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 September
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 November 18, 2014, the issuer had
999,735,151 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)
| |
September 30, | | |
December 31, | |
| |
2014 | | |
2013 | |
Assets | |
| | | |
| | |
Current assets | |
| | | |
| | |
Cash | |
$ | 15,919 | | |
$ | 162,709 | |
Accounts receivable, net of allowance for bad debts of $55,698 and $83,326 | |
| 147,515 | | |
| 562,831 | |
Prepaid expenses and other current assets | |
| 110,498 | | |
| 87,930 | |
Total current assets | |
| 273,932 | | |
| 813,470 | |
| |
| | | |
| | |
Property and equipment, net of accumulated depreciation of $1,029,249 and $1,028,102 | |
| 26,947 | | |
| 22,596 | |
Intangible assets, net of accumulated amortization of $291,516 and $259,835 | |
| 680,819 | | |
| 992,996 | |
Deposits and other | |
| 28,938 | | |
| 31,520 | |
| |
| | | |
| | |
Total assets | |
$ | 1,010,636 | | |
$ | 1,860,582 | |
| |
| | | |
| | |
Liabilities and Stockholders’ Deficit | |
| | | |
| | |
Current liabilities: | |
| | | |
| | |
Accounts payable and accrued liabilities | |
$ | 10,509,141 | | |
$ | 9,763,921 | |
Accounts payable to related parties | |
| 23,594 | | |
| 23,594 | |
Bank overdraft | |
| 35,406 | | |
| 1,928 | |
Deferred revenue | |
| 1,971,879 | | |
| 2,317,989 | |
Derivative liability | |
| 68,959 | | |
| 263,340 | |
Convertible debenture | |
| 30,000 | | |
| 30,000 | |
Current portion - notes payable | |
| 3,110,582 | | |
| 3,006,561 | |
Current portion - notes payable to related parties | |
| 348,666 | | |
| 344,158 | |
Total current liabilities | |
| 16,098,227 | | |
| 15,751,491 | |
| |
| | | |
| | |
Non-current portion – notes payable | |
| 1,371,791 | | |
| 1,505,951 | |
| |
| | | |
| | |
Total liabilities | |
| 17,470,018 | | |
| 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)
| |
September 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 999,735,151 and 998,985,151 issued and outstanding as of September 30, 2014 and December 31, 2013 | |
| 9,998 | | |
| 9,990 | |
Additional paid-in-capital | |
| 19,433,931 | | |
| 19,420,513 | |
Accumulated deficit | |
| (46,973,714 | ) | |
| (45,691,721 | ) |
Accumulated other comprehensive income – foreign currency translation | |
| 57,008 | | |
| (118,548 | ) |
| |
| | | |
| | |
Total Vertical Computer Systems, Inc. stockholders’ deficit | |
| (27,472,777 | ) | |
| (26,379,766 | ) |
| |
| | | |
| | |
Noncontrolling interest | |
| 1,111,371 | | |
| 1,080,882 | |
Total stockholders’ deficit | |
| (26,361,406 | ) | |
| (25,298,884 | ) |
| |
| | | |
| | |
Total liabilities and stockholders' deficit | |
$ | 1,010,636 | | |
$ | 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 September 30, | | |
Nine Months Ended September 30, | |
| |
2014 | | |
2013 | | |
2014 | | |
2013 | |
Revenues | |
| | | |
| | | |
| | | |
| | |
Licensing and software | |
$ | 180 | | |
$ | - | | |
$ | 2,600,360 | | |
$ | 72,720 | |
Software maintenance | |
| 873,723 | | |
| 1,069,785 | | |
| 2,871,790 | | |
| 3,285,985 | |
Cloud-based offering | |
| 92,437 | | |
| 83,418 | | |
| 299,047 | | |
| 305,229 | |
Consulting services | |
| 93,028 | | |
| 72,191 | | |
| 301,860 | | |
| 310,959 | |
Other | |
| 13,955 | | |
| 13,485 | | |
| 46,535 | | |
| 62,425 | |
Total revenues | |
| 1,073,323 | | |
| 1,238,879 | | |
| 6,119,592 | | |
| 4,037,318 | |
| |
| | | |
| | | |
| | | |
| | |
Cost of revenues | |
| 406,235 | | |
| 585,905 | | |
| 1,603,718 | | |
| 1,883,179 | |
| |
| | | |
| | | |
| | | |
| | |
Gross profit | |
| 667,088 | | |
| 652,974 | | |
| 4,515,874 | | |
| 2,154,139 | |
| |
| | | |
| | | |
| | | |
| | |
Operating expenses: | |
| | | |
| | | |
| | | |
| | |
Selling, general and administrative expenses | |
| 1,095,077 | | |
| 902,021 | | |
| 4,423,627 | | |
| 2,454,731 | |
Depreciation and amortization | |
| 10,798 | | |
| 13,130 | | |
| 34,163 | | |
| 40,403 | |
Impairment of software costs | |
| 193,293 | | |
| - | | |
| 579,204 | | |
| - | |
Total operating expenses | |
| 1,299,168 | | |
| 915,151 | | |
| 5,036,994 | | |
| 2,495,134 | |
| |
| | | |
| | | |
| | | |
| | |
Operating loss | |
| (632,080 | ) | |
| (262,177 | ) | |
| (521,120 | ) | |
| (340,995 | ) |
| |
| | | |
| | | |
| | | |
| | |
Other income (expense): | |
| | | |
| | | |
| | | |
| | |
Interest Income | |
| 1 | | |
| 35 | | |
| 17 | | |
| 46 | |
Gain (Loss) on derivative liability | |
| 88,786 | | |
| (76,355 | ) | |
| 194,381 | | |
| (82,905 | ) |
Forbearance fees | |
| (94,568 | ) | |
| (109,500 | ) | |
| (256,170 | ) | |
| (129,825 | ) |
Interest expense | |
| (222,230 | ) | |
| (217,186 | ) | |
| (668,662 | ) | |
| (522,949 | ) |
| |
| | | |
| | | |
| | | |
| | |
Net loss | |
| (860,091 | ) | |
| (665,183 | ) | |
| (1,251,554 | ) | |
| (1,076,628 | ) |
Net income (loss) attributable to noncontrolling interest | |
| 21,620 | | |
| 50,987 | | |
| (30,439 | ) | |
| 98,604 | |
Net loss attributable to Vertical Computer Systems, Inc. | |
| (838,471 | ) | |
| (614,196 | ) | |
| (1,281,993 | ) | |
| (978,024 | ) |
Dividends applicable to preferred stock | |
| (147,000 | ) | |
| (147,000 | ) | |
| (441,000 | ) | |
| (441,000 | ) |
| |
| | | |
| | | |
| | | |
| | |
Net loss available to common stockholders | |
$ | (985,471 | ) | |
$ | (761,196 | ) | |
$ | (1,722,993 | ) | |
$ | (1,419,024 | ) |
| |
| | | |
| | | |
| | | |
| | |
Basic and diluted net loss per share | |
$ | (0.00 | ) | |
$ | (0.00 | ) | |
$ | (0.00 | ) | |
$ | (0.00 | ) |
| |
| | | |
| | | |
| | | |
| | |
Basic and diluted weighted average common shares outstanding | |
| 999,535,151 | | |
| 997,843,847 | | |
| 999,382,952 | | |
| 998,116,835 | |
| |
