☒ ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934:
☐ TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934:
Indicate by check mark if the registrant is a well-known seasoned
issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒
Indicate by check mark if the registrant is not required to
file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒
Indicate by check mark whether the registrant:
(1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has
submitted electronically and posted on its corporate Web site, if any, every
Interactive Data
File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the
preceding 12 months (or for such shorter period that the registrant was required to submit and post such file.
Yes ☒ No ☐
Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained in this form, and will
not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated
by reference in Part III of this Form 10-K or amendment to this Form 10-K. ☐
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company or emerging growth company. See the definitions
of “large accelerated filer,” “accelerated filer” and “smaller reporting company” and “emerging
growth company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant
is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒
State the aggregate market value of the
voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last
sold, or the average bid and asked price of such common equity, as of the registrant’s most recently completed second fiscal
quarter: $14,934,781
We caution you
that the risks, uncertainties and other factors referenced above may not contain all of the risks, uncertainties and other factors
that are important to you. In addition, we cannot guarantee future performance of our products and services, or results or achievements.
Any forward-looking statement made by us in this Annual Report speaks only as of the date of this Annual Report or as of the date
on which it is made. Except as required by law, we undertake no obligation to publicly update any forward-looking statements,
whether as a result of new information or developments, future events or otherwise, after the date of this Annual Report.
We have common
law, unregistered trademarks for the Company and its subsidiaries based upon use of the trademarks in the United States. This
Annual Report contains references to our trademarks and to trademarks belonging to other entities. Solely for convenience, trademarks
and trade names referred to in this Annual Report, including logos, artwork and other visual displays, may appear without the
® or ™ symbols, but such references are not intended to indicate, in any way, that we will not assert, to the fullest
extent under applicable law, our rights or the rights of the applicable licensor to these trademarks and trade names. We do not
intend our use or display of other companies’ trade names or trademarks to imply a relationship with, endorsement of, or
sponsorship of us or our products or services by, any other companies.
PART
I
Item
1. Business
Forward-Looking Statements and Associated
Risks.
This Report contains forward-looking statements. Such forward-looking statements include statements regarding,
among other things, (a) our projected sales and profitability, (b) our growth strategies, (c) anticipated trends in our industry,
(d) our future financing plans, (e) our anticipated needs for working capital, and (f) the benefits related to ownership of our
common stock. Forward-looking statements, which involve assumptions and describe our future plans, strategies, and expectations,
are generally identifiable by use of the words “may,” “will,” “should,” “expect,”
“anticipate,” “estimate,” “believe,” “intend,” or “project” or the
negative of these words or other variations on these words or comparable terminology. This information may involve known and unknown
risks, uncertainties, and other factors that may cause our actual results, performance, or achievements to be materially different
from the future results, performance, or achievements expressed or implied by any forward-looking statements. These statements
may be found under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and
“Business,” as well as in this Report generally. Actual events or results may differ materially from those discussed
in forward-looking statements as a result of various factors, including, without limitation, the risks outlined under “Risk
Factors” and matters described in this Report generally. In light of these risks and uncertainties, there can be no assurance
that the forward-looking statements contained in this Report will in fact occur as projected.
Background
Vertical Computer
Systems, Inc. (“
Vertical
”, “
VCSY
”, the “
Company
”, the “
Registrant
”,
“
we
”, “
our
”, or “
us
”) was incorporated in the State of Delaware in March
1992. We operated as a non-reporting public shell company until October 1999, at which time we acquired all the outstanding capital
stock of Externet World, Inc., an Internet service provider and became an operating entity. In April 2000, we acquired 100% of
the outstanding common stock of Scientific Fuel Technology, Inc. (“
SFT
”), a company with no operations. Also
in April 2000, we merged SFT into our company, as a consequence of which the outstanding shares of SFT were cancelled, Vertical
became the surviving entity, and we assumed SFT’s reporting obligations pursuant to Rule 12g-3(a) under the Securities Exchange
Act of 1934, as amended (the “
Exchange Act
”).
Business Overview
We are a global provider
of application software, cloud-based and software services, Internet core technologies, and intellectual property assets through
our distribution network with operations or sales in the United States, Canada and Brazil.
Our business model
combines complementary and integrated software products along with internet core technologies, in order to create a distribution
matrix that we believe is capable of penetrating multiple sectors through cross-promotion.
We developed a private
communication platform (PCP), based upon our patented and patent-pending software technologies, that we believe can change the
nature of communication on the Internet by allowing and supporting development of applications in separate sectors. In addition,
the technology underlying our PCP has potential applications in the “Internet of Things” (IoT) market.
VCSY’s PCP eliminates
the central server component in communications over the Internet, since the users have a patented web server installed on their
mobile device, which may also be synchronized with their PC or other hardware components (i.e. network storage disks) and can
communicate with other users who have been selected as trusted friends. VCSY’s PCP is for users who seek to obtain a higher
level of security and protection for their information and for private secure communication of information with other selected
users.
The
first application built upon VCSY’s PCP is Ploinks
®
, a private communication application, which was developed
by our subsidiary, Ploinks, Inc. Ploinks
®
provides each user with the ability to protect their data (such as messages,
and images) from both unwanted data transmissions and from third parties gaining access and ownership rights to the user’s
personal data without that user’s express permission. Ploinks
®
is not a social media product, but users may
still use all currently available social media applications. Ploinks
®
provides users with a simple and new means
to preserve and protect any personal data that the individual wants to keep control of and share within a protected environment.
We had a soft launch of Ploinks
®
in February 2017 and
Ploinks Secure Personal Capsule™ (Ploinks SPC™)
in October 2017. Ploinks SPC™ gives users the ability to shift their personal data and communications from cloud service
provider(s) to their own personal server located on their mobile device (smartphone or tablet) and to back data up on their personal
computer (or storage device) using the Puddle™, a complimentary storage and backup service to Ploinks
®
.
Administrative Software
Our main administrative
application software, emPath
®
, which is designed to handle complex payroll and human resources challenges, is developed,
marketed and maintained by NOW Solutions. NOW Solutions, a 75% owned subsidiary, is selling its Web-based emPath
®
in
the United States and Canadian markets both as an in-house software solution and a Software-as-a-Service (“
SaaS
”)
offering, also known as cloud-based offering. For a description of our SaaS model for emPath
®,
please see the section
entitled “Cloud-Based Services” below.
Our continuous effort
to improve our emPath
®
product and its cloud-based offering has allowed us to finalize and launch our new module-based
initiative under which certain payroll/human resource modules can be marketed independently from emPath
®
or bundled
into a comprehensive solution. An upgraded version, emPath
®
7.0, was released to the general public in May 2017.
Version 7.0 significant improves the user experience, is built to support all the new modern browsers and increase performance
in processing payroll for emPath
®
’s large clients and is currently in various stages of implementation with
NOW Solutions’ customer base.
Our time and attendance
software, PTS
™
, has been designed with the flexibility to meet the needs of a simple small business requirements
as well as the most complex union-intensive clients through a rule-based time policy system coupled with a dashboardlets™
feature for presentations of information supporting numerous databases including Oracle, DB2 and SQL. For a description of this
feature, please see the section entitled “Internet Core Technologies” below.
PTS
™
will be marketed as a stand-alone best-of-breed solution through Priority Time Systems, Inc. (“
Priority Time
”)
as well as an integrated module within emPath
®
, which we will be marketing to emPath
®
’s existing
customer base. Initial marketing efforts will be focused on the United States and Canadian markets.
SnAPPnet
™
is currently sold as a best-of-breed standalone solution through our subsidiary, SnAPPnet, Inc. We are in the process of
upgrading SnAPPnet
™
look and feel, along with expanding its functionality, not only to increase the market potential
but to then integrate it with emPath
®
, so that it can also be sold to NOW Solutions’ customers as an emPath
®
module.
We believe that our
administrative software solutions, which offer lower set-up fees and faster implementation times compared to competing products,
provide customers with significant upfront cost savings and substantial increases in productivity for administration of everyday
operations.
Cloud-Based
Services
In addition to our
standard software licensing model, where the software is deployed, hosted and maintained internally by the customer, we are offering
customers with an alternate delivery method: software-as-a-service, or simply “cloud-based.” Cloud-based is a software
delivery model where the company develops, operates, and hosts the application in data centers for use by its customers over the
Internet.
A cloud-based service
is a cost-effective, reliable and secure way for businesses to obtain the same benefits of commercially licensed, internally operated
software, without the associated complexity and high start-up costs of deploying the software in-house or the need to dedicate
IT people on staff to monitor and upgrade such a system. Such services are currently under evaluation as to the marketability
of making use of the VCSY secure communication platform to create new business opportunities.
After completing emPath
®
cloud-based model to ensure a robust and competitive solution, NOW Solutions began selling that offering to existing and
new clients. The cloud-based model provides a highly reliable, secure and scalable infrastructure, enabling us not only to continue
servicing and expanding our current market of mid to large sized customers but also to increase our market reach by offering a
solution to smaller sized customers, which otherwise may not be able to afford an in-house solution.
As an expanded product
and as the result of our initial sales to customers with complex payroll, NOW Solutions has created a tailored cloud-based offering
which provides these types of customers the cost benefits of a SaaS model while meeting their complex requirements. We are also
continuing to upgrade emPath
®
for our cloud-based offering utilizing emPath
®
’s powerful payroll
component to provide private label contracting as well as distribution opportunities through existing payroll and HR providers
in their local markets.
PTS
™
,
our time and attendance software, is also to be offered as a cloud-based solution, as both a standalone product (through Priority
Time and VHS) and an integrated module with emPath
®
(through NOW Solutions).
SnAPPnet™, a
physician credentialing application, is currently offered as a cloud-based solution. We are in the process of upgrading SnAPPnet™
to be a complementary product to emPath
®
. In addition, we are adding some key new features to the application as
well as doing a design review to meet other potential markets for credentialing and markets in need of automated fillable forms.
Upon completion of the upgrade, we will market SnAPPnet™ directly to hospitals and plan to offer it through VHS to physicians
in the United States and to NOW Solutions’ existing customer base.
VCSY is in the process
of placing NOW Solutions, Inc, Priority Time and SnAPPnet, Inc. under Taladin for improved marketing of its administrative software
solutions in order to compete more effectively and allow for expansion internationally.
Software Services
In addition to the
administrative software and cloud-based services, we offer a full range of software services that include professional services,
maintenance, custom maintenance and managed services.
Internet Core Technologies
Internet core technologies
provide the software foundation to support internet-based platforms for the delivery of individual software products that can
be sold independently or combined with other software products for rapid deployment throughout our distribution system. We continue
to develop specialized software applications that can be utilized in new products.
Our first patented
internet core technology is SiteFlash™. The SiteFlash™ technology utilizes XML and publishes content on the Web, enabling
the user to build and efficiently operate websites with the unique ability to separate form, function, and content. SiteFlash™
uses an advanced component-based structure to separate, parse, and store the various components of even the most complex web pages,
permitting these components to be named, organized, filed and eventually redeployed onto the web pages of a website. Once all
of the components of a web page are converted into “
objects
,” they can be grouped, as required by the user,
into the three main types of web page components: content, form and function.
Content
includes text, pictures or multimedia.
Form
includes graphics and website colors, layout and design.
Function
includes the activities performed by or actions
executed on the website. In this way, each element of a website created using SiteFlash™ is interchangeable with any other
similar element, and these elements may be grouped together in almost any combination to create complex websites. This separation
of form, function, and content also allows for the rapid creation of affiliated websites. SiteFlash™ architectural concepts
enable integration with existing technological components within many organizations. Additional key features of SiteFlash™
are its affiliation/syndication capability, its multi-lingual capability, and its multi-modal framework (enabling use on any output
device, including wireless devices such as smart phones, as well as cellular phones and other devices with Internet capability).
It is contemplated that some of SiteFlash™’s components will be included in VCSY’s PCP.
The second patented
Internet core technology we have developed is the Emily™ XML scripting language, a Markup Language Executive (MLE), which
is Java compatible. XML is a flexible way to create common information formats and share both the format and the data on
the World Wide Web, intranets, and elsewhere. The Emily™ Framework was developed to be an engineering package comparable
to other Web development tools, such as Allaire Cold Fusion™ or Microsoft FrontPage™. The primary component of the
Emily™ Framework is the Emily XML scripting language, a programming language that runs on Windows™, Linux and several
UNIX platforms. The Emily™ Framework is used to create Web-based applications that communicate via XML and HTTP. HTTP is
the set of rules for exchanging files (text, graphic images, sound, video, and other multimedia files) on the Web.
The third patented
Internet core technology we have developed is the combination of three components: the Emily™ XML Broker, the Emily™
XML Agent and the Emily™ XML Portal. This technology has been featured as an alternative to Web Services in the 4
th
Edition of the XML Handbook, by Dr. Charles Goldfarb, considered the father of XML and inventor of all markup languages.
We are upgrading this technology for use in a new application we are developing simultaneously. Emily™ will be marketed
in the education market as a product allowing users to create applications without being programmers.
The fourth Internet
core technology is VCSY’s PCP, which is built using a number of patented and patent-pending applications (see Intellectual
Property Assets below). Using PCP, we did a soft launch of our first product, Ploinks
®
, through our subsidiary,
Ploinks, Inc., in February 2017,
and
Ploinks SPC™ in October 2017. Ploinks SPC™
gives users the ability to shift their personal data and communications from cloud service provider(s) to their own personal server
located on their mobile device (smartphone or tablet) and to back data up on their personal computer (or storage device) using
the Puddle™, a complimentary storage and backup service to Ploinks
®
.
Ploinks
®
and the Ploinks SPC™ are monthly subscription-based applications.
Intellectual Property
Assets
Our SiteFlash technology
is based upon the following patents: a System and Method for Generating Web sites in an Arbitrary Object Framework. This unique
ability is patented under U.S. Patent No. 6,826,744 and continuation patent U.S. Patent No. 7,716,629 as well as a continuation
patent (U.S. Patent No. 8,949,780) of U.S. Patent No. 7,716,629.
Our Emily™ core
technology is the basis for a “Web-based collaborative data collection system”, which allows a disparate and distributed
database to be viewed and updated as if it was a single large database. This unique ability is patented under U.S. Patent No.
7,076,521.
Our Emily™ XML
scripting language, coupled with other Company technology, is the basis for development of mobile applications. This unique ability
is patented under U.S. Patent No. 8,578,266 and its continuation patent.
Our patent for a “System
and Method Running a Web Server on a Mobile Internet Device,” which is part of VCSY’s PCP and covers the Tiny Web
Server, which is also a component of the PCP. This unique ability is patented under U.S. Patent No. 9,112,832.
Our patent for a “Mobile
Proxy Server for Internet Server Having a Dynamic IP Address” is used in our PCP for such applications Ploinks® and
Ploinks SPC™. The term “IP” stands for “Internet Protocol,” which is the principal communications
protocol for the Internet. This unique ability is patented under U.S. Patent No. 9,710,425.
Our fiber optic patent
is an invention for “Transmission of Images Over a Single Filament of Fiber Optic Cable” under U.S Patent No. 6718103.
We also have other
mobile technologies, which are patent-pending.
Market Segments
Our current products
address the following market segments:
MARKET
|
PRODUCT
|
OWNERSHIP/LICENSOR
|
LICENSEE
|
Human Resources and Payroll
|
emPath®
|
NOW Solutions
|
VHS
(a)
, Taladin
(b)
|
Software development units
|
Emily™
|
Vertical
|
VHS
(a)
|
Time and Attendance
|
PTS™
|
Priority Time
|
VHS
(a)
, NOW Solutions
(c)
|
Healthcare Credentialing
|
SnAPPnet™
|
SnAPPnet, Inc.
|
VHS
(a)
, NOW Solutions
(c)
|
Personal Secure Communication
|
Ploinks®
|
Vertical
|
Ploinks, Inc.
(d)
|
Personal Secure Communication
|
Ploinks SPC™
|
Vertical
|
Ploinks, Inc.
(d)
|
|
(a)
|
Physician
market (including medical clinics but not including hospitals)
|
|
(c)
|
Clients
of NOW Solutions
|
|
(d)
|
Personal
secure communication channel for individual consumers for the US market only
|
Business Operations and Units
Our business operations
are grouped into the following units: NOW Solutions, Ploinks, Inc., Taladin, VHS, Priority Time, SnAPPnet, Inc., Vertical do Brasil,
and other subsidiaries with minimal or no activity and other limited interests. Each of the primary divisions is discussed below.
Taladin, Inc.
Taladin, a Texas corporation,
is a wholly-owned subsidiary of the Company. Taladin is being positioned to become the parent company for NOW Solutions, Priority
Time and SnAPPnet in order to streamline and better coordinate the Company’s business administrative software product lines
and marketing efforts. It is anticipated that Taladin will also be responsible for an enterprise private communication channel
utilizing VCSY secure communication platform.
For the 12 months
ended December 31, 2017, Taladin had $338,000 of assets, no revenues and a net loss of approximately $165,770.
NOW Solutions,
Inc.
NOW Solutions, a Delaware
corporation, is a 75% owned subsidiary of the Company. NOW Solutions specializes in end-to-end, fully integrated human resources
and payroll solutions. NOW Solutions has clients in the United States and Canada ranging from private businesses to government
agencies, who typically employ 500 or more employees. NOW Solutions currently markets emPath
®
, a payroll and human
resources and payroll solution. emPath
®
meets the needs for clients who have complex payroll where they may have
employees from different unions, multiple locations in different states (U.S.) and provinces (Canada), and intricate compensation
structures. We believe that the competitive advantage of emPath
®
is its speed of implementation through a formula-builder
technology, which provides customers with rapid customization of payroll rules and calculations without the need for any programming
expertise. NOW Solutions’ product suite is targeted to address the needs of management in today’s dynamic business
environment and gives organizations a user-friendly, flexible, multi-lingual (i.e., English, Canadian French, Spanish, and Portuguese)
software solution, without the multi-million dollar implementation and support budgets typically required to use the payroll and
HR products of major competitors.
NOW Solutions has
converted some of its existing customers to its cloud-based model. In addition, during the conversion of one of our large complex
customers and in discussions with other similar complex customers, we determined that there was a critical need and opportunity
in providing a solution we labeled “tailored cloud-based”, which we believe can fulfill our customers’ unique
requirements while giving them the benefits of a cloud-based offering. NOW Solutions has a new version (Version 7.0) of its emPath®
software that was released to the general public in May 2017. Version 7.0 significant improves the user experience, is built to
support all the new modern browsers and increase performance in processing payroll for emPath
®
’s large clients.
Additionally, NOW
Solutions has embarked on a strategy to develop and license HR products complementary to its existing suite of products that can
be sold separately or integrated as emPath
®
modules, which has been greatly facilitated by emPath
®
’s
Web Services integration. PTS™ is the first product to be integrated within the emPath
®
solution. The second
product is SnAPPnet™, which is in the process of being upgraded to expand its usability beyond traditional credentialing
software so that it can be used by HR departments of NOW Solutions’ existing customer to create and administer fillable
forms routinely used for employees.
Now that Ploinks
®
and the Ploinks SPC™ have been released, we intend to make presentations to selected NOW Solutions’ customers
to jointly create an enterprise model utilizing VCSY’s PCP.
The revenue model
of NOW Solutions is based upon five components: licensing and renewable annual maintenance fees, cloud-based service fees, professional
consulting services, and managed services. Under the cloud-based delivery model, NOW Solutions typically collects monthly fees.
