VERTICAL COMPUTER
SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
(UNAUDITED)
Note 1. Organization,
Basis of Presentation and Significant Accounting Policies
The accompanying unaudited
interim consolidated financial statements of Vertical Computer Systems, Inc. (‘we”, “our”, the “Company”
or “Vertical”) have been prepared in accordance with accounting principles generally accepted in the United States
of America and rules of the Securities and Exchange Commission, and should be read in conjunction with the audited consolidated
financial statements and notes thereto contained in Vertical’s annual report on Form 10-K for the year ended December 31,
2016. 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 of which a wholly-owned subsidiary of
Vertical, as well as Priority Time Systems, Inc. (“Priority Time”) a 70% owned subsidiary, Ploinks, Inc. (“Ploinks”),
a 90% owned subsidiary and Government Internet Systems, Inc. (“GIS”), an 84.5% owned subsidiary. Vertical’s subsidiaries
which are inactive include EnFacet, Inc. (“ENF”), Globalfare.com, Inc. (“GFI”), Pointmail.com, Inc. 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 2016 annual report on Form
10-K have been omitted.
Earnings per share
Basic earnings per
share is calculated by dividing net income (loss) available to common stockholders by the weighted average number of shares of
the Company’s common stock outstanding during the period. “Diluted earnings per share” reflects the potential
dilution that could occur if our share-based awards and convertible securities were exercised or converted into common stock. The
dilutive effect of our share-based awards is computed using the treasury stock method, which assumes all share-based awards are
exercised and the hypothetical proceeds from exercise are used to purchase common stock at the average market price during the
period. The incremental shares (difference between shares assumed to be issued versus purchased), to the extent they would have
been dilutive, are included in the denominator of the diluted EPS calculation. The dilutive effect of our convertible preferred
stock and convertible debentures is computed using the if-converted method, which assumes conversion at the beginning of the year.
For the six months
ended June 30, 2017 and 2016, 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.
Capitalized Software
Costs
Software
costs incurred internally in creating computer software products are expensed until technological feasibility has been established
upon completion of a detailed program design. Thereafter, all software development costs are capitalized until the point that the
product is ready for sale, and are subsequently reported at the lower of unamortized cost or net realizable value. The Company
considers annual amortization of capitalized software costs based on the ratio of current year revenues by product to the total
estimated revenues by the product, subject to an annual minimum based on straight-line amortization over the product’s estimated
economic useful life, not to exceed five years. The Company periodically reviews capitalized software costs for impairment where
the fair value is less than the carrying value.
During
the six months ended June 30, 2017 and 2016, the Company capitalized an aggregate of $0 and $250,184 respectively, related to software
development.
Recently Issued
Accounting Pronouncements
The Company does not
expect the adoption of any recently issued accounting pronouncements to have a material impact on the Company’s financial
position, operations or cash flows.
Note 2. Going Concern
The accompanying unaudited
consolidated financial statements for the six months ended June 30, 2017 and 2016 have been prepared assuming that we will continue
as a going concern, and accordingly realize our assets and satisfy our liabilities in the normal course of business.
The carrying amounts
of assets and liabilities presented in the consolidated financial statements do not purport to represent realizable or settlement
values. As of June 30, 2017, we had negative working capital of approximately $21.5 million and defaulted on several of our debt
obligations. These conditions raise substantial doubt about our ability to continue as a going concern.
Our management is continuing
its efforts to attempt to secure funds through equity and/or debt instruments for our operations, expansion and possible acquisitions,
mergers, joint ventures, and/or other business combinations. The Company will require additional funds to pay down its liabilities,
as well as finance its expansion plans consistent with anticipated changes in operations and infrastructure. However, there can
be no assurance that the Company will be able to secure additional funds and that if such funds are available, whether the terms
or conditions would be acceptable to the Company and whether the Company will be able to turn into a profitable position and generate
positive operating cash flow. The consolidated financial statements contain no adjustment for the outcome of this uncertainty.
