UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934:
For the fiscal year ended December 31, 2016
¨ 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)
Registrant’s telephone number: (972) 437-5200
Securities registered pursuant to section 12(b) of the Act:
| Title of each class | Name of each exchange on which registered |
| None | None |
Securities registered pursuant to section 12(g) of the Act:
Common Stock, par value $0.00001 per share
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every
Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such file. Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained in this form, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or amendment to this Form 10-K. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.:
| Large accelerated filer ¨ | Accelerated filer | ¨ | |
| Non-accelerated filer ¨ | (Do not check if a smaller reporting company) | Smaller reporting company | x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the registrant’s most recently completed second fiscal quarter: $23,999,378.
As of April 24, 2017, the issuer had 1,172,114,528 shares of common stock, par value $0.00001, issued and 1,132,114,528 outstanding.
Documents incorporated by reference: None
VERTICAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2016
TABLE OF CONTENTS
We caution you that the risks, uncertainties and other factors referenced above may not contain all of the risks, uncertainties and other factors that are important to you. In addition, we cannot guarantee future performance of our products and services, or results or achievements. Any forward-looking statement made by us in this Annual Report speaks only as of the date of this Annual Report or as of the date on which it is made. Except as required by law, we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information or developments, future events or otherwise, after the date of this Annual Report.
Trademarks and Trade names
We have common law, unregistered trademarks for the Company and its subsidiaries based upon use of the trademarks in the United States. This Annual Report contains references to our trademarks and to trademarks belonging to other entities. Solely for convenience, trademarks and trade names referred to in this Annual Report, including logos, artwork and other visual displays, may appear without the ® or ™ symbols, but such references are not intended to indicate, in any way, that we will not assert, to the fullest extent under applicable law, our rights or the rights of the applicable licensor to these trademarks and trade names. We do not intend our use or display of other companies’ trade names or trademarks to imply a relationship with, endorsement of, or sponsorship of us or our products or services by, any other companies.
| 1 |
Forward-Looking Statements and Associated Risks. This Report contains forward-looking statements. Such forward-looking statements include statements regarding, among other things, (a) our projected sales and profitability, (b) our growth strategies, (c) anticipated trends in our industry, (d) our future financing plans, (e) our anticipated needs for working capital, and (f) the benefits related to ownership of our common stock. Forward-looking statements, which involve assumptions and describe our future plans, strategies, and expectations, are generally identifiable by use of the words “may,” “will,” “should,” “expect,” “anticipate,” “estimate,” “believe,” “intend,” or “project” or the negative of these words or other variations on these words or comparable terminology. This information may involve known and unknown risks, uncertainties, and other factors that may cause our actual results, performance, or achievements to be materially different from the future results, performance, or achievements expressed or implied by any forward-looking statements. These statements may be found under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business,” as well as in this Report generally. Actual events or results may differ materially from those discussed in forward-looking statements as a result of various factors, including, without limitation, the risks outlined under “Risk Factors” and matters described in this Report generally. In light of these risks and uncertainties, there can be no assurance that the forward-looking statements contained in this Report will in fact occur as projected.
Background
Vertical Computer Systems, Inc. (“Vertical”, “VCSY”, the “Company”, the “Registrant”, “we”, “our”, or “us”) was incorporated in the State of Delaware in March 1992. We operated as a non-reporting public shell company until October 1999, at which time we acquired all the outstanding capital stock of Externet World, Inc., an Internet service provider and became an operating entity. In April 2000, we acquired 100% of the outstanding common stock of Scientific Fuel Technology, Inc. (“SFT”), a company with no operations. Also in April 2000, we merged SFT into our company, as a consequence of which the outstanding shares of SFT were cancelled, Vertical became the surviving entity, and we assumed SFT’s reporting obligations pursuant to Rule 12g-3(a) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
Business Overview
We are a global provider of application software, cloud-based and software services, Internet core technologies, and intellectual property assets through our distribution network with operations or sales in the United States, Canada and Brazil.
Our business model combines complementary and integrated software products along with internet core technologies, in order to create a distribution matrix that we believe is capable of penetrating multiple sectors through cross-promotion.
We developed a secure communication platform (based upon our patented and patent-pending software technologies) that we believe can change the nature of communication on the Internet by allowing and supporting development of applications in separate sectors. In addition, the technology underlying our communication platform has potential applications in the “Internet of Things” (IoT) market.
VCSY’s secure communication platform eliminates the central server component in communications over the Internet, since the user has a web server installed on their mobile device, which may also be synchronized with their tablet, PC or other hardware components (i.e. storage disks). VCSY’s secure communication platform is for users who seek to obtain a higher level of security and protection for their information (including data, messages and images) and for private secure communication of information with other users.
The first application built upon our secure communication platform is Ploinks™, a personal secure cloud communication channel which was developed by our subsidiary, Ploinks, Inc. Ploinks™ provides each user with the ability to protect their data (such as messages, images, and videos) from both unwanted data transmissions and from third parties gaining access and ownership rights to the user’s personal data without that user’s express permission. Ploinks™ is not a social media product, but users may still use all currently available social media applications. Ploinks™ provides users with a simple and new means to preserve and protect any personal data that the individual wants to keep control of. We launched Ploinks™ in February 2017 and plan to launch the Puddle™ service, a complimentary storage and backup service to Ploinks™ for personal data on Windows-based PCs and storage devices, that synchronizes with the user’s mobile device, in April 2017.
| 2 |
Administrative Software
Our main administrative application software, emPath®, which is designed to handle complex payroll and human resources challenges, is developed, marketed and maintained by NOW Solutions. emPath® is natively Web-based, which means that the application can easily be accessed with a web browser. NOW Solutions, a 75% owned subsidiary, is selling emPath® in the United States and Canadian markets both as a software solution and a Software-as-a-Service (“SaaS”) offering, also known as Cloud-based offering. For a description of our cloud computing model for emPath®, please see the section entitled “Cloud-based services” below.
Our continuous effort to improve our emPath® product and its cloud-based offering has allowed us to finalize and launch our new module-based initiative under which certain payroll/human resource modules can be marketed independently from emPath® or bundled into a comprehensive solution. An upgrade version, EmPath® 7.0 is in beta testing with selected clients with a general release anticipated to be available in May 2017. Version 7.0 will significant improve the user experience and will support all the new modern browsers. In addition, there will be a performance increase in processing payroll for Empath’s large clients. Upon the completion of Ploinks™ Puddle™, there will be an approach to some of our emPath®’s clients to create an emPath® enterprise solution by making use of the VCSY secure communication platform.
Our time and attendance software, PTS™, has been designed with the flexibility to meet the needs of a simple small business requirements as well as the most complex union-intensive clients through a rule-based time policy system coupled with a dashboardlets™ feature for presentations of information supporting numerous databases including Oracle, DB2 and SQL. For a description of this feature, please see the section entitled “Internet Core Technologies” below.
PTS™ will be marketed as a stand-alone best-of-breed solution through Priority Time Systems, Inc. (“Priority Time”) as well as an integrated module within emPath®, which we will be marketing to emPath®’s existing customer base. Initial marketing efforts will be focused on the United States and Canadian markets.
SnAPPnet™ is currently sold as a best-of-breed standalone solution through our subsidiary, SnAPPnet, Inc. We are in the process of upgrading SnAPPnet™ look and feel, along with expanding the functionality, to not only increase the market potential but to then integrate it with emPath®, so that it can also be sold to NOW Solutions’ customers as an emPath® module.
| 3 |
We believe that our administrative software solutions, which offer lower set-up fees and faster implementation times compared to competing products, provide customers with significant upfront cost savings and substantial increases in productivity for administration of everyday operations.
Cloud-Based Services
In addition to our standard software licensing model, where the software is deployed, hosted and maintained internally by the customer, we are offering customers with an alternate delivery method: software-as-a-service, or simply “cloud-based.” Cloud-based is a software delivery model where the company develops, operates, and hosts the application in data centers for use by its customers over the Internet.
A cloud-based service is a cost-effective, reliable and secure way for businesses to obtain the same benefits of commercially licensed, internally operated software, without the associated complexity and high start-up costs of deploying the software in-house or the need to dedicate IT people on staff to monitor and upgrade such a system. Such services are currently under evaluation as to the marketability of making use of the VCSY secure communication platform to create new business opportunities.
After completing emPath® cloud-based model to ensure a robust and competitive solution, NOW Solutions began selling that offering to existing and new clients. The cloud-based model provides a highly reliable, secure and scalable infrastructure, enabling us not only to continue servicing and expanding our current market of mid to large sized customers but also to increase our market reach by offering a solution to smaller sized customers, which otherwise may not be able to afford an in-house solution.
As an expanded product and as a result of our initial sales to customers with complex payroll, NOW Solutions has created a tailored cloud-based offering which provides these types of customers the cost benefits of a cloud computing model while meeting their complex requirements. We are also continuing to upgrade emPath® for our cloud computing offering utilizing emPath®’s powerful payroll component to provide private label contracting as well as distribution opportunities through existing payroll and HR providers in their local markets.
PTS™, our time and attendance software, will also be offered as a cloud-based solution, as both a standalone product (through Priority Time and VHS) and an integrated module with emPath® (through NOW Solutions).
SnAPPnet™, a physician credentialing application, is currently offered as a cloud-based solution. We are in the process of developing a registered nurse module of SnAPPnet™. In addition, we are adding some key new features to the software application as well as doing a design review to meet other potential markets for credentialing and markets in need of automated fillable forms. We are marketing SnAPPnet™ directly to hospitals and plan to offer it through VHS to physicians in the United States and to NOW Solutions’ existing customer base.
Ploinks™ is a personal secure cloud-based product when the Puddle™ is synchronized with a user’s mobile device. Ploinks ™ is a monthly subscription based application.
Software Services
In addition to the application software and cloud-based services, we offer a full range of software services that include professional services, maintenance, custom maintenance and managed services.
Internet Core Technologies
Internet core technologies provide the software foundation to support internet-based platforms for the delivery of individual software products that can be sold independently or combined with other software products for rapid deployment of all software products throughout our distribution system. We continue to develop specialized software applications that can be utilized in new products.
Our first patented internet core technology is SiteFlash™. The SiteFlash™ technology utilizes XML and publishes content on the Web, enabling the user to build and efficiently operate websites with the unique ability to separate form, function, and content. SiteFlash™ uses an advanced component-based structure to separate, parse, and store the various components of even the most complex web pages, permitting these components to be named, organized, filed and eventually redeployed onto the web pages of a website. Once all of the components of a web page are converted into “objects,” they can be grouped, as required by the user, into the three main types of web page components: content, form and function. Content includes text, pictures or multimedia. Form includes graphics and website colors, layout and design. Function includes the activities performed by or actions executed on the website. In this way, each element of a website created using SiteFlash™ is interchangeable with any other similar element, and these elements may be grouped together in almost any combination to create complex websites. This separation of form, function, and content also allows for the rapid creation of affiliated websites. SiteFlash™ architectural concepts enable integration with existing technological components within many organizations. Additional key features of SiteFlash™’s are its affiliation/syndication capability, its multi-lingual capability, and its multi-modal framework (enabling use on any output device, including wireless devices such as smart phones, as well as cellular phones and other devices with Internet capability).
| 4 |
The second patented Internet core technology we have developed is the Emily™ XML scripting language, a Markup Language Executive (MLE), which is Java compatible. XML is a flexible way to create common information formats and share both the format and the data on the World Wide Web, intranets, and elsewhere. The Emily™ Framework was developed to be an engineering package comparable to other Web development tools, such as Allaire Cold Fusion™ or Microsoft FrontPage™. The primary component of the Emily™ Framework is the Emily XML scripting language, a programming language that runs on Windows™, Linux and several UNIX platforms. The Emily™ Framework is used to create Web-based applications that communicate via XML and HTTP. HTTP is the set of rules for exchanging files (text, graphic images, sound, video, and other multimedia files) on the Web.
The third patented Internet core technology we have developed is the combination of three components: the Emily™ XML Broker, the Emily™ XML Agent and the Emily™ XML Portal. This technology has been featured as an alternative to Web Services in the 4th Edition of the XML Handbook, by Dr. Charles Goldfarb, considered the father of XML and inventor of all markup languages. We are upgrading this technology for use in a new application we are developing simultaneously.
The fourth Internet core technology is our secure communication platform based on a web server that was licensed to the Company, and subsequently patented by the Company. The communication platform will use the Emily™ technology, and other patented and patent-pending applications (like the SiteFlash™ patents). Using this secure communication platform, we launched our first product, Ploinks™, a personal secure communication channel through our subsidiary, Ploinks, Inc., in February 2017, along with the Puddle™, a complimentary storage and backup solution on Windows-based PCs and/or other storage devices to be released in April 2017, which will be synchronized with a user’s mobile device. Upon completion of the synchronization of the user’s mobile device and the Puddle™, Ploinks™ will be marketed as a secure personal cloud.
Intellectual Property Assets
Our SiteFlash technology is based upon the following patents: a System and Method for Generating Web sites in an Arbitrary Object Framework. This unique ability is patented under U.S. Patent No. 6,826,744 and continuation patent U.S. Patent No. 7,716,629 as well as a continuation patent (U.S. Patent No. 8,949,780) of U.S. Patent No. 7,716,629.
Our Emily™ core technology is the basis for a “Web-based collaborative data collection system”, which allows a disparate and distributed database to be viewed and updated as if it was a single large database. This unique ability is patented under U.S. Patent No. 7,076,521.
Our Emily™ XML scripting language, coupled with other Company technology, is the basis for development of mobile applications. This unique ability is patented under U.S. Patent No. 8,578,266 and its continuation patent.
Our patent for a “System and Method Running a Web Server on a Mobile Internet Device,” which is part of our Mobile Framework (the “MLE Framework") and covers the Tiny Web Server, which is also a component of our MLE Framework. This unique ability is patented under U.S. Patent No. 9,112,832.
Our fiber optic patent is an invention for “Transmission of Images Over a Single Filament of Fiber Optic Cable” under U.S Patent No. 6718103.
We also have other mobile technologies, which are patent-pending.
Market Segments
Our current products address the following market segments:
| MARKET | PRODUCT | OWNERSHIP/LICENSOR | LICENSEE | |||
| Human Resources and Payroll | emPath® | NOW Solutions | VHS (a), Taladin (b) | |||
| Software development units | Emily™ | Vertical | VHS(a) | |||
| Time and Attendance | PTS™ | Priority Time | VHS (a), NOW Solutions (c) | |||
| Healthcare Credentialing | SnAPPnet™ | SnAPPnet, Inc. | VHS (a), NOW Solutions (c) | |||
| Personal Secure Communication Channel | Ploinks™ | Vertical | Ploinks, Inc.(d) |
| 5 |
| (a) | Physician market (including medical clinics but not including hospitals) |
| (b) | Government sector |
| (c) | Clients of NOW Solutions |
| (d) | Personal secure communication channel for individual consumers |
Business Operations and Units
Our business operations are grouped into the following units: NOW Solutions, Ploinks, Inc., Taladin, VHS, Priority Time Systems, SnAPPnet, Inc., Vertical do Brasil, and other subsidiaries with minimal or no activity and other limited interests. Each of the primary divisions is discussed below.
| 6 |
NOW Solutions, Inc.
NOW Solutions, a Delaware corporation, is a 75% owned subsidiary of the Company. NOW Solutions specializes in end-to-end, fully integrated human resources and payroll solutions. NOW Solutions has clients in the United States and Canada ranging from private businesses to government agencies, who typically employ 500 or more employees. NOW Solutions currently markets emPath®, a payroll and human resources and payroll solution. emPath® meets the needs for clients who have complex payroll where they may have employees from different unions, multiple locations in different states (U.S.) and provinces (Canada), and intricate compensation structures. We believe that the competitive advantage of emPath® is its speed of implementation through a formula-builder technology, which provides customers with rapid customization of payroll rules and calculations without the need for any programming expertise. NOW Solutions’ product suite is targeted to address the needs of management in today’s dynamic business environment and gives organizations a user-friendly, flexible, multi-lingual (i.e., English, Canadian French, Spanish, and Portuguese) software solution, without the multi-million dollar implementation and support budgets typically required to use the payroll and HR products of major competitors.
NOW Solutions has converted some of its existing customers to its cloud-based model and is in the process of developing methods to introduce its cloud-based offering (supporting MS SQL, Oracle and DB2 databases) through distributors in the United States. During the conversion of one of our large complex customers and in discussions with other similar complex customers, we determined that there was a critical need and opportunity in providing a solution we are labeling “tailored cloud-based”, which we believe can fulfill our customers’ unique requirements while giving them the benefits of a cloud-based offering. NOW Solutions has a new version (Version 7.0) of its emPath® software currently in beta testing with some of their clients, with the expectation of it being fully released in May 2017. Empath 7.0 not only greatly improves the user experience but also supports all modern browsers.
Additionally, NOW Solutions has embarked on a strategy of developing and licensing HR products complementary to its existing suite of products that can be sold separately or integrated as emPath® modules, which has been greatly facilitated by emPath®’s Web Services integration. PTS™ is the first product to be integrated within the emPath® solution. NOW Solutions is currently finalizing the integration of PTS™ with emPath®. The second product is SnAPPnet™, which is in the in the process of being upgraded to expand the utility of the product beyond traditional credentialing software so that it can be used by HR departments of NOW Solutions’ existing customer to create and administer fillable forms routinely used for employees.
Once the first version of Ploinks™ is released with the Puddle™, there will be presentations made to selected NOW solutions’ customers to jointly create an enterprise secure communication channel utilizing VCSY secure communication platform.
The revenue model of NOW Solutions is based upon five components: licensing and renewable annual maintenance fees, cloud-based fees, professional consulting services, and managed services. Under the cloud-based delivery model, NOW Solutions typically collects monthly fees.
For the 12 months ended December 31, 2016, NOW Solutions had approximately $541,830 of total assets, revenues of approximately $3,768,420 and net income of approximately $469,570.
Taladin, Inc.
Taladin, a Texas corporation, is a wholly-owned subsidiary of the Company. Taladin is being positioned to become the parent company for NOW Solutions, Priority Time and SnAPPnet in order to streamline and better coordinate the Company’s business administrative software product lines and marketing efforts. It is anticipated that Taladin will also be responsible for an enterprise private communication channel utilizing VCSY secure communication platform.
For the 12 months ended December 31, 2016, Taladin had no material assets, no revenues and a net loss of approximately $14,095.
Ploinks, Inc.
Ploinks, Inc., a Texas corporation (formerly OptVision Research, Inc.), is a 91% owned subsidiary of the Company.
Vertical has licensed its secure communication platform to Ploinks, Inc. in the United States, for use by consumers as a personal secure communication channel. The Ploinks™ application was launched in February 2017. Ploinks, Inc. is also developing the Puddle™, a complimentary storage and backup solution to Ploinks™ for Windows-based PCs and storage devices, which is anticipated to be launched in April 2017, which will be synchronized with a user’s mobile device. Upon completion of the synchronization of the user’s mobile device and the Puddle™, Ploinks™ will be marketed as a secure personal cloud.
| 7 |
Ploinks™ is available on http://www.ploinks.com for a monthly subscription fee.
For the 12 months ended December 31, 2016, Ploinks, Inc. had no material assets, no revenues and a net loss of $1,705,446.
Vertical Healthcare Solutions, Inc.
VHS, a Texas corporation, is a wholly-owned subsidiary of the Company. VHS will market a new platform called the “Physicians Bridge”, which will be the basis for marketing applications to physicians utilizing other Vertical technologies and products which were licensed for the physician market by Vertical to VHS. Vertical will also license its secure communication platform to VHS to be utilized in the development of a secure communication channel to be used between physicians and staff as well as between patients, staff, and physicians.
For the 12 months ended December 31, 2016, VHS had $230 of assets, no revenues, and a net loss of approximately $162,395.
Priority Time Systems, Inc.
Priority Time, a Nevada corporation, is an 70% owned subsidiary of the Company. We originally purchased 90% of the common stock of Priority Time from a shareholder of Priority Time and under a shareholder agreement with the selling shareholder, we have the option to purchase 10% of the common shares of Priority Time stock held by this shareholder. The shareholder agreement also provides for the licensing terms of Priority Time products to our other subsidiaries.
Priority Time has been developing PTS™, a time and attendance product that will be offered as both a standalone product and as an integrated module within emPath®.
