VERTICAL COMPUTER
SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
(UNAUDITED)
Note 1. Organization,
Basis of Presentation and Significant Accounting Policies
The
accompanying unaudited interim consolidated financial statements of Vertical Computer Systems, Inc. (‘we”, “our”,
the “Company” or “Vertical”) have been prepared in accordance with accounting principles generally accepted
in the United States of America and rules of the Securities and Exchange Commission, and should be read in conjunction with
the audited consolidated financial statements and notes thereto contained in Vertical’s annual report on Form 10-K for the
year ended December 31, 2013. The consolidated financial statements include the accounts of the Company and its subsidiaries (collectively,
“our”, “we”, the “Company” or “VCSY”, as applicable). Vertical’s subsidiaries
which currently maintain daily business operations are NOW Solutions, a 75% owned subsidiary, and SnAPPnet, Inc. (“SnAPPnet,
Inc.”), a wholly-owned subsidiary of Vertical. Vertical’s subsidiaries which have minimal operations are Vertical
do Brasil, Taladin, Inc. (“Taladin"), OptVision Research, Inc. (“OptVision”), Vertical Healthcare Solutions,
Inc., each a wholly-owned subsidiary of Vertical, as well as Priority Time Systems, Inc. (“Priority Time”) a 90% owned
subsidiary, and Government Internet Systems, Inc. (“GIS”), an 84.5% owned subsidiary, Vertical’s subsidiaries
which are inactive include EnFacet, Inc. (“ENF”), Globalfare.com, Inc. (“GFI”), Pointmail.com, Inc. (“PMI”)
and Vertical Internet Solutions, Inc. (“VIS”), each of which is a wholly-owned subsidiary of Vertical.
In
the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of financial
position and the results of operations for the interim periods presented have been reflected herein. The results of operations
for interim periods are not necessarily indicative of the results to be expected for the full year. Notes to the consolidated
financial statements which would substantially duplicate the disclosure contained in the audited financial statements as reported
in the 2013 annual report on Form 10-K have been omitted.
Earnings per share
Basic earnings per
share is calculated by dividing net income (loss) available to common stockholders by the weighted average number of shares of
the Company’s common stock outstanding during the period. “Diluted earnings per share” reflects the potential
dilution that could occur if our share-based awards and convertible securities were exercised or converted into common stock.
The dilutive effect of our share-based awards is computed using the treasury stock method, which assumes all share-based awards
are exercised and the hypothetical proceeds from exercise are used to purchase common stock at the average market price during
the period. The incremental shares (difference between shares assumed to be issued versus purchased), to the extent they would
have been dilutive, are included in the denominator of the diluted EPS calculation. The dilutive effect of our convertible preferred
stock and convertible debentures is computed using the if-converted method, which assumes conversion at the beginning of the year.
For the three months
ended March 31, 2014 and 2013, common stock equivalents related to the convertible debentures, convertible debt and preferred
stock and stock derivative liability were not included in the calculation of the diluted earnings per share as their effect would
be anti-dilutive.
Reclassifications
Certain reclassifications
have been made to the prior periods to conform to the current period presentation.
Capitalized Software
Costs
Software
costs incurred internally in creating computer software products are expensed until technological feasibility has been established
upon completion of a detailed program design. Thereafter, all software development costs are capitalized until the point that
the product is ready for sale, and are subsequently reported at the lower of unamortized cost or net realizable value. The Company
considers annual amortization of capitalized software costs based on the ratio of current year revenues by product to the total
estimated revenues by the product, subject to an annual minimum based on straight-line amortization over the product’s estimated
economic useful life, not to exceed five years. The Company periodically reviews capitalized software costs for impairment where
the fair value is less than the carrying value.
During
the three months ended March 31, 2014, the Company capitalized an aggregate of $33,200 related to software development and the
Company recorded impairment of $192,955 on previously capitalized software development costs.
Recently Issued
Accounting Pronouncements
The Company does not
expect the adoption of any recently issued accounting pronouncements to have a material impact on the Company’s financial
position, operations or cash flows.
Note 2. Going Concern
The accompanying unaudited
consolidated financial statements for the three months ended March 31, 2014 and 2013 have been prepared assuming that we will
continue as a going concern, and accordingly realize our assets and satisfy our liabilities in the normal course of business.