| | | |
| | | |
| | | |
| | |
Comprehensive loss | |
| | | |
| | | |
| | | |
| | |
Net loss | |
$ | (860,091 | ) | |
$ | (665,183 | ) | |
$ | (1,251,554 | ) | |
$ | (1,076,628 | ) |
Translation adjustments | |
| 22,890 | | |
| (46,906 | ) | |
| 175,556 | | |
| 65,933 | |
Comprehensive loss | |
| (837,201 | ) | |
| (712,089 | ) | |
| (1,075,998 | ) | |
| (1,010,695 | ) |
Comprehensive income (loss) attributable to noncontrolling interest | |
| 21,620 | | |
| 50,987 | | |
| (30,439 | ) | |
| 98,604 | |
Comprehensive loss attributable to Vertical Computer Systems, Inc. | |
$ | (815,581 | ) | |
$ | (661,102 | ) | |
$ | (1,106,437 | ) | |
$ | (912,091 | ) |
See accompanying notes to the unaudited
consolidated financial statements.
Vertical Computer Systems, Inc. and
Subsidiaries
Consolidated Statement of Stockholders’
Deficit
December 31, 2013 through September
30, 2014
(Unaudited)
| |
| | |
| | |
Additional | | |
| | |
Other | | |
Non-controlling | | |
| |
| |
Common Stock | | |
Paid-in | | |
Accumulated | | |
Comprehensive | | |
Controlling | | |
| |
| |
Shares | | |
Amount | | |
Capital | | |
Deficit | | |
Income | | |
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 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Shares issued for stock compensation | |
| 200,000 | | |
| 2 | | |
| 3,198 | | |
| - | | |
| - | | |
| - | | |
| 3,200 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Other comprehensive income translation adjustment | |
| - | | |
| - | | |
| - | | |
| - | | |
| 175,556 | | |
| 50 | | |
| 175,606 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Net income (loss) | |
| - | | |
| - | | |
| - | | |
| (1,281,993 | ) | |
| - | | |
| 30,439 | | |
| (1,251,554 | ) |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Balances at September 30, 2014 | |
| 999,735,151 | | |
$ | 9,998 | | |
$ | 19,433,931 | | |
$ | (46,973,714 | ) | |
$ | 57,008 | | |
$ | 1,111,371 | | |
$ | (26,361,406 | ) |
See
accompanying notes to the unaudited consolidated financial statements.
Vertical Computer
Systems, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
| |
Nine Months Ended September 30, | |
| |
2014 | | |
2013 | |
| |
| | |
| |
Cash flows from operating activities | |
| | | |
| | |
Net loss | |
$ | (1,251,554 | ) | |
$ | (1,076,628 | ) |
Adjustments to reconcile net loss to net cash used in operating activities: | |
| | | |
| | |
Depreciation and amortization | |
| 34,163 | | |
| 40,403 | |
Amortization of debt discounts | |
| - | | |
| 16,646 | |
Common shares issued for stock compensation | |
| 3,200 | | |
| - | |
Forbearance fees paid with common stock | |
| - | | |
| 47,000 | |
Impairment of software development costs | |
| 579,204 | | |
| - | |
Loss on derivatives | |
| (194,381 | ) | |
| 82,905 | |
Changes in operating assets and liabilities: | |
| | | |
| | |
Accounts receivable | |
| 415,316 | | |
| 228,846 | |
Prepaid expenses and other assets | |
| (19,986 | ) | |
| 8,533 | |
Accounts payable and accrued liabilities | |
| 755,446 | | |
| 1,175,970 | |
Deferred revenue | |
| (346,110 | ) | |
| (790,899 | ) |
Net cash used in operating activities | |
| (24,702 | ) | |
| (267,224 | ) |
| |
| | | |
| | |
Cash flow from investing activities: | |
| | | |
| | |
Software development | |
| (298,523 | ) | |
| (95,978 | ) |
Purchase of property and equipment | |
| (6,804 | ) | |
| (6,573 | ) |
Net cash used in investing activities | |
| (305,327 | ) | |
| (102,551 | ) |
| |
| | | |
| | |
Cash flows from financing activities: | |
| | | |
| | |
Borrowings on notes payable | |
| 331,282 | | |
| 2,059,150 | |
Payments of notes payable | |
| (361,345 | ) | |
| (1,470,192 | ) |
Borrowings on related party debt | |
| 25,500 | | |
| - | |
Payments on related party debt | |
| (20,992 | ) | |
| (381,583 | ) |
Bank overdraft | |
| 33,478 | | |
| 10,871 | |
Net cash provided by financing activities | |
| 7,923 | | |
| 218,246 | |
| |
| | | |
| | |
Effect of changes in exchange rates on cash | |
| 175,316 | | |
| 65,933 | |
| |
| | | |
| | |
Net change in cash and cash equivalents | |
| (146,790 | ) | |
| (85,596 | ) |
Cash and cash equivalents, beginning of period | |
| 162,709 | | |
| 111,851 | |
Cash and cash equivalents, end of period | |
$ | 15,919 | | |
$ | 26,255 | |
| |
| | | |
| | |
Supplemental disclosures of cash flow information: | |
| | | |
| | |
Cash paid for interest | |
$ | 205,463 | | |
$ | 223,624 | |
| |
| | | |
| | |
Non-cash investing and financing activities: | |
| | | |
| | |
Adjustment to debt principal due to reapplication of payments | |
$ | - | | |
$ | 4,061 | |
Common shares issued for accrued stock compensation | |
| 10,226 | | |
| 10,226 | |
Common shares cancelled | |
| - | | |
| 25 | |
Common shares issued with debt | |
| - | | |
| 19,700 | |
Loan commitment fees accrued | |
| - | | |
| 5,000 | |
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 nine months
ended September 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 nine months ended September 30, 2014, the Company capitalized an aggregate of $298,523 related to software development and
the Company recorded impairment of $579,204 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 nine months ended September 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 September 30, 2014, we had negative working capital of approximately $15.8 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 nine months ended September 30, 2014:
December 31, 2013 | |
$ | 4,542,512 | |
Repayments of third party notes | |
| (361,345 | ) |
Borrowings from third parties | |
| 331,282 | |
Currency translation | |
| (76 | ) |
September 30, 2014 | |
$ | 4,512,373 | |
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.
