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 March
31, 2015
¨
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 May 14, 2015, the issuer had 1,003,545,134
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)
| |
March 31, | | |
December 31, | |
| |
2015 | | |
2014 | |
Assets | |
| | | |
| | |
Current assets | |
| | | |
| | |
Cash | |
$ | 119,071 | | |
$ | 117,866 | |
Accounts receivable, net of allowance for bad debts of $131,562 and $97,419 | |
| 120,155 | | |
| 560,879 | |
Prepaid expenses and other current assets | |
| 49,134 | | |
| 41,387 | |
Total current assets | |
| 288,360 | | |
| 720,132 | |
| |
| | | |
| | |
Property and equipment, net of accumulated depreciation of $1,042,715 and $1,026,654 | |
| 2,279 | | |
| 28,089 | |
Intangible assets, net of accumulated amortization of $312,467 and $302,016 | |
| 789,662 | | |
| 657,978 | |
Deposits and other assets | |
| 24,138 | | |
| 24,388 | |
| |
| | | |
| | |
Total assets | |
$ | 1,104,439 | | |
$ | 1,430,587 | |
| |
| | | |
| | |
Liabilities and Stockholder's Deficit | |
| | | |
| | |
Current liabilities: | |
| | | |
| | |
Accounts payable and accrued liabilities | |
$ | 10,788,043 | | |
$ | 10,603,879 | |
Accounts payable to related parties | |
| 94,059 | | |
| 92,191 | |
Bank overdraft | |
| 32,257 | | |
| 7,699 | |
Deferred revenue | |
| 2,053,316 | | |
| 2,321,044 | |
Derivative liabilities | |
| - | | |
| 51,719 | |
Convertible debenture | |
| 30,000 | | |
| 30,000 | |
Current portion - notes payable | |
| 4,644,924 | | |
| 4,545,239 | |
Current portion - notes payable to related parties | |
| 348,666 | | |
| 348,666 | |
Total current liabilities | |
| 17,991,265 | | |
| 18,000,437 | |
| |
| | | |
| | |
Total liabilities | |
| 17,991,265 | | |
| 18,000,437 | |
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)
| |
March 31, | | |
December 31, | |
| |
2015 | | |
2014 | |
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; 2,000,000,000 shares authorized; | |
| | | |
| | |
1,003,545,134 and 999,735,151 issued and outstanding as of March 31, 2015 and December 31, 2014 | |
| 10,036 | | |
| 9,998 | |
Additional paid-in capital | |
| 20,075,422 | | |
| 19,925,061 | |
Accumulated deficit | |
| (47,854,216 | ) | |
| (47,174,557 | ) |
Accumulated other comprehensive income – foreign currency translation | |
| 380,586 | | |
| 145,808 | |
| |
| | | |
| | |
Total Vertical Computer Systems, Inc. stockholders’ deficit | |
| (27,388,172 | ) | |
| (27,093,690 | ) |
| |
| | | |
| | |
Noncontrolling interest | |
| 599,322 | | |
| 621,816 | |
Total stockholders’ deficit | |
| (26,788,850 | ) | |
| (26,471,874 | ) |
| |
| | | |
| | |
Total liabilities and stockholders' deficit | |
$ | 1,104,439 | | |
$ | 1,430,587 | |
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 March 31, | |
| |
2015 | | |
2014 | |
Revenues | |
| | | |
| | |
Licensing and software | |
$ | - | | |
$ | 875,000 | |
Software maintenance | |
| 890,729 | | |
| 1,026,363 | |
Cloud-based offering | |
| 85,247 | | |
| 109,916 | |
Consulting services | |
| 63,859 | | |
| 78,100 | |
Other | |
| 15,000 | | |
| 14,639 | |
Total revenues | |
| 1,054,835 | | |
| 2,104,018 | |
| |
| | | |
| | |
Cost of revenues | |
| 425,862 | | |
| 586,718 | |
| |
| | | |
| | |
Gross profit | |
| 628,973 | | |
| 1,517,300 | |
| |
| | | |
| | |
Operating expenses: | |
| | | |
| | |
Selling, general and administrative expenses | |
| 873,893 | | |
| 1,432,953 | |
Depreciation and amortization | |
| 31,365 | | |
| 11,919 | |
Bad debt expense | |
| 36,190 | | |
| - | |
Impairment of software costs | |
| - | | |
| 192,955 | |
Total operating expenses | |
| 941,448 | | |
| 1,637,827 | |
| |
| | | |
| | |
Operating loss | |
| (312,475 | ) | |
| (120,527 | ) |
| |
| | | |
| | |
Other income (expense): | |
| | | |
| | |
Interest income | |
| 4 | | |
| 8 | |
Gain (loss) on derivative liability | |
| (78,680 | ) | |
| 4,741 | |
Forbearance fees | |
| - | | |
| (73,301 | ) |
Interest expense | |
| (255,496 | ) | |
| (213,522 | ) |
| |
| | | |
| | |
Net loss before noncontrolling interest and income tax expense | |
| (646,647 | ) | |
| (402,601 | ) |
Income tax expense | |
| 25,506 | | |
| - | |
| |
| | | |
| | |
Net loss before noncontrolling interest | |
| (672,153 | ) | |
| (402,601 | ) |
Net loss attributable to noncontrolling interest | |
| (7,506 | ) | |
| (656 | ) |
Net loss attributable to Vertical Computer Systems, Inc. | |
| (679,659 | ) | |
| (403,257 | ) |
| |
| | | |
| | |
Dividend applicable to preferred stock | |
| (147,000 | ) | |
| (147,000 | ) |
| |
| | | |
| | |
Net loss applicable to common stockholders | |
$ | (826,659 | ) | |
$ | (550,257 | ) |
| |
| | | |
| | |
Basic and diluted loss per share | |
$ | (0.00 | ) | |
$ | (0.00 | ) |
| |
| | | |
| | |
Basic and diluted weighted average of common shares outstanding | |
| 1,000,055,816 | | |
| 999,125,151 | |
| |
| | | |
| | |
Comprehensive loss | |
| | | |
| | |
Net loss | |
$ | (672,153 | ) | |
$ | (402,601 | ) |
Translation adjustments | |
| 234,778 | | |
| 112,238 | |
Comprehensive loss | |
| (437,375 | ) | |
| (290,363 | ) |
Comprehensive loss attributable to noncontrolling
interest | |
| (7,506 | ) | |
| (656 | ) |
Comprehensive loss attributable to Vertical Computer
Systems, Inc. | |
$ | (444,881 | ) | |
$ | (291,019 | ) |
See accompanying notes to
the unaudited consolidated financial statements.