The carrying amounts
of assets and liabilities presented in the consolidated financial statements do not purport to represent realizable or settlement
values. As of March 31, 2014, we had negative working capital of approximately $15.1 million and defaulted on several of our debt
obligations. These conditions raise substantial doubt about our ability to continue as a going concern.
Our management is
continuing its efforts to attempt to secure funds through equity and/or debt instruments for our operations, expansion and possible
acquisitions, mergers, joint ventures, and/or other business combinations. The Company will require additional funds to pay down
its liabilities, as well as finance its expansion plans consistent with anticipated changes in operations and infrastructure.
However, there can be no assurance that the Company will be able to secure additional funds and that if such funds are available,
whether the terms or conditions would be acceptable to the Company and whether the Company will be able to turn into a profitable
position and generate positive operating cash flow. The consolidated financial statements contain no adjustment for the outcome
of this uncertainty.
Note 3. Notes Payable
The following table
reflects our third party debt activity, including our convertible debt, for the three months ended March 31, 2014:
December 31, 2013
|
|
$
|
4,542,512
|
|
Repayments of third party notes
|
|
|
(23,644
|
)
|
Effect of currency exchange
|
|
|
77
|
|
March 31, 2014
|
|
$
|
4,518,945
|
|
On January 9, 2013,
NOW Solutions completed a financing transaction in the aggregate amount of $1,759,150, which amount was utilized to pay off existing
indebtedness of the Company and NOW Solutions to Tara Financial Services and Robert Farias, a former employee of the Company and
all security interests granted to Tara Financial Services and Robert Farias were cancelled.
In connection with
this financing, the Company and several of its subsidiaries entered into a loan agreement (the “
Loan Agreement
”),
dated as of January 9, 2013 with Lakeshore Investment, LLC (“Lakeshore”) under which NOW Solutions issued a secured
10-year promissory note (the “
Lakeshore Note
”) bearing interest at 11% per annum to Lakeshore in the amount
of $1,759,150. The Lakeshore Note contains provisions requiring additional principal reductions in the event sales by NOW Solutions
exceed certain financial thresholds. Upon the payment of any prepayment principal amounts, the monthly installment payments shall
be adjusted proportionately on an amortized pro rata basis. The Lakeshore Note is currently payable in equal monthly
installments of $22,987 until January 31, 2022.
The Lakeshore Note
is secured by the assets of the Company’s subsidiaries, NOW Solutions, Priority Time, SnAPPnet, Inc. and the Company’s
SiteFlash technology and cross-collateralized. Upon the aggregate principal payment of $290,000 toward the Lakeshore Note, the
Company has the option to have Lakeshore release either the Priority Time collateral or the SiteFlash collateral. Upon payment
of the aggregate principal $590,000 toward the Lakeshore Note, Lakeshore shall release either the Priority Time collateral or
the SiteFlash collateral (whichever is remaining). Upon payment of the aggregate principal $890,000 toward the Lakeshore Note,
Lakeshore shall release the SnAPPnet collateral and upon full payment of the Lakeshore Note, Lakeshore shall release the NOW Solutions
collateral.
As additional consideration
for the loan, the Company granted a 5% interest in Net Claim Proceeds (less any attorney’s fees and direct costs) from any
litigation or settlement proceeds related to the SiteFlash technology to Lakeshore. In addition, until the Note is paid in full,
NOW Solutions agreed to pay a Lakeshore royalty of 6% of its annual gross revenues in excess of $5 million dollars up to a maximum
of $1,759,150.
Pursuant to the Loan
Agreement, as amended, the Company also agreed to make certain principal payments toward the Lakeshore Note of (a) $90,000 by
February 15, 2013, which was secured by 15% interest in the Company’s ownership of Priority Time and this payment was timely
made to Lakeshore and (b) $600,000 by March 15, 2013, which was secured by 25% of the Company’s ownership interest in NOW
Solutions and this payment was not made to Lakeshore. As of September 30, 2013, the common shares of NOW Solutions representing
a 25% ownership interest in NOW Solutions were in Lakeshore’s possession, but Lakeshore had not taken action to transfer
the shares in Lakeshore’s name due to forbearance agreements that have been entered into between March and August 2013.
