UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the Quarterly Period Ended March 31, 2006
[ ]TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the Transition Period from _________ to _________
Commission file number: 000-15066
CAPE SYSTEMS GROUP, INC.
(Exact name of registrant as specified on its charter)
New Jersey 22-2050350
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
3619 Kennedy Road
South Plainfield, New Jersey 07080
(Address of principle executive offices)
(908) 756-2000
(Registrant's telephone number, including area code)
Indicate by check mark whether the issuer (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [x] No [_]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes [_] No [x]
Common stock, par value $.005 per share: 105,382,168 shares outstanding as of
May 9, 2006.
Preferred stock, Series "A", par value $.01 per share: 1,356,852 shares
outstanding as of May 9, 2006.
Preferred stock, Series "B", par value $.01 per share: 1,000 shares outstanding
as of May 9, 2006.
Preferred stock, Series "C-1", par value $.01 per share: 997 shares outstanding
as of May 9, 2006.
Preferred stock, Series "D", par value $.01 per share: 7,615 shares outstanding
as of May 9, 2006.
INDEX
PART I FINANCIAL INFORMATION
ITEM 1 Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheet as of March 31, 2006 (Unaudited) and
September 30, 2005 3-4
Condensed Consolidated Statements of Operations for the three and six
months Ended March 31, 2006 and 2005 (Unaudited) 5
Condensed Consolidated Statement of Changes in Stockholders' Deficiency
for the six months ended March 31, 2006 (Unaudited) 6-7
Condensed Consolidated Statements of Cash Flows for the six months ended
March 31, 2006 and 2005 (Unaudited) 8
Notes to Condensed Consolidated Financial Statements (Unaudited) 9-16
ITEM 2 Management's Discussion and Analysis of Financial Condition and Results of
Operations 17-22
ITEM 3 Controls and Procedures 23-24
PART II OTHER INFORMATION
ITEM 1 Legal proceedings 25
ITEM 2 Unregistered sales of equity securities and use of proceeds 25
ITEM 3 Defaults upon senior securities 25
ITEM 4 Submission of matters to a vote of security holders 26
ITEM 5 Other information 26
ITEM 6 Exhibits 26
SIGNATURES 27
2
PART 1 - FINANCIAL INFORMATION
ITEM 1 - CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, 2006 (unaudited) and September 30, 2005
(in thousands except share and per share data)
ASSETS
March 31, September 30,
2006 2005
(Unaudited) (see Note 1)
CURRENT ASSETS:
Cash $ 411 $ 239
Accounts receivable, less
allowance for doubtful accounts of $14 and $9 507 572
Inventories, net of valuation allowance 214 185
Prepaid expenses and other current assets 366 480
---------- ----------
Total current assets 1,498 1,476
Equipment and improvements, net of
accumulated depreciation and
amortization of $675 and $670 41 45
Deferred financing costs,
net of accumulated amortization of
$315 and $175 131 180
Goodwill 342 342
Other intangible assets, net of accumulated
amortization of $629 and $369 915 1,175
Other assets 212 194
---------- ----------
Total assets $ 3,139 $ 3,412
========== ==========
See notes to unaudited condensed consolidated financial statements.
3
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, 2006 (unaudited) and September 30, 2005
(in thousands except share and per share data)
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
CURRENT LIABILITIES:
Notes payable - unrelated parties $ 1,227 $ 1,227
Mandatory redeemable Series D preferred stock -
504 shares at redemption value 505 505
Accounts payable 3,502 4,315
Net liabilities associated with subsidiaries
in liquidation 7,344 7,296
Payroll and related benefits accrual 1,466 1,576
Litigation related accruals 2,655 3,655
Other accrued expenses and liabilities 4,096 3,834
Deferred revenue 550 549
Long-term convertible notes payable
- unrelated parties 5,238 4,765
--------- ---------
Total current liabilities 26,583 27,722
--------- ---------
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;
105,382,168 and 92,273,778 shares issued 527 461
Additional paid-in capital 171,199 170,222
Subscription receivable (66) (66)
Accumulated deficit (193,427) (193,312)
Accumulated other comprehensive loss (1,624) (1,562)
Less: Treasury stock, 87,712 shares of
common stock (at cost) (67) (67)
--------- ---------
Total stockholders' deficiency (23,444) (24,310)
--------- ---------
Total liabilities and stockholders' deficiency $ 3,139 $ 3,412
========= =========
See notes to unaudited condensed consolidated financial statements.
