UNITED STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM 10-Q
| x | QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly
period ended September 30, 2015
| ¨ | TRANSITION
REPORT PURSUANT TO SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition
period from _____ to _____
Commission file
number 0-28685
VERTICAL
COMPUTER SYSTEMS, INC.
(Exact name
of registrant as specified in its charter)
Delaware |
65-0393635 |
(State of incorporation) |
(I.R.S. Employer Identification
No.) |
101 West
Renner Road, Suite 300
Richardson,
TX 75082
(Address of
principal executive offices)
(972)
437-5200
(Registrant’s
Telephone Number)
Indicate by
check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
Yes x
No¨
Indicate by
check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the
preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes
x No
¨
Indicate by
check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting
company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ |
|
Accelerated filer |
¨ |
Non-accelerated filer ¨ |
(Do not check if a smaller reporting
company) |
Smaller reporting company |
x |
Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes ¨
No x
As of November
16, 2015, the issuer had 1,111,601,656 shares of common stock, par value $0.00001, issued and 1,081,601,656 outstanding.
PART I
FINANCIAL
INFORMATION
Item
1. Consolidated Financial Statements
Vertical Computer Systems,
Inc. and Subsidiaries |
Consolidated
Balance Sheets
(Unaudited) |
| |
September 30, | | |
December 31, | |
| |
2015 | | |
2014 | |
Assets | |
| | | |
| | |
Current assets | |
| | | |
| | |
Cash | |
$ | 256,461 | | |
$ | 117,866 | |
Accounts receivable, net of allowance for bad debts of $154,841
and $97,419 | |
| 141,883 | | |
| 560,879 | |
Prepaid expenses and other current assets | |
| 53,171 | | |
| 41,387 | |
Total current assets | |
| 451,515 | | |
| 720,132 | |
| |
| | | |
| | |
Property and equipment, net of accumulated depreciation of $1,038,247 and $1,026,654 | |
| 2,389 | | |
| 28,089 | |
Intangible assets, net of accumulated amortization of $319,397 and $302,016 | |
| 1,129,509 | | |
| 657,978 | |
Deposits and other | |
| 23,928 | | |
| 24,388 | |
| |
| | | |
| | |
Total assets | |
$ | 1,607,341 | | |
$ | 1,430,587 | |
| |
| | | |
| | |
Liabilities and Stockholders’ Deficit | |
| | | |
| | |
Current liabilities: | |
| | | |
| | |
Accounts payable and accrued liabilities | |
$ | 10,255,351 | | |
$ | 10,659,737 | |
Accounts payable to related parties | |
| 71,843 | | |
| 36,333 | |
Bank overdraft | |
| 1,980 | | |
| 7,699 | |
Deferred revenue | |
| 1,948,865 | | |
| 2,321,044 | |
Derivative liabilities | |
| - | | |
| 51,719 | |
Convertible debentures, net of unamortized discounts of $142,718
and $0 | |
| 437,282 | | |
| 30,000 | |
Current portion - notes payable | |
| 3,853,948 | | |
| 4,545,239 | |
Current portion - notes payable to related
parties | |
| 347,887 | | |
| 348,666 | |
Total current liabilities | |
| 16,917,156 | | |
| 18,000,437 | |
| |
| | | |
| | |
Non-current portion – notes payable | |
| 715,000 | | |
| - | |
| |
| | | |
| | |
Total liabilities | |
| 17,632,156 | | |
| 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) |
| |
September 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
1,100,101,656 issued and 1,070,101,656 outstanding as of September 30, 2015 and 999,735,151 issued and outstanding as
of December 31, 2014 | |
| 11,002 | | |
| 9,998 | |
Treasury stock; 30,000,000 as of September 30, 2015 and
no shares as of December 31, 2014 | |
| (300 | ) | |
| - | |
Additional paid-in capital | |
| 21,927,665 | | |
| 19,925,061 | |
Accumulated deficit | |
| (48,979,637 | ) | |
| (47,174,557 | ) |
Accumulated other
comprehensive income – foreign currency translation | |
| 520,912 | | |
| 145,808 | |
| |
| | | |
| | |
Total Vertical Computer Systems, Inc.
stockholders’ deficit | |
| (26,520,358 | ) | |
| (27,093,690 | ) |
| |
| | | |
| | |
Noncontrolling interest | |
| 593,519 | | |
| 621,816 | |
Total stockholders’
deficit | |
| (25,926,839 | ) | |
| (26,471,874 | ) |
| |
| | | |
| | |
Total liabilities
and stockholders' deficit | |
$ | 1,607,341 | | |
$ | 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 September 30, | | |
Nine Months Ended September 30, | |
| |
2015 | | |
2014 | | |
2015 | | |
2014 | |
Revenues | |
| | | |
| | | |
| | | |
| | |
Licensing and software | |
$ | 22,500 | | |
$ | 180 | | |
$ | 22,500 | | |
$ | 2,600,360 | |
Software maintenance | |
| 850,287 | | |
| 873,723 | | |
| 2,742,035 | | |
| 2,871,790 | |
Cloud-based offering | |
| 86,417 | | |
| 92,437 | | |
| 248,444 | | |
| 299,047 | |
Consulting services | |
| 54,967 | | |
| 93,028 | | |
| 186,221 | | |
| 301,860 | |
Other | |
| 11,023 | | |
| 13,955 | | |
| 36,811 | | |
| 46,535 | |
Total revenues | |
| 1,025,194 | | |
| 1,073,323 | | |
| 3,236,011 | | |
| 6,119,592 | |
| |
| | | |
| | | |
| | | |
| | |
Cost of revenues | |
| (465,614 | ) | |
| (406,235 | ) | |
| (1,377,496 | ) | |
| (1,603,718 | ) |
| |
| | | |
| | | |
| | | |
| | |
Gross profit | |
| 559,580 | | |
| 667,088 | | |
| 1,858,515 | | |
| 4,515,874 | |
| |
| | | |
| | | |
| | | |
| | |
Operating expenses: | |
| | | |
| | | |
| | | |
| | |
Selling, general and administrative
expenses | |
| 563,406 | | |
| 1,095,077 | | |
| 2,124,196 | | |
| 4,423,627 | |
Depreciation and amortization | |
| - | | |
| 10,798 | | |
| 38,412 | | |
| 34,163 | |
Bad debt expense | |
| 8,927 | | |
| - | | |
| 59,808 | | |
| - | |
Impairment of software
costs | |
| - | | |
| 193,293 | | |
| - | | |
| 579,204 | |
Total operating expenses | |
| 572,333 | | |
| 1,299,168 | | |
| 2,222,416 | | |
| 5,036,994 | |
| |
| | | |
| | | |
| | | |
| | |
Operating loss | |
| (12,753 | ) | |
| (632,080 | ) | |
| (363,901 | ) | |
| (521,120 | ) |
| |
| | | |
| | | |
| | | |
| | |
Other income (expense): | |
| | | |
| | | |
| | | |
| | |
Interest income | |
| 1 | | |
| 1 | | |
| 7 | | |
| 17 | |
Gain (Loss) on derivative liabilities | |
| - | | |
| 88,786 | | |
| (78,680 | ) | |
| 194,381 | |
Loss on debt extinguishment | |
| (173,193 | ) | |
| - | | |
| (323,193 | ) | |
| - | |
Forbearance fees | |
| (699,900 | ) | |
| (94,568 | ) | |
| (948,900 | ) | |
| (256,170 | ) |
Interest expense | |
| (64,819 | ) | |
| (222,230 | ) | |
| (588,583 | ) | |
| (668,662 | ) |
| |
| | | |
| | | |
| | | |
| | |
Net loss before noncontrolling interest
and income tax benefit | |
| (950,664 | ) | |
| (860,091 | ) | |
| (2,303,250 | ) | |
| (1,251,554 | ) |
Income tax benefit | |
| (675,895 | ) | |
| - | | |
| (562,373 | ) | |
| - | |
Net loss before noncontrolling interest | |
| (274,769 | ) | |
| (860,091 | ) | |
| (1,740,877 | ) | |
| (1,251,554 | ) |
Net income (loss)
attributable to noncontrolling interest | |
| (36,588 | ) | |