For the 12 months ended December 31, 2017, NOW Solutions had approximately $586,588 of total assets,
revenues of approximately $3,732,608 and a net loss of approximately $199,089.
Ploinks, Inc.
Ploinks, Inc., a Texas corporation (formerly OptVision Research, Inc.), is an 88% owned subsidiary
of the Company.
Vertical has licensed
its secure communication platform to Ploinks, Inc. in the United States, for use by consumers as a personal secure communication
channel. The Ploinks
®
application was launched in February 2017
and
Ploinks
SPC™ in October 2017. Ploinks SPC™, consisting of two main components: the Ploinks® mobile application and the
Puddle™, a complimentary storage and backup service to Ploinks
®
, gives
users the ability to shift their personal data and communications from cloud service provider(s) to their own personal server
located on their mobile device (smartphone or tablet) and to backup data on their personal computer (or network storage device)
using the Puddle™. Ploinks SPC™ is marketed as a secure personal cloud.
Ploinks
®
and the Puddle™ are available on http://www.ploinks.com for a monthly subscription fee.
For the 12 months
ended December 31, 2017, Ploinks, Inc. had approximately $169,071 of total assets, no material revenues and a net loss of $836,953.
Vertical Healthcare
Solutions, Inc.
VHS, a Texas corporation,
is a wholly-owned subsidiary of the Company. VHS plans to market a new platform called the “Physicians Bridge”, which
will be the basis for marketing applications to physicians utilizing other Vertical technologies and products which were licensed
for the physician market by Vertical to VHS. Vertical will also license its PCP to VHS to develop a secure communication
channel for use by and between patients, physicians and staff.
For the 12 months
ended December 31, 2017, VHS had no material assets, no revenues, and a net loss of approximately $223,685.
Priority Time
Systems, Inc.
Priority Time, a Nevada
corporation, is an 80% owned subsidiary of the Company. We originally purchased 90% of the common stock of Priority Time from
a shareholder of Priority Time and under a shareholder agreement with the selling shareholder, we purchased 10% of the common
shares of Priority Time stock held by this shareholder for 1,000,000 VCSY common shares. The shareholder agreement also provides
for the licensing terms of Priority Time products to our other subsidiaries. Lakeshore Investments, LLC owns a 20% minority interest
in Priority Time, which it acquired in 2013.
Priority Time is finalizing
PTS™, a time and attendance product that is to be offered as both a standalone product and as an integrated module within
emPath
®
.
PTS™ is being
developed to meet the unique and complex requirements of NOW Solutions’ customers, particularly for the medical and government
markets, who provided us with specifications for an ideal time and attendance program. The most critical need of complex customers
was robust flexibility which led to the creation, from the ground up, of a rule-based time and attendance application, allowing
users to make for immediate changes within the application while also providing a state-of-the-art reporting ability to senior
executives. The result also led to a new development platform as well as another application called “dashboardlets
TM
.”
PTS™ will be commercially available once its integration with emPath
®
is finalized.
We have been using
our new development platform, which has allowed us to create a cloud-based solution that utilizes a rule-based system, which will
better meet the needs of NOW Solutions’ most complex customers and more easily create a time and attendance product for
vertical markets (i.e. medical, government, casinos, and hospitality).
For the 12 months
ended December 31, 2017, Priority Time had no material assets, no revenues and a net loss of approximately $1,768.
SnAPPnet, Inc.
SnAPPnet, Inc., a
Texas corporation, is an 80% owned subsidiary of the Company. On May 21, 2010, SnAPPnet, Inc. purchased substantially all the
assets of Pelican Applications, LLC (“
Pelican
”) in exchange for $5,335 cash, 100,000 shares of Series B Convertible
Preferred Stock of VHS, and other contingent consideration. The assets acquired included a software application product known
as SnAPPnet™ which is currently used for physician credentialing, as well as Pelican’s entire customer base. We intend
to utilize the SnAPPnet™ software to expand its offering to physicians through VHS, and to adapt the software to meet the
needs of NOW Solutions’ hospital clients who need a credentialing product for their staff.
SnAPPnet™ core
application is being rewritten to utilize our new administrative development platform, including our proprietary dashboardlets™.
A revised and improved SnAPPnet™ application should open new opportunities in markets in need of automated fillable forms.
For the 12 months
ended December 31, 2017, SnAPPnet, Inc. had assets of approximately $7,656, revenues of approximately $36,907 and a net loss of
approximately $11,206.
Government Internet
Systems, Inc.
GIS, a Nevada corporation
is our 84.5% owned subsidiary. Vertical licensed ResponseFlash™ to GIS in order to market and distribute this technology
to government entities (excluding state universities and schools) in the United States. Marketing is currently on hold and the
business opportunities are being reviewed in conjunction with VCSY secure communication platform.
For the 12 months
ended December 31, 2017, GIS had no assets, no material revenue and net loss of approximately $10,139.
Vertical do
Brasil
Our 99% owned subsidiary,
Vertical do Brasil, a Brazilian company, performs software development services on behalf of the Company and its subsidiaries.
NOW Solutions, Inc. owns 1% of Vertical do Brasil.
For the 12 months
ended December 31, 2017, Vertical do Brasil had assets of approximately $2,145, no revenues and no material net income or loss.
The following corporations
are inactive:
Vertical Internet
Solutions, Inc.
VIS, a California
corporation, is a wholly-owned subsidiary of the Company. VIS is inactive and we currently have no plans regarding this subsidiary.
For the 12 months
ended December 31, 2017, VIS had no material assets, no material revenue and no expenses.
EnFacet, Inc.
EnFacet, a Texas corporation, is a
wholly-owned subsidiary of the Company. EnFacet is inactive and we currently have no plans regarding this subsidiary.
For the 12 months
ended December 31, 2017, EnFacet had no material assets and a net loss of $28.
Globalfare.com
Globalfare, a Nevada
corporation, is a wholly-owned subsidiary of the Company. Globalfare is inactive and we currently have no plans regarding this
subsidiary.
For the 12 months
ended December 31, 2017, Globalfare had no assets and a net loss of $99.
Pointmail.com,
Inc.
Pointmail, a California
corporation, is a wholly-owned subsidiary of the Company. Pointmail is inactive and we currently have no plans regarding this
subsidiary.
For the 12 months
ended December 31, 2017, Pointmail had no assets, no revenues and no expenses.
Competition
We face substantial
competition from software and hardware vendors, system integrators, and multinational corporations focused upon information technology
and security.
In the realm of
application software, NOW Solutions’ competitors include Oracle, Lawson, Cyborg/Hewitt, Kronos, DLGL, Ultimate and SAP.
Our cloud-based emPath
®
competes with ADP, Ceridian, Ultimate Software and Quicken. However, while NOW Solutions
competes with these companies, our HR/payroll product is utilized by our many of our customers in conjunction with many of these
companies’ other modules.
Priority Time’s
competitors include Kronos, NOVAtime Technology, Asure Software, Insperity (formerly known as Administaff), and Qqest Software
Systems.
SnAPPnet, Inc. competes
with several small and mid-sized competitors in the healthcare credentialing business sector. SnAPPnet’s competitors include
EchoApps (Heathline Systems), Win/Staff PRO-FILE (Win/Staff), Medkinetics Pro (Medkinetics), IntelliAppsSE (Intellisoft Group,
Inc.), OneAPP (Sy.Med) and CACTUS Software.
It is anticipated
the consolidation of NOW Solutions, Inc, Priority Time and SnAPPnet, Inc. under Taladin will increase the company’s ability
to compete with the larger competitive products.
Ploinks SPC™
is an all-in-one secure communication solution for individuals that we believe has no direct competition to our knowledge, but
finds competitors in some of its areas, such as Snapchat and Instagram for sharing of images, Whisper, WhatsApp, Facebook messenger
in the area of secure messaging, WhatsApp, Viber for voice calling, as well as Dropbox, GoDaddy, Amazon, Microsoft and Google
for data storage.
Our primary competitors
have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical
and marketing resources than we do. However, NOW Solutions has a number of large complex clients including cities and counties
in the United States that have been users of our HR/Payroll software for many years (10 -25 years) and are highly referenceable.
We cannot guarantee that we will be able to compete successfully against current or future competitors or that competitive pressure
will not have a material and adverse effect on our financial position, results of operations and cash flows.
Our ability to compete
will also depend upon our ability to continually improve our products and services, the enhancements we develop, the quality of
our customer service, and the ease of use, performance, price and reliability of our products and services.
We believe, however,
that we possess certain competitive advantages for the following reasons:
|
1.
|
We have a number of proprietary
patented and patent-pending technologies that can be utilized in our offerings.
|
|
2.
|
NOW Solutions has an outstanding
customer support department that has supported large complex entities for decades, and
many of these large entities are leaders in their respective industries.
|
|
3.
|
emPath
®
’s
inherent strengths include its formula builder, the use of one single database (where
competing products may use two or more), and a strong, highly identifiable customer base
it can reference.
|
|
4.
|
emPath
®
is built
on a state-of-the-art Microsoft.net platform, allowing for rapid software development
and interoperability with other software packages.
|
|
5.
|
emPath
®
supports
a global platform with one database for both payroll and HR.
|
|
6.
|
Our development platform (including
the dashboardlets™ feature) provides a consistent business intelligence tool across
our administrative software product line.
|
|
7.
|
We can cross-promote our administrative
software applications between our subsidiaries and through strategic alliances with third
party companies.
|
|
8.
|
Our new secure communication platform
is based upon certain trade secrets and revolutionary technology that incorporates our
patented and patent-pending technologies.
|
|
9.
|
PCP technology will create an
added advantage for NOW Solutions existing customers and potential new customers. by
eliminating certain risks being encountered by companies through hijacking email addresses,
etc….
|
Strategic Overview
The Company’s
product portfolio reflects a number of unique characteristics and advantages that have been developed or acquired over time. At
present, we are actively pursuing the strategy of (a) further developing the technologies owned by the Company and our subsidiaries
and (b) combining all the technologies owned by the Company and our subsidiaries into viable product offerings.
The key components
of our strategy are to:
|
1.
|
Leverage our profitable subsidiary,
NOW Solutions, that has a highly-referenceable client base, including companies that
are leaders in their industries and have been users of emPath
®
and its
predecessor product for over 25 years for their payroll and human resource needs.
|
|
2.
|
Develop a portfolio of patented
technologies that we can license to third parties or utilize internally to strengthen
our existing and projected product offerings.
|
|
3.
|
Build a network of compatible
partners and acquisition or licensing of products that complement our existing offerings.
|
|
4.
|
Maximize the unique features of
our software development platform to launch our new PTS™ and SnAPPnet™ products
as well as other products to NOW Solutions’ customer base and, at the same time,
have those customers assist us in development of product specifications for their own
vertical markets.
|
|
5.
|
Build and integrate new commercially
viable products utilizing our patented technology and other administrative software.
|
|
6.
|
Expand the reach of emPath
®
internationally beyond the U.S. and Canada utilizing non-competitive local distributors
in foreign countries.
|
|
7.
|
Develop proprietary applications
on our secure communication platform and, with licensing agreements, provide a structure
whereby third-party applications can be developed upon that platform to be then distributed.
|
|
8.
|
Have third party verification
as to the capability and comparison in the marketplace.
|
|
9.
|
Enter into strategic alliances
with companies that can benefit from promoting our technology.
|
The software development
leg of our strategy is two-fold. The first is to further enhance our existing solutions and develop new products in order to better
compete with the large ERP providers like SAP and Oracle by providing complex best-of-breed alternative offerings that are more
cost-effective solutions. The second is to continue developing our intellectual property internally for mass market, best-of-breed
solutions offered as cloud-based solutions that incorporate the advantages of our complex solutions. In each such instance, the
software development leg of our strategy will be augmented by exploring solutions that can be linked to federal and state government
programs for cost savings.
Our new mobile strategy
is intended to make us a dominant player in the mobile space for the private communication sector that also serves as a complement
to the social media market, as well as providing solutions in the healthcare and corporate markets. The goal is to become a provider
with an all-in-one solution incorporating technology between a mobile device and different data storage units.
One key to the success
of our strategies is to leverage our core capabilities, by entering into co-marketing agreements with other companies, particularly
those who offer best-of-breed products that complement our product offerings. Our objective is to enter into distinct co-marketing
agreements whereby each business unit will have a separate agreement with the co-marketing partner for its particular target market.
To supplement this approach, our business units will enter into agreements with each other where they can more successfully cross-promote
and market their respective products. We are also identifying complementary products from third parties which we can private label
and sell as part of our existing product offering or separately.
Proprietary Rights
We rely upon a combination
of patent, copyright, trademark, trade secret laws, and contract provisions and to protect our proprietary rights in our technologies,
products and services. We distribute our products and services under agreements that grant users or customers a license
to use our products and services and rely upon the protections afforded by the copyright laws to protect against the unauthorized
reproduction of our products. In addition, we protect our trade secrets and other proprietary information through confidentiality
agreements with employees, consultants and other business partners. emPath
®
, PTS™, SnAPPnet™
and Ploinks
®
are protected by copyright and trademark.
Our patent portfolio
consists of the following technologies and related products:
The United States
Patent and Trademark Office (“USPTO”) granted us a patent (No. 6,718,103) for an invention for “Transmission
of Images over a Single Filament Fiber Optic Cable” in April 2004. This patent is in a theoretical stage only and
is intended to be used for transmitting images on fiber optics that might improve in orders of magnitude today’s capacity
of fiber optics to transmit images and data.
The USPTO granted
us a patent (No. 6,826,744) for an invention for “System and Method for Generating Web Sites in an Arbitrary Object Framework”
on November 30, 2004. On May 11, 2010, we were granted a continuation patent (U.S. Patent No. 7,716,629) of U.S. Patent No. 6,826,744
by the USPTO. All pending new claims were granted in the continuation patent for U.S. Patent No. 7,716,629, which has increased
the scope of the original patent by adding 32 new claims to the original 53 claims. On February 3, 2015, we were granted
a continuation patent (U.S. Patent No. 8,949,780) of U.S. Patent No. 7,716,629. All pending new claims were granted in the continuation
patent for U.S. Patent No. 8,949,780, which has increased the scope of the continuation patent and the original patent by adding
24 new claims.
Together, these patents
are the foundation of our SiteFlash™ platform.
The USPTO granted
us a patent (No. 7,076,521) for an invention for a “Web-based collaborative data collection system” on July 11, 2006. This
patent covers various aspects of the Emily™ XML Enabler Agent and the Emily™ XML Broker.
The USPTO granted
us a patent (No. 8,578,266) for a “Method and Systems for Automatically Downloading and Storing Markup Language Documents
into a Folder Based Data Structure” (formerly, a “Method and System for Providing a Framework for Processing Markup
Language Documents”) on November 5, 2013. In August 2016, we were granted a continuation patent (U.S. Patent No. 9,405,736)
of U.S. Patent No. 8,578,266 which allowed Claims 1-19 and 21 and amended claims 1, 14, and 21. These patents cover the Emily™
scripting language.
The USPTO granted
us a patent (No. 9,112,832) for a “System and Method Running a Web Server on a Mobile Internet Device” on August 18,
2015. This patent is incorporated into our secure communication platform and covers the Tiny Web Server, which is also a component
of our secure communication platform.
The USPTO granted
us a patent (U.S. Patent No. 9,710,425) for a “Mobile Proxy Server for Internet Server Having a Dynamic IP Address”
on July 8, 2017. The term “IP” stands for “Internet Protocol,” which is the principal communications protocol
for the Internet. This patented technology is incorporated in the Company’s PCP and its products.
We also have several
patent-pending software technologies and licensed software:
In 2011, we filed
two provisional applications for patents relating to our patent application filed in 2010 and these have been replaced with non-provisional
patent applications which were filed in 2012, one of which is still pending.
In 2013, we filed six patent applications (including
provisional patent applications).
In 2014, we filed
two provisional patent applications, which have been replaced with non-provisional patent applications and filed in 2015. These
patent applications are still pending.
The Company acquired
rights for U.S. Patent No. 8,903,371 (cellular telephone system and method), which was issued on December 2, 2014 under an assignment
from Luiz Valdetaro, a co-inventor who is also an employee and the Chief Technology Officer of the Company.
Although we intend
to protect our intellectual property rights as described above, there can be no assurance that these measures will be successful.
Policing unauthorized use of our products and services is difficult and the steps taken may not prevent the misappropriation of
our technology intellectual property rights. In addition, effective patent, trademark, trade secret and copyright protection
may be unavailable or limited in certain foreign countries. We seek to protect the source code of some of our products as
trade secrets and as unpublished copyright works. Source code for certain products has been or will be published in order
to obtain patent protection or to register copyright in such source code. We believe that our products, trademarks and other
proprietary rights do not infringe on the proprietary rights of third parties. There can be no assurance that third parties
will not assert infringement claims against us in the future with respect to current or future features or content of services
or products or, if so asserted that any such claims will not result in litigation or require us to enter into royalty arrangements.
Regulatory Environment; Public
Policy
In the United States
and most countries in which we conduct our operations, we are generally not regulated other than pursuant to laws applicable to
businesses in general and value-added services specifically. In some countries, we are subject to specific laws regulating the
availability of certain material related to, or to the obtaining of, personal information. Adverse developments in the legal or
regulatory environment relating to the interactive online services and Internet industry in the United States, Canada, Europe,
Asia, Latin America or elsewhere could have a material adverse effect on our business, financial condition and operating results.
A number of legislative and regulatory proposals from various international bodies and foreign and domestic governments in the
areas of telecommunications regulation, particularly related to the infrastructures on which the Internet rests, access charges,
encryption standards and related export controls, content regulation, consumer protection, advertising, intellectual property,
privacy, electronic commerce, and taxation, tariff and other trade barriers, among others, have been adopted or are now under
consideration. We are unable at this time to predict which, if any, of the proposals under consideration may be adopted and, with
respect to proposals that have been or will be adopted, whether they will have a beneficial or an adverse effect on our business,
financial condition and operating results.
Employees
As of May 10, 2018, we had 19 full-time and 4 part-time employees (16 are employed in the United States
and 7 in Canada), 1 full-time consultant and 1 part-time consultant. We are not a party to any collective bargaining agreements.
Item
1A. Risk Factors
Risk Factors
Related to Our Business, Operating Results and Financial Condition
We are subject to
various risks that may materially harm our business, financial condition and results of operations. You should carefully consider
the risks and uncertainties described below and the other information in this filing before deciding to purchase our common stock.
If any of these risks or uncertainties actually occurs, our business, financial condition or operating results could be materially
harmed. In that case, the trading price of our common stock could decline and you could lose all or part of your investment.
We Have Historically
Incurred Losses and May Continue to Do So in the Future.
We had a net loss before non-controlling interest of $3,302,089 and $5,466,230 for the years ended
December 31, 2017 and 2016, respectively, and have historically incurred losses. Accordingly, we have and may continue to experience
significant liquidity and cash flow problems because our operations are not profitable. No assurances can be given that we will
be successful in reaching or maintaining profitable operations.
We Have Been Subject to
a Going Concern Opinion from Our Independent Auditors, Which Means That We May Not Be Able to Continue Operations Unless We Obtain
Additional Funding.