Vertical Computer Systems, Inc. and
Subsidiaries
Consolidated Statement of Stockholders’
Deficit
(Unaudited)
| |
| | |
| | |
Additional | | |
| | |
Other | | |
Non-controlling | | |
| |
| |
Common Stock | | |
Paid-in | | |
Accumulated | | |
Comprehensive | | |
Controlling | | |
| |
| |
Shares | | |
Amount | | |
Capital | | |
Deficit | | |
Interest | | |
Interest | | |
Total | |
Balances at December 31, 2014 | |
| 999,735,151 | | |
$ | 9,998 | | |
$ | 19,925,061 | | |
$ | (47,174,557 | ) | |
$ | 145,808 | | |
$ | 621,816 | | |
$ | (26,471,874 | ) |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Shares issued for resolutions of derivative liabilities | |
| 3,309,983 | | |
| 33 | | |
| 130,366 | | |
| - | | |
| - | | |
| - | | |
| 130,399 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Shares issued for reimbursement of stock | |
| 500,000 | | |
| 5 | | |
| 19,995 | | |
| - | | |
| - | | |
| - | | |
| 20,000 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Dividends paid to non-controlling interest | |
| - | | |
| - | | |
| - | | |
| - | | |
| - | | |
| (30,000 | ) | |
| (30,000 | ) |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Other comprehensive income translation adjustment | |
| - | | |
| - | | |
| - | | |
| - | | |
| 234,778 | | |
| - | | |
| 234,778 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Net loss | |
| - | | |
| - | | |
| - | | |
| (679,659 | ) | |
| - | | |
| 7,506 | | |
| (672,153 | ) |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Balances at March 31, 2015 | |
| 1,003,545,134 | | |
$ | 10,036 | | |
$ | 20,075,422 | | |
$ | (47,854,216 | ) | |
$ | 380,586 | | |
$ | 599,322 | | |
$ | (26,788,850 | ) |
See
accompanying notes to the unaudited consolidated financial statements.
Vertical Computer Systems, Inc. and
Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
| |
Three Months Ended March 31, | |
| |
2015 | | |
2014 | |
| |
| | |
| |
Cash flows from operating activities | |
| | | |
| | |
Net loss | |
$ | (672,153 | ) | |
$ | (402,601 | ) |
Adjustments to reconcile net loss to net cash provided by (used in) operating activities: | |
| | | |
| | |
Depreciation and amortization | |
| 31,365 | | |
| 11,919 | |
Bad debt expense | |
| 36,190 | | |
| - | |
Impairment of software development costs | |
| - | | |
| 192,955 | |
Loss (gain) on derivatives | |
| 78,680 | | |
| (4,741 | ) |
Stock reimbursement expense | |
| 20,000 | | |
| - | |
Write-off of property and equipment | |
| 5,015 | | |
| - | |
Changes in operating assets and liabilities: | |
| | | |
| | |
Accounts receivable | |
| 390,856 | | |
| (439,805 | ) |
Prepaid expenses and other assets | |
| 6,183 | | |
| (5,417 | ) |
Accounts payable and accrued liabilities | |
| 186,028 | | |
| 793,313 | |
Deferred revenue | |
| (267,728 | ) | |
| 48,275 | |
Net cash provided by (used in) operating activities | |
| (185,564 | ) | |
| 193,898 | |
| |
| | | |
| | |
Cash flow from investing activities: | |
| | | |
| | |
Software development | |
| (142,253 | ) | |
| (33,200 | ) |
Net cash used in investing activities | |
| (142,253 | ) | |
| (33,200 | ) |
Cash flows from financing activities: | |
| | | |
| | |
Borrowings on notes payable | |
| 100,000 | | |
| - | |
Payments of notes payable | |
| - | | |
| (23,644 | ) |
Payments of related party debt | |
| - | | |
| (20,992 | ) |
Dividends paid to non-controlling interest
| |
| (30,000 | ) | |
| - | |
Bank overdraft | |
| 24,558 | | |
| 32,419 | |
Net cash provided by (used in) financing activities | |
| 94,558 | | |
| (12,217 | ) |
| |
| | | |
| | |
Effect of changes in exchange rates on cash | |
| 234,464 | | |
| 112,767 | |
Net change in cash and cash equivalents | |
| 1,205 | | |
| 261,248 | |
Cash and cash equivalents, beginning of period | |
| 117,866 | | |
| 162,709 | |
Cash and cash equivalents, end of period | |
$ | 119,071 | | |
$ | 423,957 | |
| |
| | | |
| | |
Supplemental disclosures of cash flow information: | |
| | | |
| | |
Cash paid for interest | |
$ | 68,960 | | |
$ | 89,989 | |
| |
| | | |
| | |
Non-cash investing and financing activities: | |
| | | |
| | |
Common shares issued for accrued stock compensation | |
$ | - | | |
$ | 7,900 | |
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, 2014. 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”),
a 80% owned subsidiary of Vertical. Vertical’s subsidiaries which have minimal operations are Vertical do Brasil, Taladin,
Inc. (“Taladin"), Ploinks, Inc. (“Ploinks”) (formerly, OptVision Research, Inc.), Vertical Healthcare Solutions,
Inc. (“VHS”), each a wholly-owned subsidiary of Vertical, as well as Priority Time Systems, Inc. (“Priority
Time”) a 70% 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. 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 2014 annual report on Form 10-K have been omitted.
Earnings per share
Basic earnings per
