0001144204-12-029687.txt : 20120515 0001144204-12-029687.hdr.sgml : 20120515 20120515165449 ACCESSION NUMBER: 0001144204-12-029687 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 20120331 FILED AS OF DATE: 20120515 DATE AS OF CHANGE: 20120515 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VERTICAL COMPUTER SYSTEMS INC CENTRAL INDEX KEY: 0001099509 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 880441551 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-28685 FILM NUMBER: 12845655 BUSINESS ADDRESS: STREET 1: 101 WEST RENNER ROAD, STREET 2: SUITE 300, CITY: RICHARDSON, STATE: TX ZIP: 75082 BUSINESS PHONE: (972) 437-5200 MAIL ADDRESS: STREET 1: 101 WEST RENNER ROAD, STREET 2: SUITE 300, CITY: RICHARDSON, STATE: TX ZIP: 75082 FORMER COMPANY: FORMER CONFORMED NAME: SCIENTIFIC FUEL TECHNOLOGY INC DATE OF NAME CHANGE: 19991122 10-Q 1 v313080_10q.htm FORM 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2012

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _____ to _____

_________________________

Commission file number 0-28685

_________________________

VERTICAL COMPUTER SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

Delaware	65-0393635
(State of incorporation)	(I.R.S. Employer Identification No.)

101 West Renner Road, Suite 300

Richardson, TX 75082

(Address of principal executive offices)

(972) 437-5200

(Registrant’s Telephone Number)

________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer	o		Accelerated filer	o
Non-accelerated filer	o	(Do not check if a smaller reporting company)	Smaller reporting company	x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes ¨ No x

As of May 15, 2012, the issuer had 999,435,151 shares of common stock, par value $0.00001, issued and outstanding.

PART I

FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

Vertical Computer Systems, Inc. and Subsidiaries

Consolidated Balance Sheets

(Unaudited)

	March 31,		December 31,
	2012		2011
Assets
Current assets
Cash	$	130,821	$	132,452
Accounts receivable, net of allowance for bad debts of $27,476 and $12,483		238,049		412,293
Prepaid expenses and other current assets		133,666		137,302
Total current assets		502,536		682,047

Property and equipment, net of accumulated depreciation of $1,012,364 and $1,006,512		37,928		41,050
Intangible assets, net of accumulated amortization of $186,121 and $175,551		769,355		694,294
Deposits and other		15,542		15,695

Total assets	$	1,325,361	$	1,433,086

Liabilities and Stockholder's Deficit
Current liabilities:
Accounts payable and accrued liabilities	$	6,173,350	$	6,566,970
Bank overdraft		12,498		20,401
Deferred revenue		2,673,925		2,549,718
Derivative liability		23,187		24,235
Convertible debenture		30,000		30,000
Current portion - notes payable		1,129,338		800,374
Current portion - notes payable to related parties		367,117		346,183
Total current liabilities		10,409,415		10,337,881

Non-current portion – notes payable		2,421,676		2,330,526
Non-current portion – notes payable to related parties		339,279		339,679

Total liabilities		13,170,370		13,008,086

See accompanying notes to the unaudited consolidated financial statements.

(Continued on next page)

Vertical Computer Systems, Inc. and Subsidiaries

Consolidated Balance Sheets

(Unaudited)

(Continued from previous page)
	March 31,			December 31,
	2012			2011

Series A 4% Convertible Cumulative Preferred stock; $0.001 par value; 250,000 shares authorized; 48,500 shares issued and outstanding		9,700,000			9,700,000
Series B 10% Convertible Cumulative Preferred stock; $0.001 Par Value; 375,000 shares authorized; 7,200 shares issued and outstanding		246			246
Series C 4% Convertible Cumulative Preferred stock; $100.00 par value; 200,000 shares authorized; 50,000 shares issued and outstanding		200,926			200,926
Series D 15% Convertible Cumulative Preferred stock; $0.001 Par Value; 300,000 shares authorized; 25,000 shares issued and outstanding		852			852
		9,902,024			9,902,024

Stockholders' Deficit
Common Stock; $.00001 par value; 1,000,000,000 shares authorized 997,535,151 and 997,335,151 issued and outstanding as of March 31, 2012 and December 31, 2011		9,975			9,973
Additional paid-in-capital		19,246,258			19,240,060
Accumulated deficit		(40,562,344	)		(40,372,612	)
Accumulated other comprehensive income – foreign currency translation		(222,614	)		(155,738	)

Total Vertical Computer Systems, Inc. stockholders’ deficit		(21,528,725	)		(21,278,317	)

Noncontrolling interest		(218,308	)		(198,707	)
Total stockholders’ deficit		(21,747,033	)		(21,477,024	)

Total liabilities and stockholders' deficit	$	1,325,361		$	1,433,086

See accompanying notes to the unaudited consolidated financial statements.

Vertical Computer Systems, Inc. and Subsidiaries

Consolidated Statements of Operations

(Unaudited)

	Three Months Ended March 31,
	2012			2011
Revenues
Licensing and software	$	1,000		$	167,027
Software maintenance		1,136,672			1,107,390
Cloud-based offering		137,077			147,114
Consulting services		93,730			175,405
Other		21,281			31,227
Total revenues		1,389,760			1,628,163

Cost of revenues		360,601			382,469

Gross profit		1,029,159			1,245,694

Operating expenses:
Selling, general and administrative expenses		1,046,437			1,034,809
Depreciation and amortization		15,575			16,888
Bad debt expense		20,872			-
Total operating expenses		1,082,884			1,051,697

Income (loss) from operations		(53,725	)		193,997

Other income (expense):
Interest income		14			7
Gain (loss) on derivative liability		1,048			(3,275	)
Interest expense		(156,670	)		(137,774	)

Net income (loss)		(209,333	)		52,955

Net loss attributable to noncontrolling interest		19,601			19,326
Net income (loss) attributable to Vertical Computer Systems, Inc.		(189,732	)		72,281
Dividends applicable to preferred stock		(147,000	)		(147,000	)

Net loss available to common stockholders	$	(336,732	)	$	(74,719	)

Basic and diluted loss per share	$	(0.00	)	$	(0.00	)

Basic and diluted weighted average of common shares outstanding		997,535,151			997,335,151

Comprehensive income (loss)
Net income (loss)	$	(189,732	)	$	72,281
Translation adjustments		(66,876	)		(41,921	)
Comprehensive income (loss)		(256,608	)		30,360
Comprehensive loss attributable to noncontrolling interest		19,601			19,326
Comprehensive income (loss) attributable to Vertical Computer Systems, Inc.	$	(237,007	)	$	49,686

See accompanying notes to the unaudited consolidated financial statements.

Vertical Computer Systems, Inc. and Subsidiaries

Consolidated Statement of Stockholders’ Deficit

(Unaudited)

					Additional					Other			Non-controlling
	Common Stock				Paid-in		Accumulated			Comprehensive			Controlling
	Shares		Amount		Capital		Deficit			Interest			Interest			Total
Balances at December 31, 2011		997,335,151	$	9,973	$	19,240,060	$	(40,372,612	)	$	(155,738	)	$	(198,707	)	$	(21,477,024	)

Issuance of restricted stock		200,000		2		6,198		-			-			-			6,200

Other comprehensive income translation adjustment		-		-		-		-			(66,876	)		-			(66,876	)

Net loss		-		-		-		(189,732	)		-			(19,601	)		(209,333	)

Balances at March 31, 2012		997,535,151	$	9,975	$	19,246,258	$	(40,562,344	)	$	(222,614	)	$	(218,308	)	$	(21,747,033	)

See accompanying notes to the unaudited consolidated financial statements.

Vertical Computer Systems, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

	Three months ended March 31,
	2012			2011

Cash flows from operating activities
Net income (loss)	$	(209,333	)	$	52,955
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization		15,575			16,888
Amortization of debt discounts		25,300			8,177
Bad debt expense		20,872			-
(Gain) loss on derivatives		(1,048	)		3,275
Changes in operating assets and liabilities:
Accounts receivable		153,372			(51,218	)
Prepaid expenses and other assets		3,787			(26,841	)
Accounts payable and accrued liabilities		(387,419	)		(229,475	)
Deferred revenue		124,207			199,287
Net cash used in operating activities		(254,687	)		(26,952	)

Cash flow from investing activities:
Software development		(85,629	)		(68,269	)
Purchase of property and equipment		(1,884	)		(8,201	)
Net cash used in investing activities		(87,513	)		(76,470	)

Cash flows from financing activities:
Borrowings on notes payable		430,000			50,000
Payments of notes payable		(35,586	)		(1,747	)
Payments of related party notes payable		(5,066	)		(8,963	)
Borrowings on related party debt		26,000			-
Bank overdraft		(7,903	)		(59,038	)
Net cash provided by financing activities		407,445			(19,748	)

Effect of changes in exchange rates on cash		(66,876	)		(41,921	)
Net change in cash and cash equivalents		(1,631	)		(165,091	)
Cash and cash equivalents, beginning of period		132,452			272,970
Cash and cash equivalents, end of period	$	130,821		$	107,879

Supplemental disclosures of cash flow information:
Cash paid for interest	$	74,168		$	84,770

Non-cash investing and financing activities:
Common shares issued for accrued stock compensation	$	6,200		$	-

See accompanying notes to unaudited consolidated financial statements

VERTICAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Note 1. Organization, Basis of Presentation and Significant Accounting Policies

The accompanying unaudited interim consolidated financial statements of Vertical Computer Systems, Inc. (‘we”, “our”, the “Company” or “Vertical”) have been prepared in accordance with accounting principles generally accepted in the United States of America and rules of the Securities and Exchange Commission, and should be read in conjunction with the audited consolidated financial statements and notes thereto contained in Vertical’s annual report on Form 10-K for the year ended December 31, 2011. The consolidated financial statements include the accounts of the Company and its subsidiaries, EnFacet, Inc. (“ENF”), Globalfare.com, Inc. (“GFI”), Pointmail.com, Inc. (“PMI”) and Vertical Internet Solutions, Inc. (“VIS”), all of which are inactive; Vertical Healthcare Solutions, Inc. (“VHS”), OptVision Research, Inc. (“OVR”), Taladin, Inc. (“Taladin”), Government Internet Systems, Inc. (“GIS”), an 84.5% owned subsidiary, SnAPPnet, Inc. (“SnAPPnet”), Priority Time Systems, Inc. (“Priority Time) a 90% owned subsidiary, all entities with minor activities and NOW Solutions, Inc. (“NOW Solutions”). 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 2011 annual report on Form 10-K have been omitted.

Earnings per share

Basic earnings per share is calculated by dividing net income (loss) available to common stockholders by the weighted average number of shares of the Company’s common stock outstanding during the period. “Diluted earnings per share” reflects the potential dilution that could occur if our share-based awards and convertible securities were exercised or converted into common stock. The dilutive effect of our share-based awards is computed using the treasury stock method, which assumes all share-based awards are exercised and the hypothetical proceeds from exercise are used to purchase common stock at the average market price during the period. The incremental shares (difference between shares assumed to be issued versus purchased), to the extent they would have been dilutive, are included in the denominator of the diluted EPS calculation. The dilutive effect of our convertible preferred stock and convertible debentures is computed using the if-converted method, which assumes conversion at the beginning of the year.

For the three months ended March 31, 2012 and 2011, common stock equivalents related to the convertible debentures, convertible debt and preferred stock and stock derivative liability were not included in the calculation of the diluted earnings per share as their effect would be anti-dilutive.

Reclassifications

Certain reclassifications have been made to the prior periods to conform to the current period presentation.

Note 2. Going Concern

The accompanying unaudited consolidated financial statements for the three months ended March 31, 2012 and 2011 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 March 31, 2012, we had negative working capital of approximately $9.9 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 secure funds through equity and/or debt instruments for our operations, expansion and possible acquisitions, mergers, joint ventures, and/or other business combinations as well as to generate additional revenue through our existing businesses, including the licensing of our intellectual property. 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 this uncertainty.

Note 3. Notes Payable

The following table reflects our debt activity, including our convertible debt, for the three months ended March 31, 2012:

December 31, 2011	$	3,846,762
Repayments of third party notes		(35,586	)
Repayments of related party notes		(5,066	)
Borrowings from third parties		430,000
Borrowings from related parties		26,000
Amortization of debt discount		25,300
March 31, 2012	$	4,287,410

In January 2012, NOW Solutions borrowed $26,000 from a related party. The borrowing is due on demand and does not bear interest.

In February 2012, NOW Solutions issued a promissory note in the principal amount of $105,300 to a third party lender in connection with an $80,000 loan from the lender. NOW Solutions granted the third party lender a security interest in all of its assets to secure the obligations under the note, which is junior to the presented indebtedness of NOW Solutions to Tara Financial. The note matured March 15, 2012 and is in default. A discount of $25,300 was recorded on the note which was fully amortized to interest expense during the three months ended March 31, 2012.

In February 2012, the Company and Robert Farias amended the terms of two notes in the principal amounts of $274,679 and $90,000, that were issued by NOW Solutions and VHS in July 2011 in connection with the cancellation of $364,679 of outstanding debt owed to Mr. Farias. Pursuant to the terms of the agreement, beginning February 1, 2012, the interest rate increased to 10% on the outstanding balance of principal and accrued interest accrued through January 31, 2012 under the respective note. The amended payment terms for the notes consist of monthly interest only payments through 2012 with interest and principal payments of $5,000 to be allocated between the notes commencing January 31, 2013 until the notes are fully paid. Also in February 2012, NOW Solutions granted Mr. Farias a security interest in all of its assets to secure the obligations under the $274,679 note in consideration of a personal guarantee made by Mr. Farias to secure the obligations under a note in the principal amount of $105,300 issued to a third party lender for a loan to NOW Solutions. This security interest is junior to the presented indebtedness of NOW Solutions to Tara Financial and a third party lender. Mr. Farias serves as our Executive Vice-President of Business Development.

In March 2012, the Company issued a promissory note in the principal amount of $100,000 to a third party lender in connection to a $100,000 loan from the lender, bearing interest at 12% per annum, payable in monthly installments. To secure the loan, SnAPPnet, Inc. granted the third party lender a security interest in all of its assets to secure the obligations in the aggregate principal amount of $304,000 which includes this note and other notes issued by the Company and NOW Solutions for loans made by this lender.

In March 2012, the Company issued a promissory note to a third party lender in the principal amount of $275,000, bearing interested at 12% per annum, which is due 90 days from issuance. The note was issued in connection with a loan of $250,000 to the Company. The Company recorded a discount of $25,000 on this note which is going to be amortized over the life of the note. There was not amortization of this discount recorded during the three months ended March 31, 2012.