The report of our
independent registered public accounting firm included an explanatory paragraph in connection with our financial statements for
the years ended December 31, 2017 and 2016. This paragraph states that our recurring net losses, negative working capital and
accumulated deficit, the substantial funds used in our operations and the need to raise additional funds to accomplish our objectives
raise substantial doubt about our ability to continue as a going concern. Our ability to develop our business plan and to continue
as a going concern depends upon our ability to raise capital, to succeed in the licensing of our intellectual property and to
achieve improved operating results. Our financial statements do not include any adjustments that might result from the outcome
of this uncertainty.
Our Ability to Continue
as a Going Concern Is Dependent on Our Ability to Raise Additional Funds and to Establish Profitable Operations.
The accompanying consolidated
financial statements for the years ended December 31, 2017 and 2016 have been prepared assuming that we will continue as a going
concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.
The carrying amounts of assets and liabilities presented in the financial statements do not purport to represent
realizable or settlement values. We have suffered significant recurring operating losses, used substantial funds in our operations,
and need to raise additional funds to accomplish our objectives. Stockholders’ deficit at December 31, 2017 was $34.0
million. Additionally, at December 31, 2017, we had negative working capital of approximately $21.0 million (although it
includes deferred revenue of approximately $1.8 million) and have defaulted on substantially all our debt obligations. These conditions
raise substantial doubt about our ability to continue as a going concern.
Our Success Depends On
Our Ability to Generate Sufficient Revenues to Pay for the Expenses of Our Operations.
We believe that our
success will depend upon our ability to generate revenues from our secure communication platform, SiteFlash™ and Emily™
technology products through licensing and development of commercially viable products
,
as well as increased revenues from
NOW Solutions’ products and services as well as the successful launch of our new products by our subsidiaries (such as SnAPPnet™,
and PTS™, Emily™ and web server applications), none of which can be assured. Our ability to generate revenues is subject
to substantial uncertainty and our inability to generate sufficient revenues to support our operations and debt repayment could
require us to curtail or suspend operations. Such an event would likely result in a decline in our stock price.
Our Success Depends On
Our Ability to Obtain Additional Capital.
We have funding that
is expected to be sufficient to fund our present operations for three months. However, we will need significant additional funding
in order to complete our business plan objectives. Accordingly, we will have to rely upon additional external financing sources
to meet our cash requirements. Management will continue to seek additional funding in the form of equity or debt to meet our cash
requirements. Other than common or preferred stock in our subsidiaries, we do not have any common stock available to issue to
raise money. However, there is no guarantee we will raise sufficient capital to execute our business plan. In the event that we
are unable to raise sufficient capital, our business plan will have to be substantially modified and operations curtailed or suspended.
We Have a Working Capital
Deficit, Which Means That Our Current Assets on December 31, 2017 Were Not Sufficient to Satisfy Our Current Liabilities on That
Date.
We had a working capital deficit of approximately $21.0 million at December 31, 2017, which means that
our current liabilities exceeded our current assets by approximately $21.0 million (although it includes deferred revenue
of approximately $1.8 million). Current assets are assets that are expected to be converted into cash within one year and, therefore,
may be used to pay current liabilities as they become due. Our working capital deficit means that our current assets on December
31, 2017 were not sufficient to satisfy all of our current liabilities on that date.
Our Operating Results
May Fluctuate Because of a Number of Factors, Many of Which Are Outside of Our Control.
Our operating results
may fluctuate significantly as a result of variety of factors, many of which are outside of our control. These factors include,
among others, the following:
|
●
|
the demand for our SiteFlash™,
Emily™ and other proprietary technologies;
|
|
●
|
the demand for our administrative
software products and services: emPath®, PTS™, and SnAPPnet™;
|
|
●
|
the demand for our personal
secure communication application Ploinks
®
and Ploinks SPC™;
|
|
●
|
introduction of new products
and services by us and our competitors;
|
|
●
|
costs incurred with respect
to acquisitions;
|
|
●
|
price competition or pricing
changes in the industry;
|
|
●
|
technical difficulties or
system failures;
|
|
●
|
general economic conditions
and economic conditions specific to the Internet and Internet media and communication
platforms; and
|
|
●
|
the licensing of our intellectual
property;
|
|
●
|
government regulations.
|
We Face Product Development
Risks Due to Rapid Changes in Our Industry. Failure to Keep Pace with These Changes Could Harm Our Business and Financial Results.
The markets for our
products are characterized by rapid technological developments, continually-evolving industry trends and standards and ongoing
changes in customer requirements. Our success depends on our ability to timely and effectively keep pace with these developments.
Keeping
Pace with Industry Changes.
We must enhance and
expand our product offerings to reflect industry trends, new technologies and new operating environments as they become increasingly
important to customer deployments. We must continue to expand our business models beyond traditional software licensing and subscription
models, including, by way of example, use of cloud based offering as an increasingly important method and business model for the
delivery of applications. We must also continuously work to ensure that our products meet changing industry certifications and
standards. Failure to keep pace with any changes that are important to our customers could cause us to lose customers and could
have a negative impact on our business and financial results.
Impact of Product Development
Delays or Competitive Announcements.
Our ability to adapt
to changes can be hampered by product development delays. We may experience delays in product development as we have at times
in the past. Complex products like ours may contain undetected errors or version compatibility problems, particularly when first
released, which could delay or adversely impact market acceptance. We may also experience delays or unforeseen costs associated
with integrating products we acquire with products we develop because we may be unfamiliar with errors or compatibility issues
of products we did not develop ourselves. We may choose not to deliver a partially-developed product, thereby increasing our development
costs without a corresponding benefit. This could negatively impact our business.
Our Failure to Maintain
and Increase Acceptance of Our Cloud-Based Offerings Would Inhibit Our Growth Or Cause a Significant Decline in Our Revenues.
Our future success
depends on maintaining and increasing acceptance of our cloud-based offering, particularly, of emPath® and PTS™. Any
decrease in the demand for these products would have a material adverse effect on our business, operating results and financial
condition and would place a significant strain on our management and operations.
If We Are Unable to Make
Periodic Updates for Our Products Concerning Changes in Tax Laws and Other Regulations on a Timely Basis Acceptance of Our Products
in the Market could Be Adversely Affected And Our Revenues Would Decline.
Products like emPath®
are affected by changes in tax laws and regulations, and we must generally update such products on an annual or periodic basis
to maintain their accuracy and competitiveness. We cannot be certain we will be able to release these updates on a timely basis
in the future. Any failure to do so could have a material adverse effect on the acceptance of our products. Additionally, any
significant changes in tax laws or regulations applicable to such products could require us to make significant investments in
modifications of these products, leading to significant and unexpected costs.
Errors and Defects
in Our Software Could Affect Sales of Our Products.
The software products
we offer may contain undetected errors, defects, or failures when first introduced or as new versions are released. Testing of
software products presents many challenges since it is difficult to anticipate and simulate the wide range of software computing
environments in which our customers use these products. While we test our products extensively, from time-to- time, we have discovered
errors or defects in our products. These defects and errors may result in any of the following:
|
●
|
Delays in the release of
our new products, versions and upgrades
|
|
●
|
Increased costs to fix such
defects and errors, in turn leading to a strain on our software development resources
|
|
●
|
Design modifications of the
product
|
|
●
|
A decrease in customer satisfaction
with, our products and a decrease in sales, and a loss of existing and potential customers
|
Even after our products
are tested by us and by current and prospective customers, errors and defects may be discovered after the commercial release has
commenced, which may result in loss of or delay in market acceptance which could have a material adverse impact upon our business,
operating results and financial condition.
Our software products
may be vulnerable to break-ins and similar disruptive problems; addressing these issues may be expensive and require a significant
amount of our resources.
We have included security
features in our products that are intended to protect the privacy and integrity of customer data. Despite the existence of these
security features, our software products may be vulnerable to break-ins and similar disruptive problems. Addressing these evolving
security issues may be expensive and require a significant amount of our resources.
The Sale and Support of
Software Products and the Performance of Related Services by Us Entail the Risk of Product or Service Liability Claims, Which
Could Significantly Affect Our Financial Results.
Customers use our
products in connection with the preparation and filing of tax returns and other regulatory reports. If any of our products contain
errors that produce inaccurate results upon which users rely, or cause users to misfile or fail to file required information,
we could be subject to liability claims from users. Our cloud-based usage licenses and maintenance renewal agreements with our
customers typically contain provisions intended to limit our liability to such claims, but such provisions may not be effective
in doing so. These contractual limitations may not be legally enforceable and may not afford us with adequate protection against
product liability claims in certain jurisdictions. If a successful claim for product or service liability was brought against
us, this could result in substantial cost to us and divert management’s attention from our operations.
International Operations of Our Business Subject
Us to Additional Risks in Those Foreign Countries.
Our international
operations are subject to additional risks, which increase our exposure to foreign laws and regulations. Over time, our international
operations may grow and increase their significance to our business. Sales to international customers subject our business
to a number of risks, including foreign currency fluctuations, unexpected changes in regulatory requirements related to software,
international political and economic instability, international tax laws, compliance with multiple, changing, and possibly conflicting
governmental laws and regulations, and difficulty in staffing and managing foreign operations,. In addition, there may be weaker
protection for our intellectual property abroad than in the United States, and we may have difficulties in enforcing such rights
abroad. If we are not able to comply with foreign laws and regulations, which are often complex and subject to variation
and unexpected changes, we could incur unexpected costs and potentially become involved in litigation. In addition, in the event
sales to any of our customers outside of the United States are delayed or canceled because of any of the risks described above,
our revenues may be negatively impacted.
Security and
Privacy Breaches Could Adversely Impact Our Business.
For services such as our cloud-based offerings, we may electronically store personal information about our clients and their employees.
We take security measures to protect against the unauthorized access and disclosure of such information. However, there
is no guarantee the precautions we take will be successful in protecting against all security breaches that may result in unauthorized
access to such information. If our security measures are breached or if our services are subject to attacks that degrade
or deny the ability of our clients to access our services, we may incur significant financial, legal, and regulatory exposure.
Privacy Concerns
Could Result in Changes of Regulations or Laws That Affect Our Business.
Personal privacy is
a significant issue in the United States as well as in other countries where our customers operate. Consequently, we are subject
to regulations concerning the use of personal information we collect. Changes to regulations or laws affecting privacy that apply
to our business could impose additional costs and potential liability on us and could also limit our use and disclosure of such
information. If we are required to change our business activities or revise or eliminate services, our business could be
adversely affected.
We May Have Difficulty
Managing Our Growth and Integrating Recently Acquired Companies.
Our recent growth
through acquisitions and licensing of new solutions, coupled with our development efforts to create new commercially viable products
and improve existing ones, has placed a significant strain on our managerial, operational, and financial resources. To manage
our growth, we must continue to implement and improve our operational and financial systems and to expand, train, and manage our
employee base. Any inability to manage growth effectively could have a material adverse effect on our business, operating results,
and financial condition. Further, acquisition transactions are accompanied by a number of risks, including the following:
|
●
|
the difficulty of assimilating
the operations and personnel of the acquired companies;
|
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●
|
the potential disruption
of our ongoing business and distraction of management;
|
|
●
|
the difficulty of incorporating
acquired technology or content and rights into our products and media properties;
|
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●
|
the correct assessment of
the relative percentages of in-process research and development expense which needs to
be immediately written off as compared to the amount which must be amortized over the
appropriate life of the asset;
|
|
●
|
the failure to successfully
develop an acquired in-process technology resulting in the impairment of amounts currently
capitalized as intangible assets;
|
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●
|
unanticipated expenses related
to technology integration;
|
|
●
|
the maintenance of uniform
standards, controls, procedures and policies;
|
|
●
|
the impairment of relationships
with employees and customers as a result of any integration of new personnel; and
|
|
●
|
the potential unknown liabilities
associated with acquired businesses.
|
We may not be successful
in addressing these risks or any other problems encountered in connection with acquisitions. Our failure to address these risks
could negatively affect our business operations through lost opportunities, revenues or profits, any of which would likely result
in a lower stock price.
Our Success Depends On
Our Ability to Protect Our Proprietary Technology.
Our success is dependent,
in part, upon our ability to protect and leverage the value of proprietary technology, including our private communications platform
technology (which includes the Ploinks® and Ploinks SPC™ products), our patented SiteFlash™ and Emily™ technologies,
our patent-pending technologies and administrative software solutions like emPath®, PTS™, and SnAPPnet™, as well
as our trade secrets, trade names, trademarks, service marks, domain names and other proprietary rights we either currently have
or may have in the future. Given the uncertain application of existing trademark laws to the Internet and copyright laws to software
development, there can be no assurance that existing laws will provide adequate protection for our technologies, sites or domain
names. Policing unauthorized use of our technologies, content and other intellectual property rights entails significant expenses
and could otherwise be difficult or impossible to do given the global nature of the Internet and our potential markets.
If Demand for Our Products
Grow Quickly, We May Lack the Capacity Needed to Meet Demand or We May Be Required to Increase Our Capital Spending Significantly.
Our current plans
may not be sufficient to meet our capacity needs for the foreseeable future or may not be implemented quickly enough to meet growing
demand. Moreover, if we make significant capital expenditures to increase capacity and demand does not increase as we expect,
these expenditures would adversely affect our profitability and return on capital.
Our Stock Price Has Historically
Been Volatile, Which May Make It More Difficult for Shareholders to Resell Shares When They Choose To At Prices They Find Attractive.
The trading price
of our common stock has been and may continue to be subject to wide fluctuations. The stock price may fluctuate in response to
a number of events and factors, such as quarterly variations in operating results, announcements of technological innovations
or new products and media properties by us or our competitors, changes in financial estimates and recommendations by securities
analysts, the operating and stock price performance of other companies that investors may deem comparable, and news reports relating
to trends in our markets. In addition, the stock market in general, and the market prices for Internet-related and technology-related
companies in particular, have experienced extreme volatility that often has been unrelated to the operating performance of such
companies. These broad market and industry fluctuations may adversely affect the price of our stock, regardless of our operating
performance.
Our Common Stock Is Deemed
To Be “Penny Stock,” Which May Make It More Difficult for Investors to Sell Their Shares Due To Suitability Requirements.
Our common stock is
deemed to be “penny stock” as that term is defined in Rule 3a51-1 promulgated under the Exchange Act. Penny stocks
are stocks:
|
1.
|
With a price of less than $5.00
per share;
|
|
2.
|
That are not traded on a recognized
national exchange;
|
|
3.
|
Whose prices are not quoted on
the NASDAQ automated quotation system (NASDAQ listed stock must have a price of not less
than $5.00 per share); or
|
|
4.
|
In issuers with net tangible assets
less than $2 million (if the issuer has been in continuous operation for at least three
years) or $5 million (if in continuous operation for less than three years), or
with average revenues of less than $6 million for the last three years.
|
Broker/dealers dealing
in penny stocks are required to provide potential investors with a document disclosing the risks of penny stocks. Moreover, broker/dealers
are required to determine whether an investment in a penny stock is a suitable investment for a prospective investor. These requirements
may reduce the potential market for our common stock by reducing the number of potential investors. This may make it more difficult
for investors in our common stock to sell shares to third parties or to otherwise dispose of them. This could cause our stock
price to decline.
Item
2. Properties
The Company and NOW
Solutions’ headquarters are currently located at 101 West Renner Road, Suite 300, Richardson, Texas, and comprise approximately
4,000 square feet. NOW Solutions has other offices at 6205 Airport Road, Building B, Suite 214, Mississauga, Ontario,
Canada, which comprises 793 square feet. These locations are leased from third parties and the premises are in good condition.
We believe that our facilities are adequate for our present needs and near-term growth, and that additional facilities will be
available at acceptable rates as we need them. Our other subsidiaries may be reached through our Richardson, Texas headquarters.
Item
3. 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 had agreed to 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 Company made $37,500 in payments due under the
settlement agreement through May 7, 2012 and each party had alleged the other party was in breach of the settlement agreement.
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. 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. The Company has $121,617 of principal
and interest accrued as of December 31, 2017.
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. On September 8, 2017, the court awarded Mr. Wolman
a judgment in the amount of $282,299, which accrues interest at the rate of 16% per annum plus attorney’s fees as to be
determined by the court. The Company has $298,016 of principal and accrued interest as of December 31, 2017. We intend to
resolve this matter with Mr. Wolman. This case is styled Derek Wolman v. Now Solutions, Inc., No. 65/502/17.
Item
4. Mine Safety Disclosures
Not applicable.
PART
II
Item
5. Market For Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
Our common equity
is traded on the OTC Markets and quoted on the OTCQB under the symbol “VCSY.” The OTCQB may also be referred to as
“OTCMKTS” or “Other OTC”.
The following is the
range of high and low closing bid prices of our stock, for the periods indicated below.
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|
|
High
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Low
|
|
|
|
|
|
|
|
|
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Quarter Ended December 31, 2017
|
|
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$
|
0.0180
|
|
|
$
|
0.0120
|
|
Quarter Ended September 30, 2017
|
|
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$
|
0.0158
|
|
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$
|
0.0115
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Quarter Ended June 30, 2017
|
|
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$
|
0.0200
|
|
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$
|
0.0112
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Quarter Ended March 31, 2017
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|
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$
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0.0290
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|
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$
|
0.0193
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|
Quarter Ended December 31, 2016
|
|
|
$
|
0.0475
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|
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$
|
0.0121
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Quarter Ended September 30, 2016
|
|
|
$
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0.0480
|
|
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$
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0.0205
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Quarter Ended June 30, 2016
|
|
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$
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0.0370
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|
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$
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0.0226
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Quarter Ended March 31, 2016
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|
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$
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0.0300
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|
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$
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0.0176
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The above quotations
reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions.
Number of Holders
As of May 10, 2018, there were 1,939 holders of record of VCSY common stock.
Equity Securities
Under Compensation Plans
Equity Compensation Plan Information
|
Plan category
|
|
|
Number of
securities
to be issued upon
exercise of
outstanding options,
warrants and rights
|
|
|
Weighted-average
exercise price of
outstanding options,
warrants and rights
|
|
|
Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column (a))
|
|
|
|
|
(a)
|
|
|
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(b)
|
|
|
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(c)
|
|
Equity compensation plans approved by security holders
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Equity compensation plans not approved by security
holders
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock Options
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Warrants
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Unvested Restricted Stock Awards
|
|
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6,640,000
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|
|
$
|
0.02
|
|
|
|
—
|
|
Total
|
|
|
6,640,000
|
|
|
$
|
0.02
|
|
|
|
—
|
|
|
(1)
|
Other than individual agreements with employees, directors and third-party consultants,
we do not have any equity compensation plans (i.e., stock option plans or restricted stock plans) that have been approved
by security holders.
|
|
(2)
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No stock options were issued to employees or consultants during the year ended December
31, 2017.
|
|
(3)
|
No warrants to purchase common stock were issued to employees or consultants during the
year ended December 31, 2017.
|
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(4)
|
Of the 6,640,000 common shares of restricted stock that had not vested at December 31, 2017 and were issued
in connection with individual restricted stock agreements executed in 2016 and 2017 with employees of the Company and its subsidiaries,
320,000 have vested through May 10, 2018.
|
Dividends
We have outstanding
shares of Series A and Series C 4% Convertible Cumulative Preferred stock that accrue dividends (if such dividends are declared)
at a rate of 4% on a semi-annual basis. The total dividends applicable to Series A and Series C Preferred Stock were $616,667
and $592,472 for the years ended December 31, 2017 and 2016, respectively. Our Board of Directors did not declare any dividends
on our outstanding shares of Series A or Series C Preferred Stock during 2017 or 2016, nor has the Company paid any dividends
on our outstanding shares of Series A or Series C Preferred Stock since 2001. We intend to retain future earnings, if any, to
provide funds for use in the operation and expansion of our businesses. Accordingly, we do not anticipate paying cash dividends
on any of our capital stock, including preferred stock, in the near future. For additional information concerning dividends, please
see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7.
