UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2014
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission file number 0-28685
VERTICAL COMPUTER SYSTEMS, INC.
(Exact name of registrant as specified in its
charter)
Delaware |
65-0393635 |
(State of incorporation) |
(I.R.S. Employer Identification No.) |
101 West Renner Road, Suite 300
Richardson, TX 75082
(Address of principal executive offices)
(972) 437-5200
(Registrant’s Telephone Number)
Indicate by check mark whether the registrant
(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
has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted
and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter
period that the registrant was required to submit and post such files).
Yes
x No ¨
Indicate by check mark whether the registrant
is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions
of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of
the Exchange Act.
Large accelerated filer |
¨ |
|
Accelerated filer |
¨ |
Non-accelerated filer |
¨ |
(Do not check if a smaller reporting company) |
Smaller reporting company |
x |
Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes ¨ No x
As of August 19, 2014, the issuer had 999,535,151
shares of common stock, par value $0.00001, issued and outstanding.
PART I
FINANCIAL INFORMATION
Item 1. Consolidated
Financial Statements
Vertical Computer Systems, Inc. and Subsidiaries
Consolidated Balance Sheets
(Unaudited)
| |
June 30, | | |
December 31, | |
| |
2014 | | |
2013 | |
Assets | |
| | | |
| | |
Current assets | |
| | | |
| | |
Cash | |
$ | 111,015 | | |
$ | 162,709 | |
Accounts receivable, net of allowance for bad debts of $55,847 and $83,326 | |
| 252,955 | | |
| 562,831 | |
Prepaid expenses and other current assets | |
| 101,539 | | |
| 87,930 | |
Total current assets | |
| 465,509 | | |
| 813,470 | |
| |
| | | |
| | |
Property and equipment, net of accumulated depreciation of $1,031,090 and $1,028,102 | |
| 20,946 | | |
| 22,596 | |
Intangible assets, net of accumulated amortization of $281,003 and $259,835 | |
| 658,592 | | |
| 992,996 | |
Deposits and other | |
| 31,423 | | |
| 31,520 | |
| |
| | | |
| | |
Total assets | |
$ | 1,176,470 | | |
$ | 1,860,582 | |
| |
| | | |
| | |
Liabilities and Stockholders’ Deficit | |
| | | |
| | |
Current liabilities: | |
| | | |
| | |
Accounts payable and accrued liabilities | |
$ | 9,722,253 | | |
$ | 9,763,921 | |
Accounts payable to related parties | |
| 23,594 | | |
| 23,594 | |
Bank overdraft | |
| 5,049 | | |
| 1,928 | |
Deferred revenue | |
| 2,108,801 | | |
| 2,317,989 | |
Derivative liability | |
| 157,745 | | |
| 263,340 | |
Convertible debenture | |
| 30,000 | | |
| 30,000 | |
Current portion - notes payable | |
| 3,056,307 | | |
| 3,006,561 | |
Current portion - notes payable to related parties | |
| 323,166 | | |
| 344,158 | |
Total current liabilities | |
| 15,426,915 | | |
| 15,751,491 | |
| |
| | | |
| | |
Non-current portion – notes payable | |
| 1,373,966 | | |
| 1,505,951 | |
| |
| | | |
| | |
Total liabilities | |
| 16,800,881 | | |
| 17,257,442 | |
See accompanying notes to the unaudited consolidated
financial statements.
(Continued on next page)
Vertical Computer Systems, Inc. and Subsidiaries
Consolidated Balance Sheets
(Unaudited)
(Continued from previous page)
| |
June 30, | | |
December 31, | |
| |
2014 | | |
2013 | |
Series A 4% Convertible Cumulative Preferred stock; $0.001 par value; 250,000 shares authorized; 48,500 shares issued and outstanding | |
| 9,700,000 | | |
| 9,700,000 | |
Series B 10% Convertible Cumulative Preferred stock; $0.001 Par Value; 375,000 shares authorized; 7,200 shares issued and outstanding | |
| 246 | | |
| 246 | |
Series C 4% Convertible Cumulative Preferred stock; $100.00 par value; 200,000 shares authorized; 50,000 shares issued and outstanding | |
| 200,926 | | |
| 200,926 | |
Series D 15% Convertible Cumulative Preferred stock; $0.001 Par Value; 300,000 shares authorized; 25,000 shares issued and outstanding | |
| 852 | | |
| 852 | |
| |
| 9,902,024 | | |
| 9,902,024 | |
| |
| | | |
| | |
Stockholders' Deficit | |
| | | |
| | |
Common Stock; $.00001 par value; 1,000,000,000 shares authorized 999,535,151 and 998,985,151 issued and outstanding as of June 30, 2014 and December 31, 2013 | |
| 9,996 | | |
| 9,990 | |
Additional paid-in-capital | |
| 19,430,733 | | |
| 19,420,513 | |
Accumulated deficit | |
| (46,135,243 | ) | |
| (45,691,721 | ) |
Accumulated other comprehensive income – foreign currency translation | |
| 34,118 | | |
| (118,548 | ) |
| |
| | | |
| | |
Total Vertical Computer Systems, Inc. stockholders’ deficit | |
| (26,660,396 | ) | |
| (26,379,766 | ) |
| |
| | | |
| | |
Noncontrolling interest | |
| 1,133,961 | | |
| 1,080,882 | |
Total stockholders’ deficit | |
| (25,526,435 | ) | |
| (25,298,884 | ) |
| |
| | | |
| | |
Total liabilities and stockholders' deficit | |
$ | 1,176,470 | | |
$ | 1,860,582 | |
See accompanying notes to the unaudited consolidated
financial statements.
