UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 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: 131,162,169 shares outstanding as of
August 14, 2006.
Preferred stock, Series "A", par value $.01 per share: 1,356,852 shares
outstanding as of August 14, 2006.
Preferred stock, Series "B", par value $.01 per share: 1,000 shares outstanding
as of August 14, 2006.
Preferred stock, Series "C-1", par value $.01 per share: 997 shares outstanding
as of August 14, 2006.
Preferred stock, Series "D", par value $.01 per share: 7,615 shares outstanding
as of August 14, 2006.
INDEX
PART I FINANCIAL INFORMATION
ITEM 1 Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of June
30, 2006 (Unaudited) and September 30, 2005 3-4
Condensed Consolidated Statements of Operations
for the three and nine months Ended June 30,
2006 and 2005 (Unaudited) 5
Condensed Consolidated Statement of Changes in
Stockholders' Deficiency for the nine months
ended June 30, 2006 (Unaudited) 6-7
Condensed Consolidated Statements of Cash Flows
for the nine months ended June 30, 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 17-24
ITEM 3 Controls and Procedurs 25
PART II OTHER INFORMATION
ITEM 1 Legal proceedings 26
ITEM 2 Unregistered sales of equity securities and use of 26
proceeds
ITEM 3 Defaults upon senior securities 26
ITEM 4 Submission of matters to a vote of security holders 27
ITEM 5 Other information 27
ITEM 6 Exhibits 27
SIGNATURES 28
2
PART 1 - FINANCIAL INFORMATION
ITEM 1 - CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
JUNE 30, 2006 (UNAUDITED) AND SEPTEMBER 30, 2005
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
ASSETS
June 30, September 30,
2006 2005
(Unaudited) (see Note 1)
CURRENT ASSETS:
Cash $ 167 $ 239
Accounts receivable, less
allowance for doubtful accounts of $10 and $9 416 572
Inventories, net of valuation allowance 163 185
Prepaid expenses and other current assets 336 480
------ ------
Total current assets 1,082 1,476
Equipment and improvements, net of
accumulated depreciation and
amortization of $699 and $670 37 45
Deferred financing costs,
net of accumulated amortization of
$344 and $175 102 180
Goodwill 342 342
Other intangible assets, net of accumulated
amortization of $758 and $369 786 1,175
Other assets 49 194
------ ------
Total assets $2,398 $3,412
====== ======
See notes to unaudited condensed consolidated financial statements.
3
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
JUNE 30, 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 3,155 4,315
Net liabilities associated with subsidiaries
in liquidation 7,727 7,296
Payroll and related benefits accrual 1,396 1,576
Litigation related accruals 2,655 3,655
Other accrued expenses and liabilities 4,293 3,834
Customer deposits 84 --
Deferred revenue 613 549
Long-term convertible notes payable
- unrelated parties 5,223 4,765
--------- ---------
Total current liabilities 26,878 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;
108,832,168 and 92,273,778 shares issued 543 461
Additional paid-in capital 171,203 170,222
Subscription receivable (66) (66)
Accumulated deficit (194,103) (193,312)
Accumulated other comprehensive loss (2,004) (1,562)
Less: Treasury stock, 87,712 shares of
common stock (at cost) (67) (67)
--------- ---------
Total stockholders' deficiency (24,480) (24,310)
--------- ---------
Total liabilities and stockholders' deficiency $ 2,398 $ 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 Nine Months
Ended June 30, Ended June 30,
------------------------------ ------------------------------
2006 2005 2006 2005
------------- ------------- ------------- -------------
REVENUES $ 863 $ 682 $ 2,674 $ 2,696
COST OF SALES 474 412 1,198 1,308
------------- ------------- ------------- -------------
GROSS PROFIT 389 270 1,476 1,388
------------- ------------- ------------- -------------
OPERATING EXPENSES:
Selling and administrative 825 1,142 2,812 3,116
Depreciation and
amortization of intangibles 166 135 281 257
------------- ------------- ------------- -------------
Total operating expenses 991 1,277 3,093 3,373
------------- ------------- ------------- -------------
OPERATING LOSS (602) (1,007) (1,617) (1,985)
------------- ------------- ------------- -------------
OTHER INCOME (EXPENSE):
Interest expense (includes
beneficial conversion charge
of $0 and $500 in 2006, $0 and $3,189 in 2005)
(235) (348) (1,093) (4,046)
Gain on settlements of
liabilities 163 2 1,517 169
Other 0 0 2 13
------------- ------------- ------------- -------------
Net other income/(expense) (72) (346) 426 (3,864)
------------- ------------- ------------- -------------
LOSS BEFORE PROVISION
FOR INCOME TAXES (674) (1,353) (1,191) (5,849)
------------- ------------- ------------- -------------
Provision for state income taxes (2) 0 (2) 0
Credit for sale of state tax
benefits 0 0 402 457
------------- ------------- ------------- -------------
Income tax credit 0 0 400 457
------------- ------------- ------------- -------------
NET LOSS $ (676) $ (1,353) $ (791) $ (5,392)
============= ============= ============= =============
Loss per share of common stock:
Basic and Diluted ($ .01) ($ .02) ($ .01) ($ .07)
Weighted Average number of shares outstanding:
Basic and Diluted 106,366,234 79,811,693 100,081,141 73,656,191
See notes to unaudited condensed consolidated financial statements.