In connection with these forbearance agreements, the Company increased the 5% interest in Net Claim Proceeds to an 8% interest,
paid a $100,000 transaction fee and made other payments including the issuance of 1,000,000 common shares valued at $47,000 and
$5,000 weekly payments whereby such $5,000 payments are to be applied toward a bonus of 25% of NOW Solutions’ profits for
the period that runs from March 15, 2013 through September 30, 2013. The aggregate forbearance fees paid to Lakeshore
for the year ended December 31, 2013 were $327,867. The last forbearance agreement expired on September 30, 2013 and on October
1, 2013, Lakeshore became a 25% minority owner of NOW Solutions. While there was an October 1, 2013 amendment to the Loan
Agreement that the Company believed was in effect, whereby shares of common stock representing a 25% ownership interest of NOW
Solutions (the “
NOW shares
”) in Lakeshore’s possession were to be returned to the Company, certain terms
of the amendment were not fulfilled, resulting in the Company recognizing Lakeshore as the owner of the NOW Shares.
The Company is currently in discussions with Lakeshore to work out terms under which the Company can buy back the NOW Shares.
Note 4. Derivative liability and fair
value measurements
Derivative liabilities
During 2008, one of
our officers pledged 3,000,000 shares of common stock (through a company he controls) to secure the debt owed to a third party
lender. In connection with the pledge of stock, we signed an agreement to replace these shares within one year. Subsequent to
this agreement, 1,309,983 shares of this stock were sold to satisfy the debt owed to the lender.
In August 2013, an
officer of the Company transferred 1,000,000 shares of common stock owned by him to our senior secured lenders in connection with
an option and forbearance. In connection with the transfer of the stock, the Company signed an agreement to replace these shares.
The initial fair value of these shares was determined to be $47,000 as of August 28, 2013.
In October 2013, one
of our officers transferred 1,000,000 shares of common stock (through a company he controls) on behalf of the Company to a third
party lender in consideration of a $100,000 loan made to the Company. In connection with the transfer of the stock, the Company
signed an agreement to replace these shares. The initial fair value of these shares was determined to be $85,000 as of October
31, 2013.
In December 2013,
a note payable secured by 1,000,000 shares of common stock pledged by an officer of the company (through a company he controls)
to secure payment of a $50,000 loan by a third party lender to the Company became past due. In connection with the pledge of stock,
we are obligated to replace these shares if the shares were transferred to the lender. This note is currently in default and therefore
these shares have been classified as a derivative liability as of December 31, 2013.. As the Company does not have sufficient
authorized stock to issue these shares, they were recorded as derivative liabilities. The initial fair value of these shares was
determined to be $72,000 as of December 9, 2013.
These contractual
commitments to replace all of the pledged shares was evaluated under FASB ASC 815-40, Derivatives and Hedging and was determined
to have characteristics of a liability and therefore constituted a derivative liability under the above guidance. Each reporting
period, this derivative liability is marked-to-market with the non-cash gain or loss recorded in the period as a gain or loss
on derivatives. At March 31, 2014 and December 31, 2013, the aggregate fair value of the derivative liabilities was $258,599 and
$263,340.
The aggregate change
in the fair value of derivative liabilities was a gain of $4,741 and $6,550 for the three months ended March 31, 2014 and 2013,
respectively.
The valuation of our
embedded derivatives is determined by using the VCSY stock price at March 31, 2014. As such, our derivative liabilities have been
classified as Level 1.
Fair value measurements
FASB ASC 820, Fair
Value Measurements and Disclosures, defines fair value as the exchange price that would be received for an asset or paid to transfer
a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction
between market participants on the measurement date. FASB ASC 820 also establishes a fair value hierarchy which requires an entity
to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. FASB ASC 820 describes
three levels of inputs that may be used to measure fair value:
Level 1
– Quoted
prices in active markets for identical assets or liabilities.
Level 2
– Observable
inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; or other inputs that are observable
or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3
– Unobservable
inputs that are supported by little or no market activity and that are financial instruments whose values are determined using
pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination
of fair value requires significant judgment or estimation.
If the inputs used
to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on
the lowest level of input that is significant to the fair value measurement of the instrument.