Vertical Computer Systems, Inc. and Subsidiaries
Consolidated Statements of Operations and
Comprehensive Loss
(Unaudited)
| |
Three Months Ended June 30, | | |
Six Months Ended June 30, | |
| |
2014 | | |
2013 | | |
2014 | | |
2013 | |
Revenues | |
| | | |
| | | |
| | | |
| | |
Licensing and software | |
$ | 1,725,180 | | |
$ | 72,720 | | |
$ | 2,600,180 | | |
$ | 72,720 | |
Software maintenance | |
| 971,704 | | |
| 1,130,321 | | |
| 1,998,067 | | |
| 2,216,200 | |
Cloud-based offering | |
| 96,694 | | |
| 102,743 | | |
| 206,610 | | |
| 221,811 | |
Consulting services | |
| 130,732 | | |
| 128,031 | | |
| 208,832 | | |
| 238,768 | |
Other | |
| 17,941 | | |
| 20,796 | | |
| 32,580 | | |
| 48,940 | |
Total revenues | |
| 2,942,251 | | |
| 1,454,611 | | |
| 5,046,269 | | |
| 2,798,439 | |
| |
| | | |
| | | |
| | | |
| | |
Cost of revenues | |
| 610,765 | | |
| 633,334 | | |
| 1,197,483 | | |
| 1,296,950 | |
| |
| | | |
| | | |
| | | |
| | |
Gross profit | |
| 2,331,486 | | |
| 821,277 | | |
| 3,848,786 | | |
| 1,501,489 | |
| |
| | | |
| | | |
| | | |
| | |
Operating expenses: | |
| | | |
| | | |
| | | |
| | |
Selling, general and administrative expenses | |
| 1,895,597 | | |
| 734,499 | | |
| 3,328,550 | | |
| 1,553,034 | |
Depreciation and amortization | |
| 11,446 | | |
| 13,175 | | |
| 23,365 | | |
| 27,273 | |
Impairment of software costs | |
| 192,956 | | |
| - | | |
| 385,911 | | |
| - | |
Total operating expenses | |
| 2,099,999 | | |
| 747,674 | | |
| 3,737,826
| | |
| 1,580,307 | |
| |
| | | |
| | | |
| | | |
| | |
Operating income (loss) | |
| 231,487 | | |
| 73,603 | | |
| 110,960 | | |
| (78,818 | ) |
| |
| | | |
| | | |
| | | |
| | |
Other income (expense): | |
| | | |
| | | |
| | | |
| | |
Gain (loss) on derivative liability | |
| 100,854 | | |
| (13,100 | ) | |
| 105,595 | | |
| (6,550 | ) |
Forbearance fees | |
| (88,301 | ) | |
| (15,000 | ) | |
| (161,602 | ) | |
| (20,325 | ) |
Interest expense | |
| (232,902 | ) | |
| (159,708 | ) | |
| (446,416 | ) | |
| (305,752 | ) |
| |
| | | |
| | | |
| | | |
| | |
Net income (loss) | |
| 11,138 | | |
| (114,205 | ) | |
| (391,463 | ) | |
| (411,445 | ) |
Net income (loss) attributable to noncontrolling interest | |
| (51,403 | ) | |
| 34,875 | | |
| (52,059 | ) | |
| 47,617 | |
Net loss attributable to Vertical Computer Systems, Inc. | |
| (40,265 | ) | |
| (79,330 | ) | |
| (443,522 | ) | |
| (363,828 | ) |
Dividends applicable to preferred stock | |
| (147,000 | ) | |
| (147,000 | ) | |
| (294,000 | ) | |
| (294,000 | ) |
| |
| | | |
| | | |
| | | |
| | |
Net loss available to common stockholders | |
$ | (187,265 | ) | |
$ | (226,330 | ) | |
$ | (737,522 | ) | |
$ | (657,828 | ) |
| |
| | | |
| | | |
| | | |
| | |
Basic and diluted net loss per share | |
$ | (0.00 | ) | |
$ | (0.00 | ) | |
$ | (0.00 | ) | |
$ | (0.00 | ) |
| |
| | | |
| | | |
| | | |
| | |
Basic and diluted weighted average of common shares outstanding | |
| 999,484,052 | | |
| 998,434,052 | | |
| 999,305,593 | | |
| 998,255,593 | |
| |
| | | |
| | | |
| | | |
| | |
Comprehensive loss | |
| | | |
| | | |
| | | |
| | |
Net income (loss) | |
$ | 11,138 | | |
$ | (114,205 | ) | |
$ | (391,463 | ) | |
$ | (411,445 | ) |
Translation adjustments | |
| 40,428 | | |
| 68,035 | | |
| 152,666 | | |
| 112,839 | |
Comprehensive income (loss) | |
| 51,566 | | |
| (46,170 | ) | |
| (238,797 | ) | |
| (298,606 | ) |
Comprehensive income (loss) attributable to noncontrolling interest | |
| (51,403 | ) | |
| 34,875 | | |
| (52,059 | ) | |
| 47,617 | |
Comprehensive income (loss) attributable to Vertical Computer Systems, Inc. | |
$ | 163 | | |
$ | (11,295 | ) | |
$ | (290,856 | ) | |
$ | (250,989 | ) |
See accompanying notes to the unaudited consolidated
financial statements.