5
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' DEFICIENCY
FOR THE NINE MONTHS ENDED JUNE 30, 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 5,071,275 25 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 3,150,000 15 77
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
losses(a) ------------ ------------ ----------- ------------ ------------
Balance June 30, 2006 1,365,960 $ 14 108,832,168 $ 543 $ 171,203
============ ============ =========== ============ ============
(a) Comprehensive losses for the three and nine months ended June 30, 2006
totaled $(1,055) and $(1,232) and totaled $(2,578) and $(5,195) for the three
and nine months ended June 30, 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 NINE MONTHS ENDED JUNE 30, 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 43
Common stock issued for accrued
401(k) Plan contribution
and other liabilities 390
Common stock issued in exchange
for services 92
Beneficial conversion feature
related to long-term
convertible notes 500
Stock options issued in exchange
for services 38
Net loss (791) (791)
Change in unrealized foreign
exchange translation
losses(a) (442) (442)
--------- --------- --------- --------- ---------
Balance June 30, 2006 $(194,103) $ (66) $ (2,004) $ (67) $ (24,480)
========= ========= ========= ========= =========
(a) Comprehensive losses for the three and nine months ended June 30, 2006
totaled $(1,055) and $(1,232) and totaled $(2,578) and $(5,195) for the three
and nine months ended June 30, 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 Nine Months Ended
June 30,
-------------------------
2006 2005
---------- -----------
Cash Flows from Operating Activities:
- -------------------------------------
Net loss $ (791) $(5,392)
Adjustments to reconcile net loss to
net cash provided by (used in) operating
activities:
Depreciation and amortization 281 257
Common stock issued in exchange for services 92 872
Amortization of deferred financing costs and
debt discount 169 335
Variable stock option charge 38 41
Bad Debt Expense 10 --
Charges to interest expense for beneficial
conversion features of notes payable -
unrelated parties 500 3,189
Gain on settlement of liabilities (1,517) --
Changes in operating assets and liabilities:
net of effects of acquisitions
Accounts receivable 146 (150)
Inventory 22 134
Prepaid expenses and other current assets 143 95
Intangibles and other assets 277 144
Accounts payable (770) 504
Accrued expenses and other liabilities 848 (44)
Customer deposits 22 --
Deferred revenue 64 238
------- -------
Net cash provided by (used in)
operating activities (466) 223
------- -------
Cash Flows from Investing Activities:
- -------------------------------------
Additions of equipment and improvements (21) --
Acquisition of businesses - net of cash acquired -- (1,990)
------- -------
Net cash used in investing activities (21) (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/(decrease) in cash (72) 83
Cash at beginning of period 239 101
------- -------
Cash at end of period $ 167 $ 184
======= =======
Non-cash investing and financing activities:
Long-term convertible notes payable -
unrelated parties converted into common stock $ 43 313
Common stock issued for payment of liabilities $ 390 419
Stock options issued for future services $ 38 176
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: 1) enterprise
software systems and applications, warehouse management hardware, and software
integration solutions that enable our customers to manage their order, inventory
and warehouse management needs; 2) "packaged" software for palletizing and
packaging configuration and truck/container loading; and, 3) 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 Linux and Windows-based software applications and a
portfolio of "light-directed" systems for inventory, warehouse and distribution
center management. We provide a full range of support, services and maintenance
on a 24-hour, 7-days a week, 365-days a year basis, including the provision of
wireless and wired planning and implementation services for our customers'
facilities.