Unregistered Sales
of Securities
During the last two
years, we issued the following unregistered securities:
In March 2016, the
Company cancelled 1,000,000 unregistered shares of its common stock issued during 2015 to a third party lender under an agreement
to amend certain promissory notes issued by the Company and NOW Solutions in the aggregate principal amount of $715,000. Under
the amendment, the Company agreed to make $22,000 monthly payments and an additional $10,000 penalty if such monthly payment is
not timely made.
In March 2016, the
Company issued 10,000,000 shares of the Company’s common stock with the Rule 144 restrictive legend to its consolidated
subsidiary Ploinks, Inc. These shares are held in treasury. In exchange, Ploinks, Inc. issued 5,000,000 of its common shares to
the Company.
In April 2016, the
Company and a third-party noteholder entered into an agreement under which the Company issued 5,000,000 shares of the Company’s
common stock with the Rule 144 restrictive legend in exchange for the cancellation of $130,000 in principal owed under a note
payable issued by NOW Solutions with a principal amount of $213,139. The fair market value of the shares was $92,500. A gain on
debt extinguishment of $37,500 was recorded for the year ended December 31, 2016.
In May 2016, the Company
and William Mills entered into an agreement under which the Company issued 5,000,000 shares of the Company’s common stock
with the Rule 144 restrictive legend to Mr. Mills in exchange for the cancellation of $100,000 in fees owed for services rendered
by Mr. Mills as a Director and Secretary of the Company. The fair market value of the shares was $100,000. Mr. Mills is a partner
of Parker Mills and the Secretary and a Director of the Company.
In May 2016, the Company
and a third party entered into an agreement under which the Company issued 1,500,000 shares of the Company’s common stock
with the Rule 144 restrictive legend to the third party in lieu of paying $35,969 in fees, expenses, and interest owed to the
third party for services rendered to the Company and its subsidiaries. The fair market value of the shares issued was $37,500.
A loss on debt extinguishment of $1,531 was recorded for the year ended December 31, 2016.
In June 2016, the
Company granted 3,500,000 unregistered shares of the Company’s common stock with the Rule 144 restrictive legend to employees
and a former employee of the Company and its subsidiaries pursuant to an amended agreement to defer payroll. For additional details,
please see “Related Party Transactions” in Note 3. The fair market value of the shares was $78,750.
During the year ended
December 31, 2016, the Company issued 3,000,000 shares of the Company’s common stock with the Rule 144 restrictive legend
to third-party consultants for services. The fair market value of the shares was $66,550 and was recorded as consulting fees for
the year ended December 31, 2016.
During the year ended December 31, 2016, the Company issued convertible debentures in the aggregate principal
amount of $715,000 to various third-party lenders for loans made to the Company in the same amount. The debts accrue interest at
10% per annum and are due one year from the date of issuance. Beginning six months after issuance of the respective debentures
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 loans, the Company also issued a total of 7,150,000
shares of common stock of the Company to the lenders with the Rule 144 restrictive legend and 3-year warrants under which
each lender may purchase in aggregate a total of 7,150,000 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
$186,967 against the face value of the loans based on the relative fair market value of the common stock of $114,413 and the full
fair market value of the warrants of $72,554. The warrants are accounted for as derivative liabilities. The discount is being amortized
over twelve months and amortization expense was recognized for the year ended December 31, 2016.
During the year ended
December 31, 2016, $82,001 of principal, interest and fees under a convertible note issued in the principal amount of $80,000
were converted into 5,914,783 unrestricted common shares of the Company.
During the year ended
December 31, 2016, the Company entered into subscription agreements under which third party subscribers purchased 3,000 shares
of VCSY Series A Preferred Stock for $600,000. In connection with the purchase of the VCSY Series A Preferred Stock, the subscribers
also received a total of 6,000,000 shares of common stock of the Company with the Rule 144 restrictive legend, 300,000 shares
of common stock of Ploinks, Inc., 2-year warrants under which the subscribers may purchase an aggregate total of 450,000 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 450,000 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 $366,499. 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 $229,496. The allocated fair market value of all common shares
of Ploinks, Inc. issued to the subscribers was $3,416. The fair market value of all warrants issued to the subscribers was $4,005
(which was calculated using the Black-Sholes model). The warrants were accounted for as derivative liabilities (see Note 4).
During the year ended
December 31, 2016, the Company cancelled 200,000 previously awarded but unvested unregistered shares of the Company’s common
stock issued to an employee of the Company when the employee resigned. This resulted in the reversal of previously recognized
compensation expense of $1,145 during the year ended December 31, 2016.
During the year ended
December 31, 2016, the Company granted 18,250,000 unregistered shares of its common stock pursuant to restricted stock agreements.
Shares under restricted stock agreements typically vest over a period of 1-3 years in various installments and the fair value
of the awards is being expensed over the vesting periods. The aggregate fair market value of the awards was determined to be $361,365.
Stock compensation expense of $229,223 has been recorded for the year ended December 31, 2016 as additional paid-in capital.
Stock compensation
expense for the amortization of restricted stock awards for VCSY stock was $229,223 for the year ended December 31, 2016. As of
December 31, 2016, there were 13,125,000 shares of unvested VCSY common stock compensation awards to employees and consultants.
During the year ended
December 31, 2016, 7,175,000 VCSY common shares issued under restricted stock agreements to employees of the Company were vested.
During the year ended December 31, 2016, the Company granted 150,000 shares of the common stock of Ploinks,
Inc. to third party lenders in connection with 6-month extensions of convertible debentures in the principal amount of $500,000
issued in 2015. The aggregate fair market value of the awards was determined to be $16,200 and was recorded as debt discount and
amortized through the term of the note.
During the year ended
December 31, 2016, Ploinks, Inc. granted 1,000,000 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 3 years in various installments
and the fair value of the awards is being expensed over this vesting period. The aggregate fair market value of the awards was
determined to be $108,000. Stock compensation expense of $70,800 has been recorded for the year ended December 31, 2016.
During the year ended
December 31, 2016, the Company granted 4,286,000 unregistered shares of the common stock of Ploinks, Inc. to employees and consultants
of the Company and its subsidiaries pursuant to restricted stock agreements with the Company. These shares typically vest over
3 years in various installments and the fair value of the awards is being expensed over this vesting period. The aggregate fair
market value of the awards was determined to be $462,888. Stock compensation expense of $264,227 has been recorded for the year
ended December 31, 2016. These shares were issued out of shares owned by VCSY.
During the year ended
December 31, 2016, 2,332,001 unregistered shares of the common stock of Ploinks, Inc. to employees and consultants of the Company
and its subsidiaries granted under restricted stock agreement vested.
During the year ended
December 31, 2016, 133,334 unregistered shares of the common stock of Ploinks, Inc. granted to an employee of the Company under
a restricted stock agreement were cancelled.
In September 2017,
the Company entered into an agreement to purchase a 10% ownership interest in Priority Times Systems, Inc. from a former employee
of the Company and its subsidiaries. The purchase price consisted of 1,000,000 unregistered shares of VCSY common stock with the
Rule 144 restrictive legend issued to the seller and $62,500 in cash payments due in equal installments over a three-month period.
The aggregate fair market value of the VCSY common stock grant was determined to be $12,800 on the quoted market price of VCSY
stock at date of grant.
In December 2017,
in order to facilitate the amendment of the Lakeshore Loan Agreement and the Lakeshore Note, which resulted in the curing any
existing defaults under the Lakeshore Loan Agreement and the Lakeshore Note as well as the release by Lakeshore of the security
interests in the SiteFlash assets and the assets of SnAPPnet and Priority Time which secured the Lakeshore Note, the Company issued
2,500,000 VCSY common shares at a fair market value of $35,400 and 300,000 Ploinks common shares at a fair market value of $92,850
to third party purchasers of 600,000 shares of VHS Series A Preferred Stock from a member of Lakeshore. For additional details
concerning the amendment of the Lakeshore Loan and the Lakeshore Note, please see the “Lakeshore Financing” subsection
under “Notes Payable and Convertible Debts” of Note 8.
During the year ended
December 31, 2017, the Company granted 1,700,000 unregistered shares of its common stock with the Rule 144 restrictive legend
and 230,000 shares of Ploinks, Inc. common stock to consultants of the Company and its subsidiaries pursuant to consulting agreements
with the Company. The aggregate fair market value of the VCSY common stock grant was determined to be $21,060 based on the quoted
market price of VCSY stock at date of grant and Ploinks, Inc. common stock grant was determined to be $71,185 based on a third-party
valuation of Ploinks stock. In addition, the Company agreed to issue up to a total of 4,000,000 common shares of the Company and
up to a total of 500,000 shares of Ploinks, Inc. common stock pursuant to restricted performance stock agreements with the consultants.
These shares may vest over a term of 3 years and are based upon the respective consultant achieving certain performance criteria.
During the year ended
December 31, 2017, the Company issued convertible debentures in the principal amount of $110,000 to third party lenders for loans
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 1,100,000 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 1,100,000 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 $12,292 and $5,098 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.
During the year ended December 31, 2017, the Company entered into subscription agreements under which a third-party
subscriber purchased 1,300 shares of VCSY Series A Preferred Stock for $260,000. In connection with the purchase of the VCSY Series
A Preferred Stock, the subscribers also received a total of 2,600,000 shares of common stock of the Company with the Rule 144 restrictive
legend, 130,000 shares of common stock of Ploinks, Inc., 2-year warrants under which the subscribers may purchase an aggregate
total of 195,000 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 195,000 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 $188,686. 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 $30,505. The allocated fair market
value of all common shares of Ploinks, Inc. issued to the subscribers was $40,235. The fair market value of all warrants issued
to the subscribers was $574 (which was calculated using the Black-Sholes model). The warrants were accounted for as derivative
liabilities (see Note 4).
During the year ended December 31, 2017, the Company granted a total of 651,700 shares of the common stock
of Ploinks, Inc. to third party lenders in connection with a series of 3 and 6-month extensions of convertible debentures in the
aggregated principal amount of $1,200,000 issued in 2015 and 2016. The aggregate fair market value of the awards was determined
to be $142,156 and was recorded as debt discount and is being amortized through the term of the convertible debenture. Certain
notes issued in the prior year(s) become convertible during 2017. Consequently, the embedded conversion feature was determined
to be derivative liabilities, and the Company recognized a derivative debt discount.
During the year ended
December 31, 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 year ended
December 31, 2017, the Company entered into restricted stock agreements to grant a total of 180,000 shares of the Company’s
common stock with the Rule 144 restrictive legend with employees of the Company under which the shares vest in equal installments
over a 30-month period. The fair value of the shares was $2,982 based on the quoted market price of VCSY stock on the grant date
and $1,006 was amortized to expense during the year ended December 31, 2017.
During the year ended December
31, 2017, 3,665,000 VCSY common shares vested under restricted stock agreements to employees and two consultants of the
Company.
During the year ended
December 31, 2017, 3,000,000 VCSY common shares were issued to an employee of the Company. The fair market value of the shares
was $72,000.
During the year ended
December 31, 2017, Ploinks, Inc. entered into restricted stock agreements to grant 90,000 unregistered shares of the common stock
of Ploinks, Inc. to employees 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 $15,765 based on a third-party valuation of Ploinks stock.
During the year ended
December 31, 2017, Ploinks, Inc. entered into restricted stock agreements to grant 230,000 unregistered shares of the common stock
of Ploinks, Inc. to consultants of the Company pursuant to a restricted stock agreement with Ploinks, Inc. The fair value of the
shares was $71,185 based on a third-party valuation of Ploinks stock.
During the year ended
December 31, 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.
During the year ended December
31, 2017 $27,482 was amortized to expense related to the issuance of Ploinks, Inc. restricted stock.
During the year ended
December 31, 2017, 810,001 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 $116,180 for the year ended December 31, 2017. As of December 31,
2017, there were 6,140,000 shares of unvested stock compensation awards to employees and 15,500,000 shares of unvested
stock compensation awards to non-employees.
During the period that
runs from January 1, 2018 through May 10, 2018, the Company extended the term of certain warrants to purchase a total of
5,400,000 shares of VCSY common stock (at $0.10 per share) for an additional 1-year period and granted 83,200 shares of the common
stock of Ploinks, Inc. to third-party lenders in connection with 3 and 6-month extensions of convertible debentures in the principal
amount of $540,000 that were issued in 2015 and 2016.
During the period that runs from January 1, 2018 through May 10, 2018, 320,000 shares of VCSY common
stock issued to employees of the Company vested.
During the period that
runs from January 1, 2018 through May 10, 2018, 209,998 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.
Item
6. Selected Financial Data
Not applicable.
Item
7. 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 our results of operations, liquidity and
capital resources. The following discussion and analysis should be read together with the Consolidated Financial Statements and
Notes of Vertical Computer Systems, Inc. and its subsidiaries included in Item 8 of this Report, and the cautionary statements
and risk factors included in Item 1A 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 year ended December 31, 2017 and 2016, $0 and $246,184 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 a third party to provide new and existing customers with a hosting facility providing all infrastructure
and allowing us to offer our currently sold software, emPath®, 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 require 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 issued and
the quoted price of our common stock. See Note 10 of the Consolidated Financial Statements for a further discussion of stock-based
compensation.
Valuation of the
Embedded and Warrant Derivatives
The valuation of our
embedded derivatives is determined by using the Black-Scholes Option Pricing Model. 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
In February 2016, the FASB issued ASU No.
2016-02,” Leases” (Topic 842) which includes a lessee accounting model that recognizes two types of leases - finance
leases and operating leases. The standard requires that a lessee recognize on the balance sheet assets and liabilities for leases
with lease terms of more than 12 months. The recognition, measurement, and presentation of expenses and cash flows arising from
a lease by a lessee will depend on its classification as a finance or an operating lease. New disclosures to help investors and
other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases are also
required. These disclosures include qualitative and quantitative requirements, providing information about the amounts recorded
in the financial statements. ASU 2016-02 will be effective for fiscal years beginning after December 15, 2018, including interim
periods within those fiscal years. The Company is currently evaluating the effect its adoption of this standard, if any, on our
consolidated financial position, results of operations or cash flows.
In May 2016, the FASB
issued ASU No. 2016-12,
“
Revenue from Contracts with Customers
(Topic 606): Narrow-Scope Improvements and Practical Expedients
”
,
to clarify certain core recognition principles including collectability, sales tax presentation, noncash consideration, contract
modifications and completed contracts at transition and disclosures no longer required if the full retrospective transition method
is adopted. The effective date and transition requirements for these amendments are for annual reporting periods beginning after
December 15, 2017, including interim reporting periods therein, and that would also permit public entities to elect to adopt the
amendments as of the original effective date as applicable to reporting periods beginning after December 15, 2016. The new guidance
allows for the amendment to be applied either retrospectively to each prior reporting period presented or retrospectively as a
cumulative-effect adjustment as of the date of adoption. The Company adopted the standard on January 1, 2018 and does not anticipate
this amendment will have a material impact on its consolidated financial statements.
In May 2017, the FASB
issued ASU No. 2017-09, “Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting”, to provide
clarity and reduce both (1) diversity in practice and (2) cost and complexity when applying the guidance in Topic 718, Compensation—Stock
Compensation, to a change to the terms or conditions of a share-based payment award. The ASU provides guidance about which changes
to the terms or conditions of a share-based payment award require an entity to apply modification accounting in ASC 718. The amendments
are effective for fiscal years beginning after December15, 2017 and should be applied prospectively to an award modified on or
after the adoption date. Early adoption is permitted, including adoption in an interim period. The Company adopted the standard
on January 1, 2018 and does not anticipate this amendment will have a material impact on its consolidated financial statements.
In July 2017, the
FASB issued ASU No. 2017-11, “Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480);
Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part
II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and
Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception”. The ASU was issued to address the
complexity associated with applying generally accepted accounting principles (GAAP) for certain financial instruments with
characteristics of liabilities and equity. The ASU, among other things, eliminates the need to consider the effects of down
round features when analyzing convertible debt, warrants and other financing instruments. As a result, a freestanding
equity-linked financial instrument (or embedded conversion option) no longer would be accounted for as a derivative liability
at fair value as a result of the existence of a down round feature. The amendments are effective for fiscal years beginning
after December 15, 2018 and should be applied retrospectively. Early adoption is permitted, including adoption in an interim
period. The Company is currently evaluating the effect its adoption of this standard, if any, on our consolidated financial
position, results of operations or cash flows.
Results of Operations
Year ended December 31, 2017 Compared
To Year Ended December 31, 2016
Total Revenues.
We had total revenues of $3,770,326 and $3,827,675 for the years ended December 31, 2017 and 2016, respectively. The decrease
in total revenue was $57,349 for the year ended December 31, 2017, representing a 1.5% decrease compared to the total revenue
for the year ended December 31, 2016. The decrease in revenue was primarily due to a $97,331 decrease in software maintenance,
a $65,174 decrease in cloud-based offering somewhat offset by a $114,259 increase in consulting services. Of the $3,770,326 and
$3,827,675 total revenues for the years ended December 31, 2017 and 2016, respectively, $3,732,608 and $3,768,420 of such amounts
were related to the business operations of NOW Solutions, a 75% owned subsidiary of the Company.
The revenues from
licenses and software consist of fees we bill for NOW Solutions’ new payroll and human resources (“
PRHR
”)
software licenses. These fees decreased $18,479 for the year ended December 31, 2017 compared to the year ended December 31, 2016.
Software maintenance
revenue is generated from existing customers of our PRHR software who want the continued benefit of tax updates, customer support,
and software enhancements. Software maintenance revenue decreased by $97,331 or 3.0% from the year ended December 31, 2016 to
the same period in 2017. The decrease was due to the loss of customer contracts somewhat offset by the effect of favorable currency
exchange rates on our Canadian maintenance revenue.
Consulting revenue
for the year ended December 31, 2017 increased by $114,259 from the same period in the prior year, representing a 40.6% increase.
This increase was primarily due to a rise in Canadian customer needs for software upgrade implementation and customization and
the effect of favorable currency exchange rates on our Canadian consulting revenue in 2017.
Cloud-based revenue
decreased $65,174 or 23.3% for the year ended December 31, 2017 compared to the same period in 2016. The decrease was primarily
related to user base adjustments for our Canadian cloud-based customers.
Other revenues,
consisting primarily of reimbursable travel expenses, increased by $9,376 or 75.0% for the year ended December 31, 2017 compared
to the same period for 2016. The increase was mainly attributable to higher reimbursable travel in 2017 due to increased consultant
travel.
Cost of Revenues.
We had direct costs associated with the above revenues of $1,574,645 for the year ended December 31, 2017 compared to
$1,524,853 for the same period of 2016, representing an increase of $49,792 or 3.3%. These direct costs are primarily related
to costs providing customer support, professional services, software upgrades and enhancements. The increase in direct costs is
primarily related to increased payroll and hosting fees for the year ended December 31, 2017 compared to the same period for 2016.
Selling, General
and Administrative
Expenses.
We had selling,
general and administrative expenses of $4,311,088 and $3,871,572 for the years ended December 31, 2017 and 2016, respectively.