4
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands except share and per share data)
For the Three Months For the Six Months
Ended March 31, Ended March 31,
------------------------------------ ------------------------------------
2006 2005 2006 2005
--------------- --------------- --------------- ---------------
REVENUES $ 910 $ 1,349 $ 1,811 $ 2,014
COST OF SALES 277 647 704 896
--------------- --------------- --------------- ---------------
GROSS PROFIT 633 702 1,107 1,118
--------------- --------------- --------------- ---------------
OPERATING EXPENSES:
Selling and administrative 903 1,266 1,843 1,971
Depreciation and
amortization of intangibles 135 119 281 122
--------------- --------------- --------------- ---------------
Total operating expenses 1,038 1,385 2,124 2,093
--------------- --------------- --------------- ---------------
OPERATING LOSS (405) (683) (1,017) (975)
--------------- --------------- --------------- ---------------
OTHER INCOME (EXPENSE):
Interest expense (includes
beneficial conversion charge
of $300 and $3,189 and $500 and
$3,189) (525) (3,416) (1,020) (3,698)
Gain on settlements of
liabilities 1,185 132 1,517 167
Other 0 5 3 13
--------------- --------------- --------------- ---------------
Net other income/(expense) 660 (3,279) 500 (3,518)
--------------- --------------- --------------- ---------------
INCOME / (LOSS) BEFORE PROVISION
FOR INCOME TAXES 255 (3,962) (517) (4,493)
--------------- --------------- --------------- ---------------
Provision for state income taxes 0 0 0 3
Credit for sale of state tax
benefits 0 0 (402)
(457)
--------------- --------------- --------------- ---------------
Income tax credit 0 0 (402) (454)
--------------- --------------- --------------- ---------------
NET INCOME/(LOSS) $ 255 $ (3,962) $ (115) $ (4,039)
=============== =============== =============== ===============
Net Income/(loss) per share of common stock:
Basic and Diluted $ .00 ($ .05) ($ .00) ($ .06)
Weighted Average number of shares outstanding:
Basic 99,411,388 75,786,575 96,938,595 70,578,440
Diluted 1,485,724,887 75,786,575 96,938,595 70,578,440
See notes to unaudited condensed consolidated financial statements.
5
CAPE SYSTEMS GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' DEFICIENCY
FOR THE SIX MONTHS ENDED MARCH 31, 2006
(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
- unrelated parties into
common stock 1,921,275 10 18
Common stock issued for accrued
401(k) plan contribution and
other liabilities 8,337,115 42 348
Common stock issued in
exchange for services 2,850,000 14 73
Beneficial conversion feature
related to long-term convertible
notes 500
Stock options issued in exchange
for services 38
Net loss
Change in unrealized foreign
exchange translation gains/
(losses)(a) ------------ ------------ ---------- ------------ ------------
Balance March 31, 2006 1,365,960 $ 14 105,382,168 $ 527 $ 171,199
============ ============ ============ ============ ============
(a) Comprehensive gains/(losses) for the three and six months ended March 31,
2006 totaled $84 and $(177) and totaled $(1,858) and $(2,617) for the three and
six months ended March 31, 2005.
See notes to unaudited condensed consolidated financial statements.
6
CAPE SYSTEMS GROUP INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' DEFICIENCY
FOR THE SIX MONTHS ENDED MARCH 31, 2006
(unaudited)
(in thousands except share and per share data)
(CONTINUED)
Accumulated
Other
Accumulated Subscription Comprehensive Treasury
Deficit Receivable Loss Stock Total
---------------- ----- ---------------- ---------------- ----------------
Balance September 30, 2005 $ (193,312) $ (66) $ (1,562) $ (67) $ (24,310)
Conversion of notes payable -
unrelated parties into
common stock 28
Common stock issued for accrued
401(k) Plan contribution
and other liabilities 390
Common stock issued in exchange
for services 87
Beneficial conversion feature
related to long-term
convertible notes 500
Stock options issued in exchange
for services 38
Net loss (115) (115)
Change in unrealized foreign
exchange translation gains/
(losses)(a) (62) (62)
---------------- ---- ---------------- ---------------- ----------------
Balance March 31, 2006 $ (193,427) $(66) $ (1,624) $ (67) $ (23,444)
================ ==== ================ ================= =================
(a) Comprehensive gains/(losses) for the three and six months ended March 31,
2006 totaled $84 and $(177) and totaled $(1,858) and $(2,617) for the three and
six months ended March 31, 2005.
See notes to unaudited condensed consolidated financial statements.