| 21,620 | | |
| (64,203 | ) | |
| (30,439 | ) |
Net loss attributable to Vertical Computer
Systems, Inc. | |
| (311,357 | ) | |
| (838,471 | ) | |
| (1,805,080 | ) | |
| (1,281,993 | ) |
Dividends applicable
to preferred stock | |
| (147,000 | ) | |
| (147,000 | ) | |
| (441,000 | ) | |
| (441,000 | ) |
| |
| | | |
| | | |
| | | |
| | |
Net loss available
to common stockholders | |
$ | (458,357 | ) | |
$ | (985,471 | ) | |
$ | (2,246,080 | ) | |
$ | (1,722,993 | ) |
| |
| | | |
| | | |
| | | |
| | |
Basic and diluted
net loss per share | |
$ | (0.00 | ) | |
$ | (0.00 | ) | |
$ | (0.00 | ) | |
$ | (0.00 | ) |
| |
| | | |
| | | |
| | | |
| | |
Basic and diluted
weighted average common shares outstanding | |
| 1,057,869,945 | | |
| 999,535,151 | | |
| 1,022,277,163 | | |
| 999,382,952 | |
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)
| |
Three Months Ended September 30, | | |
Nine Months Ended September 30, | |
| |
2015 | | |
2014 | | |
2015 | | |
2014 | |
| |
| | |
| | |
| | |
| |
Comprehensive loss | |
| | | |
| | | |
| | | |
| | |
Net loss | |
$ | (274,769 | ) | |
$ | (860,091 | ) | |
$ | (1,740,877 | ) | |
$ | (1,251,554 | ) |
Translation adjustments | |
| 209,796 | | |
| 22,890 | | |
| 375,104 | | |
| 175,556 | |
Comprehensive loss | |
| (64,973 | ) | |
| (837,201 | ) | |
| (1,365,773 | ) | |
| (1,075,998 | ) |
Comprehensive income (loss) attributable
to noncontrolling interest | |
| (36,588 | ) | |
| 21,620 | | |
| (64,203 | ) | |
| (30,439 | ) |
Comprehensive loss attributable
to Vertical Computer Systems, Inc. | |
$ | (101,561 | ) | |
$ | (815,581 | ) | |
$ | (1,429,976 | ) | |
$ | (1,106,437 | ) |
See
accompanying notes to the unaudited consolidated financial statements.
Vertical
Computer Systems, Inc. and Subsidiaries
Consolidated
Statement of Stockholders’ Deficit
December
31, 2014 through September 30, 2015
(Unaudited)
| |
| | |
| | |
Additional | | |
| | |
Other | | |
| | |
| |
| |
Common
Stock | | |
Treasure
Stock | | |
Paid-in | | |
Accumulated | | |
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 and loan principal | |
| 28,556,522 | | |
| 286 | | |
| - | | |
| - | | |
| 755,627 | | |
| - | | |
| - | | |
| - | | |
| 755,913 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Shares issued for loan forbearance | |
| 32,000,000 | | |
| 320 | | |
| - | | |
| - | | |
| 933,580 | | |
| - | | |
| - | | |
| - | | |
| 933,900 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Shares issued to subsidiaries and held in treasury | |
| 30,000,000 | | |
| 300 | | |
| (30,000,000 | ) | |
| (300 | ) | |
| - | | |
| - | | |
| - | | |
| - | | |
| - | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Shares and warrants issued with convertible debt | |
| 6,000,000 | | |
| 60 | | |
| - | | |
| - | | |
| 153,228 | | |
| - | | |
| - | | |
| - | | |
| 153,288 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Amortization of restricted stock awards | |
| - | | |
| - | | |
| - | | |
| - | | |
| 9,808 | | |
| - | | |
| - | | |
| - | | |
| 9,808 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Dividends paid to non-controlling interest | |
| - | | |
| - | | |
| - | | |
| - | | |
| - | | |
| - | | |
| - | | |
| (92,500 | ) | |
| (92,500 | ) |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Other comprehensive income translation adjustment | |
| - | | |
| - | | |
| - | | |
| - | | |
| - | | |
| - | | |
| 375,104 | | |
| - | | |
| 375,104 | |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Net loss | |
| - | | |
| - | | |
| - | | |
| - | | |
| - | | |
| (1,805,080 | ) | |
| - | | |
| 64,203 | | |
| (1,740,877 | ) |
| |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | |
Balances at September 30, 2015 | |
| 1,100,101,656 | | |
$ | 11,002 | | |
| (30,000,000 | ) | |
$ | (300 | ) | |
$ | 21,927,665 | | |
$ | (48,979,637 | ) | |
$ | 520,912 | | |
$ | 593,519 | | |
$ | (25,926,839 | ) |
See
accompanying notes to the unaudited consolidated financial statements.
Vertical
Computer Systems, Inc. and Subsidiaries
Consolidated
Statements of Cash Flows
(Unaudited)
| |
Nine Months Ended September 30, | |
| |
2015 | | |
2014 | |
| |
| | |
| |
Cash flows from operating activities | |
| | | |
| | |
Net loss | |
$ | (1,740,877 | ) | |
$ | (1,251,554 | ) |
Adjustments to reconcile net loss to net cash used in operating activities: | |
| | | |
| | |
Depreciation and amortization | |
| 38,412 | | |
| 34,163 | |
Amortization of debt discounts | |
| 10,570 | | |
| - | |
Common shares issued for stock compensation | |
| 20,000 | | |
| 3,200 | |
Write-off of property and equipment | |
| 4,905 | | |
| - | |
Bad debt expense | |
| 59,808 | | |
| - | |
Forbearance fees paid with common stock | |
| 933,900 | | |
| - | |
Impairment of software development costs | |
| - | | |
| 579,204 | |
Loss on extinguishment of debt and accrued interest | |
| 323,193 | | |
| - | |
Loss/(gain) on derivatives | |
| 78,680 | | |
| (194,381 | ) |
Amortization of restricted stock awards | |
| 9,808 | | |
| - | |
Settlement of accrued income taxes | |
| (562,373 | ) | |
| - | |
Changes in operating assets and liabilities: | |
| | | |
| | |
Accounts receivable | |
| 350,475 | | |
| 415,316 | |
Prepaid expenses and other assets | |
| (11,500 | ) | |
| (19,986 | ) |
Accounts payable and accrued liabilities | |
| 486,046 | | |
| 755,446 | |
Accounts payable related parties | |
| 35,510 | | |
| - | |
Deferred revenue | |
| (185,121 | ) | |
| (346,110 | ) |
Net cash used in operating activities | |
| (148,564 | ) | |
| (24,702 | ) |
| |
| | | |
| | |
Cash flow from investing activities: | |
| | | |
| | |
Software development | |
| (489,148 | ) | |
| (298,523 | ) |
Purchase of property and equipment | |
| - | | |
| (6,804 | ) |
Net cash used in investing activities | |
| (489,148 | ) | |
| (305,327 | ) |
| |
| | | |
| | |
Cash flows from financing activities: | |
| | | |
| | |
Borrowings on notes payable | |
| 335,333 | | |
| 331,282 | |
Borrowings on convertible debentures | |
| 550,000 | | |
| - | |
Payments of notes payable | |
| (52,448 | ) | |
| (361,345 | ) |
Borrowings on related party debt | |
| - | | |
| 25,500 | |
Payments on related party debt | |
| (780 | ) | |
| (20,992 | ) |
Dividends paid | |
| (92,500 | ) | |
| - | |
Bank overdraft | |
| (5,719 | ) | |
| 33,478 | |
Net cash provided by financing activities | |
| 733,886 | | |
| 7,923 | |
| |
| | | |
| | |
Effect of changes in exchange rates on cash | |
| 42,421 | | |
| 175,316 | |
| |
| | | |
| | |
Net change in cash and cash equivalents | |
| 138,595 | | |
| (146,790 | ) |
Cash and cash equivalents, beginning of period | |
| 117,866 | | |
| 162,709 | |
Cash and cash equivalents, end of period | |
$ | 256,461 | | |
$ | 15,919 | |
See accompanying
notes to unaudited consolidated financial statements.