The following table provides a summary
of the fair value of our derivative liabilities as of March 31, 2014 and December 31, 2013:
|
|
Fair value measurements on a recurring
basis
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
As of March 31, 2014:
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock derivative – 4,309,983 shares
|
|
$
|
258,599
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2013:
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock derivative – 4,309,983 shares
|
|
$
|
263,340
|
|
|
$
|
-
|
|
|
$
|
-
|
|
The estimated fair
value of short-term financial instruments, including cash, accounts receivable, accounts payable and accrued liabilities and deferred
revenue approximates their carrying value due to their short-term nature. The estimated fair value of our long-term borrowings
approximates carrying value since the related rates of interest approximate current market rates.
Note 5. Common and Preferred Stock
Transactions
During the three months
ended March 31, 2014, 400,000 common shares previously granted to employees of the Company in 2012 vested. Stock compensation
that was previously accrued totaling $7,900 was reclassified from accrued liabilities to stockholders’ equity associated
with these shares vesting.
As
of
March 31, 2014
, we have determined that we currently have (i)
the following shares of common stock issued, and (ii) outstanding shares of preferred stock which are convertible into the shares
of common stock indicated below and a contractual commitment to issue the shares of common stock indicated below:
|
999,385,151
|
|
|
Common Stock Granted and Outstanding
|
|
150,000
|
|
|
Common Stock Granted and Outstanding, but not vested
|
|
4,309,983
|
|
|
Common Shares Company Is Obligated to Reimburse to officers of the Company
for pledged shares sold and transferred on the Company’s behalf
|
|
24,250,000
|
|
|
Common Shares convertible from Preferred Series A Stock (48,500 shares outstanding)
|
|
27,274
|
|
|
Common Shares convertible from Preferred Series B Stock (7,200 shares outstanding)
|
|
5,000,000
|
|
|
Common Shares convertible from Preferred Series C Stock (50,000 shares outstanding)
|
|
94,700
|
|
|
Common Shares convertible from Preferred Series D Stock (25,000
shares outstanding)
|
|
1,033,217,108
|
|
|
Total Common Shares Outstanding and Accounted For/Reserved
|
In addition, the Company
has $30,000 in an outstanding convertible debenture that had been issued to a third party.
Accordingly, given
the fact that the Company currently has 1,000,000,000 shares of common stock authorized, the Company could exceed its authorized
shares of common stock by approximately 33,600,000 shares if all of the financial instruments described in the table above were
exercised or converted into shares of common stock (which does not include the shares that would be converted from the $30,000
outstanding debenture noted above).
We have evaluated
our convertible cumulative preferred stock under the guidance set out in FASB ASC 470-20 and have accordingly classified these
shares as temporary equity in the consolidated balance sheets.
Note 6. Stock Options, Warrants and Restricted Stock Awards
Stock Options and Warrants
There
are currently no outstanding common stock options or warrants.
Restricted Stock
A summary of the activity
of the restricted stock for the three months ended March 31, 2014 is shown below.
|
|
Shares
|
|
|
Weighted
Average
Grant-Date
Fair Value
|
|
|
|
|
|
|
|
|
Non Vested Balance at December 31, 2013
|
|
|
550,000
|
|
|
$
|
0.0186
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
Vested
|
|
|
(400,000
|
)
|
|
|
0.0198
|
|
Forfeited/Cancelled
|
|
|
-
|
|
|
|
-
|
|
Non Vested Balance at March 31,
2014
|
|
|
150,000
|
|
|
$
|
0.0155
|
|
As of March 31, 2014,
there was $191 of total unrecognized compensation costs related to stock awards. These costs are expected to be recognized over
a weighted average period of less than 3 years.
Note 7. Related Party Transactions
The following table
reflects our related party debt activity for the three months ended March 31, 2014:
December 31, 2013
|
|
$
|
344,158
|
|
Repayments of related party notes
|
|
|
(20,992
|
)
|
March 31, 2014
|
|
$
|
323,166
|
|
As of March 31, 2014 and December 31,
2013, the Company had accounts payable to two employees in an aggregate amount of $23,594. The payables are unsecured, non-interest
bearing and due on demand.