7
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands except share and per share data)
(unaudited)
For the Six Months Ended
March 31,
--------------------------
2006 2005
----------- -----------
Cash Flows from Operating Activities:
-------------------------------------
Net loss $ (115) $(4,039)
Adjustments to reconcile net loss to
net cash provided by (used in) operating
activities:
Depreciation and amortization 268 122
Common stock issued in exchange for services 87 498
Amortization of deferred financing costs and
debt discount 85 253
Charges to interest expense for beneficial
conversion features of notes payable -
unrelated parties 500 3,189
Gain on settlement of liabilities (1,517) --
Variable stock option charge 20 --
Changes in operating assets and liabilities:
net of effects of acquisitions
Accounts receivable, net 66 (198)
Inventory (29) 128
Prepaid expenses and other current assets 94 48
Intangibles and other assets 33 427
Accounts payable (813) 216
Accrued expenses and other liabilities 1,095 (268)
Customer deposits (12) --
Deferred revenue 1 (116)
------- -------
Net cash provided by (used in)
operating activities (237) 260
------- -------
Cash Flows from Investing Activities:
-------------------------------------
Additions of equipment and improvements (6) --
Acquisition of businesses - net of cash acquired -- (1,990)
------- -------
Net cash used in investing activities (6) (1,990)
------- -------
Cash Flows from Financing Activities:
-------------------------------------
Proceeds from notes and convertible notes payable-
unrelated parties 500 1,850
Deferred financing costs (85) --
------- -------
Net cash provided by financing activities 415 1,850
------- -------
Net increase in cash 172 120
Cash at beginning of period 239 101
------- -------
Cash at end of period $ 411 $ 221
======= =======
Non-cash investing and financing activities:
Long-term convertible notes payable -
unrelated parties converted into common stock $ 28
Common stock issued for payment of liabilities $ 390
See notes to unaudited condensed consolidated financial statements.
8
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. NATURE OF BUSINESS AND BASIS OF PRESENTATION (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; software integration solutions that enable
our customers to manage their order, inventory and warehouse management needs;
consultative services; packaging and logistics management software; and,
software and hardware service and maintenance. We serve our enterprise clients
through two general product and service lines: (1) enterprise solutions and, (2)
training, support 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; a portfolio of
"light-directed" systems for inventory, warehouse and distribution center
management; and, packaged software for palletizing and packaging configuration
and truck/container loading. 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 ($25,085) and
stockholders' deficiency ($23,444) at March 31, 2006, our recurring losses, our
historic rate of cash consumption, the uncertainty arising from our default on
our notes payable and the uncertainty of our liquidity-related initiatives
described in detail later, there is substantial doubt as to our ability to
continue as a going concern.
While we are continuing our efforts to increase revenues and 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)
increased sales and marketing efforts, (iii) the further development of our
technologies, (iv) 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, (v) possible
selective acquisitions to achieve the scale we believe will be necessary to
enable us to remain competitive in the global SCM industry. There can be no
assurance that we will be successful in raising the necessary funds.
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.
9
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 and six months ended March 31, 2006 are not necessarily
indicative of the results that may be expected for the fiscal year ending
September 30, 2006.
The balance sheet at September 30, 2005 has been derived from the audited
financial statements at that date but does not include all of the information
and notes required by accounting principles generally accepted in the United
States for complete financial statements.
The condensed consolidated financial statements should be read in conjunction
with 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 share is calculated by dividing net income
or loss (there are no dividend requirements on the Company's outstanding
preferred stock) by the weighted average number of common shares outstanding
during each period.
The calculation of diluted earnings per share is similar to that of basic
earnings per share, except that the denominator is increased to include the
number of additional common shares that would have been outstanding if all
potentially dilutive common shares, such as those issuable upon the exercise of
stock options and warrants and the conversion of convertible securities, were
issued during the period and appropriate adjustments were made for the
application of the treasury stock method and the elimination of interest and
other charges related to convertible securities.
As of March 31, 2006, there were 1,430,957,165 shares of common stock
potentially issuable upon the exercise of stock options (8,251,221 shares),
warrants (5,700,000 shares) and the conversion of convertible securities
(1,417,005,944 shares). However, diluted per share amounts have not been
presented in the accompanying condensed consolidated statements of operations
for the three months ended March 31, 2005 and six months ended March 31 2006 and
2005 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.
The following shares of common stock issuable upon the exercise of stock
options, warrants and convertible securities were excluded from the computation
of diluted income(loss) per common share because they were anti-dilutive for
those periods:
Three months ended March 31 Nine months ended March 31
2006 2005 2006 2005
---- ---- ---- ----
Anti-dilutive convertible
securities warrants and options 8,251,221 381,198,461 1,430,957,165 381,189,461
10
Pro Forma and Other Disclosures Related to Stock Options
As of March 31, 2006, the Company had granted options to purchase a total of
8,251,221 shares of common stock. 1,000,000 options were granted and no options
were cancelled during the three and six months ended March 31, 2006.