During the three months ended March 31, 2012 and 2011, the Company made interest payments of $74,168 and $84,770, respectively.

Note 4. Derivative liability and fair value measurements

Derivative liability

During 2008, one of our officers pledged 3,000,000 shares of common stock (through a company he controls) to secure the debt owed to a third party lender. In connection with the pledge of stock, we signed an agreement to replace these shares within one year. Subsequent to this agreement, 1,309,983 shares of this stock were sold to satisfy the debt owed to the lender. This contractual commitment to replace all of the pledged shares was evaluated under FASB ASC 815-40, Derivatives and Hedging and was determined to have characteristics of a liability and therefore constituted a derivative liability under the above guidance. Each reporting period, this derivative liability is marked-to-market with the non-cash gain or loss recorded in the period as a gain or loss on derivatives. At March 31, 2012 and December 31, 2011, the fair value of the derivative liability was $23,187 and $24,235.

The aggregate gain or loss on the change in the fair value of derivative liabilities was a gain of $1,048 and a loss of $3,275 for the three months ended March 31, 2012 and 2011, respectively.

The valuation of our embedded derivatives is determined by using the VCSY stock price at March 31, 2012. As such, our derivative liabilities have been classified as Level 1.

Fair value measurements

FASB ASC 820, Fair Value Measurements and Disclosures, defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. FASB ASC 820 describes three levels of inputs that may be used to measure fair value:

Level 1 – Quoted prices in active markets for identical assets or liabilities.

Level 2 – Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 – Unobservable inputs that are supported by little or no market activity and that are financial instruments whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant judgment or estimation.

If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level of input that is significant to the fair value measurement of the instrument.

The following table provides a summary of the fair value of our derivative liabilities as of March 31, 2012 and December 31, 2011:

	Fair value measurements on a recurring basis
	Level 1		Level 2		Level 3
As of March 31, 2012:
Liabilities
Stock derivative – 1,309,983 shares	$	23,187	$	-	$	-

As of December 31, 2011:
Liabilities
Stock derivative – 1,309,983 shares	$	24,235	$	-	$	-

The estimated fair value of short-term financial instruments, including cash, accounts receivable, accounts payable and accrued liabilities and deferred revenue approximates their carrying value due to their short-term nature. The estimated fair value of our long-term borrowings approximates carrying value since the related rates of interest approximate current market rates.

Note 5. Common and Preferred Stock Transactions

During the three months ended March 31, 2012, the Company granted 1,200,000 unregistered shares of our common stock to an employee of the Company and an employee of NOW Solutions pursuant to restricted stock agreements with the Company. These shares vest through March 27, 2014 and the fair value of the awards is being expensed over this vesting period. The aggregate fair value of the awards was determined to be $23,700.

As of the Date of this Report, we have determined that we currently have (i) the following shares of common stock issued, and (ii) outstanding shares of preferred stock which are convertible into the shares of common stock indicated below and a contractual commitment to issue the shares of common stock indicated below:

	999,435,151			Common Stock Issued
	24,250,000			Common Shares convertible from Preferred Series A Stock (48,500 shares outstanding)
	27,274			Common Shares convertible from Preferred Series B Stock (7,200 shares outstanding)
	5,000,000			Common Shares convertible from Preferred Series C Stock (50,000 shares outstanding)
	94,700			Common Shares convertible from Preferred Series D Stock (25,000 shares outstanding)
	1,309,983			Common Shares Company Is Obligated to Reimburse to an officer of the Company for Pledged Shares
	1,030,117,108			Total Common Shares Outstanding and Accounted For/Reserved

In addition, the Company has $30,000 in an outstanding convertible debenture that had been issued to a third party.

Accordingly, given the fact that the Company currently has 1,000,000,000 shares of common stock authorized, the Company could exceed its authorized shares of common stock by approximately 30,000,000 shares if all of the financial instruments described in the table above were exercised or converted into shares of common stock (excluding the $30,000 from the outstanding debenture noted above).

We have evaluated our convertible cumulative preferred stock under the guidance set out in FASB ASC 470-20 and have accordingly classified these shares as temporary equity in the consolidated balance sheets.

Note 6. Stock Options, Warrants and Restricted Stock Awards

Stock options and Warrants

There are currently no outstanding common stock options or warrants.

Restricted Stock

A summary of the activity of the restricted stock for the three months ended March 31, 2011 is shown below.

	Shares			Weighted Average Grant-Date Fair Value

Non Vested Balance at December 31, 2011		600,000		$	0.03100
Granted		1,200,000			0.01975
Vested		(200,000	)		0.03100
Forfeited/Cancelled		-			-
Non Vested Balance at March 31, 2012		1,600,000		$	0.02260

As of March 31, 2012, there was $30,294 of total unrecognized compensation costs related to stock awards. These costs are expected to be recognized over a weighted average period of less than 3 years.

Note 7. Related Party Transactions

In January 2012, NOW Solutions borrowed $26,000 from a related party. The borrowing is due on demand and does not bear interest.

Note 8. Legal Proceedings

We are involved in the following ongoing legal matters:

In August 2009, Parker Shumaker & Mills, LLP (“PSM”) filed a lawsuit in Los Angeles Superior Court to collect the outstanding balance of $51,238 under a promissory note issued by the Company to PSM in the principal amount of $75,000, plus interest at 6% per annum, late fees and attorneys’ fees. We issued the $75,000 note in connection with a settlement in October 2005 with PSM. In December 2009, we entered into a settlement agreement and stipulated judgment with PSM whereby the parties agreed to a judgment balance of $68,500, which included principal, accrued interest, late fees and attorneys’ fees, and we agreed to make monthly installment payments. Bill Mills is a Director of the Company and a partner of PSM. At March 31, 2012, all payments to PSM have been made and this matter has been resolved.

On November 18, 2009, we sued InfiniTek Corporation (“InfiniTek”) in the Texas State District Court in Fort Worth, Texas for breach of contract and other claims (the “Texas Action”) seeking equitable relief and unspecified damages when a dispute between the Company and InfiniTek was not resolved. All agreements with InfiniTek have been cancelled. On January 15, 2010, InfiniTek filed a counter-claim for non-payment of amounts billed. InfiniTek claimed it was owed $195,000 plus lost opportunity costs of not less than $220,000.

On April 7, 2010, we were served with a lawsuit filed by InfiniTek in the California Superior Court in Riverside, California seeking damages in excess of $76,303 for breach of contract and lost profit (the “California Action”). This lawsuit related to one of the causes of action and the same set of underlying facts, as those in the Texas legal action. On May 7, 2010, we filed a motion to dismiss this action. On July 14, 2010, the court denied our motion. On August 13, 2010, we filed an answer to InfiniTek’s complaint, including a denial and affirmative defenses.

On December 31, 2011, the Company and InfiniTek entered into a settlement agreement whereby the Texas Action and the California Action were both dismissed. Pursuant to the terms of the settlement agreement, Vertical agreed to pay InfiniTek $82,500 in three equal installments with the last payment due by or before August 5, 2012. Upon full payment, InfiniTek shall transfer and assign ownership of the NAVPath software developed by InfiniTek for use with NOW Solutions emPath® software application and Microsoft Dynamics NAV (formerly Navision) business solution platform. The amounts in dispute were included in our accounts payable and accrued liabilities and have been adjusted to the settlement amount of $82,500 at December 31, 2011. The Company has made $37,500 in payments due under the settlement agreement as of May 15, 2012.

On November 15, 2010, we filed a lawsuit in the Federal District Court for the Eastern District of Texas (the “Vertical Action”) against Interwoven, Inc. ("Interwoven"), LG Electronics MobileComm U.S.A., Inc., LG Electronics, Inc., Samsung Electronics Co., Ltd. and Samsung Electronics America, Inc. (collectively, the "Defendants"). We sued the Defendants for patent infringement claims under United States Patent No. 6,826,744 (“System and Method for Generating Web Sites in an Arbitrary Object Framework”) and United States Patent No. 7,716,629 (“System and Method for Generating Web Sites in an Arbitrary Object Framework”) (collectively the “the Patents-in-Suit”), both of which are owned by the Company. We seek an award of monetary damages and other relief. The case is styled Vertical Computer Systems, Inc. v Interwoven, Inc., LG Electronics Mobilecomm U.S.A., Inc., No. 2:10-CV-00490.

On November 17, 2010, we were served with a lawsuit filed on October 14, 2010 by Interwoven in the United States District Court for the Northern District of California (the “Interwoven Action”). This lawsuit is a complaint for declaratory judgment, in which Interwoven is requesting that the court find that no valid and enforceable claim of either of the two patents referenced above has been infringed by Interwoven. The case is styled Interwoven, Inc. v Vertical Computer Systems, Inc. No. 3:10-CV-4645-RS.

On January 11, 2011, Samsung Electronics Co., Ltd. and Samsung Electronics America, Inc. (“Samsung”) filed a lawsuit in the United States District Court for the Northern District of California seeking to consolidate its lawsuit with the Interwoven Action. This case is styled Samsung Electronics Co., Ltd. and Samsung Electronics America, Inc., v. Vertical Computer Systems, Inc., No. 3:11-CV-00189-RS.

On May 2, 2011, the United States District Court for the Northern District of California denied Vertical’s renewed motion to transfer the Interwoven Action to the Eastern District of Texas and granted Vertical's motion to transfer the lawsuit filed by Samsung in the Northern District of California to the Eastern district in Texas. On May 11, 2011, the United States District Court for the Eastern District of Texas granted Interwoven’s motion to transfer the case to the Northern District of California with respect to Interwoven and denied Samsung’s motion to transfer its case to the Northern district. On May 12, 2011, Vertical filed in the United States Court of Appeals for the Federal Circuit a petition for a writ of mandamus seeking review of that portion of the May 2, 2011 order by the Northern District of California which refused to transfer the Interwoven v. Vertical action to the Eastern District of Texas, which was denied on August 17, 2011.

On December 30, 2011, the United States District Court for the Northern District of California issued a claims construction order concerning the terms found in the claims of the Patents-in-Suit.

On March 8, 2012, the United States District Court for the Northern District of California in the Interwoven Action denied Interwoven’s motion to stay all judicial proceedings pending the outcome of an ex parte reexamination of each of the Patents-in-Suit by the United States Patent and Trademark Office (“USPTO”).

On April 18, 2012, the USPTO notified the Company of an office action concerning the ex parte reexamination of United States Patent No. 6,826,744. In the office action, the USPTO indicated that Claims 1-11, 18, 19, 21-33, 40, 41 and 45-53 are subject to reexamination; Claims 12-17, 20, 34-39, 42-44 are not subject to reexamination; Claims 6, 8, 19, 30, 32, 41, 50, and 51 are patentable and/or confirmed; and Claims 1-5,7, 9-11, 18, 21-29, 31, 33, 40, 45-49, 52, and 53 are rejected. The Company is in the process of responding to this office action and intends to vigorously prosecute its claims of the Patents-in-Suit to the USPTO.

On July 8, 2011, we were served with a lawsuit in the Texas State District Court in Dallas, Texas by Clark Consulting Services, Inc. (“CCS”) for breach of contract and other claims. CCS was seeking damages from us in excess of $133,750 plus attorney’s fees and interest. On August 8, 2011, we filed an answer denying CCS’s claims and setting forth affirmative defenses. In December 2011, the Company and CCS entered into a settlement agreement whereby the lawsuit was dismissed. Pursuant to the terms of the settlement agreement, the Company agreed to pay CCS $134,000, payable in monthly installments of $5,000 through June 2012 and $10,000 thereafter until the outstanding balance has been paid. The Company will be obligated to pay CCS an additional $60,000 in the event it does not make timely payment within 5 days of notice from CCS. The Company has made all payments due under the settlement agreement as of May 15, 2012.

Note 9. Subsequent Events

During the period from April 1, 2012 to May 15, 2012, the Company granted 300,000 unregistered shares of our common stock (at a fair market value of $4,650) to a consultant pursuant to a restricted stock agreement with the Company.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion is a summary of the key factors management considers necessary or useful in reviewing the Company’s results of operations, liquidity and capital resources. The following discussion and analysis should be read together with the accompanying Unaudited Consolidated Financial Statements, and the cautionary statements and risk factors included below in Item 1A of Part II of this Report.

Critical Accounting Policies

Capitalized Software Costs

Software costs incurred internally in creating computer software products are expensed until technological feasibility has been established upon completion of a detailed program design. Thereafter, all software development costs are capitalized until the point that the product is ready for sale, and are subsequently reported at the lower of unamortized cost or net realizable value. The Company considers annual amortization of capitalized software costs based on the ratio of current year revenues by product to the total estimated revenues by the product, subject to an annual minimum based on straight-line amortization over the product’s estimated economic useful life, not to exceed five years. The Company periodically reviews capitalized software costs for impairment where the fair value is less than the carrying value. During the three months ended March 31, 2012 and 2011, $85,629 and $68,269 of internal costs were capitalized, respectively.

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®, on a cloud-based 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 our 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.

Valuation of the Embedded Derivatives

The valuation of our embedded derivatives is determined by using the Company’s quoted stock price. An embedded derivative is a derivative instrument that is embedded within another contract, which under a convertible note (the host contract) includes the right to convert the note by the holder, certain default redemption right premiums and a change of control premium (payable in cash if a fundamental change occurs). In accordance with the guidance on derivative instruments, embedded derivatives are marked-to-market each reporting period, with a corresponding non-cash gain or loss charged to the current period. The practical effect of this has been that when our stock price increases so does our derivative liability, resulting in a non-cash loss that reduces our earnings and earnings per share. When our stock price declines, we record a non-cash gain, increasing our earnings and earnings per share.

The fair value recorded for the derivative liability varies from period to period. This variability may result in the actual derivative liability for a period either above or below the estimates recorded on our consolidated financial statements, resulting in significant fluctuations in other income (expense) because of the corresponding non-cash gain or loss recorded.

Results of Operations

Three Months Ended March 31, 2012 Compared To Three Months Ended March 31, 2011

Total Revenues. We had total revenues of $1,389,760 and $1,628,163 in the three months ended March 31, 2012 and 2011, respectively. The decrease in total revenues was $238,403 for the three months ended March 31, 2012 representing a 14.6% decrease compared to the total revenues for the three months ended March 31, 2011. Substantially all of the revenues for the three months ended March 31, 2012 and March 31, 2011 were related to the business operations of NOW Solutions, a wholly-owned subsidiary. Revenue from SnAPPnet, Inc. was $28,301 or 2.0% of total revenue for the three months ended March 31, 2012 and $32,474 or 2.0% of total revenues for the three months ended March 31, 2011.