Note 8. Legal Proceedings
We are involved in
the following ongoing legal matters:
On November 18, 2009,
we sued InfiniTek Corporation (“
InfiniTek
”) in the Texas State District Court in Fort Worth, Texas for breach
of contract and other claims (the “
Texas Action”
) seeking equitable relief and unspecified damages when a dispute
between the Company and InfiniTek was not resolved. All agreements with InfiniTek have been cancelled. On January 15, 2010, InfiniTek
filed a counter-claim for non-payment of amounts billed. InfiniTek claimed it was owed $195,000 plus lost opportunity costs of
not less than $220,000.
On April 7, 2010,
we were served with a lawsuit filed by InfiniTek in the California Superior Court in Riverside, California seeking damages in
excess of $76,303 for breach of contract and lost profit (the “
California Action
”). This lawsuit related to
one of the causes of action and the same set of underlying facts, as those in the Texas legal action. On May 7, 2010, we filed
a motion to dismiss this action. On July 14, 2010, the court denied our motion. On August 13, 2010, we filed an answer to InfiniTek’s
complaint, including a denial and affirmative defenses.
On December 31, 2011,
the Company and InfiniTek entered into a settlement agreement whereby the Texas Action and the California Action were both dismissed.
Pursuant to the terms of the settlement agreement, Vertical agreed to pay InfiniTek $82,500 in three equal installments with the
last payment due by or before August 5, 2012. Upon full payment, InfiniTek shall transfer and assign ownership of the NAVPath
software developed by InfiniTek for use with NOW Solutions emPath® software application and Microsoft Dynamics NAV (formerly
Navision) business solution platform. The amounts in dispute were included in our accounts payable and accrued liabilities and
have been adjusted to the settlement amount of $82,500 at December 31, 2011. The Company has made $37,500 in payments due under
the settlement agreement as of November 16, 2012 and each party is alleging the other party is in breach of the settlement agreement.
We are currently seeking to resolve all disputes with InfiniTek.
On November 15, 2010,
we filed a lawsuit in the Federal District Court for the Eastern District of Texas (the “
Vertical Action
”)
against Interwoven, Inc. ("
Interwoven
"), LG Electronics MobileComm U.S.A., Inc., LG Electronics, Inc., Samsung
Electronics Co., Ltd. and Samsung Electronics America, Inc. (collectively, the "
Defendants
"). We sued the Defendants
for patent infringement claims under United States Patent No. 6,826,744 (“System and Method for Generating Web Sites in
an Arbitrary Object Framework”) and United States Patent No. 7,716,629 (“System and Method for Generating Web Sites
in an Arbitrary Object Framework”) (collectively the “
the Patents-in-Suit
”), both of which are owned
by the Company. We seek an award of monetary damages and other relief. The case is styled Vertical Computer Systems, Inc. v Interwoven,
Inc., LG Electronics Mobilecomm U.S.A., Inc., No. 2:10-CV-00490.
On November 17, 2010,
we were served with a lawsuit filed on October 14, 2010 by Interwoven in the United States District Court for the Northern District
of California (the “
Interwoven Action
”). This lawsuit was instituted as a complaint for declaratory judgment,
in which Interwoven requested that the court find that no valid and enforceable claim of either of the two patents referenced
above has been infringed by Interwoven. The case is styled Interwoven, Inc. v Vertical Computer Systems, Inc. No. 3:10-CV-4645-RS.
On January 11, 2011,
Samsung Electronics Co., Ltd. and Samsung Electronics America, Inc. (“
Samsung
”) filed a lawsuit in the United
States District Court for the Northern District of California seeking to consolidate its lawsuit with the Interwoven Action. This
case is styled Samsung Electronics Co., Ltd. and Samsung Electronics America, Inc., v. Vertical Computer Systems, Inc., No. 3:11-CV-00189-RS.
On May 2, 2011, the
United States District Court for the Northern District of California denied Vertical’s renewed motion to transfer the Interwoven
Action to the Eastern District of Texas and granted Vertical's motion to transfer the lawsuit filed by Samsung in the Northern
District of California to the Eastern district in Texas. On May 11, 2011, the United States District Court for the Eastern District
of Texas granted Interwoven’s motion to transfer the case to the Northern District of California with respect to Interwoven
and denied Samsung’s motion to transfer its case to the Northern district.
On December 30, 2011,
the United States District Court for the Northern District of California issued a claims construction order in the Interwoven
Action concerning the terms found in the claims of the Patents-in-Suit.
