UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☒ QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30,
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 ☒
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 ☒ 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 ☒ |
|
Indicate by check
mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes ☐
No ☒
As
of August 19, 2015, the issuer had 1,092,601,656 shares of
common stock, par value $0.00001, issued and 1,062,601,656 outstanding.
PART I
FINANCIAL INFORMATION
Item 1. Consolidated
Financial Statements
Vertical Computer Systems, Inc. and Subsidiaries |
Consolidated Balance Sheets
(Unaudited) |
| |
June 30, | | |
December 31, | |
| |
2015 | | |
2014 | |
Assets | |
| | | |
| | |
Current assets | |
| | | |
| | |
Cash | |
$ | 18,891 | | |
$ | 117,866 | |
Accounts receivable, net of allowance for bad debts of $146,719 and $97,419 | |
| 81,129 | | |
| 560,879 | |
Prepaid expenses and other current assets | |
| 58,847 | | |
| 41,387 | |
Total current assets | |
| 158,867 | | |
| 720,132 | |
| |
| | | |
| | |
Property and equipment, net of accumulated depreciation of $1,043,459 and $1,026,654 | |
| 2,265 | | |
| 28,089 | |
Intangible assets, net of accumulated amortization of $319,531 and $302,016 | |
| 906,990 | | |
| 657,978 | |
Deposits and other | |
| 24,187 | | |
| 24,388 | |
| |
| | | |
| | |
Total assets | |
$ | 1,092,309 | | |
$ | 1,430,587 | |
| |
| | | |
| | |
Liabilities and Stockholders’ Deficit | |
| | | |
| | |
Current liabilities: | |
| | | |
| | |
Accounts payable and accrued liabilities | |
$ | 11,473,125 | | |
$ | 10,603,879 | |
Accounts payable to related parties | |
| 112,274 | | |
| 92,191 | |
Bank overdraft | |
| 158 | | |
| 7,699 | |
Deferred revenue | |
| 1,704,368 | | |
| 2,321,044 | |
Derivative liability | |
| — | | |
| 51,719 | |
Convertible debenture | |
| 30,000 | | |
| 30,000 | |
Current portion - notes payable | |
| 4,704,969 | | |
| 4,545,239 | |
Current portion - notes payable to related parties | |
| 348,666 | | |
| 348,666 | |
Total current liabilities | |
| 18,373,560 | | |
| 18,000,437 | |
| |
| | | |
| | |
Total liabilities | |
| 18,373,560 | | |
| 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)
| |
| | | |
| | |
| |
June 30, | | |
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 | |
| | | |
| | |
1,053,545,134 issued and 1,023,545,134 outstanding as of June 30, 2015 and
999,735,151 issued and outstanding as of December 31, 2014 | |
| 10,536 | | |
| 9,998 | |
Treasury stock; 30,000,000 as of June 30, 2015 and no shares as of December 31, 2014 | |
| (300 | ) | |
| — | |
Additional paid-in-capital | |
| 20,574,222 | | |
| 19,925,061 | |
Accumulated deficit | |
| (48,668,280 | ) | |
| (47,174,557 | ) |
Accumulated other comprehensive income – foreign currency translation | |
| 311,116 | | |
| 145,808 | |
| |
| | | |
| | |
Total Vertical Computer Systems, Inc. stockholders’ deficit | |
| (27,772,706 | ) | |
| (27,093,690 | ) |
| |
| | | |
| | |
Noncontrolling interest | |
| 589,431 | | |
| 621,816 | |
Total stockholders’ deficit | |
| (27,183,275 | ) | |
| (26,471,874 | ) |
| |
| | | |
| | |
Total liabilities and stockholders’ deficit | |
$ | 1,092,309 | | |
$ | 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 June 30, | | |
Six Months Ended June 30, | |
| |
2015 | | |
2014 | | |
2015 | | |
2014 | |
Revenues | |
| | | |
| | | |
| | | |
| | |
Licensing and software | |
$ | — | | |
$ | 1,725,180 | | |
$ | — | | |
$ | 2,600,180 | |
Software maintenance | |
| 1,001,019 | | |
| 971,704 | | |
| 1,891,748 | | |
| 1,998,067 | |
Cloud-based offering | |
| 76,780 | | |
| 96,694 | | |
| 162,027 | | |
| 206,610 | |
Consulting services | |
| 67,395 | | |
| 130,732 | | |
| 131,254 | | |
| 208,832 | |
Other | |
| 10,788 | | |
| 17,941 | | |
| 25,788 | | |
| 32,580 | |
Total revenues | |
| 1,155,982 | | |
| 2,942,251 | | |
| 2,210,817 | | |
| 5,046,269 | |
| |
| | | |
| | | |
| | | |
| | |
Cost of revenues | |
| 486,020 | | |
| 610,765 | | |
| 911,882 | | |
| 1,197,483 | |
| |
| | | |
| | | |
| | | |
| | |
Gross profit | |
| 669,962 | | |
| 2,331,486 | | |
| 1,298,935 | | |
| 3,848,786 | |
| |
| | | |
| | | |
| | | |
| | |
Operating expenses: | |
| | | |
| | | |
| | | |
| | |
Selling, general and administrative expenses | |
| 686,897 | | |
| 1,895,597 | | |
| 1,560,790 | | |
| 3,328,550 | |
Depreciation and amortization | |
| 7,047 | | |
| 11,446 | | |
| 38,412 | | |
| 23,365 | |
Bad debt expense | |
| 14,691 | | |
| — | | |
| 50,881 | | |
| — | |
Impairment of software costs | |
| — | | |
| 192,956 | | |
| — | | |
| 385,911 | |
Total operating expenses | |
| 708,635 | | |
| 2,099,999 | | |
| 1,650,083 | | |
| 3,737,826 | |
| |
| | | |
| | | |
| | | |
| | |
Operating income (loss) | |
| (38,673 | ) | |
| 231,487 | | |
| (351,148 | ) | |
| 110,960 | |
Other income (expense): | |
| | | |
| | | |
| | | |
| | |
Interest income | |
| 2 | | |
| 8 | | |
| 6 | | |
| 16 | |
Gain (loss) on derivative liability | |
| — | | |
| 100,854 | | |
| (78,680 | ) | |
| 105,595 | |
Loss on debt extinguishment | |
| (150,000 | ) | |
| — | | |
| (150,000 | ) | |
| — | |
Forbearance fees | |
| (249,000 | ) | |
| (88,301 | ) | |
| (249,000 | ) | |
| (161,602 | ) |
Interest expense | |
| (268,268 | ) | |
| (232,910 | ) | |
| (523,764 | ) | |
| (446,432 | ) |
| |
| | | |
| | | |
| | | |
| | |
Net income (loss) before noncontrolling interest and income tax expense | |
| (705,939 | ) | |
| 11,138 | | |
| (1,352,586 | ) | |
| (391,463 | ) |
Income tax expense | |
| 88,016 | | |
| — | | |
| 113,522 | | |
| — | |
Net income (loss) before noncontrolling interest | |
| (793,955 | ) | |
| 11,138 | | |
| (1,466,108 | ) | |
| (391,463 | ) |
Net income attributable to noncontrolling interest | |
| (20,109 | ) | |
| (51,403 | ) | |
| (27,615 | ) | |
| (52,059 | ) |
Net loss attributable to Vertical Computer Systems, Inc. | |
| (814,064 | ) | |
| (40,265 | ) | |
| (1,493,723 | ) | |
| (443,522 | ) |
Dividends applicable to preferred stock | |
| (147,000 | ) | |
| (147,000 | ) | |
| (294,000 | ) | |
| (294,000 | ) |
| |
| | | |
| | | |
| | | |
| | |
Net loss available to common stockholders | |
$ | (961,064 | ) | |
$ | (187,265 | ) | |
$ | (1,787,723 | ) | |
$ | (737,522 | ) |
| |
| | | |
| | | |
| | | |
| | |
Basic and diluted net loss per share | |
$ | (0.00 | ) | |
$ | (0.00 | ) | |
$ | (0.00 | ) | |
$ | (0.00 | ) |
| |
| | | |
| | | |
| | | |
| | |
Basic and diluted weighted average of common shares outstanding | |
| 1,008,270,409 | | |
| 998,484,052
| | |
| 1,004,185,805 | | |
| 999,305,593 | |
See
accompanying notes to the unaudited consolidated financial statements.