The total revenues primarily consist of fees derived from software licenses, consulting services, software maintenance and Cloud-based offerings. The revenue from new software licenses decreased by $166,027 compared to that for the three months ended March 31, 2011 as there were no new licensing sales of our emPath^® product for the 1^st quarter of 2012. We added one new customer and 2,000 additional users for an existing customer in 2011. Software maintenance in the three months ended March 31, 2012 increased by $29,282 or 2.6% from the same period in the prior year. The revenue increase in software maintenance is primarily due to contractual increases to existing customer maintenance agreements somewhat offset by the effects of unfavorable currency rate changes on our Canadian maintenance revenue. Consulting revenue, in the three months ended March 31, 2012 decreased by $81,675 from the same period in the prior year, which represents a 46.6% decrease. This decrease was due to completed consulting projects compared to the first quarter of 2011 and the effects of unfavorable currency exchange rates. Cloud-based revenues were $137,077 for the three months ended March 31, 2012 compared to $147,114 for the same period in the prior year, representing a $10,037 decrease or 6.8%. The decrease is primarily related to a credit issued to one of our customers in the first quarter of 2012. Other revenue in the three months ended March 31, 2012 decreased by $9,946 or 31.9% from the same period in the prior year. Other revenue consists primarily of reimbursable travel expenses, currency gains and losses, and other miscellaneous revenues.

Cost of Revenues. We had direct costs associated with our revenues of $360,601 for the three months ended March 31, 2012, compared to $382,469 for the three months ended March 31, 2011. The decrease in cost of revenues of $21,868 represents a 5.7% decrease. The decrease in direct cost of revenues was primarily due to decreased costs for third-party hosting expenses, lower travel expenses for consultants and lower commissions. During the three months ended March 31, 2012 and 2011, $85,629 and $68,269 of internal costs were capitalized, respectively.

Selling, General and Administrative Expenses. We had selling, general and administrative expenses of $1,046,437 and $1,034,809 in the three months ended March 31, 2012 and 2011, respectively. The increase of $11,628 is 1.1% more than the same period in 2011. We had higher employee expenses due to higher salaries, higher tax assessments related to our Canadian subsidiary and higher late fees and bank charges somewhat offset by lower travel expenses, legal fees and decreased consulting services.

Bad Debt Expense. We had bad debt expense of $20,872 for the three months ended March 31, 2012. The expense related to the non-payment of a portion of one of Now Solutions, Inc. customer invoices.

Gain (Loss) on Derivative Liability. The existing derivative liability is adjusted each quarter for changes in the market value of the Company’s common stock. The gain on derivative liability was $1,048 for the three months ended March 31, 2012 compared to a loss of $3,275 for the same period in 2011.

Interest Expense. We had interest expense of $156,670 and $137,774 for the three months ended March 31, 2012 and 2011, respectively. Interest expense increased in 2012 by $18,896, representing an increase of 13.7% compared to the same expense in the three months ended March 31, 2011. The increase was primarily due to debt acquired in the first quarter of 2012 which included $25,300 in amortization of debt discounts.

Net Income(loss). We had a net loss of $209,333 and net income of $52,955 for the three months ended March 31, 2012 and 2011, respectively. The net loss for the three months ended March 31, 2012 was due to the factors discussed above for revenues, cost of revenues and selling, general and administrative expenses, which essentially gave us an operating loss of $53,725. This was reduced by interest expense, resulting in a net loss of $209,333 for the three months ended March 31, 2012. For the three months ended March 31, 2011, operating income of $193,997 was reduced by interest expense of $137,774 and a loss on derivative liability of $3,275 resulting in net income of $52,955.

Dividends Applicable to Preferred Stock. We have outstanding Series A 4% convertible cumulative preferred stock that accrues dividends at a rate of 4% on a semi-annual basis. The Company also has outstanding Series C 4% convertible cumulative preferred stock that accrues dividends at a rate of 4% on a quarterly basis. The total dividends applicable to Series A and Series C preferred stock were $147,000 and $147,000 for the three months ended March 31, 2012 and 2011, respectively.

Net Loss Available to Common Stockholders. We had a net loss attributed to common stockholders of $336,732 and a net loss of $74,719 for the three months ended March 31, 2012 and 2011, respectively. Net loss attributed to common stockholders was due to the factors discussed above.

Net Loss Per Share. We had a net loss per share of $0.00 and $0.00 for the three months ended March 31, 2012 and 2011, respectively.

Liquidity and Capital Resources

At March 31, 2012, we had non-restricted cash-on-hand of $130,821 compared to $132,452 at December 31, 2011.

Net cash used in operating activities for the three months ended March 31, 2012 was $254,687 compared to net cash used in operating activities of $26,952 for the three months ended March 31, 2011. For the three months ended March 31, 2012, we collected cash from our customers of $1,361,093. We used the cash to pay for salaries, benefits, payroll taxes and payroll fees of $1,002,024, attorney fees of $19,500, professional fees and consulting fees of $70,416, interest payments of $74,168, taxes (including sales tax and VAT) of $174,615, and other regular trade payables of $275,057. For the three months ended March 31, 2011, we collected cash from our customers of $1,666,564. We used the cash to pay for salaries, benefits, payroll taxes and payroll fees of $1,013,321, attorney fees of $41,083, professional fees and consulting fees of $153,004, interest payments of $84,770, taxes (including sales tax and VAT) of $155,000, and other regular trade payables of $246,338.

A large portion of our cash (and revenue) comes from software maintenance. When we bill and collect for software maintenance, we record a liability in deferred revenue and recognize income ratably over the maintenance period. Deferred revenue increased $124,207 or 4.9% from the balance at December 31, 2011. The increase was due to the maintenance on new customers in 2011 and the impact of price increases on maintenance during 2011. The increased liability at March 31, 2011 will result in higher maintenance revenue in 2012, if all other factors remain relatively constant (i.e. continued price increases, limited customer losses, etc.).

Our accounts receivable trade decreased from $412,293 at December 31, 2011 to $238,049 (net of allowance for bad debts) at March 31, 2012. The decrease is a result of seasonal fluctuations in the timing of billing for software maintenance which typically yields higher receivables in December compared to March.

The accounts payable and accrued liabilities went from $6,566,970 at December 31, 2011 to $6,173,350 at March 31, 2012. As described above, we utilized some of the cash we received from collections on customer accounts receivable to pay current expenses and to pay down some of the accounts payable. The resulting balance at March 31, 2012 is 26 times more than the balance in accounts receivable. This is one of the reasons why we do not have sufficient funds available to fund our operations and repay our debt obligations under their existing terms, as described below.

We used cash to invest in equipment and the development of software products for the three months ended March 31, 2012 and March 31, 2011 of $87,513 and $76,470 respectively. Most of the equipment was computer equipment and peripherals for upgraded network servers to increase the productivity of our software developers, and new personal computers for developers, consultants and sales personnel. Software development relates to the development of new products.

For the three months ended March 31, 2012, we paid $40,652 of principal on notes payable and notes payable to related parties and had $456,000 of new debt funding in the same period. For the three months ended March 31, 2011, we paid $10,710 of principal on notes payable and notes payable to related parties and had $50,000 of new debt funding.

The total change in cash for the three months ended March 31, 2012 was a decrease of $1,631.

As of the date of the filing of this Report, we do not have sufficient funds available to fund our operations and repay our debt obligations under their existing terms. Therefore, we need to raise additional funds through selling securities, obtaining loans, renegotiating the terms of our existing debt and/or increasing sales with our new products. Our inability to raise such funds or renegotiate the terms of our existing debt will significantly jeopardize our ability to continue operations.

	Balance at		Due in Next Five Years
Contractual Obligations	March 31, 2012		2012		2013		2014		2015		2016+
Notes payable	$	4,257,410	$	1,496,455	$	252,418	$	418,370	$	432,765	$	1,657,402
Convertible debenture		30,000		30,000		-		-		-		-
Operating lease		295,385		78,934		93,269		93,330		29,852		-
Total	$	4,582,795	$	1,605,389	$	345,687	$	511,700	$	462,617	$	1,657,402

Following is the status of notes payable:

	March 31, 2012		December 31, 2011

In default	$	1,120,058	$	1,007,824
Not in default		3,137,352		2,808,938

Total Notes Payable	$	4,257,410	$	3,816,762

The carrying amounts of assets and liabilities presented in the financial statements do not purport to represent realizable or settlement values. We had a net loss of $209,333 for the three months ended March 31, 2012 and although we had net income of $52,955 for the three months ended March 31, 2011, we have historically incurred losses. Since December 31, 2009, we have used substantial funds in further developing our product line and in conducting present and new operations, and we need to raise additional funds and/or generate additional revenue through our existing businesses, including the licensing of our intellectual property, to accomplish our objectives. Additionally, at March 31, 2012, we had negative working capital of approximately $9.9 million (although this figure includes deferred revenue of approximately $2.7 million) and have defaulted on several of our debt obligations. These conditions raise substantial doubt about our ability to continue as a going concern.

Our management is continuing its efforts to attempt to secure funds through equity and/or debt instruments for our operations, expansion and possible acquisitions, mergers, joint ventures, and/or other business combinations as well as to generate additional revenue through our existing businesses, including the licensing of our intellectual property. 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 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 unaudited consolidated financial statements contain no adjustment for the outcome of this uncertainty.

Related Party Transactions

In January 2012, NOW Solutions borrowed $26,000 from a related party. The borrowing is due on demand and does not bear interest.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Not applicable.

Item 4. Controls and Procedures

Our management, principally our chief financial officer and chief executive 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 following material weakness of our internal controls:

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.

Management’s annual report on internal control over financial reporting associated with our business is set forth on Form 10-K for the year ended December 31, 2011, as filed on April 2, 2012.

There have been no material changes in our internal control over financial reporting since our reporting on Form 10-K for the year ended December 31, 2011.

PART II

OTHER INFORMATION

Item 1. Legal Proceedings

We are involved in the following ongoing legal matters:

On December 30, 2011, the United States District Court for the Northern District of California issued a claims construction order concerning the terms found in the claims of the Patents-in-Suit.

Item 1A. Risk Factors

A description of the risks associated with our business, financial condition, and results of operations is set forth on Form 10-K for the year ended December 31, 2011, as filed on April 2, 2012.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Item 3. Defaults Upon Senior Securities

None

Item 4. Mine Safety Disclosures

Not applicable

Item 5. Other Information

None

Item 6. Exhibits

The following documents are filed as part of this report:

Exhibit No.	Description	Location
31.1	Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated May 15, 2012	Provided herewith
31.2	Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated May 15, 2012	Provided herewith
32.1	Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, dated May 15, 2012	Provided herewith
32.2	Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, dated May 15, 2012	Provided herewith

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	VERTICAL COMPUTER SYSTEMS, INC.


May 15, 2012	By:	/s/ Richard Wade
		Richard Wade
		President and Chief Executive Officer


May 15, 2012	By:	/s/ Freddy Holder
		Freddy Holder
		Chief Financial Officer

EX-31.1 2 v313080_ex31-1.htm EXHIBIT 31.1

EXHIBIT 31.1

Certification of the Principal Executive Officer

I, Richard S. Wade, chief executive officer, certify that:

1. I have reviewed this quarterly report for the three months ended March 31, 2012 on Form 10-Q of Vertical Computer Systems, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of the annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: May 15, 2012	By:	/s/ Richard S. Wade
		Richard S. Wade
		Chief Executive Officer
		(Principal Executive Officer)

EX-31.2 3 v313080_ex31-2.htm EXHIBIT 31.2

EXHIBIT 31.2

Certification of the Principal Financial Officer

I, Freddy Holder, chief financial officer, certify that:

1. I have reviewed this quarterly report for the three months ended March 31, 2012 on Form 10-Q of Vertical Computer Systems, Inc.;

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: May 15, 2012	By:	/s/ Freddy Holder
		Freddy Holder
		Chief Financial Officer
		(Principal Financial Officer)

EX-32.1 4 v313080_ex32-1.htm EXHIBIT 32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Vertical Computer Systems, Inc. (the “Company”) on Form 10-Q for the three months ended March 31, 2012, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Richard S. Wade, Principal Executive Officer, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 that, to the best of my knowledge:

1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: May 15, 2012	By:	/s/ Richard S. Wade
		Richard S. Wade
		Chief Executive Officer
		(Principal Executive Officer)

EX-32.2 5 v313080_ex32-2.htm EXHIBIT 32.2

Exhibit 32.1

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Vertical Computer Systems, Inc. (the “Company”) on Form 10-Q for the three months ended March 31, 2012, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Freddy Holder, Principal Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 that, to the best of my knowledge:

1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: May 15, 2012	By:	/s/ Freddy Holder
		Freddy Holder
		Chief Financial Officer
		(Principal Financial Officer)