share is calculated by dividing net income (loss) available to common stockholders by the weighted average number of shares of
the Company’s common stock outstanding during the period. “Diluted earnings per share” reflects the potential
dilution that could occur if our share-based awards and convertible securities were exercised or converted into common stock.
The dilutive effect of our share-based awards is computed using the treasury stock method, which assumes all share-based awards
are exercised and the hypothetical proceeds from exercise are used to purchase common stock at the average market price during
the period. The incremental shares (difference between shares assumed to be issued versus purchased), to the extent they would
have been dilutive, are included in the denominator of the diluted EPS calculation. The dilutive effect of our convertible preferred
stock and convertible debentures is computed using the if-converted method, which assumes conversion at the beginning of the year.
For the three months
ended March 31, 2015 and 2014, common stock equivalents related to the convertible debentures, convertible debt and preferred
stock and stock derivative liability were not included in the calculation of the diluted earnings per share as their effect would
be anti-dilutive.
Reclassifications
Certain reclassifications
have been made to the prior periods to conform to the current period presentation.
Capitalized Software
Costs
Software
costs incurred internally in creating computer software products are expensed until technological feasibility has been established
upon completion of a detailed program design. Thereafter, all software development costs are capitalized until the point that
the product is ready for sale, and are subsequently reported at the lower of unamortized cost or net realizable value. The Company
considers annual amortization of capitalized software costs based on the ratio of current year revenues by product to the total
estimated revenues by the product, subject to an annual minimum based on straight-line amortization over the product’s estimated
economic useful life, not to exceed five years. The Company periodically reviews capitalized software costs for impairment where
the fair value is less than the carrying value.
During
the three months ended March 31, 2015, the Company capitalized an aggregate of $142,253 related to software development.
Recently Issued
Accounting Pronouncements
The Company does not
expect the adoption of any recently issued accounting pronouncements to have a material impact on the Company’s financial
position, operations or cash flows.
Note 2. Going Concern
The accompanying unaudited consolidated
financial statements for the three months ended March 31, 2015 and 2014 have been prepared assuming that we will continue as a
going concern, and accordingly realize our assets and satisfy our liabilities in the normal course of business.
The carrying amounts
of assets and liabilities presented in the consolidated financial statements do not purport to represent realizable or settlement
values. As of March 31, 2015, we had negative working capital of approximately $17.7 million and defaulted on substantially all
of our debt obligations. These conditions raise substantial doubt about our ability to continue as a going concern.
Our management is
continuing its efforts to attempt to secure funds through equity and/or debt instruments for our operations, expansion and possible
acquisitions, mergers, joint ventures, and/or other business combinations. The Company will require additional funds to pay down
its liabilities, as well as finance its expansion plans consistent with anticipated changes in operations and infrastructure.
However, there can be no assurance that the Company will be able to secure additional funds and that if such funds are available,
whether the terms or conditions would be acceptable to the Company and whether the Company will be able to turn into a profitable
position and generate positive operating cash flow. The consolidated financial statements contain no adjustment for the outcome
of this uncertainty.
Note 3. Notes Payable
The following table
reflects our third party debt activity, including our convertible debt, for the three months ended March 31, 2015:
December 31, 2014 | |
$ | 4,575,239 | |
Issuance of third party notes | |
| 100,000 | |
Effect of currency exchange | |
| (315 | ) |
March 31, 2015 | |
| 4,674,924 | |
Lakeshore Financing
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 Mr. 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 payable in equal monthly installments of $24,232 until January 31, 2022. Upon the payment of any prepayment principal
amounts, the monthly installment payments shall be proportionately adjusted proportionately on an amortized rata basis.