In 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 ($25,796) and
stockholders' deficiency ($24,480) at June 30, 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
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 Item 310 of Regulation S-B. 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 nine months ended June 30, 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 June 30, 2006, there were 2,866,780,331 shares of common stock potentially
issuable upon the exercise of stock options (8,207,721 shares), warrants
(5,700,000 shares) and the conversion of convertible securities (2,852,872,610
shares). As of June 30, 2005, there were 381,189,461 shares of common stock
potentially issuable upon the exercise of stock options (10,228,514 shares),
warrants (4,850,000 shares) and the conversion of convertible securities
(366,110,947 shares). However, diluted per share amounts have not been presented
in the accompanying condensed consolidated statements of operations for the
three months ended June 30, 2006 and 2005 and nine months ended June 30, 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.
10
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
PRO FORMA AND OTHER DISCLOSURES RELATED TO STOCK OPTIONS
As of June 30, 2006, the Company had granted options to purchase a total of
8,207,721 shares of common stock. No options were granted or cancelled during
the three months ended June 30, 2006. 1,000,000 options were granted with no
cancellations during the nine months ended June 30, 2006. Approximately 43,500
and 862,500 options were expired during the three and nine months ended June 30,
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 loss applicable to common stock and
net loss per common share would have been increased to the pro forma amounts
indicated in the following table:
Three Months Ended June 30, Nine Months Ended June 30,
--------------------------- --------------------------
2006 2005 2006 2005
------- ------- ------- -------
Net loss-as reported $ (676) $(1,353) $ (791) $(5,392)
Deduct total stock -- based
employee compensation expense
determined under a fair value-based
method for all awards (62) (116) (307) (569)
------- ------- ------- -------
Net loss - pro-forma $ (738) $(1,469) $(1,098) $(5,961)
======= ======= ======= =======
Basic and diluted
loss per common share
- as reported $ (.01) $ (.02) $ (.01) $ (.07)
Basic and diluted
loss per common share
- pro-forma $ (.01) $ (.02) $ (.01) $ (.08)
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.
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 non-cash 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 June 30, 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.
11
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 June 30, 2006 and September 30, 2005
were $7,727 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 nine months ended
June 30, 2006.
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:
Nine Months Ended
June 30, 2005
-----------------
Revenues $ 3,181
Net loss (5,379)
Net loss per share ($ .07)
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 June 30, 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 August 14,
2006.
6. CONVERTIBLE NOTES PAYABLE
Convertible notes payable of $5,223 at June 30, 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.
12
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 February 22, 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.
On May 19, 2006, June 5, 2006 and June 26, 2006 the Company on each date issued
1,050,000 common shares upon the conversion of 10% Convertible Notes with an
approximate principal balance of $7, $5, $4 respectively at conversion prices of
$0.00635, $0.00429 and $0.00346 per share, respectively.
2005 CONVERTIBLE NOTES
The 2005 Convertible Notes bear interest at 10%, mature two years from the date
of issuance, and are convertible into our common stock, at the investors'
option, at the lower of $0.09 per share or 40% of the average of the three
lowest intraday trading prices for the common stock on the NASDAQ bulletin board
for the 20 trading days before but not including the conversion date. The 2005
Warrants are exercisable until five years from the date of issuance at a
purchase price of $0.09 per share. In addition, we have granted the investors a
security interest in substantially all of our assets and intellectual property
and registration rights.
2005 WORKING CAPITAL FACILITY
On August 10, 2005, we entered into a Securities Purchase Agreement for the sale
of (i) $850 in secured convertible notes and (ii) warrants to purchase 850,000
shares of our common stock to accredited investors. The investors have provided
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.
13
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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
$0 and $500 in the three and nine months ended June 30, 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. This Form
SB-2 was declared effective on July 24, 2006. However, given the conversion
privileges in the various financing agreements, at the current market price of
our stock, we are still in default. Default has been waived through June 30,
2006.