(Continued on next
page)
Vertical Computer
Systems, Inc. and Subsidiaries
Consolidated Statements of Operations
and Comprehensive Loss
(Unaudited)
(Continued from previous page)
Comprehensive loss | |
| | | |
| | | |
| | | |
| | |
Net income (loss) | |
$ | (793,955 | ) | |
$ | 11,138 | | |
$ | (1,466,108 | ) | |
$ | (391,463 | ) |
Translation adjustments | |
| (69,470 | ) | |
| 40,428 | | |
| 165,308 | | |
| 152,666 | |
Comprehensive income (loss) | |
| (863,425 | ) | |
| 51,566 | | |
| (1,300,800 | ) | |
| (238,797 | ) |
Comprehensive income attributable to noncontrolling
interest | |
| (20,109 | ) | |
| (51,403 | ) | |
| (27,615 | ) | |
| (52,059 | ) |
Comprehensive income (loss) attributable to Vertical Computer Systems, Inc. | |
$ | (883,534 | ) | |
$ | 163 | | |
$ | (1,328,415 | ) | |
$ | (290,856 | ) |
See accompanying notes to the unaudited consolidated financial statements.
Vertical Computer
Systems, Inc. and Subsidiaries
Consolidated Statement of Stockholders’
Deficit
December 31, 2014 through June 30, 2015
(Unaudited)
| |
| | |
| | |
| | |
| | |
| | |
| | |
| |
| |
Common Stock | | |
Treasure Stock | | |
Additional Paid-in | | |
Accumulated | | |
Other Comprehensive | | |
Noncontrolling | | |
| | |
| |
Shares
| | |
Amount
| | |
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 resolution of derivative
liabilities | |
| 3,309,983 | | |
| 33 | | |
| — | | |
| — | | |
| 130,366 | | |
| — | | |
| — | | |
| — | | |
| 130,399 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Shares issued for reimbursement of stock | |
| 500,000 | | |
| 5 | | |
| — | | |
| — | | |
| 19,995 | | |
| — | | |
| — | | |
| — | | |
| 20,000 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Shares issued for accrued interest | |
| 10,000,000 | | |
| 100 | | |
| — | | |
| — | | |
| 249,900 | | |
| — | | |
| — | | |
| — | | |
| 250,000 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Shares issued for loan forbearance | |
| 10,000,000 | | |
| 100 | | |
| — | | |
| — | | |
| 248,900 | | |
| — | | |
| — | | |
| — | | |
| 249,000 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Shares issued to
subsidiaries and held in treasury | |
| 30,000,000 | | |
| 300 | | |
| (30,000,000 | ) | |
| (300 | ) | |
| — | | |
| — | | |
| — | | |
| — | | |
| — | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Dividends paid to non-controlling interest | |
| — | | |
| — | | |
| — | | |
| — | | |
| — | | |
| — | | |
| — | | |
| (60,000 | ) | |
| (60,000 | ) |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Other comprehensive income translation adjustment | |
| — | | |
| — | | |
| — | | |
| — | | |
| — | | |
| — | | |
| 165,308 | | |
| — | | |
| 165,308 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Net loss | |
| — | | |
| — | | |
| — | | |
| — | | |
| — | | |
| (1,493,723 | ) | |
| — | | |
| 27,615 | | |
| (1,466,108 | ) |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Balances at June 30, 2015 | |
| 1,053,545,134 | | |
$ | 10,536 | | |
| (30,000,000 | ) | |
$ | (300 | ) | |
$ | 20,574,222 | | |
$ | (48,668,280 | ) | |
$ | 311,116 | | |
$ | 589,431 | | |
$ | (27,183,275 | ) |
See
accompanying notes to the unaudited consolidated financial statements.
Vertical Computer
Systems, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
| |
| | | |
| | |
| |
Six Months Ended June 30, | |
| |
2015 | | |
2014 | |
| |
| | | |
| | |
Cash flows from operating activities | |
| | | |
| | |
Net loss | |
$ | (1,466,108 | ) | |
$ | (391,463 | ) |
Adjustments to reconcile net loss to net cash used in operating activities: | |
| | | |
| | |
Depreciation and amortization | |
| 38,412 | | |
| 23,365 | |
Impairment of software development costs | |
| — | | |
| 385,911 | |
Loss (Gain) on derivatives | |
| 78,680 | | |
| (105,595 | ) |
Write off of equipment | |
| 5,015 | | |
| — | |
Bad debt expense | |
| 50,881 | | |
| — | |
Stock compensation | |
| 20,000 | | |
| — | |
Stock issued for loan forbearance | |
| 249,000 | | |
| — | |
Loss on stock issued for accrued interest
| |
| 150,000
| | |
| — | |
Changes in operating assets and liabilities: | |
| | | |
| | |
Accounts receivable | |
| 428,869 | | |
| 309,876 | |
Prepaid expenses and other assets | |
| (17,259 | ) | |
| (13,512 | ) |
Accounts payable and accrued liabilities | |
| 969,246 | | |
| (31,357 | ) |
Accounts payable to related parties
| |
| 20,083 | | |
| — | |
Deferred revenue | |
| (616,676 | ) | |
| (209,188 | ) |
Net cash used in operating activities | |
| (89,857 | ) | |
| (31,963 | ) |
| |
| | | |
| | |
Cash flow from investing activities: | |
| | | |
| | |
Software development | |
| (266,615 | ) | |
| (71,984 | ) |
Purchase of property and equipment | |
| — | | |
| (575 | ) |
Net cash used in investing activities | |
| (266,615 | ) | |
| (72,559 | ) |
Cash flows from financing activities: | |
| | | |
| | |
| |
| | | |
| | |
Borrowings on notes payable | |
| 160,000 | | |
| 261,282 | |
Payments of notes payable | |
| — | | |
| (343,598 | ) |
Payments on related party debt | |
| — | | |
| (20,992 | ) |
Dividends paid | |
| (60,000 | ) | |
| — | |
Bank overdraft | |
| (7,541 | ) | |
| 3,121 | |
Net cash provided by (used in) financing activities | |
| 92,459 | | |
| (100,187 | ) |
| |
| | | |
| | |
Effect of changes in exchange rates on cash | |
| 165,038 | | |
| 153,015 | |
Net change in cash and cash equivalents | |
| (98,975 | ) | |
| (51,694 | ) |
Cash and cash equivalents, beginning of period | |
| 117,866 | | |
| 162,709 | |
Cash and cash equivalents, end of period | |
$ | 18,891 | | |
$ | 111,015 | |
| |
| | | |
| | |
Supplemental disclosures of cash flow information: | |
| | | |
| | |
Cash paid for interest | |
$ | 72,127 | | |
$ | 142,861 | |
| |
| | | |
| | |
Non-cash investing and financing activities: | |
| | | |
| | |
Common shares issued for accrued stock compensation | |
$ | — | | |
$ | 10,226 | |
Common shares issued for accrued interest | |
| 100,000 | | |
| — | |
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, 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 six months
ended June 30, 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 six months ended June 30, 2015, the Company capitalized an aggregate of $266,615 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 six months ended June 30, 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 June 30, 2015, we had negative working capital of approximately $18.2 million and defaulted on several of our debt
obligations. These conditions raise substantial doubt about our ability to continue as a going concern.
