current assets 322,502
Equipment, furniture and fixtures, net of accumulated
depreciation of $42,330 12,054
Other assets 3,704
---------
Total assets $ 338,260
=========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Current portion of long-term debt $ 6,613
Accounts payable 24,960
Accrued expenses and other liabilities 17,399
Deferred revenue 166,890
---------
Total current liabilities 215,862
Long-term debt, net of current portion 9,493
Deferred tax liabilities 4,200
---------
Total liabilities 229,555
---------
Commitments
- -----------
STOCKHOLDERS' EQUITY
Common stock par value $1 per share;
100,000 shares authorized, 28,690 issued and outstanding 28,690
Additional paid-in capital 106,911
Retained earnings 34,103
Less: Treasury stock, 11,813 shares of common stock, at cost (60,999)
---------
Total stockholders' equity 108,705
---------
Total liabilities and stockholders' equity $ 338,260
=========
See notes to the financial statements
F-66
CAPE SYSTEMS, INC.
(A Subsidiary of Cape Systems and Consulting Services Ltd.)
Cape Systems, Inc.
Statement of Operations and Retained Earnings
For the Year Ended December 31, 2003
REVENUE $ 769,172
COST OF SALES 134,233
---------
GROSS PROFIT 634,939
OPERATING EXPENSES
Selling, general and administrative 561,802
Depreciation 8,236
Research and development 24,132
---------
Total operating expenses 594,170
---------
Operating income 40,769
OTHER EXPENSE
Interest expense (2,565)
Other (3,937)
---------
Other expense (6,502)
---------
INCOME BEFORE
PROVISION FOR INCOME TAXES 34,267
Provision for income taxes 2,413
---------
NET INCOME 31,854
Retained earnings beginning of year 2,249
---------
Retained earnings end of year $ 34,103
=========
See notes to financial statements
F-67
CAPE SYSTEMS, INC.
(A Subsidiary of Cape Systems and Consulting Services Ltd.)
Cape Systems, Inc.
Statement of Cash Flows
For the Year Ended December 31, 2003
Cash Flows from Operating Activities
Net Income $ 31,854
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 8,236
Bad debts 2,554
Change in operating assets and liabilities
Accounts receivable 71,594
Deferred taxes (1,800)
Prepaid expense and other current assets 15,585
Accounts payable (9,100)
Accrued expenses and other liabilities 11,977
---------
Net cash provided by operating activities 130,900
---------
Cash flows from investing activities -
additions to equipment, furniture and fixtures (1,996)
---------
Cash flows from financing activities
Proceeds from notes payable --
Repayment of notes payable (10,734)
---------
Net cash used in financing activities (10,734)
Net increase in cash 118,170
Cash at beginning of year 34,830
---------
Cash at end of year $ 153,000
=========
Supplemental Disclosures of Cash Flow Information
Cash paid for:
Income taxes $ 4,314
Interest $ 2,565
See notes to financial statements
F-68
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-69
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. 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 in
2003.
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
------------
Equipment, furniture and fixtures 3 - 10 years $42,777
Computer equipment 3 - 5 years 7,677
---------
50,454
Less: accumulated depreciation 38,400
---------
Total $12,054
=========
F-70
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:
Unsecured note payable in monthly installments of $306,
including interest at 7.5% through May 2009 $12,034
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
-------
16,106
Less current portion 6,613
-------
Long-term portion $ 9,493
-------
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-71
CAPE SYSTEMS, INC.
(A Subsidiary of Cape Systems and Consulting Services Ltd.)
NOTES TO THE FINANCIAL STATEMENTS
NOTE 5: INCOME TAXES
Provision for income taxes consist of the following:
Current:
Federal $ 4,213
-------
Total Current $ 4,213
-------
Deferred:
Federal $(1,800)
-------
Total Deferred $(1,800)
-------
Total $ 2,413
=======
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, the deferred tax asset relates to the allowance for
doubtful accounts and deferred revenue. At December 31, 2003, 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 was approximately $44,000.
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 for such services performed.
In addition, the Company paid approximately $24,000 during 2003 to a corporation
owned by an Officer of the Company for various consulting services.
F-72
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-73
F-74
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.
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.
II-2
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;
o $100,000 was disbursed on September 19, 2005;
o $100,000 was disbursed on October 19, 2005;
o $100,000 was disbursed on November 16, 2005; and
o $300,000 was disbursed on March 31, 2006.
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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.
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.
In March 2006, we issued 340,875 shares of common stock to our Chief
Executive Officer, Nicholas Toms, for past compensation owed of $10,226. This
issuance is considered exempt under Section 4(2) of the Securities Act of 1933.
* 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.
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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 eference 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).
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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).
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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).
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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).
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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).
4.58 Waiver, dated as of March 17, 2006, by and among Cape Systems
Group, Inc., AJW Offshore, Ltd., AJW Qualified Partners, LLC,
AJW Partners, LLC and New Millennium Capital Partners II, LLC
(filed herewith).
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).
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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).
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 a 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.
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(3) File a post-effective amendment to remove from registration any of the
securities that remain unsold at the end of the offering.
(4) For determining liability of the undersigned small business issuer
under the Securities Act to any purchaser in the initial distribution of the
securities, the undersigned undertakes that in a primary offering of securities
of the undersigned small business issuer pursuant to this registration
statement, regardless of the underwriting method used to sell the securities to
the purchaser, if the securities are offered or sold to such purchaser by means
of any of the following communications, the undersigned small business issuer
will be a seller to the purchaser and will be considered to offer or sell such
securities to such purchaser:
(i) Any preliminary prospectus or prospectus of the undersigned
small business issuer relating to the offering required to be filed pursuant to
Rule 424;
(ii) Any free writing prospectus relating to the offering prepared
by or on behalf of the undersigned small business issuer or used or referred to
by the undersigned small business issuer;
(iii) The portion of any other free writing prospectus relating to
the offering containing material information about the undersigned small
business issuer or its securities provided by or on behalf of the undersigned
small business issuer; and
(iv) Any other communication that is an offer in the offering made
by the undersigned small business issuer to the purchaser.
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 April 21, 2006.
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
Pursuant to the requirements of the Securities Act of 1933, as amended, this
registration statement has been signed below by the following persons in the
capacities and on the dates indicated below.
Signature Title Date
- -----------------------------------------------------------------------------
* Chief Executive Officer April 21, 2006
- ---------------------- (Principal Executive Officer),
Nicholas R. Toms Chief Financial Officer
(Principal Financial Officer),
Principal Accounting
Officer and Director
* Executive Chairman of the April 21, 2006
- ---------------------- Board of Directors
Hugo Biermann
* Director April 21, 2006
- ----------------------
Otto Leistner
* By: /s/ NICHOLAS R. TOMS
---------------------
Nicholas R. Toms
Attorney-in-fact
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