Note 3. Notes Payable
The following table
reflects our third party debt activity, including our convertible debt, for the six months ended June 30, 2017:
December 31, 2016
|
|
$
|
5,853,145
|
|
Borrowings from third parties
|
|
|
240,000
|
|
Repayments of third party notes
|
|
|
(44,705
|
)
|
Conversion of convertible debt principal to common stock
|
|
|
(19,213
|
)
|
Debt discounts due valuation of derivative liabilities
|
|
|
(21,495
|
)
|
Debt discounts due to convertible debt extensions
|
|
|
(31,914
|
)
|
Debt discounts due to issuance of warrants and common stock
|
|
|
(7,074
|
)
|
Amortization of debt discounts
|
|
|
372,210
|
|
Effect of currency exchange
|
|
|
(1
|
)
|
June 30, 2017
|
|
$
|
6,340,953
|
|
During the six months
ended June 30, 2017, the Company borrowed $180,000 from a third party lender at 10% interest per annum of which $40,000 was repaid.
During the six months
ended June 30, 2017, the Company issued a convertible debenture in the principal amount of $60,000 to a third party lender for
a loan made to the Company in the same amount. 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 debenture and provided that the lowest closing price of the common stock for
each of the 5 trading days immediately preceding the conversion date has been $0.03 or higher, the holder of the respective debenture
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 600,000 shares of common stock of the Company to the lender with the Rule 144 restrictive
legend and 3-year warrants under which each lender may purchase in aggregate a total of 600,000 unregistered shares of common stock
of the Company at a purchase price of $0.10 per share. In connection with the issuance of shares of common stock and warrants,
the Company recorded a discount of $9,916 against the face value of the loan based on the relative fair market value of the common
stock and full fair market value of the warrants. The warrants are accounted for as a derivative liability. The discount is being
amortized over twelve months and $54 of amortization expense was recognized for the six months ended June 30, 2017.
During the six months
ended June 30, 2017, $22,421 of principal, interest and legal fees under a convertible note issued in the principal amount of $90,000
was converted into 1,688,762 common shares. In May 2017, the Company amended the convertible note originally issued to a third
party lender in the principal amount of $80,000 to $90,000 and cancelled a $10,000 note payable issued to the third party lender.
This convertible note has been paid in full.
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 cloud-based offering 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 two subsidiaries to Lakeshore: Priority Time Systems, Inc.,
and in SnAPPnet, Inc.. This resulted in an additional non-controlling interest recognized in the equity of the Company of $391,920
and $99,210 for Priority Time Systems, Inc. and SnAPPnet, Inc., respectively, during 2014. The Company had an option to buy back
Lakeshore’s ownership interest in NOW Solutions, Priority Time and SnAPPnet, Inc. (which expired on January 31, 2015).
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 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 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.
Under the August 2015
agreement, the Company also agreed to make a $500,000 payment for amounts due to Lakeshore under the Lakeshore Note and the Loan
Agreement. In the event that the Company 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 for a total purchase price of $950,000. In addition, since the Company did not make the
$500,000 payment to Lakeshore on or before August 21, 2015, no further payment on the Note was due until January 1, 2016 at which
time the Note plus all accrued interest were recalculated and the Note was re-amortized under the same interest rate and terms
as the Note and the maturity date of the Note was extended 10 years from January 1, 2016.
The Lakeshore note
is in default and the Company is currently evaluating solutions to resolve all issues with Lakeshore.
During the six months
ended June 30, 2017, NOW Solutions, a subsidiary of the Company, accrued dividends to Lakeshore of $65,000.
For additional transactions
after June 30, 2017 concerning notes payable, please see “Subsequent Events” in Note 9.
Note 4. Derivative liability and fair
value measurements
Derivative liabilities
As of June 30, 2017, the Company has convertible notes and common stock warrants that qualify as derivative
liabilities under ASC 815.
As of June 30, 2017,
the aggregate fair value of the outstanding derivative liabilities was $396,674. For the six months ended June 30, 2017, the net
gain on the change in fair value of derivative liabilities was $619,898.
The Company estimated
the fair value of the derivative liabilities using the Black-Scholes option pricing model and the following key assumptions during
2017:
|
|
2017
|
|
Expected dividends
|
|
|
0
|
%
|
Expected terms (years)
|
|
|
0.07 - 3.00
|
|
Volatility
|
|
|
103% - 118
|
%
|
Risk-free rate
|
|
|
1.24% - 1.55
|
%
|
Fair value measurements
FASB ASC 820, Fair
Value Measurements and Disclosures, defines fair value as the exchange price that would be received for an asset or paid to transfer
a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between
market participants on the measurement date. FASB ASC 820 also establishes a fair value hierarchy which requires an entity to maximize
the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. FASB ASC 820 describes three
levels of inputs that may be used to measure fair value:
Level 1
– Quoted
prices in active markets for identical assets or liabilities.