The total selling, general and administrative expenses for the year ended December 31, 2017 increased by $439,516 compared
to the selling, general and administrative expenses for the year ended December 31, 2016, representing an 11.4% increase.
The increase was primarily due to increases in salaries and benefits (as we did not capitalize salaries in 2017 vs 6 months of
capitalized salaries in 2016) and penalties partially offset by decreases in consulting expenses, non-cash stock compensation
and legal fees.
Depreciation
and Amortization
. We had depreciation and amortization of $1,453 for 2017 compared to $1,083 in 2016. The increase is
due to depreciation on computer equipment purchased in 2017.
Bad Debt Expense
.
We had bad debt expense of $93,757 for 2017 compared to $98,896 in 2016. The 2017 and 2016 expenses were related to a reserve
for several customer accounts greater than 90 days past due.
Impairment
of Software Costs.
For the year ended December 31, 2016, $1,421,155 of capitalized software development costs related
to Ploinks development was written off as impaired.
Operating
Loss.
We had an operating loss of $2,210,617
for the year ended December 31, 2017 compared to operating loss of $3,089,884 for the year ended December 31, 2016, a difference
of $879,267. The decrease in operating loss between 2017 and 2016 is primarily a result the impairment of Ploinks
®
development costs in 2016 partially offset by increased selling, general and administrative expenses.
Gain/loss on
Derivative Liability.
Derivative liabilities are adjusted each quarter for changes in the market value of the Company’s
common stock, common stock warrants, and convertible debentures. Market value for common stock warrants and convertible debentures
is determined using the Black-Scholes Model. The gain on derivative liability was $879,780 for the year ended December 31, 2017
compared to a loss on derivative liability of $268,728 for the year ended December 31, 2016.
Interest Expense
.
We had interest expense of $1,819,147 and $1,998,762
for the years ended December 31, 2017 and 2016, respectively. Interest expense decreased for the year ended December 31, 2017
by $179,615, representing a 9.0% decrease compared to interest expense for the year ended December 31, 2016. The
decrease was primarily due to fully amortized debt discounts related to convertible debentures.
Interest Income.
Interest income for the year ended December 31, 2017 was $21 compared to $53 for the year ended December 31, 2016.
Forbearance
Fees
. Forbearance fees relate to fees charged by our lenders on loans in default. Forbearance fees for the year ended
December 31, 2017 were $12,000 compared to $58,500 for the same period in 2016. Forbearance fees for 2017 related a lender of
Vertical Healthcare Solutions. Forbearance fees for 2016 related to lenders of VCSY and NOW Solutions.
Gain/Loss on Extinguishment
of Debt.
For the year ended December 31, 2017, we had a $128,250 loss on extinguishment of debt. The loss relates
to the fair market value of VCSY and Ploinks’ stock issued to third-party investors as incentive to purchase
Vertical Healthcare Solutions preferred stock from NOW Solutions senior secured lender. For the year ended December 31, 2016,
we had a gain of $35,969. The gain relates to the fair market value of 5 million shares of VCSY common stock issued to a NOW Solutions
lender to settle a portion of debt principal.
Net Loss before
Income Tax Expense.
We had a net loss before income tax expense of $3,290,213 for the year ended December 31, 2017
compared to a net loss of $5,379,852 for the year ended December 31, 2016. The net loss before income tax expense for 2017 was
primarily due to an operating loss of $2,210,617 increased by $12,000 of forbearance fees, loss on debt extinguishment of
$128,250 and interest expense of $1,819,147, partially reduced by a gain on derivative liabilities of $879,780. The net
loss before income tax expense for 2016 was primarily due to an operating loss of $3,089,884 increased by $58,500 of forbearance
fees, loss on derivative liabilities of $268,728 and interest expense of $1,998,762.
Income Tax Expense/Benefit
.
We had income tax expense of $11,876 and $86,378 for the year ended December 31, 2017 and 2016, respectively. Income taxes
expense for both years relates to NOW Solutions, a 75% owned subsidiary of the Company.
Dividend Applicable
to Preferred Stock.
The Company has outstanding Series A 4% Convertible Cumulative Preferred Stock that accrue dividends
(if such dividends are declared) at a rate of 4% on a semi-annual basis. The Company also has outstanding Series C 4% Convertible
Cumulative Preferred Stock that accrue dividends (if such dividends are declared) at a rate of 4% on a quarterly basis. For the
years ended December 31, 2017 and 2016, the total dividends applicable to Series A and Series C Preferred Stock (from prior years)
were $616,667 and $592,472, respectively. The Company did not declare or pay any dividends in 2017 or 2016.
Net Loss Applicable
to Common Stockholders.
We had net loss
attributed to common stockholders of $3,686,908 and $5,870,223 for the years ended December 31, 2017 and 2016, respectively.
Net loss applicable to common stockholders for the year ended December 31, 2017 decreased by $2,183,315 compared to December
31, 2016. The net loss applicable to common stockholders was due to the combination of factors described above.
Net Loss Per
Share.
The Company had a net loss per share of $0.00 and $0.01 for the years ended December 31, 2017 and 2016, respectively.
Financial Condition, Liquidity, Capital
Resources and Recent Developments
At December 31, 2017,
we had non-restricted cash-on-hand of $62,084 compared to $190,448 at December 31, 2016.
Net cash used in operating activities for the year ended December 31, 2017 was $685,677 compared to
net cash used in operating activities of $486,755 for the year ended December 31, 2016.
The majority of 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. During 2017, our deferred maintenance revenue (a liability)
decreased slightly from $1,794,264 to $1,752,421. The decrease was primarily due to a decrease in deferred revenue for non-renewal
of maintenance for certain US customers partially offset by an increase in Canadian deferred revenue due to currency exchange
rates.
Our accounts receivable
decreased from $367,278 at December 31, 2016 to $349,002 at December 31, 2017 (net of allowance for bad debts). The
decrease in receivables of $18,276 was primarily due to faster collections on Canadian receivables.
Accounts payable, accounts
payable to related parties and accrued liabilities increased from $12,214,844 at December 31, 2016 to $14,271,154 at
December 31, 2017. The increase of $2,056,310 was primarily related to an increase in accounts payable, accrued payroll,
accrued payroll taxes/penalties and accrued interest on notes payable. The balance in accounts payable and accrued liabilities
is approximately 40.9 times the balance in accounts receivable. This is one of the reasons we do not have sufficient funds
available to fund our operations and repay our debt obligations under their existing terms, as described below.
Net cash used in investing
activities for the year ended December 31, 2017 was $5,568 consisting of the purchase of computer equipment. Net cash used in
investing activities for the year ended December 31, 2016 was $249,989 consisting of the development of software products and
purchase of computer equipment.
Net cash provided by financing activities for the year ended December 31, 2017 was $580,795 consisting of
borrowings on notes payable of $370,500, borrowings on convertible debentures of $110,000 and issuance of stock subscriptions of
$260,000 partially offset by repayments on notes payable of $159,705. Net cash provided by financing activities for the
year ended December 31, 2016 was $1,076,249 consisting of borrowings on notes payable of $170,000, borrowings on convertible debentures
of $715,000 and issuance of stock subscriptions of $600,000 somewhat offset by repayments on notes payable of $113,699, dividends
paid to non-controlling subsidiary shareholders of $295,000 and a decrease in back overdrafts of $52.
The total change in
cash and cash equivalents for the year ended December 31, 2017 when compared to the year ended December 31, 2016 was a decrease
of $128,364.
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, increasing sales of our products and services and/or succeed in licensing our intellectual property.
Our inability to raise such funds or renegotiate the terms of our existing debt will significantly jeopardize our ability to continue
operations.
Contractual Obligations and Commercial
Commitments
As of December 31,
2017, the following contractual obligations and commercial commitments were outstanding:
|
|
Balance at
|
|
|
Due in Next Five Years
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contractual Obligations
|
|
12/31/17
|
|
|
2018
|
|
|
2019
|
|
|
2020
|
|
|
2021
|
|
|
2022+
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notes payable
|
|
$
|
6,142,085
|
|
|
$
|
3,983,945
|
|
|
$
|
148,722
|
|
|
$
|
165,932
|
|
|
$
|
185,134
|
|
|
$
|
1,658,352
|
|
Convertible debts
|
|
|
1,340,000
|
|
|
|
1,340,000
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Operating lease
|
|
|
77,918
|
|
|
|
65,250
|
|
|
|
8,445
|
|
|
|
4,223
|
|
|
|
—
|
|
|
|
—
|
|
Total
|
|
$
|
7,560,003
|
|
|
$
|
5,389,195
|
|
|
$
|
157,167
|
|
|
$
|
170,155
|
|
|
$
|
185,134
|
|
|
$
|
1,658,352
|
|
Of the above notes payable, the default status is as follows:
|
|
2017
|
|
|
2016
|
|
In default
|
|
$
|
3,390,190
|
|
|
$
|
4,901,950
|
|
Not in default
|
|
|
4,091,895
|
|
|
|
1,614,222
|
|
Total Notes Payable
|
|
$
|
7,482,085
|
|
|
$
|
6,516,172
|
|
Going Concern Uncertainty
We had a net loss before non-controlling interest of $3,302,089 and $5,466,230 for the years ended
December 31, 2017 and 2016, respectively, and have historically incurred losses. In addition, we had a working capital deficit
of approximately $21.0 million at December 31, 2017. The foregoing raises substantial doubt about our ability to continue
as a going concern.
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.
Furthermore, we are
exploring certain opportunities with a number of companies to participate in co-marketing of each other’s products. We are
proceeding to license our intellectual property to third parties. The exact results of our opportunities to license our intellectual
property to other parties are unknown at this time.
Off-Balance Sheet Arrangements.
None.
Item
7A. Quantitative and Qualitative Disclosures About Market Risk
None.
Item
8. Financial Statements and Supplementary Data
Please refer to the
Audited Consolidated Financial Statements of the Company and its subsidiaries for the fiscal years ended December 31, 2017 and
2016, which are attached to this Report.
Item
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
Item
9A. Controls and Procedures
Evaluation of
Disclosure 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. In particular, we have identified the material weaknesses described below.
Management’s
Annual Report on Internal Control over Financial Reporting
Our management is
responsible for establishing and maintaining disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under
the Exchange Act for the Company.
In order to ensure
whether our internal control over financial reporting is effective, management has assessed such controls for its financial reporting
as of December 31, 2016. This assessment was based on criteria for effective internal control over financial reporting described
in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission
(“COSO”).
In performing this
assessment, management has identified the following material weaknesses as of December 31, 2017:
|
●
|
There is an over-reliance
upon independent financial reporting consultants for review of critical accounting areas
and disclosures and material non-standard transactions.
|
|
●
|
There is a lack of sufficient
accounting staff due to the size of the Company which results in a lack of segregation
of duties necessary for a good system of internal control.
|
|
●
|
There is a lack of control
procedures that include multiple levels of supervision and review. Certain parts of the
work of our chief financial officer are not monitored or reviewed.
|
|
●
|
Consolidation and currency
translations are performed manually.
|
The absence of adequate segregation
of duties may have an effect on the systems which we use in the evaluating and processing of certain accounts and areas and in
the posting and recording of journal entries into certain accounts, as described below:
|
○
|
Although
we implemented a new accounting system effective January 1, 2009 that allows for the
consolidation of the various entities in Vertical Computer Systems along with the translation
from local currency to reporting currency, the system needs to be refined in order to
perform currency translations accurately. As a result, we continue to performing our
consolidation and currency translations manually. This will be remediated once funds
become available to effectively implement needed system changes.
|
|
○
|
Improving
the control and oversight of the duties relating to the systems we use in the evaluation
and processing of certain accounts and areas in the posting and recording of journal
entries into certain accounts (in which material weaknesses have been identified as described
above). This improvement should include reviews by management of the accounting
processes as well as a reorganization of some of the accounting functions. In January
2010, we contracted with a consulting firm to assess our internal controls over financial
reporting and propose improvements that can be implemented given our size and number
of employees. The company has not yet implemented these improvements in their entirety
as of the filing of this report due to employee turnover and resource limitations.
|
|
○
|
Improving
the segregation of duties relating to the processing of accounts and the recording of
journal entries into certain accounts. The company has recently increased the size of
its accounting staff which will allow for needed segregation of duties within the organization.
As of the date of this report, the company is evaluating and reorganizing the duties
of its accounting staff in order to address this internal control weakness.
|
As a result of these material weaknesses in our internal control over financial reporting, our management
concluded that our internal control over financial reporting as of December 31, 2017 was not effective based on the criteria
set forth by COSO in Internal Control – Integrated Framework. A material weakness in internal control over financial reporting
is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable
possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or
detected on a timely basis.
Management’s
Plan for Remediation of Material Weaknesses
In light of the conclusion
that our internal control over financial reporting was not effective, our management is in the process of implementing a plan
intended to remediate such ineffectiveness and to strengthen our internal controls over financial reporting through the implementation
of certain remedial measures, which include:
|
○
|
We
have implemented a new accounting system effective January 1, 2009 that allows for the
consolidation of the various entities in Vertical Computer Systems along with the translation
from local currency to reporting currency. Although the system eliminates many of the
manual steps in translation and consolidation, many of the steps continue to be manual.
This system also allows for some automation for recording software maintenance revenue
and the recording of the deferred revenue liability account. This automation improves
the accuracy of these accounts and is no longer considered a material weakness.
|
|
○
|
Improving
the control and oversight of the duties relating to the systems we use in the evaluation
and processing of certain accounts and areas in the posting and recording of journal
entries into certain accounts (in which material weaknesses have been identified as described
above). This improvement should include reviews by management of the accounting processes
as well as a reorganization of some of the accounting functions. In January 2010, we
contracted with a consulting firm to assess our internal controls over financial reporting
and propose improvements that can be implemented given our size and number of employees.
|
|
○
|
Improving
the segregation of duties relating to the processing of accounts and the recording of
journal entries into certain accounts. This improvement is expected to come based on
recommendations from the consulting firm assessing our internal controls over financial
reporting.
|
This annual report
does not include an attestation report of our public accounting firm regarding internal control over financial reporting. Management’s
report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the Securities and
Exchange Commission that permit us to provide only management’s report in this annual report.
Item
9B. Other Information
None.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Note
1. Organization, Basis of Presentation and Significant Accounting Policies
Nature
of Business
Vertical
Computer Systems, Inc. was incorporated in Delaware in March 1992. We are a multinational provider of application software, software
services, Internet core technologies, and derivative software application products through our distribution network. Our business
model combines complementary, integrated software products, internet core technologies, and a multinational distribution system
of partners, in order to create a distribution matrix that is capable of penetrating multiple sectors through cross selling our
products and services. We operate one business segment.
Basis
of Presentation
The
consolidated financial statements include the accounts of the Company and its subsidiaries (collectively, “our”, “we”,
the “Company,” “Vertical”, 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”), an 80% owned subsidiary, Ploinks, Inc. (“Ploinks”),
an 88% 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. To date,
we have generated revenues primarily from software licenses, software as a service, consulting fees and maintenance agreements
from NOW Solutions and SnAPPnet and patent licenses from Vertical Computer Systems, the parent company.
Principles
of Consolidation
The
consolidated financial statements include the accounts of the Company and its subsidiaries. Equity investments in which we exercise
significant influence, but do not control and are not the primary beneficiary, are accounted for using the equity method of accounting.
Investments in which we do not exercise significant influence over the investee are accounted for using the cost method of accounting.
All intercompany accounts and transactions have been eliminated. We currently have no investments accounted for using the equity
or cost methods of accounting.
Cash
and Cash Equivalents
Cash
equivalents are highly liquid investments with an original maturity of three months or less.
Revenue
Recognition
Our
revenue recognition policies are in accordance with standards on software revenue recognition, which includes 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 those. 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 a third party to provide new and existing customers with a hosting facility 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 a cloud-based offering.
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 our cloud-based offering can enter into an agreement to purchase a software license at any time. We generate
revenue from our cloud-based offering as the customer utilizes the software over the Internet.
We
will provide consulting services to customers in conjunction with our 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 our cloud-based offering, are charged a fee equal to the number of employees paid each month multiplied
by an agreed-upon monthly rate per employee. The revenue is recognized as the cloud-based offering services are rendered each
month.
Concentration
of Credit Risk
We maintain our cash in bank deposit
accounts, which, at times, may exceed federally insured limits. We have not experienced any such losses in these accounts. Substantially
all of our revenue was derived from recurring maintenance fees related to our payroll processing software. The company’s
revenue consists of 63% in Canada and 37% in the US. Receivables arising from sales of the Company’s products are not collateralized.
As of December 31, 2017, three customers represented approximately 91% (42%, 37%, and 12%) of accounts receivable. As of December
31, 2016, two customers represented approximately 71% (40% and 31%) of accounts receivable.
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.
For
the year ended December 31, 2017 and 2016, the company capitalized $0 and $246,184, respectively of software development costs
related to its Ploinks subsidiary. During 2016, the company recorded an impairment loss of $1,421,155 related to software development
cost.
Property
and Equipment
Property
and equipment are stated at cost. Depreciation is computed primarily utilizing the straight-line method over the estimated economic
life of three to five years. Maintenance, repairs and minor renewals are charged directly to expenses as incurred. Additions and
betterment to property and equipment are capitalized. When assets are disposed of, the related cost and accumulated depreciation
thereon are removed from the accounts and any resulting gain or loss is included in the statement of operations.
Impairment
of Long-Lived Assets
Long-lived
assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable through the estimated undiscounted cash flows expected to result from the use and eventual disposition of the
assets. Whenever any such impairment exists, an impairment loss will be recognized for the amount by which the carrying value
exceeds the fair value. During 2016, the company recorded an impairment loss of $1,421,155 related to software development cost.
Stock-based
Compensation
We
account for share-based compensation in accordance with the provisions of share-based payments, which requires measurement of
compensation cost for all stock-based awards at fair value on date of grant and recognition of compensation over the service period
for awards expected to vest. The fair value of restricted stock and restricted stock units is determined based on the number of
shares granted and the quoted price of our common stock. Equity instruments issued to other than employees are valued at the earlier
of a commitment date or upon completion of the services, based on the fair value of the equity instruments, and are recognized
as expense over the service period.
Allowance
for Doubtful Accounts
We
establish an allowance for bad debts through a review of several factors including historical collection experience, current aging
status of the customer accounts, and financial condition of our customers. We do not generally require collateral for our accounts
receivable. Our allowance for doubtful accounts was $234,439 and $139,705 as of December 31, 2017 and 2016, respectively.
Income
Taxes
We
provide for income taxes in accordance with the asset and liability method of accounting for income taxes.
Under
the asset and liability method, deferred income taxes are recognized for the tax consequences of “temporary differences”
by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts
and the tax basis of existing assets and liabilities. A valuation allowance is provided when management cannot determine whether
it is more likely than not the deferred tax asset will be realized. The effect on deferred income taxes of a change in tax rates
is recognized in income in the period that includes the enactment date.
Since
January 1, 2007, we account for uncertain tax positions in accordance with the authoritative guidance issued by the Financial
Accounting Standards Board (“FASB”) on income taxes which addresses how we should recognize, measure and present in
our financial statements uncertain tax positions that have been taken or are expected to be taken in a tax return. Pursuant to
this guidance, we can recognize a tax benefit only if it is “more likely than not” that a particular tax position
will be sustained upon examination or audit. To the extent the “more likely than not” standard has been satisfied,
the benefit associated with a tax position is measured as the largest amount that is greater than 50% likely of being realized
upon settlement. No asset for unrecognized tax benefits was recorded as of December 31, 2017 and 2016.