PTS™ is being developed to meet the unique and complex requirements of NOW Solutions’ customers, particularly for the medical and government markets, who provided us with specifications for an ideal time and attendance program. The most critical need of complex customers was robust flexibility which led to the creation, from the ground up, of a rule-based time and attendance application, allowing users to make for immediate changes within the application while also providing a state-of-the-art reporting ability to senior executives. The result also led to a new development platform as well as another application called “dashboardletsTM.” PTS™ will be commercially available once a major emPath® update is completed and its integration with emPath® finalized.
We have been using our new development platform, which has allowed us to create a cloud-based solution that utilizes a rule-based system, which will better meet the needs of NOW Solutions’ most complex customers and more easily create a time and attendance product for vertical markets (i.e. medical, government, casinos, and hospitality).
For the 12 months ended December 31, 2016, Priority Time had no assets, no revenues and a net loss of approximately $1,235.
SnAPPnet, Inc.
SnAPPnet, Inc., a Texas corporation, is an 80% owned subsidiary of the Company. On May 21, 2010, SnAPPnet, Inc. purchased substantially all the assets of Pelican Applications, LLC (“Pelican”) in exchange for $5,335 cash, 100,000 shares of Series B Convertible Preferred Stock of VHS, and other contingent consideration. The assets acquired included a software application product known as SnAPPnet™ which is currently used for physician credentialing, as well as Pelican’s entire customer base. We intend to utilize the SnAPPnet™ software to expand its offering to physicians, and to adapt the software to meet the needs of NOW Solutions’ hospital clients who may need a credentialing product for nurses.
SnAPPnet™ core application is being rewritten to utilize our new administrative development platform, including our proprietary dashboardlets™. The revised and improved SnAPPnet™ application will open new possibilities in markets in need of automated fillable forms.
For the 12 months ended December 31, 2016, SnAPPnet, Inc. had assets of approximately $7,675, revenues of approximately $59,255 and a net loss of approximately $5,300.
| 8 |
Government Internet Systems, Inc.
GIS, a Nevada corporation is our 84.5% owned subsidiary. Vertical licensed ResponseFlash™ to GIS in order to market and distribute this technology to government entities (excluding state universities and schools) in the United States. Marketing is currently on hold and the business opportunities are being reviewed in conjunction with VCSY secure communication platform.
For the 12 months ended December 31, 2016, GIS had no assets, no material revenue and net loss of approximately $9,929.
Vertical do Brasil
Our 100% owned subsidiary, Vertical do Brasil, a Brasilian company, houses a software development team that performs services on behalf of the Company and its subsidiaries.
For the 12 months ended December 31, 2016, Vertical do Brasil had assets of approximately $4,013, no revenues and net loss of approximately $207,577.
The following corporations are inactive:
Vertical Internet Solutions, Inc.
VIS, a California corporation, is a wholly-owned subsidiary of the Company. VIS is inactive and we currently have no plans regarding this subsidiary.
For the 12 months ended December 31, 2016, VIS had no material assets, no material revenue and no expenses.
EnFacet, Inc.
EnFacet, a Texas corporation, is a wholly-owned subsidiary of the Company. EnFacet is inactive and we currently have no plans regarding this subsidiary.
For the 12 months ended December 31, 2016, EnFacet had no material assets and a net loss of $28.
Globalfare.com
Globalfare, a Nevada corporation, is a wholly-owned subsidiary of the Company. Globalfare is inactive and we currently have no plans regarding this subsidiary.
For the 12 months ended December 31, 2016, Globalfare had no assets and a net loss of $99.
Pointmail.com, Inc.
Pointmail, a California corporation, is a wholly-owned subsidiary of the Company. Pointmail is inactive and we currently have no plans regarding this subsidiary.
For the 12 months ended December 31, 2016, Pointmail had no assets, no revenues and no expenses.
Competition
We face substantial competition from software and hardware vendors, system integrators, and multinational corporations focused upon information technology and security.
In the realm of application software, NOW Solutions’ competitors include Oracle, Lawson, Cyborg /Hewitt, Kronos, DLGL, Ultimate and SAP. Our cloud-based emPath® competes with ADP, Ceridian, Ultimate Software and Quicken. However, while NOW Solutions competes with these companies, our payroll product is utilized by our many of our customers in conjunction with many of these companies’ other modules.
Priority Time’s competitors include Kronos, NOVAtime Technology, Asure Software, Insperity (formerly known as Administaff), and Qqest Software Systems.
| 9 |
SnAPPnet, Inc. competes with several small and mid-sized competitors in the healthcare credentialing business sector. SnAPPnet’s competitors include EchoApps (Heathline Systems), Win/Staff PRO-FILE (Win/Staff), Medkinetics Pro (Medkinetics), IntelliAppsSE (Intellisoft Group, Inc.), OneAPP (Sy.Med) and CACTUS Software.
Ploinks™ is an all-in-one solution that we believe has no direct competition to our knowledge, but finds competitors in some of its areas, such as Snapchat and Instagram for images, Whisper, WhatsApp, Facebook messenger in the area of secure messaging, as well as Dropbox, GoDaddy, Amazon, Microsoft and Google for cloud services.
Our primary competitors have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical and marketing resources than we do. However, we have a number of large complex clients including cities and counties in the United States that have been users of our Payroll/HRMS software for many years (10 -25 years) and are highly referenceable. We cannot guarantee that we will be able to compete successfully against current or future competitors or that competitive pressure will not have a material and adverse effect on our financial position, results of operations and cash flows.
Our ability to compete will also depend upon our ability to continually improve our products and services, the enhancements we develop, the quality of our customer service, and the ease of use, performance, price and reliability of our products and services.
We believe, however, that we possess certain competitive advantages for the following reasons:
| 1. | We have a number of proprietary patented and patent-pending technologies that can be utilized in our offerings. |
| 2. | NOW Solutions has an outstanding customer support department that has supported large complex entities for a number of years, and many of these large entities are leaders in their respective industries. |
| 3. | emPath®’s inherent strengths include its formula builder, the use of one single database (where competing products may use two or more), and a strong, highly identifiable customer base it can reference. |
| 4. | emPath® is built on a state-of-the-art Microsoft.net platform, allowing for rapid software development and interoperability with other software packages. |
| 5. | Our development platform (including the dashboardlets™ feature) will provide a consistent business intelligence tool across our administrative software product line. |
| 6. | We can cross-promote our administrative software applications between companies. |
| 7. | emPath® supports a global platform with one database for both payroll and HR. |
| 8. | Our new secure communication platform is based upon certain trade secrets and revolutionary technology with patented and patent-pending technology. |
Strategic Overview
The Company’s product portfolio reflects a number of unique characteristics and advantages that have been developed or acquired over time. At present, we are actively pursuing the strategy of (a) further developing the technologies owned by the Company and our subsidiaries and (b) combining all the technologies owned by the Company and our subsidiaries into viable product offerings.
The key components of our strategy are to:
| 1. | Leverage our strong, profitable subsidiary, NOW Solutions, that has a highly-referenceable client base, including companies that are leaders in their industries and have been users of emPath® and its predecessor product for over 25 years for their payroll and human resource needs. |
| 2. | Develop a portfolio of patented technologies that can be licensed to third parties or utilized internally to strengthen our existing and projected product offerings. |
| 3. | Build a network of compatible partners and acquisition or licensing of products that complement our existing offerings. |
| 10 |
| 4. | Maximize the unique features of our new software development platform to launch our new PTS™ and SnAPPnet™ products as well as other products to NOW Solutions’ customer base and, at the same time, have those customers assist us in development of product specifications for their own vertical markets. |
| 5. | Build and integrate new commercially viable products utilizing our patented technology and other administration software. |
| 6. | Expand the reach of emPath® internationally beyond the U.S. and Canada utilizing non-competitive local distributors in foreign countries. |
| 7. | Develop proprietary applications on our secure communication platform and, with licensing agreements, provide a structure whereby third-party applications can be developed upon that platform to be then distributed. |
| 8. | Have third party verification as to the capability and comparison in the marketplace. |
| 9. | Do joint partnerships with companies that benefit from our technology. |
The software development leg of our strategy is two-fold. The first is to further enhance our existing solutions and develop new products in order to better compete with the large ERP providers like SAP and Oracle by providing complex best-of-breed alternative offerings that are more cost effective solutions. The second is to continue developing our intellectual property internally for mass market, best-of-breed solutions offered as cloud-based solutions that incorporate the advantages of our complex solutions. In each such instance, the software development leg of our strategy will be augmented by exploring solutions that can be linked to federal and state government programs for cost savings.
Our new mobile strategy is intended to make us a dominant player in the mobile space for the private communication sector that also serves as a complement to the social media market, as well as providing solutions in the healthcare and corporate markets. The goal is to become a provider with an all-in-one solution incorporating technology between a mobile device and different data storage units.
One key to the success of our strategies is to leverage our core capabilities, by entering into co-marketing agreements with other companies, particularly those who offer best-of-breed products that complement our product offerings. Our objective is to enter into distinct co-marketing agreements whereby each business unit will have a separate agreement with the co-marketing partner for its particular target market. To supplement this approach, our business units will enter into agreements with each other where they can more successfully cross-promote and market their respective products. We are also identifying complementary products from third parties which we can private label and sell as part of our existing product offering or separately.
Proprietary Rights
We rely upon a combination of patent, copyright, trademark, trade secret laws, and contract provisions and to protect our proprietary rights in our technologies, products and services. We distribute our products and services under agreements that grant users or customers a license to use our products and services and rely upon the protections afforded by the copyright laws to protect against the unauthorized reproduction of our products. In addition, we protect our trade secrets and other proprietary information through confidentiality agreements with employees, consultants and other business partners. emPath®, PTS™, SnAPPnet™, PASS™ and Ploinks™ are protected by copyright and trademark.
Our patent portfolio consists of the following technologies and related products:
The USPTO granted us a patent (No. 6,718,103) for an invention for “Transmission of Images over a Single Filament Fiber Optic Cable” in April 2004. This patent is in a theoretical stage only and is intended to be used for transmitting images on fiber optics that might improve in orders of magnitude today’s capacity of fiber optics to transmit images and data.
The USPTO granted us a patent (No. 6,826,744) for an invention for “System and Method for Generating Web Sites in an Arbitrary Object Framework” on November 30, 2004. On May 11, 2010, we were granted a continuation patent (U.S. Patent No. 7,716,629) of U.S. Patent No. 6,826,744 by the USPTO. All pending new claims were granted in the continuation patent for U.S. Patent No. 7,716,629, which has increased the scope of the original patent by adding 32 new claims to the original 53 claims. On February 3, 2015, we were granted a continuation patent (U.S. Patent No. 8,949,780) of U.S. Patent No. 7,716,629. All pending new claims were granted in the continuation patent for U.S. Patent No. 8,949,780, which has increased the scope of the continuation patent and the original patent by adding 24 new claims.
| 11 |
Together, these patents are the foundation of our SiteFlash™ platform.
The USPTO granted us a patent (No. 7,076,521) for an invention for a “Web-based collaborative data collection system” on July 11, 2006. This patent covers various aspects of the Emily™ XML Enabler Agent and the Emily™ XML Broker.
The USPTO granted us a patent (No. 8,578,266) for a “Method and Systems for Automatically Downloading and Storing Markup Language Documents into a Folder Based Data Structure” (formerly, a “Method and System for Providing a Framework for Processing Markup Language Documents”) on November 5, 2013. In August 2016, we were granted a continuation patent (U.S. Patent No. 9,405,736) of U.S. Patent No. 8,578,266 which allowed Claims 1-19 and 21 and amended claims 1, 14, and 21. These patents cover the Emily™ scripting language.
THE USPTO granted us a patent (No. 9,112,832) for a “System and Method Running a Web Server on a Mobile Internet Device.” This patent is incorporated into our secure communication platform and covers the Tiny Web Server, which is also a component of our secure communication platform.
We also have several patent-pending software technologies and licensed software:
In 2011, we filed two provisional applications for patents relating to our patent application filed in 2010 and these have been replaced with non-provisional patent applications which were filed in 2012, which are still pending.
In 2013, we filed six patent applications (including provisional patent applications).
In 2014, we filed two provisional patent applications, which have been replaced with non-provisional patent applications and filed in 2015. These patent applications are still pending.
The Company acquired rights for U.S. Patent No. 8,903,371 (cellular telephone system and method), which was issued on December 2, 2014 under an assignment from Luiz Valdetaro, a co-inventor who is also an employee and the Chief Technology Officer of the Company.
Although we intend to protect our intellectual property rights as described above, there can be no assurance that these measures will be successful. Policing unauthorized use of our products and services is difficult and the steps taken may not prevent the misappropriation of our technology intellectual property rights. In addition, effective patent, trademark, trade secret and copyright protection may be unavailable or limited in certain foreign countries. We seek to protect the source code of some of our products as trade secrets and as unpublished copyright works. Source code for certain products has been or will be published in order to obtain patent protection or to register copyright in such source code. We believe that our products, trademarks and other proprietary rights do not infringe on the proprietary rights of third parties. There can be no assurance that third parties will not assert infringement claims against us in the future with respect to current or future features or content of services or products or, if so asserted that any such claims will not result in litigation or require us to enter into royalty arrangements.
Regulatory Environment; Public Policy
In the United States and most countries in which we conduct our operations, we are generally not regulated other than pursuant to laws applicable to businesses in general and value-added services specifically. In some countries, we are subject to specific laws regulating the availability of certain material related to, or to the obtaining of, personal information. Adverse developments in the legal or regulatory environment relating to the interactive online services and Internet industry in the United States, Canada, Europe, Asia, Latin America or elsewhere could have a material adverse effect on our business, financial condition and operating results. A number of legislative and regulatory proposals from various international bodies and foreign and domestic governments in the areas of telecommunications regulation, particularly related to the infrastructures on which the Internet rests, access charges, encryption standards and related export controls, content regulation, consumer protection, advertising, intellectual property, privacy, electronic commerce, and taxation, tariff and other trade barriers, among others, have been adopted or are now under consideration. We are unable at this time to predict which, if any, of the proposals under consideration may be adopted and, with respect to proposals that have been or will be adopted, whether they will have a beneficial or an adverse effect on our business, financial condition and operating results.
Employees
As of April 24, 2017, we had 23 full-time and 4 part-time employees (20 are employed in the United States and 7 in Canada), 2 full time consultants and 1 part time consultant. We are not a party to any collective bargaining agreements.
| 12 |
Risk Factors Related to Our Business, Operating Results and Financial Condition
We are subject to various risks that may materially harm our business, financial condition and results of operations. You should carefully consider the risks and uncertainties described below and the other information in this filing before deciding to purchase our common stock. If any of these risks or uncertainties actually occurs, our business, financial condition or operating results could be materially harmed. In that case, the trading price of our common stock could decline and you could lose all or part of your investment.
We Have Historically Incurred Losses and May Continue to Do So in the Future.
We had a net loss of $5,466,230 and $2,495,612 for the years ended December 31, 2016 and 2015, respectively, and have historically incurred losses. Accordingly, we have and may continue to experience significant liquidity and cash flow problems because our operations are not profitable. No assurances can be given that we will be successful in reaching or maintaining profitable operations.
We Have Been Subject to a Going Concern Opinion from Our Independent Auditors, Which Means That We May Not Be Able to Continue Operations Unless We Obtain Additional Funding.
The report of our independent registered public accounting firm included an explanatory paragraph in connection with our financial statements for the years ended December 31, 2016 and 2015. This paragraph states that our recurring net losses, negative working capital and accumulated deficit, the substantial funds used in our operations and the need to raise additional funds to accomplish our objectives raise substantial doubt about our ability to continue as a going concern. Our ability to develop our business plan and to continue as a going concern depends upon our ability to raise capital, to succeed in the licensing of our intellectual property and to achieve improved operating results. Our financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Our Ability to Continue as a Going Concern Is Dependent on Our Ability to Raise Additional Funds and to Establish Profitable Operations.
The accompanying consolidated financial statements for the years ended December 31, 2016 and 2015 have been prepared assuming that we will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.
The carrying amounts of assets and liabilities presented in the financial statements do not purport to represent realizable or settlement values. We have suffered significant recurring operating losses, used substantial funds in our operations, and need to raise additional funds to accomplish our objectives. Stockholders’ deficit at December 31, 2016 was $31.0 million. Additionally, at December 31, 2016, we had negative working capital of approximately $20.6 million (although it includes deferred revenue of approximately $1.8 million) and have defaulted on substantially all of our debt obligations. These conditions raise substantial doubt about our ability to continue as a going concern.
Our Success Depends On Our Ability to Generate Sufficient Revenues to Pay for the Expenses of Our Operations.
We believe that our success will depend upon our ability to generate revenues from our SiteFlash™ and Emily™ technology products through licensing and development of commercially viable products, as well as increased revenues from NOW Solutions’ products and services as well as the successful launch of our new products by our subsidiaries (such as SnAPPnet™, and PTS™, Emily™ and web server applications), none of which can be assured. Our ability to generate revenues is subject to substantial uncertainty and our inability to generate sufficient revenues to support our operations and debt repayment could require us to curtail or suspend operations. Such an event would likely result in a decline in our stock price.
Our Success Depends On Our Ability to Obtain Additional Capital.
We have funding that is expected to be sufficient to fund our present operations for three months. However, we will need significant additional funding in order to complete our business plan objectives. Accordingly, we will have to rely upon additional external financing sources to meet our cash requirements. Management will continue to seek additional funding in the form of equity or debt to meet our cash requirements. Other than common or preferred stock in our subsidiaries, we do not have any common stock available to issue to raise money. However, there is no guarantee we will raise sufficient capital to execute our business plan. In the event that we are unable to raise sufficient capital, our business plan will have to be substantially modified and operations curtailed or suspended.
| 13 |
We Have a Working Capital Deficit, Which Means That Our Current Assets on December 31, 2016 Were Not Sufficient to Satisfy Our Current Liabilities on That Date.
We had a working capital deficit of approximately $20.6 million at December 31, 2016, which means that our current liabilities exceeded our current assets by approximately $20.6 million (although it includes deferred revenue of approximately $1.8 million). Current assets are assets that are expected to be converted into cash within one year and, therefore, may be used to pay current liabilities as they become due. Our working capital deficit means that our current assets on December 31, 2016 were not sufficient to satisfy all of our current liabilities on that date.
Our Operating Results May Fluctuate Because of a Number of Factors, Many of Which Are Outside of Our Control.
Our operating results may fluctuate significantly as a result of variety of factors, many of which are outside of our control. These factors include, among others, the following:
| · | the demand for our SiteFlash™, Emily™ and other proprietary technologies; |
| · | the demand for our administrative software products and services: emPath®, PTS™, and SnAPPnet™; |
| · | the demand for our personal secure communication application Ploinks™; |
| · | introduction of new products and services by us and our competitors; |
| · | costs incurred with respect to acquisitions; |
| · | price competition or pricing changes in the industry; |
| · | technical difficulties or system failures; |
| · | general economic conditions and economic conditions specific to the Internet and Internet media and communication platforms; and |
| · | the licensing of our intellectual property. |
We Face Product Development Risks Due to Rapid Changes in Our Industry. Failure to Keep Pace with These Changes Could Harm Our Business and Financial Results.
The markets for our products are characterized by rapid technological developments, continually-evolving industry trends and standards and ongoing changes in customer requirements. Our success depends on our ability to timely and effectively keep pace with these developments.
Keeping Pace with Industry Changes.
We must enhance and expand our product offerings to reflect industry trends, new technologies and new operating environments as they become increasingly important to customer deployments. We must continue to expand our business models beyond traditional software licensing and subscription models, including, by way of example, use of cloud based offering as an increasingly important method and business model for the delivery of applications. We must also continuously work to ensure that our products meet changing industry certifications and standards. Failure to keep pace with any changes that are important to our customers could cause us to lose customers and could have a negative impact on our business and financial results.
Impact of Product Development Delays or Competitive Announcements.
Our ability to adapt to changes can be hampered by product development delays. We may experience delays in product development as we have at times in the past. Complex products like ours may contain undetected errors or version compatibility problems, particularly when first released, which could delay or adversely impact market acceptance. We may also experience delays or unforeseen costs associated with integrating products we acquire with products we develop because we may be unfamiliar with errors or compatibility issues of products we did not develop ourselves. We may choose not to deliver a partially-developed product, thereby increasing our development costs without a corresponding benefit. This could negatively impact our business.
Our Failure to Maintain and Increase Acceptance of Our Cloud-Offerings Would Inhibit Our Growth Or Cause a Significant Decline in Our Revenues.