Vertical Computer Systems, Inc. and Subsidiaries
Consolidated Statement of Stockholders’
Deficit
December 31, 2013 through June 30, 2014
(Unaudited)
| |
| | |
| | |
Additional | | |
| | |
Other | | |
Non-controlling | | |
| |
| |
Common Stock | | |
Paid-in | | |
Accumulated | | |
Comprehensive | | |
Controlling | | |
| |
| |
Shares | | |
Amount | | |
Capital | | |
Deficit | | |
Interest | | |
Interest | | |
Total | |
Balances at December 31, 2013 | |
| 998,985,151 | | |
$ | 9,990 | | |
$ | 19,420,513 | | |
$ | (45,691,721 | ) | |
$ | (118,548 | ) | |
$ | 1,080,882 | | |
$ | (25,298,884 | ) |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Shares issued for stock
compensation that was previously accrued | |
| 550,000 | | |
| 6 | | |
| 10,220 | | |
| - | | |
| - | | |
| - | | |
| 10,226 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Other comprehensive income
translation adjustment | |
| - | | |
| - | | |
| - | | |
| - | | |
| 152,666 | | |
| 1,020 | | |
| 153,686 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Net
(loss) income | |
| - | | |
| - | | |
| - | | |
| (443,522 | ) | |
| - | | |
| 52,059 | | |
| (391,463 | ) |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Balances at June
30, 2014 | |
| 999,535,151 | | |
$ | 9,996 | | |
$ | 19,430,733 | | |
$ | (46,135,243 | ) | |
$ | 34,118 | | |
$ | 1,133,961 | | |
$ | (25,526,435 | ) |
See
accompanying notes to the unaudited consolidated financial statements.
Vertical
Computer Systems, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
| |
Six Months Ended June 30, | |
| |
2014 | | |
2013 | |
| |
| | |
| |
Cash flows from operating activities | |
| | | |
| | |
Net loss | |
$ | (391,463 | ) | |
$ | (411,445 | ) |
Adjustments to reconcile net loss to net cash used in operating activities: | |
| | | |
| | |
Depreciation and amortization | |
| 23,365 | | |
| 27,273 | |
Impairment of software development costs | |
| 385,911 | | |
| - | |
Loss (Gain) on derivatives | |
| (105,595 | ) | |
| 6,550 | |
Changes in operating assets and liabilities: | |
| | | |
| | |
Accounts receivable | |
| 309,876 | | |
| 147,516 | |
Prepaid expenses and other assets | |
| (13,512 | ) | |
| (51,459 | ) |
Accounts payable and accrued liabilities | |
| (31,357 | ) | |
| 536,507 | |
Deferred revenue | |
| (209,188 | ) | |
| (396,865 | ) |
Net cash used in operating activities | |
| (31,963 | ) | |
| (141,923 | ) |
| |
| | | |
| | |
Cash flow from investing activities: | |
| | | |
| | |
Software development | |
| (71,984 | ) | |
| (44,518 | ) |
Purchase of property and equipment | |
| (575 | ) | |
| (3,476 | ) |
Net cash used in investing activities | |
| (72,559 | ) | |
| (47,994 | ) |
| |
| | | |
| | |
Cash flows from financing activities: | |
| | | |
| | |
Borrowings on notes payable | |
| 261,282 | | |
| 1,834,150 | |
Payments of notes payable | |
| (343,598 | ) | |
| (1,448,558 | ) |
Payments on related party debt | |
| (20,992 | ) | |
| (381,583 | ) |
Bank overdraft | |
| 3,121 | | |
| (1,842 | ) |
Net cash provided by (used in) financing activities | |
| (100,187 | ) | |
| 2,167 | |
| |
| | | |
| | |
Effect of changes in exchange rates on cash | |
| 153,015 | | |
| 112,839 | |
Net change in cash and cash equivalents | |
| (51,694 | ) | |
| (74,911 | ) |
Cash and cash equivalents, beginning of period | |
| 162,709 | | |
| 111,851 | |
Cash and cash equivalents, end of period | |
$ | 111,015 | | |
$ | 36,940 | |
| |
| | | |
| | |
Supplemental disclosures of cash flow information: | |
| | | |
| | |
Cash paid for interest | |
$ | 142,861 | | |
$ | 169,018 | |
| |
| | | |
| | |
Non-cash investing and financing activities: | |
| | | |
| | |
Common shares issued for accrued stock compensation | |
| 10,226 | | |
| 10,226 | |
See accompanying notes to unaudited consolidated
financial statements.
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 six months ended
June 30, 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 six months ended June 30, 2014, the Company capitalized an aggregate of $71,984 related to software development and the Company
recorded impairment of $385,911 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 six months ended June 30, 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 June 30, 2014, we had negative working capital of approximately $15.0 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 six months ended June 30, 2014:
December 31, 2013 | |
$ | 4,542,512 | |
Repayments of third party notes | |
| (343,598 | ) |
Borrowings from third parties | |
| 261,282 | |
Currency translation | |
| 77 | |
June 30, 2014 | |
$ | 4,460,273 | |
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.
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 was 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 was 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. All amounts due under this loan agreement
have been repaid.
In April 2014, the Company and a third party lender entered into a loan agreement under which the lender loaned
Vertical $30,000. Pursuant to the loan agreement, Vertical agreed to pay a commitment fee of $1,500 and issued a promissory note
in the principal amount of $30,000 bearing interest at 11% per annum and due in ninety days. The note and commitment fee
have not been paid.
During the six months ended
June 30, 2014 and 2013, the Company made interest payments of $142,861 and $169,018, respectively.
Note 4. Derivative liability and fair value
measurements
Derivative liability
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 June 30,
2014 and December 31, 2013, the aggregate fair value of the derivative liabilities was $157,745 and $263,340.
The aggregate change in
the fair value of derivative liabilities was a gain of $105,595 and a loss of $6,550 for the six months ended June 30, 2014 and
2013, respectively.
The valuation of our embedded
derivatives is determined by using the VCSY stock price at June 30, 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 June 30, 2014 and December 31, 2013:
| |
Fair value measurements on a recurring basis | |
| |
Level 1 | | |
Level 2 | | |
Level 3 | |
As of June 30, 2014: | |
| | | |
| | | |
| | |
Liabilities | |
| | | |
| | | |
| | |
Stock derivative – 4,309,983 shares | |
$ | 157,745 | | |
$ | - | | |
$ | - | |
| |
| | | |
| | | |
| | |
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 six months ended
June 30, 2014, 550,000 common shares granted to employees of the Company and a consultant of the Company, valued at $10,226, vested.