Level 2
– Observable
inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; or other inputs that are observable
or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3
– Unobservable
inputs that are supported by little or no market activity and that are financial instruments whose values are determined using
pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of
fair value requires significant judgment or estimation.
If the inputs used
to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on
the lowest level of input that is significant to the fair value measurement of the instrument.
The following table provides a summary of
the fair value of our derivative liabilities as of June 30, 2017 and December 31, 2016:
|
|
Fair value measurements on a recurring basis
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
As of June 30, 2017:
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative liabilities – convertible debt and warrants
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
396,674
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2016:
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
None
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
1,014,192
|
|
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 Company uses Level 3 inputs to estimate the fair
value of its derivative liabilities.
The below table presents
the change in the fair value of the derivative liabilities during the six months ended June 30, 2017:
Fair value as of December 31, 2016
|
|
$
|
1,014,192
|
|
Additions recognized as debt discounts
|
|
|
21,495
|
|
Additions recognized in equity financing
|
|
|
451
|
|
Reduction due to settlement upon conversion
|
|
|
(19,566
|
)
|
Gain on change in fair value of derivatives
|
|
|
(619,898
|
)
|
Fair value as of June 30, 2017
|
|
$
|
396,674
|
|
Note 5. Common and Preferred Stock Transactions
In May 2017, the Company
granted 300,000 unregistered shares of its common stock with the Rule 144 restrictive legend and 50,000 shares of Ploinks, Inc.
common stock to a consultant of the Company and its subsidiaries pursuant to a consulting agreement with the Company. The aggregate
fair market value of the VCSY common stock grant was determined to be $4,200 based on the quoted market price of VCSY stock at
date of grant and Ploinks, Inc. common stock grant was determined to be $5,400 based on a third party valuation of Ploinks stock.
In addition, the Company agreed to issue up to 2,000,000 common shares of the Company and 200,000 shares of Ploinks, Inc. common
stock pursuant to restricted performance stock agreements with the consultant. These shares may vest over a term of 3 years and
are based upon the Consultant achieving certain performance criteria.
During the six months
ended June 30, 2017, the Company issued a convertible debenture in the principal amount of $60,000 to a third party lender for
a loan made to the Company in the same amount. 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 debenture and provided that the lowest closing price of the common stock for
each of the 5 trading days immediately preceding the conversion date has been $0.03 or higher, the holder of the respective debenture
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 600,000 shares of common stock of the Company to the lender with the Rule 144 restrictive
legend and 3-year warrants under which each lender may purchase in aggregate a total of 600,000 unregistered shares of common stock
of the Company at a purchase price of $0.10 per share. In connection with the issuance of shares of common stock and warrants,
the Company recorded a discount of $9,916 against the face value of the loan based on the relative fair market value of the common
stock and full fair market value of the warrants. The warrants are accounted for as a derivative liability. The discount is being
amortized over twelve months and $54 of amortization expense was recognized for the six months ended June 30, 2017.
During the six months
ended June 30, 2017, the Company entered into a subscription agreement under which a third party subscriber purchased 1,000 shares
of VCSY Series A Preferred Stock for $200,000. In connection with the purchase of the VCSY Series A Preferred Stock, the subscribers
also received a total of 2,000,000 shares of common stock of the Company with the Rule 144 restrictive legend, 100,000 shares of
common stock of Ploinks, Inc., 2-year warrants under which the subscribers may purchase an aggregate total of 150,000 unregistered
shares of common stock of the Company at a purchase price of $0.10 per share and 2-year warrants under which the subscribers may
purchase an aggregate total of 150,000 unregistered shares of common stock of the Company at a purchase price of $0.20 per share.
The allocated fair market value of the VCSY Series A Preferred Stock issued to the subscribers was $36,670. Each share of VCSY
Series A Preferred Stock is convertible into 500 shares of the Company’s common stock. The allocated fair market value of
all common shares of the Company issued to the subscribers was $22,800. The allocated fair market value of all common shares of
Ploinks, Inc. issued to the subscribers was $1,196. The fair market value of all warrants issued to the subscribers was $451 (which
was calculated using the Black-Sholes model). The warrants were accounted for as derivative liabilities (see Note 4).
During the six months
ended June 30, 2017, the Company granted 295,500 shares of the common stock of Ploinks, Inc. to third party lenders in connection
with 3 to 6-month extensions of convertible debentures in the principal amount of $1,035,000 issued in 2015 and 2016. The aggregate
fair market value of the awards was determined to be $31,914 and was recorded as debt discount, and is being amortized through
the term of the convertible debenture.