Our future success depends on maintaining and increasing acceptance of our Cloud-based offering, particularly, of emPath® and PTS™. Any decrease in the demand for these products would have a material adverse effect on our business, operating results and financial condition and would place a significant strain on our management and operations.
| 14 |
If We Are Unable to Make Periodic Updates for Our Products Concerning Changes in Tax Laws and Other Regulations on a Timely Basis Acceptance of Our Products in the Market could Be Adversely Affected And Our Revenues Would Decline.
Products like emPath® are affected by changes in tax laws and regulations, and we must generally update such products on an annual or periodic basis to maintain their accuracy and competitiveness. We cannot be certain we will be able to release these updates on a timely basis in the future. Any failure to do so could have a material adverse effect on the acceptance of our products. Additionally, any significant changes in tax laws or regulations applicable to such products could require us to make significant investments in modifications of these products, leading to significant and unexpected costs.
Errors and Defects in Our Software Could Affect Sales of Our Products.
The software products we offer may contain undetected errors, defects, or failures when first introduced or as new versions are released. Testing of software products presents many challenges since it is difficult to anticipate and simulate the wide range of software computing environments in which our customers use these products. While we test our products extensively, from time-to- time, we have discovered errors or defects in our products. These defects and errors may result in any of the following:
| · | Delays in the release of our new products, versions and upgrades |
| · | Increased costs to fix such defects and errors, in turn leading to a strain on our software development resources |
| · | Design modifications of the product |
| · | A decrease in customer satisfaction with, our products and a decrease in sales, and a loss of existing and potential customers |
Even after our products are tested by us and by current and prospective customers, errors and defects may be discovered after the commercial release has commenced, which may result in loss of or delay in market acceptance which could have a material adverse impact upon our business, operating results and financial condition.
Our software products may be vulnerable to break-ins and similar disruptive problems; addressing these issues may be expensive and require a significant amount of our resources.
We have included security features in our products that are intended to protect the privacy and integrity of customer data. Despite the existence of these security features, our software products may be vulnerable to break-ins and similar disruptive problems. Addressing these evolving security issues may be expensive and require a significant amount of our resources.
The Sale and Support of Software Products and the Performance of Related Services by Us Entail the Risk of Product or Service Liability Claims, Which Could Significantly Affect Our Financial Results.
Customers use our products in connection with the preparation and filing of tax returns and other regulatory reports. If any of our products contain errors that produce inaccurate results upon which users rely, or cause users to misfile or fail to file required information, we could be subject to liability claims from users. Our Cloud-based usage licenses and maintenance renewal agreements with our customers typically contain provisions intended to limit our liability to such claims, but such provisions may not be effective in doing so. These contractual limitations may not be legally enforceable and may not afford us with adequate protection against product liability claims in certain jurisdictions. If a successful claim for product or service liability was brought against us, this could result in substantial cost to us and divert management’s attention from our operations.
International Operations of Our Business Subject Us to Additional Risks in Those Foreign Countries.
Our international operations are subject to additional risks, which increase our exposure to foreign laws and regulations. Over time, our international operations may grow and increase their significance to our business. Sales to international customers subject our business to a number of risks, including foreign currency fluctuations, unexpected changes in regulatory requirements related to software, international political and economic instability, international tax laws, compliance with multiple, changing, and possibly conflicting governmental laws and regulations, and difficulty in staffing and managing foreign operations,. In addition, there may be weaker protection for our intellectual property abroad than in the United States, and we may have difficulties in enforcing such rights abroad. If we are not able to comply with foreign laws and regulations, which are often complex and subject to variation and unexpected changes, we could incur unexpected costs and potentially become involved in litigation. In addition, in the event sales to any of our customers outside of the United States are delayed or canceled because of any of the risks described above, our revenues may be negatively impacted.
| 15 |
Security and Privacy Breaches Could Adversely Impact Our Business.
For services such as our cloud-based offerings, we may electronically store personal information about our clients and their employees. We take security measures to protect against the unauthorized access and disclosure of such information. However, there is no guarantee the precautions we take will be successful in protecting against all security breaches that may result in unauthorized access to such information. If our security measures are breached or if our services are subject to attacks that degrade or deny the ability of our clients to access our services, we may incur significant financial, legal, and regulatory exposure.
Privacy Concerns Could Result in Changes of Regulations or Laws That Affect Our Business.
Personal privacy is a significant issue in the United States as well as in other countries where our customers operate. Consequently, we are subject to regulations concerning the use of personal information we collect. Changes to regulations or laws affecting privacy that apply to our business could impose additional costs and potential liability on us and could also limit our use and disclosure of such information. If we are required to change our business activities or revise or eliminate services, our business could be adversely affected.
We May Have Difficulty Managing Our Growth and Integrating Recently Acquired Companies.
Our recent growth through acquisitions and licensing of new solutions, coupled with our development efforts to create new commercially viable products and improve existing ones, has placed a significant strain on our managerial, operational, and financial resources. To manage our growth, we must continue to implement and improve our operational and financial systems and to expand, train, and manage our employee base. Any inability to manage growth effectively could have a material adverse effect on our business, operating results, and financial condition. Further, acquisition transactions are accompanied by a number of risks, including the following:
| · | the difficulty of assimilating the operations and personnel of the acquired companies; |
| · | the potential disruption of our ongoing business and distraction of management; |
| · | the difficulty of incorporating acquired technology or content and rights into our products and media properties; |
| · | the correct assessment of the relative percentages of in-process research and development expense which needs to be immediately written off as compared to the amount which must be amortized over the appropriate life of the asset; |
| · | the failure to successfully develop an acquired in-process technology resulting in the impairment of amounts currently capitalized as intangible assets; |
| · | unanticipated expenses related to technology integration; |
| · | the maintenance of uniform standards, controls, procedures and policies; |
| · | the impairment of relationships with employees and customers as a result of any integration of new personnel; and |
| · | the potential unknown liabilities associated with acquired businesses. |
We may not be successful in addressing these risks or any other problems encountered in connection with acquisitions. Our failure to address these risks could negatively affect our business operations through lost opportunities, revenues or profits, any of which would likely result in a lower stock price.
Our Success Depends On Our Ability to Protect Our Proprietary Technology.
Our success is dependent, in part, upon our ability to protect and leverage the value of proprietary technology, including our private communications platform technology (which includes the Ploinks™ products), our patented SiteFlash™ and Emily™ technologies, our patent-pending technologies and administrative software solutions like emPath®, PTS™, and SnAPPnet™, as well as our trade secrets, trade names, trademarks, service marks, domain names and other proprietary rights we either currently have or may have in the future. Given the uncertain application of existing trademark laws to the Internet and copyright laws to software development, there can be no assurance that existing laws will provide adequate protection for our technologies, sites or domain names. Policing unauthorized use of our technologies, content and other intellectual property rights entails significant expenses and could otherwise be difficult or impossible to do given the global nature of the Internet and our potential markets.
If Demand for Our Products Grow Quickly, We May Lack the Capacity Needed to Meet Demand or We May Be Required to Increase Our Capital Spending Significantly.
Our current plans may not be sufficient to meet our capacity needs for the foreseeable future or may not be implemented quickly enough to meet growing demand. Moreover, if we make significant capital expenditures to increase capacity and demand does not increase as we expect, these expenditures would adversely affect our profitability and return on capital.
| 16 |
Our Stock Price Has Historically Been Volatile, Which May Make It More Difficult for Shareholders to Resell Shares When They Choose To At Prices They Find Attractive.
The trading price of our common stock has been and may continue to be subject to wide fluctuations. The stock price may fluctuate in response to a number of events and factors, such as quarterly variations in operating results, announcements of technological innovations or new products and media properties by us or our competitors, changes in financial estimates and recommendations by securities analysts, the operating and stock price performance of other companies that investors may deem comparable, and news reports relating to trends in our markets. In addition, the stock market in general, and the market prices for Internet-related and technology-related companies in particular, have experienced extreme volatility that often has been unrelated to the operating performance of such companies. These broad market and industry fluctuations may adversely affect the price of our stock, regardless of our operating performance.
Our Common Stock Is Deemed To Be “Penny Stock,” Which May Make It More Difficult for Investors to Sell Their Shares Due To Suitability Requirements.
Our common stock is deemed to be “penny stock” as that term is defined in Rule 3a51-1 promulgated under the Exchange Act. Penny stocks are stocks:
| 1. | With a price of less than $5.00 per share; |
| 2. | That are not traded on a recognized national exchange; |
| 3. | Whose prices are not quoted on the NASDAQ automated quotation system (NASDAQ listed stock must have a price of not less than $5.00 per share); or |
| 4. | In issuers with net tangible assets less than $2 million (if the issuer has been in continuous operation for at least three years) or $5 million (if in continuous operation for less than three years), or with average revenues of less than $6 million for the last three years. |
Broker/dealers dealing in penny stocks are required to provide potential investors with a document disclosing the risks of penny stocks. Moreover, broker/dealers are required to determine whether an investment in a penny stock is a suitable investment for a prospective investor. These requirements may reduce the potential market for our common stock by reducing the number of potential investors. This may make it more difficult for investors in our common stock to sell shares to third parties or to otherwise dispose of them. This could cause our stock price to decline.
The Company and NOW Solutions’ headquarters are currently located at 101 West Renner Road, Suite 300, Richardson, Texas, and comprise approximately 4,000 square feet. NOW Solutions has other offices at 6205 Airport Road, Building B, Suite 214, Mississauga, Ontario, Canada, which comprises 793 square feet. All of these locations are leased from third parties and the premises are in good condition. We believe that our facilities are adequate for our present needs and near-term growth, and that additional facilities will be available at acceptable rates as we need them. Our other subsidiaries may be reached through our Richardson, Texas headquarters.
We are involved in the following ongoing legal matters:
On December 31, 2011, the Company and InfiniTek corporation (“InfiniTek”) entered into a settlement agreement to dismiss an action filed by the Company against InfiniTek in the Texas State District Court in Fort Worth, Texas, for breach of contract and other claims, a counter claim filed by InfiniTek against the Company for non-payment of amounts claimed the Company owed to InfiniTek, and an action filed by InfiniTek against the Company in California Superior Court in Riverside, California seeking damages for breach of contract and lost profit. Pursuant to the terms of the settlement agreement, Vertical agreed to pay InfiniTek $82,500 in three equal installments with the last payment due by or before August 5, 2012. Upon full payment, InfiniTek shall transfer and assign ownership of the NAVPath software developed by InfiniTek for use with NOW Solutions emPath® software application and Microsoft Dynamics NAV (formerly Navision) business solution platform. The amounts in dispute were included in our accounts payable and accrued liabilities and have been adjusted to the settlement amount of $82,500 at December 31, 2011. The Company has made $37,500 in payments due under the settlement agreement as of the date of this Report and each party is alleging the other party is in breach of the settlement agreement. We intend to resolve all disputes with InfiniTek.
| 17 |
On February 13, 2017, the Company was served with a complaint filed by Parker Mills in the Superior Court of the State of California, County of Los Angeles, Central District, for failure to make payment on the outstanding balance due under a $100,000 convertible debenture issued by the Company to Parker Mills. The plaintiff seeks payment of the principal balance due under the convertible debenture of $100,000, interest at the rate of 12% per annum, attorney’s fees and court costs. We intend to resolve this matter with Parker Mills. This case is styled Parker Mills, LLP v. Vertical Computer Systems, Inc., No. BC649122. William Mills is a partner of Parker Mills and the Secretary and a Director of the Company.
On April 12, 2017, NOW Solutions, Inc. was served with a Notice of Motion for Summary Judgment in Lieu of Complaint, which was filed by Derek Wolman in the Supreme Court of the State of New York in County of New York for failure to make outstanding payments on the outstanding balance due under one promissory note in the principal amount of $150,000 (issued on November 17, 2009) and one promissory note in the principal amount of $50,000 (issued on August 28, 2014), both of which were issued by NOW Solutions to Mr. Wolman. The plaintiff seeks a judgment totaling $282,299 (which includes principal and accrued interest), plus additional accrued interest from the date the complaint was filed, attorney’s fees and expenses. We intend to resolve this matter with Mr. Wolman. This case is styled Derek Wolman v. Now Solutions, Inc., No. 65/502/17.
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
Our common equity is traded on the OTC Markets and quoted on the OTCQB under the symbol “VCSY.” The OTCQB may also be referred to as “OTCMKTS” or “Other OTC”.
The following is the range of high and low closing bid prices of our stock, for the periods indicated below.
| High | Low | |||||||
| Quarter Ended December 31, 2016 | $ | 0,0244 | $ | 0.0178 | ||||
| Quarter Ended September 30, 2016 | $ | 0.0262 | $ | 0.0188 | ||||
| Quarter Ended June 30, 2016 | $ | 0.0273 | $ | 0.0169 | ||||
| Quarter Ended March 31, 2016 | $ | 0.0233 | $ | 0.0151 | ||||
| Quarter Ended December 31, 2015 | $ | 0,0475 | $ | 0.0121 | ||||
| Quarter Ended September 30, 2015 | $ | 0.0480 | $ | 0.0205 | ||||
| Quarter Ended June 30, 2015 | $ | 0.0370 | $ | 0.0226 | ||||
| Quarter Ended March 31, 2015 | $ | 0.0300 | $ | 0.0176 | ||||
The above quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions.
Number of Holders
As of April 24, 2017, there were 1,929 holders of record of VCSY common stock.
Equity Securities Under Compensation Plans
| Equity Compensation Plan Information | ||||||||||||
| Plan category | Number of securities to be issued upon exercise of outstanding options, warrants and rights | Weighted-average exercise price of outstanding options, warrants and rights | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) | |||||||||
| (a) | (b) | (c) | ||||||||||
| Equity compensation plans approved by security holders | - | - | - | |||||||||
| Equity compensation plans not approved by security holders | ||||||||||||
| 18 |
| Equity Compensation Plan Information | ||||||||||||
| Plan category | Number of securities to be issued upon exercise of outstanding options, warrants and rights | Weighted-average exercise price of outstanding options, warrants and rights | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) | |||||||||
| Stock Options | - | - | - | |||||||||
| Warrants | - | - | - | |||||||||
| Unvested Restricted Stock Awards | 13,125,000 | $ | 0.02 | - | ||||||||
| Total | 13,125,000 | $ | 0.02 | - | ||||||||
| (1) | Other than individual agreements with employees, directors and third party consultants, we do not have any equity compensation plans (i.e., stock option plans or restricted stock plans) that have been approved by security holders. |
| (2) | No stock options were issued to employees or consultants during the year ended December 31, 2016. |
| (3) | No warrants to purchase common stock were issued to employees or consultants during the year ended December 31, 2016. |
| (4) | Of the 13,125,000 common shares of restricted stock that had not vested at December 31, 2016 and were issued in connection with individual restricted stock agreements executed in 2015 and 2016 with employees of the Company and its subsidiaries, 550,000 have vested through April 24, 2017. |
Dividends
We have outstanding shares of Series A and Series C 4% Convertible Cumulative Preferred stock that accrue dividends (if such dividends are declared) at a rate of 4% on a semi-annual basis. The total dividends applicable to Series A and Series C Preferred Stock were $592,472 and $588,000 for the years ended December 31, 2016 and 2015, respectively. Our Board of Directors did not declare any dividends on our outstanding shares of Series A or Series C Preferred Stock during 2016 or 2015, nor has the Company paid any dividends on our outstanding shares of Series A or Series C Preferred Stock since 2001. We intend to retain future earnings, if any, to provide funds for use in the operation and expansion of our businesses. Accordingly, we do not anticipate paying cash dividends on any of our capital stock, including preferred stock, in the near future. For additional information concerning dividends, please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7.
Unregistered Sales of Securities
During the last two years, we issued the following unregistered securities:
In February 2015, the Company increased the number of its authorized shares of common stock to 2,000,000,000.
In March 2015, in connection with a $100,000 loan to Taladin, Ploinks, Inc. agreed to issue 1,000,000 shares of its common stock to the third party lender. The fair value of these subsidiary shares was determined to be nominal.
In March 2015, pursuant to an indemnity and reimbursement agreement executed between Mr. Valdetaro and the Company, we issued 1,000,000 shares of our common stock to reimburse Mr. Valdetaro for 1,000,000 shares of common stock with the Rule 144 restrictive legend transferred to Lakeshore on the Company’s behalf in connection with an extension granted by Lakeshore in August 2013. The issuance of these shares eliminated the derivative liability associated with the value of these shares. The fair market value of these shares on the date of issuance was $38,000 and resulted in the resolution of derivative liabilities and a loss on derivative liabilities of $26,000.
| 19 |
In March 2015, pursuant to two indemnity and reimbursement agreements executed between Mountain Reservoir Corporation (“MRC”) and the Company, we issued a total of 2,809,983 shares of our common stock with the Rule 144 restrictive legend to reimburse MRC. Of these shares, the Company was obligated to reimburse MRC with 1,309,983 shares of common stock that had been pledged by MRC and sold by a third party lender in 2009, 500,000 shares of common stock that had been wrongfully converted by the same lender in 2014, and 1,000,000 shares of common stock that had been transferred to another third party lender in 2013 on the Company’s behalf for a loan made by the lender. MRC has assigned its claim against the third party lender for the lender’s wrongful conversion of 500,000 common shares to the Company and we are pursuing the claim in the third party lender’s bankruptcy proceeding. The issuance of these shares eliminated the derivative liability associated with the value of these shares. The fair market value of these shares on the date of issuance was $112,399 of which $92,399 resulted in the resolution of derivative liabilities and a loss on derivative liabilities of $64,680 and $20,000 was recognized as stock reimbursement expense during the twelve months ended December 31, 2015.
In June 2015, in connection with an amendment concerning certain promissory notes issued by the Company and NOW Solutions to Mr. Weber in the aggregate principal amount of $735,400, the Company issued 20,000,000 shares of its common stock with the Rule 144 restrictive legend to its subsidiary, Taladin, Inc., which pledged these shares to secure payment of certain notes payable issued to Weber. The previous pledge agreements between MRC and Mr. Weber were cancelled. These shares are held in treasury.
In June 2015, the Company issued 10,000,000 common shares with the Rule 144 restrictive legend to its consolidated subsidiary NOW Solutions. These shares are held in treasury.
During the year ended December 31, 2015, the Company granted 2,250,000 unregistered shares of its common stock to employees of the Company and its subsidiaries pursuant to restricted stock agreements with the Company. These shares vest over 3 years in equal installments and the fair value of the awards is being expensed over this vesting period. The aggregate fair market value of the awards was determined to be $54,750. Stock compensation expense of $19,616 has been recorded for the year ended December 31, 2015 as additional paid-in capital.
During the year ended December 31, 2015, the Company issued 36,500,000 unregistered shares of its common stock as forbearance fees and late fees to lenders in connection with loans made to the Company and its subsidiaries. The aggregate fair value of these shares was determined to be $1,050,900.
During the year ended December 31, 2015, the Company issued 35,556,522 unregistered shares of its common stock to lenders to pay off accrued principal and interest debt in the aggregate amount of $482,612 and legal fees of $20,000 related to loans made by these lenders to the Company and its subsidiaries. The aggregate fair value of these shares was determined to be $895,913. Accordingly, the Company recorded a loss on debt extinguishment of $393,301.
As of December 31, 2015, there were 2,250,000 unvested stock compensation awards.
During the year ended December 31, 2015, the Company issued 9,000,000 unregistered shares of its common stock and 3-5 year warrants to purchase 6,800,000 shares of common stock at a purchase price between $0.05-$0.10 per share (of which one warrant for 800,000 shares included a cashless warrant exercise provision). These shares and warrants were granted to lenders in connection with loans made by these lenders to the Company and its subsidiaries in the aggregate principal amount of $745,333. The aggregate relative fair value of these shares was determined to be $211,783 (which includes $82,904 under the Black-Scholes formula), and was accounted for as a discount on the loans. Amortization expense is $80,864 during the year ended December 31, 2015 and unamortized discounts are $130,919.
During the year ended December 31, 2015, Ploinks, Inc. granted 800,000 unregistered shares of the common stock of Ploinks, Inc. to employees of the Company pursuant to restricted stock agreements with Ploinks, Inc. These shares typically vest over 3 years in various installments.