(Continued
on next page)
Vertical
Computer Systems, Inc. and Subsidiaries
Consolidated
Statements of Cash Flows
(Unaudited)
(Continued from previous page)
| |
Nine Months Ended September 30, | |
| |
2015 | | |
2014 | |
| |
| | |
| |
Supplemental disclosures of cash flow information: | |
| | | |
| | |
Cash paid for interest | |
$ | 98,857 | | |
$ | 205,463 | |
| |
| | | |
| | |
Non-cash investing and financing activities: | |
| | | |
| | |
Common shares issued for accrued stock compensation | |
| - | | |
| 10,226 | |
Common shares issued for conversion of debt and accrued interest | |
| 432,720 | | |
| - | |
Common stock issued for settlement of derivative liabilities | |
| 130,399 | | |
| - | |
Debt discount due to shares and warrants issued with debt | |
| 153,288 | | |
| - | |
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”, “Vertical” or “VCSY”) 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”), an 80% owned subsidiary of Vertical. Vertical’s subsidiaries which have minimal
operations are Vertical do Brasil, Taladin, Inc. (“Taladin"), and 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,
Ploinks, Inc. (“Ploinks”) (formerly, OptVision Research, Inc.), a 93% 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, stock warrants and convertible securities were exercised or
converted into common stock. The dilutive effect of our share-based awards is computed using the treasury stock method, which
assumes all share-based awards are exercised and the hypothetical proceeds from exercise are used to purchase common stock at
the average market price during the period. The incremental shares (difference between shares assumed to be issued versus purchased),
to the extent they would have been dilutive, are included in the denominator of the diluted EPS calculation. The dilutive effect
of our convertible preferred stock and convertible debentures is computed using the if-converted method, which assumes conversion
at the beginning of the year.
For
the nine months ended September 30, 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 nine months ended September 30, 2015, the Company capitalized an aggregate of $489,148 related to software development.
During
the nine months ended September 30, 2014, the Company capitalized an aggregate of $298,523 related to software development and
the Company recorded impairment of $579,204 on previously capitalized software development costs.
Recently
Issued Accounting Pronouncements
The
Company does not expect the adoption of any recently issued accounting pronouncements to have a material impact on the Company’s
financial position, operations or cash flows.
Note
2. Going Concern
The
accompanying unaudited consolidated financial statements for the nine months ended September 30, 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 September 30, 2015, we had negative working capital of approximately $15 million and defaulted on
several of our debt obligations. These conditions raise substantial doubt about our ability to continue as a going concern.
Our
management is continuing its efforts to attempt to secure funds through equity and/or debt instruments for our operations, expansion
and possible acquisitions, mergers, joint ventures, and/or other business combinations. The Company will require additional funds
to pay down its liabilities, as well as finance its expansion plans consistent with anticipated changes in operations and infrastructure.
However, there can be no assurance that the Company will be able to secure additional funds and that if such funds are available,
whether the terms or conditions would be acceptable to the Company and whether the Company will be able to turn into a profitable
position and generate positive operating cash flow. The consolidated financial statements contain no adjustment for the outcome
of this uncertainty.
Note 3.
Notes Payable
The
following table reflects our third party debt activity, including our convertible debt, for the nine months ended September 30,
2015:
December 31, 2014 | |
$ | 4,575,239 | |
Repayments of third party notes | |
| (52,448 | ) |
Borrowings from third parties | |
| 885,333 | |
Stock issued for debt payments | |
| (258,552 | ) |
Debt discounts due to stock and warrants issued with debt | |
| (153,288 | ) |
Amortization of debt discounts | |
| 10,570 | |
Currency translation | |
| (624 | ) |
September 30, 2015 | |
$ | 5,006,230 | |
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 which was
increased to 8% under an amendment to the Loan Agreement in 2013. 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 September 30,
2015 or December 31, 2014.
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 in connection with Lakeshore’s 25% minority ownership interest in NOW Solutions.
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 paid fees of $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.
In
July 2015, we entered into an agreement with Lakeshore to amend the terms of the Loan Agreement and the Lakeshore Note. Under
the terms of the amendment, the Company issued 13,000,000 common shares with the Rule 144 restrictive legend, resulting in a forbearance
loss of $455,000 and Ploinks, Inc. agreed to issue 3,000,000 common shares of its stock to Lakeshore. The fair value of the Ploinks
shares was determined to be nominal. Also in July 2015, the Company further amended the Lakeshore Note and the Loan Agreement
with Lakeshore. Pursuant to this Agreement, the Company issued 2,000,000 shares of its common stock with the Rule 144 restrictive
legend resulting in a forbearance loss of $54,200 and paid $15,000 to Lakeshore as forbearance fees.
In
August 2015, we entered into an agreement with Lakeshore to amend the terms of the Loan Agreement and the Lakeshore Note. Under
the terms of the amendment, the Company issued 7,000,000 shares of its common stock with the Rule 144 restrictive legend resulting
in a forbearance loss of $175,700 and Ploinks, Inc. agreed to issue 2,000,000 common shares of its stock to Lakeshore. The fair
value of the Ploinks shares was determined to be nominal.
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 did not make the Lakeshore $500,000 payment on or before August 21, 2015, then Lakeshore in lieu of
the $500,000 payment, would obtain a purchase option (the “2015 Purchase Option”) to purchase an additional
250 shares of NOW Solutions common stock (representing a 25% ownership interest in NOW Solutions) 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 did not make the $500,000 payment to Lakeshore 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 January 1, 2016. In October 2015, Lakeshore provided notice to the Company 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 by December
31, 2015, 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.
At
September 30, 2015, the Note was in default. During the nine months ended September 30, 2015, the Company paid dividends to Lakeshore
of $92,500.
Additional
Financing
In
March 2015, Taladin, Inc., a subsidiary of the Company, and a third party lender entered into a loan agreement under which the
lender loaned Taladin $100,000. Pursuant to the loan agreement, Taladin, issued a promissory note in the principal amount of $100,000
bearing interest at 12% per annum and 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.
Also
in June 2015, Mr. 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. In July 2015,
Mr. Weber was issued 15,000,000 common shares (at a fair market value of $408,000) as repayment of accrued interest and principal
$259,010 owed under a judgment, resulting in a loss on extinguishment of $148,985. These shares were issued to Mr. Weber
in lieu of payments due under an agreement between the Company and Victor Weber to pay off a judgment held by Mr. Weber against
the Company.
In
August 2015, the Company issued 556,522 shares of its common stock with the Rule 144 restrictive legend to a third party lender
at a fair market value of $13,913 as repayment of debt and accrued interest of $11,130 resulting in a loss on extinguishment of
$2,783.
In
August 2015, the Company granted stock awards to an employee consisting of 3,000,000 shares of its common stock with the Rule
144 restrictive legend (at a fair market value of $84,000), 60,000 shares of preferred stock of VHS and 200,000 shares of common
stock of Ploinks, Inc. in connection with a loan modification agreement to pay off accrued interest in the amount of $62,575 related
to certain loans made by the employee to the Company and its affiliates. This resulted in a loss on extinguishment of $21,425.
The fair value of the VHS and Ploinks shares was determined to be nominal.
In
the third quarter ended September 30, 2015, the Company borrowed $150,000 from a third party lender. The note is due on demand.
The company made payment of $50,000 on this loan during the third quarter ended September 30, 2015.
During
the third quarter ended September 30, 2015, the Company borrowed $25,333 from a third party lender. The notes are due on demand
and bear interest at 11%. The Company made payments of $2,448 during the third quarter ended September 30, 2015.