Our management is
continuing its efforts to attempt to secure funds through equity and/or debt instruments for our operations, expansion and possible
acquisitions, mergers, joint ventures and/or other business combinations. The Company will require additional funds to pay down
its liabilities, as well as finance its expansion plans consistent with anticipated changes in operations and infrastructure.
However, there can be no assurance that the Company will be able to secure additional funds and that if such funds are available,
whether the terms or conditions would be acceptable to the Company and whether the Company will be able to turn into a profitable
position and generate positive operating cash flow. The consolidated financial statements contain no adjustment for the outcome
of this uncertainty.
Note 3. Notes Payable
The following table
reflects our third party debt activity, including our convertible debt, for the six months ended June 30, 2015:
December 31, 2014 | |
$ | 4,575,239 | |
Repayments of third party notes | |
| — | |
Borrowings from third parties | |
| 160,000 | |
Currency translation | |
| (270 | ) |
June 30, 2015 | |
$ | 4,734,969 | |
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 June 30, 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 Lakeshore
Note and the 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). At June 30, 2015, the Note was in default and the Company was in discussions with Lakeshore
to cure the default and buy back Lakeshore’s ownership interests in our subsidiaries. During the six months ended June 30,
2015, the Company paid dividends to Lakeshore of $60,000.
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.
In the second quarter ended June 30, 2015, the Company borrowed
$60,000 from a third party lender. The note is due on demand and bears interest at 11% per annum.
In June 2015, the
Company and Victor Weber agreed to amend certain promissory notes (the “Weber Notes”) issued by the Company
and NOW Solutions in the aggregate principal amount of $745,400 to Mr. Weber. Under the terms of the amendment of the Weber Notes,
the defaults were cured, the interest rate was reduced from 12% to 10% and the Company agreed to make monthly $20,000 payments
to Mr. Weber beginning September 1, 2015 until January 15, 2020 at which time all outstanding amounts under the Weber Notes will
be due. In consideration of the amendment and extension to pay the Weber Notes, Ploinks, Inc., the Company’s subsidiary,
agreed to issue 1,000,000 shares of its common stock to Mr. Weber. The fair value of these subsidiary shares was determined to
be nominal. In connection with the amendment, the Company issued 20,000,000
shares of its common stock with the Rule 144 restrictive legend to its subsidiary, Taladin, Inc., which pledged these shares to
secure payment of the Weber Note and the previous pledge agreements with Mountain Reservoir Corporation (“MRC”) were
cancelled. MRC is controlled by the W5 Family Trust. Mr. Richard Wade, the President and CEO of the Company, is the trustee of
the W5 Family Trust. These 20,000,000 common shares are held
in treasury. In addition, Victor Weber was issued 10,000,000 common shares as forbearance resulting in a forbearance loss of $249,000
and 10,000,000 common shares as repayment of $100,000 of accrued interest resulting in a loss on extinguishment of $150,000.
For additional transactions
after June 30, 2015, including several amendments to the Lakeshore Loan Agreement and the Lakeshore Note, please see “Subsequent
Events” in Note 8.
Note 4. Derivative liability and fair
value measurements
Derivative liability
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 with the Rule 144 restrictive legend 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 MRC and the Company, we issued a total of 2,809,983 shares of our
common stock with the Rule 144 restrictive legend 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 $105,595 for the six months ended June
30, 2015 and 2014, respectively.
The valuation of our
embedded derivatives is determined by using the VCSY stock price at each measurement date. As such, our derivative liabilities have been
classified as Level 1.
Fair value measurements
FASB ASC 820, Fair
Value Measurements and Disclosures, defines fair value as the exchange price that would be received for an asset or paid to transfer
a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction
between market participants on the measurement date. FASB ASC 820 also establishes a fair value hierarchy which requires an entity
to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. FASB ASC 820 describes
three levels of inputs that may be used to measure fair value:
Level 1 – Quoted
prices in active markets for identical assets or liabilities.
Level 2 – Observable
inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; or other inputs that are observable
or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 – Unobservable
inputs that are supported by little or no market activity and that are financial instruments whose values are determined using
pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination
of fair value requires significant judgment or estimation.
If the inputs used
to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on
the lowest level of input that is significant to the fair value measurement of the instrument.
The following table provides a summary
of the fair value of our derivative liabilities as of June 30, 2015 and December 31, 2014:
|
|
Fair value measurements on a recurring basis |
|
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
As of June 30, 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 with the Rule 144 restrictive legend 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 with the Rule 144 restrictive
legend 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 six months
ended June 30, 2015.
In June 2015, pursuant to an agreement between the
Company and Victor Weber to pay off a judgment held by Mr. Weber against the Company, we issued a total of 20,000,000 shares of
our common stock with the Rule 144 restrictive legend to Mr. Weber at a fair market value of $499,000. Of these 20,000,000 common shares, 10,000,000 common shares were issued as forbearance resulting in a forbearance loss of $249,000 and 10,000,000 common shares as repayment of $100,000 payment due under the agreement resulting in a loss on extinguishment of $150,000. For additional details about the judgment and the agreement, please “Legal Proceedings”
under Note 7.
In June 2015, in
connection with an amendment concerning certain promissory notes issued by the Company and NOW Solutions to Mr. Weber in the
aggregate principal amount of $735,400, the Company issued 20,000,000 shares of its common stock with the Rule 144
restrictive legend to its subsidiary, Taladin, Inc., which pledged these shares to secure payment of the notes to Weber. The
previous pledge agreements between MRC and Mr. Weber were cancelled. These shares are held in treasury.