Approximately 183,000 and 819,000 options were expired during the three and six
months ended March 31, 2006. 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 income/(loss) applicable to common stock and net income/(loss) per common
share would have been increased to the pro forma amounts indicated in the
following table:
Three Months Ended March 31, Six Months Ended March 31,
---------------------------- -------------------------
2006 2005 2006 2005
------- ------- ------- -------
Net income/(loss)-as reported $ 255 $(3,962) $ (115) $(4,039)
Deduct total stock -
based employee compensation
expense determined under a
fair value-based method for
all awards (111) (214) (245) (454)
------- ------- ------- -------
Net income/(loss) - pro-forma $ 144 $(4,176) $ (360) $(4,493)
======= ======= ======= =======
Basic and diluted income/
(loss) per common share
- as reported $ (.00) $ (.05) $ (.00) $ (.06)
Basic and diluted income/
(loss) per common share
- pro-forma $ (.00) $ (.06) $ (.00) $ (.06)
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 2006 and 2005:
2006 2005
---- ----
Expected dividend yield 0.00% 0.00%
Expected stock price
volatility 144% 157%
Risk-free interest rate 4.5% 3.5%
Expected life of options 5 years 5 years
Fair value per share of
options granted $0.03 $0.08
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.
11
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. Accordingly, the
remaining estimated liabilities of these businesses are classified as estimated
remaining liabilities associated with subsidiaries in liquidation in the
accompanying March 31, 2006 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 March 31, 2006 and September 30, 2005
were $7,344 and $7,296, respectively.
Except for the changes in the unrealized foreign translation loss, there were no
results of operations of these businesses for the three and six months ended
March 31, 2006 and 2005.
4. BUSINESS COMBINATION
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 Cape Systems and Consulting Solutions Ltd. and its subsidiary, Cape
Systems Inc., 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:
Six Months Ended
March 31, 2005
-----------------
Revenues $ 2,361
Net loss (3,980)
Net loss per share ($.06)
The unaudited pro forma results of operations are not necessarily indicative of
what the actual results of operations of the Company would have been had the
acquisitions occurred at the beginning of fiscal 2005, nor do they purport to be
indicative of the future results of operations of the Company.
5. NOTES PAYABLE
Notes payable consist of past due notes payable to Renaissance Software, Inc.
("Renaissance") in the amount of $1,227 as of March 31, 2006. The Company issued
approximately $1,500 in promissory notes payable, bearing interest at 8%, in
connection with the purchase of Renaissance in fiscal 2000 that 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 May 10, 2006.
12
6. CONVERTIBLE NOTES PAYABLE
Convertible notes payable of $5,238 at March 31, 2006 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) $850 in convertible notes (the "2005 Working Capital Facility") and warrants
to purchase 850,000 shares of common stock.
2004 Convertible Notes
The 2004 Convertible Notes bear interest at 10% and mature two years from the
date of issuance. At the investors' option, 50% of the 2004 Convertible Notes
will be convertible into our common stock at the lower of $0.30 or 60% of the
average of the three lowest intraday trading prices for the common stock on a
principal market for the 20 trading days before but not including the conversion
date and the other 50% of the 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. On March 30, 2006, the Company issued
1,010,000 common shares upon the conversion of 10% Convertible Notes with an
approximate principal balance of $12 at a conversion price of $0.0117 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.
13
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
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
$300 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 $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
$300 and $500 in the three and six months ended March 31, 2006.
We are currently in default pursuant to secured convertible notes issued
pursuant to the securities purchase agreements dated August 10, 2005, January
11, 2005 and April 28, 2004 (the "SPAs"). Pursuant to the SPAs, 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 Form 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 SPAs, however,
the Form SB-2 registration statement is currently being reviewed and has not
been declared effective. Default has been waived through March 31, 2006.
7. STOCKHOLDERS' DEFICIENCY
Shares Issued for Services and Accrued Liabilities
During the six months ended March 31, 2006, the Company issued 2,850,000 shares
of common stock for various consulting and professional services rendered and
recorded approximately $87 based on the fair value of the shares issued, and
8,337,115 shares of common stock in satisfaction of other liabilities of $390.
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. 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 carry forwards that were saleable, of which
New Jersey permitted the Company to sell approximately $6,297. On December 17,
2004, the Company received $457 from the sale of these benefits which was
recognized in the first quarter of fiscal 2005. On December 19, 2005, the
Company received $402 from the sale of these benefits which was recognized in
the six months ended March 31, 2006.
14
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 and accrued 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.
On or about January 30, 2006, we settled for $10 in common stock (200,000
shares) an action previously disclosed and accrued by us which was commenced by
Sonata Software vs. Vertex Interactive, Inc. et. al. The action had demanded
$242 to be due Sonata Software, a previously used vendor.
On or about March 31, 2006, we settled for $25 an action previously disclosed
and accrued by us which was commenced by Roger Henley (CSI) vs. Vertex
Interactive, Inc. et. al. The action had demanded $1,000 to be due.
The above-settled actions resulted in a gain of $1,185 and $1,517 during the
three and six month periods ended March 31, 2006.
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. We have made no subsequent payments; however it is our intent
to 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 March 31, 2006 will be satisfied by the calendar year
ending December 31, 2006.