In March 2016, the Company cancelled 1,000,000 unregistered shares of its common stock issued during 2015 to a third party lender under an agreement to amend certain promissory notes issued by the Company and NOW Solutions in the aggregate principal amount of $715,000. Under the amendment, the Company agreed to make $22,000 monthly payments and an additional $10,000 penalty if such monthly payment is not timely made.
| 20 |
In March 2016, the Company issued 10,000,000 shares of the Company’s common stock with the Rule 144 restrictive legend to its consolidated subsidiary Ploinks, Inc. These shares are held in treasury. In exchange, Ploinks, Inc. issued 5,000,000 of its common shares to the Company.
In April 2016, the Company and a third-party noteholder entered into an agreement under which the Company issued 5,000,000 shares of the Company’s common stock with the Rule 144 restrictive legend in exchange for the cancellation of $130,000 in principal owed under a note payable issued by NOW Solutions with a principal amount of $213,139. The fair market value of the shares was $92,500. A gain on debt extinguishment of $37,500 was recorded for the year ended December 31, 2016.
In May 2016, the Company and William Mills entered into an agreement under which the Company issued 5,000,000 shares of the Company’s common stock with the Rule 144 restrictive legend to Mr. Mills in exchange for the cancellation of $100,000 in fees owed for services rendered by Mr. Mills as a Director and Secretary of the Company. The fair market value of the shares was $100,000. Mr. Mills is a partner of Parker Mills and the Secretary and a Director of the Company.
In May 2016, the Company and a third party entered into an agreement under which the Company issued 1,500,000 shares of the Company’s common stock with the Rule 144 restrictive legend to the third party in lieu of paying $35,969 in fees, expenses, and interest owed to the third party for services rendered to the Company and its subsidiaries. The fair market value of the shares issued was $37,500. A loss on debt extinguishment of $1,531 was recorded for the year ended December 31, 2016.
In June 2016, the Company granted 3,500,000 unregistered shares of the Company’s common stock with the Rule 144 restrictive legend to employees and a former employee of the Company and its subsidiaries pursuant to an amended agreement to defer payroll. For additional details, please see “Related Party Transactions” in Item 13. The fair market value of the shares was $78,750.
During the year ended December 31, 2016, the Company issued 3,000,000 shares of the Company’s common stock with the Rule 144 restrictive legend to another third party for services rendered. The fair market value of the shares was $66,550 and was recorded as tax consulting fees for the year ended December 31, 2016.
During the year ended December 31, 2016, the Company issued convertible debentures in the aggregate principal amount of $715,000 to various third party lenders for loans made to the Company in the same amount. The debts accrue interest at 10% per annum and are due one year from the date of issuance. Beginning six months after issuance of the respective debentures and provided that the lowest closing price of the common stock for each of the 5 trading days immediately preceding the conversion date has been $0.03 or higher, the holder of the respective debenture may convert the debenture into shares of common stock at a price per share of 80% of the average per share price of the Company’s common stock for the 5 trading days preceding the notice of conversion date using the 3 lowest closing prices. In connection with the loans, the Company also issued a total of 7,150,000 shares of common stock of the Company to the lenders with the Rule 144 restrictive legend and 3 year warrants under which each lender may purchase in aggregate a total of 7,150,000 unregistered shares of common stock of the Company at a purchase price of $0.10 per share. In connection with the issuance of shares of common stock and warrants, the Company recorded a discount of $186,967 against the face value of the loans based on the relative fair market value of the common stock of $114,413 and the full fair market value of the warrants of $72,554. The warrants are accounted for as derivative liabilities. The discount is being amortized over twelve months and amortization expense was recognized for the year ended December 31, 2016.
During the year ended December 31, 2016, $82,001 of principal, interest and fees under a convertible note issued in the principal amount of $80,000 were converted into 5,914,783 unrestricted common shares of the Company.
| 21 |
During the year ended December 31, 2016, the Company entered into subscription agreements under which third party subscribers purchased 3,000 shares of VCSY Series A Preferred Stock for $600,000. In connection with the purchase of the VCSY Series A Preferred Stock, the subscribers also received a total of 6,000,000 shares of common stock of the Company with the Rule 144 restrictive legend, 300,000 shares of common stock of Ploinks, Inc., 2-year warrants under which the subscribers may purchase an aggregate total of 450,000 unregistered shares of common stock of the Company at a purchase price of $0.10 per share and 2-year warrants under which the subscribers may purchase an aggregate total of 450,000 unregistered shares of common stock of the Company at a purchase price of $0.20 per share. The allocated fair market value of the VCSY Series A Preferred Stock issued to the subscribers was $366,499. Each share of VCSY Series A Preferred Stock is convertible into 500 shares of the Company’s common stock. The allocated fair market value of all common shares of the Company issued to the subscribers was $229,496. The allocated fair market value of all common shares of Ploinks, Inc. issued to the subscribers was $3,416. The fair market value of all warrants issued to the subscribers was $4,005 (which was calculated using the Black-Sholes model). The warrants were accounted for as derivative liabilities (see Note 4).
During the year ended December 31, 2016, the Company cancelled 200,000 previously awarded but unvested unregistered shares of the Company’s common stock issued to an employee of the Company when the employee resigned. This resulted in the reversal of previously recognized compensation expense of $1,145 during the year ended December 31, 2016.
During the year ended December 31, 2016, the Company granted 18,250,000 unregistered shares of its common stock pursuant to restricted stock agreements. Shares under restricted stock agreements typically vest over a period of 1-3 years in various installments and the fair value of the awards is being expensed over the vesting periods. The aggregate fair market value of the awards was determined to be $361,365. Stock compensation expense of $229,223 has been recorded for the year ended December 31, 2016 as additional paid-in capital.
Stock compensation expense for the amortization of restricted stock awards for VCSY stock was $229,223 for the year ended December 31, 2016. As of December 31, 2016, there were 13,125,000 shares of unvested VCSY common stock compensation awards to employees and consultants.
During the year ended December 31, 2016, 7,175,000 VCSY common shares issued under restricted stock agreements to employees of the Company were vested.
During the year ended December 31, 2016, the Company granted 150,000 shares of the common stock of Ploinks, Inc. to third party lenders in connection with 6-month extensions of convertible debentures in the principal amount of $500,000 issued in 2015. The aggregate fair market value of the awards was determined to be $16,200 and was recorded as debt discount, and amortized through the term of the note.
During the year ended December 31, 2016, Ploinks, Inc. granted 1,000,000 unregistered shares of the common stock of Ploinks, Inc. to an employee of the Company pursuant to a restricted stock agreement with Ploinks, Inc. These shares typically vest over 3 years in various installments and the fair value of the awards is being expensed over this vesting period. The aggregate fair market value of the awards was determined to be $108,000. Stock compensation expense of $70,800 has been recorded for the year ended December 31, 2016.
During the year ended December 31, 2016, the Company granted 4,286,000 unregistered shares of the common stock of Ploinks, Inc. to employees and consultants of the Company and its subsidiaries pursuant to restricted stock agreements with the Company. These shares typically vest over 3 years in various installments and the fair value of the awards is being expensed over this vesting period. The aggregate fair market value of the awards was determined to be $462,888. Stock compensation expense of $264,227 has been recorded for the year ended December 31, 2016. These shares were issued out of shares owned by VCSY.
During the year ended December 31, 2016, 2,332,001 unregistered shares of the common stock of Ploinks, Inc. to employees and consultants of the Company and its subsidiaries granted under restricted stock agreement vested.
During the year ended December 31, 2016, 133,334 unregistered shares of the common stock of Ploinks, Inc. granted to an employee of the Company under a restricted stock agreement were cancelled.
From January 1, 2017 to April 24, 2017, the Company granted 3,000,000 VCSY common shares pursuant to a stock award to an employee of the Company and its subsidiaries.
From January 1, 2017 to April 24, 2017, $10,000 of principal and interest under a convertible note issued in the principal amount of $80,000 was converted into 723,089 common shares.
From January 1, 2017 to April 24, 2017, 550,000 VCSY common shares issued under restricted stock agreements to employees and a consultant of the Company vested.
From January 1, 2017 to April 24, 2017, 200,001 shares of the common stock of Ploinks, Inc. issued under restricted stock agreements to consultants and employees of the Company vested.
Unless otherwise noted, the offers, sales and issuances of our unregistered securities set forth above involved no underwriter’s discounts or commissions. In engaging in the transactions described above which involved our unregistered securities, we relied upon the private offering exemption provided under Section 4(2) of the Securities Act of 1933, as amended, in that the transactions involved private offerings of our unregistered securities, we did not make a public offering or sale of our securities, the investors were either accredited or unaccredited but sophisticated, and the investors represented to us that they were acquiring the securities for investment purposes and for their own accounts, and not with an eye toward further distribution.
Item 6. Selected Financial Data
Not applicable.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion is a summary of the key factors management considers necessary or useful in reviewing our results of operations, liquidity and capital resources. The following discussion and analysis should be read together with the Consolidated Financial Statements and Notes of Vertical Computer Systems, Inc. and its subsidiaries included in Item 8 of this Report, and the cautionary statements and risk factors included in Item 1A of this Report.
| 22 |
Critical Accounting Policies
Capitalized Software Costs
Software costs incurred internally in creating computer software products are expensed until technological feasibility has been established upon completion of a detailed program design. Thereafter, all software development costs are capitalized until the point that the product is ready for sale, and are subsequently reported at the lower of unamortized cost or net realizable value. The Company considers annual amortization of capitalized software costs based on the ratio of current year revenues by product to the total estimated revenues by the product, subject to an annual minimum based on straight-line amortization over the product’s estimated economic useful life, not to exceed five years. The Company periodically reviews capitalized software costs for impairment where the fair value is less than the carrying value. During the year ended December 31, 2016 and 2015, $246,184 and $541,300 of internal costs were capitalized, respectively.
Revenue Recognition
Our revenue recognition policies are in accordance with standards on software revenue recognition, which include guidance on revenue arrangements with multiple deliverables and arrangements that include the right to use of software stored on another entity’s hardware.
In the case of non-software arrangements, we apply the guidance on revenue arrangements with multiple deliverables and wherein multiple elements are allocated to each element based on the element’s relative fair value. Revenue allocated to separate elements is recognized for each element in accordance with our accounting policies described below. If we cannot account for items included in a multiple-element arrangement as separate units of accounting, they are combined and accounted for as a single unit of accounting and generally recognized as the undelivered items or services are provided to the customer.
Consulting. We provide consulting services, primarily implementation and training services, to our clients using a time and materials pricing methodology. The Company prices its delivery of consulting services on a time and materials basis where the customer is either charged an agreed-upon daily rate plus out-of-pocket expenses or an hourly rate plus out-of-pocket expenses. In this case, the Company is paid fees and other amounts generally on a monthly basis or upon the completion of the deliverable service and recognizes revenue as the services are performed.
Software License. We sell concurrent perpetual software licenses to our customers. The license gives the customer the right to use the software without regard to a specific term. We recognize the license revenue upon execution of a contract and delivery of the software, provided the license fee is fixed and determinable, no significant production, modification or customization of the software is required and collection is considered probable by management. When the software license arrangement requires the Company to provide consulting services that are essential to the functionality of the software, the product license revenue is recognized upon the acceptance by the customer and consulting fees are recognized as services are performed.
Software licenses are generally sold as part of a multiple-element arrangement that may include maintenance and, under a separate agreement, consulting services. The consulting services are generally performed by the Company, but the customer may use a third-party to perform the consulting services. We consider these separate agreements as being negotiated as a package. The Company determines whether there is vendor specific objective evidence of fair value (‘‘VSOEFV’’) for each element identified in the arrangement, to determine whether the total arrangement fees can be allocated to each element. If VSOEFV exists for each element, the total arrangement fee is allocated based on the relative fair value of each element. In cases where there is not VSOEFV for each element, or if it is determined that services are essential to the functionality of the software being delivered, we initially defer revenue recognition of the software license fees until VSOEFV is established or the services are performed. However, if VSOEFV is determinable for all of the undelivered elements, and assuming the undelivered elements are not essential to the delivered elements, we will defer recognition of the full fair value related to the undelivered elements and recognize the remaining portion of the arrangement value through application of the residual method. Where VSOEFV has not been established for certain undelivered elements, revenue for all elements is deferred until those elements have been delivered or their fair values have been determined. Evidence of VSOEFV is determined for software products based on actual sales prices for the product sold to a similar class of customer and based on pricing strategies set forth in the Company’s standard pricing list. Evidence of VSOEFV for consulting services is based upon standard billing rates and the estimated level of effort for individuals expected to perform the related services. The Company establishes VSOEFV for maintenance agreements using the percentage method such that VSOEFV for maintenance is a percentage of the license fee charged annually for a specific software product, which in most instances is 18% of the portion of arrangement fees allocated to the software license element.
Maintenance Revenue. In connection with the sale of a software license, a customer may elect to purchase software maintenance services. Most of the customers that purchase software licenses from us also purchase software maintenance services. These maintenance services are typically renewed on an annual basis. We charge an annual maintenance fee, which is typically a percentage of the initial software license fee and may be increased from the prior year amount based on inflation or other agreed upon percentage. The annual maintenance fee generally is paid to the Company at the beginning of the maintenance period, and we recognize these revenues ratably over the term of the related contract.
| 23 |
While most of our customers pay for their annual maintenance at the beginning of the maintenance period, a few customers have payment terms that allow them to pay for their annual maintenance on a quarterly or monthly basis. If the annual maintenance fee is not paid at the beginning of the maintenance period (or at the beginning of the quarter or month for those few maintenance customers), we will ratably recognize the maintenance revenue if management believes the collection of the maintenance fee is imminent. Otherwise, we will defer revenue recognition until the time that the maintenance fee is paid by the customer. We normally continue to provide maintenance service while awaiting payment from customers. When the payment is received, revenue is recognized for the period that revenue was previously deferred. This may result in volatility in software maintenance revenue from period to period.
Cloud-based offering. We have contracted with a third party to provide new and existing customers with a hosting facility providing all infrastructure and allowing us to offer our currently sold software, emPath®, on a service basis. However, a contractual right to take possession of the software license or run it on another party’s hardware is not granted to the customer. We refer to the delivery method to give functionality to new customers utilizing this service as cloud-based. Since the customer is not given contractual right to take possession of the software, the scope of ASC 350-40 does not apply. A customer using cloud-based software can enter into an agreement to purchase a software license at any time. We generate revenue from cloud-based offering as the customer utilizes the software over the Internet.
We will provide consulting services to customers in conjunction with the cloud-based offering. The rate for such service is based on standard hourly or daily billing rates. The consulting revenue is recognized as services are performed. Customers utilizing their own computer to access cloud-based functionality are charged a fee equal to the number of employees paid each month multiplied by an agreed-upon rate per employee. The revenue is recognized as the cloud-based services are rendered each month.
Allowances for Doubtful Accounts
The Company maintains allowances for doubtful accounts, for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. We review delinquent accounts at least quarterly to identify potential doubtful accounts, and together with customer follow-up, estimate the amounts of potential losses.
Deferred Taxes
The Company records a valuation allowance to reduce the deferred tax assets to the amount that management believes is more likely than not to be realized in the foreseeable future, based on estimates of foreseeable future taxable income and taking into consideration historical operating information. In the event management estimates that the Company will not be able to realize all or part of its net deferred tax assets in the foreseeable future, a valuation allowance is recorded through a charge to income in the period such determination is made. Likewise, should management estimate that the Company will be able to realize its deferred tax assets in the future in excess of its net recorded assets, an adjustment to reduce the valuation allowance would increase income in the period such determination is made.
Stock-Based Compensation Expense
We account for share-based compensation in accordance with the provisions of share-based payments, which require measurement of compensation cost for all stock-based awards at fair value on date of grant and recognition of compensation over the service period for awards expected to vest. The fair value of restricted stock and restricted stock units is determined based on the number of shares issued and the quoted price of our common stock. See Note 10 of the Consolidated Financial Statements for a further discussion of stock-based compensation.
Valuation of the Embedded and Warrant Derivatives
The valuation of our embedded derivatives is determined by using the Black-Scholes Option Pricing Model. An embedded derivative is a derivative instrument that is embedded within another contract, which under a convertible note (the host contract) includes the right to convert the note by the holder, certain default redemption right premiums and a change of control premium (payable in cash if a fundamental change occurs). In accordance with the guidance on derivative instruments, embedded derivatives are marked-to-market each reporting period, with a corresponding non-cash gain or loss charged to the current period. The practical effect of this has been that when our stock price increases so does our derivative liability, resulting in a non-cash loss that reduces our earnings and earnings per share. When our stock price declines, we record a non-cash gain, increasing our earnings and earnings per share.
| 24 |
The fair value recorded for the derivative liability varies from period to period. This variability may result in the actual derivative liability for a period either above or below the estimates recorded on our consolidated financial statements, resulting in significant fluctuations in other income (expense) because of the corresponding non-cash gain or loss recorded.
Recently Issued Accounting Pronouncements
The Company does not expect the adoption of any recently issued accounting pronouncements to have a significant impact on the Company’s consolidated financial statements.
Results of Operations
Year ended December 31, 2016 Compared To Year Ended December 31, 2015
Total Revenues. We had total revenues of $3,827,675 and $4,263,635 for the years ended December 31, 2016 and 2015, respectively. The decrease in total revenue was $435,960 for the year ended December 31, 2016, representing a 10.2% decrease compared to the total revenue for the year ended December 31, 2015. The decrease in revenue was primarily due to a $338,341 decrease in software maintenance, a $42,102 decrease in cloud-based offering and a $11,049 decrease in consulting services. Of the $3,827,675 and $4,263,635 total revenues for the years ended December 31, 2016 and 2015, respectively, $3,768,420 and $4,186,363 of such amounts were related to the business operations of NOW Solutions, a 75% owned subsidiary of the Company.
The revenues from licenses and software consist of fees we bill for NOW Solutions’ new payroll and human resources (“PRHR”) software licenses. These fees decreased $3,210 for the year ended December 31, 2016 compared to the year ended December 31, 2015.
Software maintenance revenue is generated from existing customers of our PRHR software who want the continued benefit of tax updates, customer support, and software enhancements. Software maintenance revenue decreased by $338,341 or 9.5% from the year ended December 31, 2015 to the same period in 2016. The decrease was due to the loss of customer contracts and the effect of unfavorable currency exchange rates on our Canadian maintenance revenue.
Consulting revenue for the year ended December 31, 2016 decreased by $11,049 from the same period in the prior year, representing a 3.8% decrease. This decrease was due to a decline in US customer needs for software upgrade implementation and customization and the effect of unfavorable currency exchange rates on our Canadian consulting revenue in 2015.
Cloud-based revenue decreased $42,102 or 13.1% for the year ended December 31, 2016 compared to the same period in 2015. The decrease was primarily related to customer user base adjustments and the effect of unfavorable currency exchange rates on our Canadian cloud-based revenue.
Other revenues, consisting primarily of reimbursable travel expenses, decreased by $41,258 or 76.7% for the year ended December 31, 2016 compared to the same period for 2015. The decrease was mainly attributable to lower reimbursable travel in 2016 due to decreased consultant travel.
Cost of Revenues. We had direct costs associated with the above revenues of $1,524,853 for the year ended December 31, 2016 compared to $1,767,155 for the same period of 2015, representing a decrease of $242,302 or 13.7%. These direct costs are primarily related to costs providing customer support, professional services, software upgrades and enhancements. The decrease in direct costs is primarily related to decreased consulting fees and hosting fees for the year ended December 31, 2016 compared to the same period for 2015.
Selling, General and Administrative Expenses. We had selling, general and administrative expenses of $3,871,572 and $3,088,568 for the years ended December 31, 2016 and 2015, respectively. The total selling, general and administrative expenses for the year ended December 31, 2016 increased by $783,004 compared to the selling, general and administrative expenses for the year ended December 31, 2015, representing a 25.4% increase. The increase was primarily due to an increase in salaries and benefits (of which $602k related to non-cash equity compensation), an increase in consulting fees (of which $44k related to non-cash equity compensation), and an increase in late charges on notes payable in default. These increases were partially offset by decreased travel expenses, a decrease in legal fees and decreased shareholder communication expense.
Depreciation and Amortization. We had depreciation and amortization of $1,083 for 2016 compared to $38,412 in 2015. The decrease is a result of most equipment and intangible assets having reached the end of their useful lives.
| 25 |
Bad Debt Expense. We had bad debt expense of $98,896 for 2016 compared to $3,300 in 2015. The 2016 and 2015 expenses were related to a reserve for several customer accounts greater than 90 days past due.