In June 2015, the
Company issued 10,000,000 common shares with the Rule 144 restrictive legend to its consolidated subsidiary NOW Solutions as an equity contribution. These shares are held in treasury.
For additional common stock and preferred stock transactions after June 30, 2015, please see subsequent events.
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 with the Rule 144 restrictive legend 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 with the Rule 144 restrictive legend 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 six months ended June 30, 2015.
As of June 30, 2015
and December 31, 2014, the Company had accounts payable to employees for unreimbursed expenses and related party contractors in
an aggregate amount of $112,274 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, 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. On
July 24 2014, the court granted plaintiff’s motion for summary judgment against defendants. The judgment was filed on
September 18, 2014. In June 2015, the Company and Mr. Weber entered into an agreement to pay off the $365,000 outstanding
balance under the judgment, which included $275,000 in principal, accrued interest, attorney’s fees and court costs.
Under the terms of the agreement between, the Company issued 10,000,000 shares of its common stock with the Rule 144
restrictive legend to Mr. Weber at a fair market value of $250,000 in consideration of Mr. Weber’s forbearance in not
taking any action to enforce the judgment. The Company also agreed to make payments of $100,000 by June 15, 2015 and $265,000
by July 15, 2015, or in the alternative, the Company had the option to issue another 10,000,000 shares of the Company’s
common stock with the Rule 144 restrictive legend in lieu of making the $100,000 payment and issue an additional 15,000,000
shares of the Company’s common stock with the Rule 144 restrictive legend in lieu of making the $265,000 payment. On
June 15, 2015, the Company issued 10,000,000 shares with the Rule 144 restrictive legend at a fair market value of $250,000
to Mr. Weber as repayment of a $100,000 payment resulting in a loss on extinguishment of $150,000. On July 15, 2015, the Company issued 15,000,000 shares with the
Rule 144 restrictive legend at a fair market value of $408,000 to Mr. Weber as repayment of the $265,000 payment. Under the
agreement, Mr. Weber will file disposition documents that the judgment has been satisfied and the matter is resolved.
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.
Note 8. Subsequent Events
In July 2015,
the Company and certain of its subsidiaries entered into an agreement with Lakeshore to amend the terms of the Loan Agreement
and the Lakeshore Note issued by NOW Solutions to Lakeshore. Under the terms of the amendment, the Company issued 13,000,000
common shares with the Rule 144 restrictive legend and Ploinks, Inc. agreed to issue 3,000,000 common shares of its stock to
Lakeshore in consideration of Lakeshore’s forbearance from taking any action concerning the existing defaults under the
Lakeshore Note and the Loan Agreement. The Company also agreed to make a $310,000 payment for amounts due to Lakeshore under
the Lakeshore Note and the Loan Agreement. Under the amendment, the Company also obtained a 90 day option to purchase Lakeshore’s 25%
ownership interest in NOW Solutions and Lakeshore’s 20% ownership interests in SnAPPnet, Inc. and Priority Time
Systems, Inc. for $1,450,000.
In July 2015, pursuant
to an agreement between the Company and Victor Weber to pay off a judgment held by Mr. Weber against the Company, the Company
issued 15,000,000 shares of its common stock with the Rule 144 restrictive legend to Mr. Weber at a fair market value of $408,000
to Mr. Weber as repayment of a $265,000 payment due under the agreement. For additional details about the judgment and the
agreement, please “Legal Proceedings” under Note 7.
In July 2015, the
Company further amended the Lakeshore Note and the Loan Agreement with Lakeshore. In consideration for Lakeshore’s forbearance
on taking action on the existing default until July 27, 2015, the Company paid a $15,000 forbearance fee and issued 2,000,000
shares of its common stock with the Rule 144 restrictive legend at a fair market value of $55,200 to Lakeshore.
In August 2015, the
Company and certain of its subsidiaries entered into an agreement with Lakeshore to amend the terms of the Loan Agreement and
the Lakeshore Note issued by NOW Solutions to Lakeshore. Under the terms of the amendment, the Company issued 7,000,000 shares
of its common stock with the Rule 144 restrictive legend at a fair market value of $175,700 and Ploinks, Inc. agreed to issue
2,000,000 common shares of its stock to Lakeshore in consideration of Lakeshore’s forbearance from taking any action concerning
the existing defaults under the Lakeshore Note and the Loan Agreement.
The Company also agreed
to make a $500,000 payment for amounts due to Lakeshore under the Lakeshore Note and the Loan Agreement. In the event that the
Company fails to pay Lakeshore $500,000 on or before August 21, 2015, then Lakeshore shall have a purchase option (the “2015
Purchase Option”) to purchase an additional 250 shares of NOW Solutions common stock until December 31, 2015 as follows:
(a) 84 shares of NOW Solutions common stock currently owned by VCSY for a purchase price of $450,000 and (b) 166 shares of NOW
Solutions common stock for a purchase price of $500,000 payable to NOW Solutions.
Furthermore, in the
event that the Company fails to pay Lakeshore $500,000 on or before August 21, 2015, no further payment on the Note will be due
until January1, 2016 at which time the Note plus all accrued interest will be recalculated and the Note will be re-amortized under
the same interest rate and terms as the Note and the maturity date of the Note will be extended 10 years from January1, 2016.
Notwithstanding the foregoing, if Lakeshore does not provide notice to the Company by December 15, 2015 of its intent to exercise
the 2015 Purchase Option concerning the purchase of additional common shares of NOW Solutions, then Lakeshore’s option will
be cancelled and the Company shall make a principal reduction payment in the amount of $250,000 on or before December 31, 2015.
In the event that
Lakeshore exercises the 2015 Purchase Option and purchases the additional common shares of NOW Solutions, then (a) after the second
year, but before the end of the fourth year from the date Lakeshore purchases the additional shares of NOW Solutions under the
2015 Purchase Option, the Company will have the option to purchase for cash, all of Lakeshore’s 500 shares for a price equal to
the greater of $4.0 Million, 60% of trailing twelve months revenue, or 2.75X EBITDA. If the Company does not exercise its purchase
option prior to the end of the fourth year from the date Lakeshore purchases the additional shares of NOW Solutions under the
2015 Purchase Option, then Lakeshore will have a purchase option to purchase for cash, all of the Company’s 500 shares for
the greater of $3.5 Million, 55% of trailing twelve months revenue, or 2.50 X EBITDA, which will expire at the end of the seventh
year from the date Lakeshore purchases the additional shares of NOW Solutions under the 2015 Purchase Option if exercised by Lakeshore.
NOW Solutions
will continue to make the $2,500 weekly payment which will be applied toward Lakeshore’s share of dividends until at
least January 8, 2016. Any reconciliation payments due to Lakeshore will be deferred until January 15, 2016, at which time
all reconciliation payments due through September 30, 2015 will be paid to Lakeshore. Lakeshore agreed it will not take any
action to enforce its rights under the security agreements related to the Note, provided that the $2,500 weekly payments are
made and the January 15, 2016 reconciliation payment is timely made.