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.
The
following represents a reconciliation of the numerators and denominators of the basic and diluted earnings per share computation:
|
|
Year Ended December 31, 2017
|
|
|
Year Ended December 31, 2016
|
|
|
|
Net Loss
Applicable to
Common
Stockholders
(Numerator)
|
|
|
Shares
(Denominator)
|
|
|
Per Share
Amount
|
|
|
Net Loss
Applicable to
Common
Stockholders
(Numerator)
|
|
|
Shares
(Denominator)
|
|
|
Per Share
Amount
|
|
Basic and Diluted EPS
|
|
$
|
(3,686,908
|
)
|
|
|
1,137,125,217
|
|
|
$
|
(0.00
|
)
|
|
$
|
(5,870,223
|
)
|
|
|
1,106,272,758
|
|
|
$
|
(0.01
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
of December 31, 2017 and 2016, common stock equivalents related to the convertible debt, preferred stock and stock derivative
liabilities were not included in the denominators of the diluted earnings per share as their effect would be anti-dilutive.
Fair
Value of Financial Instruments
For
certain of our financial instruments, including cash, accounts receivable, short term debt and accrued expenses, the carrying
amounts approximate fair value due to the short maturity of these instruments. The carrying value of our long-term debt approximates
its fair value based on the quoted market prices for the same or similar issues or the current rates offered to us for debt of
the same remaining maturities. For additional information, please see Note 4 – Derivative Liabilities and Fair Value Measurements.
Use
of Estimates
The
preparation of financial statements in conformity with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure
of contingent assets and liabilities at the date of financial statements and the reported amounts of revenue and expenses during
the reporting period. Among the more significant estimates included in these financial statements are the estimated allowance
for doubtful accounts receivable, valuation allowance for deferred tax assets, impairment of long-lived assets and intangible
and the valuation of warrants and restricted stock grants. Actual results could materially differ from those estimates.
Cash
Reimbursements
We
record reimbursement by our customers for out-of-pocket expense as part of consulting services revenue in accordance with the
guidance related to income statement characterization of reimbursements received for out of pocket expense incurred.
Reclassifications
Certain
reclassifications have been made to the prior periods to conform to the current period presentation.
Recently
Issued Accounting Pronouncements
In February 2016, the FASB issued ASU
No. 2016-02,” Leases” (Topic 842) which includes a lessee accounting model that recognizes two types of leases - finance
leases and operating leases. The standard requires that a lessee recognize on the balance sheet assets and liabilities for leases
with lease terms of more than 12 months. The recognition, measurement, and presentation of expenses and cash flows arising from
a lease by a lessee will depend on its classification as a finance or an operating lease. New disclosures to help investors and
other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases are also
required. These disclosures include qualitative and quantitative requirements, providing information about the amounts recorded
in the financial statements. ASU 2016-02 will be effective for fiscal years beginning after December 15, 2018, including interim
periods within those fiscal years. The Company is currently evaluating the effect its adoption of this standard, if any, on our
consolidated financial position, results of operations or cash flows.
In May 2016, the FASB issued ASU No. 2016-12,
“Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients”, to clarify
certain core recognition principles including collectability, sales tax presentation, noncash consideration, contract modifications
and completed contracts at transition and disclosures no longer required if the full retrospective transition method is adopted.
The effective date and transition requirements for these amendments are for annual reporting periods beginning after December
15, 2017, including interim reporting periods therein, and that would also permit public entities to elect to adopt the amendments
as of the original effective date as applicable to reporting periods beginning after December 15, 2016. The new guidance allows
for the amendment to be applied either retrospectively to each prior reporting period presented or retrospectively as a cumulative-effect
adjustment as of the date of adoption. The Company adopted the standard on January 1, 2018 and does not anticipate this amendment
will have a material impact on its consolidated financial statements.
In May 2017, the FASB issued ASU No. 2017-09,
“Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting”, to provide clarity and reduce
both (1) diversity in practice and (2) cost and complexity when applying the guidance in Topic 718, Compensation—Stock Compensation,
to a change to the terms or conditions of a share-based payment award. The ASU provides guidance about which changes to the terms
or conditions of a share-based payment award require an entity to apply modification accounting in ASC 718. The amendments are
effective for fiscal years beginning after December15, 2017 and should be applied prospectively to an award modified on or after
the adoption date. Early adoption is permitted, including adoption in an interim period. The Company adopted the standard on January
1, 2018 and does not anticipate this amendment will have a material impact on its consolidated financial statements.
In July 2017, the FASB issued ASU No.
2017-11, “Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic
815): (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite
Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling
Interests with a Scope Exception”. The ASU was issued to address the complexity associated with applying generally accepted
accounting principles (GAAP) for certain financial instruments with characteristics of liabilities and equity. The ASU, among
other things, eliminates the need to consider the effects of down round features when analyzing convertible debt, warrants and
other financing instruments. As a result, a freestanding equity-linked financial instrument (or embedded conversion option) no
longer would be accounted for as a derivative liability at fair value as a result of the existence of a down round feature. The
amendments are effective for fiscal years beginning after December 15, 2018 and should be applied retrospectively. Early adoption
is permitted, including adoption in an interim period. The Company is currently evaluating the effect its adoption of this standard,
if any, on our consolidated financial position, results of operations or cash flows.
Note
2. Going Concern Uncertainty
The
accompanying consolidated financial statements for 2017 and 2016 have been prepared assuming that the Company will continue as
a going concern, which contemplates the realization of assets and the satisfaction of 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 December 31, 2017, the Company had negative working capital of approximately $21.0 million and defaulted
on several of its debt obligations. The company also incurred net losses in 2017 and 2016. These conditions raise substantial
doubt about the Company’s ability to continue as a going concern.
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. Related Party Transactions
In
May 2016, the Company and William Mills entered into an agreement under which the Company issued 5,000,000 shares of the Company’s
common stock with the Rule 144 restrictive legend to Mr. Mills in exchange for the cancellation of $100,000 in fees owed for services
rendered by Mr. Mills as a Director and Secretary of the Company. The fair market value of the shares was $100,000. Mr. Mills
is a partner of Parker Mills and the Secretary and a Director of the Company.
On June 30, 2016, the Company amended an agreement (originally entered into in July 2010) with certain
former and current employees of the Company, concerning the deferral of payroll claims of approximately $883,190 for salary earned
from 2012 to June 30, 2016 and $1,652,113 for salary earned from 2001 to 2012. The deferral period ended on December 31, 2017 at
which time payroll claims of approximately $1,118,561 for salary earned from 2012 to December 31, 2017 and $1,652,113 for salary
earned from 2001 to 2012, remained unpaid and is reflected as a current liability on the Company’s consolidated financial
statements.
Pursuant
to the terms of the amended agreement, each current and former employee who is a party to the agreement (the “Employee(s)”)
agreed to defer payment of salary from the date of the agreement (“Salary Deferral”) for a period of three months
for salary earned from July 1, 2012 to June 30, 2016 and for a period of six months for salary earned from 2001 to June 30, 2012.
In consideration for the Salary Deferral, the Company issued a total 3,500,000 shares of the Company’s common stock with
the Rule 144 restrictive legend (at a fair market value of $78,750) and agreed to pay each Employee a sum equal to the amount
of unpaid salary at December 31, 2003 plus the amount of unpaid salary at the end of any calendar year after 2003 in which such
salary was earned, plus a bonus (the “Bonus”) of nine percent interest, compounded annually until such time as the
unpaid salary has been paid in full. The Company and the Employees have agreed that the Bonus will be paid from amounts anticipated
to be paid to the Company in respect of specified intellectual property assets of the Company.
In
order to effect the payments due under this agreement, the Company assigned to the Employees a twenty percent interest in any
net proceeds (gross proceeds less attorney’s fees and direct costs) derived from infringement claims and any license fees
paid by a subsidiary of the Company or third party to the Company regarding (a) U.S. patent #6,826,744 and U.S. patent #7,716,629
(plus any continuation patents) on Adhesive Software’s SiteFlash™ Technology, (b) U.S. patent #7,076,521 (plus any
continuation patents) in respect of “Web-Based Collaborative Data Collection System”, and (c) U.S. patent U.S. Patent
No. #8,578,266 and #9,405,736 (plus any continuation patents) in respect to “Method and System for Automatically Downloading
and Storing Markup Language Documents into a Folder Based Data Structure,” and (d) any license payments made (i) by a subsidiary
of the Company to the Company in connection with a licensing or distribution agreement between the Company and such subsidiary
or (ii) by third party to the Company in connection with a licensing or distribution agreement between the Company and a third
party
Under
the terms of this agreement, the Bonus is contingent on payment of unpaid wages. In addition, the Bonus is contingent upon generating
revenues from the sources of the twenty percent interests in net proceeds assigned to the current and former employees. The interests
that were assigned under the agreement for net proceeds consist of the underlying patents of the SiteFlash™ and Emily™
technologies and licensing under distribution and licensing agreements between the Company and subsidiaries and between the Company
and third parties. Currently, there is no foreseeable income to be generated from these sources to which a twenty percent interest
can reasonably be projected or otherwise applies to. There is no pending litigation regarding any of these patents. In addition,
with respect to any licenses from Vertical to its subsidiaries, the licenses of technology underlying these patents were for a
three percent royalty on gross revenues. If there were income, any payments under this agreement would likely be minimal. Currently,
there is no income being generated from licensing. No subsidiary is currently offering a product to the market using these licensed
technologies nor does Vertical have any agreement to license these technologies to a third party.
Since
payment of the Bonus is contingent upon first paying all unpaid salary and there are no foreseeable revenues to pay the twenty
percent interest in these technologies, it is doubtful at the present time that any Bonus will be paid and therefore the Bonus
was not accrued as of December 31, 2017 as this contingent liability is considered remote. Cumulative bonus interest through December
31, 2017 is $4,435,576.
As
of December 31, 2017 and 2016, the Company had accounts payable to related parties in an aggregate amount of $148,760 and $139,546,
respectively.
Related
Party Notes Payable
|
|
December 31,
|
|
|
|
2017
|
|
|
2016
|
|
Notes payable bearing interest at 10% to 15% per annum. Of these notes payable $208,242 and $208,242 were in default at December 31, 2017 and 2016, respectively.
|
|
$
|
208,242
|
|
|
$
|
208,242
|
|
|
|
|
|
|
|
|
|
|
Convertible debenture bearing interest at 10% per annum, due one year from date of issuance.
|
|
$
|
100,000
|
|
|
$
|
100,000
|
|
Total notes payable to related parties
|
|
|
308,242
|
|
|
|
308,242
|
|
|
|
|
|
|
|
|
|
|
Current maturities
|
|
|
(308,242
|
)
|
|
|
(308,242
|
)
|
|
|
|
|
|
|
|
|
|
Long-term portion of notes payable to related parties
|
|
$
|
—
|
|
|
$
|
—
|
|
The
following table reflects our related party debt activity for the years ended December 31, 2017 and 2016:
December 31, 2015
|
|
$
|
417,445
|
|
Common shares issued for debt principal
|
|
|
(130,000
|
)
|
Amortization of debt discounts due to stock and warrants issued with debt
|
|
|
20,797
|
|
December 31, 2016
|
|
|
308,242
|
|
December 31, 2017
|
|
$
|
308,242
|
|
Note
4. Derivative Liabilities and Fair Value Measurements
Derivative
liabilities
During
the years ended December 31, 2017 and 2016, the Company entered into several loan agreements with third party lenders and a related
party lender under which certain convertible debentures (which are convertible into shares of the Company’s common stock)
and warrants to purchase shares of the Company’s common stock were issued. During the year ended December 31, 2016, the
Company entered into subscription agreements with third parties to purchase shares of the Company’s Series A Preferred Stock
(which are convertible the Company’s common stock) and warrants to purchase shares of the Company’s common stock.
For
additional details regarding these transactions, please see the 2016 and 2017 summaries for convertible debentures and subscription
agreements under “Common and Preferred Stock” in Note 10.
During
2016, certain notes issued by the Company became convertible and qualified as derivative liabilities under ASC 815. In addition,
the outstanding common stock warrants associated with the notes became tainted and were required to be accounted for as derivative
liabilities under ASC 815.
For
the year ended December 31, 2017, the aggregate change in the fair value of derivative liabilities was a gain of $879,780. For
the year ended December 31, 2016, the aggregate change in the fair value of derivative liabilities was a loss of $268,728.
The
valuation of our embedded derivatives is determined by using the Black-Scholes Option Pricing Model. As such, our derivative liabilities
have been classified as Level 3.
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
|
2016
|
Expected dividends
|
0%
|
0%
|
Expected terms (years)
|
0.08 – 2.51
|
0.16 – 3.04
|
Volatility
|
108% - 128%
|
101% - 139%
|
Risk-free rate
|
1.53% - 1.98%
|
0.36% - 1.61%
|
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 December 31, 2017 and December 31, 2016:
|
|
|
Fair value measurements on a recurring basis
|
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
As of December 31, 2017:
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
Derivatives
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
159,537
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2016:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivatives
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
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 estimated fair value of our long-term
borrowings approximates carrying value since the related rates of interest approximate current market rates.
The
below table presents the change in the fair value of the derivative liabilities during the year ended December 31, 2017 and 2016:
Fair value as of December 31, 2015
|
|
$
|
—
|
|
Additions recognized as debt discounts
|
|
|
741,583
|
|
Additions reclassified from equity
|
|
|
50,557
|
|
Additions recognized in equity financing
|
|
|
4,005
|
|
Reduction due to settlement upon conversion
|
|
|
(50,681
|
)
|
Loss on change in fair value of derivatives
|
|
|
268,728
|
|
Fair value as of December 31, 2016
|
|
$
|
1,014,192
|
|
Additions recognized as debt discounts
|
|
|
44,240
|
|
Additions recognized in equity financing
|
|
|
451
|
|
Reduction due to settlement upon conversion
|
|
|
(19,566
|
)
|
Gain on change in fair value of derivatives
|
|
|
(879,780
|
)
|
Fair value as of December 31, 2017
|
|
$
|
159,537
|
|
Note
5. Property and Equipment
Property
and equipment consist of the following as of December 31, 2017 and 2016:
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
Equipment (3-5 year life)
|
|
$
|
920,963
|
|
|
$
|
915,280
|
|
Leasehold improvements (5 year life)
|
|
|
87,714
|
|
|
|
87,714
|
|
Furniture and fixtures (3-5 year life)
|
|
|
45,470
|
|
|
|
45,500
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
1,054,147
|
|
|
|
1,048,494
|
|
|
|
|
|
|
|
|
|
|
Accumulated depreciation
|
|
|
(1,044,936
|
)
|
|
|
(1,043,397
|
)
|
|
|
$
|
9,211
|
|
|
$
|
5,097
|
|
Depreciation
expense for 2017 and 2016 was $1,453 and $1,083, respectively.
Note
6. Intangible Assets
Intangible
assets consisted of the following as of December 31, 2017 and 2016:
|
|
2017
|
|
|
2016
|
|
Acquired software (5-year life)
|
|
$
|
303,994
|
|
|
$
|
304,003
|
|
Customer list (5-year life)
|
|
|
2,200
|
|
|
|
2,200
|
|
Trademark
|
|
|
5,000
|
|
|
|
5,000
|
|
Website (5-year life)
|
|
|
15,000
|
|
|
|
15,000
|
|
Total
|
|
|
326,194
|
|
|
|
326,203
|
|
Accumulated amortization
|
|
|
(319,504
|
)
|
|
|
(319,513
|
)
|
|
|
$
|
6,690
|
|
|
$
|
6,690
|
|
Amortization
expense for 2017 and 2016 was $0 and $0, respectively.
During
2017, the Company did not capitalize any costs related to software development.
During
2016, the Company capitalized an aggregate of $246,184 related to software development and wrote off $1,421,155 of impaired software
development costs related to its Ploinks™ software application, which included the $246,184.
Note
7. Accounts Payable and Accrued Expenses
Accounts
payable and accrued liabilities consist of the following:
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
2,847,404
|
|
|
$
|
2,613,942
|
|
Accrued payroll
|
|
|
3,205,759
|
|
|
|
2,734,024
|
|
Accrued payroll tax and penalties
|
|
|
2,911,718
|
|
|
|
2,309,970
|
|
Accrued interest
|
|
|
4,236,038
|
|
|
|
3,371,112
|
|
Accrued taxes
|
|
|
511,966
|
|
|
|
598,684
|
|
Accrued liabilities - other
|
|
|
409,509
|
|
|
|
447,566
|
|
|
|
$
|
14,122,394
|
|
|
$
|
12,075,298
|
|
Accrued
payroll primarily consists of deferred compensation for several executives who agreed to defer a portion of their salaries due
to cash flow constraints. Accrued payroll tax and penalties relate to unpaid payroll taxes, interest and penalties for NOW Solutions,
Inc. and for certain non-functioning subsidiaries, The Internal Revenue Service has made a claim for payroll taxes owed of approximately
$1.5 million and has garnished certain receivables from U.S. customers. Accrued taxes primarily consist of U.S. sales tax, Canadian
GST, Canadian income tax and U.S. income tax. Accrued liabilities – other primarily consists of accrued rent, board of director
fees, unbilled professional and consulting fees, and other accrued expenses.
Note
8. Notes Payable and Convertible Debts
The
following table reflects our third-party debt activity, including our convertible debt, for the years ended December 31, 2016
and 2015:
December 31, 2015
|
|
$
|
5,397,020
|
|
Repayments of third party notes
|
|
|
(113,699
|
)
|
Borrowings from third parties
|
|
|
885,000
|
|
Conversion of convertible debt principal to common stock
|
|
|
(74,297
|
)
|
Debt discounts due to stock and warrants issued with debt
|
|
|
(872,196
|
)
|
Amortization of debt discounts
|
|
|
627,542
|
|
Attorney fees added to note principal
|
|
|
3,500
|
|
Currency translation
|
|
|
275
|
|
December 31, 2016
|
|
|
5,853,145
|
|
Repayments of third party notes
|
|
|
(159,705
|
)
|
Borrowings from third parties
|
|
|
480,500
|
|
Conversion of convertible debt principal to common stock
|
|
|
(19,213
|
)
|
Debt discounts due to parent stock and warrants and subsidiary stock issued with debt and derivative liabilities from convertible debt
|
|
|
(198,688
|
)
|
Amortization of debt discounts
|
|
|
478,398
|
|
Subsidiary dividends to noncontrolling interest added to note principal
|
|
|
250,000
|
|
Accrued interest added to note principal
|
|
|
414,364
|
|
Currency translation
|
|
|
(663
|
)
|
December 31, 2017
|
|
$
|
7,098,138
|
|
During
the year ended December 31, 2016, the Company issued convertible debentures in the aggregate principal amount of $715,000 to various
third party lenders for loans made to the Company in the same amount. The debts accrue interest at 10% per annum and are due one
year from the date of issuance. Beginning six months after issuance of the respective debentures 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 loans, the Company also issued a total of 7,150,000 shares of common stock
of the Company to the lenders with the Rule 144 restrictive legend and 3 year warrants under which each lender may purchase in
aggregate a total of 7,150,000 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 $186,967 against the face value of
the loans 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 derivative liabilities. The discount is being amortized over twelve months and $105,597 of amortization expense
was recognized for the year ended December 31, 2016.