Convertible
Debentures
During
the nine months ended September 30, 2015, the Company issued $550,000 of convertible debentures to various third party lenders
for loans made to the Company in the aggregate amount of $550,000. The debt accrues interest at 10% per annum and is due one year
from the date of issuance. Beginning six months after issuance of the respective debenture, the holder of the debenture may convert
the debenture into shares of common stock at a price per share of either (a) 80% of the average per share price of the Company’s
common stock for the 5 trading days preceding the notice of conversion date using the 3 lowest closing prices or (b) 75% of the
average per share closing bid price of the Company’s common stock during the 10 trading days prior to the notice of conversion
date using the lowest 5 closing bid prices per share (which shall not be lower than $0.03 per share). In connection with the loans,
the Company also issued a total of 6,000,000 shares of common stock of the Company to the lenders and 3-5 year warrants under
which each lender may purchase in aggregate a total of 5,500,000 shares of common stock of the Company at a purchase price of
between $0.05-$0.10 per share (of which one warrant for 1,000,000 includes a cashless warrant exercise provision). In connection
with the issuance of common stock and warrants, the Company recorded a discount of $153,288 against the face value of the loans
based on the relative fair market value of the common stock and warrants. The discount is being amortized over twelve months and
$10,570 of amortization expense was recognized for the nine months ended September 30, 2015.
For
additional transactions after September 30, 2015, 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. Mr. Valdetaro is
the CTO of the Company.
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 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 September 30, 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 resulted in a loss of $78,680 and a gain of $194,381 for the nine
months ended September 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 September 30, 2015 and December 31, 2014:
| |
Fair value measurements on a recurring
basis | |
| |
Level 1 | | |
Level 2 | | |
Level 3 | |
As of September 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, in connection with a $100,000 loan to Taladin, Ploinks, Inc. agreed to issue 1,000,000 shares of its common stock
to the third party lender. The fair value of these subsidiary shares was determined to be nominal.
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 nine months ended September 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. These shares are held in treasury.
In
July 2015, the Company issued 13,000,000 common shares with the Rule 144 restrictive legend resulting in a forbearance loss of
$455,000 and Ploinks, Inc. agreed to issue 3,000,000 common shares of its stock to Lakeshore. The fair value of the Ploinks shares
was determined to be nominal.
In
July 2015, 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 as repayment of a $265,000 payment due under the agreement pursuant to an agreement between the Company
and Victor Weber to pay off a judgment held by Mr. Weber against the Company, This resulting in a loss on extinguishment of $148,985.
For additional details about the judgment and the agreement, please “Legal Proceedings” under Note 7.
In
July 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 resulting in a forbearance loss of $54,200 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
August 2015, the Company issued 7,000,000 shares of its common stock with the Rule 144 restrictive legend resulting in a forbearance
loss of $175,700 to Lakeshore. In connection with the amendment, and in lieu of a $500,000 payment the Company was obligated to
make under the amendment, Lakeshore also obtained a purchase option (the “2015 Purchase Option”) to purchase an additional
250 shares of NOW Solutions common stock (representing a 25% ownership interest in NOW Solutions) 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. 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.
In
August 2015, the Company issued 556,522 shares of its common stock with the Rule 144 restrictive legend to a third party lender
at a fair market value of $13,913 as repayment of debt and accrued interest of $11,130 resulting in a loss on extinguishment of
$2,783.
In
August 2015. the Company granted stock awards to an employee consisting of 3,000,000 shares of its common stock with the Rule
144 restrictive legend (at a fair market value of $84,000), 60,000 shares of preferred stock of VHS and 200,000 shares of common
stock of Ploinks, Inc. in connection with a loan modification agreement to pay off accrued interest in the amount of $62,575 related
to certain loans made by the employee to the Company and its affiliates. This resulted in a loss on extinguishment of $21,425.
The fair value of the VHS and Ploinks shares was determined to be nominal.
In
September 2015, the Company issued 2,250,000 shares of its common stock with the Rule 144 restrictive legend to employees of the
Company and its subsidiaries (at a fair market value of $54,750), pursuant to restricted stock agreements under which the shares
vest in equal installments over a 24-30 month period. $9,808 was recognized as compensation expense related to these shares during
the three months ended September 30, 2015. As of September 30, 2015, $44,942 remains to be amortized over the remaining vesting
period.
In
September 2015, the Company issued 800,000 shares of common stock of Ploinks, Inc. to employees of the Company and its subsidiaries,
pursuant to restricted stock agreements under which the shares vest in equal installments over a 24-30 month period. The fair
value of the Ploinks shares was determined to be nominal.
During
the nine months ended September 30, 2015, the Company issued $550,000 of convertible debentures to various third party lenders
for loans made to the Company in the aggregate amount of $550,000. The debt accrues interest at 10% per annum and is due one year
from the date of issuance. Beginning six months after issuance of the respective debenture, the holder of the debenture may convert
the debenture into shares of common stock at a price per share of either (a) 80% of the average per share price of the Company’s
common stock for the 5 trading days preceding the notice of conversion date using the 3 lowest closing prices or (b) 75% of the
average per share closing bid price of the Company’s common stock during the 10 trading days prior to the notice of conversion
date using the lowest 5 closing bid prices per share (which shall not be lower than $0.03 per share). In connection with the loans,
the Company also issued a total of 6,000,000 shares of common stock of the Company to the lenders and 3-5 year warrants under
which each lender may purchase in aggregate a total of 5,500,000 shares of common stock of the Company at a purchase price of
between $0.05-$0.10 per share (of which one warrant for 1,000,000 includes a cashless warrant exercise provision). In connection
with the issuance of common stock and warrants, the Company recorded a discount of $153,288 against the face value of the loans
based on the relative fair market value of the common stock and warrants. The discount is being amortized over twelve months and
$10,570 of amortization expense was recognized for the nine months ended September 30, 2015.
For
additional common stock and preferred stock transactions after September 30, 2015, please see “Subsequent Events”
in Note 8.
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 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 nine months ended September 30, 2015.
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, 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. Pursuant to the agreement, Mr. Weber filed
disposition documents that the judgment has been satisfied and this 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
October 2015 the Company issued $50,000 of convertible debentures to a third party lender for a $50,000 loan made to the Company.
The debt accrues interest at 10% per annum and is due one year from the date of issuance. Beginning six months after issuance
of the respective debenture, the lender may convert the debenture into shares of common stock at a price per share of 80% of the
average per share price of the Company’s common stock for the 5 trading days preceding the notice of conversion date using
the 3 lowest closing prices. In connection with the loan, the Company also issued a total of 500,000 shares of common stock of
the Company to the lender and a 3 year warrant under which the lender may purchase a total of 500,000 shares of common stock of
the Company at a purchase price of $0.10 per share.
In
October 2015, the Company and a third party lender entered into an agreement concerning loans made by the lender to the Company
during 2015 for $65,833, which bear interest at 12% per annum and are due on demand. In connection with this agreement,
the Company issued 1,500,000 shares of VCSY common stock with the Rule 144 restrictive legend at a fair market value of $29,250.
In
October 2015, the Company and a third party lender entered into an amendment of a forbearance agreement concerning a $100,000
and $50,000 note issued by the Company under which the Company issued 1,000,000 shares of VCSY common stock with the Rule 144
restrictive legend at a fair market value of $20,000 as a forbearance fee and 7,000,000 shares of VCSY common stock with the Rule
144 restrictive legend at a fair market value of $140,000 to cancel $63,907 of accrued interest due under both notes.
In
October 2015, the Company and a third party lender entered into a forbearance agreement concerning certain notes in the aggregate
principal amount of $1,288,919 issued by the Company to the lender under which the Company issued 1,500,000 shares of VCSY common
stock with the Rule 144 restrictive legend as a forbearance fee.
Item
2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The
following discussion is a summary of the key factors management considers necessary or useful in reviewing the Company’s
results of operations, liquidity and capital resources. The following discussion and analysis should be read together with the
accompanying Unaudited Consolidated Financial Statements, and the cautionary statements and risk factors included below in Item
1A of Part II of this Report.