The Lakeshore Note
is secured by the assets of the Company’s subsidiaries, NOW Solutions, Priority Time, SnAPPnet, Inc. (“SnAPPnet”)
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 of $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 of $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. Management has estimated the fair value of the royalty to be nominal as of its issuance date and no royalty was
owed as of March 31, 2015 or December 31, 2014.
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, 2014 and 2013 were $197,156 and $327,867, respectively. 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 initial recognition of this noncontrolling interest in NOW Solutions resulted in a loss on loan remedy
of $1,457,240 during the year ended December 31, 2013.
In December 2014,
the Company and Lakeshore entered into an amendment of the Lakeshore Note and the Loan Agreement. Under the terms of the amendment,
NOW Solutions agreed to make $2,500 weekly advance payments to Lakeshore to be applied to the 25% dividend of NOW Solutions’
net income after taxes. Within 10 business days after the Company files its periodic reports with the SEC, NOW Solutions will
also make quarterly payment advances to Lakeshore based on 60% of Lakeshore’s 25% share of NOW Solutions estimated quarterly
net income after taxes, less any weekly payment advances received by Lakeshore during the then-applicable quarter and the weekly
$2,500 payments shall be increased or decreased based only upon any increases or decreases of maintenance and SaaS fees during
the then-completed quarter (but will not decrease below a minimum of $2,500 per week). NOW Solutions shall pay Lakeshore the balance
of Lakeshore’s 25% of NOW’s yearly net income after taxes (less any advances) within 10 business days after the Company
files it annual 10-K report with the SEC and any payments in excess of Lakeshore’s 25% of NOW yearly profit shall be credited
towards future weekly advance payments. The Company also agreed to pay attorney fees of $40,000 and pay $80,000 to a former consultant
and employee of the Company who is a member of Lakeshore. In consideration of the extension to cure the default under the Note
and Loan Agreement, the Company transferred a 20% ownership interest in Priority Time Systems, Inc., a 90% owned subsidiary of
VCSY, and in SnAPPnet, Inc., a 100% owned subsidiary of VCSY, to Lakeshore. This resulted in an additional noncontrolling interest
recognized in the equity of the Company of $391,920 and $99,210 for Priority Time Systems, Inc. and SnAPPnet, Inc., respectively,
during 2014. The Company had an option to buy back Lakeshore’s ownership interest in NOW Solutions, Priority Time and SnAPPnet,
Inc. (which expired on January 31, 2015). The Note is currently in default and the Company is in discussions with Lakeshore to
cure the default and buy back Lakeshore’s ownership interests in our subsidiaries. During the three months ended March 31,
2015, the Company paid dividends to Lakeshore of $30,000.
In February 2015,
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, Taladin, Inc., a subsidiary of the Company, issued a promissory note in the principal amount of $100,000 bearing
interest at 12% per annum and is due on demand.
Note 4. Derivative liability and fair
value measurements
Derivative liabilities
In March 2015, pursuant
to an indemnity and reimbursement agreement executed between Mr. Valdetaro and the Company, we issued 1,000,000 shares of our
common stock to reimburse Mr. Valdetaro for 1,000,000 shares of common stock transferred to Lakeshore on the Company’s behalf
in connection with an extension granted by Lakeshore in August 2013. The issuance of these shares eliminated the derivative liability
associated with the value of these shares. The fair market value of these shares on the date of issuance was $38,000 and resulted
in the resolution of derivative liabilities.
In March 2015, pursuant
to two indemnity and reimbursement agreements executed between Mountain Reservoir Corporation (“MRC”) and the Company,
we issued a total of 2,809,983 shares of our common stock to reimburse MRC. Of these shares, the Company was obligated to
reimburse MRC with 1,309,983 shares of common stock that had been pledged by MRC and sold by a third party lender in 2009, 500,000
shares of common stock that had been wrongfully converted by the same lender in 2014, and 1,000,000 shares of common stock that
had been transferred to another third party lender in 2013 on the Company’s behalf for a loan made by the lender.
MRC has assigned its claim against the third party lender for the lender’s wrongful conversion of 500,000 common shares
to the Company and we are pursuing the claim in the third party lender’s bankruptcy proceeding. The issuance of these
shares eliminated the derivative liability associated with the value of these shares. The fair market value of these
shares on the date of issuance was $112,399 of which $92,399 resulted in the resolution of derivative liabilities and $20,000
was recognized as stock reimbursement expense during the three months ended March 31, 2015.
In March 2015, 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 past
due loan by a third party lender were eliminated as part of the derivative liability as the lender did not exercise their rights
to obtain the stock. The derivative liability associated with this obligation of $12,000 was written-off to (gain) loss on derivative
liability during the three months ended March 31, 2015.
These contractual
commitments to replace all of the shares associated with the derivative liability in 2014 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. As of March 31, 2015, the derivative liability has been eliminated since
the shares have been issued or the obligation to issue the shares has been resolved. As of December 31, 2014, the aggregate fair
value of the derivative liabilities was $51,719.