During
the year ended December 31, 2016, $82,001 of principal, interest and fees under a convertible note were converted into 5,914,783
unrestricted common shares of the Company.
During
the year ended December 31, 2017, the Company issued convertible debentures in the principal amount of $110,000 to third party
lenders for loans 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 1,100,000 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 1,100,000
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 $12,292 and $5,098 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.
During
the year ended December 31, 2017, $22,421 of principal, interest and legal fees under a convertible note issued in the principal
amount of $90,000 (as amended) was converted into 1,688,762 common shares. In May 2017, the Company amended this convertible note
which was 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 same third-party lender. This convertible note has been paid in full.
During
the year ended December 31, 2017, the Company made payments of $126,500 of principal and interest due under 3 convertible debentures
in the principal amount of $115,000 issued by the Company to a third-party lender. These convertible debentures have been paid
in full.
During the year ended December 31, 2017,
the Company granted a total of 651,700 shares of the common stock of Ploinks, Inc. to third party lenders in connection with a
series of 3 and 6-month extensions of convertible debentures in the aggregated principal amount of $1,200,000 issued in 2015 and
2016. The aggregate fair market value of the awards was determined to be $142,156 and was recorded as debt discount and is being
amortized through the term of the convertible debenture. Certain notes issued in the prior year(s) become convertible during 2017.
Consequently, the embedded conversion feature was determined to be derivative liabilities, and the Company recognized a derivative
debt discount. Amortization expense of $39,142 for this debt discount was recorded during the year ended December 31, 2017.
During the year ended December 31, 2017, the Company’s total amortization of debt discounts was $478,398 and was recorded as interest expense.
Lakeshore
Financing
On
January 9, 2013, 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
original amount of $1,759,150 and payable in equal monthly installments of $24,232 until January 31, 2022. Upon the payment of
any prepayment principal amounts, the monthly installment payments will be adjusted proportionately on an amortized rata basis.
The
Lakeshore Note was originally secured by the assets of the Company’s subsidiaries, NOW Solutions, Priority Time, SnAPPnet,
Inc. (“
SnAPPnet
”) and the Company’s SiteFlash™ technology, which were all cross-collateralized.
Upon full payment of the Lakeshore Note, Lakeshore will be obligated to 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 Lakeshore a 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 December 31, 2017
or December 31, 2016.
Under
an amendment of the Lakeshore Note and the Loan Agreement executed on January 31, 2013, Vertical was obligated to transfer 25%
of its ownership interest in NOW Solutions in the event certain principal payments were not timely made to Lakeshore. When the
last forbearance agreement with Lakeshore expired, Lakeshore became a 25% minority owner of NOW Solutions on October 1, 2013.
In
December 2014, the Company and Lakeshore entered into an amendment of the Lakeshore Note and the Loan Agreement. In consideration
of an extension Lakeshore granted to NOW Solutions 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 SnAPPnet, Inc.
In
December 2017, the Vertical and NOW Solutions and Lakeshore entered into an amendment (the “2017 Lakeshore Loan Amendment
“) to the Loan Agreement and the Lakeshore Note issued to Lakeshore. Pursuant to the terms of this amendment, the principal
balance of the Note was amended to $2,291,395, which included (a) all unpaid dividends and outstanding attorneys’ fees in
the amount of $250,000 and (b) all outstanding accrued interest in the amount of $414,364. Under the 2017 Lakeshore Loan Amendment,
any existing defaults under the Lakeshore Note and related security agreements were cured, the interest rate reverted to the non-default
rate of 11% interest per annum, the Lakeshore Note was re-amortized and the term of the Lakeshore Note was extended for an additional
10 years, with monthly installment payments consisting of $31,564 due on the 10
th
day of each month, beginning on January
10, 2018. In addition, the security agreements for the SiteFlash assets, the assets of Priority Time, and the assets of SnAPPnet
were cancelled and Lakeshore agreed to file notices of termination of all UCC lien statements in connection with these assets.
The security agreement concerning the assets of NOW Solutions remain in effect and upon full payment of the Lakeshore Note, Lakeshore
will release the NOW Solutions collateral. Furthermore, the interest in “Net Claim Proceeds” from the SiteFlash Assets
was increased from 8% to 20% under this amendment.
The
2017 Lakeshore Loan Amendment also provides that if NOW Solutions makes any advance toward net income (less Vertical’s management
fee and management allocations) to Vertical, then NOW Solutions shall pay Lakeshore 25% share of such an advance no later than
one business day after Vertical receives its 75% percent share.
In
order to facilitate the execution of the 2017 Lakeshore Loan Amendment which resulted in the cure of any existing defaults under
the Loan Agreement and the Note, as well as the release by Lakeshore of the security interests in the SiteFlash assets and the
assets of SnAPPnet and Priority Time, the Company issued 2,500,000 VCSY common shares at a fair market value of $35,400 and 300,000
Ploinks common shares at a fair market value of $92,850 to certain third party purchasers of 600,000 shares of VHS Series A Preferred
Stock from a member of Lakeshore. The company recorded a loss on debt extinguishment of $128,250 during the year ended December 31, 2017.
During
the year ended December 31, 2017, the Company, through its subsidiary, accrued dividends of $250,000 payable to Lakeshore of which
$250,000 was rolled into their note payable balance. During the year ended December 31, 2016, the Company, through its subsidiary,
paid $295,000 towards dividends owed.
|
|
December 31
|
|
|
December 31
|
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
Third
Party Notes Payable
|
|
|
|
|
|
|
|
|
Unsecured notes payable issued to third party lenders bearing interest at rates between 10% and 15% per annum and are past due their original maturity dates. Of these notes, $1,555,639 and $1,570,368 were in default or non-performing as of December 31, 2017 and 2016, respectively.
|
|
$
|
2,146,139
|
|
|
$
|
1,830,377
|
|
|
|
|
|
|
|
|
|
|
Secured notes payable issued to third party lenders, bearing interest at 10% to 18% per annum. These notes are secured by stock pledges by MRC totaling 33,976,296 common shares. Of these notes $1,025,449 and $1,025,449 were in default or non-performing at December 31, 2017 and 2016, respectively.
|
|
|
1,025,449
|
|
|
|
1,025,449
|
|
|
|
|
|
|
|
|
|
|
Secured notes payable issued to third party lenders, bearing interest at 11% to 18% per annum. These notes are secured by certain technology owned by the Company, supporting its Emily product. Of these notes $470,860 were in default or non-performing at December 31, 2017 and 2016.
|
|
|
470,860
|
|
|
|
470,860
|
|
|
|
|
|
|
|
|
|
|
Secured note payable issued to Lakeshore, bearing interest at 11% per annum. The note is secured by all assets of NOW Solutions and was secured by all of the assets of Priority Time, and SnAPPnet, Inc. as well as the SiteFlash™ technology until these security interests were cancelled in December 2017. This note was current at December 31, 2017 but was in default at December 31, 2016.
|
|
|
2,291,395
|
|
|
|
1,627,031
|
|
Total notes payable to third parties
|
|
|
5,933,843
|
|
|
|
4,953,717
|
|
Current maturities
|
|
|
3,775,703
|
|
|
|
4,953,717
|
|
Long-term portion of notes payable to third parties
|
|
$
|
2,158,140
|
|
|
$
|
—
|
|
Certain
notes payable also contain provisions requiring additional principal reductions in the event sales by NOW Solutions exceed certain
financial thresholds or the Company receives “Net Proceeds” from infringement claims regarding U.S. Patent #6,826,744,
U.S. Patent #7,716,629 and U.S. Patent #8,949,780 (which include the SiteFlash™ technology).
The company had new borrowings on third
party notes of $370,500, increased note principal on the Lakeshore debt by $250,000 for unpaid dividends and made note payments
of $44,705 during the year ended December 31, 2017.
Third
Party Convertible Promissory Notes and Debentures
Third
party convertible promissory notes and debentures consist of the following:
|
|
December 31,
2017
|
|
|
December 31,
2016
|
|
|
|
|
|
|
|
|
In December 2003, we issued a debenture in the amount of $30,000 to a third party. The debt accrues interest at 13% per annum and was due December 2005. The holder may convert the debenture into shares of common stock at 100% of the closing price.
|
|
$
|
30,000
|
|
|
$
|
30,000
|
|
|
|
|
|
|
|
|
|
|
Convertible debentures to various third-party lenders for loans made to the Company in the aggregate amount of $1,210,000 net of unamortized discounts of $75,705. The debts accrue interest at 10% per annum and are 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.
|
|
|
1,134,295
|
|
|
|
869,428
|
|
|
|
|
|
|
|
|
|
|
Total convertible debentures
|
|
|
1,164,295
|
|
|
|
899,428
|
|
Current maturities
|
|
|
(1,164,295
|
)
|
|
|
(899,428
|
)
|
Long-term portion of convertible debentures
|
|
$
|
—
|
|
|
$
|
—
|
|
Future
minimum payments for third party, related party, and convertible debentures for the next five years are as follows:
Year
|
|
|
Amount
|
|
|
|
|
|
|
2018
|
|
$
|
5,323,945
|
|
2019
|
|
|
148,722
|
|
2020
|
|
|
165,932
|
|
2021
|
|
|
185,134
|
|
2022+
|
|
|
1,658,352
|
|
|
|
|
|
|
Total notes payable
|
|
|
7,482,085
|
|
Unamortized discounts
|
|
|
(75,705
|
)
|
Notes payable, net of discounts
|
|
$
|
7,406,380
|
|
For
additional transactions involving notes payable after December 31, 2017, please see “Subsequent Events” in Note 12.
Note
9. Income Taxes
We
account for income taxes using the asset and liability method of accounting for income taxes. Deferred income taxes are recognized
for the tax consequences of “temporary differences” by applying enacted statutory tax rate applicable to future years
to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities and result
primarily form differences in methods used to amortize intangible assets. A valuation allowance is provided when management cannot
determine whether it is more likely than not that the deferred tax asset will be realized. The effect on deferred income taxes
of the change in tax rates is recognized in income in the period that includes the enactment date. The difference between the
statutory tax rate and the effective tax rate is the valuation allowance.
The
provision of income taxes consists of the following for the years ended December 31, 2017 and 2016:
|
|
|
Years Ended December 31,
|
|
|
|
|
2017
|
|
|
2016
|
|
Current
|
|
|
|
|
|
|
|
Federal
|
|
|
|
—
|
|
|
|
73,016
|
|
State
|
|
|
|
—
|
|
|
|
—
|
|
Foreign
|
|
|
|
11,876
|
|
|
|
13,362
|
|
|
|
|
|
11,876
|
|
|
|
86,378
|
|
During
2017 and 2016, the Company recorded an income tax provision of $11,876 and $86,378, respectively related to income taxes for
NOW Solutions, a 75% owned subsidiary of the Company.
Temporary
difference between the financial statement carrying amount and tax bases of assets and liabilities that give rise to deferred
tax assets relate to the following:
|
|
December 31,
2017
|
|
|
December 31,
2016
|
|
Net operating loss carry-forward
|
|
$
|
6,848,000
|
|
|
$
|
10,255,000
|
|
Reserves
|
|
|
258,000
|
|
|
|
512,000
|
|
Accrued vacation
|
|
|
24,000
|
|
|
|
38,000
|
|
Deferred compensation
|
|
|
649,000
|
|
|
|
892,000
|
|
Deferred revenue
|
|
|
368,000
|
|
|
|
610,000
|
|
|
|
|
8,147,000
|
|
|
|
12,307,000
|
|
Valuation allowance
|
|
|
(8,147,000
|
)
|
|
|
(12,307,000
|
)
|
|
|
$
|
—
|
|
|
$
|
—
|
|
At December 31, 2017 and December 31,
2016, VCSY had available net operating loss carry-forwards of approximately $22.6 million and $20.6 million, respectively. At December
31, 2017 and 2016, NOW Solutions had available net operating loss carry-forwards of approximately $395,000 and $281,000, respectively.
These net operating loss carry-forwards expire in varying amounts through 2032.
The
benefit for income taxes differs from the amount computed by applying the U.S. federal income tax rate of 34% to loss before income
taxes as follows for the years ended December 31, 2017 and 2016:
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
U.S. federal income tax expense at statutory rates
|
|
|
(1,103,299
|
)
|
|
|
(1,852,199
|
)
|
Permanent differences
|
|
|
109,130
|
|
|
|
5,719
|
|
Foreign income tax expense
|
|
|
11,876
|
|
|
|
13,362
|
|
Change in valuation allowance
|
|
|
994,169
|
|
|
|
1,919,496
|
|
|
|
|
11,876
|
|
|
|
86,378
|
|
As
of December 31, 2016, all garnishments of NOW Solutions Canada customer receivables in order to pay debts owed to the Canada Revenue
Agency for income tax and good and services taxes (“GST”) had been removed and all outstanding debts related to the
GST had been paid.
Open
tax years for U.S. federal income taxes for VCSY are 2012, 2013, 2014, 2015, 2016 and 2017. Open tax years for U.S. federal income
taxes for NOW Solutions are 2013, 2014, 2015, 2016 and 2017.
The
Tax Cuts and Jobs Act (the “Act”) was enacted on December 22, 2017. The Act reduces the US federal corporate tax rate
from 35% to 21%, requires companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously
tax deferred and creates new taxes on certain foreign sourced earnings. As of December 31, 2017, the Company has not completed
the accounting for the tax effects of enactment of the Act; however, as described below, it has made a reasonable estimate of
the effects on existing deferred tax balances. These amounts are provisional and subject to change. The most significant impact
of the legislation for the Company was a $5,046,000 reduction of the value of the Company’s net deferred tax assets (which
represent future tax benefits) as a result of lowering the U.S. corporate income tax rate from 35% to 21%. The Act also includes
a requirement to pay a one-time transition tax on the cumulative value of earnings and profits that were previously not repatriated
for U.S. income tax purposes. The Company has not made sufficient progress on the transition tax analysis to reasonably estimate
the effects, and therefore, has not recorded provisional amounts. However, based on analysis to date the one-time transition tax
is not expected to be material.
Note
10. Common and Preferred Stock
Terms
of Common and Preferred Stock
Common
Stock
. The authorized capital stock of the Company consists of 2,000,000,000 shares of common stock, par value $0.00001 per
share, of which 1,188,095,201 were issued and 1,148,095,201 were outstanding at December 31, 2017 and 1,167,841,439 were issued
and 1,127,841,439 were outstanding at December 31, 2016. Each share of our common stock entitles the holder to one vote on each
matter submitted to a vote of our stockholders, including the election of directors. There is no cumulative voting and there are
no redemption or sinking fund provisions related to the common stock. Stockholders of our common stock have no preemptive, conversion
or other subscription rights.
Series
A Cumulative Convertible Preferred Stock
. We have authorized the issuance of 250,000 shares of Series A 4% Cumulative Convertible
Preferred Stock (“Series A Preferred Stock”), of which there are 52,800 shares issued and outstanding at December
31, 2017 and 51,500 shares issued and outstanding at December 31, 2016. Holders of these shares of Series A Preferred Stock are
entitled to vote on an as-converted basis with the holders of common stock, except that the holders are entitled to vote as a
separate class on any matters affecting the Series A Preferred Stock stockholders, on the sale of the business, the increase in
the number of directors, the payment of a dividend on any junior stock, and the issuance of any stock that is on parity or senior
to the Series A Preferred Stock. Each share of Series A Preferred Stock is entitled to 500 votes per share. Dividends accrue at
an annual rate of 4% of the liquidation preference and are payable quarterly subject to the board’s discretion. Each share
of Series A Preferred Stock is convertible into 500 shares of common stock of the Company. In the event of liquidation, each share
of Series A Preferred Stock will be entitled to a preference of $200, plus accrued but unpaid dividends, prior to the holders
of any junior class of stock.
Series
B 10% Cumulative Convertible Preferred Stock
. We have authorized the issuance of 375,000 shares of Series B 10% Cumulative
Convertible Redeemable Preferred Stock (“Series B Preferred Stock”), of which there are 7,200 shares outstanding at
December 31, 2017 and December 31, 2016. Holders of Series B Preferred Stock are not entitled to vote on matters presented to
the stockholders, except as otherwise required by law. Cash or stock dividends accrue cumulatively at an annual rate of 10% per
annum on March 15 and September 15 of each year and are payable subject to the board’s discretion. Each share of Series
B Preferred Stock is convertible into 3.788 shares of common stock of the Company. The shares of Series B Preferred Stock are
redeemable at a rate of $6.25 per share, or $45,000 if all outstanding shares are redeemed. In the event of liquidation, each
share will be entitled to a preference of all dividends accrued and unpaid on each share up to the date fixed for distribution
to any holders of any class of common stock.
Series
C 4% Cumulative Convertible Preferred Stock
. We have authorized the issuance of 200,000 shares of Series C 4% Cumulative Convertible
Preferred Stock (“Series C Preferred Stock”), of which there are 50,000 shares outstanding at December 31, 2017 and
December 31, 2016. Holders of Series C Preferred Stock are not entitled to vote on matters presented to the stockholders, except
as otherwise required by law. Cash dividends accrue at an annual rate of 4% of the liquidation preference and are payable quarterly
subject to the board’s discretion. Each share of Series C Preferred Stock is convertible into 400 shares of common stock
of the Company; however, of the 50,000 shares of the Company’s Series “C” Cumulative Convertible Preferred Stock
that are outstanding, the holder of 37,500 shares waived the conversion rights associated with these shares pursuant to an agreement
in 2010. In the event of liquidation, each share will be entitled to a preference of all dividends accrued and unpaid on each
share up to the date fixed for distribution to any holder of any class of common stock.
In the event of liquidation, each share
of Series C Preferred Stock will be entitled to a preference of $100, plus accrued but unpaid dividends, prior to the holders
of any junior class of stock.
Series
D 15% Cumulative Convertible Preferred Stock
. We have authorized the issuance of 300,000 shares of Series D 15% Cumulative
Convertible Redeemable Preferred Stock (“Series D Preferred Stock”), of which there were 25,000 shares outstanding
at December 31, 2017 and December 31, 2016. Holders of these shares are not entitled to vote on matters presented to the stockholders,
except as otherwise required by law. Cash dividends accrue cumulatively at an annual rate of 15% per annum on March 15 and September
15 of each year and are payable subject to the board’s discretion. Any aggregate deficiency shall be cumulative and shall
be fully paid or set apart for payment before any dividend shall be paid or set apart for payment of any class of common stock.
Each share of Series D Preferred Stock is convertible into 3.788 shares of common stock of the Company. The shares of Series D
Preferred Stock are redeemable at a rate of $6.25 per share, or $156,250 if all outstanding shares are redeemed. In the event
of liquidation, each share will be entitled to a preference of all dividends accrued and unpaid on each share up to the date fixed
for distribution to any holders of any class of common stock.
2017
Common
Stock
In
September 2017, the Company entered into an agreement to purchase a 10% ownership interest in Priority Times Systems, Inc. from
a former employee of the Company and its subsidiaries. The purchase price consisted of 1,000,000 unregistered shares of VCSY common
stock with the Rule 144 restrictive legend issued to the seller and $62,500 in cash payments due in equal installments over a
three-month period. The aggregate fair market value of the VCSY common stock grant was determined to be $12,800 on the quoted
market price of VCSY stock at date of grant.