7. STOCKHOLDERS' DEFICIENCY
SHARES ISSUED FOR SERVICES AND ACCRUED LIABILITIES
During the nine months ended June 30, 2006, the Company issued 3,150,000 shares
of common stock for various consulting and professional services rendered and
recorded approximately $92 based on the fair value of the shares issued, and
8,337,115 shares of common stock in satisfaction of other liabilities of $390.
Subsequent to June 30, 2006, the Company issued 14,930,000 shares of common
stock upon the conversion of 10% Convertible Notes with an approximate principal
balance of $64 at conversion prices ranging from $0.00346 to $0.00459. In
addition the Company issued 5,400,000 shares of common stock with an approximate
principal balance of $36 to the Board of Directors for services rendered in 2006
and 2,000,000 shares of common stock with an approximate principal balance of
$40 to Glenn Barlow for consulting services.
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 nine months ended June 30, 2006.
The Company will attempt to obtain approval to sell the remaining available net
operating losses of approximately $4,501 between July 1, 2006 and June 30, 2007.
This amount, which is a carryover of its remaining tax benefits from state
fiscal year 2004 (the Company did not qualify for state fiscal 2005), 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.
14
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 $0 and $1,517 during the three
and nine month periods ended June 30, 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 June 30, 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.
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 vested 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 or 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. In July, Mr. Ayling
resigned as Vice President, but retains the positions as Head of International
Marketing and an officer and Director of Cape Consulting and Services Ltd., our
wholly-owned subsidiary.
15
CAPE SYSTEMS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 nine months ended June 30, 2006, the Company incurred costs
of $23 and $70 for these services of which $0 was due and payable as of June 30,
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 incurred $56 and $143 for the three and nine months ended
June 30, 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 nine months ended June 30, 2006:
2006
------
Revenues
North America $2,073
United Kingdom 601
------
$2,674
======
Identifiable assets
North America $ 25
United Kingdom 12
------
$ 37
======
12. SUBSEQUENT EVENTS
On August 8, 2006, we entered into a Securities Purchase Agreement for the sale
of $300 in secured convertible notes and (ii) warrants to purchase 3,000,000
shares of our common stock to accredited investors.
The secured convertible notes bear interest at 8%, 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 OTC 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.
The warrants are exercisable until January 2013 at a purchase price of $0.015
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.
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 NINE MONTHS ENDED JUNE 30,
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 JUNE 30, 2006 ("2006") COMPARED TO THE THREE MONTHS ENDED
JUNE 30, 2005 ("2005"). EXCEPT FOR SHARE-RELATED ITEMS, ALL AMOUNTS ARE IN
THOUSANDS UNLESS OTHERWISE NOTED.
OPERATING REVENUES:
Revenues increased by $181 (or 27%) from $682 in 2005 to $863 in 2006.
Enterprise sales revenues increased by $192 (256%) to $267 from $75 during the
corresponding period in 2005 based on three large 2006 installations. "Packaged
software" sales increased by $94 (48%) to $291 from $197. $75 of this "packaged
software" sales increase was attributable to the UK operations. Offsetting this
was support, maintenance and other service revenues which decreased $105 (26%)
from $410 in 2005 to $305 in 2006. The decrease was predominantly a result of a
decrease of $108 in service, maintenance & support contracts in the enterprise
business which was partially offset by increased support revenues generated by
the UK packaged software operations.
Revenues generated by the operations in London and Dallas, that were owned by us
commencing as of January 12, 2005, accounted for $426 (or 49%) in 2006 compared
to $325 (48%) in 2005. The balance of the revenues ($437 in 2006 and $357 in
2005) were generated by the NJ enterprise operations.
PRODUCTS AND SERVICES:
Sales to customers by the product and service line groupings for the three
months ended June 30, 2006 and 2005 are as follows:
June 30
-----------
2006 2005
---- ----
Enterprise/Software Sales $558 $272
Support, Maintenance and Other 305 410
---- ----
$863 $682
==== ====
GROSS PROFIT:
Gross profit increased by $119 (44%) from $270 in 2005 to $389 in 2006 due to
absolute and relative gross profit improvement in the UK ($96 versus $33, 43%
versus 26%, respectively) and the NJ enterprise business segment ($136 versus
$81, $31% versus 23%, respectively). As a percent of total operating revenues,
gross profit was 45% in 2006 as compared to 40% in 2005.