On October 10, 2014, the Company and NOW Solutions received a notice of default from Lakeshore concerning the Lakeshore Note.
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.
In August 2014, the
Company and a third party lender entered into a loan agreement under which the lender loaned Vertical $50,000. Pursuant to the
loan agreement, Vertical agreed to pay a commitment fee of $2,000 and issued a promissory note in the principal amount of $50,000
bearing interest at 18% per annum and due November 9, 2014. The note and commitment fee have not been paid.
In September 2014,
the Company and a third party lender entered into a loan agreement under which the lender loaned Vertical $20,000. Pursuant to
the loan agreement, Vertical issued a promissory note in the principal amount of $20,000, bearing interest at 11% per annum and
due on demand.
During the nine months
ended September 30, 2014 and 2013, the Company made interest payments of $184,313 and $223,624 on third party debt, respectively.
Please see “Subsequent
Events” in Note 9, for details on events after the period covered by this Report.
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 September 30, 2014 and December 31, 2013, the aggregate fair value of the derivative liabilities was $68,959
and $263,340.
The aggregate change in the fair value
of derivative liabilities resulted in a gain of $194,381 and a loss of $82,905 for the nine months ended September 30, 2014 and
2013, respectively.
The valuation of our
embedded derivatives is determined by using the VCSY stock price at September 30, 2014 and December 31, 2013. 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 September 30, 2014 and December 31, 2013:
| |
Fair value measurements on a recurring basis | |
| |
Level 1 | | |
Level 2 | | |
Level 3 | |
As of September 30, 2014: | |
| | | |
| | | |
| | |
Liabilities | |
| | | |
| | | |
| | |
Stock derivative – 4,309,983 shares | |
$ | 68,959 | | |
$ | - | | |
$ | - | |
| |
| | | |
| | | |
| | |
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 nine months
ended September 30, 2014, 550,000 common shares granted to employees of the Company and a consultant of the Company vested. Stock
compensation that was previously accrued totaling $10,226 was reclassified from accrued liabilities to stockholders’ equity
associated with these shares vested.
During the nine months
ended September 30, 2014, the Company granted 200,000 common shares to an employee of the Company. The shares vested immediately
upon grant and the fair value of the shares was determined to be $3,200. The fair value was expensed in full during the nine months
ended September 30, 2014.
As of September 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:
| 999,735,151 | | |
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) |
| 1,033,417,108 | | |
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 34,000,000 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 nine months ended September 30, 2014 is shown below.
| |
Shares | | |
Weighted Average Grant- Date Fair Value | |
Non Vested Balance at December 31, 2013 | |
| 550,000 | | |
$ | 0.0186 | |
Granted | |
| 200,000 | | |
| 0.0160 | |
Vested | |
| (750,000 | ) | |
| 0.0179 | |
Forfeited/Cancelled | |
| - | | |
| - | |
Non Vested Balance at September 30, 2014 | |
| - | | |
$ | - | |
As of September 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 nine months ended September 30, 2014:
December 31, 2013 | |
$ | 344,158 | |
Borrowings from related party notes | |
| 25,500 | |
Repayments of related party notes | |
| (20,992 | ) |
September 30, 2014 | |
$ | 348,666 | |
During the nine
months ended September 30, 2014, the Company borrowed $25,500 from an employee of the Company. The note is unsecured, bears
interest at 11% per annum and is due on demand.
As of September 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 bearing and due on demand.
Note 8. Legal Proceedings
We are involved in the following
ongoing legal matters:
On November 18, 2009,
we sued InfiniTek Corporation (“InfiniTek”) in the Texas State District Court in Fort Worth, Texas for breach
of contract and other claims (the “Texas Action”) seeking equitable relief and unspecified damages when a dispute
between the Company and InfiniTek was not resolved. All agreements with InfiniTek have been cancelled. On January 15, 2010, InfiniTek
filed a counter-claim for non-payment of amounts billed. InfiniTek claimed it was owed $195,000 plus lost opportunity costs of
not less than $220,000.
On April 7, 2010,
we were served with a lawsuit filed by InfiniTek in the California Superior Court in Riverside, California seeking damages in
excess of $76,303 for breach of contract and lost profit (the “California Action”). This lawsuit related to
one of the causes of action and the same set of underlying facts, as those in the Texas legal action. On May 7, 2010, we filed
a motion to dismiss this action. On July 14, 2010, the court denied our motion. On August 13, 2010, we filed an answer to InfiniTek’s
complaint, including a denial and affirmative defenses.