Impairment of Software Costs. For the year ended December 31, 2016 $1,421,155 of capitalized software development costs related to Ploinks development was written off as impaired.
Operating Loss. We had an operating loss of $3,089,884 for the year ended December 31, 2016 compared to operating loss of $633,800 for the year ended December 31, 2015, a difference of $2,456,084. The increase in operating loss between 2016 and 2015 is primarily a result of lower revenues and gross profit, higher selling, general and administrative expenses, higher bad debt expense and the impairment of Ploinks development costs.
Gain/loss on Derivative Liability. Derivative liabilities are adjusted each quarter for changes in the market value of the Company’s common stock. In general, as our stock price increases, the derivative liability increases, resulting in a loss. As our stock price decreases, the derivative liability decreases, resulting in a gain. The loss on derivative liability was $268,728 for the year ended December 31, 2016 compared to a loss on derivative liability of $78,680 for the year ended December 31, 2015.
Interest Expense. We had interest expense of $1,998,762 and $895,920 for the years ended December 31, 2016 and 2015, respectively. Interest expense increased for the year ended December 31, 2016 by $1,102,845, representing a 130.2% increase compared to interest expense for the year ended December 31, 2015. The increase was primarily due to interest and debt discounts related to the issuance of convertible debentures in 2016 and an adjustment credit in 2015 on interest recorded in a prior year on the settlement of Canadian income taxes.
Interest Income. Interest income for the year ended December 31, 2016 was $53 compared to $9 for the year ended December 31, 2015.
Forbearance Fees. Forbearance fees relate to fees charged by our lenders on loans in default. Forbearance fees for the year ended December 31, 2016 were $58,500 compared to $1,065,900 for the same period in 2015. Forbearance fees for 2016 related to lenders of VCSY and NOW Solutions. Forbearance fees for 2015 related to the issuance of VCSY common shares on senior secured debt of NOW Solutions and other notes in default for VCSY and NOW Solutions.
Gain/Loss on Extinguishment of Debt. We had a $35,969 gain on debt extinguishment for the year ended December 31, 2016. The gain relates to the fair market value of 5 million shares of VCSY common stock issued to a NOW Solutions lender to settle a portion of debt principal. For the year ended December 31, 2015 we had a loss of 393,301. The loss relates to the fair market value of VCSY common stock issued to settle certain note payable and accrued interest balances.
Net Loss before Income Tax Benefit. We had a net loss of $5,379,852 for the year ended December 31, 2016 compared to a net loss of $3,067,592 for the year ended December 31, 2015. The net loss for 2016 was primarily due to an operating loss of $3,089,884 increased by $58,500 of forbearance fees, loss on derivative liabilities of $268,728 and interest expense of $1,998,762. The net loss for 2015 was primarily due to an operating loss of $633,800 increased by $1,065,900 of forbearance fees, loss on debt extinguishment of $393,301, loss on derivative liabilities of $78,680 and interest expense of $895,920.
Income Tax Expense/Benefit. We had an income tax expense of $86,378 and an income tax benefit of $571,980 for the year ended December 31, 2016 and 2015, respectively. Income taxes expense for 2016 relates to NOW Solutions, a 75% owned subsidiary of the Company. The 2015 benefit is related to $9,642 of estimated foreign income tax expense offset by a benefit for settlement of foreign income taxes from previous years of $581,622.
Dividend Applicable to Preferred Stock. The Company has outstanding Series A 4% Convertible Cumulative Preferred Stock that accrues dividends (if such dividends are declared) at a rate of 4% on a semi-annual basis. The Company also has outstanding Series C 4% Convertible Cumulative Preferred Stock that accrues dividends (if such dividends are declared) at a rate of 4% on a quarterly basis. For the years ended December 31, 2016 and 2015, the total dividends applicable to Series A and Series C Preferred Stock (from prior years) were $592,472 each year. The Company did not declare or pay any dividends in 2016 or 2015.
Net Loss Applicable to Common Stockholders. We had net loss attributed to common stockholders of $5,870,223 and $3,153,367 for the years ended December 31, 2016 and 2015, respectively. Net loss applicable to common stockholders for the year ended December 31, 2016 increased by $2,712,384 compared to December 31, 2015. The increase in the net loss applicable to common stockholders was due to the combination of factors described above.
Net Loss Per Share. The Company had a net loss per share of $0.01 and $0.00 for the years ended December 31, 2016 and 2015, respectively.
| 26 |
Financial Condition, Liquidity, Capital Resources and Recent Developments
At December 31, 2016, we had non-restricted cash-on-hand of $190,448 compared to $37,141 at December 31, 2015.
Net cash used in operating activities for the year ended December 31, 2016 was $486,755 compared to net cash used in operating activities of $526,012 for the year ended December 31, 2015.
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. During 2016, our deferred maintenance revenue (a liability) increased slightly from $1,658,158 to $1,794,264. The increase was primarily due to an increase in currency exchange rates on Canadian deferred revenue and an increase in deferred revenue for one US customers who renewed a three year maintenance contract in December 2016.
Our accounts receivable decreased from $382,463 at December 31, 2015 to $367,278 at December 31, 2016 (net of allowance for bad debts). The decrease in receivables of $15,185 was due to faster year-end collections of customer receivables in 2016.
Accounts payable and accrued liabilities increased from $10,645,353 at December 31, 2015 to $12,214,844 at December 31, 2016. The increase of $1,569,491 was primarily related to an increase in accrued taxes and accrued interest on notes payable. The balance in accounts payable and accrued liabilities is approximately 33.2 times the balance in accounts receivable. This is one of the reasons we do not have sufficient funds available to fund our operations and repay our debt obligations under their existing terms, as described below.
Net cash used in investing activities for the year ended December 31, 2016 was $249,989 consisting of the development of software products and purchase of computer equipment. Net cash used in investing activities for the year ended December 31, 2015 was $541,300 consisting of the development of software products.
Net cash provided by financing activities for the year ended December 31, 2016 was $1,076,249 consisting of borrowings on notes payable of $170,000, borrowings on convertible debentures of $715,000 and issuance of stock subscriptions of $600,000 somewhat offset by repayments on notes payable of $113,699, dividends paid to non-controlling subsidiary shareholders of $295,000 and a decrease in back overdrafts of $52. Net cash provided by financing activities for the year ended December 31, 2015 was $959,413 consisting of borrowings on notes payable of $555,333, borrowings of related party convertible debentures of $100,000, borrowings on convertible debentures of $580,000 somewhat offset by repayments on notes payable of $132,848, payments on related party debt of $10,425, dividends paid to non-controlling subsidiary shareholders of $125,000 and an increase in back overdrafts of $7,647.
The total change in cash and cash equivalents for the year ended December 31, 2016 when compared to the year ended December 31, 2015 was an increase of $153,307.
As of the date of the filing of this Report, we do not have sufficient funds available to fund our operations and repay our debt obligations under their existing terms. Therefore, we need to raise additional funds through selling securities, obtaining loans, renegotiating the terms of our existing debt, increasing sales of our products and services and/or succeed in licensing our intellectual property. Our inability to raise such funds or renegotiate the terms of our existing debt will significantly jeopardize our ability to continue operations.
Contractual Obligations and Commercial Commitments
As of December 31, 2016, the following contractual obligations and commercial commitments were outstanding:
| Balance at | Due in Next Five Years | |||||||||||||||||||||||
| Contractual Obligations | 12/31/16 | 2017 | 2018 | 2019 | 2020 | 2021+ | ||||||||||||||||||
| Notes payable | $ | 5,161,959 | $ | 5,161,959 | $ | - | $ | - | $ | - | - | |||||||||||||
| Convertible debts | 1,354,213 | 1,354,213 | - | - | - | - | ||||||||||||||||||
| Operating lease | 143,676 | 82,649 | 61,027 | - | - | - | ||||||||||||||||||
| Total | $ | 6,659,848 | $ | 6,598,821 | $ | 61,027 | $ | - | $ | - | $ | - | ||||||||||||
| 27 |
Of the above notes payable, the default status is as follows:
| 2016 | 2015 | |||||||
| In default | $ | 4,901,950 | $ | 4,310,384 | ||||
| Not in default | 1,614,222 | 1,635,050 | ||||||
| Total Notes Payable | $ | 6,516,172 | $ | 5,945,434 | ||||
Going Concern Uncertainty
We had a net loss of $5,466,230 and $2,495,612 for the years ended December 31, 2016 and 2015, respectively, and have historically incurred losses. In addition, we had a working capital deficit of approximately $20.6 million at December 31, 2016. The foregoing raises substantial doubt about our ability to continue as a going concern.
Management is continuing its efforts to attempt to secure funds through equity and/or debt instruments for our operations, expansion and possible acquisitions, mergers, joint ventures, and/or other business combinations. We will require additional funds to pay down our liabilities, as well as finance our expansion plans consistent with our anticipated changes in operations and infrastructure. However, there can be no assurance that we will be able to secure additional funds and that if such funds are available, whether the terms or conditions would be acceptable to us and whether we will be able to turn into a profitable position and generate positive operating cash flow. The consolidated financial statements contain no adjustment for the outcome of this uncertainty.
Furthermore, we are exploring certain opportunities with a number of companies to participate in co-marketing of each other’s products. We are proceeding to license our intellectual property to third parties. The exact results of our opportunities to license our intellectual property to other parties are unknown at this time.
Off-Balance Sheet Arrangements.
None.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
None.
Item 8. Financial Statements and Supplementary Data
Please refer to the Audited Consolidated Financial Statements of the Company and its subsidiaries for the fiscal years ended December 31, 2016 and 2015, which are attached to this Report.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, principally our chief executive officer (who is also currently serving as our Principal Accounting Officer), evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our management concluded that our disclosure controls and procedures as of the end of the period covered by this report were not effective such that the information required to be disclosed by us in reports filed under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding disclosure. In particular, we have identified the material weaknesses described below.
| 28 |
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act for the Company.
In order to ensure whether our internal control over financial reporting is effective, management has assessed such controls for its financial reporting as of December 31, 2016. This assessment was based on criteria for effective internal control over financial reporting described in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).
In performing this assessment, management has identified the following material weaknesses as of December 31, 2016:
| ● | There is an over-reliance upon independent financial reporting consultants for review of critical accounting areas and disclosures and material non-standard transactions. |
| ● | There is a lack of sufficient accounting staff due to the size of the Company which results in a lack of segregation of duties necessary for a good system of internal control. |
| ● | There is a lack of control procedures that include multiple levels of supervision and review. Certain parts of the work of our chief financial officer are not monitored or reviewed. |
| ● | Consolidation and currency translations are performed manually. |
The absence of adequate segregation of duties may have an effect on the systems which we use in the evaluating and processing of certain accounts and areas and in the posting and recording of journal entries into certain accounts, as described below:
| ○ | Although we implemented a new accounting system effective January 1, 2009 that allows for the consolidation of the various entities in Vertical Computer Systems along with the translation from local currency to reporting currency, the system needs to be refined in order to perform currency translations accurately. As a result, we continue to performing our consolidation and currency translations manually. This will be remediated once funds become available to effectively implement needed system changes. |
| ○ | Improving the control and oversight of the duties relating to the systems we use in the evaluation and processing of certain accounts and areas in the posting and recording of journal entries into certain accounts (in which material weaknesses have been identified as described above). This improvement should include reviews by management of the accounting processes as well as a reorganization of some of the accounting functions. In January 2010, we contracted with a consulting firm to assess our internal controls over financial reporting and propose improvements that can be implemented given our size and number of employees. The company has not yet implemented these improvements in their entirety as of the filing of this report due to employee turnover and resource limitations. |
| ○ | Improving the segregation of duties relating to the processing of accounts and the recording of journal entries into certain accounts. The company has recently increased the size of its accounting staff which will allow for needed segregation of duties within the organization. As of the date of this report, the company is evaluating and reorganizing the duties of its accounting staff in order to address this internal control weakness. |
As a result of these material weaknesses in our internal control over financial reporting, our management concluded that our internal control over financial reporting as of December 31, 2016, was not effective based on the criteria set forth by COSO in Internal Control – Integrated Framework. A material weakness in internal control over financial reporting is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.
Management’s Plan for Remediation of Material Weaknesses
In light of the conclusion that our internal control over financial reporting was not effective, our management is in the process of implementing a plan intended to remediate such ineffectiveness and to strengthen our internal controls over financial reporting through the implementation of certain remedial measures, which include:
| ○ | We have implemented a new accounting system effective January 1, 2009 that allows for the consolidation of the various entities in Vertical Computer Systems along with the translation from local currency to reporting currency. Although the system eliminates many of the manual steps in translation and consolidation, many of the steps continue to be manual. This system also allows for some automation for recording software maintenance revenue and the recording of the deferred revenue liability account. This automation improves the accuracy of these accounts and is no longer considered a material weakness. |
| 29 |
| ○ | Improving the control and oversight of the duties relating to the systems we use in the evaluation and processing of certain accounts and areas in the posting and recording of journal entries into certain accounts (in which material weaknesses have been identified as described above). This improvement should include reviews by management of the accounting processes as well as a reorganization of some of the accounting functions. In January 2010, we contracted with a consulting firm to assess our internal controls over financial reporting and propose improvements that can be implemented given our size and number of employees. |
| ○ | Improving the segregation of duties relating to the processing of accounts and the recording of journal entries into certain accounts. This improvement is expected to come based on recommendations from the consulting firm assessing our internal controls over financial reporting. |
This annual report does not include an attestation report of our public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report.
None.
| 30 |
Item 10. Directors, Executive Officers and Corporate Governance
Our present directors and executive officers are as follows:
| Name | Age | Position | Tenure | |||
| Richard S. Wade | 73 | President, Chief Executive Officer and Director | 16 years | |||
| William K. Mills | 58 | Secretary and Director | 16 years |
Richard S. Wade, President, Chief Executive Officer (Principal Executive Officer and Principal Accounting Officer) and Director of VCSY, Chairman and Director of NOW Solutions
Richard S. Wade is President, CEO and Chairman of the Board of the Company and has been a director since October 1999. Before coming to Externet World, Inc. in mid-1999, and then transitioning to what is now the Company in late 1999, Mr. Wade held a number of executive positions with companies in the Pacific Rim from 1983 through early 1999, including the position of Chief Operating Officer of Struthers Industries, Inc., a public company in the business of wireless applications. Prior to these executive positions, Mr. Wade spent over 10 years with Duty Free Shoppers, Inc., culminating in his attaining the positions of president of their Mid-Pacific Division and then president of their U.S. Division. Prior to that, Mr. Wade was a CPA and staff auditor with Peat, Marwick & Mitchell. Over the course of his career, Mr. Wade has accumulated experience in retail operations, distribution, international operations, and financial matters. The breadth of Mr. Wade’s managerial and operational experience led the Board of Directors to believe this individual is qualified to serve as a director of the Company. Mr. Wade earned his Bachelor of Science in Accounting at Brigham Young University, a Master of Science in Business Policy from Columbia University Business School and received a certificate of recognition from the government of Guam.
William K. Mills, Secretary and Director of VCSY
William K. Mills has been a director since December 2000. Mr. Mills is a founding partner of Parker Shumaker Mills, LLP (formerly Parker Mills, LLP) where he specializes in complex commercial business representations, including transactional and litigation matters, such as legal malpractice, intellectual property and general corporate and governmental representations since 1995. Between 1991 and 1994, Mr. Mills was a senior attorney and partner with Lewis, D’Amato, Brisbois & Bisgaard, prior to which he was a senior attorney with Radcliff & West from 1989 to 1991, senior associate with Buchalter, Nemer Fields & Younger from 1987 to 1991 and an attorney with Daniels, Baratta & Fine from 1982 to 1987. Mr. Mills holds a J.D. from UCLA Law School and an A.B. in American Government from Harvard College. Active in professional and community organizations, Mr. Mills has served as General Counsel to the California Association of Black Lawyers, a member of the Los Angeles County Bar Judicial Appointments Committee, and a Board Member of the John M. Langston Bar Association. Mr. Mills has also served on the boards of the Didi Hirsch Mental Health Foundation, the United Way’s Los Angeles Metropolitan Region Board, the Los Angeles City Ethics Commission, and the Los Angeles County Judicial Procedures Commission. The breadth of Mr. Mills’ professional and legal experience led the Board of Directors to believe this individual is qualified to serve as a director of the Company.
Significant Employees of the Company
Luiz Valdetaro, Chief Technology Officer of VCSY and NOW Solutions, Director of NOW Solutions
Prior to joining the Company, Mr. Valdetaro was previously a consultant (1993-1997) and Chief Technology Officer (1997-1999) of Diversified Data Resources, a software company. Prior to that, Mr. Valdetaro was a Senior Systems Engineer for System/One and EDS, after System/One was acquired by EDS. Prior to that, Mr. Valdetaro was a senior systems engineer for Bank of America. Mr. Valdetaro is a graduate of Pontific Catholic University, Rio de Janeiro, Brazil with a B.S. in Electronic Engineering and a M.S. in Systems Engineering.
| 31 |
Laurent Tetard, Chief Operating Officer-SaaS
Mr. Tetard joined the Company in 1999, where he oversaw business development, managed software design projects and handled daily operations. His responsibilities included working with clients and strategic partners to develop business plans, implement strategies and methodologies to support software development. Combining his education and experience, Mr. Tetard has specialized in managing design, implementation, documentation and installation of Internet compatible applications. From 1994 to 1996, Mr. Tetard was a Public Relations Officer with the French Air Force, in Toulouse, France. Earlier in his career, he completed a thesis in collaboration with the French Aeronautics and Space Research Center (“ONERA”) and served engineering internships at Aerospatiale, France. Mr. Tetard is an honor’s graduate of the noted French Ecole Nationale Superieure D’arts et Metiers (“ENSAM”), with a BS in Engineering and a MS in Multidisciplinary Engineering.
Harold Frazier, Jr., Director of Mobile Software Development
Harold Frazier, Jr. serves as the Director of Mobile Software Development of Vertical Computer Systems, Inc. He graduated from the University of Michigan, Ann Arbor with a B.S. in Computer Science. Since 2004, Mr. Frazier has focused on creating enterprise mobile software solutions in the education, social media, security, automotive and medical industries.
Significant Employees of NOW Solutions
Marianne M. Franklin, President and Chief Executive Officer
Marianne M. Franklin is President and Chief Executive Officer of NOW Solutions. Ms. Franklin brings her experience in the payroll and human resources industry, which included over eight years working at Ross Systems, most recently as Vice President of North American sales. Prior to this function, Ms. Franklin was Director of Ross’ HR/Payroll Canadian Sales. Ms. Franklin’s background also includes two years with ADP and 13 years in the banking industry, working with payroll products.
Jamie Patterson, Director of Software Development
Mr. Patterson joined the Company in 2006, originally as the Quality Assurance Manager, after working as an independent contractor for the company for three years. In 2000, he joined the Hewlett-Packard Company as a Research and Development Software Engineer. From 1992 to 2000 he worked for Ross Systems starting as a Support Analyst in the Customer Support Department. In 1993 he began developing software in the Integration Services department and Product Development department. Prior to Ross Systems, he worked as an IT engineer and software developer supporting a payroll application. Mr. Patterson is a graduate of University of Texas at Arlington with a Masters of Computer Science and Engineering degree and from the University of Washington with a B.S. in Civil Engineering.
Compliance with Section 16(a) of the Exchange Act
Section 16(a) of the Exchange Act requires the Company’s officers and directors, and persons who own more than 10% of a registered class of the Company's equity securities, to file reports of ownership and changes in ownership with the SEC. Officers, directors and greater than 10% stockholders are required by SEC regulations to furnish the Company with copies of all Section 16(a) forms they file.
To the best of the Company's knowledge, based solely on review of the copies of such forms furnished to it, or written representations that no other forms were required, the Company believes that all Section 16(a) filing requirements applicable to its officers, directors and greater than 10% stockholders were complied with during 2016.
Code of Ethics
We have adopted a Code of Ethics that applies to our Principal Executive Officer, Principal Accounting Officer and other persons performing executive functions, as well as all other employees and directors of the Company and its subsidiaries. Our Code of Ethics is filed as Exhibit 14.1 to this Report, and is available at our Internet website located at http://www.vcsy.com/investor.php.
Corporate Governance
Family Relationships
There are no family relationships between or among the directors, executive officers or persons nominated or charged by us to become directors or executive officers.