Critical Accounting Policies
Capitalized
Software Costs
Software
costs incurred internally in creating computer software products are expensed until technological feasibility has been established
upon completion of a detailed program design. Thereafter, all software development costs are capitalized until the point that
the product is ready for sale, and are subsequently reported at the lower of unamortized cost or net realizable value. The Company
considers annual amortization of capitalized software costs based on the ratio of current year revenues by product to the total
estimated revenues by the product, subject to an annual minimum based on straight-line amortization over the product’s estimated
economic useful life, not to exceed five years. The Company periodically reviews capitalized software costs for impairment where
the fair value is less than the carrying value. During the nine months ended September 30, 2015 and 2014, $489,148 and $298,523
of internal costs were capitalized, respectively.
Revenue
Recognition
Our
revenue recognition policies are in accordance with standards on software revenue recognition, which include guidance on revenue
arrangements with multiple deliverables and arrangements that include the right to use of software stored on another entity’s
hardware.
In
the case of non-software arrangements, we apply the guidance on revenue arrangements with multiple deliverables and wherein multiple
elements are allocated to each element based on the element’s relative fair value. Revenue allocated to separate elements
is recognized for each element in accordance with our accounting policies described below. If we cannot account for items included
in a multiple-element arrangement as separate units of accounting, they are combined and accounted for as a single unit of accounting
and generally recognized as the undelivered items or services are provided to the customer.
Consulting.
We provide consulting services, primarily implementation and training services, to our clients using a time and materials
pricing methodology. The Company prices its delivery of consulting services on a time and materials basis where the customer is
either charged an agreed-upon daily rate plus out-of-pocket expenses or an hourly rate plus out-of-pocket expenses. In this case,
the Company is paid fees and other amounts generally on a monthly basis or upon the completion of the deliverable service and
recognizes revenue as the services are performed.
Software
License. We sell concurrent perpetual software licenses to our customers. The license gives the customer the right to use
the software without regard to a specific term. We recognize the license revenue upon execution of a contract and delivery of
the software, provided the license fee is fixed and determinable, no significant production, modification or customization of
the software is required and collection is considered probable by management. When the software license arrangement requires the
Company to provide consulting services that are essential to the functionality of the software, the product license revenue is
recognized upon the acceptance by the customer and consulting fees are recognized as services are performed.
Software
licenses are generally sold as part of a multiple-element arrangement that may include maintenance and, under a separate agreement,
consulting services. The consulting services are generally performed by the Company, but the customer may use a third-party to
perform the consulting services. We consider these separate agreements as being negotiated as a package. The Company determines
whether there is vendor specific objective evidence of fair value (‘‘VSOEFV’’) for each element identified
in the arrangement, to determine whether the total arrangement fees can be allocated to each element. If VSOEFV exists for each
element, the total arrangement fee is allocated based on the relative fair value of each element. In cases where there is not
VSOEFV for each element, or if it is determined that services are essential to the functionality of the software being delivered,
we initially defer revenue recognition of the software license fees until VSOEFV is established or the services are performed.
However, if VSOEFV is determinable for all of the undelivered elements, and assuming the undelivered elements are not essential
to the delivered elements, we will defer recognition of the full fair value related to the undelivered elements and recognize
the remaining portion of the arrangement value through application of the residual method. Where VSOEFV has not been established
for certain undelivered elements, revenue for all elements is deferred until those elements have been delivered or their fair
values have been determined. Evidence of VSOEFV is determined for software products based on actual sales prices for the product
sold to a similar class of customer and based on pricing strategies set forth in the Company’s standard pricing list. Evidence
of VSOEFV for consulting services is based upon standard billing rates and the estimated level of effort for individuals expected
to perform the related services. The Company establishes VSOEFV for maintenance agreements using the percentage method such that
VSOEFV for maintenance is a percentage of the license fee charged annually for a specific software product, which in most instances
is 18% of the portion of arrangement fees allocated to the software license element.
Maintenance
Revenue. In connection with the sale of a software license, a customer may elect to purchase software maintenance services.
Most of the customers that purchase software licenses from us also purchase software maintenance services. These maintenance services
are typically renewed on an annual basis. We charge an annual maintenance fee, which is typically a percentage of the initial
software license fee and may be increased from the prior year amount based on inflation or other agreed upon percentage. The annual
maintenance fee generally is paid to the Company at the beginning of the maintenance period, and we recognize these revenues ratably
over the term of the related contract.
While
most of our customers pay for their annual maintenance at the beginning of the maintenance period, a few customers have payment
terms that allow them to pay for their annual maintenance on a quarterly or monthly basis. If the annual maintenance fee is not
paid at the beginning of the maintenance period (or at the beginning of the quarter or month for those few maintenance customers),
we will ratably recognize the maintenance revenue if management believes the collection of the maintenance fee is imminent. Otherwise,
we will defer revenue recognition until the time that the maintenance fee is paid by the customer. We normally continue to provide
maintenance service while awaiting payment from customers. When the payment is received, revenue is recognized for the period
that revenue was previously deferred. This may result in volatility in software maintenance revenue from period to period.
Cloud-based
offering. We have contracted with third parties to provide new and existing customers with hosting facilities providing all
infrastructure and allowing us to offer our currently sold software, emPath® and SnAPPnet™, on a service basis. However,
a contractual right to take possession of the software license or run it on another party’s hardware is not granted to the
customer. We refer to the delivery method to give functionality to new customers utilizing this service as cloud-based. Since
the customer is not given contractual right to take possession of the software, the scope of ASC 350-40 does not apply. A customer
using cloud-based software can enter into an agreement to purchase a software license at any time. We generate revenue from cloud-based
offering as the customer utilizes the software over the Internet.
We
will provide consulting services to customers in conjunction with the cloud-based offering. The rate for such service is based
on standard hourly or daily billing rates. The consulting revenue is recognized as services are performed. Customers utilizing
their own computer to access cloud-based functionality are charged a fee equal to the number of employees paid each month multiplied
by an agreed-upon rate per employee. The revenue is recognized as the cloud-based services are rendered each month.
Allowances
for Doubtful Accounts
The
Company maintains allowances for doubtful accounts, for estimated losses resulting from the inability of its customers to make
required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability
to make payments, additional allowances may be required. We review delinquent accounts at least quarterly to identify potential
doubtful accounts, and together with customer follow-up, estimate the amounts of potential losses.
Deferred
Taxes
The
Company records a valuation allowance to reduce the deferred tax assets to the amount that management believes is more likely
than not to be realized in the foreseeable future, based on estimates of foreseeable future taxable income and taking into consideration
historical operating information. In the event management estimates that the Company will not be able to realize all or part of
its net deferred tax assets in the foreseeable future, a valuation allowance is recorded through a charge to income in the period
such determination is made. Likewise, should management estimate that the Company will be able to realize its deferred tax assets
in the future in excess of its net recorded assets, an adjustment to reduce the valuation allowance would increase income in the
period such determination is made.
Stock-Based
Compensation Expense
We
account for share-based compensation in accordance with the provisions of share-based payments, which requires measurement of
compensation cost for all stock-based awards at fair value on date of grant and recognition of compensation over the service period
for awards expected to vest. The fair value of restricted stock and restricted stock units is determined based on the number of
shares granted and the quoted price of our common stock. Equity instruments issued to other than employees are valued at the earlier
of a commitment date or upon completion of the services, based on the fair value of the equity instruments, and are recognized
as expense over the service period.
Valuation
of the Embedded and Warrant Derivatives
The
valuation of our embedded derivatives is determined by using the Company’s quoted stock price. An embedded derivative is
a derivative instrument that is embedded within another contract, which under a convertible note (the host contract) includes
the right to convert the note by the holder, certain default redemption right premiums and a change of control premium (payable
in cash if a fundamental change occurs). In accordance with the guidance on derivative instruments, embedded derivatives are marked-to-market
each reporting period, with a corresponding non-cash gain or loss charged to the current period. The practical effect of this
has been that when our stock price increases so does our derivative liability, resulting in a non-cash loss that reduces our earnings
and earnings per share. When our stock price declines, we record a non-cash gain, increasing our earnings and earnings per share.