On December 31, 2011,
the Company and InfiniTek entered into a settlement agreement whereby the Texas Action and the California Action were both dismissed.
Pursuant to the terms of the settlement agreement, Vertical agreed to pay InfiniTek $82,500 in three equal installments with the
last payment due by or before August 5, 2012. Upon full payment, InfiniTek shall transfer and assign ownership of the NAVPath
software developed by InfiniTek for use with NOW Solutions emPath® software application and Microsoft Dynamics NAV (formerly
Navision) business solution platform. The amounts in dispute were included in our accounts payable and accrued liabilities and
have been adjusted to the settlement amount of $82,500 at December 31, 2011. The Company has made $37,500 in payments due under
the settlement agreement as of November 16, 2012 and each party is alleging the other party is in breach of the settlement agreement.
We are currently seeking to resolve all disputes with InfiniTek.
On November 15, 2010,
we filed a lawsuit in the Federal District Court for the Eastern District of Texas (the “Vertical Action”)
against Interwoven, Inc. ("Interwoven"), LG Electronics MobileComm U.S.A., Inc., LG Electronics, Inc., Samsung
Electronics Co., Ltd. and Samsung Electronics America, Inc. (collectively, the "Defendants"). We sued the Defendants
for patent infringement claims under United States Patent No. 6,826,744 (“System and Method for Generating Web Sites in
an Arbitrary Object Framework”) and United States Patent No. 7,716,629 (“System and Method for Generating Web Sites
in an Arbitrary Object Framework”) (collectively the “the Patents-in-Suit”), both of which are owned
by the Company. We seek an award of monetary damages and other relief. The case is styled Vertical Computer Systems, Inc. v Interwoven,
Inc., LG Electronics Mobilecomm U.S.A., Inc., No. 2:10-CV-00490.
On November 17, 2010,
we were served with a lawsuit filed on October 14, 2010 by Interwoven in the United States District Court for the Northern District
of California (the “Interwoven Action”). This lawsuit was instituted as a complaint for declaratory judgment,
in which Interwoven requested that the court find that no valid and enforceable claim of either of the two patents referenced
above has been infringed by Interwoven. The case is styled Interwoven, Inc. v Vertical Computer Systems, Inc. No. 3:10-CV-4645-RS.
On January 11, 2011,
Samsung Electronics Co., Ltd. and Samsung Electronics America, Inc. (“Samsung”) filed a lawsuit in the United
States District Court for the Northern District of California seeking to consolidate its lawsuit with the Interwoven Action. This
case is styled Samsung Electronics Co., Ltd. and Samsung Electronics America, Inc., v. Vertical Computer Systems, Inc., No. 3:11-CV-00189-RS.
On May 2, 2011, the
United States District Court for the Northern District of California denied Vertical’s renewed motion to transfer the Interwoven
Action to the Eastern District of Texas and granted Vertical's motion to transfer the lawsuit filed by Samsung in the Northern
District of California to the Eastern district in Texas. On May 11, 2011, the United States District Court for the Eastern District
of Texas granted Interwoven’s motion to transfer the case to the Northern District of California with respect to Interwoven
and denied Samsung’s motion to transfer its case to the Northern district.
On December 30, 2011,
the United States District Court for the Northern District of California issued a claims construction order in the Interwoven Action
concerning the terms found in the claims of the Patents-in-Suit.
On October 12, 2012,
the United States Patent and Trademark Office (“USPTO”) issued an ex parte reexamination certificate of United
States Patent No. 7,716,629. In the ex parte reexamination certificate, Claims 21-36, 29, 30, and 32 were confirmed; Claims
1, 8, 11, 13, 28 and 31 were determined to be patentable as amended, Claims 2-6, 9, 10, 12, 14-17, 19 and 20, which were dependent
on an amended claim, were determined to be patentable, and claims 7, 18 and 27 were not reexamined.
On October 25, 2012,
the USPTO notified the Company of its intent to issue an ex parte reexamination certificate concerning the ex parte reexamination
of United States Patent No. 6,826,744. In the notice of intent to issue ex parte reexamination certificate, the USPTO notified
that the prosecution on the merits is closed in this ex parte reexamination proceeding and indicated that Claims 6, 8, 19, 22,
30, 32, 41, 44, 50, 51 were confirmed; Claims 1 and 26 were cancelled; Claims 12-17, 20, 34-39, 42 and 43 are not subject to reexamination;
newly presented Claims 54-57 are patentable and continuation of patent claims amended: 2-5, 7, 9-11, 18, 21, 23-25, 27-29, 31,
33, 40, 45-49, 52 and 53.
On January 4, 2013,
the United States District Court for the Northern District of California in the Interwoven Action denied Interwoven’s motion
for summary judgment for unenforceability and invalidity of the Patents-in-Suit in its entirety.
On July 17, 2013, the
United States District Court for the Northern District of California in the Interwoven Action ruled on Interwoven’s motion
for summary judgment with respect to infringement and damages concerning the Patents-in-Suit. The court denied Interwoven’s
motion for summary judgment on the issue of direct infringement and granted summary judgment in favor of Interwoven with respect
to infringement on the doctrine of equivalents and with respect to indirect infringement. The court also granted in part and denied
in part Interwoven’s motion to exclude certain expert witness testimony.
On September 16, 2013,
the United States District Court for the Eastern District of Texas issued a claims construction order in the Vertical Action concerning
the terms found in the claims of the Patents-in-Suit. On December 12, the Company settled the patent infringement claim that the
Company initiated in federal court against LG. Pursuant to the confidential settlement agreement, the Company has granted to LG
a non-exclusive, fully paid-up license under the two patents (“Patents-in-Suit”) with any continuation patents
of the Patents-in-Suit and any other continuation patents with the same priority claim as the Patents-in-Suit.
On December 12, 2013,
the Company settled its patent infringement claim against LG Electronics. Pursuant to the confidential settlement agreement, the
Company granted to LG Electronics a non-exclusive, fully paid-up license under the Patents-in-Suit which were the subject of the
legal proceeding. The litigation concerning the Patents-in-Suit with LG has been resolved.
