VERTICAL COMPUTER
SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
(UNAUDITED)
Note 1. Organization,
Basis of Presentation and Significant Accounting Policies
The accompanying unaudited
interim consolidated financial statements of Vertical Computer Systems, Inc. (‘we”, “our”, the “Company”
or “Vertical”) have been prepared in accordance with accounting principles generally accepted in the United States
of America and rules of the Securities and Exchange Commission, and should be read in conjunction with the audited consolidated
financial statements and notes thereto contained in Vertical’s annual report on Form 10-K for the year ended December 31,
2017. 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 87% owned subsidiary and Government Internet Systems, Inc. (“GIS”), an 84.5% owned subsidiary. Vertical’s
subsidiaries which are inactive include EnFacet, Inc. (“ENF”), Globalfare.com, Inc. (“GFI”), Pointmail.com,
Inc. and Vertical Internet Solutions, Inc. (“VIS”), each of which is a wholly-owned subsidiary of Vertical.
In the opinion of management,
all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of financial position and the results
of operations for the interim periods presented have been reflected herein. The results of operations for interim periods are not
necessarily indicative of the results to be expected for the full year. Notes to the consolidated financial statements which would
substantially duplicate the disclosure contained in the audited financial statements as reported in the 2017 annual report on Form
10-K have been omitted.
Revenue Recognition
On January 1, 2018,
the company adopted ASU No. 2016-12, “Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical
Expedients” using the modified retrospective method applied to those contracts which were not completed as of January 1,
2018. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts are
not adjusted and continue to be reported in accordance with our historic accounting under Topic 605. There was no impact to the
opening balance of accumulated deficit as of January 1, 2018 or revenues for the quarter ended September 30, 2018, as a result
of applying Topic 606.
The Company applies
a five-step approach in determining the amount and timing of revenue to be recognized: (1) identifying the contract with a customer,
(2) identifying the performance obligations in the contract, (3) determining the transaction price, (4) allocating the transaction
price to the performance obligations in the contract and (5) recognizing revenue when the performance obligation is satisfied.
Substantially all the Company’s revenue is recognized at the time control of the products transfers to the customer.
ASC 606-10-50-5 requires
that entities disclose disaggregated revenue information in categories (such as type of good or service, geography, market, type
of contract, etc.). ASC 606-10-55-89 explains that the extent to which an entity’s revenue is disaggregated depends on the
facts and circumstances that pertain to the entity’s contracts with customers and that some entities may need to use more
than one type of category to meet the objective for disaggregating revenue.
The Company disaggregates
revenue by industry as well as by country to depict the nature and economic characteristics affecting revenue. The following table
presents our revenue disaggregated by industry for the three and nine months ended:
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
Industry
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agriculture
|
|
$
|
69,535
|
|
|
$
|
70,749
|
|
|
$
|
212,271
|
|
|
$
|
255,653
|
|
Automotive
|
|
|
9,339
|
|
|
|
7,132
|
|
|
|
23,877
|
|
|
|
21,133
|
|
Distribution
|
|
|
15,686
|
|
|
|
33,439
|
|
|
|
63,661
|
|
|
|
65,991
|
|
Education
|
|
|
197,160
|
|
|
|
171,490
|
|
|
|
632,113
|
|
|
|
495,605
|
|
Financial Services
|
|
|
18,605
|
|
|
|
18,720
|
|
|
|
62,294
|
|
|
|
55,329
|
|
Government
|
|
|
124,311
|
|
|
|
99,755
|
|
|
|
388,458
|
|
|
|
327,450
|
|
Healthcare
|
|
|
270,926
|
|
|
|
292,538
|
|
|
|
918,632
|
|
|
|
891,430
|
|
Manufacturing
|
|
|
55,792
|
|
|
|
54,813
|
|
|
|
177,315
|
|
|
|
161,900
|
|
Manufacturing Services
|
|
|
8,401
|
|
|
|
11,133
|
|
|
|
27,764
|
|
|
|
31,894
|
|
Media
|
|
|
28,072
|
|
|
|
28,288
|
|
|
|
86,211
|
|
|
|
81,436
|
|
Oil and Gas
|
|
|
55,016
|
|
|
|
48,929
|
|
|
|
155,968
|
|
|
|
144,012
|
|
Pulp and Paper Distribution
|
|
|
23,126
|
|
|
|
23,935
|
|
|
|
70,455
|
|
|
|
89,685
|
|
Pulp and Paper Manufacturing
|
|
|
5,150
|
|
|
|
4,975
|
|
|
|
15,414
|
|
|
|
14,074
|
|
Engineering
|
|
|
—
|
|
|
|
25,681
|