In August 2015, the
Company and a third party lender entered into an amendment concerning a $51,000 promissory note issued by the Company. Under the
terms of the agreement and new convertible note in the principal amount of $11,130, the Company issued 556,522 unrestricted common
shares to the lender at conversion price of $0.02 per share. The fair market value of the shares was $12,913 and the note was
cancelled.
In August 2015, the Company issued 1,500,000
shares with the Rule 144 restrictive legend to a lender in conjunction with a debt issuance of $100,000.
Item
2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion
is a summary of the key factors management considers necessary or useful in reviewing the Company’s results of operations,
liquidity and capital resources. The following discussion and analysis should be read together with the accompanying Unaudited
Consolidated Financial Statements, and the cautionary statements and risk factors included below in Item 1A of Part II of this
Report.
Critical Accounting Policies
Capitalized Software Costs
Software costs incurred internally
in creating computer software products are expensed until technological feasibility has been established upon completion of a
detailed program design. Thereafter, all software development costs are capitalized until the point that the product is ready
for sale, and are subsequently reported at the lower of unamortized cost or net realizable value. The Company considers annual
amortization of capitalized software costs based on the ratio of current year revenues by product to the total estimated revenues
by the product, subject to an annual minimum based on straight-line amortization over the product’s estimated economic useful
life, not to exceed five years. The Company periodically reviews capitalized software costs for impairment where the fair value
is less than the carrying value. During the six months ended June 30, 2015 and 2014, $266,615 and $71,984 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 or if it is determined that services are essential to the functionality of the
software being delivered, we initially defer revenue recognition of the software license fees until VSOEFV is established or
the services are performed. However, if VSOEFV is determinable for all of the undelivered elements, and assuming the
undelivered elements are not essential to the delivered elements, we will defer recognition of the full fair value related to
the undelivered elements and recognize the remaining portion of the arrangement value through application of the residual
method. Where VSOEFV has not been established for certain undelivered elements, revenue for all elements is deferred until
those elements have been delivered or their fair values have been determined. Evidence of VSOEFV is determined for software
products based on actual sales prices for the product sold to a similar class of customer and based on pricing strategies set
forth in the Company’s standard pricing list. Evidence of VSOEFV for consulting services is based upon standard billing
rates and the estimated level of effort for individuals expected to perform the related services. The Company establishes
VSOEFV for maintenance agreements using the percentage method such that VSOEFV for maintenance is a percentage of the license
fee charged annually for a specific software product, which in most instances is 18% of the portion of arrangement fees
allocated to the software license element.
Maintenance Revenue.
In connection with the sale of a software license, a customer may elect to purchase software maintenance services. Most of
the customers that purchase software licenses from us also purchase software maintenance services. These maintenance services
are typically renewed on an annual basis. We charge an annual maintenance fee, which is typically a percentage of the initial
software license fee and may be increased from the prior year amount based on inflation or other agreed upon percentage. The annual
maintenance fee generally is paid to the Company at the beginning of the maintenance period, and we recognize these revenues ratably
over the term of the related contract.
While most of our
customers pay for their annual maintenance at the beginning of the maintenance period, a few customers have payment terms that
allow them to pay for their annual maintenance on a quarterly or monthly basis. If the annual maintenance fee is not paid at the
beginning of the maintenance period (or at the beginning of the quarter or month for those few maintenance customers), we will
ratably recognize the maintenance revenue if management believes the collection of the maintenance fee is imminent. Otherwise,
we will defer revenue recognition until the time that the maintenance fee is paid by the customer. We normally continue to provide
maintenance service while awaiting payment from customers. When the payment is received, revenue is recognized for the period
that revenue was previously deferred. This may result in volatility in software maintenance revenue from period to period.
Cloud-based offering.
We have contracted with third parties to provide new and existing customers with hosting facilities providing all infrastructure
and allowing us to offer our currently sold software, emPath® and SnAPPnet™, on a service basis. However, a contractual
right to take possession of the software license or run it on another party’s hardware is not granted to the customer. We
refer to the delivery method to give functionality to new customers utilizing this service as cloud-based. Since the customer
is not given contractual right to take possession of the software, the scope of ASC 350-40 does not apply. A customer using cloud-based
software can enter into an agreement to purchase a software license at any time. We generate revenue from cloud-based offering
as the customer utilizes the software over the Internet.
We will provide consulting
services to customers in conjunction with the cloud-based offering. The rate for such service is based on standard hourly or daily
billing rates. The consulting revenue is recognized as services are performed. Customers utilizing their own computer to access
cloud-based functionality are charged a fee equal to the number of employees paid each month multiplied by an agreed-upon rate
per employee. The revenue is recognized as the cloud-based services are rendered each month.
Allowances for
Doubtful Accounts
The Company maintains
allowances for doubtful accounts, for estimated losses resulting from the inability of its customers to make required payments.
If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required. We review delinquent accounts at least quarterly to identify potential doubtful accounts,
and together with customer follow-up, estimate the amounts of potential losses.
Deferred Taxes
The Company records
a valuation allowance to reduce the deferred tax assets to the amount that management believes is more likely than not to be realized
in the foreseeable future, based on estimates of foreseeable future taxable income and taking into consideration historical operating
information. In the event management estimates that the Company will not be able to realize all or part of its net deferred tax
assets in the foreseeable future, a valuation allowance is recorded through a charge to income in the period such determination
is made. Likewise, should management estimate that the Company will be able to realize its deferred tax assets in the future in
excess of its net recorded assets, an adjustment to reduce the valuation allowance would increase income in the period such determination
is made.
Stock-Based Compensation
Expense
We account for share-based
compensation in accordance with the provisions of share-based payments, which requires measurement of compensation cost for all
stock-based awards at fair value on date of grant and recognition of compensation over the service period for awards expected
to vest. The fair value of restricted stock and restricted stock units is determined based on the number of shares granted and
the quoted price of our common stock. Equity instruments issued to other than employees are valued at the earlier of a commitment
date or upon completion of the services, based on the fair value of the equity instruments, and are recognized as expense over
the service period.
Valuation of the
Embedded and Warrant Derivatives
The valuation of our
embedded derivatives is determined by using the Company’s quoted stock price. An embedded derivative is a derivative instrument
that is embedded within another contract, which under a convertible note (the host contract) includes the right to convert the
note by the holder, certain default redemption right premiums and a change of control premium (payable in cash if a fundamental
change occurs). In accordance with the guidance on derivative instruments, embedded derivatives are marked-to-market each reporting
period, with a corresponding non-cash gain or loss charged to the current period. The practical effect of this has been that when
our stock price increases so does our derivative liability, resulting in a non-cash loss that reduces our earnings and earnings
per share. When our stock price declines, we record a non-cash gain, increasing our earnings and earnings per share.