On March 20, 2014,
the Company settled the patent infringement claim that the Company initiated in federal court against Samsung. Pursuant to the
confidential settlement agreement, the Company has granted to Samsung a non-exclusive, fully paid-up license under the Patents-in-Suit
with any continuation patents of the Patents-in-Suit and any other patents with the same priority claim as the Patents-in-Suit.
The litigation concerning the Patents-in-Suit with Samsung has been resolved.
On May 8, 2014, the
Company settled the patent infringement claim that the Company initiated in federal court against Interwoven. Pursuant to the confidential
settlement agreement, the Company has granted to Interwoven and its subsidiaries, affiliates and parent companies (which include
Autonomy Corporation PLC and Hewlett-Packard Company, Inc.), a non-exclusive, fully paid-up license to the Patents-in-Suit with
any continuation patents of the Patents-in-Suit and any other patents with the same priority claim as the Patents-in-Suit. The
Interwoven Action has been resolved.
On July 8, 2011, we
were served with a lawsuit in the Texas State District Court in Dallas, Texas by Clark Consulting Services, Inc. (“CCS”)
for breach of contract and other claims. CCS was seeking damages from us in excess of $133,750 plus attorney’s fees
and interest. On August 8, 2011, we filed an answer denying CCS’s claims and setting forth affirmative defenses.
In December 2011, the Company and CCS entered into a settlement agreement whereby the lawsuit was dismissed. Pursuant to the terms
of the settlement agreement, the Company agreed to pay CCS $134,000, which was to be paid in installment payments. Due to the Company’s
failure to make timely payments, an additional $60,000 was added to the outstanding balance. On October 26, 2012, we entered into
an agreement under which we agreed to make monthly payments of $5,000 and pay the outstanding balance plus attorney’s fees
and costs by February 1, 2013. As of December 31, 2012, the settlement amount of $149,000 has been included in accounts payable
and accrued liabilities. During 2013, the parties entered into several agreements to extend the date by which the Company has to
pay off the balance of the settlement amount whereby. Under these agreements, the Company agreed to make monthly payments of $10,000
(of which $2,500 of each payment would be applied as late fees) beginning in February 2013 through November 2013 until the outstanding
balance has been paid. As of November 18, 2014, all payments have been made and this matter has been resolved.
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 November 18, 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. The judgment was filed on September 18, 2014. 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.
On October 20, 2014,
Michael T. Galvan and Michelle Bates (“Galvan & Bates”) filed a lawsuit in the Court of Chancery in the
State of Delaware seeking to have the court compel the Company to hold a shareholder meeting for the purpose of electing all directors
of the Company, designating the time and place of a meeting and other details reasonably necessary to hold such a meeting, attorney
costs and fees (including reasonable attorney’s fees), and such other relief as the court deems proper. Galvan and Bates
are stockholders of the Company. This case is styled Michael T. Galvan and Michelle Bates v. Vertical Computer Systems, Inc., No.
10234.
Note 9. Subsequent Events
In October 2014, the
Company and a third party lender entered into a loan agreement under which the lender loaned Vertical $100,000. Pursuant to the
loan agreement, Vertical agreed issued a promissory note in the principal amount of $100,000 bearing interest at 11% per annum
and due on January 5, 2015. In connection with the loan, the company issued 100,000 shares of Series A Preferred Stock of its subsidiary,
OptVision Research, Inc. to the lender.
On October 7, 2014,
the United States Patent and Trademark sent a Notice of Allowance for a continuation patent, U.S. Patent 12/77,885 entitled “System
and Method for Generating Websites in an Arbitrary Object Framework” to the Company, which is a continuation patent of U.S.
Patent No. 7,716,629.
On October 10, 2014,
the Company and NOW Solutions received a notice of default from Lakeshore concerning the Lakeshore Note. The Company is in discussions
with Lakeshore to resolve the default. For additional details on the Lakeshore Note and security interests, please see “Notes
Payable” in Note 3.
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 nine months
ended September 30, 2014 and 2013, $298,523 and $95,978 of internal costs were capitalized, respectively, and the Company recorded
impairment of $579,204 on previously capitalized software development costs during the nine months ended September 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 Nine months ended
September 30, 2014 Compared To Three and Nine months ended September 30, 2013
Total Revenues.
We had total revenues of $1,073,323 and $1,238,878 for the three months ended September 30, 2014 and 2013, respectively. The decrease
in total revenues was $165,555 for the three months ended September 30, 2014 representing a 13.4% decrease compared to the total
revenues for the three months ended September 30, 2013. Substantially all of the revenues for the three months ended September
30, 2014 and 2013 were related to the business operations of NOW Solutions. Revenue from SnAPPnet, Inc. was $24,410 or 2.3% of
total revenues for the three months ended September 30, 2014 and $21,587 or 1.7% of total revenues for the three months ended September
30, 2013.
Revenues for the three
months ended September 30, 2014 and 2013 primarily consist of fees derived from software licenses, consulting services, software
maintenance and Cloud-based offerings. There were no new licensing sales of our emPath® product during the third quarter of
2014 or 2013. Software maintenance in the three months ended September 30, 2014 decreased by $196,062 or 18.3% from the same period
in the prior year. The revenue decrease in software maintenance is primarily due to non-renewal of maintenance agreements by customers
and the effects of unfavorable currency rate changes on our Canadian maintenance revenue. Consulting revenue, in the three months
ended September 30, 2014 increased by $20,837 from the same period in the prior year, which represents a 28.9% increase. This increase
was due to additional consulting services for version upgrades and enhancements to existing accounts during the third quarter of
2014. Cloud-based revenues were $92,437 for the three months ended September 30, 2014 compared to $83,418 for the same period in
the prior year, representing a $9,019 increase or 10.8%. The increase is primarily related to a customer rate adjustment and a
customer user base adjustment during 2014. Other revenue in the three months ended September 30, 2014 increased by $471 or 3.5%
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 $6,119,592 and $4,037,318 in the nine months ended September 30, 2014 and 2013, respectively. The increase in total revenues
was $2,082,274 for the nine months ended September 30, 2014 representing a 51.6% increase compared to the total revenues for the
nine months ended September 30, 2013. Revenue for NOW Solutions was $3,405,751 or 55.7% and revenue for VCSY was $2,600,000 or
42.5% of total revenues for the nine months ended September 30, 2014. Substantially all of the revenues for the nine months ended
September 30, 2013 were related to the business operations of NOW Solutions. Revenue from SnAPPnet, Inc. was $113,841 or 1.9% of
total revenues for the nine months ended September 30, 2014 and $89,274 or 2.2% of total revenues for the nine months ended September
30, 2013.