|
|
|
34,777
|
|
|
|
93,089
|
|
Government Contractor
|
|
|
117,010
|
|
|
|
28,847
|
|
|
|
214,898
|
|
|
|
93,575
|
|
Other
|
|
|
—
|
|
|
|
294
|
|
|
|
—
|
|
|
|
811
|
|
Total revenues
|
|
$
|
998,129
|
|
|
$
|
920,718
|
|
|
$
|
3,084,108
|
|
|
$
|
2,823,067
|
|
The following table
presents our revenue disaggregated by country for the three and nine months ended:
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
Country
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Canada
|
|
$
|
612,629
|
|
|
$
|
579,564
|
|
|
$
|
1,975,042
|
|
|
$
|
1,723,187
|
|
United States
|
|
|
385,500
|
|
|
|
341,154
|
|
|
|
1,109,066
|
|
|
|
1,099,880
|
|
Total revenues
|
|
$
|
998,129
|
|
|
$
|
920,718
|
|
|
$
|
3,084,108
|
|
|
$
|
2,823,067
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per share
Basic earnings per
share is calculated by dividing net income (loss) available to common stockholders by the weighted average number of shares of
the Company’s common stock outstanding during the period. “Diluted earnings per share” reflects the potential
dilution that could occur if our share-based awards and convertible securities were exercised or converted into common stock. The
dilutive effect of our share-based awards is computed using the treasury stock method, which assumes all share-based awards are
exercised and the hypothetical proceeds from exercise are used to purchase common stock at the average market price during the
period. The incremental shares (difference between shares assumed to be issued versus purchased), to the extent they would have
been dilutive, are included in the denominator of the diluted EPS calculation. The dilutive effect of our convertible preferred
stock and convertible debentures is computed using the if-converted method, which assumes conversion at the beginning of the year.
For the nine months
ended September 30, 2018 and 2017, common stock equivalents related to the convertible debentures, convertible debt and preferred
stock and stock derivative liability were not included in the calculation of the diluted earnings per share as their effect would
be anti-dilutive. For the three and nine months ended September 30, 2018 and 2017, the Company had 56,358,481 and 83,059,735 potential
common shares under convertible notes, which were included in the calculation of diluted loss per share.
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 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 the amendment did not 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 because 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.
In November 2016, the
FASB issued ASU 2016-18, Statement of Cash Flows - Restricted Cash (Topic 230), which amends the existing guidance relating to
the disclosure of restricted cash and restricted cash equivalents on the statement of cash flows. ASU 2016-18 is effective for
the fiscal year beginning after December 15, 2017, and interim periods within that fiscal year, and early adoption is permitted.
The adoption of ASU 2016-18 had no effect on our Consolidated Condensed Statements of Cash Flows.
Note 2. Going Concern
The accompanying unaudited
consolidated financial statements for the nine months ended September 30, 2018 and 2017 have been prepared assuming that we will
continue as a going concern, and accordingly realize our assets and satisfy our liabilities in the normal course of business.
The carrying amounts
of assets and liabilities presented in the consolidated financial statements do not purport to represent realizable or settlement
values. As of September 30, 2018, we had negative working capital of approximately $24.9 million and defaulted on several of our
debt obligations. These conditions raise substantial doubt about our ability to continue as a going concern.
Our management is continuing
its efforts to attempt to secure funds through equity and/or debt instruments for our operations, expansion and possible acquisitions,
mergers, joint ventures, and/or other business combinations. The Company will require additional funds to pay down its liabilities,
as well as finance its expansion plans consistent with anticipated changes in operations and infrastructure. However, there can
be no assurance that the Company will be able to secure additional funds and that if such funds are available, whether the terms
or conditions would be acceptable to the Company and whether the Company will be able to turn into a profitable position and generate
positive operating cash flow. The consolidated financial statements contain no adjustment for the outcome of this uncertainty.