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<div style="FONT: 10pt Times New Roman, Times, Serif"> Note 5. Common and Preferred Stock Transactions   During the three months ended March 31, 2012, the Company granted 1,200,000 unregistered shares of our common stock to an employee of the Company and an employee of NOW Solutions pursuant to restricted stock agreements with the Company. These shares vest through March 27, 2014 and the fair value of the awards is being expensed over this vesting period. The aggregate fair value of the awards was determined to be $23,700.   As of the Date of this Report, we have determined that we currently have (i) the following shares of common stock issued, and (ii) outstanding shares of preferred stock which are convertible into the shares of common stock indicated below and a contractual commitment to issue the shares of common stock indicated below:   <table style="WIDTH: 100%; BORDER-COLLAPSE: collapse; FONT: 10pt Times New Roman, Times, Serif" cellspacing="0" cellpadding="0"> <tr style="BACKGROUND-COLOR: rgb(204,255,204); VERTICAL-ALIGN: bottom"> <td style="TEXT-ALIGN: left; WIDTH: 1%; FONT-SIZE: 10pt">  </td> <td style="TEXT-ALIGN: right; WIDTH: 10%; FONT-SIZE: 10pt"> 999,435,151</td> <td style="TEXT-ALIGN: left; WIDTH: 1%; FONT-SIZE: 10pt">  </td> <td style="WIDTH: 2%; FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: left; WIDTH: 86%; FONT-SIZE: 10pt">Common Stock Issued</td> </tr> <tr style="BACKGROUND-COLOR: white; VERTICAL-ALIGN: bottom"> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: right; FONT-SIZE: 10pt">24,250,000</td> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt"> </td> <td style="FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt">Common Shares convertible from Preferred Series A Stock (48,500 shares outstanding)</td> </tr> <tr style="BACKGROUND-COLOR: rgb(204,255,204); VERTICAL-ALIGN: bottom"> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: right; FONT-SIZE: 10pt">27,274</td> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt"> </td> <td style="FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt">Common Shares convertible from Preferred Series B Stock (7,200 shares outstanding)</td> </tr> <tr style="BACKGROUND-COLOR: white; VERTICAL-ALIGN: bottom"> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: right; FONT-SIZE: 10pt">5,000,000</td> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt"> </td> <td style="FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt">Common Shares convertible from Preferred Series C Stock (50,000 shares outstanding)</td> </tr> <tr style="BACKGROUND-COLOR: rgb(204,255,204); VERTICAL-ALIGN: bottom"> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: right; FONT-SIZE: 10pt">94,700</td> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt"> </td> <td style="FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt">Common Shares convertible from Preferred Series D Stock  (25,000 shares outstanding)</td> </tr> <tr style="BACKGROUND-COLOR: white; VERTICAL-ALIGN: bottom"> <td style="BORDER-BOTTOM: black 1pt solid; TEXT-ALIGN: left; FONT-SIZE: 10pt">  </td> <td style="BORDER-BOTTOM: black 1pt solid; TEXT-ALIGN: right; FONT-SIZE: 10pt"> 1,309,983</td> <td style="BORDER-BOTTOM: black 1pt solid; TEXT-ALIGN: left; PADDING-BOTTOM: 1pt; FONT-SIZE: 10pt">  </td> <td style="BORDER-BOTTOM: black 1pt solid; PADDING-BOTTOM: 1pt; FONT-SIZE: 10pt">  </td> <td style="BORDER-BOTTOM: black 1pt solid; TEXT-ALIGN: left; PADDING-BOTTOM: 1pt; FONT-SIZE: 10pt"> Common Shares Company Is Obligated to Reimburse to an officer of the Company for Pledged Shares</td> </tr> <tr style="BACKGROUND-COLOR: rgb(204,255,204); VERTICAL-ALIGN: bottom"> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: right; FONT-SIZE: 10pt">1,030,117,108</td> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt"> </td> <td style="FONT-SIZE: 10pt; FONT-WEIGHT: bold"> </td> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt; FONT-WEIGHT: bold"> Total Common Shares Outstanding and Accounted For/Reserved</td> </tr> </table>    In addition, the Company has $30,000 in an outstanding convertible debenture that had been issued to a third party.   Accordingly, given the fact that the Company currently has 1,000,000,000 shares of common stock authorized, the Company could exceed its authorized shares of common stock by approximately 30,000,000 shares if all of the financial instruments described in the table above were exercised or converted into shares of common stock (excluding the $30,000 from the outstanding debenture noted above).   We have evaluated our convertible cumulative preferred stock under the guidance set out in FASB ASC 470-20 and have accordingly classified these shares as temporary equity in the consolidated balance sheets. </div>

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<div style="FONT: 10pt Times New Roman, Times, Serif"> Note 3. Notes Payable   The following table reflects our debt activity, including our convertible debt, for the three months ended March 31, 2012:   <table style="WIDTH: 80%; BORDER-COLLAPSE: collapse; FONT: 10pt Times New Roman, Times, Serif" cellspacing="0" cellpadding="0" align="center"> <tr style="BACKGROUND-COLOR: rgb(204,255,204); VERTICAL-ALIGN: bottom"> <td style="WIDTH: 86%; FONT-SIZE: 10pt">December 31, 2011</td> <td style="WIDTH: 2%; FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: left; WIDTH: 1%; FONT-SIZE: 10pt">$</td> <td style="TEXT-ALIGN: right; WIDTH: 10%; FONT-SIZE: 10pt"> 3,846,762</td> <td style="TEXT-ALIGN: left; WIDTH: 1%; FONT-SIZE: 10pt">  </td> </tr> <tr style="BACKGROUND-COLOR: white; VERTICAL-ALIGN: bottom"> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt">Repayments of third party notes</td> <td style="FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: right; FONT-SIZE: 10pt">(35,586</td> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt">)</td> </tr> <tr style="BACKGROUND-COLOR: rgb(204,255,204); VERTICAL-ALIGN: bottom"> <td style="TEXT-ALIGN: left; FONT: 10pt Times New Roman, Times, Serif"> Repayments of related party notes</td> <td style="FONT: 10pt Times New Roman, Times, Serif"> </td> <td style="TEXT-ALIGN: left; FONT: 10pt Times New Roman, Times, Serif">  </td> <td style="TEXT-ALIGN: right; FONT: 10pt Times New Roman, Times, Serif"> (5,066</td> <td style="TEXT-ALIGN: left; FONT: 10pt Times New Roman, Times, Serif">)</td> </tr> <tr style="BACKGROUND-COLOR: white; VERTICAL-ALIGN: bottom"> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt">Borrowings from third parties</td> <td style="FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: right; FONT-SIZE: 10pt">430,000</td> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt"> </td> </tr> <tr style="BACKGROUND-COLOR: rgb(204,255,204); VERTICAL-ALIGN: bottom"> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt">Borrowings from related parties</td> <td style="FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: right; FONT-SIZE: 10pt">26,000</td> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt"> </td> </tr> <tr style="BACKGROUND-COLOR: white; VERTICAL-ALIGN: bottom"> <td style="TEXT-ALIGN: left; PADDING-BOTTOM: 1pt; FONT-SIZE: 10pt"> Amortization of debt discount</td> <td style="PADDING-BOTTOM: 1pt; FONT-SIZE: 10pt"> </td> <td style="BORDER-BOTTOM: black 1pt solid; TEXT-ALIGN: left; FONT-SIZE: 10pt">  </td> <td style="BORDER-BOTTOM: black 1pt solid; TEXT-ALIGN: right; FONT-SIZE: 10pt"> 25,300</td> <td style="TEXT-ALIGN: left; PADDING-BOTTOM: 1pt; FONT-SIZE: 10pt">  </td> </tr> <tr style="BACKGROUND-COLOR: rgb(204,255,204); VERTICAL-ALIGN: bottom"> <td style="PADDING-BOTTOM: 1pt; FONT-SIZE: 10pt">March 31, 2012</td> <td style="PADDING-BOTTOM: 1pt; FONT-SIZE: 10pt"> </td> <td style="BORDER-BOTTOM: black 1pt solid; TEXT-ALIGN: left; FONT-SIZE: 10pt"> $</td> <td style="BORDER-BOTTOM: black 1pt solid; TEXT-ALIGN: right; FONT-SIZE: 10pt"> 4,287,410</td> <td style="TEXT-ALIGN: left; PADDING-BOTTOM: 1pt; FONT-SIZE: 10pt">  </td> </tr> </table>   In January 2012, NOW Solutions borrowed $26,000 from a related party. The borrowing is due on demand and does not bear interest.   In February 2012, NOW Solutions issued a promissory note in the principal amount of $105,300 to a third party lender in connection with an $80,000 loan from the lender. NOW Solutions granted the third party lender a security interest in all of its assets to secure the obligations under the note, which is junior to the presented indebtedness of NOW Solutions to Tara Financial. The note matured March 15, 2012 and is in default. A discount of $25,300 was recorded on the note which was fully amortized to interest expense during the three months ended March 31, 2012.   In February 2012, the Company and Robert Farias amended the terms of two notes in the principal amounts of $274,679 and $90,000, that were issued by NOW Solutions and VHS in July 2011 in connection with the cancellation of $364,679 of outstanding debt owed to Mr. Farias. Pursuant to the terms of the agreement, beginning February 1, 2012, the interest rate increased to 10% on the outstanding balance of principal and accrued interest accrued through January 31, 2012 under the respective note. The amended payment terms for the notes consist of monthly interest only payments through 2012 with interest and principal payments of $5,000 to be allocated between the notes commencing January 31, 2013 until the notes are fully paid. Also in February 2012, NOW Solutions granted Mr. Farias a security interest in all of its assets to secure the obligations under the $274,679 note in consideration of a personal guarantee made by Mr. Farias to secure the obligations under a note in the principal amount of $105,300 issued to a third party lender for a loan to NOW Solutions. This security interest is junior to the presented indebtedness of NOW Solutions to Tara Financial and a third party lender. Mr. Farias serves as our Executive Vice-President of Business Development.   In March 2012, the Company issued a promissory note in the principal amount of $100,000 to a third party lender in connection to a $100,000 loan from the lender, bearing interest at 12% per annum, payable in monthly installments. To secure the loan, SnAPPnet, Inc. granted the third party lender a security interest in all of its assets to secure the obligations in the aggregate principal amount of $304,000 which includes this note and other notes issued by the Company and NOW Solutions for loans made by this lender.   In March 2012, the Company issued a promissory note to a third party lender in the principal amount of $275,000, bearing interested at 12% per annum, which is due 90 days from issuance. The note was issued in connection with a loan of $250,000 to the Company. The Company recorded a discount of $25,000 on this note which is going to be amortized over the life of the note. There was not amortization of this discount recorded during the three months ended March 31, 2012.   During the three months ended March 31, 2012 and 2011, the Company made interest payments of $74,168 and $84,770, respectively. </div>

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<div style="FONT: 10pt Times New Roman, Times, Serif"> Note 9. Subsequent Events   During the period from April 1, 2012 to May 15, 2012, the Company granted 300,000 unregistered shares of our common stock (at a fair market value of $4,650) to a consultant pursuant to a restricted stock agreement with the Company. </div>

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<div style="FONT: 10pt Times New Roman, Times, Serif"> Note 8. Legal Proceedings   We are involved in the following ongoing legal matters:   In August 2009, Parker Shumaker & Mills, LLP (“PSM”) filed a lawsuit in Los Angeles Superior Court to collect the outstanding balance of $51,238 under a promissory note issued by the Company to PSM in the principal amount of $75,000, plus interest at 6% per annum, late fees and attorneys’ fees. We issued the $75,000 note in connection with a settlement in October 2005 with PSM. In December 2009, we entered into a settlement agreement and stipulated judgment with PSM whereby the parties agreed to a judgment balance of $68,500, which included principal, accrued interest, late fees and attorneys’ fees, and we agreed to make monthly installment payments. Bill Mills is a Director of the Company and a partner of PSM. At March 31, 2012, all payments to PSM have been made and this matter has been resolved.   On November 18, 2009, we sued InfiniTek Corporation (“InfiniTek”) in the Texas State District Court in Fort Worth, Texas for breach of contract and other claims (the “Texas Action”) seeking equitable relief and unspecified damages when a dispute between the Company and InfiniTek was not resolved. All agreements with InfiniTek have been cancelled. On January 15, 2010, InfiniTek filed a counter-claim for non-payment of amounts billed. InfiniTek claimed it was owed $195,000 plus lost opportunity costs of not less than $220,000.   On April 7, 2010, we were served with a lawsuit filed by InfiniTek in the California Superior Court in Riverside, California seeking damages in excess of $76,303 for breach of contract and lost profit (the “California Action”). This lawsuit related to one of the causes of action and the same set of underlying facts, as those in the Texas legal action. On May 7, 2010, we filed a motion to dismiss this action. On July 14, 2010, the court denied our motion. On August 13, 2010, we filed an answer to InfiniTek’s complaint, including a denial and affirmative defenses.   On December 31, 2011, the Company and InfiniTek entered into a settlement agreement whereby the Texas Action and the California Action were both dismissed. Pursuant to the terms of the settlement agreement, Vertical agreed to pay InfiniTek $82,500 in three equal installments with the last payment due by or before August 5, 2012. Upon full payment, InfiniTek shall transfer and assign ownership of the NAVPath software developed by InfiniTek for use with NOW Solutions emPath® software application and Microsoft Dynamics NAV (formerly Navision) business solution platform. The amounts in dispute were included in our accounts payable and accrued liabilities and have been adjusted to the settlement amount of $82,500 at December 31, 2011. The Company has made $37,500 in payments due under the settlement agreement as of May 15, 2012.   On November 15, 2010, we filed a lawsuit in the Federal District Court for the Eastern District of Texas (the “Vertical Action”) against Interwoven, Inc. ("Interwoven"), LG Electronics MobileComm U.S.A., Inc., LG Electronics, Inc., Samsung Electronics Co., Ltd. and Samsung Electronics America, Inc. (collectively, the "Defendants"). We sued the Defendants for patent infringement claims under United States Patent No. 6,826,744 (“System and Method for Generating Web Sites in an Arbitrary Object Framework”) and United States Patent No. 7,716,629 (“System and Method for Generating Web Sites in an Arbitrary Object Framework”) (collectively the “the Patents-in-Suit”), both of which are owned by the Company. We seek an award of monetary damages and other relief. The case is styled Vertical Computer Systems, Inc. v Interwoven, Inc., LG Electronics Mobilecomm U.S.A., Inc., No. 2:10-CV-00490.   On November 17, 2010, we were served with a lawsuit filed on October 14, 2010 by Interwoven in the United States District Court for the Northern District of California (the “Interwoven Action”). This lawsuit is a complaint for declaratory judgment, in which Interwoven is requesting that the court find that no valid and enforceable claim of either of the two patents referenced above has been infringed by Interwoven. The case is styled Interwoven, Inc. v Vertical Computer Systems, Inc. No. 3:10-CV-4645-RS.   On January 11, 2011, Samsung Electronics Co., Ltd. and Samsung Electronics America, Inc. (“Samsung”) filed a lawsuit in the United States District Court for the Northern District of California seeking to consolidate its lawsuit with the Interwoven Action. This case is styled Samsung Electronics Co., Ltd. and Samsung Electronics America, Inc., v. Vertical Computer Systems, Inc., No. 3:11-CV-00189-RS.   On May 2, 2011, the United States District Court for the Northern District of California denied Vertical’s renewed motion to transfer the Interwoven Action to the Eastern District of Texas and granted Vertical's motion to transfer the lawsuit filed by Samsung in the Northern District of California to the Eastern district in Texas. On May 11, 2011, the United States District Court for the Eastern District of Texas granted Interwoven’s motion to transfer the case to the Northern District of California with respect to Interwoven and denied Samsung’s motion to transfer its case to the Northern district. On May 12, 2011, Vertical filed in the United States Court of Appeals for the Federal Circuit a petition for a writ of mandamus seeking review of that portion of the May 2, 2011 order by the Northern District of California which refused to transfer the Interwoven v. Vertical action to the Eastern District of Texas, which was denied on August 17, 2011.    On December 30, 2011, the United States District Court for the Northern District of California issued a claims construction order concerning the terms found in the claims of the Patents-in-Suit.   On March 8, 2012, the United States District Court for the Northern District of California in the Interwoven Action denied Interwoven’s motion to stay all judicial proceedings pending the outcome of an ex parte reexamination of each of the Patents-in-Suit by the United States Patent and Trademark Office (“USPTO”).   On April 18, 2012, the USPTO notified the Company of an office action concerning the ex parte reexamination of United States Patent No. 6,826,744.  In the office action, the USPTO indicated that Claims 1-11, 18, 19, 21-33, 40, 41 and 45-53 are subject to reexamination; Claims 12-17, 20, 34-39, 42-44 are not subject to reexamination; Claims 6, 8, 19, 30, 32, 41, 50, and 51 are patentable and/or confirmed; and Claims 1-5,7, 9-11, 18, 21-29, 31, 33, 40, 45-49, 52, and 53 are rejected.  The Company is in the process of responding to this office action and intends to vigorously prosecute its claims of the Patents-in-Suit to the USPTO.   On July 8, 2011, we were served with a lawsuit in the Texas State District Court in Dallas, Texas by Clark Consulting Services, Inc. (“CCS”) for breach of contract and other claims.  CCS was seeking damages from us in excess of $133,750 plus attorney’s fees and interest.  On August 8, 2011, we filed an answer denying CCS’s claims and setting forth affirmative defenses.  In December 2011, the Company and CCS entered into a settlement agreement whereby the lawsuit was dismissed. Pursuant to the terms of the settlement agreement, the Company agreed to pay CCS $134,000, payable in monthly installments of $5,000 through June 2012 and $10,000 thereafter until the outstanding balance has been paid. The Company will be obligated to pay CCS an additional $60,000 in the event it does not make timely payment within 5 days of notice from CCS. The Company has made all payments due under the settlement agreement as of May 15, 2012. </div>