Other Obligations
On or about January 24, 2006 we received a collection notice for $119 comprised
of penalties and interest imposed by the U.S Department of Labor in connection
with deficiencies in our Savings and Retirement Plan annual report for the plan
year ended December 31, 2002. Due to capital constraints, we are not in a
position to make any payments at this time.
15
Employment Agreements
In connection with the Cape 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.
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
serves 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 and six months ended March 31, 2006, the Company incurred costs
of $24 and $49 for these services of which $0 was due and payable as of March
31, 2006. In addition, in connection with the Cape acquisition, we entered into
a consulting agreement with IMC Development Group ("IMC"), which is owned by
Peter Ayling, for which we paid $23 and $47 for the three and six months ended
March 31, 2006 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 six months ended March 31, 2006:
2006
----
Revenues
North America $1,432
United Kingdom 379
----
$1,811
====
Identifiable assets
North America $26
United Kingdom 15
----
$41
====
16
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Quarterly Report on Form 10-QSB contains, in addition to historical
information, certain forward-looking statements that involve significant risks
and uncertainties. Such forward-looking statements are based on management's
belief, as well as assumptions made by and information currently available to,
management pursuant to the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995. Our actual results could differ materially from
those expressed in or implied by the forward-looking statements contained
herein. Factors that could cause or contribute to such differences include, but
are not limited to, those discussed herein and in Item 1: "Business", included
in our Annual Report on Form 10-KSB for the year ended September 30, 2005. Cape
undertakes no obligation to release publicly the result of any revisions to
these forward-looking statements that may be made to reflect events or
circumstances after the date of this Quarterly Report or to reflect the
occurrence of other unanticipated events.
This discussion and analysis should be read in conjunction with the unaudited
condensed consolidated financial statements and related notes of the Company
contained elsewhere in this report. In this discussion, unless otherwise noted,
the years "2006" and "2005" refer to the three and six months ended March 31,
2006 and 2005, respectively.
Critical Accounting Policies and Estimates
The preparation of the unaudited condensed consolidated financial statements
requires management to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and the related
disclosure of contingent assets and liabilities. Management bases its estimates
and judgments on historical experience and on various other factors that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Management continuously
evaluates its estimates and judgments, and actual results may differ from these
estimates under different assumptions or conditions.
Those estimates and judgments that were most critical to the preparation of the
financial statements involved the allowance for doubtful accounts, inventory
reserves, recoverability of intangible assets and the estimation of the net
liabilities associated with subsidiaries in liquidation as further explained in
the Company's Form 10-KSB for the year ended September 30, 2005.
RECENT ACCOUNTING PRONOUNCEMENTS:
In December 2004, the Financial Accounting Standards Board (the "FASB") issued
SFAS No. 123(R) "Share-Based Payment" ("SFAS 123(R)"), which amends SFAS 123 and
will be effective for public companies that are small business issuers for
annual periods beginning after December 15, 2005. SFAS 123(R) will require us to
expense all employee stock options and other share-based payments over the
service period. The FASB believes the use of a binomial lattice model for option
valuation is capable of more fully reflecting certain characteristics of
employee share options compared to the Black-Scholes options pricing model. SFAS
123(R) may be adopted in one of three ways - the modified prospective transition
method, a variation of the modified prospective transition method or the
modified retrospective transition method. We are currently evaluating how we
will adopt SFAS 123(R) and evaluating the effect that the adoption will have on
our financial position and results of operations. Since we have used the
intrinsic value method for employee stock options and, generally, have not
recorded any related expense, the adoption of a fair value method for employee
stock options is likely to generate additional compensation expense.
17
Results of Operations
Three months ended March 31, 2006 ("2006") compared to the three months ended
March 31, 2005 ("2005"). Except for share-related items, all amounts are in
thousands unless otherwise noted.
Operating Revenues:
Operating revenues decreased by approximately $439 (or 32.5%) from approximately
$1,349 in 2005 to approximately $910 in 2006.
Revenues generated by the operations in London and Dallas, which were owned by
us commencing as of January 12, 2005, accounted for approximately $386 (or
42.4%) in 2006 vs. $345 (25.6%) in 2005.
Products and Services:
Sales to customers by the product and service line groupings for the three
months ended March 31, 2006 and 2005 are as follows:
March 31
----------------------
2006 2005
--------- --------
Enterprise Sales $ 506 $ 873
Support, Maintenance and Other 404 476
--------- --------
$ 910 $ 1,349
========= ========
Enterprise sales revenues decreased by $367 (42.0%) during the period
predominantly due to delayed customer WMS projects and lost sales due to
constrained marketing efforts and our financial condition.
Service, maintenance and other revenues decreased $72 from $476 in 2005 to $404
in 2006. The decrease was a result of a decrease of $124 in service and
maintenance support contracts in our WMS business which was partially offset by
increased support revenues generated by the Texas and UK packaged software
operations.