Revenues for the nine
months ended September 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 $2,527,640 compared to that for the
nine months ended September 30, 2013 due to new licensing sales of SiteFlash product during 2014. Software maintenance in the nine
months ended September 30, 2014 decreased by $414,195 or 12.6% from the same period in the prior year. The revenue decrease in
software maintenance is primarily due to non-renewal of maintenance agreements by customers and the effects of unfavorable currency
rate changes on our Canadian maintenance revenue. Consulting revenue, in the nine months ended September 30, 2014, decreased by
$9,099 from the same period in the prior year, which represents a 2.9% decrease. This decrease was primarily due to effects of
unfavorable currency rate changes on our Canadian consulting revenue during the nine months ended September 30, 2014. Cloud-based
revenues were $299,047 for the nine months ended September 30, 2014 compared to $305,229 for the same period in the prior year,
representing a $6,182 decrease or 2.0%. The decrease is primarily related to effects of unfavorable currency rate changes on our
Canadian revenue. Other revenue in the nine months ended September 30, 2014 decreased by $15,890 or 25.5% 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 $406,235 for the three months ended September 30, 2014, compared to
$585,905 for the three months ended September 30, 2013. The decrease in cost of revenues of $179,670 represents a 30.7% decrease.
The decrease in direct cost of revenues was primarily due to decreased royalties on third party software licensing, decreased third
party hosting fees and decreased payroll costs.
For the nine months
ended September 30, 2014, direct costs of revenues were $1,603,718 compared to $1,883,179 for the same period in 2013 resulting
in a decrease of $279,461 or 14.8%. The decrease in direct cost of revenues was primarily due to decreased third party hosting
fees and decreased payroll costs somewhat offset by increased commissions.
Selling, General
and Administrative Expenses. We had selling, general and administrative expenses of $1,095,077 and $902,021 in the three
months ended September 30, 2014 and 2013, respectively. The increase of $193,056 is 21.4% more than the same period in 2013. We
had increased legal expenses to prosecute patent infringement on the Company’s intellectual property and increased penalties
related to delinquent tax payments, somewhat offset by lower payroll and consulting costs.
For the nine months
ended September 30, 2014 we had $4,423,627 compared to $2,454,731 for the nine months ended September 30, 2013. The increase of
$1,968,896 was 80.2% higher than the same period in 2013. We had increased legal expenses to prosecute patent infringement on the
Company’s intellectual property and increased penalties related to delinquent tax payments, somewhat offset by lower payroll
costs.
Impairment of
Software Costs. During the three and nine months ended September 30, 2014, $193,293 and $579,204, respectively of capitalized
software development costs were considered impaired.
Gain (Loss) on
Derivative Liability. Derivative liabilities are adjusted each quarter for changes in the market value of the Company’s
common stock. The gain on derivative liabilities was $88,786 for the three months ended September 30, 2014 compared to a loss of
$76,355 for the same period in 2013. The gain on derivative liabilities was $194,381 for the nine months ended September 30, 2014
compared to a loss of $82,905 for the nine months ended September 30, 2013. The gain for the three months ended and nine months
ended September 30, 2014 are related to revaluation of the liability at a lower stock price.
Forbearance Fees.
Forbearance fees relate to fees charged by our lenders on loans in default. Forbearance fees for the three months ended September
30, 2014 were $94,568 compared to $109,500 for the three months ended September 30, 2013. The fees are related to our senior secured
debt for NOW Solutions. Forbearance fees for the nine months ended September 30, 2014 were $256,170 compared to $129,825 for the
nine months ended September 30, 2013. The fees are primarily related to our senior secured debt for NOW Solutions.
Interest Expense.
We had interest expense of $222,230 and $217,186 for the three months ended September 30, 2014 and 2013, respectively. Interest
expense increased by $5,044 representing an increase of 2.3% compared to the same expense in the three months ended September 30,
2013. The increase was primarily due to increased borrowings in 2013 and higher interest rates on debts in default.
For the nine months
ended September 30, 2014, we had interest expense of $668,662 compared to $522,949 for the same period in 2013, representing a
$145,713 or 27.9% increase for the period. The increase was primarily due to increased borrowings in 2013 and higher interest rates
on debts in default.
Net Income (loss).
We had a net loss of $860,091 and $665,183 for the three months ended September 30, 2014 and 2013, respectively. The net loss for
the three months ended September 30, 2014 was due to the factors discussed above for revenues, cost of revenues and selling, general
and administrative expenses, which essentially gave us an operating loss of $632,080. This loss was increased by impairment of
software development costs, forbearance fees and interest expense which was somewhat offset by a gain on derivative liability.
We had a net loss of
$1,251,554 and $1,076,628 for the nine months ended September 20, 2014 and 2013, respectively. The net loss was due to the factors
discussed above for revenues, cost of revenues and selling, general and administrative expenses, which essentially gave us an operating
loss of $521,120. This income was reduced by impairment of software development costs, forbearance fees and interest expense, which
was somewhat offset by a gain on derivative liability.
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 September 30, 2014 and 2013 and $441,000 for both the nine months ended September 30, 2014 and
2013.
Net Loss Available
to Common Stockholders. We had a net loss attributed to common stockholders of $985,471 and $761,196 for the three months
ended September 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 $1,722,993 and $1,419,024 for the nine months ended September 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 nine months ended September 30, 2014 and 2013, respectively.