The fair value recorded
for the derivative liability varies from period to period. This variability may result in the actual derivative liability for
a period either above or below the estimates recorded on our consolidated financial statements, resulting in significant fluctuations
in other income (expense) because of the corresponding non-cash gain or loss recorded.
Recently Issued
Accounting Pronouncements
The Company does not
expect the adoption of any recently issued accounting pronouncements to have a material impact on the Company’s financial
position, operations or cash flows.
Results of Operations
Three and six months ended
June 30, 2015 Compared To Three and six months ended June 30, 2014
Total Revenues.
We had total revenues of $1,155,982 and $2,942,251 for the three months ended June 30, 2015 and 2014, respectively. The
decrease in total revenues was $1,786,269 for the three months ended June 30, 2015 representing a 60.7% decrease compared to the
total revenues for the three months ended June 30, 2014. Substantially all of the revenues for the three months ended June 30,
2015 were related to the business operations of NOW Solutions. Revenue from SnAPPnet, Inc. was $20,277 or 1.8% of total revenues
for the three months ended June 30, 2015 and $35,135 or 1.2% of total revenues for the three months ended June 30, 2014. Revenue
for VCSY was $1,725,000 or 58.6% of total revenues for the three months ended June 30, 2014. VCSY had no revenue for the three
months ended June 30, 2015.
Total revenues for
the three months ended June 30, 2015 and 2014 primarily consist of fees derived from software licenses, consulting services, software
maintenance and Cloud-based offerings. The revenue from new software licenses decreased by $1,725,180 compared to that for the
three months ended June 30, 2014, as no new license sales of SiteFlash™ occurred during the second quarter of 2015. Software
maintenance in the three months ended June 30, 2015 increased by $29,315 or 3.0% from the same period in the prior year. The revenue
increase in software maintenance is primarily due to contractual increases to existing customer maintenance agreements partially
offset by the effects of unfavorable currency rate changes on our Canadian maintenance revenue. Consulting revenue, in the three
months ended June 30, 2015 decreased by $63,337 from the same period in the prior year, which represents a 48% decrease. This
decrease was due to less demand for version upgrades and enhancements to existing customer accounts during the second quarter
of 2015. Cloud-based revenues were $ 76,780 for the three months ended June 30, 2015 compared to $96,694 for the same period in
the prior year, representing a $19,914 decrease or 21%. The decrease is primarily related to a customer rate adjustment and
a customer user base adjustment during the 3 months ended June 30, 2015 and the effects of unfavorable currency rate changes on
our Canadian cloud-based revenue. Other revenue in the three months ended June 30, 2015 decreased by $7,153 or 39.9% 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 $2,210,817 and $5,046,269 in the six months ended June 30, 2015 and 2014, respectively. The decrease in total revenues was
$2,835,452 representing a 56.2% decrease. Substantially all of the revenues for the six months ended June 30, 2015 were related
to the business operations of NOW Solutions. Revenue from SnAPPnet, Inc. was $39,483 or 1.8% for the six months ended June 30,
2015 and $89,431 or 1.8% for the six months ended June 30, 2014. VCSY had no revenue for the six months ended June 30, 2015. Revenue
for VCSY was $2,600,000 or 51.5% of total revenues for the six months ended June 30, 2014.
Total revenues
for the six months ended June 30, 2015 and 2014 primarily consist of fees derived from software licenses, consulting
services, software maintenance and cloud-based offerings. The revenue from new software licenses decreased by $2,600,180
compared to that for the six months ended June 30, 2014 as no new license sales of SiteFlash™ occurred during the six
months ended June 30, 2015. Software maintenance in the six months ended June 30, 2015 decreased by $106,319 or 5.3% from the
same period in the prior year. The revenue decrease in software maintenance is primarily due to the effects of unfavorable
currency rate changes on our Canadian maintenance revenue somewhat offset by contractual increases to existing customer
maintenance agreements. Consulting revenue, in the six months ended June 30, 2015 decreased by $77,578 from the same period
in the prior year, which represents a 37.15% decrease. This decrease was primarily a result of less demand for version
upgrades and enhancements to existing customer accounts during the first six months of 2015. Cloud-based revenues were
$162,027 for the six months ended June 30, 2015 compared to $206,610 for the same period in the prior year, representing a
$44,583 decrease or 21.6%. The decrease is primarily related to a customer rate adjustment and a customer user base
adjustment during the 6 months ended June 30, 2015 and the effects of unfavorable currency rate changes on our Canadian
cloud-based revenue. Other revenue in the six months ended June 30, 2015 decreased by $6,792 or 20.8% 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 $486,020 for the three months ended June 30, 2015, compared to $610,765
for the three months ended June 30, 2014. The decrease in cost of revenues of $124,745 represents a 20.4% decrease. The decrease
in direct cost of revenues was primarily due to decreased royalty fees, payroll and rent expense. During the three months ended
June 30, 2015 and 2014, $124,375 and $38,784 of internal costs were capitalized, respectively.
For the six months
ended June 30, 2014, direct costs of revenues were $911,882 compared to $1,197,483 for the same period in 2014 resulting in a
decrease of $285,601 or 23.9%. The decrease in direct cost of revenues was primarily due to decreased royalty fees, payroll and
rent expense. During the six months ended June 30, 2014 and 2013, $266,628 and $71,984 of internal costs were capitalized, respectively.
Selling, General
and Administrative Expenses. We had selling, general and administrative expenses of $686,897 and $1,895,597 in the three
months ended June 30, 2015 and 2014, respectively. The decrease of $1,208,700 is 63.8% less than the same period in 2015. The
decrease is primarily due to decreased legal fees to prosecute patent infringement on the company’s intellectual property,
decreased travel, consulting fees, rent, royalties and commitment fees.
For the six months
ended June 30, 2015 we had $1,560,790 compared to $3,328,550 for the six months ended June 30, 2014. The $1,767,760 or 53.1% decrease
is primarily due to decreased legal fees to prosecute patent infringement on the company’s intellectual property, decreased
travel, consulting fees, rent, royalties, commitment fees and foreign taxes and tax penalties.
Bad Debt Expense.
We had bad debt expense for the three and six months ended June 30, 2015 of $14,691 and $50,881 compared to none for the
comparable three and six months ended June 30, 2014. Bad debt expense relates to the adjustment for uncollected customer accounts
greater than 90 days.
Impairment of
Software Costs. During the three and six months ended June 30, 2014, $192,956 and $385,911, respectively of capitalized
software development costs were considered impaired. There was no impairment during 2015.
Gain (Loss)
on Derivative Liability. The existing derivative liability is adjusted each quarter for changes in the market value of
the Company’s common stock. In general, as our stock price increases, the derivative liability increases, resulting in a
loss. As the stock price decreases, the derivative liability decreases, resulting in a gain. During the first quarter 2015, the
Company issued common shares and eliminated the derivative liabilities. The gain on derivative liability was $100,854 for the
three months ended June 30, 2014. The loss on derivative liability was $78,680 for the six months ended June 30, 2015 compared
to a gain of $105,595 for the six months ended June 30, 2014.