Gross Profit:
Gross profit decreased by approximately $69 (or 9.8%) from approximately $702 in
2005 to $633 in 2006. As a percent of operating revenues, gross profit was 69.6%
in 2006 as compared to 52.0% in 2005. The gross profit percentage of operating
revenues was favorably impacted by a greater relative percentage of higher
margin support revenues.
Operating Expenses:
Selling and administrative expenses decreased approximately $363 (or 28.7%) from
approximately $1,266 in 2005 to $903 in 2006 predominantly due to higher
professional fees incurred resulting from acquisitions, regulatory filings and
contractual obligations in 2005. During 2006, although we continue to maintain
various cost control initiatives, we anticipate these costs may rise from
current levels as we undertake greater sales and marketing activities to enhance
revenues.
While we continued to work on and upgrade our various products, there were no
specifically designated research and development expenses ("R&D"). As part of
our ongoing cost control efforts, we focused the core of our technical resources
on the enhancement of existing products and the maintenance of service quality
levels.
The increase in depreciation and amortization expense to $135 in 2006, as
compared to $119 in 2005, is primarily due to the amortization of additional
assets purchased in current and prior periods.
18
Interest expense (including beneficial conversion charges relating to the
conversion of the convertible notes) decreased by approximately $2,891 from
$3,416 in 2005 to $525 in 2006. This decrease is due to beneficial conversion
costs which decreased to $300 in 2006 from $3,189 in 2005.
Gain on settlements increased approximately $1,053 mainly due to our ability to
settle certain debts and obligations for less than their book value.
The current income tax provision in both years was negligible due primarily to
the net operating loss carryforwards. The net income for the period improved by
approximately $4,217 to a profit of $255 from a loss of ($3,962) in 2005, due to
the factors mentioned above.
Six months ended March 31, 2006 ("2006") compared to the six months ended March
31, 2005 ("2005"). With the exception of share-related items, all amounts are in
thousands unless otherwise noted.
Operating Revenues:
Revenues decreased by $203 (or 10.1%) from $2,014 in 2005 to $1,811 in 2006.
Products and Services:
Sales to customers for the six months ended March 31, 2006 and 2005 are as
follows:
March 31
----------------------
2006 2005
--------- --------
Enterprise Sales $ 1,069 $ 1,114
Support, Maintenance and Other 742 900
--------- - -------
$ 1,811 $ 2,014
========= =========
Aggregate enterprise sales revenues declined from $1,114 in 2005 to $1,069 in
2006. This decline resulted predominantly in the NJ WMS division which declined
from $890 to $445 while service and support revenues decreased by $365 from $779
to $414 in 2006. The NJ WMS revenue decrease was partially offset by the London
and Dallas operations, which were not owned by us for the entire corresponding
period in 2005 and which contributed $952 in 2006 versus $345 in 2005.
Gross Profit:
Gross profit decreased by $11 (or 1.0%) to $1,107 in 2006. As a percent of
operating revenues, gross profit was 61.1% in 2006 as compared to 55.5% in 2005.
Gross profits were favorably impacted primarily by the addition of the London
and Dallas operations which we did not own for the entire corresponding period
in 2005 and which contributed $582 in 2006 vs. $237 in 2005. Gross margin
improvement was predominantly the result of higher margins in NJ WMS activities.
Operating Expenses:
Selling and administrative expenses decreased $128 (or 6.5%) from $1,971 in 2005
to $1,843 in 2006 as we continued our various cost control initiatives.
While we continued to work on and upgrade our various products, there were no
specifically designated research and development expenses ("R&D"). As a result
of the previously-mentioned cost control efforts, we focused the core of our
technical resources on the enhancement of existing products and the maintenance
of service quality levels.
19
The increase in depreciation and amortization expense to $281 in 2006, as
compared to approximately $122 in 2005, is primarily due to the amortization of
intangible assets recorded in connection with the Cape Systems purchase.
Interest expense increased by $2,678 from $3,698 in 2005 to $1,020 in 2006. The
charge for the beneficial conversion of convertible debt decreased by $2,689 to
$500.
Gain on settlements increased $1,350 mainly due to our ability to settle certain
debts and obligations for less than their book value.
The current income tax provision in both years was negligible due primarily to
the net operating loss carryforwards.
We realized a tax credit of $402 in 2006 and $457 in 2005 by selling NJ State
net operating loss carryforwards during these periods.
The net loss for the period decreased by approximately $3,924 to $115 from a
loss of $4,039 in 2005, mainly due to the factors mentioned above.
Liquidity and Capital Resources
Based upon our substantial working capital deficiency ($25,085) and
stockholders' deficiency ($23,444) at March 31, 2006, 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 for a further unknown period of time, there is
substantial doubt as to our ability to continue as a going concern.