In
December 2017, in order to facilitate the amendment of the Lakeshore Loan Agreement and the Lakeshore Note, which resulted in
the curing any existing defaults under the Lakeshore Loan Agreement and the Lakeshore Note as well as the release by Lakeshore
of the security interests in the SiteFlash assets and the assets of SnAPPnet and Priority Time which secured the Lakeshore Note,
the Company issued 2,500,000 VCSY common shares at a fair market value of $35,400 and 300,000 Ploinks common shares at a fair
market value of $92,850 to third party purchasers of 600,000 shares of VHS Series A Preferred Stock from a member of Lakeshore.
For additional details concerning the amendment of the Lakeshore Loan and the Lakeshore Note, please see the “Lakeshore
Financing” subsection under “Notes Payable and Convertible Debts” of Note 8.
During
the year ended December 31, 2017, the Company granted 1,700,000 unregistered shares of its common stock with the Rule 144 restrictive
legend and 230,000 shares of Ploinks, Inc. common stock to consultants of the Company and its subsidiaries pursuant to consulting
agreements with the Company. The aggregate fair market value of the VCSY common stock grant was determined to be $21,060 based
on the quoted market price of VCSY stock at date of grant and Ploinks, Inc. common stock grant was determined to be $71,185 based
on a third-party valuation of Ploinks stock. In addition, the Company agreed to issue up to a total of 4,000,000 common shares
of the Company and up to a total of 500,000 shares of Ploinks, Inc. common stock pursuant to restricted performance stock agreements
with the consultants. These shares may vest over a term of 3 years and are based upon the respective consultant achieving certain
performance criteria.
During
the year ended December 31, 2017, the Company issued convertible debentures in the principal amount of $110,000 to third party
lenders for loans 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 1,100,000 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 1,100,000
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 $12,292 and $5,098 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.
During
the year ended December 31, 2017, the Company entered into subscription agreements under which a third party subscriber purchased
1,300 shares of VCSY Series A Preferred Stock for $260,000. In connection with the purchase of the VCSY Series A Preferred Stock,
the subscribers also received a total of 2,600,000 shares of common stock of the Company with the Rule 144 restrictive legend,
130,000 shares of common stock of Ploinks, Inc., 2-year warrants under which the subscribers may purchase an aggregate total of
195,000 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 195,000 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 $188,686.
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 $30,505. The allocated fair market value of
all common shares of Ploinks, Inc. issued to the subscribers was $40,235. The fair market value of all warrants issued to the
subscribers was $574 (which was calculated using the Black-Sholes model). The warrants were accounted for as derivative liabilities
(see Note 4).
During the year ended December 31, 2017,
the Company granted a total of 651,700 shares of the common stock of Ploinks, Inc. to third party lenders in connection with a
series of 3 and 6-month extensions of convertible debentures in the aggregated principal amount of $1,200,000 issued in 2015 and
2016. The aggregate fair market value of the awards was determined to be $142,156 and was recorded as debt discount and is being
amortized through the term of the convertible debenture. Certain notes issued in the prior year(s) become convertible during 2017.
Consequently, the embedded conversion feature was determined to be derivative liabilities, and the Company recognized a derivative
debt discount.
During
the year ended December 31, 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 year ended December 31, 2017, the Company entered into restricted stock agreements to grant a total of 180,000 shares of the
Company’s common stock with the Rule 144 restrictive legend with employees of the Company under which the shares vest in
equal installments over a 30-month period. The fair value of the shares was $2,982 based on the quoted market price of VCSY stock
on the grant date and $1,006 was amortized to expense during the year ended December 31, 2017.
During
the year ended December 31, 2017, 3,665,000 VCSY common shares vested under restricted stock agreements to employees and two consultants
of the Company.
During
the year ended December 31, 2017, 3,000,000 VCSY common shares were issued to an employee of the Company. The fair market value
of the shares was $72,000.
During
the year ended December 31, 2017, Ploinks, Inc. entered into restricted stock agreements to grant 90,000 unregistered shares of
the common stock of Ploinks, Inc. to employees 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 $15,765 based on a third-party valuation of Ploinks stock.
During
the year ended December 31, 2017, Ploinks, Inc. entered into restricted stock agreements to grant 230,000 unregistered shares
of the common stock of Ploinks, Inc. to consultants of the Company pursuant to a restricted stock agreement with Ploinks, Inc.
The fair value of the shares was $71,185 based on a third-party valuation of Ploinks stock.
During
the year ended December 31, 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.
During the year ended December 31, 2017 $279,482 was amortized to expense related to the issuance of Ploinks, Inc. restricted stock.
During
the year ended December 31, 2017, 810,001 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 $116,180 for the year ended December 31, 2017. As of December 31, 2017, there were 6,140,000 shares
of unvested stock compensation awards to employees and 15,500,000 shares of unvested stock compensation awards to non-employees.
Preferred
Stock
For
the year ended December 31, 2017, total dividends applicable to Series A and Series C Preferred Stock was $616,667. The Company
did not declare or pay any dividends in 2017. Although no dividends have been declared, the cumulative total of preferred stock
dividends due to these stockholders upon declaration was $10,104,851 as of December 31, 2017.
2016
Common
Stock
In
March 2016, the Company cancelled 1,000,000 unregistered shares of its common stock issued during 2015 to a third party lender
under an agreement to amend certain promissory notes issued by the Company and NOW Solutions in the aggregate principal amount
of $715,000. Under the amendment, the Company agreed to make $22,000 monthly payments and an additional $10,000 penalty if such
monthly payment is not timely made.
In
March 2016, the Company issued 10,000,000 shares of the Company’s common stock with the Rule 144 restrictive legend to its
consolidated subsidiary Ploinks, Inc. These shares are held in treasury. In exchange, Ploinks, Inc. issued 5,000,000 of its common
shares to the Company.
In
April 2016, the Company and a third-party noteholder entered into an agreement under which the Company issued 5,000,000 shares
of the Company’s common stock with the Rule 144 restrictive legend in exchange for the cancellation of $130,000 in principal
owed under a note payable issued by NOW Solutions with a principal amount of $213,139. The fair market value of the shares was
$92,500. A gain on debt extinguishment of $37,500 was recorded for the year ended December 31, 2016.
In
May 2016, the Company and William Mills entered into an agreement under which the Company issued 5,000,000 shares of the Company’s
common stock with the Rule 144 restrictive legend to Mr. Mills in exchange for the cancellation of $100,000 in fees owed for services
rendered by Mr. Mills as a Director and Secretary of the Company. The fair market value of the shares was $100,000. Mr. Mills
is a partner of Parker Mills and the Secretary and a Director of the Company.
In
May 2016, the Company and a third party entered into an agreement under which the Company issued 1,500,000 shares of the Company’s
common stock with the Rule 144 restrictive legend to the third party in lieu of paying $35,969 in fees, expenses, and interest
owed to the third party for services rendered to the Company and its subsidiaries. The fair market value of the shares issued
was $37,500. A loss on debt extinguishment of $1,531 was recorded for the year ended December 31, 2016.
In
June 2016, the Company granted 3,500,000 unregistered shares of the Company’s common stock with the Rule 144 restrictive
legend to employees and a former employee of the Company and its subsidiaries pursuant to an amended agreement to defer payroll.
For additional details, please see “Related Party Transactions” in Note 3. The fair market value of the shares was
$78,750.
During
the year ended December 31, 2016, the Company issued 3,000,000 shares of the Company’s common stock with the Rule 144 restrictive
legend to third-party consultants for services. The fair market value of the shares was $66,550 and was recorded as consulting
fees for the year ended December 31, 2016.
During
the year ended December 31, 2016, the Company issued convertible debentures in the aggregate principal amount of $715,000 to various
third-party lenders for loans made to the Company in the same amount. The debts accrue interest at 10% per annum and are due one
year from the date of issuance. Beginning six months after issuance of the respective debentures 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 loans, the Company also issued a total of 7,150,000 shares of common stock
of the Company to the lenders with the Rule 144 restrictive legend and 3 year warrants under which each lender may purchase in
aggregate a total of 7,150,000 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 $186,967 against the face value of
the loans based on the relative fair market value of the common stock of $114,413 and the full fair market value of the warrants
of $72,554. The warrants are accounted for as derivative liabilities. The discount is being amortized over twelve months and amortization
expense was recognized for the year ended December 31, 2016.
During
the year ended December 31, 2016, $82,001 of principal, interest and fees under a convertible note issued in the principal amount
of $80,000 were converted into 5,914,783 unrestricted common shares of the Company.
During
the year ended December 31, 2016, the Company entered into subscription agreements under which third party subscribers purchased
3,000 shares of VCSY Series A Preferred Stock for $600,000. In connection with the purchase of the VCSY Series A Preferred Stock,
the subscribers also received a total of 6,000,000 shares of common stock of the Company with the Rule 144 restrictive legend,
300,000 shares of common stock of Ploinks, Inc., 2-year warrants under which the subscribers may purchase an aggregate total of
450,000 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 450,000 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 $366,499.
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 $229,496. The allocated fair market value
of all common shares of Ploinks, Inc. issued to the subscribers was $3,416. The fair market value of all warrants issued to the
subscribers was $4,005 (which was calculated using the Black-Sholes model). The warrants were accounted for as derivative liabilities
(see Note 4).
During
the year ended December 31, 2016, the Company cancelled 200,000 previously awarded but unvested unregistered shares of the Company’s
common stock issued to an employee of the Company when the employee resigned. This resulted in the reversal of previously recognized
compensation expense of $1,145 during the year ended December 31, 2016.
During
the year ended December 31, 2016, the Company granted 18,250,000 unregistered shares of its common stock pursuant to restricted
stock agreements. Shares under restricted stock agreements typically vest over a period of 1-3 years in various installments and
the fair value of the awards is being expensed over the vesting periods. The aggregate fair market value of the awards was determined
to be $361,365. Stock compensation expense of $229,223 has been recorded for the year ended December 31, 2016 as additional paid-in
capital.
Stock
compensation expense for the amortization of restricted stock awards for VCSY stock was $229,223 for the year ended December 31,
2016. As of December 31, 2016, there were 13,125,000 shares of unvested VCSY common stock compensation awards to employees and
consultants.
During
the year ended December 31, 2016, 7,175,000 VCSY common shares issued under restricted stock agreements to employees of the Company
were vested.
During
the year ended December 31, 2016, the Company granted 150,000 shares of the common stock of Ploinks, Inc. to third party lenders
in connection with 6-month extensions of convertible debentures in the principal amount of $500,000 issued in 2015. The aggregate
fair market value of the awards was determined to be $16,200 and was recorded as debt discount, and amortized through the term
of the note.
During
the year ended December 31, 2016, Ploinks, Inc. granted 1,000,000 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 3 years
in various installments and the fair value of the awards is being expensed over this vesting period. The aggregate fair market
value of the awards was determined to be $108,000. Stock compensation expense of $70,800 has been recorded for the year ended
December 31, 2016.
During
the year ended December 31, 2016, the Company granted 4,286,000 unregistered shares of the common stock of Ploinks, Inc. to employees
and consultants of the Company and its subsidiaries pursuant to restricted stock agreements with the Company. These shares typically
vest over 3 years in various installments and the fair value of the awards is being expensed over this vesting period. The aggregate
fair market value of the awards was determined to be $462,888. Stock compensation expense of $264,227 has been recorded for the
year ended December 31, 2016. These shares were issued out of shares owned by VCSY.
During
the year ended December 31, 2016, 2,332,001 unregistered shares of the common stock of Ploinks, Inc. to employees and consultants
of the Company and its subsidiaries granted under restricted stock agreement vested.
During
the year ended December 31, 2016, 133,334 unregistered shares of the common stock of Ploinks, Inc. granted to an employee of the
Company under a restricted stock agreement were cancelled.
For
additional transactions concerning common and preferred stock after December 31, 2017, please see “Subsequent Events”
in Note 13.
Preferred
Stock
For
the year ended December 31, 2016, total dividends applicable to Series A and Series C Preferred Stock was $592,472. The Company
did not declare or pay any dividends in 2016. Although no dividends have been declared, the cumulative total of preferred stock
dividends due to these stockholders upon declaration was $9,488,184 as of December 31, 2016.
Note
11. Option and Warrant Activity
Option
and warrant activity years ended December 31, 2017 and 2016 is summarized as follows:
|
|
Incentive Stock Options
|
|
|
Non-Statutory Stock Options
|
|
|
Warrants
|
|
|
Weighted Average Exercise Price
|
|
Outstanding at December 31, 2015
|
|
|
—
|
|
|
|
—
|
|
|
|
6,800,000
|
|
|
$
|
0.091
|
|
Options/Warrants granted
|
|
|
—
|
|
|
|
—
|
|
|
|
8,050,000
|
|
|
$
|
0.106
|
|
Options/Warrants exercised
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Options/Warrants expired/cancelled
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Outstanding at December 31, 2016
|
|
|
—
|
|
|
|
—
|
|
|
|
14,850,000
|
|
|
$
|
0.100
|
|
Options/Warrants granted
|
|
|
—
|
|
|
|
—
|
|
|
|
1,490,000
|
|
|
$
|
0.101
|
|
Options/Warrants exercised
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Options/Warrants expired/cancelled
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Outstanding at December 31, 2017
|
|
|
—
|
|
|
|
—
|
|
|
|
16,340,000
|
|
|
$
|
0.101
|
|
The
weighted average remaining life of the outstanding warrants as of December 31, 2017 and 2016 was 1.60 and 2.48, respectively.
The intrinsic value of the exercisable warrants as of December 31, 2017 and 2016 was $.0170 and $.0220.
Note
12. Commitments and Contingencies
Commitments
We
lease various office spaces which leases run from July 2016 through September 2018. We have future minimum rental payments as
follows:
Years ending December 31,
|
|
|
Amount
|
|
2018
|
|
|
|
65,250
|
|
2019
|
|
|
|
8,445
|
|
2020
|
|
|
|
4,223
|
|
2021
|
|
|
|
—
|
|
2022
|
|
|
|
—
|
|
Total
|
|
|
$
|
77,918
|
|
Rental
expense for the years ended December 31, 2017 and 2016 was $105,899 and $106,208, respectively.
Contingencies
On June 30, 2016, the Company amended an agreement (originally entered into in July 2010) with certain
former and current employees of the Company, concerning the deferral of payroll claims of approximately $883,190 for salary earned
from 2012 to June 30, 2016 and $1,652,113 for salary earned from 2001 to 2012. The deferral period ended on December 31, 2017 at
which time payroll claims of approximately $1,118,561 for salary earned from 2012 to December 31, 2017 and $1,652,113 for salary
earned from 2001 to 2012, remained unpaid and is reflected as a current liability on the Company’s consolidated financial
statements.
Pursuant
to the terms of the amended agreement, each current and former employee who is a party to the agreement (the “Employee(s)”)
agreed to defer payment of salary from the date of the agreement (“Salary Deferral”) for a period of three months
for salary earned from July 1, 2012 to June 30, 2016 and for a period of six months for salary earned from 2001 to June 30, 2012.
In consideration for the Salary Deferral, the Company issued a total 3,500,000 shares of the Company’s common stock with
the Rule 144 restrictive legend (at a fair market value of $78,750) and agreed to pay each Employee a sum equal to the amount
of unpaid salary at December 31, 2003 plus the amount of unpaid salary at the end of any calendar year after 2003 in which such
salary was earned, plus a Bonus of nine percent interest, compounded annually until such time as the unpaid salary has been paid
in full. The Company and the Employees have agreed that the Bonus will be paid from amounts anticipated to be paid to the Company
in respect of specified intellectual property assets of the Company.
In
order to effect the payments due under this agreement, the Company assigned to the Employees a twenty percent interest in any
net proceeds (gross proceeds less attorney’s fees and direct costs) derived from infringement claims and any license fees
paid by a subsidiary of the Company or third party to the Company regarding (a) U.S. patent #6,826,744 and U.S. patent #7,716,629
(plus any continuation patents) on Adhesive Software’s SiteFlash™ Technology, (b) U.S. patent #7,076,521 (plus any
continuation patents) in respect of “Web-Based Collaborative Data Collection System”, and (c) U.S. patent U.S. Patent
No. #8,578,266 and #9,405,736 (plus any continuation patents) in respect to “Method and System for Automatically Downloading
and Storing Markup Language Documents into a Folder Based Data Structure,” and (d) any license payments made (i) by a subsidiary
of the Company to the Company in connection with a licensing or distribution agreement between the Company and such subsidiary
or (ii) by third party to the Company in connection with a licensing or distribution agreement between the Company and a third
party.
Under
the terms of this agreement, the Bonus is contingent on payment of unpaid wages. In addition, the Bonus is contingent upon generating
revenues from the sources of the twenty percent interests in net proceeds assigned to the current and former employees. The interests
that were assigned under the agreement for net proceeds consist of the underlying patents of the SiteFlash™ and Emily™
technologies and licensing under distribution and licensing agreements between the Company and subsidiaries and between the Company
and third parties. Currently, there is no foreseeable income to be generated from these sources to which a twenty percent interest
can reasonably be projected or otherwise applies to. There is no pending litigation regarding any of these patents. In addition,
with respect to any licenses from Vertical to its subsidiaries, the licenses of technology underlying these patents were for a
three percent royalty on gross revenues. If there were income, any payments under this agreement would likely be minimal. Currently,
there is no income being generated from licensing. No subsidiary is currently offering a product to the market using these licensed
technologies nor does Vertical have any agreement to license these technologies to a third party.
Since
payment of the Bonus is contingent upon first paying all unpaid salary and there are no foreseeable revenues to pay the twenty
percent interest in these technologies, it is doubtful at the present time that any Bonus will be paid and therefore the Bonus
was not accrued as of December 31, 2017 as this contingent liability is considered remote. Cumulative bonus interest through December
31, 2017 is $4,435,576.
Royalties
When
we acquire rights to patents, licenses, or other intellectual property, we generally agree to pay royalties on any net sales of
any products utilizing these rights. There were no sales of products requiring royalties in 2017 and 2016.
We
also have royalty agreements associated with certain notes payable that provide a royalty when revenues exceed certain thresholds
in addition to royalty agreements on subsidiary revenues pursuant to the terms of an acquisition agreement. For the years ended
December 31, 2017 and 2016, we accrued royalties of $4,614 and $7,405, respectively, on revenues from subsidiaries.
Litigation
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 had agreed
to 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 Company made $37,500 in payments due
under the settlement agreement through May 7, 2012 and each party had alleged the other party was in breach of the settlement
agreement.
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. 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. The Company has $121,617 of principal and interest accrued as of December 31, 2017.
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. On September 8, 2017, the court awarded
Mr. Wolman a judgment in the amount of $282,299, which accrues interest at the rate of 16% per annum plus attorney’s fees
as to be determined by the court. The Company has $298,016 of principal and accrued interest as of December 31, 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
13. Subsequent Events
During
the period that runs from January 1, 2018 through May 10, 2018, the Company extended the term of certain warrants to purchase
a total of 5,400,000 shares of VCSY common stock (at $0.10 per share) for an additional 1-year period and granted 83,200 shares
of the common stock of Ploinks, Inc. to third-party lenders in connection with 3 and 6-month extensions of convertible debentures
in the principal amount of $540,000 that were issued in 2015 and 2016.
During
the period that runs from January 1, 2018 through May 10, 2018, 320,000 shares of VCSY common stock issued to employees of
the Company vested.
During
the period that runs from January 1, 2018 through May 10, 2018, 209,998 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.