As of June 30, 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:
| 999,535,151 | | |
Common Stock Granted and Outstanding |
| 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 33,000,000 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 six months ended June 30, 2014 is shown below.
| |
Shares | | |
Weighted Average Grant- Date Fair Value | |
Non Vested Balance at December 31, 2013 | |
| 550,000 | | |
$ | 0.0186 | |
Granted |
| |
| - | | |
| - | |
Vested |
| |
| (550,000 | ) | |
| 0.0186 | |
Forfeited/Cancelled |
| |
| - | | |
| - | |
Non Vested Balance at June 30, 2014 | |
| - | | |
| - | |
As of June 30, 2014, there
were no unrecognized compensation costs related to stock awards.
Note 7. Related Party Transactions
The following table reflects
our related party debt activity for the six months ended June 30, 2014:
December 31, 2013 | |
$ | 344,158 | |
Repayments of related party notes | |
| (20,992 | ) |
June 30, 2014 | |
$ | 323,166 | |
As of June 30, 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
sought an award of monetary damages and other relief. The case was 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 was 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
was 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 August 19, 2014, the outstanding settlement balance is $20,922.
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 August 19, 2014, all payments have been made and this matter has been resolved.
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 July 24 2014, the court granted plaintiff’s
motion for summary judgment against defendants. 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
For subsequent events concerning
parties we are involved in litigation with, please see “Legal Proceedings” under Note 8.
Item
2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion
is a summary of the key factors management considers necessary or useful in reviewing the Company’s results of operations,
liquidity and capital resources. The following discussion and analysis should be read together with the accompanying Unaudited
Consolidated Financial Statements, and the cautionary statements and risk factors included below in Item 1A of Part II of this
Report.
Critical Accounting Policies
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 six months ended
June 30, 2014 and 2013, $71,984 and $44,518 of internal costs were capitalized, respectively, and the Company recorded impairment
of $385,911 on previously capitalized software development costs during the six months ended June 30, 2014.
Revenue Recognition
Our revenue recognition
policies are in accordance with standards on software revenue recognition, which include guidance on revenue arrangements with
multiple deliverables and arrangements that include the right to use of software stored on another entity’s hardware.
In the case of non-software
arrangements, we apply the guidance on revenue arrangements with multiple deliverables and wherein multiple elements are allocated
to each element based on the element’s relative fair value. Revenue allocated to separate elements is recognized for each
element in accordance with our accounting policies described below. If we cannot account for items included in a multiple-element
arrangement as separate units of accounting, they are combined and accounted for as a single unit of accounting and generally recognized
as the undelivered items or services are provided to the customer.
Consulting. We provide
consulting services, primarily implementation and training services, to our clients using a time and materials pricing methodology.
The Company prices its delivery of consulting services on a time and materials basis where the customer is either charged an agreed-upon
daily rate plus out-of-pocket expenses or an hourly rate plus out-of-pocket expenses. In this case, the Company is paid fees and
other amounts generally on a monthly basis or upon the completion of the deliverable service and recognizes revenue as the services
are performed.
Software License.
We sell concurrent perpetual software licenses to our customers. The license gives the customer the right to use the software without
regard to a specific term. We recognize the license revenue upon execution of a contract and delivery of the software, provided
the license fee is fixed and determinable, no significant production, modification or customization of the software is required
and collection is considered probable by management. When the software license arrangement requires the Company to provide consulting
services that are essential to the functionality of the software, the product license revenue is recognized upon the acceptance
by the customer and consulting fees are recognized as services are performed.
Software licenses are generally
sold as part of a multiple-element arrangement that may include maintenance and, under a separate agreement, consulting services.
The consulting services are generally performed by the Company, but the customer may use a third-party to perform the consulting
services. We consider these separate agreements as being negotiated as a package. The Company determines whether there is vendor
specific objective evidence of fair value (‘‘VSOEFV’’) for each element identified in the arrangement,
to determine whether the total arrangement fees can be allocated to each element. If VSOEFV exists for each element, the total
arrangement fee is allocated based on the relative fair value of each element. In cases where there is not VSOEFV for each element,
or if it is determined that services are essential to the functionality of the software being delivered, we initially defer revenue
recognition of the software license fees until VSOEFV is established or the services are performed. However, if VSOEFV is determinable
for all of the undelivered elements, and assuming the undelivered elements are not essential to the delivered elements, we will
defer recognition of the full fair value related to the undelivered elements and recognize the remaining portion of the arrangement
value through application of the residual method. Where VSOEFV has not been established for certain undelivered elements, revenue
for all elements is deferred until those elements have been delivered or their fair values have been determined. Evidence of VSOEFV
is determined for software products based on actual sales prices for the product sold to a similar class of customer and based
on pricing strategies set forth in the Company’s standard pricing list. Evidence of VSOEFV for consulting services is based
upon standard billing rates and the estimated level of effort for individuals expected to perform the related services. The Company
establishes VSOEFV for maintenance agreements using the percentage method such that VSOEFV for maintenance is a percentage of the
license fee charged annually for a specific software product, which in most instances is 18% of the portion of arrangement fees
allocated to the software license element.
Maintenance Revenue.
In connection with the sale of a software license, a customer may elect to purchase software maintenance services. Most of the
customers that purchase software licenses from us also purchase software maintenance services. These maintenance services are typically
renewed on an annual basis. We charge an annual maintenance fee, which is typically a percentage of the initial software license
fee and may be increased from the prior year amount based on inflation or other agreed upon percentage. The annual maintenance
fee generally is paid to the Company at the beginning of the maintenance period, and we recognize these revenues ratably over the
term of the related contract.