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<div style="FONT: 10pt Times New Roman, Times, Serif"> Note 4. Derivative liability and fair value measurements   Derivative liability   During 2008, one of our officers pledged 3,000,000 shares of common stock (through a company he controls) to secure the debt owed to a third party lender. In connection with the pledge of stock, we signed an agreement to replace these shares within one year. Subsequent to this agreement, 1,309,983 shares of this stock were sold to satisfy the debt owed to the lender. This contractual commitment to replace all of the pledged shares was evaluated under FASB ASC 815-40, Derivatives and Hedging and was determined to have characteristics of a liability and therefore constituted a derivative liability under the above guidance. Each reporting period, this derivative liability is marked-to-market with the non-cash gain or loss recorded in the period as a gain or loss on derivatives. At March 31, 2012 and December 31, 2011, the fair value of the derivative liability was $23,187 and $24,235.   The aggregate gain or loss on the change in the fair value of derivative liabilities was a gain of $1,048 and a loss of $3,275 for the three months ended March 31, 2012 and 2011, respectively.    The valuation of our embedded derivatives is determined by using the VCSY stock price at March 31, 2012. As such, our derivative liabilities have been classified as Level 1.   Fair value measurements   FASB ASC 820, Fair Value Measurements and Disclosures, defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. FASB ASC 820 describes three levels of inputs that may be used to measure fair value:   Level 1 – Quoted prices in active markets for identical assets or liabilities.   Level 2 – Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.   Level 3 – Unobservable inputs that are supported by little or no market activity and that are financial instruments whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant judgment or estimation.   If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level of input that is significant to the fair value measurement of the instrument.   The following table provides a summary of the fair value of our derivative liabilities as of March 31, 2012 and December 31, 2011:   <table style="WIDTH: 100%; FONT: 10pt Times New Roman, Times, Serif" cellspacing="0" cellpadding="0"> <tr style="VERTICAL-ALIGN: bottom"> <td style="PADDING-BOTTOM: 1pt; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 1pt; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="BORDER-BOTTOM: black 1pt solid; TEXT-ALIGN: center; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px" colspan="10">Fair value measurements on a recurring basis</td> <td style="PADDING-BOTTOM: 1pt; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> </tr> <tr style="VERTICAL-ALIGN: bottom"> <td style="PADDING-BOTTOM: 1pt; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 1pt; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="BORDER-BOTTOM: black 1pt solid; TEXT-ALIGN: center; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px" colspan="2">Level 1</td> <td style="PADDING-BOTTOM: 1pt; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 1pt; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="BORDER-BOTTOM: black 1pt solid; TEXT-ALIGN: center; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px" colspan="2">Level 2</td> <td style="PADDING-BOTTOM: 1pt; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 1pt; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="BORDER-BOTTOM: black 1pt solid; TEXT-ALIGN: center; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px" colspan="2">Level 3</td> <td style="PADDING-BOTTOM: 1pt; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> </tr> <tr style="BACKGROUND-COLOR: rgb(204,255,204); VERTICAL-ALIGN: bottom"> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; WIDTH: 64%; PADDING-RIGHT: 0px; PADDING-TOP: 0px"> As of March 31, 2012:</td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; WIDTH: 1%; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; WIDTH: 1%; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; WIDTH: 9%; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; WIDTH: 1%; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; WIDTH: 1%; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; WIDTH: 1%; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; WIDTH: 9%; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; WIDTH: 1%; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; WIDTH: 1%; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; WIDTH: 1%; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; WIDTH: 9%; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; WIDTH: 1%; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> </tr> <tr style="BACKGROUND-COLOR: white; VERTICAL-ALIGN: bottom"> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px"> Liabilities</td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> </tr> <tr style="BACKGROUND-COLOR: rgb(204,255,204)"> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0.12in; PADDING-RIGHT: 0px; PADDING-TOP: 0px"> Stock derivative – 1,309,983 shares</td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px"> $</td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px"> 23,187</td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px"> $</td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px"> -</td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px"> $</td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px"> -</td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; VERTICAL-ALIGN: bottom; PADDING-TOP: 0px">  </td> </tr> <tr style="BACKGROUND-COLOR: white"> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; VERTICAL-ALIGN: bottom; PADDING-TOP: 0px">  </td> </tr> <tr style="BACKGROUND-COLOR: rgb(204,255,204); VERTICAL-ALIGN: bottom"> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px"> As of December 31, 2011:</td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> </tr> <tr style="BACKGROUND-COLOR: white; VERTICAL-ALIGN: bottom"> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px"> Liabilities</td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> </tr> <tr style="BACKGROUND-COLOR: rgb(204,255,204)"> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0.12in; PADDING-RIGHT: 0px; PADDING-TOP: 0px"> Stock derivative – 1,309,983 shares</td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px"> $</td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px"> 24,235</td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px"> $</td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px"> -</td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px">  </td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px"> $</td> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; PADDING-TOP: 0px"> -</td> <td style="PADDING-BOTTOM: 0px; TEXT-INDENT: 0px; PADDING-LEFT: 0px; PADDING-RIGHT: 0px; VERTICAL-ALIGN: bottom; PADDING-TOP: 0px">  </td> </tr> </table>   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. </div>

15575

-53725

-256608

<div style="FONT: 10pt Times New Roman, Times, Serif"> 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, 2011. The consolidated financial statements include the accounts of the Company and its subsidiaries, EnFacet, Inc. (“ENF”), Globalfare.com, Inc. (“GFI”), Pointmail.com, Inc. (“PMI”) and Vertical Internet Solutions, Inc. (“VIS”), all of which are inactive; Vertical Healthcare Solutions, Inc. (“VHS”), OptVision Research, Inc. (“OVR”), Taladin, Inc. (“Taladin”), Government Internet Systems, Inc. (“GIS”), an 84.5% owned subsidiary, SnAPPnet, Inc. (“SnAPPnet”), Priority Time Systems, Inc. (“Priority Time) a 90% owned subsidiary, all entities with minor activities and NOW Solutions, Inc. (“NOW Solutions”). 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 2011 annual report on Form 10-K have been omitted.   Earnings per share   Basic earnings per share is calculated by dividing net income (loss) available to common stockholders by the weighted average number of shares of the Company’s common stock outstanding during the period. “Diluted earnings per share” reflects the potential dilution that could occur if our share-based awards and convertible securities were exercised or converted into common stock. The dilutive effect of our share-based awards is computed using the treasury stock method, which assumes all share-based awards are exercised and the hypothetical proceeds from exercise are used to purchase common stock at the average market price during the period. The incremental shares (difference between shares assumed to be issued versus purchased), to the extent they would have been dilutive, are included in the denominator of the diluted EPS calculation. The dilutive effect of our convertible preferred stock and convertible debentures is computed using the if-converted method, which assumes conversion at the beginning of the year.   For the three months ended March 31, 2012 and 2011, common stock equivalents related to the convertible debentures, convertible debt and preferred stock and stock derivative liability were not included in the calculation of the diluted earnings per share as their effect would be anti-dilutive.   Reclassifications   Certain reclassifications have been made to the prior periods to conform to the current period presentation. </div>

1000

1046437

-7903

-3787

-66876

1136672

5066

-1631

74168

1082884

<div style="FONT: 10pt Times New Roman, Times, Serif"> Note 6. Stock Options, Warrants and Restricted Stock Awards   Stock options and Warrants   There are currently no outstanding common stock options or warrants.   Restricted Stock   A summary of the activity of the restricted stock for the three months ended March 31, 2011 is shown below.   <table style="WIDTH: 90%; BORDER-COLLAPSE: collapse; FONT: 10pt Times New Roman, Times, Serif; MARGIN-LEFT: 0.5in" cellspacing="0" cellpadding="0"> <tr style="VERTICAL-ALIGN: bottom"> <td style="FONT-SIZE: 10pt; FONT-WEIGHT: bold"> </td> <td style="PADDING-BOTTOM: 1pt; FONT-SIZE: 10pt"> </td> <td style="BORDER-BOTTOM: black 1pt solid; TEXT-ALIGN: center; FONT-SIZE: 10pt" colspan="2">Shares</td> <td style="PADDING-BOTTOM: 1pt; FONT-SIZE: 10pt"> </td> <td style="PADDING-BOTTOM: 1pt; FONT-SIZE: 10pt; FONT-WEIGHT: bold">  </td> <td style="BORDER-BOTTOM: black 1pt solid; TEXT-ALIGN: center; FONT-SIZE: 10pt; FONT-WEIGHT: bold" colspan="2">Weighted Average Grant-Date Fair Value</td> <td style="PADDING-BOTTOM: 1pt; FONT-SIZE: 10pt; FONT-WEIGHT: bold">  </td> </tr> <tr style="VERTICAL-ALIGN: bottom"> <td style="FONT-SIZE: 10pt; FONT-WEIGHT: bold"> </td> <td style="FONT-SIZE: 10pt; FONT-WEIGHT: bold"> </td> <td style="TEXT-ALIGN: right; FONT-SIZE: 10pt; FONT-WEIGHT: bold" colspan="2"> </td> <td style="FONT-SIZE: 10pt; FONT-WEIGHT: bold"> </td> <td style="FONT-SIZE: 10pt; FONT-WEIGHT: bold"> </td> <td style="FONT-SIZE: 10pt; FONT-WEIGHT: bold" colspan="2">  </td> <td style="FONT-SIZE: 10pt; FONT-WEIGHT: bold"> </td> </tr> <tr style="BACKGROUND-COLOR: rgb(204,255,204); VERTICAL-ALIGN: bottom"> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt; FONT-WEIGHT: bold" colspan="2">Non Vested Balance at December 31, 2011</td> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: right; FONT-SIZE: 10pt">600,000</td> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt"> </td> <td style="FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt">$</td> <td style="TEXT-ALIGN: right; FONT-SIZE: 10pt">0.03100</td> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt"> </td> </tr> <tr style="BACKGROUND-COLOR: white; VERTICAL-ALIGN: bottom"> <td style="TEXT-ALIGN: right; WIDTH: 23%; FONT-SIZE: 10pt"> Granted</td> <td style="WIDTH: 51%; FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: left; WIDTH: 1%; FONT-SIZE: 10pt">  </td> <td style="TEXT-ALIGN: right; WIDTH: 10%; FONT-SIZE: 10pt"> 1,200,000</td> <td style="TEXT-ALIGN: left; WIDTH: 1%; FONT-SIZE: 10pt">  </td> <td style="WIDTH: 2%; FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: left; WIDTH: 1%; FONT-SIZE: 10pt">  </td> <td style="TEXT-ALIGN: right; WIDTH: 10%; FONT-SIZE: 10pt"> 0.01975</td> <td style="TEXT-ALIGN: left; WIDTH: 1%; FONT-SIZE: 10pt">  </td> </tr> <tr style="BACKGROUND-COLOR: rgb(204,255,204); VERTICAL-ALIGN: bottom"> <td style="TEXT-ALIGN: right; FONT-SIZE: 10pt">Vested</td> <td style="FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: right; FONT-SIZE: 10pt">(200,000</td> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt">)</td> <td style="FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt"> </td> <td style="TEXT-ALIGN: right; FONT-SIZE: 10pt">0.03100</td> <td style="TEXT-ALIGN: left; FONT-SIZE: 10pt"> </td> </tr> <tr style="BACKGROUND-COLOR: white; VERTICAL-ALIGN: bottom"> <td style="TEXT-ALIGN: right; PADDING-BOTTOM: 1pt; FONT-SIZE: 10pt"> Forfeited/Cancelled</td> <td style="PADDING-BOTTOM: 1pt; FONT-SIZE: 10pt"> </td> <td style="BORDER-BOTTOM: black 1pt solid; TEXT-ALIGN: left; FONT-SIZE: 10pt">  </td> <td style="BORDER-BOTTOM: black 1pt solid; TEXT-ALIGN: right; FONT-SIZE: 10pt"> -</td> <td style="TEXT-ALIGN: left; PADDING-BOTTOM: 1pt; FONT-SIZE: 10pt">  </td> <td style="PADDING-BOTTOM: 1pt; FONT-SIZE: 10pt"> </td> <td style="BORDER-BOTTOM: black 1pt solid; TEXT-ALIGN: left; FONT-SIZE: 10pt">  </td> <td style="BORDER-BOTTOM: black 1pt solid; TEXT-ALIGN: right; FONT-SIZE: 10pt"> -</td> <td style="TEXT-ALIGN: left; PADDING-BOTTOM: 1pt; FONT-SIZE: 10pt">  </td> </tr> <tr style="BACKGROUND-COLOR: rgb(204,255,204); VERTICAL-ALIGN: bottom"> <td style="TEXT-ALIGN: left; PADDING-BOTTOM: 1pt; FONT-SIZE: 10pt; FONT-WEIGHT: bold" colspan="2">Non Vested Balance at March 31, 2012</td> <td style="BORDER-BOTTOM: black 1pt solid; TEXT-ALIGN: left; FONT-SIZE: 10pt">  </td> <td style="BORDER-BOTTOM: black 1pt solid; TEXT-ALIGN: right; FONT-SIZE: 10pt"> 1,600,000</td> <td style="TEXT-ALIGN: left; PADDING-BOTTOM: 1pt; FONT-SIZE: 10pt">  </td> <td style="PADDING-BOTTOM: 1pt; FONT-SIZE: 10pt"> </td> <td style="BORDER-BOTTOM: black 1pt solid; TEXT-ALIGN: left; FONT-SIZE: 10pt"> $</td> <td style="BORDER-BOTTOM: black 1pt solid; TEXT-ALIGN: right; FONT-SIZE: 10pt"> 0.02260</td> <td style="TEXT-ALIGN: left; PADDING-BOTTOM: 1pt; FONT-SIZE: 10pt">  </td> </tr> </table>   As of March 31, 2012, there was $30,294 of total unrecognized compensation costs related to stock awards. These costs are expected to be recognized over a weighted average period of less than 3 years. </div>