The aggregate change in the fair value
of derivative liabilities was a loss of $78,680 and a gain of $4,741 for the three months ended March 31, 2015 and March 31, 2014,
respectively.
The valuation of our
embedded derivatives was determined by using the VCSY stock price at December 31, 2014 and the resolution dates. As such, our
derivative liabilities were classified as Level 1.
Fair value measurements
FASB ASC 820, Fair
Value Measurements and Disclosures, defines fair value as the exchange price that would be received for an asset or paid to transfer
a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction
between market participants on the measurement date. FASB ASC 820 also establishes a fair value hierarchy which requires an entity
to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. FASB ASC 820 describes
three levels of inputs that may be used to measure fair value:
Level 1 – Quoted
prices in active markets for identical assets or liabilities.
Level 2 – Observable
inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; or other inputs that are observable
or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 – Unobservable inputs that are
supported by little or no market activity and that are financial instruments whose values are determined using pricing models,
discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires
significant judgment or estimation.
If the inputs used
to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on
the lowest level of input that is significant to the fair value measurement of the instrument.
The following table provides a summary
of the fair value of our derivative liabilities as of March 31, 2015 and December 31, 2014:
| |
Fair value measurements on a recurring
basis | |
| |
Level 1 | | |
Level 2 | | |
Level 3 | |
As of March 31, 2015: | |
| | | |
| | | |
| | |
Liabilities | |
| | | |
| | | |
| | |
Stock derivative – 0 shares | |
$ | - | | |
$ | - | | |
$ | - | |
| |
| | | |
| | | |
| | |
As of December 31, 2014: | |
| | | |
| | | |
| | |
Liabilities | |
| | | |
| | | |
| | |
Stock derivative – 4,309,983 shares | |
$ | 51,719 | | |
$ | - | | |
$ | - | |
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
In February 2015,
after holding an annual stockholder meeting, the Company filed an amendment of its certificate of incorporation in the state of
Delaware to increase the authorized number of shares of common stock to 2,000,000,000.
In March 2015, pursuant
to an indemnity and reimbursement agreement executed between Mr. Valdetaro and the Company, we issued 1,000,000 shares of our
common stock to reimburse Mr. Valdetaro for 1,000,000 shares of common stock transferred to Lakeshore on the Company’s behalf
in connection with an extension granted by Lakeshore in August 2013. The issuance of these shares eliminated the derivative liability
associated with the value of these shares. The fair market value of these shares on the date of issuance was $38,000 and resulted
in the resolution of derivative liabilities.
In March 2015, pursuant
to two indemnity and reimbursement agreements executed between Mountain Reservoir Corporation (“MRC”) and the Company,
we issued a total of 2,809,983 shares of our common stock to reimburse MRC. Of these shares, the Company was obligated to
reimburse MRC with 1,309,983 shares of common stock that had been pledged by MRC and sold by a third party lender in 2009, 500,000
shares of common stock that had been wrongfully converted by the same lender in 2014, and 1,000,000 shares of common stock that
had been transferred to another third party lender in 2013 on the Company’s behalf for a loan made by the lender.
MRC has assigned its claim against the third party lender for the lender’s wrongful conversion of 500,000 common shares
to the Company and we are pursuing the claim in the third party lender’s bankruptcy proceeding. The issuance of these
shares eliminated the derivative liability associated with the value of these shares. The fair market value of these
shares on the date of issuance was $112,399 of which $92,399 resulted in the resolution of derivative liabilities and $20,000
was recognized as stock reimbursement expense during the three months ended March 31, 2015.
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. Related Party Transactions
In March 2015, pursuant
to an indemnity and reimbursement agreement executed between Mr. Valdetaro and the Company, we issued 1,000,000 shares of our
common stock to reimburse Mr. Valdetaro for 1,000,000 shares of common stock transferred to Lakeshore on the Company’s behalf
in connection with an extension granted by Lakeshore in August 2013. The issuance of these shares eliminated the derivative liability
associated with the value of these shares. The fair market value of these shares on the date of issuance was $38,000 and resulted
in the resolution of derivative liabilities.
In March 2015, pursuant
to two indemnity and reimbursement agreements executed between Mountain Reservoir Corporation (“MRC”) and the Company,
we issued a total of 2,809,983 shares of our common stock to reimburse MRC. Of these shares, the Company was obligated to
reimburse MRC with 1,309,983 shares of common stock that had been pledged by MRC and sold by a third party lender in 2009, 500,000
shares of common stock that had been wrongfully converted by the same lender in 2014, and 1,000,000 shares of common stock that
had been transferred to another third party lender in 2013 on the Company’s behalf for a loan made by the lender.
MRC has assigned its claim against the third party lender for the lender’s wrongful conversion of 500,000 common shares
to the Company and we are pursuing the claim in the third party lender’s bankruptcy proceeding. The issuance of these
shares eliminated the derivative liability associated with the value of these shares. The fair market value of these
shares on the date of issuance was $112,399 of which $92,399 resulted in the resolution of derivative liabilities and $20,000
was recognized as stock reimbursement expense during the three months ended March 31, 2015.
As of March 31, 2015
and December 31, 2014, the Company had accounts payable to employees for unreimbursed expenses and related party contractors in
an aggregate amount of $94,059 and $92,191, respectively. The payables are unsecured, non-interest bearing and due on demand.