While most of our customers
pay for their annual maintenance at the beginning of the maintenance period, a few customers have payment terms that allow them
to pay for their annual maintenance on a quarterly or monthly basis. If the annual maintenance fee is not paid at the beginning
of the maintenance period (or at the beginning of the quarter or month for those few maintenance customers), we will ratably recognize
the maintenance revenue if management believes the collection of the maintenance fee is imminent. Otherwise, we will defer revenue
recognition until the time that the maintenance fee is paid by the customer. We normally continue to provide maintenance service
while awaiting payment from customers. When the payment is received, revenue is recognized for the period that revenue was previously
deferred. This may result in volatility in software maintenance revenue from period to period.
Cloud-based offering.
We have contracted with third parties to provide new and existing customers with hosting facilities providing all infrastructure
and allowing us to offer our currently sold software, emPath® and SnAPPnet™, on a service basis. However, a contractual
right to take possession of the software license or run it on another party’s hardware is not granted to the customer. We
refer to the delivery method to give functionality to new customers utilizing this service as cloud-based. Since the customer is
not given contractual right to take possession of the software, the scope of ASC 350-40 does not apply. A customer using cloud-based
software can enter into an agreement to purchase a software license at any time. We generate revenue from cloud-based offering
as the customer utilizes the software over the Internet.
We will provide consulting
services to customers in conjunction with the cloud-based offering. The rate for such service is based on standard hourly or daily
billing rates. The consulting revenue is recognized as services are performed. Customers utilizing their own computer to access
cloud-based functionality are charged a fee equal to the number of employees paid each month multiplied by an agreed-upon rate
per employee. The revenue is recognized as the cloud-based services are rendered each month.
Allowances for Doubtful
Accounts
The Company maintains allowances
for doubtful accounts, for estimated losses resulting from the inability of its customers to make required payments. If the financial
condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances
may be required. We review delinquent accounts at least quarterly to identify potential doubtful accounts, and together with customer
follow-up, estimate the amounts of potential losses.
Deferred Taxes
The Company records a valuation
allowance to reduce the deferred tax assets to the amount that management believes is more likely than not to be realized in the
foreseeable future, based on estimates of foreseeable future taxable income and taking into consideration historical operating
information. In the event management estimates that the Company will not be able to realize all or part of its net deferred tax
assets in the foreseeable future, a valuation allowance is recorded through a charge to income in the period such determination
is made. Likewise, should management estimate that the Company will be able to realize its deferred tax assets in the future in
excess of its net recorded assets, an adjustment to reduce the valuation allowance would increase income in the period such determination
is made.
Stock-Based Compensation
Expense
We account for share-based
compensation in accordance with the provisions of share-based payments, which requires measurement of compensation cost for all
stock-based awards at fair value on date of grant and recognition of compensation over the service period for awards expected to
vest. The fair value of restricted stock and restricted stock units is determined based on the number of shares granted and the
quoted price of our common stock. Equity instruments issued to other than employees are valued at the earlier of a commitment date
or upon completion of the services, based on the fair value of the equity instruments, and are recognized as expense over the service
period.
Valuation of the Embedded
and Warrant Derivatives
The valuation of our embedded
derivatives is determined by using the Company’s quoted stock price. An embedded derivative is a derivative instrument that
is embedded within another contract, which under a convertible note (the host contract) includes the right to convert the note
by the holder, certain default redemption right premiums and a change of control premium (payable in cash if a fundamental change
occurs). In accordance with the guidance on derivative instruments, embedded derivatives are marked-to-market each reporting period,
with a corresponding non-cash gain or loss charged to the current period. The practical effect of this has been that when our
stock price increases so does our derivative liability, resulting in a non-cash loss that reduces our earnings and earnings per
share. When our stock price declines, we record a non-cash gain, increasing our earnings and earnings per share.
The fair value recorded
for the derivative liability varies from period to period. This variability may result in the actual derivative liability for
a period either above or below the estimates recorded on our consolidated financial statements, resulting in significant fluctuations
in other income (expense) because of the corresponding non-cash gain or loss recorded.
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.
Results of Operations
Three and six months ended
June 30, 2014 Compared To Three and six months ended June 30, 2013
Total Revenues.
We had total revenues of $2,942,251 and $1,454,611 for the three months ended June 30, 2014 and 2013, respectively. The
increase in total revenues was $1,487,640 for the three months ended June 30, 2014 representing a 102.3% increase compared to
the total revenues for the three months ended June 30, 2013. Substantially all of the revenues for the three months ended June
30, 2013 were related to the business operations of NOW Solutions. Revenue from SnAPPnet, Inc. was $35,135 or 1.2% of total revenues
for the three months ended June 30, 2014 and $33,646 or 2.3% of total revenues for the three months ended June 30, 2013. Revenue
for VCSY was $1,725,000 or 58.6% of total revenues for the three months ended June 30, 2014. VCSY had no revenue for the three
months ended June 30, 2013.
Total revenues for the
three months ended June 30, 2014 and 2013 primarily consist of fees derived from software licenses, consulting services, software
maintenance and Cloud-based offerings. The revenue from new software licenses increased by $1,652,460 compared to that for the
three months ended June 30, 2013, due to new license sales of SiteFlash during the second quarter of 2014. Software maintenance
in the three months ended June 30, 2014 decreased by $158,617 or 14.0% from the same period in the prior year. The revenue decrease
in software maintenance is primarily due to non-renewal of customer contracts and the effects of unfavorable currency rate changes
on our Canadian maintenance revenue partially offset by contractual increases to existing customer maintenance agreements. Consulting
revenue, in the three months ended June 30, 2014 increased by $2,701 from the same period in the prior year, which represents
a 2.1% increase. This increase was due to additional consulting services for version upgrades and enhancements to existing customer
accounts during the second quarter of 2014. Cloud-based revenues were $96,694 for the three months ended June 30, 2014 compared
to $102,743 for the same period in the prior year, representing a $6,049 decrease or 5.9%. The decrease is primarily related to
a customer rate adjustment and a customer user base adjustment during the 3 months ended June 30, 2014 and the effects of unfavorable
currency rate changes on our Canadian cloud-based revenue. Other revenue in the three months ended June 30, 2014 decreased by
$2,855 or 13.7% from the same period in the prior year. Other revenue consists primarily of reimbursable travel expenses, currency
gains and losses, and other miscellaneous revenues.