On October 12, 2012,
the United States Patent and Trademark Office (“
USPTO
”) issued an ex parte reexamination certificate of United
States Patent No. 7,716,629. In the ex parte reexamination certificate, Claims 21-36, 29, 30, and 32 were confirmed; Claims
1, 8, 11, 13, 28 and 31 were determined to be patentable as amended, Claims 2-6, 9, 10, 12, 14-17, 19 and 20, which were dependent
on an amended claim, were determined to be patentable, and claims 7, 18 and 27 were not reexamined.
On October 25, 2012,
the USPTO notified the Company of its intent to issue an ex parte reexamination certificate concerning the ex parte reexamination
of United States Patent No. 6,826,744. In the notice of intent to issue ex parte reexamination certificate, the USPTO notified
that the prosecution on the merits is closed in this ex parte reexamination proceeding and indicated that Claims 6, 8, 19, 22,
30, 32, 41, 44, 50, 51 were confirmed; Claims 1 and 26 were cancelled; Claims 12-17, 20, 34-39, 42 and 43 are not subject to reexamination;
newly presented Claims 54-57 are patentable and continuation of patent claims amended: 2-5, 7, 9-11, 18, 21, 23-25, 27-29, 31,
33, 40, 45-49, 52 and 53.
On January 4, 2013,
the United States District Court for the Northern District of California in the Interwoven Action denied Interwoven’s motion
for summary judgment for unenforceability and invalidity of the Patents-in-Suit in its entirety.
On July 17, 2013,
the United States District Court for the Northern District of California in the Interwoven Action ruled on Interwoven’s
motion for summary judgment with respect to infringement and damages concerning the Patents-in-Suit. The court denied Interwoven’s
motion for summary judgment on the issue of direct infringement and granted summary judgment in favor of Interwoven with respect
to infringement on the doctrine of equivalents and with respect to indirect infringement. The court also granted in part and denied
in part Interwoven’s motion to exclude certain expert witness testimony.
On September 16, 2013,
the United States District Court for the Eastern District of Texas issued a claims construction order in the Vertical Action concerning
the terms found in the claims of the Patents-in-Suit. On December 12, the Company settled the patent infringement claim that the
Company initiated in federal court against LG. Pursuant to the confidential settlement agreement, the Company has granted to LG
a non-exclusive, fully paid-up license under the two patents (“
Patents-in-Suit
”) with any continuation patents
of the Patents-in-Suit and any other continuation patents with the same priority claim as the Patents-in-Suit.
On December 12, 2013,
the Company settled its patent infringement claim against LG Electronics. Pursuant to the confidential settlement agreement, the
Company granted to LG Electronics a non-exclusive, fully paid-up license under the Patents-in-Suit which were the subject of the
legal proceeding. The litigation concerning the Patents-in-Suit with LG has been resolved.
On March 20, 2014,
the Company settled the patent infringement claim that the Company initiated in federal court against Samsung. Pursuant to the
confidential settlement agreement, the Company has granted to Samsung a non-exclusive, fully paid-up license under the Patents-in-Suit
with any continuation patents of the Patents-in-Suit and any other patents with the same priority claim as the Patents-in-Suit.
The litigation concerning the Patents-in-Suit with Samsung has been resolved.
On May 8, 2014, the
Company settled the patent infringement claim that the Company initiated in federal court against Interwoven. Pursuant to the
confidential settlement agreement, the Company has granted to Interwoven and its subsidiaries, affiliates and parent companies
(which include Autonomy Corporation PLC and Hewlett-Packard Company, Inc.), a non-exclusive, fully paid-up license to the Patents-in-Suit
with any continuation patents of the Patents-in-Suit and any other patents with the same priority claim as the Patents-in-Suit.
The Interwoven Action has been resolved.
On July 8, 2011, we
were served with a lawsuit in the Texas State District Court in Dallas, Texas by Clark Consulting Services, Inc. (“
CCS
”)
for breach of contract and other claims. CCS was seeking damages from us in excess of $133,750 plus attorney’s fees
and interest. On August 8, 2011, we filed an answer denying CCS’s claims and setting forth affirmative defenses.