Forbearance
Fees. Forbearance fees relate to fees charged by our lenders on loans in default. Forbearance fees for the three
months ended June 30, 2015 were $249,000 compared to $88,301 for the three months ended June 30, 2014. The fees for the three
months ended June 30, 2015 are related to the fair market value of 10 million shares of VCSY common stock with the Rule 144
restrictive legend issued to a VCSY lender. The fees for the three months ended June 30, 2014 are related to our senior
secured debt for NOW Solutions. Forbearance fees for the six months ended June 30, 2015 were $249,000 compared to $161,602
for the six months ended June 30, 2014. The fees for the six months ended June 30, 2015 are related to the fair market value
of 10 million shares with the Rule 144 restrictive legend of VCSY common stock issued to a VCSY lender. The fees for the six
months ended June 30, 2014 are primarily related to our senior secured debt for NOW Solutions.
Loss on Debt
Extinguishment. We had $150,000 loss on debt extinguishment for the three and six months ended June 30, 2015. The
loss relates to the fair market value of the issuance of $10 million shares with the Rule 144 restrictive legend of VCSY common
stock to a VCSY lender to settle a $100,000 accrued interest payment.
Interest
Expense. We had interest expense of $268,268 and $232,910 for the three months ended June 30, 2015 and 2014,
respectively. Interest expense increased in 2015 by $35,358 representing an increase of 15.2% compared to the same expense in
the three months ended June 30, 2014. The increase was primarily due to interest and commitment fees on new borrowings and
interest on accounts payable balances.
For the six months
ended June 30, 2014, we had net interest expense of $ 523,764 compared to $446,432 for the same period in 2014, representing a
$77,332 or 17.3% increase for the period. The increase was primarily due to interest and commitment fees on new borrowings and
interest on accounts payable balances.
Net
Income (loss). We had a net loss before noncontrolling interest and income tax expense of $705,939 and net income
before noncontrolling interest and income tax expense of $11,138 for the three months ended June 30, 2015 and 2014,
respectively. The net loss for the three months ended June 30, 2015 was due to the factors discussed above for revenues, cost
of revenues and selling, general and administrative expenses, which essentially gave us operating loss of $38,673. This was
increased by interest expense and forbearance fees and a loss on debt extinguishment, resulting in a net loss of $705,939 for
the three months ended June 30, 2015. We had net income of $11,138 for the three months ended June 30, 2014. The net income
for the three months ended June 30, 2014 was due to the factors discussed above for revenues, cost of revenues, impairment of
capitalized software costs and selling, general and administrative expenses, which essentially gave us operating income of
$231,487. This was reduced by interest expense and forbearance fees and increased by a gain on derivative liability,
resulting in net income of $11,138 for the three months ended June 30, 2014.
We incurred net
losses before noncontrolling interest and income tax expense of $1,352,586 and $391,463 for the six months ended June 30,
2015 and 2014, respectively. The changes were due to the reasons discussed above.
Income Tax Provision.
We had an income tax provision of $88,016 and $113,522 for the three and six months ended June 30, 2015, respectively. 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 three and six months ended June 30, 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
for both the three months ended June 30, 2015 and 2014 and $294,000 for both the six months ended June 30, 2015 and 2014.
Net Loss Available
to Common Stockholders. We had a net loss attributed to common stockholders of $961,064 and $187,265 for the three months
ended June 30, 2015 and 2014, respectively. Net loss attributed to common stockholders was due to the factors discussed above.
We had a net loss
attributed to common stockholders of $1,787,723 and $737,522 for the six months ended June 30, 2015 and 2014, respectively. Net
loss available to common stockholders was due to the factors discussed above.
Net Loss Per
Share. We had a net loss per share of $0.00 and $0.00 for the six months ended June 30, 2015 and 2014, respectively.
Liquidity
and Capital Resources
At June 30, 2015,
we had non-restricted cash-on-hand of $18,891 compared to $117,866 at December 31, 2014.
Net cash used in operating
activities for the six months ended June 30, 2015 was $89,857 compared to net cash used in operating activities of $31,963 for
the six months ended June 30, 2014.
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 $616,676 or 26.6% from
the balance at December 31, 2014. 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 $560,879 (net of allowance for bad debts) at December 31, 2014 to $81,129 (net of allowance for bad debts)
at June 30, 2015. The decrease is a result of seasonal fluctuations in the timing of billing for software maintenance which typically
yields higher receivables in December compared to June.
The accounts payable
and accrued liabilities went from $10,603,879 at December 31, 2014 to $11,473,125 at June 30, 2015. The increase is primarily
related to increased trade accounts payable, accrued interest and accrued payroll. The resulting balance at June 30, 2015 is 141
times more than the balance in accounts receivable. This is one of the reasons why we do not have sufficient funds available to
fund our operations and repay our debt obligations under their existing terms, as described below.
We used cash to invest
in equipment and the development of software products for the six months ended June 30, 2015 and June 30, 2014 of $266,615 and
$72,559, respectively. Most of the equipment was computer equipment and peripherals for upgraded network servers to increase the
productivity of our software developers and new personal computers for developers, consultants and sales personnel. Software development
relates to the development of new products.
For the six months
ended June 30, 2015, we had $160,000 of new debt funding and paid $60,000 of dividends to noncontrolling shareholders of NOW Solutions.
For the six months ended June 30, 2014, we paid $364,590 of principal on notes payable and notes payable to related parties and
had $261,282 of new debt funding in the same period.
The total change in
cash for the six months ended June 30, 2015 was a decrease of $98,975.
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 | |
| |
June 30, | | |
| | | |
| | | |
| | | |
| | | |
| | |
Contractual Obligations | |
2015 | | |
2015 | | |
2016 | | |
2017 | | |
2018 | | |
2019+ | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Notes payable | |
$ | 5,053,635 | | |
$ | 5,053,635 | | |
$ | — | | |
$ | — | | |
$ | — | | |
$ | — | |
Convertible debenture | |
| 30,000 | | |
| 30,000 | | |
| — | | |
| — | | |
| — | | |
| — | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Operating lease | |
| 8,446 | | |
| 4,223 | | |
| 4,223 | | |
| — | | |
| — | | |
| — | |
Total | |
$ | 5,092,081 | | |
$ | 5,087,858 | | |
$ | 4,223 | | |
$ | — | | |
$ | — | | |
$ | — | |
Of the above notes payable and
convertible debentures, the default status is as follows:
| |
| | | |
| | |
| |
June 30, 2015 | | |
December 31, 2014 | |
| |
| | | |
| | |
In default | |
$ | 4,338,235 | | |
$ | 4,758,405 | |
Not in default | |
| 745,400 | | |
| 165,500 | |
| |
| | | |
| | |
Total Notes Payable | |
$ | 5,083,635 | | |
$ | 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 attributable to common stock holders of $1,787,723 and $737,522 for the six months ended June 30,
2015 and 2014, respectively and have historically incurred losses. Since December 31, 2009, we have used substantial funds in
further developing our product line and in conducting present and new operations, and we need to raise additional funds
and/or generate additional revenue through our existing businesses, including the licensing of our intellectual property, to
accomplish our objectives. Additionally, at June 30, 2015, we had negative working capital of approximately $18.2 million
(although this figure includes deferred revenue of approximately $1.7 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, 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, 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. On
July 24, 2014, the court granted plaintiff’s motion for summary judgment against defendants. The judgment was filed on
September 18, 2014. In June 2015, the Company and Mr. Weber entered into an agreement to pay off the $365,000 outstanding
balance under the judgment, which included $275,000 in principal, accrued interest, attorney’s fees and court costs.