We had total revenues of
$5,046,269 and $2,798,439 in the six months ended June 30, 2014 and 2013, respectively. The increase in total revenues was $2,247,830
representing a 80.3% increase. Substantially all of the revenues for the six months ended June 30, 2013 were related to the business
operations of NOW Solutions. Revenue from SnAPPnet, Inc. was $89,431 or 1.8% for the six months ended June 30, 2014 and $67,687
or 2.4% for the six months ended June 30, 2013. Revenue for VCSY was $2,600,000 or 51.5% of total revenues for the six months ended
June 30, 2014. VCSY had no revenue for the six months ended June 30, 2013.
Total revenues for the
six months ended June 30, 2014 and 2013 primarily consist of fees derived from software licenses, consulting services, software
maintenance and cloud-based offerings. The revenue from new software licenses increased by $2,527,460 compared to that for the
six months ended June 30, 2013 due to new license sales of SiteFlash during 2014. Software maintenance in the six months ended
June 30, 2014 decreased by $218,133 or 9.8% from the same period in the prior year. The revenue decrease in software maintenance
is primarily due to non-renewal of customer contracts and the effects of unfavorable currency rate changes on our Canadian maintenance
revenue partially offset by contractual increases to existing customer maintenance. Consulting revenue, in the six months ended
June 30, 2014 decreased by $29,936 from the same period in the prior year, which represents a 12.5% decrease. This decrease was
primarily a result of additional consulting services in 2013 for two customers to install emPath modules and to deploy emPath
at additional locations. Cloud-based revenues were $206,610 for the six months ended June 30, 2014 compared to $221,811 for the
same period in the prior year, representing a $15,201 decrease or 6.9%. The decrease is primarily related to a customer rate adjustment
and a customer user base adjustment during the 6 months ended June 30, 2014 and the effects of unfavorable currency rate changes
on our Canadian cloud-based revenue. Other revenue in the six months ended June 30, 2014 decreased by $16,360 or 33,4% from the
same period in the prior year. Other revenue consists primarily of reimbursable travel expenses, currency gains and losses, and
other miscellaneous revenues.
Cost of Revenues.
We had direct costs associated with our revenues of $610,765 for the three months ended June 30, 2014, compared to $633,334
for the three months ended June 30, 2013. The decrease in cost of revenues of $22,569 represents a 3.6% decrease. The decrease
in direct cost of revenues was primarily due to decreased payroll costs somewhat offset by increased royalty fees. During the
three months ended June 30, 2014 and 2013, $38,784 and $38,644 of internal costs were capitalized, respectively.
For the six months ended
June 30, 2014, direct costs of revenues were $1,197,483 compared to $1,296,950 for the same period in 2013 resulting in a decrease
of $99,467 or 7.7%. The decrease in direct cost of revenues was primarily due to decreased payroll costs somewhat offset by increased
royalty fees. During the six months ended June 30, 2014 and 2013, $71,984 and $44,518 of internal costs were capitalized, respectively.
Selling, General
and Administrative Expenses. We had selling, general and administrative expenses of $1,895,597 and $734,499 in the three
months ended June 30, 2014 and 2013, respectively. The increase of $1,161,098 is 158.1% more than the same period in 2013. The
increase is primarily due to increased legal fees to prosecute patent infringement on the company’s intellectual property,
increased consulting fees and increased royalties.
For the six months ended
June 30, 2014 we had $3,328,550 compared to $1,553,034 for the six months ended June 30, 2013. The $1,775,516 or 114.3% increase
is primarily due to increased legal fees to prosecute patent infringement on the company’s intellectual property, increased
foreign taxes, tax penalties, consulting fees and royalties.
Bad Debt Expense.
We had no bad debt expense for the three and six months ended June 30, 2014 and 2013.
Gain (Loss) on Derivative
Liability. The existing derivative liability is adjusted each quarter for changes in the market value of the Company’s
common stock. In general, as our stock price increases, the derivative liability increases, resulting in a loss. As the stock
price decreases, the derivative liability decreases, resulting in a gain. The gain on derivative liability was $100,854 for the
three months ended June 30, 2014 compared to a loss of $13,100 for the same period in 2013. The gain on derivative liability was
$105,595 for the six months ended June 30, 2014 compared to a loss of $6,550 for the six months ended June 30, 2013.
Forbearance Fees.
Forbearance fees relate to fees charged by our lenders on loans in default. Forbearance fees for the three months ended June 30,
2014 were $88,301compared to $15,000 for the three months ended June 30, 2013. The fees are related to our senior secured debt
for Now Solutions. Forbearance fees for the six months ended June 30, 2014 were $161,602 compared to $20,325 for the six months
ended June 30, 2013. The fees are primarily related to our senior secured debt for Now Solutions.
Impairment of Software
Costs. During the three and six months ended June 30, 2014, $192,956 and $385,911, respectively of capitalized software
development costs were considered impaired.
Interest Expense.
We had interest expense of $232,910 and $159,708 for the three months ended June 30, 2014 and 2013, respectively. Interest
expense increased in 2014 by $73,202 representing an increase of 45.8% compared to the same expense in the three months ended
June 30, 2013. The increase was primarily due to interest and commitment fees on new borrowings and interest on accounts payable
balances.