124207

<div style="FONT: 10pt Times New Roman, Times, Serif"> Note 7. Related Party Transactions   In January 2012, NOW Solutions borrowed $26,000 from a related party. The borrowing is due on demand and does not bear interest.   In February 2012, the Company and Robert Farias amended the terms of two notes in the principal amounts of $274,679 and $90,000, that were issued by NOW Solutions and VHS in July 2011 in connection with the cancellation of $364,679 of outstanding debt owed to Mr. Farias. Pursuant to the terms of the agreement, beginning February 1, 2012, the interest rate increased to 10% on the outstanding balance of principal and accrued interest accrued through January 31, 2012 under the respective note. The amended payment terms for the notes consist of monthly interest only payments through 2012 with interest and principal payments of $5,000 to be allocated between the notes commencing January 31, 2013 until the notes are fully paid. Also in February 2012, NOW Solutions granted Mr. Farias a security interest in all of its assets to secure the obligations under the $274,679 note in consideration of a personal guarantee made by Mr. Farias to secure the obligations under a note in the principal amount of $105,300 issued to a third party lender for a loan to NOW Solutions. This security interest is junior to the presented indebtedness of NOW Solutions to Tara Financial and a third party lender. Mr. Farias serves as our Executive Vice-President of Business Development. </div>

407445

35586

-209333

0.00

21281 997535151 <div style="FONT: 10pt Times New Roman, Times, Serif"> Note 2. Going Concern   The accompanying unaudited consolidated financial statements for the three months ended March 31, 2012 and 2011 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 March 31, 2012, we had negative working capital of approximately $9.9 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 secure funds through equity and/or debt instruments for our operations, expansion and possible acquisitions, mergers, joint ventures, and/or other business combinations as well as to generate additional revenue through our existing businesses, including the licensing of our intellectual property. 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 this uncertainty. </div>

-189732

-19601

-66876

200000

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Notes Payable

3 Months Ended

Mar. 31, 2012

Notes Payable

Note 3. Notes Payable

The following table reflects our debt activity, including our convertible debt, for the three months ended March 31, 2012:

December 31, 2011	$	3,846,762
Repayments of third party notes		(35,586	)
Repayments of related party notes		(5,066	)
Borrowings from third parties		430,000
Borrowings from related parties		26,000
Amortization of debt discount		25,300
March 31, 2012	$	4,287,410

In January 2012, NOW Solutions borrowed $26,000 from a related party. The borrowing is due on demand and does not bear interest.

During the three months ended March 31, 2012 and 2011, the Company made interest payments of $74,168 and $84,770, respectively.

- Definition

The entire disclosure for information about short-term and long-term debt arrangements, which includes amounts of borrowings under each line of credit, note payable, commercial paper issue, bonds indenture, debenture issue, own-share lending arrangements and any other contractual agreement to repay funds, and about the underlying arrangements, rationale for a classification as long-term, including repayment terms, interest rates, collateral provided, restrictions on use of assets and activities, whether or not in compliance with debt covenants, and other matters important to users of the financial statements, such as the effects of refinancing and noncompliance with debt covenants.

+ References+ Details

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Going Concern
3 Months Ended

Mar. 31, 2012

Going Concern

Note 2. Going Concern

The accompanying unaudited consolidated financial statements for the three months ended March 31, 2012 and 2011 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 March 31, 2012, we had negative working capital of approximately $9.9 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 secure funds through equity and/or debt instruments for our operations, expansion and possible acquisitions, mergers, joint ventures, and/or other business combinations as well as to generate additional revenue through our existing businesses, including the licensing of our intellectual property. 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 this uncertainty.

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XML 17 R2.htm IDEA: XBRL DOCUMENT v2.4.0.6

Consolidated Balance Sheets (USD $)

Mar. 31, 2012

Dec. 31, 2011

Current assets

Cash $ 130,821 $ 132,452

Accounts receivable, net of allowance for bad debts of $27,476 and $12,483 238,049 412,293

Prepaid expenses and other current assets 133,666 137,302

Total current assets 502,536 682,047

Property and equipment, net of accumulated depreciation of $1,012,364 and $1,006,512 37,928 41,050

Intangible assets, net of accumulated amortization of $186,121 and $175,551 769,355 694,294

Deposits and other 15,542 15,695

Total assets 1,325,361 1,433,086

Current liabilities:

Accounts payable and accrued liabilities 6,173,350 6,566,970

Bank overdraft 12,498 20,401

Deferred revenue 2,673,925 2,549,718

Derivative liability 23,187 24,235

Convertible debenture 30,000 30,000

Current portion - notes payable 1,129,338 800,374

Current portion - notes payable to related parties 367,117 346,183

Total current liabilities 10,409,415 10,337,881

Non-current portion - notes payable 2,421,676 2,330,526

Non-current portion - notes payable to related parties 339,279 339,679

Total liabilities 13,170,370 13,008,086

Convertible Cumulative Preferred stock 9,902,024 9,902,024

Stockholders' Deficit

Common Stock; $.00001 par value; 1,000,000,000 shares authorized 997,535,151 and 997,335,151 issued and outstanding as of March 31, 2012 and December 31, 2011 9,975 9,973

Additional paid-in-capital 19,246,258 19,240,060

Accumulated deficit (40,562,344) (40,372,612)

Accumulated other comprehensive income - foreign currency translation (222,614) (155,738)

Total Vertical Computer Systems, Inc. stockholders' deficit (21,528,725) (21,278,317)

Noncontrolling interest (218,308) (198,707)

Total stockholders' deficit (21,747,033) (21,477,024)

Total liabilities and stockholders' deficit 1,325,361 1,433,086

Series A 4% Convertible Cumulative Preferred stock

Current liabilities:

Convertible Cumulative Preferred stock 9,700,000 9,700,000

Series B 10% Convertible Cumulative Preferred stock

Current liabilities:

Convertible Cumulative Preferred stock 246 246

Series C 4% Convertible Cumulative Preferred stock

Current liabilities:

Convertible Cumulative Preferred stock 200,926 200,926

Series D 15% Convertible Cumulative Preferred stock

Current liabilities:

Convertible Cumulative Preferred stock $ 852 $ 852

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Sum of the carrying values as of the balance sheet date of obligations incurred through that date and due within one year (or the operating cycle, if longer), including liabilities incurred (and for which invoices have typically been received) and payable to vendors for goods and services received, taxes, interest, rent and utilities, accrued salaries and bonuses, payroll taxes and fringe benefits.

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Amount due from customers or clients, within one year of the balance sheet date (or the normal operating cycle, whichever is longer), for goods or services (including trade receivables) that have been delivered or sold in the normal course of business, reduced to the estimated net realizable fair value by an allowance established by the entity of the amount it deems uncertain of collection.

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-Paragraph 3

-Subparagraph a(1)

-Article 5

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Accumulated adjustment, net of tax, that results from the process of translating subsidiary financial statements and foreign equity investments into the reporting currency from the functional currency of the reporting entity, net of reclassification of realized foreign currency translation gains or losses.

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Excess of issue price over par or stated value of the entity's capital stock and amounts received from other transactions involving the entity's stock or stockholders. Includes adjustments to additional paid in capital. Some examples of such adjustments include recording the issuance of debt with a beneficial conversion feature and certain tax consequences of equity instruments awarded to employees. Use this element for the aggregate amount of additional paid-in capital associated with common and preferred stock. For additional paid-in capital associated with only common stock, use the element additional paid in capital, common stock. For additional paid-in capital associated with only preferred stock, use the element additional paid in capital, preferred stock.

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Sum of the carrying amounts as of the balance sheet date of all assets that are recognized. Assets are probable future economic benefits obtained or controlled by an entity as a result of past transactions or events.

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Sum of the carrying amounts as of the balance sheet date of all assets that are expected to be realized in cash, sold, or consumed within one year (or the normal operating cycle, if longer). Assets are probable future economic benefits obtained or controlled by an entity as a result of past transactions or events.

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Carrying value as of the balance sheet date of payments made in excess of existing cash balances, which will be honored by the bank but reflected as a loan to the entity. Overdrafts generally have a very short time frame for correction or repayment and are therefore more similar to short-term bank financing than trade financing.

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-Glossary Current Liabilities

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-Paragraph 1

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Unrestricted cash available for day-to-day operating needs, for an entity that has cash equivalents, but does not aggregate cash equivalents with cash on the balance sheet.

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Aggregate par or stated value of issued nonredeemable common stock (or common stock redeemable solely at the option of the issuer). This item includes treasury stock repurchased by the entity. Note: elements for number of nonredeemable common shares, par value and other disclosure concepts are in another section within stockholders' equity.

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-Publisher SEC

-Name Regulation S-X (SX)

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The portion of the carrying value of long-term convertible debt as of the balance sheet date that is scheduled to be repaid within one year or in the normal operating cycle if longer. Convertible debt is a financial instrument which can be exchanged for a specified amount of another security, typically the entity's common stock, at the option of the issuer or the holder.

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The carrying amount of consideration received or receivable as of the balance sheet date on potential earnings that were not recognized as revenue in conformity with GAAP, and which are expected to be recognized as such within one year or the normal operating cycle, if longer, including sales, license fees, and royalties, but excluding interest income.

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-Name Staff Accounting Bulletin (SAB)

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-Section A

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Fair values as of the balance sheet date of all liabilities resulting from contracts that meet the criteria of being accounted for as derivative instruments, and which are expected to be extinguished or otherwise disposed of within a year or the normal operating cycle, if longer, net of the effects of master netting arrangements.

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-Subparagraph (a)

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The aggregate sum of gross carrying value of a major finite-lived intangible asset class, less accumulated amortization and any impairment charges. A major class is composed of intangible assets that can be grouped together because they are similar, either by their nature or by their use in the operations of a company.

+ References

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-Publisher FASB

-Name Statement of Financial Accounting Standard (FAS)

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-Paragraph 45

-Subparagraph a(1)

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Sum of the carrying amounts as of the balance sheet date of all liabilities that are recognized. Liabilities are probable future sacrifices of economic benefits arising from present obligations of an entity to transfer assets or provide services to other entities in the future.

+ References

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-Paragraph 1

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Total of all Liabilities and Stockholders' Equity items (or Partners' Capital, as applicable), including the portion of equity attributable to noncontrolling interests, if any.

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-Publisher SEC

-Name Regulation S-X (SX)

-Number 210

-Section 02

-Paragraph 32

-Article 5

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-Name Accounting Standards Codification

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-Name Regulation S-X (SX)

-Number 210

-Article 7

-Section 03

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Total obligations incurred as part of normal operations that are expected to be paid during the following twelve months or within one business cycle, if longer.

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-Publisher SEC

-Name Regulation S-X (SX)

-Number 210

-Section 02

-Paragraph 21

-Article 5

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Carrying value as of the balance sheet date of notes payable (with maturities initially due after one year or beyond the operating cycle if longer), excluding current portion.

+ References

Reference 1: http://www.xbrl.org/2003/role/presentationRef

-Publisher SEC

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-Subparagraph (SX 210.5-02.22)

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Total of all stockholders' equity (deficit) items, net of receivables from officers, directors, owners, and affiliates of the entity which is directly or indirectly attributable to that ownership interest in subsidiary equity which is not attributable to the parent (noncontrolling interest, minority interest).

+ References

Reference 1: http://www.xbrl.org/2003/role/presentationRef

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-SubTopic 10

-Section S99

-Paragraph 1

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-Name Regulation S-X (SX)

-Number 210

-Section 02

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Consolidated Statements of Cash Flows (USD $)
3 Months Ended

Mar. 31, 2012

Mar. 31, 2011

Cash flows from operating activities

Net income (loss) $ (209,333) $ 52,955

Adjustments to reconcile net income (loss) to net cash used in operating activities:

Depreciation and amortization 15,575 16,888

Amortization of debt discounts 25,300 8,177

Bad debt expense 20,872

(Gain) loss on derivatives (1,048) 3,275

Changes in operating assets and liabilities:

Accounts receivable 153,372 (51,218)

Prepaid expenses and other assets 3,787 (26,841)

Accounts payable and accrued liabilities (387,419) (229,475)

Deferred revenue 124,207 199,287

Net cash used in operating activities (254,687) (26,952)

Cash flow from investing activities:

Software development (85,629) (68,269)

Purchase of property and equipment (1,884) (8,201)

Net cash used in investing activities (87,513) (76,470)

Cash flows from financing activities:

Borrowings on notes payable 430,000 50,000

Payments of notes payable (35,586) (1,747)

Payments of related party notes payable (5,066) (8,963)

Borrowings on related party debt 26,000

Bank overdraft (7,903) (59,038)

Net cash provided by financing activities 407,445 (19,748)

Effect of changes in exchange rates on cash (66,876) (41,921)

Net change in cash and cash equivalents (1,631) (165,091)

Cash and cash equivalents, beginning of period 132,452 272,970

Cash and cash equivalents, end of period 130,821 107,879

Supplemental disclosures of cash flow information:

Cash paid for interest 74,168 84,770

Non-cash investing and financing activities:

Common shares issued for accrued stock compensation $ 6,200

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Organization, Basis of Presentation and Significant Accounting Policies
3 Months Ended

Mar. 31, 2012

Organization, Basis of Presentation and Significant Accounting Policies

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, 2011. The consolidated financial statements include the accounts of the Company and its subsidiaries, EnFacet, Inc. (“ENF”), Globalfare.com, Inc. (“GFI”), Pointmail.com, Inc. (“PMI”) and Vertical Internet Solutions, Inc. (“VIS”), all of which are inactive; Vertical Healthcare Solutions, Inc. (“VHS”), OptVision Research, Inc. (“OVR”), Taladin, Inc. (“Taladin”), Government Internet Systems, Inc. (“GIS”), an 84.5% owned subsidiary, SnAPPnet, Inc. (“SnAPPnet”), Priority Time Systems, Inc. (“Priority Time) a 90% owned subsidiary, all entities with minor activities and NOW Solutions, Inc. (“NOW Solutions”). 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 2011 annual report on Form 10-K have been omitted.