During the six months
ended June 30, 2017, the Company granted 3,000,000 VCSY common shares pursuant to a stock award to an employee of the Company and
its subsidiaries (at a fair market value of $72,000).
During the six months
ended June 30, 2017, $22,421 of principal, interest and legal fees under a convertible note issued in the principal amount of $90,000
was converted into 1,688,762 common shares. In May 2017, the Company had amended this convertible note originally issued to a third
party lender in the principal amount of $80,000 to $90,000 and cancelled a $10,000 note payable issued to the third party lender.
This convertible note has been paid in full.
During the six months
ended June 30, 2017, the Company entered into a restricted stock agreement to grant 120,000 shares of the Company’s common
stock with the Rule 144 restrictive legend with an employee of the Company under which the shares vest in equal installments over
a 30-month period. The fair value of the shares was $2,208 based on the quoted market price of VCSY stock on the grant date and
$368 was amortized to expense during the six months ended June 30, 2017.
During the six months
ended June 30, 2017, 550,000 VCSY common shares vested under restricted stock agreements to employees and a consultant of the Company.
During the six months
ended June 30, 2017, Ploinks, Inc. entered into a restricted stock agreement to grant 60,000 unregistered shares of the common
stock of Ploinks, Inc. to an employee of the Company pursuant to a restricted stock agreement with Ploinks, Inc. These shares typically
vest over a 30-month period in equal installments and the fair value of the awards is being expensed over this vesting period.
The fair value of the shares was $6,480 based on a third party valuation of Ploinks stock and $1,082 was amortized to expense during
the six months ended June 30, 2017.
During the six months ended June 30, 2017, the Company granted 300,000 unregistered shares of the common stock
of Ploinks, Inc. to an employee of a subsidiary of the Company’s pursuant to a restricted stock agreement with the Company.
150,000 shares vested immediately upon grant of the shares (as noted below) and 150,000 shares will vest in 4 months from the date
of grant. The fair value of the shares was $32,400 based on a third party valuation of Ploinks stock and $22,127 was amortized
to expense during the six months ended June 30, 2017
During the six months
ended June 30, 2017, 350,001 shares of the common stock of Ploinks, Inc. issued under restricted stock agreements to consultants
and employees of the Company and a subsidiary of the Company vested.
Stock compensation
expense for the amortization of restricted stock awards was $67,494 for the six months ended June 30, 2017. As of June 30, 2017,
there were 11,695,000 shares of unvested stock compensation awards to employees and 16,000,000 shares of unvested stock compensation
awards to non-employees.
We have evaluated our
convertible cumulative preferred stock under the guidance set out in FASB ASC 470-20 and accordingly classified these shares as
temporary equity in the consolidated balance sheets.
For additional transactions
after June 30, 2017 concerning stock transactions, please see “Subsequent Events” in Note 9.
Note 6. Option and Warrant Activity
Option and warrant
activities during the six months ended June 30, 2017 is summarized as follows:
|
|
Incentive Stock Options
|
|
|
Non-Statutory
Stock Options
|
|
|
Warrants
|
|
|
Weighted
Average Exercise
Price
|
|
Outstanding at December 31, 2016
|
|
|
—
|
|
|
|
—
|
|
|
|
14,850,000
|
|
|
$
|
0.100
|
|
Options/Warrants granted
|
|
|
—
|
|
|
|
—
|
|
|
|
900,000
|
|
|
$
|
0.117
|
|
Options/Warrants exercised
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Options/Warrants expired/cancelled
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Outstanding at June 30, 2017
|
|
|
—
|
|
|
|
—
|
|
|
|
15,750,000
|
|
|
$
|
0.101
|
|
The weighted average
remaining life of the outstanding warrants as of June 30, 2017 was 1.98. The intrinsic value of the exercisable warrants as of
June 30, 2017 was $.0139.
For additional transactions
after June 30, 2017 concerning warrants and stock options, please see “Subsequent Events” in Note 9.
Note 7. Related Party Transactions
Related party debt,
including our convertible debt was $308,242 as of June 30, 2017 and December 31, 2016.
As of June 30, 2017
and December 31, 2016, the Company had accounts payable to employees for unreimbursed expenses and related party contractors in
an aggregate amount of $162,500 and $139,546, respectively. The payables are unsecured, non-interest bearing and due on demand.