For the six months ended
June 30, 2014, we had net interest expense of $446,432 compared to $305,752 for the same period in 2013, representing a $140,680
or 46.0% increase for the period. The increase was primarily due to interest and commitment fees on new borrowings and interest
on accounts payable balances.
Net Income(loss).
We had net income of $11,138 and net loss of $114,205 for the three months ended June 30, 2014 and 2013, respectively.
The net income for the three months ended June 30, 2014 was due to the factors discussed above for revenues, cost of revenues,
impairment of capitalized software costs and selling, general and administrative expenses, which essentially gave us operating
income of $231,487. This was reduced by interest expense and forbearance fees and increased by a gain on derivative liability,
resulting in net income of $11,138 for the three months ended June 30, 2014. For the three months ended June 30, 2013, the operating
income of $73,603 was reduced by interest expense and a loss on derivative liability, resulting in a net loss of $114,205.
We incurred net losses
of $391,463 and $411,445 for the six months ended June 30, 2014 and 2013, respectively. The changes were due to the reasons discussed
above.
Dividends Applicable
to Preferred Stock. We have outstanding Series A 4% convertible cumulative preferred stock that accrues dividends at a
rate of 4% on a semi-annual basis. The Company also has outstanding Series C 4% convertible cumulative preferred stock that accrues
dividends at a rate of 4% on a quarterly basis. The total dividends applicable to Series A and Series C preferred stock were $147,000
for both the three months ended June 30, 2014 and 2013 and $294,000 for both the six months ended June 30, 2014 and 2013.
Net Loss Available
to Common Stockholders. We had a net loss attributed to common stockholders of $187,265 and $226,330 for the three months
ended June 30, 2014 and 2013, respectively. Net loss attributed to common stockholders was due to the factors discussed above.
We had a net loss attributed
to common stockholders of $737,522 and $657,828 for the six months ended June 30, 2014 and 2013, respectively. Net loss available
to common stockholders was due to the factors discussed above.
Net Loss Per Share.
We had a net loss per share of $0.00 and $0.00 for the six months ended June 30, 2014 and 2013, respectively.
Liquidity
and Capital Resources
At June 30, 2014, we had
non-restricted cash-on-hand of $111,015 compared to $162,709 at December 31, 2013.
Net cash used in operating
activities for the six months ended June 30, 2014 was $31,963 compared to net cash used in operating activities of $141,923 for
the six months ended June 30, 2013.
A large portion of our
cash (and revenue) comes from software maintenance. When we bill and collect for software maintenance, we record a liability in
deferred revenue and recognize income ratably over the maintenance period. Deferred revenue decreased $209,188 or 9.0% from the
balance at December 31, 2013. The decrease was due to a higher number of customers on calendar year maintenance agreements which
results in higher deferred revenue in December.
Our accounts receivable
trade decreased from $309,876 (net of allowance for bad debts) at December 31, 2013 to $252,955 (net of allowance for bad debts)
at June 30, 2014. The decrease is a result of seasonal fluctuations in the timing of billing for software maintenance which typically
yields higher receivables in December compared to June.
The accounts payable and
accrued liabilities went from $9,763,921 at December 31, 2013 to $9,722,253 at June 30, 2014. The decrease is primarily related
to payment of accrued payroll tax and penalties, somewhat offset by increased trade accounts payable and accrued interest. The
resulting balance at June 30, 2014 is 38 times more than the balance in accounts receivable. This is one of the reasons why we
do not have sufficient funds available to fund our operations and repay our debt obligations under their existing terms, as described
below.
We used cash to invest
in equipment and the development of software products for the six months ended June 30, 2014 and June 30, 2013 of $72,559 and
$47,994, respectively. Most of the equipment was computer equipment and peripherals for upgraded network servers to increase the
productivity of our software developers, and new personal computers for developers, consultants and sales personnel. Software
development relates to the development of new products.
For the six months ended
June 30, 2014, we paid $364,590 of principal on notes payable and notes payable to related parties and had $261,282 of new debt
funding in the same period. For the six months ended June 30, 2013, we paid $1,830,141 of principal on notes payable and notes
payable to related parties and had $1,834,150 of new debt funding in the same period.
The total change in cash
for the six months ended June 30, 2014 was a decrease of $51,694.
As of the date of the
filing of this Report, we do not have sufficient funds available to fund our operations and repay our debt obligations under their
existing terms. Therefore, we need to raise additional funds through selling securities, obtaining loans, renegotiating the terms
of our existing debt and/or increasing sales with our new products. Our inability to raise such funds or renegotiate the terms
of our existing debt will significantly jeopardize our ability to continue operations.
| |
Balance at
June 30, | | |
Due in Next Five Years | |
Contractual Obligations | |
2014 | | |
2014 | | |
2015 | | |
2016 | | |
2017 | | |
2018+ | |
Notes payable | |
$ | 4,753,439 | | |
$ | 3,292,278 | | |
$ | 121,099 | | |
$ | 135,112 | | |
$ | 150,747 | | |
$ | 1,054,203 | |
Convertible debenture | |
| 30,000 | | |
| 30,000 | | |
| - | | |
| - | | |
| - | | |
| - | |
Operating lease | |
| 75,438 | | |
| 45,586 | | |
| 29,852 | | |
| - | | |
| - | | |
| - | |
Total | |
$ | 4,858,877 | | |
$ | 3,367,864 | | |
$ | 150,951 | | |
$ | 135,112 | | |
$ | 150,747 | | |
$ | 1,054,203 | |
Of the above notes payable, the
default status is as follows:
| |
June 30, 2014 | | |
December 31, 2013 | |
| |
| | |
| |
In default | |
$ | 3,270,247 | | |
$ | 3,299,806 | |
Not in default | |
| 1,513,192 | | |
| 1,586,864 | |
| |
| | | |
| | |
Total Notes Payable | |
$ | 4,783,439 | | |
$ | 4,886,670 | |
The carrying amounts of
assets and liabilities presented in the financial statements do not purport to represent realizable or settlement values. We had
a net loss of $737,522 and $657,828 for the six months ended June 30, 2014 and 2013, respectively and have historically incurred
losses. Since December 31, 2009, we have used substantial funds in further developing our product line and in conducting present
and new operations, and we need to raise additional funds and/or generate additional revenue through our existing businesses,
including the licensing of our intellectual property, to accomplish our objectives. Additionally, at June 30, 2014, we had negative
working capital of approximately $15.0 million (although this figure includes deferred revenue of approximately $2.1 million)
and have 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. We will require additional funds to pay down our liabilities, as
well as finance our expansion plans consistent with our anticipated changes in operations and infrastructure. However, there can
be no assurance that we will be able to secure additional funds and that if such funds are available, whether the terms or conditions
would be acceptable to us and whether we 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.