Involvement in Legal Proceedings
To the best of our knowledge, during the past five years, none of the following occurred with respect to a present or former director or executive officer of the Company:
| 32 |
(1) any bankruptcy petition filed by or against such person or any business of which such person was a general partner or executive officer either at the time of the bankruptcy or within two years prior to that time;
(2) any conviction in a criminal proceeding or being subject to a pending criminal proceeding (excluding traffic violations and other minor offenses);
(3) being subject to any order, judgment or decree, not subsequently reversed, suspended or vacated, of any court of any competent jurisdiction, permanently or temporarily enjoining, barring, suspending or otherwise limiting his involvement in any type of business, securities or banking activities; or
(4) being found by a court of competent jurisdiction (in a civil action), the SEC or the Commodities Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended or vacated.
Board of Directors Meetings and Subcommittees.
Meetings. Our Board of Directors held several meetings during the fiscal year ended December 31, 2016. All board actions were completed through unanimous written consents.
Audit Committee and Financial Expert. Our Board of Directors (the “Board”) does not have a separate audit committee. Although Mr. Wade (a member of the Board) has the qualifications of an “audit committee financial expert” as defined in Item 407(d)(5), Mr. Wade would not be deemed independent since he is an employee of the Company. At this point, we do not intend to establish a separate audit committee as this function will be performed by our full Board of Directors.
Compensation Committee. As all our executive officers are currently under employment agreements or are at-will employees, we do not have a separate compensation committee. At this point, we do not intend to establish a separate compensation committee as this function will be performed by our full Board of Directors.
Nominating Committee. We do not currently have a separate nominating committee as this function is performed by our full Board of Directors.
Shareholder Communication. We communicate regularly with shareholders through press releases, as well as annual, quarterly, and current (Form 8-K) reports. Our Chief Executive Officer addresses investor concerns on an on-going basis. Interested parties, including shareholders and other security holders, may communicate directly with our Board of Directors or with individual directors by writing to our Chief Executive Officer at 101 W. Renner Road, Suite 300, Richardson, TX 75082.
Item 11. Executive Compensation
The following table shows all the cash compensation paid by the Company, as well as certain other compensation paid or accrued, during the fiscal years ended December 31, 2015 and 2016 to our highest paid executive officers and employees, who were employed by us during 2015 and 2016. No restricted stock awards, long-term incentive plan payouts or other types of compensation, other than the compensation identified in the chart below, were paid to these executive officers during these fiscal years. Except as set forth below, no other executive officer of Vertical earned a total annual salary and bonus for any of these years in excess of $100,000.
| 33 |
SUMMARY COMPENSATION TABLE
The below table shows information of compensation of the named officers for fiscal years ended December 31, 2015 and December 31, 2016:
| Annual Compensation | Long-Term Compensation | |||||||||||||||||||||||||||||
| Awards | Payouts | |||||||||||||||||||||||||||||
| Name and Principal Position | Year | Salary | Bonus(5) | Other Annual Compensation | Restricted Stock Award(s) | Options/ SARs | LTIP Payouts | All Other Compensation | ||||||||||||||||||||||
| ($) | ($) | ($) | ($) | (#) | ($) | ($) | ||||||||||||||||||||||||
| Richard Wade(1) | 2016 | $ | 300,000 | - | - | 112,500 | - | - | - | |||||||||||||||||||||
| President/ Chief Executive Officer | 2015 | $ | 300,000 | - | - | - | - | - | - | |||||||||||||||||||||
| Luiz Valdetaro (2) | 2016 | $ | 200,000 | - | - | 67,500 | - | - | - | |||||||||||||||||||||
| Chief Technology Officer | 2015 | $ | 200,000 | - | - | - | - | - | - | |||||||||||||||||||||
| Laurent Tetard (3) | 2016 | $ | 193,333 | - | - | 33,750 | - | - | - | |||||||||||||||||||||
| Chief Operating Officer-SaaS | 2015 | $ | 190,000 | - | - | - | - | - | - | |||||||||||||||||||||
| James Salz (4) | 2016 | $ | 168,333 | - | - | 33,750 | - | - | - | |||||||||||||||||||||
| Corporate Counsel | 2015 | $ | 165,000 | - | - | - | - | - | - | |||||||||||||||||||||
No stock options were exercised by the named executive officers during the fiscal year ended December 31, 2016 or 2015.
| (1) | Mr. Wade deferred $881,688 of salary earned during the period from 2002 through 2008, as adjusted in connection with an agreement to defer payroll claims between the Company and certain employees of the Company executed in 2010. For 2012, 2013, 2014, 2015 and 2016, the Company accrued unpaid salary for Mr. Wade of $63,500, $37,500, $25,000, $87,500 and $16,372 respectively. The restricted stock award for Mr. Wade was granted under a restricted stock agreement for 5,000,000 VCSY common shares, under which 1,500,000 shares were vested at December 31, 2016. |
| (2) | Mr. Valdetaro deferred $467,071 of salary earned during the period from 2002 through 2007, as adjusted in connection with an agreement to defer payroll claims between the Company and certain employees of the Company executed in 2010. For 2012, 2013, 2014, 2015 and 2016, the Company accrued unpaid salary for Mr. Valdetaro of $41,667, $66,667, $41,667, $66,667 and $58,078, respectively. The restricted stock award for Mr. Valdetaro was granted under a restricted stock agreement for 3,000,000 VCSY common shares, under which 1,000,000 shares were vested at December 31, 2016. |
| (3) | Prior to 2012, Mr. Tetard served as the Executive Vice President of International Operations of NOW Solutions. Mr. Tetard deferred $98,438 of salary earned during the period from 2002 through 2007, as adjusted in connection with an agreement to defer payroll claims between the Company and certain employees of the Company executed in 2010. For 2012 and 2015, the Company accrued unpaid salary for Mr. Tetard of $20,625 and $7,917, respectively. The restricted stock award for Mr. Tetard was granted under a restricted stock agreement for 1,500,000 VCSY common shares, under which 500,000 shares were vested at December 31, 2016. |
| (4) | Mr. Salz deferred $185,914 of salary earned during the period from 2002 through 2007, as adjusted in connection with an agreement to defer payroll claims between the Company and certain employees of the Company executed in 2010. For 2012, 2013, 2014, 2015 and 2016, the Company accrued unpaid salary for Mr. Salz of $27,498, $55,000, $73,336, $48,125 and $43,083, respectively. The restricted stock award for Mr. Salz was granted under a restricted stock agreement and an award for 1,500,000 VCSY common shares, under which 500,000 shares were vested at December 31, 2016. |
| (5) | All executives are entitled to an annual bonus from a bonus pool for executives equal to 5% of the Company taxable income before net operating loss deduction and special deductions from the federal tax return filed. Each executive’s share of the bonus pool is equal to the percentage of their annual base compensation to the total of the combined annual base compensation of all executives in the pool. |
No options or warrants held by executive officers or directors were granted or exercised during the fiscal years ended December 31, 2016 and 2015.
In December 2001, we executed an employment agreement with Richard Wade pursuant to which Mr. Wade serves as Chief Executive Officer and President of the Company. The agreement currently renews on annual basis unless terminated by either party. Under the agreement, Mr. Wade receives an annual base salary of $300,000 In the event the agreement is terminated by Mr. Wade’s death, his estate shall be entitled to compensation accrued to the time of death plus the lesser of one year’s base compensation or the compensation due through the remainder of the employment term. In the event of termination by the Company without cause, Mr. Wade would receive base compensation for the remainder of the employment term.
| 34 |
In January 2012, we executed an employment agreement with Luiz Valdetaro to serve as Chief Technology Officer of the Company and its subsidiaries. The initial term of the agreement was 2 years and renews on annual basis unless terminated by either party. Under the agreement, Mr. Valdetaro receives an annual base salary of $200,000. In the event the employment agreement is terminated by Mr. Valdetaro’s death, his estate shall be entitled to compensation accrued to the time of death plus the lesser of one year’s base compensation or the compensation due for the lesser of 12 months or through the remainder of the employment term. In the event of termination by the Company without cause, Mr. Valdetaro would receive base compensation for no less than six months of the remainder of the employment term. Mr. Valdetaro may also terminate his employment for good reason and shall be entitled to continued health insurance benefits and base compensation at the rate in effect at the time of his termination for good reason through the end of twelve months after which his employment is terminated for good reason.
In February 2012, we executed an employment agreement with Laurent Tetard to serve as Chief Operating Officer-SaaS of the Company and its subsidiaries. The initial term of the agreement was 2 years and renews on annual basis unless terminated by either party. Under the agreement, Mr. Tetard receives an annual base salary of $190,000. In the event the employment agreement is terminated by Mr. Tetard’s death, his estate shall be entitled to compensation accrued to the time of death plus the lesser of one year’s base compensation or the compensation due for the lesser of 12 months or through the remainder of the employment term. In the event of termination by the Company without cause, Mr. Tetard would receive base compensation for no less than six months of the remainder of the employment term. Mr. Tetard may also terminate his employment for good reason and shall be entitled to continued health insurance benefits and base compensation at the rate in effect at the time of his termination for good reason through the end of twelve months after which his employment is terminated for good reason. In connection with the employment agreement, the Company issued Mr. Tetard 600,000 shares of its common stock at a fair market value of $13,500 and VHS issued 15,000 shares of Series B Preferred Stock of VHS at a fair market value which is nominal.
Outstanding Equity Awards
The below table shows information of outstanding equity awards of the named officers at the end of 2016:
| OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END (2016) | ||||||||||||||||||||||||||||||||||||
| Option Awards | Stock Awards | |||||||||||||||||||||||||||||||||||
| Name | Number
of Securities Underlying Unexercised Options (#) Exercisable | Number
of Securities Underlying Unexercised Options (#) non- exercisable | Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options (#) | Option Exercise Price ($) | Option Expiration Date | Number
of Shares or Units of Stock That Have Not Vested (#) | Market Value of Shares or Units of Stock That Have Not Vested ($) | Equity Incentive Plan Awards: Number of Unearned Shares, Units or Other Rights That Have Not Vested (#) | Equity Incentive Plan Awards: Market or Payout Value of Unearned Shares, Units or Other Rights That Have Not Vested ($) | |||||||||||||||||||||||||||
| Richard Wade, President/ Chief Executive Officer(1) | 3,500,000 | |||||||||||||||||||||||||||||||||||
| Luiz Valdetaro, Chief Technology Officer(2) | 2,000,000 | |||||||||||||||||||||||||||||||||||
| Laurent Tetard, Chief Operating Officer-SaaS(3) | 1,000,000 | |||||||||||||||||||||||||||||||||||
James Salz, Corporate Counsel(4) | 1,000,000 | |||||||||||||||||||||||||||||||||||
| (1) | Pursuant to a restricted stock agreement with the Company, Mr. Wade, the Company’s President and CEO, was issued 5,000,000 unregistered shares of VCSY common stock (at a fair market value of $112,500 in June 2016, based upon the total number of shares issued and the share price on the date of the grant), vesting in equal installments over a 28-month period, of which 1,500,000 shares had vested at December 31, 2016. |
| 35 |
| (2) | Pursuant to a restricted stock agreement with the Company, Mr. Valdetaro, the Company’s Chief Technology Officer, was issued 3,000,000 unregistered shares of VCSY common stock (at a fair market value of $67,500 in June 2016, based upon the total number of shares issued and the share price on the date of the grant), vesting in equal installments over a 28-month period, of which 1,000,000 shares had vested at December 31, 2016. |
| (3) | Pursuant to a restricted stock agreement with the Company, Mr. Tetard, the Company’s COO-SAAS, was issued 1,500,000 unregistered shares of VCSY common stock (at a fair market value of $33,750 in June 2016, based upon the total number of shares issued and the share price on the date of the grant), vesting in equal installments over a 28-month period, of which 500,000 shares had vested at December 31, 2016. |
| (4) | Pursuant to a restricted stock agreement with the Company, Mr. Salz, the Company’s Corporate Counsel, was issued 1,500,000 unregistered shares of VCSY common stock (at a fair market value of $33,750 in June 2016, based upon the total number of shares issued and the share price on the date of the grant), vesting in equal installments over a 28-month period, of which 500,000 shares had vested at December 31, 2016. |
Narrative Disclosure to Outstanding Equity Awards at Fiscal Year End
Stock Option Plan. The Company has no formal stock option plan and has issued no stock options or warrants to any employees or to any other parties and do not have any stock options outstanding.
Stock Awards. The Company’s restricted stock agreements generally provide for the stock to vest in equal installments over a 1 to 3-year period. In the event the employee is terminated without cause, a portion of the remaining unvested stock will vest on a pro-rata basis.
COMPENSATION OF DIRECTORS
We do not pay any compensation to our employee directors for their service on the Board. However, we do pay our non-employee directors as indicated below. The below table provides compensation for all non-employee directors in 2016:
| DIRECTOR COMPENSATION | ||||||||||||||||||||||||||||
| Name | Fees Earned or Paid in Cash | Stock Awards | Option Awards | Non-Equity Incentive Plan Compensation | Nonqualified Deferred Compensation Earnings | All Other Compensation | Total | |||||||||||||||||||||
| ($) | ($) | ($) | ($) | ($) | (#) | ($) | ||||||||||||||||||||||
| William Mills (1) | 42,000 | - | - | - | - | - | 42,000 | |||||||||||||||||||||
| (1) | In May 2016, the Company and William Mills entered into an agreement under which the Company issued 5,000,000 shares of the Company’s common stock with the Rule 144 restrictive legend to Mr. Mills in exchange for the cancellation of $100,000 in fees owed for services previously rendered by Mr. Mills as a Director and the Secretary of the Company. The fair market value of the shares was $100,000. |
Narrative Disclosure to Director Compensation Table
Non-employee directors were entitled to receive $3,500 per month in 2016 and 2015.
Reimbursement of Expenses
The Company reimburses travel expenses of members for their attendance at Board meetings.
Compensation Risks Assessment
As required by rules adopted by the SEC, management has made an assessment of the Company’s compensation policies and practices with respect to all employees to determine whether risks arising from those policies and practices are reasonably likely to have a material adverse effect on the Company. In doing so, management considered various features and elements of the compensation policies and practices that discourage excessive or unnecessary risk taking. As a result of the assessment, the Company has determined that its compensation policies and practices do not create risks that are reasonably likely to have a material adverse effect on the Company.
| 36 |
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Security Ownership By Named Executive Officers, Directors and Beneficial Owners
The following table sets forth certain information regarding the beneficial ownership of the shares of common stock as of April 24, 2017, by each of our directors and executive officers and any person or entity known by us to be the beneficial owner of more than 5% of the outstanding shares of common stock. The table also shows the beneficial ownership of our stock by all directors and executive officers as a group. The table includes the number of shares subject to outstanding options and warrants to purchase shares of common stock. The percentages are based on 1,184,869,528 shares of common stock outstanding as of April 24, 2017, together with options, warrants or other securities convertible or exchangeable by the beneficial owners into shares of common stock within 60 days of April 24, 2017.
| Title of Class | Name and Address of Beneficial Owner(1) | Shares of Common Stock Beneficially Owned | Percent of Class | |||||||
| Common | Richard Wade | 79,450,190 | (2) | 7.03 | % | |||||
| Common | William K. Mills | 7,333,333 | (3) | * | ||||||
| Common | All Directors and Executive Officers as a group (2 persons) | 86,783,523 | 7.68 | % | ||||||
| * | Less than 1%. |
| (1) | The address of each director and officer is c/o Vertical Computer Systems, Inc., 101 West Renner Road, Suite 300, Richardson, TX 75082. |
| (2) | Includes 74,932,543 shares owned by MRC. MRC has pledged approximately 35,000,000 common shares as collateral to secure various promissory notes issued in the aggregate principal amount of approximately $1,290,000. Mr. Wade is the President and CEO of the Company. MRC is a corporation controlled by the W5 Family Trust and Mr. Wade is the trustee of the W5 Family Trust. |
| (3) | Includes 5,250,000 shares owned by Mr. Mills, 1,083,333 shares of VCSY common stock owned by Parker Mills, L.L.P. (“Parker Mills”) and 3-year warrants to purchase 1,000,000 shares of VCSY common stock at $0.05 per share granted to Parker Mills. William Mills is a Director of the Company and a partner of Parker Mills. |
Item 13. Certain Relationships and Related Transactions, and Director Independence
Certain Relationships and Related Transactions
In March 2015, pursuant to an indemnity and reimbursement agreement executed between Mr. Valdetaro and the Company, we issued 1,000,000 shares of our common stock with the Rule 144 restrictive legend to reimburse Mr. Valdetaro for 1,000,000 shares of common stock transferred to Lakeshore on the Company’s behalf in connection with an extension granted by Lakeshore in August 2013. The issuance of these shares eliminated the derivative liability associated with the value of these shares. The fair market value of these shares on the date of issuance was $38,000 and resulted in the resolution of derivative liabilities and a loss on derivative liabilities of $26,000.
In March 2015, pursuant to two indemnity and reimbursement agreements executed between Mountain Reservoir Corporation (“MRC”) and the Company, we issued a total of 2,809,983 shares of our common stock with the Rule 144 restrictive legend to reimburse MRC. Of these shares, the Company was obligated to reimburse MRC with 1,309,983 shares of common stock that had been pledged by MRC and sold by a third party lender in 2009, 500,000 shares of common stock that had been wrongfully converted by the same lender in 2014, and 1,000,000 shares of common stock that had been transferred to another third party lender in 2013 on the Company’s behalf for a loan made by the lender. MRC assigned its claim against the third party lender for the lender’s wrongful conversion of 500,000 common shares to the Company and we are pursuing the claim in the third party lender’s bankruptcy proceeding. The issuance of these shares eliminated the derivative liability associated with the value of these shares. The fair market value of these shares on the date of issuance was $112,399 of which $92,399 resulted in the resolution of derivative liabilities and a loss on derivative liabilities of $64,680 and $20,000 was recognized as stock reimbursement expense during the twelve months ended December 31, 2015.
| 37 |
In December 2015, the Company issued a convertible debenture in the principal amount of $100,000 to Parker Mills, LLP (“Parker Mills”). The debt accrues interest at 10% per annum and is due one year from the date of issuance. Beginning six months after issuance of the debenture, the holder of the debenture may convert the debenture into shares of common stock at a price per share of 80% of the average per share price of the Company’s common stock for the 5 trading days preceding the notice of conversion date using the 3 lowest closing prices. In connection with the loan, the Company also issued a total of 1,000,000 shares of common stock of the Company to the lender and 3-year warrants under which the lender may purchase in aggregate a total of 1,000,000 unregistered shares of common stock of the Company at a purchase price of $0.10 per share. In connection with the issuance of common stock and warrants, the Company recorded a discount of $20,798 against the face value of the loans based on the relative fair market value of the common stock and warrants. William Mills is a partner of Parker Mills and the Secretary and a Director of the Company.
In May 2016, the Company and William Mills entered into an agreement under which the Company issued 5,000,000 shares of the Company’s common stock with the Rule 144 restrictive legend to Mr. Mills in exchange for the cancellation of $100,000 in fees owed services rendered by Mr. Mills as a Director and Secretary of the Company. The fair market value of the shares was $100,000. Mr. Mills is a partner of Parker Mills and the Secretary and a Director of the Company.
On June 30, 2016, the Company amended an agreement (originally entered into in July 2010) with certain former and current employees of the Company, concerning the deferral of payroll claims of approximately $883,190 for salary earned from 2012 to June 30, 2016 and $1,652,113 for salary earned from 2001 to 2012, which remain unpaid and is reflected as a current liability on the Company’s consolidated financial statements.
Pursuant to the terms of the amended agreement, each current and former employee who is a party to the agreement (the “Employee(s)”) agreed to defer payment of salary from the date of the agreement (“Salary Deferral”) for a period of three months for salary earned from July 1, 2012 to June 30, 2016 and for a period of six months for salary earned from 2001 to June 30, 2012. In consideration for the Salary Deferral, the Company issued a total 3,500,000 shares of the Company’s common stock with the Rule 144 restrictive legend (at a fair market value of $78,750) and agreed to pay each Employee a sum equal to the amount of unpaid salary at December 31, 2003 plus the amount of unpaid salary at the end of any calendar year after 2003 in which such salary was earned, plus a bonus (the “Bonus”) of nine percent interest, compounded annually until such time as the unpaid salary has been paid in full. The Company and the Employees have agreed that the Bonus will be paid from amounts anticipated to be paid to the Company in respect of specified intellectual property assets of the Company.