Under the terms of the agreement between, the Company issued 10,000,000 shares of its common stock with the Rule 144
restrictive legend to Mr. Weber at a fair market value of $250,000 in consideration of Mr. Weber’s forbearance in not
taking any action to enforce the judgment. The Company also agreed to make payments of $100,000 by June 15, 2015 and $265,000
by July 15, 2015, or in the alternative, the Company had the option to issue another 10,000,000 shares of the Company’s
common stock with the Rule 144 restrictive legend in lieu of making the $100,000 payment and issue an additional 15,000,000
shares of the Company’s common stock with the Rule 144 restrictive legend in lieu of making the $265,000 payment. On
June 15, 2015, the Company issued 10,000,000 shares with the Rule 144 restrictive legend at a fair market value of $250,000
to Mr. Weber as repayment of a $100,000 payment resulting in a loss on extinguishment of $150,000. On July 15, 2015, the
Company issued 15,000,000 shares with the Rule 144 restrictive legend at a fair market value of $408,000 to Mr. Weber as
repayment of the $265,000 payment. Under the agreement, Mr. Weber will file disposition documents that the judgment
has been satisfied and the matter is resolved.
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 with the Rule 144 restrictive legend to reimburse Mr. Valdetaro for 1,000,000 shares of our 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 with the Rule 144 restrictive legend 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 June 2015, pursuant
to an agreement between the Company and Victor Weber to pay off a judgment held by Mr. Weber against the Company, we issued a total
of 20,000,000 shares of our common stock with the Rule 144 restrictive legend to Mr. Weber at a fair market value of $499,000.
Of these 20,000,000 common shares, 10,000,000 common shares were issued as forbearance resulting in a forbearance loss of $249,000
and 10,00,000 common shares as repayment of $100,000 payment due under the agreement resulting in a loss on extinguishment of $15,000
For additional details about the judgment and the agreement, please “Legal Proceedings” under Note 7.
In June 2015, in connection
with an amendment concerning certain promissory notes issued by the Company and NOW Solutions to Mr. Weber in the aggregate principal
amount of $735,400, the Company issued 20,000,000 shares of its common stock with the Rule 144 restrictive legend to its subsidiary,
Taladin, Inc., which pledged these shares to secure payment of the notes to Weber. These shares are held in treasury. The previous
pledge agreements between MRC and Mr. Weber were cancelled. In consideration of the amendment and extension to pay the Weber Notes,
Ploinks, Inc., the Company’s subsidiary, agreed to issue 1,000,000 shares of its common stock to Mr. Weber.
In June 2015, the Company issued 10,000,000 shares of its common stock with the Rule 144 restrictive legend
to its consolidated subsidiary NOW Solutions as an equity contribution. These shares are held in treasury.
In July 2015, the
Company issued 13,000,000 shares of its common stock with the Rule 144 restrictive legend and Ploinks, Inc. agreed to issue 3,000,000
common shares of its stock to Lakeshore in consideration of Lakeshore’s forbearance from taking any action concerning the
existing defaults under the Lakeshore Note and the Loan Agreement
In July 2015, pursuant
to an agreement between the Company and Victor Weber to pay off a judgment held by Mr. Weber against the Company, the Company
issued 15,000,000 shares of its common stock with the Rule 144 restrictive legend to Mr. Weber at a fair market value of $408,000
to Mr. Weber as repayment of $265,000 payment due under the agreement.
In July 2015, the
Company issued 2,000,000 shares of its common stock with the Rule 144 restrictive legend at a fair market value of $55,200 to
Lakeshore in consideration of the Lakeshore’s forbearance in taking action on the existing default until the Lakeshore Note
and the Loan Agreement.
In August 2015, the
Company issued 7,000,000 shares of its common stock with the Rule 144 restrictive legend at a fair market value of $175,700 and
Ploinks, Inc. agreed to issue 2,000,000 common shares of its stock to Lakeshore in consideration of Lakeshore’s forbearance
from taking any action concerning the existing defaults under the Loan and the Note Agreement.
In August 2015, the
Company and a third party lender entered into an amendment concerning a $51,000 promissory note issued by the Company. Under the
terms of the agreement and new convertible note in the principal amount of $11,130, the Company issued 556,522 unrestricted common
shares to the lender at conversion price of $0.02 per share. The fair market value of the shares was $12,913 and the note was
cancelled.
In August 2015, the Company issued 1,500,000 shares with the Rule 144 restrictive legend to a lender in conjunction with a debt issuance of $100,000.
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 August 19, 2015,
the outstanding principal and accrued interest currently due under the note is approximately$1,565,000.
Item 4. Mine Safety
Disclosures
Not applicable
Item 5. Other Information
None
Item 6. Exhibits
The following documents are filed as part of this
report:
Exhibit
No. |
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Description |
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Location |
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31.1 |
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Certification of Principal Executive Officer and Principal Accounting Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated August 19, 2015 |
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Provided herewith |
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32.1 |
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Certification of Principal Executive Officer and Principal Accounting Officer Pursuant Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, dated August 19, 2015 |
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Provided herewith |
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101.INS* |
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XBRL Instance Document |
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Provided herewith |
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101.SCH* |
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XBRL Taxonomy Extension Schema |
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Provided herewith |
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101.CAL * |
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XBRL Taxonomy Extension Calculation Linkbase |
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Provided herewith |
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101.DEF* |
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XBRL Taxonomy Extension Definition Linkbase |
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Provided herewith |
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101.LAB* |
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XBRL Taxonomy Extension Label Linkbase |
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Provided herewith |
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101.PRE* |
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XBRL Taxonomy Extension Presentation Document |
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Provided herewith |
* Pursuant
to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of
a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed
not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject
to liability under those sections.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
|
VERTICAL COMPUTER SYSTEMS, INC. |
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August 19, 2015 |
By: |
/s/ Richard Wade |
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Richard Wade |
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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 and six months ended June 30, 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: August 19, 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 and six months ended June 30,
2014, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Richard S. Wade, Principal
Executive Officer and Principal Accounting Officer, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 that, to the best of my knowledge:
1.
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
2.
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations
of the Company.
Date: August 19, 2015 |
By: |
/s/ Richard S. Wade |
|
Richard S. Wade |
|
Chief Executive Officer |
|
(Principal
Executive Officer and |
|
Principal
Accounting Officer) |
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|