Liquidity
and Capital Resources
At September 30, 2014,
we had non-restricted cash-on-hand of $15,919 compared to $162,709 at December 31, 2013.
Net cash used in operating
activities for the nine months ended September 30, 2014 was $24,702 compared to net cash used in operating activities of $267,224
for the nine months ended September 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 $346,110 or 14.9% 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 $562,831 (net of allowance for bad debts) at December 31, 2013 to $147,515 (net of allowance for bad debts)
at September 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 September.
The accounts payable
and accrued liabilities went from $9,763,921 at December 31, 2013 to $10,509,141 at September 30, 2014. The increase is primarily
related to accrued payroll tax and penalties and accrued interest. The resulting balance at September 30, 2014 is 71 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 nine months ended September 30, 2014 and September 30, 2013 of $305,327
and $102,551, 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 nine months
ended September 30, 2014, we paid $382,337 of principal on notes payable and notes payable to related parties and had $356,782
of new debt funding in the same period. For the nine months ended September 30, 2013, we paid $1,851,775 of principal on notes
payable and notes payable to related parties and had $2,059,150 of new debt funding in the same period.
The total change in
cash for the nine months ended September 30, 2014 was a decrease of $146,790.
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 | | |
Due in Next Five Years | |
Contractual Obligations | |
September 30, 2014 | | |
2014 | | |
2015 | | |
2016 | | |
2017 | | |
2018+ | |
| |
| | |
| | |
| | |
| | |
| | |
| |
Notes payable | |
$ | 4,831,039 | | |
$ | 3,369,694 | | |
$ | 121,077 | | |
$ | 135,088 | | |
$ | 150,721 | | |
$ | 1,054,459 | |
Convertible debenture | |
| 30,000 | | |
| 30,000 | | |
| - | | |
| - | | |
| - | | |
| - | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Operating lease | |
| 66,346 | | |
| 23,826 | | |
| 38,297 | | |
| 4,223 | | |
| - | | |
| - | |
Total | |
$ | 4,927,385 | | |
$ | 3,423,520 | | |
$ | 151,374 | | |
$ | 139,311 | | |
$ | 150,721 | | |
$ | 1,054,459 | |
Of the notes payable,
the default status is as follows:
| |
September 30, 2014 | | |
December 31, 2013 | |
| |
| | |
| |
In default | |
$ | 3,195,595 | | |
$ | 3,299,806 | |
Not in default | |
| 1,665,444 | | |
| 1,586,864 | |
| |
| | | |
| | |
Total Notes Payable | |
$ | 4,861,039 | | |
$ | 4,886,670 | |
During October 2014,
the company defaulted one of its outstanding notes payable with a principal balance of $1,495,444 and $1,586,864 as of September
30, 2014 and December 31, 2013, respectively.
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 $1,251,554 and $1,076,628 for the nine months ended September 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 September 30, 2014, we had
negative working capital of approximately $15.8 million (although this figure includes deferred revenue of approximately $2.0
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
seek an award of monetary damages and other relief. The case is styled Vertical Computer Systems, Inc. v Interwoven, Inc., LG Electronics
Mobilecomm U.S.A., Inc., No. 2:10-CV-00490.
On November 17, 2010,
we were served with a lawsuit filed on October 14, 2010 by Interwoven in the United States District Court for the Northern District
of California (the “Interwoven Action”). This lawsuit was instituted as a complaint for declaratory judgment,
in which Interwoven requested that the court find that no valid and enforceable claim of either of the two patents referenced above
has been infringed by Interwoven. The case is styled Interwoven, Inc. v Vertical Computer Systems, Inc. No. 3:10-CV-4645-RS.
On January 11, 2011,
Samsung Electronics Co., Ltd. and Samsung Electronics America, Inc. (“Samsung”) filed a lawsuit in the United
States District Court for the Northern District of California seeking to consolidate its lawsuit with the Interwoven Action. This
case is styled Samsung Electronics Co., Ltd. and Samsung Electronics America, Inc., v. Vertical Computer Systems, Inc., No. 3:11-CV-00189-RS.
On May 2, 2011, the
United States District Court for the Northern District of California denied Vertical’s renewed motion to transfer the Interwoven
Action to the Eastern District of Texas and granted Vertical's motion to transfer the lawsuit filed by Samsung in the Northern
District of California to the Eastern district in Texas. On May 11, 2011, the United States District Court for the Eastern District
of Texas granted Interwoven’s motion to transfer the case to the Northern District of California with respect to Interwoven
and denied Samsung’s motion to transfer its case to the Northern district.
On December 30, 2011,
the United States District Court for the Northern District of California issued a claims construction order in the Interwoven Action
concerning the terms found in the claims of the Patents-in-Suit.
On October 12, 2012,
the United States Patent and Trademark Office (“USPTO”) issued an ex parte reexamination certificate of United
States Patent No. 7,716,629. In the ex parte reexamination certificate, Claims 21-36, 29, 30, and 32 were confirmed; Claims
1, 8, 11, 13, 28 and 31 were determined to be patentable as amended, Claims 2-6, 9, 10, 12, 14-17, 19 and 20, which were dependent
on an amended claim, were determined to be patentable, and claims 7, 18 and 27 were not reexamined.
On October 25, 2012,
the USPTO notified the Company of its intent to issue an ex parte reexamination certificate concerning the ex parte reexamination
of United States Patent No. 6,826,744. In the notice of intent to issue ex parte reexamination certificate, the USPTO notified
that the prosecution on the merits is closed in this ex parte reexamination proceeding and indicated that Claims 6, 8, 19, 22,
30, 32, 41, 44, 50, 51 were confirmed; Claims 1 and 26 were cancelled; Claims 12-17, 20, 34-39, 42 and 43 are not subject to reexamination;
newly presented Claims 54-57 are patentable and continuation of patent claims amended: 2-5, 7, 9-11, 18, 21, 23-25, 27-29, 31,
33, 40, 45-49, 52 and 53.