In order to effect the payments due under the agreement, the Company assigned to the Employees a twenty percent interest in any net proceeds (gross proceeds less attorney’s fees and direct costs) derived from infringement claims and any license fees paid by a subsidiary of the Company or third party to the Company regarding (a) U.S. patent #6,826,744 and U.S. patent #7,716,629 (plus any continuation patents) on Adhesive Software’s SiteFlash™ Technology, (b) U.S. patent #7,076,521 (plus any continuation patents) in respect of “Web-Based Collaborative Data Collection System”, and (c) U.S. patent U.S. Patent No. #8,578,266 and #9,405,736 (plus any continuation patents) in respect to “Method and System for Automatically Downloading and Storing Markup Language Documents into a Folder Based Data Structure,” and (d) any license payments made (i) by a subsidiary of the Company to the Company in connection with a licensing or distribution agreement between the Company and such subsidiary or (ii) by third party to the Company in connection with a licensing or distribution agreement between the Company and a third party
Under the terms of this agreement, the Bonus is contingent on payment of unpaid wages. In addition, the Bonus is contingent upon generating revenues from the sources of the twenty percent interests in net proceeds assigned to the current and former employees. The interests that were assigned under the Agreement for net proceeds consist of the underlying patents of the SiteFlash™ and Emily™ technologies. Currently, there is no foreseeable income to be generated from these sources to which a twenty percent interest can reasonably be projected or otherwise applies to. There is no pending litigation regarding any of these patents. In addition, with respect to any licenses from Vertical to its subsidiaries, the licenses of technology underlying these patents were for a three percent royalty on gross revenues. If there were income, any payments under this agreement would likely be minimal. Currently, there is no income being generated from licensing. No subsidiary is currently offering a product to the market using these licensed technologies nor does Vertical have any agreement to license these technologies to a third party.
Since payment of the Bonus is contingent upon first paying all unpaid salary and there are no foreseeable revenues to pay the twenty percent interest in these technologies, it is doubtful at the present time that any Bonus will be paid and therefore the Bonus was not accrued as of December 31, 2016 as this contingent liability is considered remote. Cumulative bonus interest through December 31, 2016 is $3,816,659.
As of December 31, 2016 and 2015, the Company had accounts payable to related parties and related party contractors in an aggregate amount of $139,546 and $108,379, respectively. The payables are unsecured, non-interest bearing and due on demand.
Director Independence; Board Leadership Structure
The Company’s common stock is quoted through the OTC Markets and quoted on the OTCQB under the symbol “VCSY”. For purposes of determining whether members of the Company’s Board of Directors are “independent,” the Company’s Board utilizes the standards set forth in the NASDAQ Stock Market Marketplace Rules. At present, the Company’s entire Board serves as its Audit, Compensation and Nominating Committees. The Company’s Board of Directors has determined that, of the Company’s present directors, William Mills, constituting one of the two members of the Board, is an “independent director,” as defined under NASDAQ’s Marketplace Rules, for purposes of qualifying as independent members of the Board and an Audit, Compensation and Nominating Committee of the Board, but that Richard Wade is not an “independent director” since he serves as executive officer of the Company. In reaching its conclusion, the Board determined that Mr. Mills does not have a relationship with the Company that, in the Board’s opinion, would interfere with his exercise of independent judgment in carrying out the responsibilities of a director, nor does Mr. Mills have any of the specific relationships set forth in NASDAQ’s Marketplace Rules that would disqualify him from being considered an independent director.
| 38 |
Currently, Mr. Richard Wade serves as both Chairman of the Board and Chief Executive Officer. As noted above, Mr. William Mills is the sole independent director and Mr. Mills has not taken on any supplemental role in his capacity as director. It is anticipated that additional independent directors may be added to the Board, however, the Company’s Board of Directors has not set a timetable for such action.
The Company’s Board of Directors is of the view that the current leadership structure is suitable for the Company at its present stage of development, and that the interests of the Company are best served by the combination of the roles of Chairman of the Board and Chief Executive Officer.
As a matter of regular practice, and as part of its oversight function, the Company’s Board of Directors undertakes a review of the significant risks in respect of the Company’s business. Such review is conducted in concert with the Company’s in-house legal staff, and is supplemented as necessary by outside professionals with expertise in substantive areas germane to the Company’s business. With the Company’s current governance structure, the Company’s Board of Directors and senior executives are, by and large, the same individuals, and consequently, there is not a significant division of oversight and operational responsibilities in managing the material risks facing the Company.
| 39 |
Item 14. Principal Accountant Fees and Services
Audit Fees. The aggregate fees billed for professional services rendered by our principal accounting firm of MaloneBailey were $72,000 and $74,500 for the audit of our annual financial statements for 2016 and 2015, which included the reviews of the financial statements in our Forms 10-Q for the applicable fiscal years.
Tax Fees. The principal accounting firm of MaloneBailey did not provide any tax services in 2016 and 2015.
All Other Fees. Other than the services described above, the aggregate fees billed for services rendered by our principal accountant was $0 and $0, respectively, for the fiscal years ended 2016 and 2015.
| 40 |
Item 15. Exhibits and Financial Statement Schedules
The following documents are filed as part of this report:
| a. | Exhibits: |
| Exhibit No. | Description | Location | ||
| 2.1 | Certificate of Ownership and Merger Merging Scientific Fuel Technology, Inc. into Vertical Computer Systems, Inc. | Incorporated by reference to Exhibit 2.1 to the Company’s Form 10-K filed on April 14, 2016 | ||
| 3.1 | Original Unamended Certificate of Incorporation of Vertical Computer Systems, Inc. (f/k/a Xenogen Technology, Inc.) | Incorporated by reference to Exhibit 2.1 to the Company’s Form 10-K filed on April 14, 2016 | ||
| 3.2 | Certificate of Amendment of Certificate of Incorporation (changed name to Vertical Computer Systems, Inc.) | Incorporated by reference to Exhibit 2.1 to the Company’s Form 10-K filed on April 14, 2016 | ||
| 3.3 | Certificate of Amendment of Certificate of Incorporation (2000) | Incorporated by reference to Exhibit 2.1 to the Company’s Form 10-K filed on April 14, 2016 | ||
| 3.4 | Certificate of Amendment of Certificate of Incorporation | Incorporated by reference to Exhibit 3.1 to the Company’s Form 8-K filed on February 27, 2015 | ||
| 3.5 | Amended and Restated By-Laws of the Company | Incorporated by reference to Exhibit 3.1 to the Company’s Form 8-K filed on January 13, 2015 | ||
| 4.1 | Certificate of Designation of 4% Cumulative Redeemable Series A Preferred Stock | Incorporated by reference to Exhibit 2.1 to the Company’s Form 10-K filed on April 14, 2016 | ||
| 4.2 | Certificate of Designation of 10% Cumulative Redeemable Series B Preferred Stock | Incorporated by reference to Exhibit 2.1 to the Company’s Form 10-K filed on April 14, 2016 | ||
| 4.3 | Certificate of Designation of 4% Cumulative Redeemable Series C Preferred Stock | Incorporated by reference to Exhibit 2.1 to the Company’s Form 10-K filed on April 14, 2016 | ||
| 4.4 | Certificate of Designation of 15% Cumulative Redeemable Series D Preferred Stock | Incorporated by reference to Exhibit 2.1 to the Company’s Form 10-K filed on April 14, 2016 | ||
| 4.5 | Form of Restricted Stock Agreement | Incorporated by reference to Exhibit 2.1 to the Company’s Form 10-K filed on April 14, 2016 | ||
| 4.6 | Form of Convertible Note | Incorporated by reference to Exhibit 2.1 to the Company’s Form 10-K filed on April 14, 2016 | ||
| 4.7 | Form of Stock Purchase Warrant | Incorporated by reference to Exhibit 2.1 to the Company’s Form 10-K filed on April 14, 2016 | ||
| 10.1 | Employment Agreement between the Company and Richard Wade | Incorporated by reference to Exhibit 2.1 to the Company’s Form 10-K filed on April 14, 2016 | ||
| 10.2 | Secured Term Promissory Note in the principal amount of $1,759,150 payable by NOW Solutions to Lakeshore Investment, LLC. | Incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed on January 15, 2013 |
| 41 |
| 14.1 | Code of Ethics | Incorporated by reference to Exhibit 2.1 to the Company’s Form 10-K filed on April 14, 2016 | ||
| 21.1 | Subsidiaries of the Company | Incorporated by reference to Exhibit 2.1 to the Company’s Form 10-K filed on April 14, 2016 | ||
| 31.1 | Certification of Principal Executive Officer and Principal Accounting Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated April 24, 2017 | Provided herewith | ||
| 32.1 | Certification of Principal Executive Officer and Principal Accounting Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, dated April 24, 2017 | Provided herewith | ||
| 101.INS* | XBRL Instance Document | Provided herewith | ||
| 101.SCH* | XBRL Taxonomy Extension Schema | Provided herewith | ||
| 101.CAL * | XBRL Taxonomy Extension Calculation Linkbase | Provided herewith | ||
| 101.DEF* | XBRL Taxonomy Extension Definition Linkbase | Provided herewith | ||
| 101.LAB* | XBRL Taxonomy Extension Label Linkbase | Provided herewith | ||
| 101.PRE* | XBRL Taxonomy Extension Presentation Linkbase | Provided herewith |
* Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
| 42 |
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| VERTICAL COMPUTER SYSTEMS, INC. | ||
| April 24, 2017 | By: | /s/ Richard Wade |
| Richard Wade, | ||
| President and Chief Executive Officer | ||
| (Principal Executive Officer and | ||
| Principal Accounting Officer) | ||
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| DIRECTORS: | ||
| April 24, 2017 | By: | /s/ Richard Wade |
| Richard Wade, Director | ||
| April 24, 2017 | By: | /s/ William Mills |
| William Mills, Director | ||
| 43 |
VERTICAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
| F-1 |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Vertical Computer Systems, Inc.
Richardson, Texas
We have audited the accompanying consolidated balance sheets of Vertical Computer Systems, Inc. and its subsidiaries (collectively, the “Company”) as of December 31, 2016 and 2015 and the related consolidated statements of operations and comprehensive loss, stockholders’ deficit, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform an audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Vertical Computer Systems, Inc. and its subsidiaries as of December 31, 2016 and 2015 and the consolidated results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company suffered net losses and has a working capital deficiency, which raises substantial doubt about its ability to continue as a going concern. Management’s plans regarding those matters also are described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ MaloneBailey, LLP
www.malonebailey.com
Houston, Texas
April 24, 2017
| F-2 |
VERTICAL COMPUTER SYSTEMS, INC.
| December 31, | December 31, | |||||||
| 2016 | 2015 | |||||||
| Assets | ||||||||
| Current assets: | ||||||||
| Cash | $ | 190,448 | $ | 37,141 | ||||
| Accounts receivable, net of allowance for bad debts of $139,705 and $97,973 | 367,278 | 382,463 | ||||||
| Prepaid expenses and other current assets | 10,355 | 57,488 | ||||||
| Total current assets | 568,081 | 477,092 | ||||||
| Property and equipment, net of accumulated depreciation of $1,043,397 and $1,038,609 | 5,097 | 2,375 | ||||||
| Intangible assets, net of accumulated amortization of $319,513 and $319,413 | 6,690 | 1,181,661 | ||||||
| Deposits and other assets | 8,064 | 7,909 | ||||||
| Total assets | $ | 587,932 | $ | 1,669,037 | ||||
| Liabilities and Stockholders’ Deficit | ||||||||
| Current liabilities: | ||||||||
| Accounts payable and accrued liabilities | 12,075,298 | 10,536,974 | ||||||
| Accounts payable to related parties | 139,546 | 108,379 | ||||||
| Bank overdraft | - | 52 | ||||||
| Deferred revenue | 1,794,264 | 1,658,158 | ||||||
| Derivative liabilities | 1,014,192 | - | ||||||
| Convertible debentures, net of unamortized discounts of $354,785 and $110,171 | 899,428 | 499,879 | ||||||
| Notes payable | 4,953,717 | 4,897,141 | ||||||
| Notes payable and convertible debt to related parties, net of unamortized discounts of $0 and $20,798 | 308,242 | 417,445 | ||||||
| Total current liabilities | 21,184,687 | 18,118,028 | ||||||
| Total liabilities | 21,184,687 | 18,118,028 | ||||||
| Series A 4% Convertible Cumulative Preferred stock; $0.001 par value; 250,000 shares authorized; 51,500 shares issued and outstanding as of December 31, 2016 and 48,500 shares issued and outstanding as of December 31, 2015; | 10,066,499 | 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 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 | ||||||
| 10,268,523 | 9,902,024 | |||||||
| Stockholders’ Deficit | ||||||||
| Common stock: $0.00001 par value, 2,000,000,000 shares authorized, 1,167,841,439 issued and 1,127,841,439 outstanding as of December 31, 2016 and 1,114,601,656 issued and 1,084,601,656 outstanding as of December 31, 2015 | 11,679 | 11,147 | ||||||
| Treasury stock: 40,000,000 shares as of December 31, 2016 and 30,000,000 shares as of December 31, 2015 | (400 | ) | (300 | ) | ||||
| Additional paid-in capital | 23,672,153 | 22,252,823 | ||||||
| Accumulated deficit | (55,017,675 | ) | (49,739,924 | ) | ||||
| Accumulated other comprehensive income – foreign currency translation | 424,996 | 558,668 | ||||||
| Total Vertical Computer Systems, Inc. stockholders’ deficit | (30,909,247 | ) | (26,917,586 | ) | ||||
| Non-controlling interest | 43,969 | 566,571 | ||||||
| Total stockholders’ deficit | (30,865,278 | ) | (26,351,015 | ) | ||||
| Total liabilities and stockholders’ deficit | $ | 587,932 | $ | 1,669,037 | ||||
See accompanying notes to consolidated financial statements.
| F-3 |
VERTICAL COMPUTER SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
AND OTHER COMPREHENSIVE LOSS
| Years Ended December 31, | ||||||||
| 2016 | 2015 | |||||||
| Revenues: | ||||||||
| Licensing and software | $ | 19,290 | $ | 22,500 | ||||
| Software maintenance | 3,235,281 | 3,573,622 | ||||||
| Consulting services | 279,517 | 292,129 | ||||||
| Cloud-based offering | 281,080 | 321,619 | ||||||
| Other | 12,507 | 53,765 | ||||||
| Total Revenues | 3,827,675 | 4,263,635 | ||||||
| Cost of Revenues | (1,524,853 | ) | (1,767,155 | ) | ||||
| Gross Profit | 2,302,822 | 2,496,480 | ||||||
| Operating Expenses: | ||||||||
| Selling, general and administrative expenses | 3,871,572 | 3,088,568 | ||||||
| Depreciation and amortization | 1,083 | 38,412 | ||||||
| Bad debt expense | 98,896 | 3,300 | ||||||
| Impairment of software costs | 1,421,155 | - | ||||||
| Total operating expenses | 5,392,706 | 3,130,280 | ||||||
| Operating loss | (3,089,884 | ) | (633,800 | ) | ||||
| Other Income (Expense): | ||||||||
| Loss on derivative liabilities | (268,728 | ) | (78,680 | ) | ||||
| Forbearance fees | (58,500 | ) | (1,065,900 | ) | ||||
| Gain (loss) on extinguishment of debt | 35,969 | (393,301 | ) | |||||
| Interest income | 53 | 9 | ||||||
| Interest expense | (1,998,762 | ) | (895,920 | ) | ||||
| Net loss before non-controlling interest and income tax benefit | (5,379,852 | ) | (3,067,592 | ) | ||||
| Income tax expense (benefit) | 86,378 | (571,980 | ) | |||||
| Net loss before non-controlling interest | (5,466,230 | ) | (2,495,612 | ) | ||||
| Net loss (income) attributable to non-controlling interest | 188,479 | (69,755 | ) | |||||
| Net loss attributable to Vertical Computer Systems, Inc. | (5,277,751 | ) | (2,565,367 | ) | ||||
| Dividends applicable to preferred stock | (592,472 | ) | (588,000 | ) | ||||
| Net loss available to common stockholders | $ | (5,870,223 | ) | $ | (3,153,367 | ) | ||
| Basic and diluted loss per share | $ | (0.01 | ) | $ | (0.00 | ) | ||
| Basic and diluted weighted average common shares outstanding | 1,106,272,758 | 1,036,597,308 | ||||||
| Comprehensive loss: | ||||||||
| Net loss | $ | (5,466,230 | ) | $ | (2,495,612 | ) | ||
| Translation adjustments | (133,672 | ) | 412,860 | |||||
| Comprehensive loss | (5,599,902 | ) | (2,082,752 | ) | ||||
| Comprehensive income (loss) attributable to non-controlling interest | 188,479 | (69,755 | ) | |||||
| Comprehensive loss attributable to Vertical Computer Systems, Inc. | $ | (5,411,423 | ) | $ | (2,152,507 | ) | ||
See accompanying notes to consolidated financial statements.
| F-4 |
VERTICAL COMPUTER SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ DEFICIT
YEARS ENDED DECEMBER 31, 2016 AND 2015
| Additional | Other | Non- | ||||||||||||||||||||||||||||||||||
| Common Stock | Treasure Stock | Paid-in | Accumulated | Comprehensive | controlling | |||||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Capital | Deficit | Interest | Interest | Total | ||||||||||||||||||||||||||||
| Balances at December 31, 2014 | 999,735,151 | $ | 9,998 | - | - | $ | 19,925,061 | $ | (47,174,557 | ) | $ | 145,808 | $ | 621,816 | $ | (26,471,874 | ) | |||||||||||||||||||
| Shares issued for resolution of derivative liabilities | 3,309,983 | 33 | - | - | 130,366 | - | - | - | 130,399 | |||||||||||||||||||||||||||
| Shares issued for reimbursement of stock | 500,000 | 5 | - | - | 19,995 | - | - | - | 20,000 | |||||||||||||||||||||||||||
| Shares issued for accrued interest and loan principal | 35,556,522 | 356 | - | - | 895,557 | - | - | - | 895,913 | |||||||||||||||||||||||||||
| Shares issued for loan forbearance | 36,500,000 | 365 | - | - | 1,050,535 | - | - | - | 1,050,900 | |||||||||||||||||||||||||||
| Shares issued to subsidiaries and held in treasury | 30,000,000 | 300 | (30,000,000 | ) | (300 | ) | - | - | - | - | - | |||||||||||||||||||||||||
| Shares and warrants issued with convertible debt | 7,500,000 | 75 | - | - | 182,458 | - | - | - | 182,533 | |||||||||||||||||||||||||||
| Shares issued for loan discounts | 1,500,000 | 15 | - | - | 29,235 | - | - | - | 29,250 | |||||||||||||||||||||||||||
| Amortization of restricted stock awards | - | - | - | - | 19,616 | - | - | - | 19,616 | |||||||||||||||||||||||||||
| Dividends paid by subsidiary to non-controlling interest | - | - | - | - | - | - | - | (125,000 | ) | (125,000 | ) | |||||||||||||||||||||||||
| Other comprehensive income translation adjustment | - | - | - | - | - | - | 412,860 | - | 412,860 | |||||||||||||||||||||||||||
| Net loss | - | - | - | - | - | (2,565,367 | ) | - | 69,755 | (2,495,612 | ) | |||||||||||||||||||||||||
| Balances at December 31, 2015 | 1,114,601,656 | $ | 11,147 | (30,000,000 | ) | (300 | ) | $ | 22,252,823 | $ | (49,739,924 | ) | $ | 558,668 | $ | 566,571 | $ | (26,351,015 | ) | |||||||||||||||||
| Amortization of restricted stock awards | - | - | - | - | 229,223 | - | - | - | 229,223 | |||||||||||||||||||||||||||
| Forfeited restricted stock awards | - | - | - | - | (1,145 | ) | - | - | - | (1,145 | ) | |||||||||||||||||||||||||
| Shares issued to subsidiary and held in treasury | 10,000,000 | 100 | (10,000,000 | ) | (100 | ) | - | - | - | - | - | |||||||||||||||||||||||||
| Shares issued for vested restricted stock awards | 7,175,000 | 72 | - | - | (72 | ) | - | - | - | - | ||||||||||||||||||||||||||
| Cancellation of shares issued for loan forbearance | (1,000,000 | ) | (10 | ) | - | - | 10 | - | - | - | - | |||||||||||||||||||||||||
| Shares issued for accounts payable | 1,500,000 | 15 | - | - | 37,485 | - | - | - | 37,500 | |||||||||||||||||||||||||||
| Shares issued for services | 3,000,000 | 30 | - | - | 66,520 | - | - | - | 66,550 | |||||||||||||||||||||||||||
| Shares issued for related party accounts payable | 5,000,000 | 50 | - | - | 99,950 | - | - | - | 100,000 | |||||||||||||||||||||||||||
| Shares issued with convertible debt | 7,150,000 | 71 | - | - | 114,342 | - | - | - | 114,413 | |||||||||||||||||||||||||||
| Shares issued for conversion of convertible debt | 5,914,783 | 59 | - | - | 81,942 | - | - | - | 82,001 | |||||||||||||||||||||||||||
| Shares issued for payment of note principal | 5,000,000 | 50 | - | - | 92,450 | - | - | - | 92,500 | |||||||||||||||||||||||||||
| Reclassification of warrants as derivative liabilities | - | - | - | - | (50,557 | ) | - | - | - | (50,557 | ) | |||||||||||||||||||||||||
| Settlement of derivative liability upon conversion of debt | - | - | - | - | 50,681 | - | - | - | 50,681 | |||||||||||||||||||||||||||
| Shares issued to employees and contractors | 3,500,000 | 35 | - | - | 78,715 | - | - | - | 78,750 | |||||||||||||||||||||||||||
| Shares and subsidiary shares issued for equity subscriptions | 6,000,000 | 60 | - | - | 232,852 | - | - | (3,416 | ) | 229,496 | ||||||||||||||||||||||||||
| Dividends paid by subsidiary to non-controlling interest | - | - | - | - | - | - | - | (295,000 | ) | (295,000 | ) | |||||||||||||||||||||||||
| Issuance of subsidiary shares for services | - | - | - | - | 370,734 | - | - | (35,707 | ) | 335,027 | ||||||||||||||||||||||||||
| Issuance of subsidiary shares for debt extension | - | - | - | - | 16,200 | - | - | - | 16,200 | |||||||||||||||||||||||||||
| Other comprehensive income translation adjustment | - | - | - | - | - | - | (133,672 | ) | - | (133,672 | ) | |||||||||||||||||||||||||
| Net loss | - | - | - | - | - | (5,277,751 | ) | - | (188,479 | ) | (5,466,230 | ) | ||||||||||||||||||||||||
| Balances at December 31, 2016 | 1,167,841,439 | $ | 11,679 | $ | (40,000,000 | ) | $ | (400 | ) | $ | 23,672,153 | $ | (55,017,675 | ) | $ | 424,996 | $ | 43,969 | $ | (30,865,278 | ) | |||||||||||||||
See accompanying notes to consolidated financial statements.