OPERATING EXPENSES:
Selling and administrative expenses decreased $317 (or 28%) from $1,142 in 2005
to $825 in 2006 predominantly due to lower professional fees relating to
acquisitions, regulatory filings and contractual obligations. During the balance
of 2006, although we continue to maintain various cost control initiatives, we
anticipate these costs may rise from current levels as we continue to both
undertake greater sales and marketing activities to expand revenues and locate
and evaluate acquisition opportunities to achieve necessary economies of scale.
18
We continued to upgrade, improve and develop new functionality for our various
enterprise WMS software and hardware and "packaged software" offerings, the
expense for which is included within our normal operations. As part of our
ongoing cost control efforts, while we focused the core of our technical
resources on the enhancement of existing products and the maintenance of service
quality levels, we also began development of a new WMS hardware design and
incurred limited research and development expenses ("R&D").
Depreciation and amortization expense increased to $166 in 2006 from $135 in
2005 due to an increase in deferred financing expense from the SPA financing.
Interest expense decreased by $113 from $348 in 2005 to $235 in 2006 due to
recognition in Q3 2005 of the 15% default interest rate applied to the first six
months of 2005.
After a review of specific liabilities, Other Gains increased $160 to $163 due
to reversal of certain liabilities which, in our opinion, were overaccrued.
The current income tax provision in both years was negligible due primarily to
the net operating loss carryforwards.
The net loss for the period decreased by $677 (50%) to a loss of ($676) from a
loss of ($1,353) in 2005, due to the factors mentioned above.
NINE MONTHS ENDED JUNE 30, 2006 ("2006") COMPARED TO THE NINE MONTHS ENDED JUNE
30, 2005 ("2005"). WITH THE EXCEPTION OF SHARE-RELATED ITEMS, ALL AMOUNTS ARE IN
THOUSANDS UNLESS OTHERWISE NOTED.
Results for the nine months ended June 30, 2006 are not comparable to the nine
months ended June 30, 2005 as the June 30, 2005 financial statements do not
include the first quarter results of the UK and Texas operations, which were
acquired as of January 12, 2005.
OPERATING REVENUES:
Revenues decreased by $22 (or 1.0%) from $2,696 in 2005 to $2,674 in 2006.
Aggregate enterprise & packaged software sales revenues rose $310 (or 22%), from
$1,430 in 2005 to $1,740 in 2006. This increase resulted from an increase in
packaged software sales in Texas and the UK, which were not owned by us until
January 12, 2005, from $435 in 2005 to $976 in 2006 while enterprise sales
decreased from $996 to $764. Aggregate support & maintenance revenues decreased
by $332 from $1,266 to $934 in 2006 as NJ enterprise support declined from
$1,019 to $532, partially offset by increased support revenues from Texas and
the UK whose combined revenues increased from $148 to $401.
PRODUCTS AND SERVICES:
Sales to customers for the nine months ended June 30, 2006 and 2005 are as
follows:
June 30
---------------
2006 2005
------ ------
Enterprise/Packaged Software Sales $1,740 $1,430
Support, Maintenance and Other 934 1,266
------ ------
$2,674 $2,696
====== ======
19
GROSS PROFIT:
Gross profit increased by $88 (or 6.0%), from $1,388 to $1,476 in 2006. As a
percent of operating revenues, gross profit was 55% in 2006 as compared to 52%
in 2005. Gross profits both absolutely and relatively, were favorably impacted
primarily by the addition of the UK and Texas operations which we did not own
for the entire corresponding period in 2005 and which contributed $815 in 2006
compared to $426 in 2005.
OPERATING EXPENSES:
Selling and administrative expenses decreased $304 (or 10%), from $3,116 in 2005
to $2,812 in 2006 as we continued our various cost control initiatives and
acquisition-related costs were reduced.
While we continued to work on and upgrade our various products, there was no
specifically designated R&D. As a result of the previously mentioned cost
control efforts, we focused the core of our technical resources on the
enhancement and upgrade of existing products and the maintenance of service
quality levels. However, we did commence limited but focused, R&D with respect
to certain of our enterprise products. We have also executed a contract with a
major European construction steel fabricator to develop new software for
integrating robotic machinery and our palletization/load optimization
capabilities.