Earnings per share

Basic earnings per share is calculated by dividing net income (loss) available to common stockholders by the weighted average number of shares of the Company’s common stock outstanding during the period. “Diluted earnings per share” reflects the potential dilution that could occur if our share-based awards and convertible securities were exercised or converted into common stock. The dilutive effect of our share-based awards is computed using the treasury stock method, which assumes all share-based awards are exercised and the hypothetical proceeds from exercise are used to purchase common stock at the average market price during the period. The incremental shares (difference between shares assumed to be issued versus purchased), to the extent they would have been dilutive, are included in the denominator of the diluted EPS calculation. The dilutive effect of our convertible preferred stock and convertible debentures is computed using the if-converted method, which assumes conversion at the beginning of the year.

For the three months ended March 31, 2012 and 2011, common stock equivalents related to the convertible debentures, convertible debt and preferred stock and stock derivative liability were not included in the calculation of the diluted earnings per share as their effect would be anti-dilutive.

Reclassifications

Certain reclassifications have been made to the prior periods to conform to the current period presentation.

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Consolidated Balance Sheets (Parenthetical) (USD $)

Mar. 31, 2012

Dec. 31, 2011

Accounts receivable, allowance for bad debts $ 27,476 $ 12,483

Property and equipment, accumulated depreciation 1,012,364 1,006,512

Intangible assets, accumulated amortization $ 186,121 $ 175,551

Common Stock, par value $ 0.00001 $ 0.00001

Common Stock, shares authorized 1,000,000,000 1,000,000,000

Common Stock, issued 997,535,151 997,335,151

Common Stock, outstanding 997,535,151 997,335,151

Series A 4% Convertible Cumulative Preferred stock

Convertible Cumulative Preferred stock, par value $ 0.001 $ 0.001

Convertible Cumulative Preferred stock, shares authorized 250,000 250,000

Convertible Cumulative Preferred stock, shares issued 48,500 48,500

Convertible Cumulative Preferred stock, shares outstanding 48,500 48,500

Series B 10% Convertible Cumulative Preferred stock

Convertible Cumulative Preferred stock, par value $ 0.001 $ 0.001

Convertible Cumulative Preferred stock, shares authorized 375,000 375,000

Convertible Cumulative Preferred stock, shares issued 7,200 7,200

Convertible Cumulative Preferred stock, shares outstanding 7,200 7,200

Series C 4% Convertible Cumulative Preferred stock

Convertible Cumulative Preferred stock, par value $ 100.00 $ 100.00

Convertible Cumulative Preferred stock, shares authorized 200,000 200,000

Convertible Cumulative Preferred stock, shares issued 50,000 50,000

Convertible Cumulative Preferred stock, shares outstanding 50,000 50,000

Series D 15% Convertible Cumulative Preferred stock

Convertible Cumulative Preferred stock, par value $ 0.001 $ 0.001

Convertible Cumulative Preferred stock, shares authorized 300,000 300,000

Convertible Cumulative Preferred stock, shares issued 25,000 25,000

Convertible Cumulative Preferred stock, shares outstanding 25,000 25,000

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Software maintenance 1,136,672 1,107,390

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Consulting services 93,730 175,405

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Interest expense (156,670) (137,774)

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Net loss attributable to noncontrolling interest 19,601 19,326

Net income (loss) attributable to Vertical Computer Systems, Inc. (189,732) 72,281

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Stock Options, Warrants and Restricted Stock Awards
3 Months Ended

Mar. 31, 2012

Stock Options, Warrants and Restricted Stock Awards

Note 6. Stock Options, Warrants and Restricted Stock Awards

Stock options and Warrants

There are currently no outstanding common stock options or warrants.

Restricted Stock

A summary of the activity of the restricted stock for the three months ended March 31, 2011 is shown below.

Shares Weighted Average Grant-Date Fair Value

Non Vested Balance at December 31, 2011 600,000 $ 0.03100

Granted 1,200,000 0.01975

Vested (200,000 ) 0.03100

Forfeited/Cancelled - -

Non Vested Balance at March 31, 2012 1,600,000 $ 0.02260

As of March 31, 2012, there was $30,294 of total unrecognized compensation costs related to stock awards. These costs are expected to be recognized over a weighted average period of less than 3 years.

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The entire disclosure for compensation-related costs for equity-based compensation, which may include disclosure of policies, compensation plan details, allocation of equity compensation, incentive distributions, equity-based arrangements to obtain goods and services, deferred compensation arrangements, employee stock ownership plan details and employee stock purchase plan details.

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Common and Preferred Stock Transactions
3 Months Ended

Mar. 31, 2012

Common and Preferred Stock Transactions

Note 5. Common and Preferred Stock Transactions

During the three months ended March 31, 2012, the Company granted 1,200,000 unregistered shares of our common stock to an employee of the Company and an employee of NOW Solutions pursuant to restricted stock agreements with the Company. These shares vest through March 27, 2014 and the fair value of the awards is being expensed over this vesting period. The aggregate fair value of the awards was determined to be $23,700.

As of the Date of this Report, we have determined that we currently have (i) the following shares of common stock issued, and (ii) outstanding shares of preferred stock which are convertible into the shares of common stock indicated below and a contractual commitment to issue the shares of common stock indicated below:

999,435,151 Common Stock Issued

24,250,000 Common Shares convertible from Preferred Series A Stock (48,500 shares outstanding)

27,274 Common Shares convertible from Preferred Series B Stock (7,200 shares outstanding)

5,000,000 Common Shares convertible from Preferred Series C Stock (50,000 shares outstanding)

94,700 Common Shares convertible from Preferred Series D Stock (25,000 shares outstanding)

1,309,983 Common Shares Company Is Obligated to Reimburse to an officer of the Company for Pledged Shares

1,030,117,108 Total Common Shares Outstanding and Accounted For/Reserved



In addition, the Company has $30,000 in an outstanding convertible debenture that had been issued to a third party.

Accordingly, given the fact that the Company currently has 1,000,000,000 shares of common stock authorized, the Company could exceed its authorized shares of common stock by approximately 30,000,000 shares if all of the financial instruments described in the table above were exercised or converted into shares of common stock (excluding the $30,000 from the outstanding debenture noted above).

We have evaluated our convertible cumulative preferred stock under the guidance set out in FASB ASC 470-20 and have accordingly classified these shares as temporary equity in the consolidated balance sheets.

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Subsequent Events
3 Months Ended

Mar. 31, 2012

Subsequent Events

Note 9. Subsequent Events

During the period from April 1, 2012 to May 15, 2012, the Company granted 300,000 unregistered shares of our common stock (at a fair market value of $4,650) to a consultant pursuant to a restricted stock agreement with the Company.

X

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The entire disclosure for significant events or transactions that occurred after the balance sheet date through the date the financial statements were issued or the date the financial statements were available to be issued. Examples include: the sale of a capital stock issue, purchase of a business, settlement of litigation, catastrophic loss, significant foreign exchange rate changes, loans to insiders or affiliates, and transactions not in the ordinary course of business.

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Related Party Transactions
3 Months Ended

Mar. 31, 2012

Related Party Transactions

Note 7. Related Party Transactions

In January 2012, NOW Solutions borrowed $26,000 from a related party. The borrowing is due on demand and does not bear interest.

In February 2012, the Company and Robert Farias amended the terms of two notes in the principal amounts of $274,679 and $90,000, that were issued by NOW Solutions and VHS in July 2011 in connection with the cancellation of $364,679 of outstanding debt owed to Mr. Farias. Pursuant to the terms of the agreement, beginning February 1, 2012, the interest rate increased to 10% on the outstanding balance of principal and accrued interest accrued through January 31, 2012 under the respective note. The amended payment terms for the notes consist of monthly interest only payments through 2012 with interest and principal payments of $5,000 to be allocated between the notes commencing January 31, 2013 until the notes are fully paid. Also in February 2012, NOW Solutions granted Mr. Farias a security interest in all of its assets to secure the obligations under the $274,679 note in consideration of a personal guarantee made by Mr. Farias to secure the obligations under a note in the principal amount of $105,300 issued to a third party lender for a loan to NOW Solutions. This security interest is junior to the presented indebtedness of NOW Solutions to Tara Financial and a third party lender. Mr. Farias serves as our Executive Vice-President of Business Development.

X

- Definition

The entire disclosure for related party transactions, including the nature of the relationship(s), a description of the transactions, the amount of the transactions, the effects of any change in the method of establishing the terms of the transaction from the previous period, stated interest rate, expiration date, terms and manner of settlement per the agreement with the related party, and amounts due to or from related parties. If the entity and one or more other entities are under common ownership or management control and this control affects the operating results or financial position, disclosure includes the nature of the control relationship even if there are no transactions between the entities. Disclosure may also include the aggregate amount of current and deferred tax expense for each statement of earnings presented where the entity is a member of a group that files a consolidated tax return, the amount of any tax related balances due to or from affiliates as of the date of each statement of financial position presented, the principal provisions of the method by which the consolidated amount of current and deferred tax expense is allocated to the members of the group and the nature and effect of any changes in that method. Examples of related party transactions include transactions between (a) a parent company and its subsidiary; (b) subsidiaries of a common parent; (c) and entity and its principal owners; and (d) affiliates.

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Legal Proceedings
3 Months Ended

Mar. 31, 2012

Legal Proceedings

Note 8. Legal Proceedings

We are involved in the following ongoing legal matters:

In August 2009, Parker Shumaker & Mills, LLP (“PSM”) filed a lawsuit in Los Angeles Superior Court to collect the outstanding balance of $51,238 under a promissory note issued by the Company to PSM in the principal amount of $75,000, plus interest at 6% per annum, late fees and attorneys’ fees. We issued the $75,000 note in connection with a settlement in October 2005 with PSM. In December 2009, we entered into a settlement agreement and stipulated judgment with PSM whereby the parties agreed to a judgment balance of $68,500, which included principal, accrued interest, late fees and attorneys’ fees, and we agreed to make monthly installment payments. Bill Mills is a Director of the Company and a partner of PSM. At March 31, 2012, all payments to PSM have been made and this matter has been resolved.

On November 18, 2009, we sued InfiniTek Corporation (“InfiniTek”) in the Texas State District Court in Fort Worth, Texas for breach of contract and other claims (the “Texas Action”) seeking equitable relief and unspecified damages when a dispute between the Company and InfiniTek was not resolved. All agreements with InfiniTek have been cancelled. On January 15, 2010, InfiniTek filed a counter-claim for non-payment of amounts billed. InfiniTek claimed it was owed $195,000 plus lost opportunity costs of not less than $220,000.

On April 7, 2010, we were served with a lawsuit filed by InfiniTek in the California Superior Court in Riverside, California seeking damages in excess of $76,303 for breach of contract and lost profit (the “California Action”). This lawsuit related to one of the causes of action and the same set of underlying facts, as those in the Texas legal action. On May 7, 2010, we filed a motion to dismiss this action. On July 14, 2010, the court denied our motion. On August 13, 2010, we filed an answer to InfiniTek’s complaint, including a denial and affirmative defenses.

On December 31, 2011, the Company and InfiniTek entered into a settlement agreement whereby the Texas Action and the California Action were both dismissed. Pursuant to the terms of the settlement agreement, Vertical agreed to pay InfiniTek $82,500 in three equal installments with the last payment due by or before August 5, 2012. Upon full payment, InfiniTek shall transfer and assign ownership of the NAVPath software developed by InfiniTek for use with NOW Solutions emPath® software application and Microsoft Dynamics NAV (formerly Navision) business solution platform. The amounts in dispute were included in our accounts payable and accrued liabilities and have been adjusted to the settlement amount of $82,500 at December 31, 2011. The Company has made $37,500 in payments due under the settlement agreement as of May 15, 2012.

On November 15, 2010, we filed a lawsuit in the Federal District Court for the Eastern District of Texas (the “Vertical Action”) against Interwoven, Inc. ("Interwoven"), LG Electronics MobileComm U.S.A., Inc., LG Electronics, Inc., Samsung Electronics Co., Ltd. and Samsung Electronics America, Inc. (collectively, the "Defendants"). We sued the Defendants for patent infringement claims under United States Patent No. 6,826,744 (“System and Method for Generating Web Sites in an Arbitrary Object Framework”) and United States Patent No. 7,716,629 (“System and Method for Generating Web Sites in an Arbitrary Object Framework”) (collectively the “the Patents-in-Suit”), both of which are owned by the Company. We seek an award of monetary damages and other relief. The case is styled Vertical Computer Systems, Inc. v Interwoven, Inc., LG Electronics Mobilecomm U.S.A., Inc., No. 2:10-CV-00490.

On November 17, 2010, we were served with a lawsuit filed on October 14, 2010 by Interwoven in the United States District Court for the Northern District of California (the “Interwoven Action”). This lawsuit is a complaint for declaratory judgment, in which Interwoven is requesting that the court find that no valid and enforceable claim of either of the two patents referenced above has been infringed by Interwoven. The case is styled Interwoven, Inc. v Vertical Computer Systems, Inc. No. 3:10-CV-4645-RS.

On January 11, 2011, Samsung Electronics Co., Ltd. and Samsung Electronics America, Inc. (“Samsung”) filed a lawsuit in the United States District Court for the Northern District of California seeking to consolidate its lawsuit with the Interwoven Action. This case is styled Samsung Electronics Co., Ltd. and Samsung Electronics America, Inc., v. Vertical Computer Systems, Inc., No. 3:11-CV-00189-RS.

On May 2, 2011, the United States District Court for the Northern District of California denied Vertical’s renewed motion to transfer the Interwoven Action to the Eastern District of Texas and granted Vertical's motion to transfer the lawsuit filed by Samsung in the Northern District of California to the Eastern district in Texas. On May 11, 2011, the United States District Court for the Eastern District of Texas granted Interwoven’s motion to transfer the case to the Northern District of California with respect to Interwoven and denied Samsung’s motion to transfer its case to the Northern district. On May 12, 2011, Vertical filed in the United States Court of Appeals for the Federal Circuit a petition for a writ of mandamus seeking review of that portion of the May 2, 2011 order by the Northern District of California which refused to transfer the Interwoven v. Vertical action to the Eastern District of Texas, which was denied on August 17, 2011.