Item 3. Quantitative
and Qualitative Disclosures About Market Risk.
Not applicable.
Item 4. Controls and
Procedures
Our management, principally
our chief executive officer (who is also currently serving as our Principal Accounting Officer), evaluated the effectiveness of
our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our management
concluded that our disclosure controls and procedures as of the end of the period covered by this report were not effective such
that the information required to be disclosed by us in reports filed under the Exchange Act is (i) recorded, processed, summarized
and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to our
management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding
disclosure.
Management’s annual
report on internal control over financial reporting associated with our business is set forth on Form 10-K for the year ended
December 31, 2013, as filed on April 15, 2014.
There have been no material
changes in our internal control over financial reporting since our reporting on Form 10-K for the year ended December 31, 2013.
PART II
OTHER INFORMATION
Item 1. 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 sought an award of monetary damages and other relief. The case was 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 was 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
was 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 August 19, 2014, the outstanding settlement balance is $20,922.
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 August 19, 2014, all payments have been made and this matter has been resolved.
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 July 24 2014, the court granted plaintiff’s
motion for summary judgment against defendants. 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.
Item 1A. Risk Factors
A description of the risks associated with
our business, financial condition, and results of operations is set forth on Form 10-K for the year ended December 31, 2013, as
filed on April 15, 2014.
Item 2. Unregistered
Sales of Equity Securities and Use of Proceeds
During the six months
ended June 30, 2014, 550,000 common shares granted to employees of the Company and a consultant of the Company, valued at $10,226,
vested.
Item 3. Defaults Upon
Senior Securities
None
Item 4. Mine Safety
Disclosures
Not applicable
Item 5. Other Information
None
Item 6. Exhibits
The following documents are filed as part of this report:
Exhibit No. |
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Description |
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Location |
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31.1 |
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Certification of Principal Executive Officer and Principal Accounting Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, dated August 19, 2014 |
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Provided herewith |
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32.1 |
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Certification of Principal Executive Officer and Principal Accounting Officer Pursuant Chief Executive Officer Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002, dated August 19, 2014 |
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Provided herewith |
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101.INS* |
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XBRL Instance Document |
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Provided herewith |
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101.SCH* |
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XBRL Taxonomy Extension Schema |
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Provided herewith |
Exhibit No. |
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Description |
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Location |
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101.CAL * |
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XBRL Taxonomy Extension Calculation Linkbase |
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Provided herewith |
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101.DEF* |
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XBRL Taxonomy Extension Definition Linkbase |
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Provided herewith |
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101.LAB* |
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XBRL Taxonomy Extension Label Linkbase |
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Provided herewith |
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101.PRE* |
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XBRL Taxonomy Extension Presentation Document |
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Provided herewith |
| * | Pursuant to Rule 406T of Regulation S-T, the
Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes
of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the
Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections. |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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VERTICAL COMPUTER SYSTEMS, INC. |
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August 19, 2014 |
By: |
/s/ Richard Wade |
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Richard Wade |
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President and Chief Executive Officer |
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(Principal Executive Officer and |
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Principal Accounting Officer) |
EXHIBIT 31.1
Certification of the Principal Executive
Officer and Principal Accounting Officer
I, Richard S. Wade, chief executive officer
(principal executive officer and principal accounting officer), certify that:
1.
I have reviewed this annual report for the three and six months ended June 30, 2014 on Form 10-Q of Vertical Computer Systems,
Inc.;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to
the period covered by this report;
3. Based
on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented
in this report;
4. I
am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and
15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for
the registrant and have:
(a) Designed
such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision,
to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in which this report is being prepared;
(b) Designed
such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our
supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated
the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation;
and
(d) Disclosed
in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s
most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of the annual report) that has materially
affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. I
have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors
and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a) All
significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which
are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information;
and
(b) Any
fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s
internal control over financial reporting.
Date: August 19, 2014 |
By: |
/s/ Richard S. Wade |
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Richard S. Wade |
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Chief Executive Officer |
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(Principal Executive Officer and
Principal Accounting Officer) |
Exhibit 32.1
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT
OF 2002
In connection with the Annual Report of Vertical
Computer Systems, Inc. (the “Company”) on Form 10-Q for the three and six months ended June 30, 2014, as filed with
the Securities and Exchange Commission on the date hereof (the “Report”), I, Richard S. Wade, Principal Executive Officer
and Principal Accounting Officer, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 that, to the best of my knowledge:
1. The
Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
2. The
information contained in the Report fairly presents, in all material respects, the financial condition and results of operations
of the Company.
Date: August 19, 2014 |
By: |
/s/ Richard S. Wade |
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Richard S. Wade |
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Chief Executive Officer |
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(Principal Executive Officer and
Principal Accounting
Officer) |