The increase in depreciation and amortization expense to $281 in 2006, as
compared to approximately $257 in 2005, is primarily due to the amortization of
intangible assets recorded in connection with the Cape Systems purchase.
Interest expense decreased by $264 from $857 in 2005 to $593 in 2006. The charge
for the beneficial conversion of convertible debt decreased by $2,689 to $500
based on reduced funding in 2006
Gain on settlements increased $1,348 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 $4,601 to ($791) from a
loss of ($5,392) in 2005, due to the factors mentioned above.
LIQUIDITY AND CAPITAL RESOURCES
Based upon our substantial working capital deficiency ($25,796) and
stockholders' deficiency ($24,480) at June 30, 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.
20
FISCAL 2006 OUTLOOK:
At June 30, 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:
(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 and extended
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. As a result,
we have executed a contract with a new client for the development of a
custom-made software to integrate robotic handling capabilities and an enhanced
version of our pallet optimization technology.
(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 $7,727 of net liabilities
of these remaining European entities as of June 30, 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 dependent upon the decisions to be issued
by the respective court appointed liquidators. We have been in contact with our
Italian counsel on this issue, however, we have not actively pursued settlements
with the court appointed liquidators as a result of our limited financial
resources.
(iii) We continue to negotiate 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. However, our ability to initiate significant new settlement
discussions is currently hampered by our limited financial resources.
21
(iv) During the nine months ended June 30, 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.
There were no net gains from settlements during the current period.
(v) During the nine months ended June 30, 2006 convertible notes payable to
unrelated parties in the principal amount of $43 were converted into 5,071,275
shares of common stock. During the three months ended June 30, 2006 convertible
notes payable in the principal amount of $15 were converted into 3,150,000
shares of common stock.
(vi) On August 8, 2006, we entered into a Securities Purchase Agreement for the
sale of $300 in secured convertible notes and (ii) warrants to purchase 3,000
shares of our common stock to accredited investors.
The secured convertible notes bear interest at 8%, 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 OTC 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.
The warrants are exercisable until January 2013 at a purchase price of $0.015
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.
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
SECURITIES PURCHASE AGREEMENTS
To obtain funding for our ongoing operations, we have entered into Securities
Purchase Agreements with several accredited investors, on the following dates
for the sale of secured convertible notes and warrants:
SECURED
CONVERTIBLE INTEREST WARRANTS
TRANSACTION DATE NOTES SOLD RATE CONVERSION PRICE (SHARES)
- ---------------------------------------------------------------------------------------------------------------------------
April 28, 2004 $3,000 10% $.30 or 40% of the average of the lowest three 3,000,000
($2,523 intraday trading prices during the twenty trading
remaining) days immediately preceding conversion
January 11, 2005 $1,850 10% $.09 or 40% of the average of the lowest three 1,850,000
intraday trading prices during the twenty trading
days immediately preceding conversion
August 10, 2005 $850 10% $.09 or 40% of the average of the lowest three 850,000
intraday trading prices during the twenty trading
days immediately preceding conversion
August 8, 2006 $300 8% $.09 or 40% of the average of the lowest three 3,000,000
intraday trading prices during the twenty trading
days immediately preceding conversion
- ---------------------------------------------------------------------------------------------------------------------------
The secured convertible notes bear interest as described above, mature
two years from the date of issuance or two years from when we are in compliance
with the terms of the securities purchase agreements, and are convertible into
our common stock, at the investors' option, on the terms as described above. As
of August 15, 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 $.01 and, therefore, the conversion price for the
secured convertible notes was $.0004. Based on this conversion price, the $5,538
in secured convertible notes remaining, excluding interest, would convert into
1,384,500,000 shares of our common stock. If the price of our common stock
should decrease, we will be required to issue substantially more shares, which
will cause dilution to our existing stockholders. 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.
In connection with the sale of convertible notes, we granted the
investors registration rights. Pursuant to the registration rights agreements,
we were required to file registration statements for the shares underlying the
convertible notes and warrants within a specified period of time from the sale
of such securities and to have the registration statement declared effective by
the Securities and Exchange Commission within another specified period of time.