The
fair value recorded for the derivative liability varies from period to period. This variability may result in the actual derivative
liability for a period either above or below the estimates recorded on our consolidated financial statements, resulting in significant
fluctuations in other income (expense) because of the corresponding non-cash gain or loss recorded.
Recently
Issued Accounting Pronouncements
The
Company does not expect the adoption of any recently issued accounting pronouncements to have a material impact on the Company’s
financial position, operations or cash flows.
Results
of Operations
Three
and Nine Months Ended September 30, 2015 Compared To Three and Nine Months Ended September 30, 2014
Total
Revenues. We had total revenues of $1,025,194 and $1,073,323 for the three months ended September 30, 2015 and 2014, respectively.
The decrease in total revenues was $48,129 for the three months ended September 30, 2015 representing a 4.5% decrease compared
to the total revenues for the three months ended September 30, 2014. Substantially all of the revenues for the three months ended
September 30, 2015 and 2014 were related to the business operations of NOW Solutions. Revenue from SnAPPnet, Inc. was $22,528
or 2.2% of total revenues for the three months ended September 30, 2014 and $24,410 or 2.3% of total revenues for the three months
ended September 30, 2014.
Revenues
for the three months ended September 30, 2015 and 2014 primarily consist of fees derived from software licenses, consulting services,
software maintenance and Cloud-based offerings. There were $22,500 of new licensing sales of our emPath® product during the
third quarter of 2015 compared to none for the third quarter of 2014. Software maintenance in the three months ended September
30, 2015 decreased by $23,436 or 2.7% from the same period in the prior year. The revenue decrease in software maintenance is
related to the effects of unfavorable currency rate changes on our Canadian maintenance revenue somewhat offset by an increase
in US maintenance revenue. Consulting revenue, in the three months ended September 30, 2015 decreased by $38,061 from the same
period in the prior year, which represents a 41.2% decrease. This decrease was due to reduced consulting services for version
upgrades and enhancements to existing accounts during the third quarter of 2015. Cloud-based revenues were $86,417 for the three
months ended September 30, 2015 compared to $92,437 for the same period in the prior year, representing a $6,020 decrease or 6.5%.
The decrease is related to the effects of unfavorable currency rate changes on our Canadian cloud-based revenue. Other revenue
in the three months ended September 30, 2015 decreased by $2,932 or 21.0% 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 $3,236,011 and $6,119,592 in the nine months ended September 30, 2015 and 2014, respectively. The decrease
in total revenues was $2,883,581 for the nine months ended September 30, 2015 representing a 47.1% decrease compared to the total
revenues for the nine months ended September 30, 2014. Substantially all of the revenues for the three months ended September
30, 2015 were related to the business operations of NOW Solutions. Revenue for NOW Solutions was $3,405,751 or 55.7% and revenue
for VCSY was $2,600,000 or 42.5% of total revenues for the nine months ended September 30, 2014. Revenue from SnAPPnet, Inc. was
$61,966 or 1.9% of total revenues for the nine months ended September 30, 2015 and $113,841 or 1.9% of total revenues for the
nine months ended September 30, 2014.
Revenues
for the nine months ended September 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 increased by $2,577,860 compared to that
for the nine months ended September 30, 2014 as there were no new licensing sales of SiteFlash™ during 2015. Software maintenance
in the nine months ended September 30, 2015 decreased by $129,755 or 4.5% from the same period in the prior year. The revenue
decrease in software maintenance is related to the effects of unfavorable currency rate changes on our Canadian maintenance revenue
somewhat offset by an increase in US maintenance revenue. Consulting revenue, in the nine months ended September 30, 2015, decreased
by $115,639 from the same period in the prior year, which represents a 38.7% decrease. This decrease was primarily due to reduced
consulting services for version upgrades and enhancements to existing accounts during the nine months ended September 30, 2015.
Cloud-based revenues were $248,444 for the nine months ended September 30, 2015 compared to $299,047 for the same period in the
prior year, representing a $50,603 decrease or 16.8%. The decrease is primarily related to a decrease in SnAPPnet hosting fees
and the effects of unfavorable currency rate changes on our Canadian cloud-based revenue. Other revenue in the nine months ended
September 30, 2015 decreased by $9,724 or 20.9% from the same period in the prior year. Other revenue consists primarily of reimbursable
travel expenses, currency gains and losses, and other miscellaneous revenues.
Cost
of Revenues. We had direct costs associated with our revenues of $465,614 for the three months ended September 30, 2015,
compared to $406,235 for the three months ended September 30, 2014. The increase in cost of revenues of $59,379 represents a 14.6%
increase. The increase in direct cost of revenues was primarily due to a third quarter 2014 adjustment to reduced estimated royalties
for the year.
For
the nine months ended September 30, 2015, direct costs of revenues were $1,377,496 compared to $1,603,718 for the same
period in 2014 resulting in a decrease of $226,222 or 14.1%. The decrease in direct cost of revenues was primarily due to
decreased payroll costs, increased royalties, commissions and rent.
Selling,
General and Administrative Expenses. We had selling, general and administrative expenses of $563,406 and $1,095,077 in
the three months ended September 30, 2015 and 2014, respectively. The decrease of $531,671 is 48.6% less than the same period
in 2014. We had decreased legal expenses to prosecute patent infringement on the Company’s intellectual property, decreased
penalties related to delinquent tax payments and decreased payroll costs.
For
the nine months ended September 30, 2015 we had selling, general and administrative expenses of $2,124,196 compared to $4,423,627
for the nine months ended September 30, 2014. The decrease of $2,299,431 was 52.0% lower than the same period in 2014. We had
decreased legal expenses to prosecute patent infringement on the Company’s intellectual property, decreased penalties related
to delinquent payroll tax payments, decreased foreign withholding taxes, decreased royalties, consulting fees and rent.
Depreciation
and amortization. For the three months ended September 30, 2015, all property and equipment and intangible assets were
fully depreciated and amortized compared to $10,798 of depreciation and amortization for the three months ended September 30, 2014.
For the nine months ended September 30, 2015 and 2014, $38,412 and $34,163, respectively of depreciation and amortization was
recorded.
Bad
debt expense. During the three and nine months ended September 30, 2015, $8,927 and $59,808, respectively was recorded
for accounts receivables that was greater than ninety days past due. No bad debt expense was recorded for 2014.
Impairment
of Software Costs. During the three and nine months ended September 30, 2014, $193,293 and $579,204, respectively of capitalized
software development costs were considered impaired. There was no impairment for 2015.
Gain
(Loss) on Derivative Liability. Derivative liabilities are adjusted each quarter for changes in the market value of the
Company’s common stock. During the first quarter 2015, the Company issued common shares and eliminated the derivative liabilities.
The gain on derivative liabilities was $88,786 for the three months ended September 30, 2014. The loss on derivative liabilities
was $78,680 for the nine months ended September 30, 2014 compared to a loss of $194,381 for the nine months ended September 30,
2014.
Forbearance
Fees. Forbearance fees relate to fees charged by our lenders on loans in default. Forbearance fees for the three months
ended September 30, 2015 were $699,900 compared to $94,568 for the three months ended September 30, 2014. The fees for the three
months ended September 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 and 22 million shares of VCSY common stock with the rule 144 restrictive legend issued
to the senior secured lenders of NOW Solutions. The fees for the three months ended September 30, 2014 are related to the senior
secured debt of NOW Solutions.
Forbearance
fees for the nine months ended September 30, 2015 were $948,900 compared to $256,170 for the nine months ended September 30, 2014.