Note 8. Legal Proceedings
We are involved in
the following ongoing legal matters:
On 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 intend to resolve all disputes with InfiniTek.
On February 13, 2017,
the Company was served with a complaint filed by Parker Mills in the Superior Court of the State of California, County of Los Angeles,
Central District, for failure to make payment on the outstanding balance due under a $100,000 convertible debenture issued by the
Company to Parker Mills. The plaintiff seeks payment of the principal balance due under the convertible debenture of $100,000,
interest at the rate of 12% per annum, attorney’s fees and court costs. The Company has $112,985 of principal and interest
accrued as of March 31, 2017. In June 2017, the court entered a default judgment against the Company. We intend to resolve this
matter with Parker Mills. This case is styled Parker Mills, LLP v. Vertical Computer Systems, Inc., No.
BC649122
.
William Mills is a partner of Parker Mills and the Secretary and a Director of the Company.
On April 12, 2017, NOW
Solutions, Inc. was served with a Notice of Motion for Summary Judgment in Lieu of Complaint, which was filed by Derek Wolman
in the Supreme Court of the State of New York in County of New York for failure to make outstanding payments on the outstanding
balance due under one promissory note in the principal amount of $150,000 (issued on November 17, 2009) and one promissory note
in the principal amount of $50,000 (issued on August 28, 2014), both of which were issued by NOW Solutions to Mr. Wolman.
The plaintiff seeks a judgment totaling $282,299 (which includes principal and accrued interest), plus additional accrued interest
from the date the complaint was filed, attorney’s fees and expenses. The Company has $260,286 of principal and interest
accrued as of June 30, 2017. We intend to resolve this matter with Mr. Wolman. This case is styled Derek Wolman v. Now Solutions,
Inc., No. 65/502/17.
Note 9. Subsequent Events
In July 2017, the United
States Patent and Trademark office issued a patent (Patent No. 9710425) for the invention titled “Mobile Proxy Server for
Internet Server Having a Dynamic IP Address” for Claims 1-20. The term “IP” stands for “Internet Protocol,”
which is the principal communications protocol for the Internet. This patented technology is incorporated in the Ploinks SPC™
and the Company’s core communication platform.
In July 2017, the Company
granted 500,000 unregistered shares of its common stock with the Rule 144 restrictive legend and 30,000 shares of common stock
of Ploinks, Inc. to a consultant of the Company and its subsidiaries pursuant to a consulting agreement with the Company.
During the period that
runs from July 1, 2017 through August 21, 2017, the Company issued a convertible debenture in the principal amount of $50,000 to
a third party lender for a loan made to the Company in the same amount. 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 debenture and provided that the lowest closing price
of the common stock for each of the 5 trading days immediately preceding the conversion date has been $0.03 or higher, the holder
of the debenture 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 with
the Rule 144 restrictive legend and 3-year warrants under which the lender may purchase up to 500,000 unregistered shares of common
stock of the Company at a purchase price of $0.10 per share.
During the period that
runs from July 1, 2017 through August 21, 2017, the Company entered into a subscription agreement under which a third party subscriber
purchased 300 shares of VCSY Series A Preferred Stock for $60,000. In connection with the purchase of the VCSY Series A Preferred
Stock, the subscriber also received a total of 600,000 shares of common stock of the Company with the Rule 144 restrictive legend,
30,000 shares of common stock of Ploinks, Inc., 2-year warrants under which the subscriber may purchase an aggregate total of 45,000
unregistered shares of common stock of the Company at a purchase price of $0.10 per share and 2-year warrants under which the subscriber
may purchase an aggregate total of 45,000 unregistered shares of common stock of the Company at a purchase price of $0.20 per share.
During the period that
runs from July 1, 2017 through August 21, 2017, the Company granted 4,500 shares of common stock of Ploinks, Inc. to a third party
lender in connection with a 6-month extension of a convertible debenture in the principal amount of $15,000 issued in 2016.
During the period that
runs from July 1, 2017 through August 21, 2017, the Company made payments of $126,500 of principal and interest due under a convertible
debenture in the principal amount of $115,000 issued by the Company to a third party lender. This convertible debenture has been
paid in full.
During the period that
runs from July 1, 2017 through August 21, 2017, 250,000 VCSY common shares issued under restricted stock agreements to an employee
of the Company vested.
During the period that
runs from July 1, 2017 through August 21, 2017, 80,000 common shares of stock of Ploinks, Inc. issued under restricted stock agreements
to an employee of the Company vested.