The successful implementation of our business plan has required, and our ability
to continue as a going concern will require, on a going forward basis,
substantial funds to finance (i) expansion of our sales & marketing program,
(ii) continuing operations, (iii) further development of our enterprise
technologies, (iv) settlement of existing liabilities including past due payroll
obligations to our employees, officers and directors, and our obligations under
existing or possible litigation settlements and (v) 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.
Fiscal 2006 Outlook:
At March 31, 2006, we had current obligations accumulated during the past
several years that substantially exceeded our current assets. 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 and short-term debt and related interest, if required; undertake capital
expenditures; and, to pay liabilities that could arise from litigation claims
and judgments.
Our sources of ongoing liquidity include the cash flows from our operations,
potential new credit facilities and potential additional equity investments.
Consequently, we continue to aggressively pursue revenue-enhancing initiatives,
additional debt and equity financing and the restructuring of certain existing
debt obligations. 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 increasing core WMS revenues have been completed or are in
process:
20
(i) We have integrated the Cape acquisition and realigned our sales and
marketing efforts to focus on high dollar-value software and hardware
transactions, are developing a sales strategy with multiple channels of
distribution and are pursuing strategic relationships with companies offering
complementary products or services. Additionally, within the confines of our
current financial condition, we have retained additional engineering and
software technical expertise, which functions were formerly partially
outsourced, to enhance our product development and R&D activities.
(ii) 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. Upon legal resolution of the approximately $7,344 of net liabilities
of these remaining European entities as of March 31, 2006, 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.
(iii) We are negotiating with vendors to settle old account balances at
substantial discounts. In addition, we are negotiating to settle certain notes
payable and litigation accruals at a discount or with the issuance of shares of
our common stock.
(iv) During the six months ended March 31, 2006, we realized net gains of $1,517
from settlements of liabilities totaling $1,563 through the issuance of $10
(200,000 shares) in common stock and payments of approximately $35 in cash.
(v) During the six months ended March 31, 2006 convertible notes payable to
unrelated parties in the principal amount of $28 were converted into 1,921,275
shares of common stock.
(vi) 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 to accredited investors through a private
placement. 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.
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 2%
of the outstanding principal amount of the secured convertible notes per month
plus accrued and unpaid interest. We have received waivers of default on the
Securities Purchase Agreement through March 31, 2006.
The warrants are exercisable until January 2010 at a purchase price of $0.09 per
share. The investors may exercise the warrants on a cashless basis if the shares
of common stock underlying the warrants are not then registered pursuant to an
effective registration statement. In the event the investors exercise the
warrants on a cashless basis, we will not receive any proceeds and the holder
will receive a reduced number of shares equal to the amount of cash that would
have been received. 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.
(vii) 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.
21
The investors have provided 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
$300 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 $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.
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 March 31, 2006, all events of default
and all liquidated damages under the various securities purchase agreements and
convertible notes. However, since April 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. We have filed a
registration statement on Form SB-2, as amended, registering additional shares
to be issued upon conversion of the secured convertible notes pursuant to the
2004 and 2005 SPAs, however, the Form SB-2 registration statement is currently
being reviewed and has not been declared effective.
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.
(viii) On January 12, 2005, we entered into a Stock Purchase Agreement with
Peter B. Ayling, Elizabeth M. Ayling, Brad L. Leonard, Michael C. Moore, Cape
Systems and Consulting Services Ltd. and Cape Systems, Inc. pursuant to which we
purchased on that date all of the issued and outstanding shares of common stock
of Cape Systems and Consulting Services Ltd. (collectively "Cape Systems") from
Peter B. Ayling and Elizabeth M. Ayling and Cape Systems, Inc. from Brad L.
Leonard and Michael C. Moore for an aggregate purchase price of $2,000,000.
Pursuant to the Stock Purchase Agreement, the parties executed an escrow
agreement pursuant to which $200,000 of the purchase price was placed in escrow
for a period of 15 months as a fund for indemnity claims arising out of the
transaction. The escrow was released on April 12, 2006. The acquisition was
accounted for pursuant to the purchase method in accordance with Statement of
Financial Accounting Standards No. 141, "Business Combinations" effective as of
January 12, 2005. In connection with the Stock Purchase Agreement, we entered
into an employment agreement with Brad L. Leonard and a consulting agreement
with IMC Development Group.
While we are continuing our efforts to control 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.