In December 2011, the Company and CCS entered into a settlement agreement whereby the lawsuit was dismissed. Pursuant to the terms
of the settlement agreement, the Company agreed to pay CCS $134,000, which was to be paid in installment payments. Due to the
Company’s failure to make timely payments, an additional $60,000 was added to the outstanding balance. On October 26, 2012,
we entered into an agreement under which we agreed to make monthly payments of $5,000 and pay the outstanding balance plus attorney’s
fees and costs by February 1, 2013. As of December 31, 2012, the settlement amount of $149,000 has been included in accounts payable
and accrued liabilities. During 2013, the parties entered into several agreements to extend the date by which the Company has
to pay off the balance of the settlement amount whereby. Under these agreements, the Company agreed to make monthly payments of
$10,000 (of which $2,500 of each payment would be applied as late fees) beginning in February 2013 through November 2013 until
the outstanding balance has been paid. As of May 15, 2014, the outstanding settlement balance is $50,500.
On October 11 2012,
Micro Focus (US), Inc. (“
Micro Focus
”) filed a lawsuit against NOW Solutions in the United States District
Court for the southern division district of Maryland alleging breaches of its contractual obligations under an independent software
agreement and copyright infringement. On January 28, 2013, NOW Solutions and Micro Focus entered into a settlement agreement whereby
NOW Solutions agreed to pay Micro Focus $420,000, of which $70,000 in installment payments were made with the outstanding balance
due on April 30, 2013. In connection with the settlement, the Company entered into a guaranty agreement with Micro Focus concerning
NOW Solutions’ obligations under the promissory note. The Company did not make the $375,000 payment due to Micro Focus.
On May 15, 2013, Vertical was served with a lawsuit in the Circuit Court for Montgomery County, Maryland by Micro Focus concerning
the guaranty by Vertical to Micro Focus concerning NOW Solutions’ failure to make payment of the outstanding balance due
under the promissory note. On July 3, 2013, NOW Solutions was served with a lawsuit for a confessed judgment in the Circuit Court
for Montgomery County, Maryland by Micro Focus concerning NOW Solutions’ failure to make payment of the outstanding balance
due under the promissory note. On January 15, 2014, the Company and NOW Solutions consented to a judgment in the amount of $350,000,
plus $36,000 in accrued interest and attorney’s fees in the amount of $80,000, plus accrued interest at the rate of 10%
per annum until paid. As of May 15, 2014, the Company has made payments in the amount of $250,000 to Micro Focus.
On February 4, 2014,
Victor Weber filed a lawsuit against Vertical Mountain Reservoir Corporation (“
MRC
”), and Richard Wade in the
District Court of Clark County, Nevada for failure to make payment of the outstanding balance due under a $275,000 promissory
note issued by Vertical to Mr. Weber. The plaintiff seeks payment of the principal balance due under the note $275,000, default
interest at the rate of 18% per annum, attorney’s fees and court costs, and punitive damages. On April 14, the Company and
MRC filed an answer to Mr. Weber’s complaint. We are currently seeking to resolve this matter with Mr. Weber. Mr. Wade is
the President and CEO of Vertical and the President of MRC. MRC is a corporation controlled by the W5 Family Trust. Mr. Wade is
the trustee of the W5 Family Trust.
Note
9. Subsequent Events
In April 2014, the
Company and a third party lender entered into a loan agreement under which the lender loaned Vertical $150,000. Pursuant to the
loan agreement, Vertical issued a promissory note in the principal amount of $150,000 bearing interest at 12% per annum and due
by May 15, 2014. In connection with the loan, the company is obligated to pay a commitment fee of $14,500 and other payments
totaling $43,500 owed to the lender under previous contractual obligations with the lender by May 15, 2014. All amounts due under
this loan agreement have been repaid.
In May 2014, the Company
and a third party lender entered into a loan agreement under which the lender loaned Vertical $81,282. Pursuant to the loan agreement,
Vertical issued a promissory note in the principal amount of $81,282, bearing interest at 12% per annum and due by May 31, 2014.
In connection with the loan, the company is obligated to pay a commitment fee of $7,500 and other payments totaling $95,500
owed to the lender under previous contractual obligations with the lender by May 31, 2014.
During the period
that runs from April 1, 2014 through May 15, 2014, 150,000 shares granted to a consultant of the Company in 2012, valued at $2,325,
vested.
For subsequent events
concerning parties we are involved in litigation with, please see “Legal Proceedings” under Note 8.