Note 3. Notes Payable
The following table
reflects our third party debt activity, including our convertible debt, for the nine months ended September 30, 2018:
December 31, 2017
|
|
$
|
7,098,138
|
|
Repayments of third party notes
|
|
|
(20,944
|
)
|
Borrowings from third parties
|
|
|
795,100
|
|
Debt discounts due to stock, warrants and derivative liabilities
|
|
|
(130,569
|
)
|
Amortization of debt discounts
|
|
|
219,641
|
|
Effect of currency exchange
|
|
|
(281
|
)
|
September 30, 2018
|
|
$
|
7,961,085
|
|
|
|
|
|
|
During the nine months
ended September 30, 2018, the Company borrowed $282,000 from a third party lender at 10% interest per annum, and the Company made
total payments of $20,944 on notes payable to third parties.
During the nine months
ended September 30, 2018, the Company issued promissory notes to third party lenders in the aggregate principal amount of $470,000
for loans made by these lenders in the same amount to the Company. These notes bear interest at 10% per annum and are due within
90 days of the date the respective note was issued and on demand. In connection with the loans, the Company issued 1-year to 3-year
warrants to purchase an aggregate total of 2,700,000 shares of VCSY common stock at a purchase price of $0.10-$0.20 per share to
certain third party lenders.
During the nine
months ended September 30, 2018, the Company extended the term of certain warrants to purchase a total of 12,100,000 shares
of VCSY common stock (at $0.10 per share) for an additional 1-year period and granted a total of 320,199 shares of the common
stock of Ploinks, Inc. to third party lenders in connection with certain extensions of convertible debentures in the
aggregate principal amount of $1,210,000 that were issued from 2015 through 2017. The aggregate fair market value of the
Ploinks shares was determined to be $99,102 and was recorded as debt discount and is being amortized through the term of the
convertible debenture. The incremental change in the fair value of the extended warrants was immaterial and did not change
the conclusion of the debt modification. The due dates for all these convertible debentures were extended until October 1,
2018.
During the nine months
ended September 30, 2018, NOW Solutions issued a note payable in the principal amount of $43,100, to a third party bearing interest
at 10% annum for advances made on behalf of NOW Solutions in 2013.
On July 25, 2018,
Taladin executed an amendment to a pledge agreement (the “Amended Pledge Agreement”) with a third party lender.
In connection with the Amended Pledge Agreement, the Company and NOW Solutions also executed an amendment of certain
promissory notes (the “Taladin Pledged Notes”) issued to the lender by the Company and NOW Solutions to a third
party lender in the aggregate principal amount of $715,000. The outstanding balance due under the Notes as of June 30, 2018,
including interest, was $2,093,334 (plus $280,000 in penalties).
Under the original
pledge agreement, Taladin pledged 20,000,000 shares (the “Taladin Pledged Shares”) of the Company’s common stock
to the lender to secure obligations under the Taladin Pledged Notes, as amended, consisting of (a) promissory note issued by NOW
Solutions in the principal amount of $215,000 issued on September 4, 2003 and assigned to the lender effective on January 4, 2004,
(b) the promissory note issued by VCSY in the principal amount of $200,000 issued on October 24, 2006 and (c) the promissory note
issued by VCSY in the principal amount of $300,000 issued on March 5, 2007.
Terms of the Amended
Pledge Agreement
. Under the terms of the Amended Pledge Agreement, in lieu of selling the Taladin Pledged Shares pursuant to
the original terms of the pledge agreement, Taladin and the lender agreed that Taladin, or a party acting on Taladin’s behalf,
had the right to purchase a total of 10,000,000 shares of the Taladin Pledged Shares from Taladin at a purchase price of $0.015
per share over a certain period of time. The Company made $150,000 in payments to the lender and all rights to the 10,000,000 shares
of the Pledged Stock have been retained by Taladin.