In the event that we did not timely file the registration statements or have
them declared effective, we are obligated to pay liquidated damages. We filed a
registration statement on Form S-1, registering shares for resale underlying the
secured convertible notes and warrants issued pursuant to the April 2004
securities purchase agreement. The S-1 was declared effective on August 9, 2004.
We filed a registration statement on Form SB-2, registering shares for resale
underlying the secured convertible notes and warrants issued pursuant to the
April 2004 and January 2005 securities purchase agreements. The SB-2 was
declared effective on July 24, 2006. However, these registration statements do
not cover the number of shares to be registered pursuant to the registration
rights agreements, and a s a result, we are in default under our securities
purchase agreements dated April 2004, January 2005 and August 2005.
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As a result of these defaults, we are obligated to pay the debenture
holders the principal amount of the debentures together with interest and
certain other amounts. We do not have the capital resources to pay the amounts
required under this agreement. The secured convertible debenture holders have
informed us that they do not intend to take any action at this time due to the
default. The debenture holders have waived all events of defaults in the past,
including all events of default occurring through June 30, 2006; however, we do
not have any legally binding commitment from the debenture holders to waive the
default provisions going forward. 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. 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 lenders,
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 lenders pursuant to
our existing security agreements.
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ITEM 3. CONTROLS AND PROCEDURES
(A) EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES.
Our management, with the participation of our chief executive officer
and chief financial officer, evaluated the effectiveness of our disclosure
controls and procedures pursuant to Rule 13a-15 under the Securities Exchange
Act of 1934 as of June 30, 2006. In designing and evaluating the disclosure
controls and procedures, management recognizes that any controls and procedures,
no matter how well designed and operated, can provide only reasonable assurance
of achieving the desired control objectives. In addition, the design of
disclosure controls and procedures must reflect the fact that there are resource
constraints and that management is required to apply its judgment in evaluating
the benefits of possible controls and procedures relative to their costs.
Based on our evaluation, our chief executive officer and chief
financial officer concluded that our disclosure controls and procedures are
designed at a reasonable assurance level but were not fully effective during the
quarter in providing 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.
During the third quarter of fiscal 2006, we determined we had not accurately
made two entries with respect to the issuance of equity securities. One instance
related solely to the recording of the stock issuance on June 29 instead of July
7 while the other related to an omission of the issuance of 300,000 shares with
a value of $6,000. We have instituted a policy requiring the controller, at the
end of each quarter, to reconcile the accounting records to the stock issuance
report prepared and maintained by the corporate secretary to ensure that all
equity issuances have been properly recorded.
(B) CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING.
We regularly review our system of internal control over financial
reporting and make changes to our processes and systems to improve controls and
increase efficiency, while ensuring that we maintain an effective internal
control environment. Changes may include such activities as implementing new,
more efficient systems, consolidating activities, and migrating processes.
There were no changes in our internal control over financial reporting
that occurred during the period covered by this Quarterly Report on Form 10-QSB
that have materially affected, or are reasonably likely to materially affect,
our internal control over financial reporting.
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PART II - OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
From time to time, we may become involved in various lawsuits and legal
proceedings, which arise in the ordinary course of business. However, litigation
is subject to inherent uncertainties, and an adverse result in these or other
matters may arise from time to time that may harm our business. We have
previously disclosed in our annual and quarterly filings all legal proceedings
or claims, of which we are aware, that we believe will have, individually or in
the aggregate, a material adverse affect on our business, financial condition or
operating results. There have been no material developments during the period
covered by this report.
ITEM 2 UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the quarter ended June 30, 2006, we issued 3,150,000 shares of
our common stock to four accredited investors upon conversion of $15,000 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 June 30, 2006, we issued 300,000 shares of our
common stock to Jan Pilkington Miksa for consulting services valued at $6,000.
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.
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. This Form
SB-2 was declared effective on July 24, 2006. However, given the conversion
privileges in the various financing agreements, at the current market price of
our stock, we are still in default.
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 June 30, 2006, all events of default
and all liquidated damages under the various securities purchase agreements and
convertible notes. However, since July 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.
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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)
27
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
CAPE SYSTEMS GROUP, INC.
Date: August 18, 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)
28