Note 7. Legal Proceedings
We are involved in
the following ongoing legal matters:
On December 31, 2011,
the Company and InfiniTek corporation (“Infinitek”) entered into a settlement agreement to dismiss an action filed
by the Company against InfiniTek in the Texas State District Court in Fort Worth, Texas, for breach of contract and other claims,
a counter claim filed by InfiniTek against the Company for non-payment of amounts claimed the Company owed to InfiniTek, and an
action filed by InfiniTek against the Company in California Superior Court in Riverside, California seeking damages for breach
of contract and lost profit. 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 the date of this Report 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 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. The Company held an annual meeting of shareholders on February 25, 2015. This matter is resolved.
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 three months ended March 31, 2015 and 2014, $142,253 and $33,200
of internal costs were capitalized, respectively.
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
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 Months Ended March
31, 2015 Compared To Three Months Ended March 31, 2014
Total Revenues.
We had total revenues of $1,054,835 and $2,104,018 in the three months ended March 31, 2015 and 2014, respectively. The
decrease in total revenues was $1,049,183 for the three months ended March 31, 2015 representing a 49.9% decrease compared to
the total revenues for the three months ended March 31, 2014. Of the $1,054,835 and $2,104,018 total revenues for the three months
ended March 31, 2015 and 2014, respectively, $1,035,674 and $1,174,722 of such amounts were related to the business operations
of NOW Solutions, a 75% owned subsidiary of the Company. Revenue from SnAPPnet, Inc. was $19,161 or 1.8% of total revenue for
the three months ended March 31, 2015 and $54,296 or 2.6% of total revenues for the three months ended March 31, 2014.
The total revenues
primarily consist of fees derived from software licenses, consulting services, software maintenance and cloud-based offerings.
The revenue from licenses and software decreased by $875,000 compared to that for the three months ended March 31, 2014 due to
a one-time license agreement for SiteFlash in the first quarter of 2014. Software maintenance in the three months ended March
31, 2015 decreased by $135,634 or 13.2% from the same period in the prior year. The revenue decrease in software maintenance is
primarily due to unfavorable currency rate changes on our Canadian revenue and the loss or reduction of customer maintenance agreements
in the first quarter of 2015. Consulting revenue, in the three months ended March 31, 2015 decreased by $14,241 from the same
period in the prior year, which represents a 18.2% decrease. This decrease was primarily due to less billable consulting services
for the first quarter of 2015 compared to 2014 and the effects of unfavorable currency rate changes on our Canadian revenue. Cloud-based
revenues were $85,247 for the three months ended March 31, 2015 compared to $109,916 for the same period in the prior year, representing
a $24,669 decrease or 22.4%. The decrease is primarily related to renegotiation of a customer contract and unfavorable currency
rate changes on our Canadian cloud-based revenue. Other revenue in the three months ended March 31, 2015 increased by $361 or
2.5% 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 $425,862 for the three months ended March 31, 2015, compared to $586,718
for the three months ended March 31, 2014. The decrease in cost of revenues of $160,856 represents a 27.4% decrease. The decrease
in direct cost of revenues was primarily due to lower payroll and consulting through attrition and lower rent due to the consolidation
of our office space for the three months ended March 31, 2015. During the three months ended March 31, 2015 and 2014, $142,253
and $33,200 of internal costs were capitalized, respectively.
Selling, General
and Administrative Expenses. We had selling, general and administrative expenses of $873,893 and $1,432,953 in the three
months ended March 31, 2015 and 2014, respectively. The decrease of $559,060 is 39.0% less than for the same period in 2014. The
decrease is primarily due to decreased legal fees to prosecute patent infringement on the company’s intellectual property,
decreased foreign taxes and tax penalties somewhat offset by increased costs related to the company’s annual shareholder’s
meeting.
Depreciation
and Amortization. We had depreciation and amortization expense of $31,365 and $11,919 for the three months ended March
31, 2015 and 2014, respectively. The increase of $19,446 or 163.2% relates to additional long lived assets purchased in 2015 as
well as a true up of depreciation on existing assets. Amortization expenses relates to the amortization of intangible assets such
as acquired software, customer lists and websites.
Bad Debt Expense.
We had bad debt expense of $36,190 for the three months ended March 31, 2015 related to the allowance of customer accounts greater
than 90 days past due.
Impairment of
Software Costs. During the three months ended March 31, 2014, $192,955 of capitalized software development costs were
considered impaired.
Income (Loss)
from Operations. We had a net loss from operations of $312,475 and $120,527 for the three months ended March 31, 2015
and 2014, respectively. The increased loss was due to decreased revenues and increased depreciation and bad debt expense partially
offset by decrease cost of revenue, selling, general and administrative expenses and impairment of software.
Gain (Loss)
on Derivative Liability. Derivative liabilities are adjusted each quarter for changes in the market value of the Company’s
common stock. In general, as our stock price increases, the derivative liability increases, resulting in a loss. As our stock
price decreases, the derivative liability decreases, resulting in a gain. The loss on derivative liability was $78,680 for the
three months ended March 31, 2015 compared to a gain of $4,741 for the same period in 2014. During the first quarter 2015, the
Company issued common shares and eliminated the derivative liabilities.