The fees for the nine months ended September 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 and 22 million shares of VCSY common stock with the rule 144
restrictive legend issued to the senior secured lenders of NOW Solutions. The forbearance fees for the nine months ended September
30, 2014 are primarily related to the senior secured debt of NOW Solutions.
Loss
on Debt Extinguishment. We had a $173,193 and $323,193 loss on debt extinguishment for the three and nine months ended
September 30, 2015. The loss relates to the fair market value of the issuance of 28,556,522 shares with the rule 144 restrictive
legend of VCSY common stock to VCSY, NOW Solutions and Priority Time lenders to settle debt and accrued interest payments.
Interest
Expense. We had interest expense of $64,819 and $222,230 for the three months ended September 30, 2015 and 2014, respectively.
Interest expense decreased by $157,411 representing a decrease of 70.8% compared to the same expense in the three months ended
September 30, 2014. The decrease was primarily due to an adjustment in 2015 on interest recorded in a prior year on the settlement
of Canadian income taxes.
For
the nine months ended September 30, 2015, we had interest expense of $588,583 compared to $668,662 for the same period in 2014,
representing a $80,079 or 12% decrease for the period. The decrease was primarily due to an adjustment in 2015 on interest recorded
in a prior year on the settlement of Canadian income taxes somewhat offset by increased borrowings in 2015.
Net
loss before income taxes. We had a net loss before income taxes of $950,664 and $860,091 for the three months ended September
30, 2015 and 2014, respectively. The net loss before income taxes for the three months ended September 30, 2015 was due to the
factors discussed above for revenues, cost of revenues and selling, general and administrative expenses, which essentially gave
us an operating loss of $12,753. This loss was increased by forbearance fees, loss on debt extinguishment and interest expense.
The net loss for the three months ended September 30, 2014 was due to the factors discussed above for revenues, cost of revenues
and selling, general and administrative expenses, which essentially gave us an operating loss of $632,080. This loss was increased
by impairment of software development costs, forbearance fees and interest expense which was somewhat offset by a gain on derivative
liability.
We
had a net loss before income taxes of $2,303,250 and $1,251,554 for the nine months ended September 20, 2015 and 2014, respectively.
The net loss before income taxes was due to the factors discussed above for revenues, cost of revenues and selling, general and
administrative expenses, which essentially gave us an operating loss of $363,901. This loss was increased by forbearance fees,
loss on derivative liability, loss on debt extinguishment and interest expense. The net loss for the nine months ended September
30, 2014 was due to the factors discussed above for revenues, cost of revenues and selling, general and administrative expenses,
which essentially gave us an operating loss of $521,120. This income was reduced by impairment of software development costs,
forbearance fees and interest expense, which was somewhat offset by a gain on derivative liability.
Income
tax benefit. We had an income tax benefit of $675,895 and $562,373 for the three and nine months ended September 30, 2015,
respectively. The income tax benefit is related to NOW Solutions, a 75% owned subsidiary of the Company. The income tax benefit
is related to an adjustment for the settlement of Canadian income taxes recorded in a previous year.
Dividends
Applicable to Preferred Stock. We have outstanding Series A 4% convertible cumulative preferred stock that accrues dividends
at a rate of 4% on a semi-annual basis. The Company also has outstanding Series C 4% convertible cumulative preferred stock that
accrues dividends at a rate of 4% on a quarterly basis. The total dividends applicable to Series A and Series C preferred stock
were $147,000 for both the three months ended September 30, 2015 and 2014 and $441,000 for both the nine months ended September
30, 2015 and 2014.
Net
Loss Available to Common Stockholders. We had a net loss attributed to common stockholders of $458,357 and $985,471 for
the three months ended September 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 $2,246,080 and $1,722,993 for the nine months ended September 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 nine months ended September 30, 2015 and 2014,
respectively.
Liquidity
and Capital Resources
At
September 30, 2015, we had non-restricted cash-on-hand of $256,461 compared to $117,866 at December 31, 2014.
Net
cash used in operating activities for the nine months ended September 30, 2015 was $148,564 compared to net cash used in operating
activities of $24,702 for the nine months ended September 30, 2014. During the nine months ended September 30, 2015 we received
$3,485,041 of cash from customers, used $1,925,341 for payroll, benefits and payroll taxes, $98,857 for interest payments, $378,691
for professional fees, $96,006 for insurance payments, $215,063 for tax payments other than payroll, $79,186 for audit fees and
$840,460 for accounts payable to vendors.
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 $372,179
or 16% 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 $141,883 (net of allowance
for bad debts) at September 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 September.
The
accounts payable and accrued liabilities went from $10,659,737 at December 31, 2014 to $10,255,351 at September 30, 2015. The
change is primarily related to increased accounts payable, executive payroll and accrued interest partially offset by decreased
taxes, penalties and interest payable related to the settlement of Canadian income taxes. The resulting balance at September 30,
2014 is 72 times more than the balance in accounts receivable. This is one of the reasons why we do not have sufficient funds
available to fund our operations and repay our debt obligations under their existing terms, as described below.
We
used cash to invest in equipment and the development of software products for the nine months ended September 30, 2015 and September
30, 2014 of $489,148 and $305,327, respectively. Most of the equipment was computer equipment and peripherals for upgraded network
servers to increase the productivity of our software developers, and new personal computers for developers, consultants and sales
personnel. Software development relates to the development of new products.
For
the nine months ended September 30, 2015, we paid $53,228 of principal on notes payable and related party notes payable, paid
dividends of $92,500 to NOW Solutions noncontrolling interest owners and had $885,333 of new debt funding in the same period.
For the nine months ended September 30, 2014, we paid $382,337 of principal on notes payable and notes payable to related parties
and had $356,782 of new debt funding in the same period.
The
total change in cash for the nine months ended September 30, 2015 was an increase of $138,595.
As
of the date of the filing of this Report, we do not have sufficient funds available to fund our operations and repay our debt
obligations under their existing terms. Therefore, we need to raise additional funds through selling securities, obtaining loans,
renegotiating the terms of our existing debt and/or increasing sales with our new products. Our inability to raise such funds
or renegotiate the terms of our existing debt will significantly jeopardize our ability to continue operations.
| |
Balance at | | |
Due in Next Five Years | |
Contractual Obligations | |
September 30, 2015 | | |
2015 | | |
2016 | | |
2017 | | |
2018 | | |
2019+ | |
| |
| | |
| | |
| | |
| | |
| | |
| |
Notes payable | |
$ | 4,916,835 | | |
$ | 4,101,835 | | |
$ | 100,000 | | |
$ | 148,278 | | |
$ | 151,722 | | |
$ | 415,000 | |
Convertible debentures | |
| 580,000 | | |
| 30,000 | | |
| 550,000 | | |
| - | | |
| - | | |
| - | |
Operating lease | |
| 227,411 | | |
| 20,023 | | |
| 76,380 | | |
| 74,204 | | |
| 56,804 | | |
| - | |
Total | |
$ | 5,724,246 | | |
$ | 4,151,858 | | |
$ | 726,380 | | |
$ | 222,482 | | |
$ | 208,526 | | |
$ | 415,000 | |
Of
the notes payable, the default status is as follows:
| |
September 30, 2015 | | |
December 31, 2014 | |
| |
| | |
| |
In default | |
$ | 3,868,022 | | |
$ | 4,758,405 | |
Not in default | |
| 1,486,095 | | |
| 165,500 | |
| |
| | | |
| | |
Total Notes Payable | |
$ | 5,354,117 | | |
$ | 4,923,905 | |
The
carrying amounts of assets and liabilities presented in the financial statements do not purport to represent realizable or settlement
values. We had a net loss of $1,740,877 and $1,251,554 for the nine months ended September 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
September 30, 2015, we had negative working capital of approximately $15 million (although this figure includes deferred revenue
of approximately $1.9 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, 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. Pursuant to the agreement, Mr. Weber filed
disposition documents that the judgment has been satisfied and this 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, in connection with a $100,000 loan to Taladin, Ploinks, Inc. agreed to issue 1,000,000 shares of its common stock
to the third party lender. The fair value of these subsidiary shares was determined to be nominal.