On January 4, 2013,
the United States District Court for the Northern District of California in the Interwoven Action denied Interwoven’s motion
for summary judgment for unenforceability and invalidity of the Patents-in-Suit in its entirety.
On July 17, 2013, the
United States District Court for the Northern District of California in the Interwoven Action ruled on Interwoven’s motion
for summary judgment with respect to infringement and damages concerning the Patents-in-Suit. The court denied Interwoven’s
motion for summary judgment on the issue of direct infringement and granted summary judgment in favor of Interwoven with respect
to infringement on the doctrine of equivalents and with respect to indirect infringement. The court also granted in part and denied
in part Interwoven’s motion to exclude certain expert witness testimony.
On September 16, 2013,
the United States District Court for the Eastern District of Texas issued a claims construction order in the Vertical Action concerning
the terms found in the claims of the Patents-in-Suit. On December 12, the Company settled the patent infringement claim that the
Company initiated in federal court against LG. Pursuant to the confidential settlement agreement, the Company has granted to LG
a non-exclusive, fully paid-up license under the two patents (“Patents-in-Suit”) with any continuation patents
of the Patents-in-Suit and any other continuation patents with the same priority claim as the Patents-in-Suit.
On December 12, 2013,
the Company settled its patent infringement claim against LG Electronics. Pursuant to the confidential settlement agreement, the
Company granted to LG Electronics a non-exclusive, fully paid-up license under the Patents-in-Suit which were the subject of the
legal proceeding. The litigation concerning the Patents-in-Suit with LG has been resolved.
On March 20, 2014,
the Company settled the patent infringement claim that the Company initiated in federal court against Samsung. Pursuant to the
confidential settlement agreement, the Company has granted to Samsung a non-exclusive, fully paid-up license under the Patents-in-Suit
with any continuation patents of the Patents-in-Suit and any other patents with the same priority claim as the Patents-in-Suit.
The litigation concerning the Patents-in-Suit with Samsung has been resolved.
On May 8, 2014, the
Company settled the patent infringement claim that the Company initiated in federal court against Interwoven. Pursuant to the confidential
settlement agreement, the Company has granted to Interwoven and its subsidiaries, affiliates and parent companies (which include
Autonomy Corporation PLC and Hewlett-Packard Company, Inc.), a non-exclusive, fully paid-up license to the Patents-in-Suit with
any continuation patents of the Patents-in-Suit and any other patents with the same priority claim as the Patents-in-Suit. The
Interwoven Action has been resolved.
On July 8, 2011, we
were served with a lawsuit in the Texas State District Court in Dallas, Texas by Clark Consulting Services, Inc. (“CCS”)
for breach of contract and other claims. CCS was seeking damages from us in excess of $133,750 plus attorney’s fees
and interest. On August 8, 2011, we filed an answer denying CCS’s claims and setting forth affirmative defenses.
In December 2011, the Company and CCS entered into a settlement agreement whereby the lawsuit was dismissed. Pursuant to the terms
of the settlement agreement, the Company agreed to pay CCS $134,000, which was to be paid in installment payments. Due to the Company’s
failure to make timely payments, an additional $60,000 was added to the outstanding balance. On October 26, 2012, we entered into
an agreement under which we agreed to make monthly payments of $5,000 and pay the outstanding balance plus attorney’s fees
and costs by February 1, 2013. As of December 31, 2012, the settlement amount of $149,000 has been included in accounts payable
and accrued liabilities. During 2013, the parties entered into several agreements to extend the date by which the Company has to
pay off the balance of the settlement amount whereby. Under these agreements, the Company agreed to make monthly payments of $10,000
(of which $2,500 of each payment would be applied as late fees) beginning in February 2013 through November 2013 until the outstanding
balance has been paid. As of November 18, 2014, all payments have been made and this matter has been resolved.
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 November 18, 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. The judgment was filed on September 18, 2014. 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.
On October 20, 2014,
Michael T. Galvan and Michelle Bates (“Galvan & Bates”) filed a lawsuit in the Court of Chancery in the
State of Delaware seeking to have the court compel the Company to hold a shareholder meeting for the purpose of electing all directors
of the Company, designating the time and place of a meeting and other details reasonably necessary to hold such a meeting, attorney
costs and fees (including reasonable attorney’s fees), and such other relief as the court deems proper. Galvan and Bates
are stockholders of the Company. This case is styled Michael T. Galvan and Michelle Bates v. Vertical Computer Systems, Inc., No.
10234.
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 nine months
ended September 30, 2014, 750,000 common shares granted to employees of the Company and a consultant of the Company, valued at
$13,426 vested.
Item 3. Defaults
Upon Senior Securities
On October 10, 2014,
the Company and NOW Solutions received a notice of default from Lakeshore concerning the Lakeshore Note. The Company is in discussions
with Lakeshore to resolve the default. 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. For additional details on
the Lakeshore Note and security interests, please see “Notes Payable” in Note 3 of Part I of this Report.
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 November 18, 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 November 18, 2014 |
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Provided herewith |
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101.INS* |
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XBRL Instance Document |
|
Provided herewith |
|
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101.SCH* |
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XBRL Taxonomy Extension Schema |
|
Provided herewith |
|
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101.CAL * |
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XBRL Taxonomy Extension Calculation Linkbase |
|
Provided herewith |
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101.DEF* |
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XBRL Taxonomy Extension Definition Linkbase |
|
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 |
|
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.
|
VERTICAL COMPUTER SYSTEMS, INC. |
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November 18, 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 nine months ended September 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: November 18, 2014 |
By: |
/s/ Richard S. Wade |
|
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Richard S. Wade |
|
|
Chief Executive Officer |
|
|
(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 Quarterly Report
of Vertical Computer Systems, Inc. (the “Company”) on Form 10-Q for the three and nine months ended September 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: November 18, 2014 |
By: |
/s/ Richard S. Wade |
|
|
Richard S. Wade |
|
|
Chief Executive Officer |
|
|
(Principal Executive Officer and |
|
|
Principal Accounting Officer) |