On December 30, 2011, the United States District Court for the Northern District of California issued a claims construction order concerning the terms found in the claims of the Patents-in-Suit.

On March 8, 2012, the United States District Court for the Northern District of California in the Interwoven Action denied Interwoven’s motion to stay all judicial proceedings pending the outcome of an ex parte reexamination of each of the Patents-in-Suit by the United States Patent and Trademark Office (“USPTO”).

On April 18, 2012, the USPTO notified the Company of an office action concerning the ex parte reexamination of United States Patent No. 6,826,744. In the office action, the USPTO indicated that Claims 1-11, 18, 19, 21-33, 40, 41 and 45-53 are subject to reexamination; Claims 12-17, 20, 34-39, 42-44 are not subject to reexamination; Claims 6, 8, 19, 30, 32, 41, 50, and 51 are patentable and/or confirmed; and Claims 1-5,7, 9-11, 18, 21-29, 31, 33, 40, 45-49, 52, and 53 are rejected. The Company is in the process of responding to this office action and intends to vigorously prosecute its claims of the Patents-in-Suit to the USPTO.

On July 8, 2011, we were served with a lawsuit in the Texas State District Court in Dallas, Texas by Clark Consulting Services, Inc. (“CCS”) for breach of contract and other claims. CCS was seeking damages from us in excess of $133,750 plus attorney’s fees and interest. On August 8, 2011, we filed an answer denying CCS’s claims and setting forth affirmative defenses. In December 2011, the Company and CCS entered into a settlement agreement whereby the lawsuit was dismissed. Pursuant to the terms of the settlement agreement, the Company agreed to pay CCS $134,000, payable in monthly installments of $5,000 through June 2012 and $10,000 thereafter until the outstanding balance has been paid. The Company will be obligated to pay CCS an additional $60,000 in the event it does not make timely payment within 5 days of notice from CCS. The Company has made all payments due under the settlement agreement as of May 15, 2012.

X

- Definition

The entire disclosure for legal proceedings, legal contingencies, litigation, regulatory and environmental matters and other contingencies.

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Consolidated Statement of Stockholders' Deficit (USD $)

Total

Common Stock

Additional Paid-in Capital

Accumulated Deficit

Other Comprehensive Interest

Non-controlling Controlling Interest

Beginning Balance at Dec. 31, 2011 $ (21,477,024) $ 9,973 $ 19,240,060 $ (40,372,612) $ (155,738) $ (198,707)

Beginning Balance (in shares) at Dec. 31, 2011 997,335,151

Issuance of restricted stock (in shares) 200,000

Issuance of restricted stock 6,200 2 6,198

Other comprehensive income translation adjustment (66,876) (66,876)

Net loss (209,333) (189,732) (19,601)

Ending Balance at Mar. 31, 2012 $ (21,747,033) $ 9,975 $ 19,246,258 $ (40,562,344) $ (222,614) $ (218,308)

Ending Balance (in shares) at Mar. 31, 2012 997,535,151

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Derivative liability and fair value measurements
3 Months Ended

Mar. 31, 2012

Derivative liability and fair value measurements

Note 4. Derivative liability and fair value measurements

Derivative liability

During 2008, one of our officers pledged 3,000,000 shares of common stock (through a company he controls) to secure the debt owed to a third party lender. In connection with the pledge of stock, we signed an agreement to replace these shares within one year. Subsequent to this agreement, 1,309,983 shares of this stock were sold to satisfy the debt owed to the lender. This contractual commitment to replace all of the pledged shares was evaluated under FASB ASC 815-40, Derivatives and Hedging and was determined to have characteristics of a liability and therefore constituted a derivative liability under the above guidance. Each reporting period, this derivative liability is marked-to-market with the non-cash gain or loss recorded in the period as a gain or loss on derivatives. At March 31, 2012 and December 31, 2011, the fair value of the derivative liability was $23,187 and $24,235.

The aggregate gain or loss on the change in the fair value of derivative liabilities was a gain of $1,048 and a loss of $3,275 for the three months ended March 31, 2012 and 2011, respectively.



The valuation of our embedded derivatives is determined by using the VCSY stock price at March 31, 2012. As such, our derivative liabilities have been classified as Level 1.

Fair value measurements

FASB ASC 820, Fair Value Measurements and Disclosures, defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. FASB ASC 820 describes three levels of inputs that may be used to measure fair value:

Level 1 – Quoted prices in active markets for identical assets or liabilities.

Level 2 – Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 – Unobservable inputs that are supported by little or no market activity and that are financial instruments whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant judgment or estimation.

If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level of input that is significant to the fair value measurement of the instrument.

The following table provides a summary of the fair value of our derivative liabilities as of March 31, 2012 and December 31, 2011:

Fair value measurements on a recurring basis

Level 1 Level 2 Level 3

As of March 31, 2012:

Liabilities

Stock derivative – 1,309,983 shares $ 23,187 $ - $ -

As of December 31, 2011:

Liabilities

Stock derivative – 1,309,983 shares $ 24,235 $ - $ -

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.

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Consolidated Balance Sheets (USD $)	Mar. 31, 2012	Dec. 31, 2011
Current assets
Cash	$ 130,821	$ 132,452
Accounts receivable, net of allowance for bad debts of $27,476 and $12,483	238,049	412,293
Prepaid expenses and other current assets	133,666	137,302
Total current assets	502,536	682,047
Property and equipment, net of accumulated depreciation of $1,012,364 and $1,006,512	37,928	41,050
Intangible assets, net of accumulated amortization of $186,121 and $175,551	769,355	694,294
Deposits and other	15,542	15,695
Total assets	1,325,361	1,433,086
Current liabilities:
Accounts payable and accrued liabilities	6,173,350	6,566,970
Bank overdraft	12,498	20,401
Deferred revenue	2,673,925	2,549,718
Derivative liability	23,187	24,235
Convertible debenture	30,000	30,000
Current portion - notes payable	1,129,338	800,374
Current portion - notes payable to related parties	367,117	346,183
Total current liabilities	10,409,415	10,337,881
Non-current portion - notes payable	2,421,676	2,330,526
Non-current portion - notes payable to related parties	339,279	339,679
Total liabilities	13,170,370	13,008,086
Convertible Cumulative Preferred stock	9,902,024	9,902,024
Stockholders' Deficit
Common Stock; $.00001 par value; 1,000,000,000 shares authorized 997,535,151 and 997,335,151 issued and outstanding as of March 31, 2012 and December 31, 2011	9,975	9,973
Additional paid-in-capital	19,246,258	19,240,060
Accumulated deficit	(40,562,344)	(40,372,612)
Accumulated other comprehensive income - foreign currency translation	(222,614)	(155,738)
Total Vertical Computer Systems, Inc. stockholders' deficit	(21,528,725)	(21,278,317)
Noncontrolling interest	(218,308)	(198,707)
Total stockholders' deficit	(21,747,033)	(21,477,024)
Total liabilities and stockholders' deficit	1,325,361	1,433,086
Series A 4% Convertible Cumulative Preferred stock
Current liabilities:
Convertible Cumulative Preferred stock	9,700,000	9,700,000
Series B 10% Convertible Cumulative Preferred stock
Current liabilities:
Convertible Cumulative Preferred stock	246	246
Series C 4% Convertible Cumulative Preferred stock
Current liabilities:
Convertible Cumulative Preferred stock	200,926	200,926
Series D 15% Convertible Cumulative Preferred stock
Current liabilities:
Convertible Cumulative Preferred stock	$ 852	$ 852

Consolidated Statements of Cash Flows (USD $)	3 Months Ended
Consolidated Statements of Cash Flows (USD $)	Mar. 31, 2012	Mar. 31, 2011
Cash flows from operating activities
Net income (loss)	$ (209,333)	$ 52,955
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization	15,575	16,888
Amortization of debt discounts	25,300	8,177
Bad debt expense	20,872
(Gain) loss on derivatives	(1,048)	3,275
Changes in operating assets and liabilities:
Accounts receivable	153,372	(51,218)
Prepaid expenses and other assets	3,787	(26,841)
Accounts payable and accrued liabilities	(387,419)	(229,475)
Deferred revenue	124,207	199,287
Net cash used in operating activities	(254,687)	(26,952)
Cash flow from investing activities:
Software development	(85,629)	(68,269)
Purchase of property and equipment	(1,884)	(8,201)
Net cash used in investing activities	(87,513)	(76,470)
Cash flows from financing activities:
Borrowings on notes payable	430,000	50,000
Payments of notes payable	(35,586)	(1,747)
Payments of related party notes payable	(5,066)	(8,963)
Borrowings on related party debt	26,000
Bank overdraft	(7,903)	(59,038)
Net cash provided by financing activities	407,445	(19,748)
Effect of changes in exchange rates on cash	(66,876)	(41,921)
Net change in cash and cash equivalents	(1,631)	(165,091)
Cash and cash equivalents, beginning of period	132,452	272,970
Cash and cash equivalents, end of period	130,821	107,879
Supplemental disclosures of cash flow information:
Cash paid for interest	74,168	84,770
Non-cash investing and financing activities:
Common shares issued for accrued stock compensation	$ 6,200

Consolidated Balance Sheets (Parenthetical) (USD $)	Mar. 31, 2012	Dec. 31, 2011
Accounts receivable, allowance for bad debts	$ 27,476	$ 12,483
Property and equipment, accumulated depreciation	1,012,364	1,006,512
Intangible assets, accumulated amortization	$ 186,121	$ 175,551
Common Stock, par value	$ 0.00001	$ 0.00001
Common Stock, shares authorized	1,000,000,000	1,000,000,000
Common Stock, issued	997,535,151	997,335,151
Common Stock, outstanding	997,535,151	997,335,151
Series A 4% Convertible Cumulative Preferred stock
Convertible Cumulative Preferred stock, par value	$ 0.001	$ 0.001
Convertible Cumulative Preferred stock, shares authorized	250,000	250,000
Convertible Cumulative Preferred stock, shares issued	48,500	48,500
Convertible Cumulative Preferred stock, shares outstanding	48,500	48,500
Series B 10% Convertible Cumulative Preferred stock
Convertible Cumulative Preferred stock, par value	$ 0.001	$ 0.001
Convertible Cumulative Preferred stock, shares authorized	375,000	375,000
Convertible Cumulative Preferred stock, shares issued	7,200	7,200
Convertible Cumulative Preferred stock, shares outstanding	7,200	7,200
Series C 4% Convertible Cumulative Preferred stock
Convertible Cumulative Preferred stock, par value	$ 100.00	$ 100.00
Convertible Cumulative Preferred stock, shares authorized	200,000	200,000
Convertible Cumulative Preferred stock, shares issued	50,000	50,000
Convertible Cumulative Preferred stock, shares outstanding	50,000	50,000
Series D 15% Convertible Cumulative Preferred stock
Convertible Cumulative Preferred stock, par value	$ 0.001	$ 0.001
Convertible Cumulative Preferred stock, shares authorized	300,000	300,000
Convertible Cumulative Preferred stock, shares issued	25,000	25,000
Convertible Cumulative Preferred stock, shares outstanding	25,000	25,000

Document and Entity Information	3 Months Ended
Document and Entity Information	Mar. 31, 2012	May 15, 2012
Document Information [Line Items]
Document Type	10-Q
Amendment Flag	false
Document Period End Date	Mar. 31, 2012
Document Fiscal Year Focus	2012
Document Fiscal Period Focus	Q1
Trading Symbol	VCSY
Entity Registrant Name	VERTICAL COMPUTER SYSTEMS INC
Entity Central Index Key	0001099509
Current Fiscal Year End Date	--12-31
Entity Filer Category	Smaller Reporting Company
Entity Common Stock, Shares Outstanding		999,435,151

Consolidated Statements of Operations (USD $)	3 Months Ended
Consolidated Statements of Operations (USD $)	Mar. 31, 2012	Mar. 31, 2011
Revenues
Licensing and software	$ 1,000	$ 167,027
Software maintenance	1,136,672	1,107,390
Cloud-based offering	137,077	147,114
Consulting services	93,730	175,405
Other	21,281	31,227
Total revenues	1,389,760	1,628,163
Cost of revenues	360,601	382,469
Gross profit	1,029,159	1,245,694
Operating expenses:
Selling, general and administrative expenses	1,046,437	1,034,809
Depreciation and amortization	15,575	16,888
Bad debt expense	20,872
Total operating expenses	1,082,884	1,051,697
Income (loss) from operations	(53,725)	193,997
Other income (expense):
Interest income	14	7
Gain (loss) on derivative liability	1,048	(3,275)
Interest expense	(156,670)	(137,774)
Net income (loss)	(209,333)	52,955
Net loss attributable to noncontrolling interest	19,601	19,326
Net income (loss) attributable to Vertical Computer Systems, Inc.	(189,732)	72,281
Dividends applicable to preferred stock	(147,000)	(147,000)
Net loss available to common stockholders	(336,732)	(74,719)
Basic and diluted loss per share	$ 0.00	$ 0.00
Basic and diluted weighted average of common shares outstanding	997,535,151	997,335,151
Comprehensive income (loss)
Net income (loss)	(189,732)	72,281
Translation adjustments	(66,876)	(41,921)
Comprehensive income (loss)	(256,608)	30,360
Comprehensive loss attributable to noncontrolling interest	19,601	19,326
Comprehensive income (loss) attributable to Vertical Computer Systems, Inc.	$ (237,007)	$ 49,686

Subsequent Events	3 Months Ended
Subsequent Events	Mar. 31, 2012
Subsequent Events	Note 9. Subsequent Events During the period from April 1, 2012 to May 15, 2012, the Company granted 300,000 unregistered shares of our common stock (at a fair market value of $4,650) to a consultant pursuant to a restricted stock agreement with the Company.

Consolidated Statement of Stockholders' Deficit (USD $)	Total	Common Stock	Additional Paid-in Capital	Accumulated Deficit	Other Comprehensive Interest	Non-controlling Controlling Interest
Beginning Balance at Dec. 31, 2011	$ (21,477,024)	$ 9,973	$ 19,240,060	$ (40,372,612)	$ (155,738)	$ (198,707)
Beginning Balance (in shares) at Dec. 31, 2011		997,335,151
Issuance of restricted stock (in shares)		200,000
Issuance of restricted stock	6,200	2	6,198
Other comprehensive income translation adjustment	(66,876)				(66,876)
Net loss	(209,333)			(189,732)		(19,601)
Ending Balance at Mar. 31, 2012	$ (21,747,033)	$ 9,975	$ 19,246,258	$ (40,562,344)	$ (222,614)	$ (218,308)
Ending Balance (in shares) at Mar. 31, 2012		997,535,151