Terms of the Amendment
of the Notes
. Under the terms of the amendment to the Taladin Pledged Notes, all defaults under these notes were cured; however,
the default interest rate of 16% continues to apply, subject to the terms of the amendment of the Taladin Pledged Notes. The Taladin
Pledged Notes have been amended as follows: (a) $125,000 will applied to the currently outstanding penalties in the amount of $280,000,
which were deemed to be paid in full (and the remaining $155,000 in penalties were cancelled) and (b) a payment of $25,000 was
applied toward the Taladin Pledged Notes; (c) beginning on September 1, 2018, and continuing on the first day of each month thereafter,
the Company shall make $25,000 monthly installments payments until January 31, 2020 (the “Maturity Date”) at which
time all outstanding amounts under the Taladin Pledged Notes will be due; (d) upon an additional payment of $175,000, the annual
interest rate for all of the Taladin Pledged Notes will be reduced to an annual interest rate of 12%, provided that if, at any
time the delinquent monthly payments exceed $75,000, the annual interest rate will be raised to an annual interest rate of 16%.
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 the event NOW Solutions does not make payment to Lakeshore, the loan will
be in default and NOW Solutions has five business days from discovery and notice by Lakeshore to make payment plus a penalty in
the amount of 20% of the unpaid 25% share amount.
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 nine months
ended September 30, 2018, the Company, through its subsidiary, declared dividends to Lakeshore of $90,332 of which $89,090 were
paid and $1,242 were left accrued. During the nine months ended September 30, 2017, the Company, through its subsidiary, declared
dividends to Lakeshore of $65,000 which were added to the note balance as part of the December 2017 amendment discussed above.
For additional transactions
and updates concerning notes payable after September 30, 2018, please see “Subsequent Events” in Note 9.
Note 4. Derivative Liability and Fair
Value Measurements
Derivative liability
As of September 30,
2018, the Company has convertible notes and common stock warrants that qualify as derivative liabilities under ASC 815.
As of September 30,
2018, the aggregate fair value of the outstanding derivative liabilities was $63,576. For the nine months ended September 30, 2018,
the net gain on the change in fair value of derivative liabilities was $129,346.
The Company estimated
the fair value of the derivative liabilities using the Black-Scholes option pricing model and the following key assumptions during
2018:
|
2018
|
Expected dividends
|
0%
|
Expected terms (years)
|
0.
21
– 2.92
|
Volatility
|
38% - 164%
|
Risk-free rate
|
2.19% - 2.88%
|
Fair value measurements
FASB ASC 820, Fair
Value Measurements and Disclosures, defines fair value as the exchange price that would be received for an asset or paid to transfer
a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between
market participants on the measurement date. FASB ASC 820 also establishes a fair value hierarchy which requires an entity to maximize
the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. FASB ASC 820 describes three
levels of inputs that may be used to measure fair value:
Level 1
– Quoted
prices in active markets for identical assets or liabilities.
Level 2
– Observable
inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; or other inputs that are observable
or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3
– Unobservable
inputs that are supported by little or no market activity and that are financial instruments whose values are determined using
pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of
fair value requires significant judgment or estimation.
If the inputs used
to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on
the lowest level of input that is significant to the fair value measurement of the instrument.
The following table provides a summary of
the fair value of our derivative liabilities as of September 30, 2018 and December 31, 2017:
|
|
Fair value measurements on a recurring basis
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
As of September 30, 2018:
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative liabilities – convertible debt and warrants
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
63,576
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2017:
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative liabilities - convertible debt and warrants
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
159,537
|
|
The estimated fair
value of short-term financial instruments, including cash, accounts receivable, accounts payable and accrued liabilities and deferred
revenue approximates their carrying value due to their short-term nature. The Company uses Level 3 inputs to estimate the fair
value of its derivative liabilities.
The below table presents
the change in the fair value of the derivative liabilities during the nine months ended September 30, 2018:
Fair value as of December 31, 2017
|
|
$
|
159,537
|
|
Additions recognized as debt discounts
|
|
|
26,647
|
|
Additions due to warrant derivative
|
|
|
6,738
|
|
Gain on change in fair value of derivatives
|
|
|
(129,346
|
)
|
Fair value as of September 30, 2018
|
|
$
|
63,576
|
|
Note 5. Common and Preferred Stock Transactions
On July 25, 2018,
Taladin executed an amendment to a pledge agreement (the “Amended Pledge Agreement”) with a third party lender.