22
ITEM 3. CONTROLS AND PROCEDURES
a) Evaluation of Disclosure Controls and Procedures: As of March 31, 2006,
our management carried out an evaluation, under the supervision of our
Chief Executive Officer and Chief Financial Officer of the effectiveness
of the design and operation of our system of disclosure controls and
procedures pursuant to the Securities and Exchange Act, Rule 13a-15(e) and
15d-15(e) under the Exchange Act). Based on that evaluation, our chief
executive officer and chief financial officer concluded that our
disclosure controls and procedures are effective to provide reasonable
assurance that information we are required to disclose in reports that we
file or submit under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in Securities and Exchange
Commission rules and forms, and that such information is accumulated and
communicated to our management, including our chief executive officer and
chief financial officer, as appropriate, to allow timely decisions
regarding required disclosure.
b) Changes in internal controls: As described below, there were changes in
our internal controls over financial reporting that occurred during the
period covered by this report that have materially affected, or are
reasonably likely to materially effect, our internal control over
financial reporting.
Changes in Internal Controls and Procedures
During the quarter ended March 31, 2006, we implemented several changes in our
internal controls and procedures to address material weaknesses discovered in
our disclosure controls and procedures in connection with the filing our our
annual report for our fiscal year ended September 30, 2005. Such material
weaknesses were:
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 our Form 10-KSB was missing some of the required generally accepted
accounting principles disclosures.
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.
o Failure to properly calculate the beneficial conversion charges resulting
from issuance and modification of terms of its convertible debt
instruments during the quarter ended March 31, 2005. Such weakness
resulted in restatement to the Company's financial statements for the
quarter ended March 31, 2005 to increase by $1,200,000 the amount of
beneficial conversion charges recorded in the statement of operations.
In order to remediate the revenue recognition issue, we instituted a policy
requiring at least two accounting personnel, one of which must be the Chief
Financial Officer, to review all contracts and provide independent assessment of
how revenue should be accounted for. In the event that such personnel have
conflicting opinions on the recognition of revenue, we will seek outside,
independent advice to determine the method of revenue recognition to be
utilized. In addition, we have modified our accounting system and procedures to
classify contract revenue as deferred revenue until all elements of the contract
have been delivered.
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In order to remediate the weakness in our closing process and financial
reporting process and recording of beneficial conversion charges, we retained an
outside Certified Public Accountant, who reviews the closing procedures,
financial statement preparation and identification of all entries and
disclosures in order to mitigate any misstatements in our financial statements.
These changes were effective in preventing the material weaknesses from
reoccuring in the quarter ended March 31, 2006.
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PART II - OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
From time to time, we may become involved in various lawsuits and
legal proceedings, which arise in the ordinary course of business. However,
litigation is subject to inherent uncertainties, and an adverse result in these
or other matters may arise from time to time that may harm our business. We have
previously disclosed in our annual and quarterly filings all legal proceedings
or claims, of which we are aware, that we believe will have, individually or in
the aggregate, a material adverse affect on our business, financial condition or
operating results. Except as described below, there have been no material
developments during the period covered by this report.
Recently settled Litigation
On or about January 30, 2006, we settled for 200,000 shares of
common stock, valued at $10,000, an action previously disclosed and accrued,
which was commenced by Sonata Software vs. Vertex Interactive, Inc. et. al. The
action had demanded $242,000 to be due Sonata Software, a previously used
vendor.
On or about March 31, 2006, we settled for $25,000 a consent
judgment, previously disclosed and accrued, in the amount of approximately
$1,000,000 entered against us on July 19, 2002 in the United States District
Court, District of New Jersey, in the matter captioned Henley et. al. vs. Vertex
Interactive, Inc. et. al.
ITEM 2 UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the quarter ended March 31, 2006, we issued 1,010,000 shares
of our common stock to four accredited investors upon conversion of $11,817 in
secured convertible debentures. 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, 2006, we issued 340,875 shares of
our common stock to Nicholas Toms, our Chief Executive Officer, for previously
accrued and unpaid salary. This issuance is considered exempt under Regulation D
of the Securities Act of 1933 and Rule 506 promulgated thereunder.
ITEM 3 DEFAULTS UPON SENIOR SECURITIES
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 March 31, 2006,
all events of default and all liquidated damages under the various securities
purchase agreements and convertible notes. However, since April 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. We have filed a registration statement on Form SB-2, as amended,
registering additional shares to be issued upon conversion of the secured
convertible notes pursuant to the 2004 and 2005 SPAs, however, the SB-2
registration statement is currently being reviewed and has not been declared
effective.
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ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5 OTHER INFORMATION
None.
ITEM 6 EXHIBITS
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14 and Rule 15d-14(a),
promulgated under the Securities and Exchange Act of 1934, as amended
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14 and Rule 15d 14(a),
promulgated under the Securities and Exchange Act of 1934, as amended
32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (Chief Executive Officer)
32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (Chief Financial Officer)
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SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
CAPE SYSTEMS GROUP, INC.
Date: May 15, 2006 By: /s/ NICHOLAS R. TOMS
---------------------
Nicholas R. Toms
Chief Executive Officer
(Principal Executive Officer) and
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
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