Forbearance
Fees. Forbearance fees relate to fees charged by our lenders on loans in default. Forbearance fees for the three months
ended March 31, 2014 were $73,301. The fees are related to our senior secured debt for NOW Solutions.
Interest Expense.
We had interest expense of $255,496 and $213,522 for the three months ended March 31, 2015 and 2014, respectively. Interest
expense increased in 2015 by $41,974, representing an increase of 19.7% compared to the same expense in the three months ended
March 31, 2014. The increase is primarily due to increased debt borrowings at March 31, 2015 compared to March 31, 2014 and additional
interest on amounts due to vendors.
Net loss.
We had a net loss of $646,647 and $402,601 for the three months ended March 31, 2015 and 2014, respectively. The net loss for
the three months ended March 31, 2015 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 $312,475. The operating loss was increased by the
loss on derivative liability and interest expense resulting in a net loss of $646,647 for the three months ended March 31, 2015.
The net loss for the three months ended March 31, 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 $120,527. The operating loss was
decreased by the gain on derivative liability and increased by interest expense and forbearance fees, resulting in a net loss
of $402,601 for the three months ended March 31, 2014.
Income Tax Provision.
We had an income tax provision of $25,506 for the three months ended March 31, 2015. The income tax provision is related to
NOW Solutions, a 75% owned subsidiary of the Company. The income tax provision is related to foreign and US income tax. No income
tax provision was recorded in the first quarter of 2014 as VCSY owned 100% of NOW Solutions and was able to utilize its tax loss
carry-forwards to offset NOW Solutions’ taxable income.
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
and $147,000 for the three months ended March 31, 2015 and 2014, respectively.
Net Loss Available
to Common Stockholders. We had a net loss attributed to common stockholders of $826,659 and $550,257 for the three months
ended March 31, 2015 and 2014, respectively. Net loss attributed 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 three months ended March 31, 2015 and 2014, respectively.
Liquidity
and Capital Resources
At
March 31, 2015, we had non-restricted cash-on-hand of $119,071 compared to $117,866 at December
31, 2014.
Net cash used in operating
activities for the three months ended March 31, 2015 was $185,564 compared to net cash provided by operating activities of $193,898
for the three months ended March 31, 2014. For the three months ended March 31, 2015, we collected cash from our customers and
other licensees of $1,456,541. We used the cash to pay for salaries, benefits, payroll taxes and payroll fees of $888,794, attorney
fees of $81,108, professional fees and consulting fees of $158,725 interest payments of $68,960, taxes of $15,960, and other regular
trade payables of $428,558. For the three months ended March 31, 2014, we collected cash from our customers and other licensees
of $1,535,110. We used the cash to pay for salaries, benefits, payroll taxes and payroll fees of $480,650, attorney fees of $134,580,
professional fees and consulting fees of $47,489 interest payments of $89,989, taxes (including sales tax and VAT) of $74,472,
and other regular trade payables of $514,032.
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 $267,728 or 11.5% from
the balance at December 31, 2014. The decrease was primarily due to the loss or reduction of customer maintenance agreements in
the first quarter of 2015.
Our accounts receivable
trade decreased from $560,879 at December 31, 2014 to $120,155 (net of allowance for bad debts) at March 31, 2015. The decrease
is a primarily a result of a seasonal fluctuations in the timing of billing for software maintenance which typically yields higher
receivables in December compared to March.
The accounts payable
and accrued liabilities went from $10,603,879 at December 31, 2014 to $10,788,043 at March 31, 2015. The resulting balance at
March 31, 2015 is 90 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 for the
development of new software products for the three months ended March 31, 2015 and March 31, 2014 of $142,253 and $33,200 respectively.
For the three months
ended March 31, 2015, we borrowed $100,000 from a third party lender. For the three months ended March 31, 2014, we paid $44,636
of principal on notes payable and notes payable to related parties.
For the three months
ended March 31, 2015, we paid $30,000 of dividends to non-controlling interests.
The total change in
cash for the three months ended March 31, 2015 was an increase of $1,205.
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.
As of March 31, 2015,
the following contractual obligations and commercial commitments were outstanding:
| |
Balance at | | |
Due in Next Five Years | |
Contractual Obligations | |
March 31,
2015 | | |
2015 | | |
2016 | | |
2017 | | |
2018 | | |
2019+ | |
Notes payable | |
$ | 4,993,590 | | |
$ | 4,993,590 | | |
| - | | |
| - | | |
| - | | |
| - | |
Convertible debts | |
| 30,000 | | |
| 30,000 | | |
| - | | |
| - | | |
| - | | |
| - | |
Operating lease | |
| 42,520 | | |
| 38,297 | | |
| 4,223 | | |
| - | | |
| - | | |
| - | |
Total | |
$ | 5,066,110 | | |
$ | 5,061,887 | | |
$ | 4,223 | | |
| - | | |
| - | | |
| - | |
Of the above notes payable,
the default status is as follows:
| |
March 31, 2015 | | |
December 31, 2014 | |
| |
| | |
| |
In default | |
$ | 4,758,090 | | |
$ | 4,758,405 | |
Not in default | |
| 265,500 | | |
| 165,500 | |
| |
| | | |
| | |
Total Notes Payable | |
$ | 5,023,590 | | |
$ | 4,923,905 | |
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 $679,659 for the three months ended March 31, 2015 and a net loss of $403,257 for the three months ended March
31, 2014, and we 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 March 31, 2015, we had negative working capital of approximately $17.7 million (although this figure includes deferred revenue
of approximately $2.1 million) and have defaulted on substantially all 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, 2014, as filed on April 15, 2015.