Under the original pledge agreement, Taladin pledged 20,000,000 shares (the “Taladin Pledged Shares”) of the
Company’s common stock to the lender to secure obligations under the Taladin Pledged Notes, as also amended. Under the
terms of the Amended Pledge Agreement, in lieu of selling the Taladin Pledged Shares pursuant to the original terms of the
pledge agreement, Taladin and the lender agreed that Taladin, or a party acting on Taladin’s behalf, had the right to
purchase a total of 10,000,000 shares of the Taladin Pledged Shares from Taladin at a purchase price of $0.015 per share over
a certain period of time. The Company made $150,000 in payments to the lender and all rights to the 10,000,000 shares of the
Pledged Stock have been retained by Taladin.
During the nine months
ended September 30, 2018, the Company issued promissory notes to third party lenders in the aggregate principal amount of $470,000
for loans made by these lenders in the same amount to the Company. These notes bear interest at 10% per annum and are due within
90 days of the date the respective note was issued and on demand. In connection with the loans, the Company issued 1-year to 3-year
warrants to purchase an aggregate total of 2,700,000 shares of VCSY common stock at a purchase price of $0.10-$0.20 per share to
certain third party lenders.
During the nine
months ended September 30, 2018, the Company issued an additional 2,500,000 VCSY common shares at a fair market value of
$33,000 and an additional 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. These additional shares were issued 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, when VHS did not meet performance standards. The company recorded the combined fair
value of $125,850 as non-operating penalties in other income (expense) for the six months ended June 30, 2018.
During the nine
months ended September 30, 2018, the Company extended the term of certain warrants to purchase an aggregate total of 225,000
shares of VCSY common stock at a purchase price of $0.10 and $0.20 per share for an additional 1-year period to third party
subscribers who purchased an aggregate total of 750 shares of VCSY Series A Preferred Convertible Stock in the aggregate
amount of $150,000.
During the nine
months ended September 30, 2018, the Company extended the term of certain warrants to purchase a total of 12,100,000 shares
of VCSY common stock (at $0.10 per share) for an additional 1-year period and granted a total of 320,199 shares of the common
stock of Ploinks, Inc. to third party lenders in connection with certain extensions of convertible debentures in the
aggregate principal amount of $1,210,000 that were issued from 2015 through 2017. The due dates for all these convertible
debentures were extended until October 1, 2018. The incremental change in the fair value of the extended warrants was
immaterial and did not change the conclusion of the debt modification.
During the nine months
ended September 30, 2018, 570,000 shares of VCSY common stock issued to employees of the Company vested.
During the nine months
ended September 30, 2018, warrants to purchase 1,000,000 shares of VCSY common stock at a purchase price of $0.10 per share expired.
During the nine months
ended September 30, 2018, 289,998 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.
Stock compensation
expense for the amortization of restricted stock awards was $33,127 for the nine months ended September 30, 2018. As of September
30, 2018, there were 5,490,000 shares of unvested stock compensation awards to employees and 15,500,000 shares of unvested stock
compensation awards to non-employees.
We have evaluated our
convertible cumulative preferred stock under the guidance set out in FASB ASC 470-20 and accordingly classified these shares as
temporary equity in the consolidated balance sheets.
For additional transactions
after September 30, 2018 concerning stock transactions, please see “Subsequent Events” in Note 9.
Note 6. Option and Warrant Activity
Option and warrant
activities during the nine months ended September 30, 2018 is summarized as follows:
|
|
Incentive Stock Options
|
|
|
Non-Statutory Stock Options
|
|
|
Warrants
|
|
|
Weighted Average Exercise Price
|
|
Outstanding at December 31, 2017
|
|
|
—
|
|
|
|
—
|
|
|
|
16,340,000
|
|
|
$
|
0.101
|
|
Options/Warrants granted
|
|
|
—
|
|
|
|
—
|
|
|
|
2,700,000
|
|
|
$
|
0.181
|
|
Options/Warrants exercised
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Options/Warrants expired/cancelled
|
|
|
—
|
|
|
|
—
|
|
|
|
1,000,000
|
|
|
|
0.10
|
|
Outstanding at September 30, 2018
|
|
|
—
|
|
|
|
—
|
|
|
|
18,040,000
|
|
|
$
|
0.114
|
|
The
weighted average remaining life of the outstanding warrants as of September 30, 2018 was 1.79. The intrinsic value of the exercisable
warrants as of September 30, 2018 was $0.009.