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 nine months ended September 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.
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. These shares are held in treasury.
In
July 2015, the Company issued 13,000,000 common shares with the Rule 144 restrictive legend resulting in a forbearance loss of
$455,000 and Ploinks, Inc. agreed to issue 3,000,000 common shares of its stock to Lakeshore. The fair value of the Ploinks shares
was determined to be nominal.
In
July 2015, 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 as repayment of a $265,000 payment due under the agreement pursuant to an agreement between the Company
and Victor Weber to pay off a judgment held by Mr. Weber against the Company, This resulting in a loss on extinguishment of $148,985.
In
July 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 resulting in a forbearance loss of $54,200 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
August 2015, the Company issued 7,000,000 shares of its common stock with the Rule 144 restrictive legend resulting in a forbearance
loss of $175,700 to Lakeshore. In connection with the amendment, and in lieu of a $500,000 payment the Company was obligated to
make under the amendment, Lakeshore also obtained a purchase option (the “2015 Purchase Option”) to purchase an additional
250 shares of NOW Solutions common stock (representing a 25% ownership interest in NOW Solutions) 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. 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.
In
August 2015. the Company granted stock awards to an employee consisting of 3,000,000 shares of its common stock with the Rule
144 restrictive legend (at a fair market value of $84,000), 60,000 shares of preferred stock of VHS and 200,000 shares of common
stock of Ploinks, Inc. in connection with a loan modification agreement to pay off accrued interest in the amount of $62,575 related
to certain loans made by the employee to the Company and its affiliates. This resulted in a loss on extinguishment of $21,425.
The fair value of the VHS and Ploinks shares was determined to be nominal.
In
September 2015, the Company issued 2,250,000 shares of its common stock with the Rule 144 restrictive legend to employees of the
Company and its subsidiaries (at a fair market value of $54,700), pursuant to restricted stock agreements under which the shares
vest in equal installments over a 24-30 month period. $9,808 was recognized as compensation expense related to these shares during
the three months ended September 30, 2015.
In
September 2015, the Company issued 800,000 shares of common stock of Ploinks, Inc. to employees of the Company and its subsidiaries,
pursuant to restricted stock agreements under which the shares vest in equal installments over a 24-30 month period. The fair
value of the Ploinks shares was determined to be nominal.
During
the nine months ended September 30, 2015, the Company issued $550,000 of convertible debentures to various third party lenders
for loans made to the Company in the aggregate amount of $550,000. The debt accrues interest at 10% per annum and is due one year
from the date of issuance. Beginning six months after issuance of the respective debenture, the holder of the debenture may convert
the debenture into shares of common stock at a price per share of either (a) 80% of the average per share price of the Company’s
common stock for the 5 trading days preceding the notice of conversion date using the 3 lowest closing prices or (b) 75% of the
average per share closing bid price of the Company’s common stock during the 10 trading days prior to the notice of conversion
date using the lowest 5 closing bid prices per share (which shall not be lower than $0.03 per share). In connection with the loans,
the Company also issued a total of 6,000,000 shares of common stock of the Company to the lenders and 3-5 year warrants under
which each lender may purchase in aggregate a total of 5,500,000 shares of common stock of the Company at a purchase price of
between $0.05-$0.10 per share (of which one warrant for 1,000,000 includes a cashless warrant exercise provision). In connection
with the issuance of common stock and warrants, the Company recorded a discount of $153,288 against the face value of the loans
based on the relative fair market value of the common stock and warrants. The discount is being amortized over twelve months and
$10,570 of amortization expense was recognized for the nine months ended September 30, 2015.
In
October 2015, the Company issued $50,000 of convertible debentures to a third party lender for a $50,000 loan made to the Company.
The debt accrues interest at 10% per annum and is due one year from the date of issuance. Beginning six months after issuance
of the respective debenture, the lender may convert the debenture into shares of common stock at a price per share of 80% of the
average per share price of the Company’s common stock for the 5 trading days preceding the notice of conversion date using
the 3 lowest closing prices. In connection with the loan, the Company also issued a total of 500,000 shares of common stock of
the Company to the lender and a 3 year warrant under which the lender may purchase a total of 500,000 shares of common stock of
the Company at a purchase price of $0.10 per share.
In
October 2015, the Company and a third party lender entered into an agreement concerning loans made by the lender to the Company
during 2015 for $65,833, which bear interest at 12% per annum and are due on demand. In connection with this agreement,
the Company issued 1,500,000 shares of VCSY common stock with the Rule 144 restrictive legend at a fair market value of $29,250.
In
October 2015, the Company and a third party lender entered into an amendment of a forbearance agreement concerning a $100,000
and $50,000 note issued by the Company under which the Company issued 1,000,000 shares of VCSY common stock with the Rule 144
restrictive legend at a fair market value of $20,000 as a forbearance fee and 7,000,000 shares of VCSY common stock with the Rule
144 restrictive legend at a fair market value of $140,000 to cancel $63,907 of accrued interest due under both notes.
In
October 2015, the Company and a third party lender entered into a forbearance agreement concerning certain notes in the aggregate
principal amount of $1,288,919 issued by the Company to the lender under which the Company issued 1,500,000 shares of VCSY common
stock with the Rule 144 restrictive legend as a forbearance fee.
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 November 16, 2015, the outstanding principal and accrued interest currently due under the note is approximately $1,565,000.
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 to Lakeshore in consideration of an amendment between the parties and Lakeshore’s forbearance from taking
any action concerning the existing defaults under the Lakeshore Note and the Loan Agreement provided the $2,500 weekly payments
are made and the January 15, 2016 reconciliation payment is made (for more details to the amendment of the Loan Agreement and
the Note, please see Item 1, Note 3).
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. |
|
Description |
|
Location |
|
|
|
|
|
31.1 |
|
Certification of Principal Executive Officer and Principal Accounting Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated November 16, 2015 |
|
Provided herewith |
|
|
|
|
|
32.1 |
|
Certification of Principal Executive Officer
and Principal Accounting Officer Pursuant Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
dated November 16, 2015 |
|
Provided herewith |
|
|
|
|
|
101.INS* |
|
XBRL Instance Document |
|
Provided herewith |
|
|
|
|
|
101.SCH* |
|
XBRL Taxonomy Extension Schema |
|
Provided herewith |
|
|
|
|
|
101.CAL * |
|
XBRL Taxonomy Extension Calculation Linkbase |
|
Provided herewith |
|
|
|
|
|
101.DEF* |
|
XBRL Taxonomy Extension Definition Linkbase |
|
Provided herewith |
|
|
|
|
|
101.LAB* |
|
XBRL Taxonomy Extension Label Linkbase |
|
Provided herewith |
|
|
|
|
|
101.PRE* |
|
XBRL Taxonomy Extension Presentation Document |
|
Provided herewith |
| * | Pursuant to Rule 406T
of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement
or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes
of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those
sections. |
SIGNATURES
Pursuant to the requirements of
the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
|
VERTICAL COMPUTER SYSTEMS, INC. |
|
|
|
November 16, 2015 |
By: |
/s/ Richard
Wade |
|
|
Richard Wade |
|
|
President and Chief Executive Officer |
|
|
(Principal Executive Officer and |
|
|
Principal Accounting Officer) |
EXHIBIT 31.1
Certification of the Principal Executive
Officer and Principal Accounting Officer
I, Richard S. Wade, chief executive officer
(principal executive officer and principal accounting officer), certify that:
1.
I have reviewed this annual report for the three and nine months ended September 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: November 16, 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 nine months ended September 30, 2015,
as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Richard S. Wade, Principal
Executive Officer and Principal Accounting Officer, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 that, to the best of my knowledge:
1.
The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
2.
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations
of the Company.
Date: November 16, 2015 |
By: |
/s/ Richard S. Wade |
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Richard S. Wade |
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Chief Executive Officer |
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(Principal Executive Officer and
Principal Accounting Officer) |