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, 2014.
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
We are involved in
the following ongoing legal matters:
On December 31, 2011, the Company and
InfiniTek corporation (“Infinitek”) entered into a settlement agreement to dismiss an action filed by the Company
against InfiniTek in the Texas State District Court in Fort Worth, Texas, for breach of contract and other claims, a counter claim
filed by InfiniTek against the Company for non-payment of amounts claimed the Company owed to InfiniTek, and an action filed by
InfiniTek against the Company in California Superior Court in Riverside, California seeking damages for breach of contract and
lost profit. 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 the date of this Report 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 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. The Company held an annual meeting of shareholders on February 25, 2015. This matter is resolved.
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, 2014, as
filed on April 15, 2015.
Item 2. Unregistered
Sales of Equity Securities and Use of Proceeds
In February 2015,
after holding an annual stockholder meeting, the Company filed an amendment of its certificate of incorporation in the state of
Delaware to increase the authorized number of shares of common stock to 2,000,000,000.
In March 2015, pursuant
to an indemnity and reimbursement agreement executed between Mr. Valdetaro and the Company, we issued 1,000,000 shares of our
common stock to reimburse Mr. Valdetaro for 1,000,000 shares of common stock transferred to Lakeshore on the Company’s behalf
in connection with an extension granted by Lakeshore in August 2013. The issuance of these shares eliminated the derivative liability
associated with the value of these shares. The fair market value of these shares on the date of issuance was $38,000 and resulted
in the resolution of derivative liabilities.
In March 2015, pursuant
to two indemnity and reimbursement agreements executed between Mountain Reservoir Corporation (“MRC”) and the Company,
we issued a total of 2,809,983 shares of our common stock to reimburse MRC. Of these shares, the Company was obligated to
reimburse MRC with 1,309,983 shares of common stock that had been pledged by MRC and sold by a third party lender in 2009, 500,000
shares of common stock that had been wrongfully converted by the same lender in 2014, and 1,000,000 shares of common stock that
had been transferred to another third party lender in 2013 on the Company’s behalf for a loan made by the lender.
MRC has assigned its claim against the third party lender for the lender’s wrongful conversion of 500,000 common shares
to the Company and we are pursuing the claim in the third party lender’s bankruptcy proceeding. The issuance of these
shares eliminated the derivative liability associated with the value of these shares. The fair market value of these
shares on the date of issuance was $112,399 of which $92,399 resulted in the resolution of derivative liabilities and $20,000
was recognized as stock reimbursement expense during the three months ended March 31, 2015.
Item 3. Defaults
Upon Senior Securities
Note payable of $1,759,150
issued by NOW Solutions to Lakeshore Investment, LLC, dated January 9, 2013. The note is secured with the assets of NOW Solutions,
Priority Time Systems, SnAPPnet, and the SiteFlash™ assets and bears a default interest rate of 16%. As of May 14, 2015,
the outstanding principle and accrued interest currently due under the note is $1,500,426.
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:
31.1 |
|
Certification of Principal
Executive Officer and Principal Accounting Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated May 14,
2015 |
|
Provided herewith |
|
|
|
|
|
32.1 |
|
Certification of Principal Executive Officer
and Principal Accounting Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, dated May 14, 2015 |
|
Provided herewith |
|
|
|
|
|
101.INS* |
|
XBRL Instance Document |
|
Provided herewith |
|
|
|
|
|
101.SCH* |
|
XBRL Taxonomy Extension Schema |
|
Provided herewith |
|
|
|
|
|
101.CAL * |
|
XBRL Taxonomy Extension Calculation Linkbase |
|
Provided herewith |
|
|
|
|
|
101.DEF* |
|
XBRL Taxonomy Extension Definition Linkbase |
|
Provided herewith |
|
|
|
|
|
101.LAB* |
|
XBRL Taxonomy Extension Label Linkbase |
|
Provided herewith |
|
|
|
|
|
101.PRE* |
|
XBRL Taxonomy Extension Presentation Linkbase |
|
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. |
|
|
|
|
May 14, 2015 |
|
By: |
/s/ Richard Wade |
|
|
|
Richard Wade, |
|
|
|
President and Chief Executive Officer |
|
|
|
(Principal Executive Officer and
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 months ended March 31, 2015 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: May 14, 2015 |
By: |
/s/ Richard S. Wade |
|
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 Annual
Report of Vertical Computer Systems, Inc. (the “Company”) on Form 10-Q for the three months ended March 31, 2015, 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: May 14, 2015 |
By: |
/s/ Richard S. Wade |
|
Richard S. Wade |
|
Chief Executive Officer |
|
(Principal Executive Officer
and
Principal Accounting Officer) |
|
|