For additional transactions
after September 30, 2018 concerning warrants and stock options, please see “Subsequent Events” in Note 9.
Note 7. Related Party Transactions
The following table
reflects our related party debt activity, including our convertible debt, for the nine months ended September 30, 2018:
December 31, 2017
|
|
$
|
308,242
|
|
Borrowings from related party
|
|
|
45,000
|
|
September 30, 2018
|
|
$
|
353,242
|
|
During the nine months
ended September 30, 2018, a director of the Company loaned the Company $45,000. The debt bears interest at 10% and is payable upon
demand.
As of September 30,
2018, and December 31, 2017, the Company had accounts payable to employees for unreimbursed expenses and related party contractors
in an aggregate amount of $183,641 and $148,760, respectively. The payables are unsecured, non-interest bearing and due on demand.
As of September 30,
2018, and December 31, 2017, the Company has accrued payroll to certain current and former employees of $2,857,777 and $2,770,684,
respectively.
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, 2016 at which time payroll claims of approximately $878,099
for salary earned from 2012 to December 31, 2016 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 during 2016 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 September 30, 2018 and December 31, 2017 as this contingent liability is considered remote. Cumulative bonus interest through
September 30, 2018 is $4,984,867.
Note 8. Legal Proceedings
We are involved in
the following ongoing legal matters:
On December 31, 2011,
the Company and InfiniTek corporation (“InfiniTek”) entered into a settlement agreement to dismiss an action filed
by the Company against InfiniTek in the Texas State District Court in Fort Worth, Texas, for breach of contract and other claims,
a counter claim filed by InfiniTek against the Company for non-payment of amounts claimed the Company owed to InfiniTek, and an
action filed by InfiniTek against the Company in California Superior Court in Riverside, California seeking damages for breach
of contract and lost profit. Pursuant to the terms of the settlement agreement, Vertical agreed to pay InfiniTek $82,500 in three
equal installments with the last payment due by or before August 5, 2012. Upon full payment, InfiniTek 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 $130,839 of principal and interest accrued as of September 30, 2018.
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 $340,883 of principal and accrued interest as of September 30, 2018. We intend to resolve this
matter with Mr. Wolman. This case is styled Derek Wolman v. Now Solutions, Inc., No. 65/502/17.
Note 9. Subsequent Events
During
the period that runs from October 1, 2018 through November 27, 2018, the Company issued a promissory note to a third party lender
in the principal amount of $100,000 for a loan made by the lender in the same amount to the Company. The note bears interest at
10% per annum and is due within 90 days of the date the respective note was issued. In connection with the loan, the Company issued
1-year warrants to purchase an aggregate 2,000,000 shares of VCSY common stock at a purchase price of $0.10-$0.20 per share to
the third party lender.
During the period
that runs from October 1, 2018 through November 27, 2018, 5,950,000 shares of VCSY common stock issued under restricted stock
agreements to employees and consultants of the Company and a subsidiary of the Company vested.
During the period that
runs from October 1, 2018 through November 27, 495,334 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.
During the period that
runs from October 1, 2018 through November 27, 2018, the Company issued certain 3-year warrants to purchase an aggregate
total of 12,100,000 shares of VCSY common stock at a purchase price of $0.10 per share to third party lenders in connection
with certain extensions of convertible debentures in the aggregate principal amount of $12,100,000 that were issued from 2015
through 2017. The incremental change in the fair value of the extended warrants was immaterial and did not change the
conclusion of the debt modification. The due dates for all these convertible debentures were extended until January 15,
2019.
During the
period that runs from October 1, 2018 through November 27, 2018, the Company extended the term of certain warrants to
purchase an aggregate total of 450,000 shares of VCSY common stock at a purchase price of $0.10 and $0.20 per share for an
additional 1-year period to third party subscribers who purchased an aggregate total of 1,500 shares of VCSY Series A
Preferred Convertible Stock in the aggregate amount of $300,000.