| F-5 |
VERTICAL COMPUTER SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
| Years Ended December 31, | ||||||||
| 2016 | 2015 | |||||||
| Cash flows from operating activities: | ||||||||
| Net loss | $ | (5,466,230 | ) | $ | (2,495,612 | ) | ||
| Adjustments to reconcile net loss to net cash provided by (used in) operating activities: | ||||||||
| (Gain) loss on extinguishment of debt and accrued interest | (35,969 | ) | 393,301 | |||||
| Depreciation and amortization | 1,083 | 38,412 | ||||||
| Amortization of restricted stock awards | 307,973 | 19,616 | ||||||
| Amortization of subsidiary restricted stock awards | 335,027 | - | ||||||
| Amortization of debt discounts | 648,339 | 80,864 | ||||||
| Loss on derivatives | 268,728 | 78,680 | ||||||
| Common shares issued for stock compensation | - | 20,000 | ||||||
| Common shares issued for services | 66,550 | - | ||||||
| Impairment of software development costs | 1,421,155 | - | ||||||
| Forbearance fees paid with common stock | - | 1,050,900 | ||||||
| Bad debt expense | 98,896 | 3,300 | ||||||
| Write off of property and equipment | - | 4,919 | ||||||
| Settlement of accrued income taxes | - | (581,622 | ) | |||||
| Forfeited restricted stock awards | (1,145 | ) | - | |||||
| Changes in operating assets and liabilities: | ||||||||
| Accounts receivable | (79,856 | ) | 158,158 | |||||
| Prepaid expense and other assets | 47,024 | 164 | ||||||
| Accounts payable and accrued liabilities | 1,665,678 | 1,083,971 | ||||||
| Accounts payable to related parties | 131,167 | 72,046 | ||||||
| Deferred revenue | 104,825 | (453,109 | ) | |||||
| Net cash provided by (used in) operating activities | (486,755 | ) | (526,012 | ) | ||||
| Cash flows from investing activities: | ||||||||
| Software development | (246,184 | ) | (541,300 | ) | ||||
| Purchase of equipment | (3,805 | ) | - | |||||
| Net cash used in investing activities | (249,989 | ) | (541,300 | ) | ||||
| Cash flows from financing activities: | ||||||||
| Payments of notes payable | (113,699 | ) | (132,848 | ) | ||||
| Borrowings on notes payable | 170,000 | 555,333 | ||||||
| Payments on related party debt | - | (10,425 | ) | |||||
| Borrowings on related party debt and convertible debt | - | 100,000 | ||||||
| Borrowings on convertible debentures | 715,000 | 580,000 | ||||||
| Issuance of preferred stock | 600,000 | - | ||||||
| Dividends paid by subsidiary to non-controlling interest | (295,000 | ) | (125,000 | ) | ||||
| Bank overdraft | (52 | ) | (7,647 | ) | ||||
| Net cash provided by financing activities | 1,076,249 | 959,413 | ||||||
| Effect of changes in exchange rates on cash | (186,198 | ) | 27,174 | |||||
| Net decrease in cash | 153,307 | (80,725 | ) | |||||
| Cash, beginning of period | 37,141 | 117,866 | ||||||
| Cash, end of period | $ | 190,448 | $ | 37,141 | ||||
| F-6 |
VERTICAL COMPUTER SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
| Years Ended December 31, | ||||||||
| 2016 | 2015 | |||||||
| Supplemental Disclosure of Cash Flows Information: | ||||||||
| Cash paid for interest | $ | 182,618 | $ | 128,712 | ||||
| Non-cash Investing and Financing Activities: | ||||||||
| Common shares issued for vested restricted stock | 72 | - | ||||||
| Issuance of shares for settlement of accounts payable and related party accounts payable | 137,500 | - | ||||||
| Common shares issued for conversion of debt and accrued interest | 82,001 | 895,913 | ||||||
| Common stock issued for settlement of derivative liabilities | - | 130,399 | ||||||
| Common stock issued for settlement of note principal | 130,000 | - | ||||||
| Debt discount due to derivative liabilities | 741,583 | - | ||||||
| Debt discount due to subsidiary shares issued for debt extensions | 16,200 | - | ||||||
| Debt discount due to shares issued with debt | 114,413 | 211,783 | ||||||
| Reclassification of warrants as derivative liabilities | 50,557 | - | ||||||
| Accrued interest capitalized into debt principal | - | 188,552 | ||||||
| Settlement of derivative due to conversion | 50,681 | - | ||||||
| Restricted stock cancelled | 10 | - | ||||||
See accompanying notes to consolidated financial statements.
| F-7 |
VERTICAL COMPUTER SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Organization, Basis of Presentation and Significant Accounting Policies
Nature of Business
Vertical Computer Systems, Inc. was incorporated in Delaware in March 1992. We are a multinational provider of application software, software services, Internet core technologies, and derivative software application products through our distribution network. Our business model combines complementary, integrated software products, internet core technologies, and a multinational distribution system of partners, in order to create a distribution matrix that is capable of penetrating multiple sectors through cross selling our products and services. We operate one business segment.
Basis of Presentation
The consolidated financial statements include the accounts of the Company and its subsidiaries (collectively, “our”, “we”, the “Company” or “VCSY”, as applicable). Vertical’s subsidiaries which currently maintain daily business operations are NOW Solutions, a 75% owned subsidiary, and SnAPPnet, Inc. (“SnAPPnet”), an 80% owned subsidiary of Vertical. Vertical’s subsidiaries which have minimal operations are Vertical do Brasil, Taladin, Inc. (“Taladin"), and Vertical Healthcare Solutions, Inc. (“VHS”), each of which a wholly-owned subsidiary of Vertical, as well as Priority Time Systems, Inc. (“Priority Time”) a 70% owned subsidiary, Ploinks, Inc. (“Ploinks”), a 91% owned subsidiary and Government Internet Systems, Inc. (“GIS”), an 84.5% owned subsidiary. Vertical’s subsidiaries which are inactive include EnFacet, Inc. (“ENF”), Globalfare.com, Inc. (“GFI”), Pointmail.com, Inc. and Vertical Internet Solutions, Inc. (“VIS”), each of which is a wholly-owned subsidiary of Vertical. To date, we have generated revenues primarily from software licenses, software as a service, consulting fees and maintenance agreements from NOW Solutions and SnAPPnet and patent licenses from Vertical Computer Systems, the parent company.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its subsidiaries. Equity investments in which we exercise significant influence, but do not control and are not the primary beneficiary, are accounted for using the equity method of accounting. Investments in which we do not exercise significant influence over the investee are accounted for using the cost method of accounting. All intercompany accounts and transactions have been eliminated. We currently have no investments accounted for using the equity or cost methods of accounting.
Cash and Cash Equivalents
Cash equivalents are highly liquid investments with an original maturity of three months or less.
Revenue Recognition
Our revenue recognition policies are in accordance with standards on software revenue recognition, which includes guidance on revenue arrangements with multiple deliverables and arrangements that include the right to use of software stored on another entity’s hardware.
In the case of non-software arrangements, we apply the guidance on revenue arrangements with multiple deliverables and wherein multiple elements are allocated to each element based on the element’s relative fair value. Revenue allocated to separate elements is recognized for each element in accordance with our accounting policies described below. If we cannot account for items included in a multiple-element arrangement as separate units of accounting, they are combined and accounted for as a single unit of accounting and generally recognized as the undelivered items or services are provided to the customer.
Consulting. We provide consulting services, primarily implementation and training services, to our clients using a time and materials pricing methodology. The Company prices its delivery of consulting services on a time and materials basis where the customer is either charged an agreed-upon daily rate plus out-of-pocket expenses or an hourly rate plus out-of-pocket expenses. In this case, the Company is paid fees and other amounts generally on a monthly basis or upon the completion of the deliverable service and recognizes revenue as the services are performed.
| F-8 |
Software License. We sell concurrent perpetual software licenses to our customers. The license gives the customer the right to use the software without regard to a specific term. We recognize the license revenue upon execution of a contract and delivery of the software, provided the license fee is fixed and determinable, no significant production, modification or customization of the software is required and collection is considered probable by management. When the software license arrangement requires the Company to provide consulting services that are essential to the functionality of the software, the product license revenue is recognized upon the acceptance by the customer and consulting fees are recognized as services are performed.
Software licenses are generally sold as part of a multiple element arrangement that may include maintenance and, under a separate agreement, consulting services. The consulting services are generally performed by the Company, but the customer may use a third party to perform those. We consider these separate agreements as being negotiated as a package. The Company determines whether there is vendor specific objective evidence of fair value (‘‘VSOEFV’’) for each element identified in the arrangement to determine whether the total arrangement fees can be allocated to each element. If VSOEFV exists for each element, the total arrangement fee is allocated based on the relative fair value of each element. In cases where there is not VSOEFV for each element, or if it is determined that services are essential to the functionality of the software being delivered, we initially defer revenue recognition of the software license fees until VSOEFV is established or the services are performed. However, if VSOEFV is determinable for all of the undelivered elements, and assuming the undelivered elements are not essential to the delivered elements, we will defer recognition of the full fair value related to the undelivered elements and recognize the remaining portion of the arrangement value through application of the residual method. Where VSOEFV has not been established for certain undelivered elements, revenue for all elements is deferred until those elements have been delivered or their fair values have been determined. Evidence of VSOEFV is determined for software products based on actual sales prices for the product sold to a similar class of customer and based on pricing strategies set forth in the Company’s standard pricing list. Evidence of VSOEFV for consulting services is based upon standard billing rates and the estimated level of effort for individuals expected to perform the related services. The Company establishes VSOEFV for maintenance agreements using the percentage method such that VSOEFV for maintenance is a percentage of the license fee charged annually for a specific software product, which in most instances is 18% of the portion of arrangement fees allocated to the software license element.
Maintenance Revenue. In connection with the sale of a software license, a customer may elect to purchase software maintenance services. Most of the customers that purchase software licenses from us also purchase software maintenance services. These maintenance services are typically renewed on an annual basis. We charge an annual maintenance fee, which is typically a percentage of the initial software license fee and may be increased from the prior year amount based on inflation or other agreed upon percentage. The annual maintenance fee generally is paid to the Company at the beginning of the maintenance period, and we recognize these revenues ratably over the term of the related contract.
While most of our customers pay for their annual maintenance at the beginning of the maintenance period, a few customers have payment terms that allow them to pay for their annual maintenance on a quarterly or monthly basis. If the annual maintenance fee is not paid at the beginning of the maintenance period (or at the beginning of the quarter or month for those few maintenance customers), we will ratably recognize the maintenance revenue if management believes the collection of the maintenance fee is imminent. Otherwise, we will defer revenue recognition until the time that the maintenance fee is paid by the customer. We normally continue to provide maintenance service while awaiting payment from customers. When the payment is received, revenue is recognized for the period that revenue was previously deferred. This may result in volatility in software maintenance revenue from period to period.
Cloud-based offering. We have contracted with a third party to provide new and existing customers with a hosting facility providing all infrastructure and allowing us to offer our currently sold software, emPath® and SnAPPnet™, on a service basis. However, a contractual right to take possession of the software license or run it on another party’s hardware is not granted to the customer. We refer to the delivery method to give functionality to new customers utilizing this service as a cloud-based offering. Since the customer is not given contractual right to take possession of the software, the scope of ASC 350-40 does not apply. A customer using our cloud-based offering can enter into an agreement to purchase a software license at any time. We generate revenue from our cloud-based offering as the customer utilizes the software over the Internet.
We will provide consulting services to customers in conjunction with our cloud-based offering. The rate for such service is based on standard hourly or daily billing rates. The consulting revenue is recognized as services are performed. Customers, utilizing their own computer to access our cloud-based offering, are charged a fee equal to the number of employees paid each month multiplied by an agreed-upon monthly rate per employee. The revenue is recognized as the cloud-based offering services are rendered each month.
| F-9 |
Concentration of Credit Risk
We maintain our cash in bank deposit accounts, which, at times, may exceed federally insured limits. We have not experienced any such losses in these accounts. Substantially all of our revenue was derived from recurring maintenance fees related to our payroll processing software. The company’s revenue consists of 60% in Canada and 40% in the US. Receivables arising from sales of the Company’s products are not collateralized. As of December 31, 2016, two customers represented approximately 71% (40% and 31%) of accounts receivable. As of December 31, 2015, four customers represented approximately 81.4% (31.7%, 25.2%, 12.7 and 11.8%) of accounts receivable.
Capitalized Software Costs
Software costs incurred internally in creating computer software products are expensed until technological feasibility has been established upon completion of a detailed program design. Thereafter, all software development costs are capitalized until the point that the product is ready for sale, and are subsequently reported at the lower of unamortized cost or net realizable value. The Company considers annual amortization of capitalized software costs based on the ratio of current year revenues by product to the total estimated revenues by the product, subject to an annual minimum based on straight-line amortization over the product’s estimated economic useful life, not to exceed five years. The Company periodically reviews capitalized software costs for impairment where the fair value is less than the carrying value.
For the year ended December 31, 2016 and 2015, the company capitalized $246,184 and $541,300, respectively of software development costs related to its Ploinks subsidiary. During 2016, the company recorded an impairment loss of $1,421,155 related to software development cost. During 2015, there was no impairment of long-lived assets.
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed primarily utilizing the straight-line method over the estimated economic life of three to five years. Maintenance, repairs and minor renewals are charged directly to expenses as incurred. Additions and betterment to property and equipment are capitalized. When assets are disposed of, the related cost and accumulated depreciation thereon are removed from the accounts and any resulting gain or loss is included in the statement of operations.
Impairment of Long-Lived Assets
Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable through the estimated undiscounted cash flows expected to result from the use and eventual disposition of the assets. Whenever any such impairment exists, an impairment loss will be recognized for the amount by which the carrying value exceeds the fair value. During 2016, the company recorded an impairment loss of $1,421,155 related to software development cost. During 2015, there was no impairment of long-lived assets.
Stock-based Compensation
We account for share-based compensation in accordance with the provisions of share-based payments, which requires measurement of compensation cost for all stock-based awards at fair value on date of grant and recognition of compensation over the service period for awards expected to vest. The fair value of restricted stock and restricted stock units is determined based on the number of shares granted and the quoted price of our common stock. Equity instruments issued to other than employees are valued at the earlier of a commitment date or upon completion of the services, based on the fair value of the equity instruments, and are recognized as expense over the service period.
Allowance for Doubtful Accounts
We establish an allowance for bad debts through a review of several factors including historical collection experience, current aging status of the customer accounts, and financial condition of our customers. We do not generally require collateral for our accounts receivable. Our allowance for doubtful accounts was $139,705 and $97,973 as of December 31, 2016 and 2015, respectively.
| F-10 |
Income Taxes
We provide for income taxes in accordance with the asset and liability method of accounting for income taxes.
Under the asset and liability method, deferred income taxes are recognized for the tax consequences of “temporary differences” by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. A valuation allowance is provided when management cannot determine whether it is more likely than not the deferred tax asset will be realized. The effect on deferred income taxes of a change in tax rates is recognized in income in the period that includes the enactment date.
Since January 1, 2007, we account for uncertain tax positions in accordance with the authoritative guidance issued by the Financial Accounting Standards Board (“FASB”) on income taxes which addresses how we should recognize, measure and present in our financial statements uncertain tax positions that have been taken or are expected to be taken in a tax return. Pursuant to this guidance, we can recognize a tax benefit only if it is “more likely than not” that a particular tax position will be sustained upon examination or audit. To the extent the “more likely than not” standard has been satisfied, the benefit associated with a tax position is measured as the largest amount that is greater than 50% likely of being realized upon settlement. No liability for unrecognized tax benefits was recorded as of December 31, 2016 and 2015.
Earnings per Share
Basic earnings per share is calculated by dividing net income (loss) available to common stockholders by the weighted average number of shares of the Company’s common stock outstanding during the period. “Diluted earnings per share” reflects the potential dilution that could occur if our share-based awards and convertible securities were exercised or converted into common stock. The dilutive effect of our share-based awards is computed using the treasury stock method, which assumes all share-based awards are exercised and the hypothetical proceeds from exercise are used to purchase common stock at the average market price during the period. The incremental shares (difference between shares assumed to be issued versus purchased), to the extent they would have been dilutive, are included in the denominator of the diluted EPS calculation. The dilutive effect of our convertible preferred stock and convertible debentures is computed using the if-converted method, which assumes conversion at the beginning of the year.
The following represents a reconciliation of the numerators and denominators of the basic and diluted earnings per share computation:
| Year Ended December 31, 2016 | Year Ended December 31, 2015 | |||||||||||||||||||||||
| Net Loss Applicable to Common Stockholders (Numerator) | Shares (Denominator) | Per Share Amount | Net Loss Applicable to Common Stockholders (Numerator) | Shares (Denominator) | Per Share Amount | |||||||||||||||||||
| Basic and Diluted EPS | $ | (5,870,223 | ) | 1,106,272,758 | $ | (0.01 | ) | $ | (3,153,367 | ) | 1,036,597,308 | $ | (0.00 | ) | ||||||||||
As of December 31, 2016, and 2015, common stock equivalents related to the convertible debt, preferred stock and stock derivative liabilities were not included in the denominators of the diluted earnings per share as their effect would be anti-dilutive.
Fair Value of Financial Instruments
For certain of our financial instruments, including cash, accounts receivable, short term debt and accrued expenses, the carrying amounts approximate fair value due to the short maturity of these instruments. The carrying value of our long-term debt approximates its fair value based on the quoted market prices for the same or similar issues or the current rates offered to us for debt of the same remaining maturities. For additional information, please see Note 4 – Derivative Liabilities and Fair Value Measurements.
| F-11 |
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of financial statements and the reported amounts of revenue and expenses during the reporting period. Among the more significant estimates included in these financial statements are the estimated allowance for doubtful accounts receivable, valuation allowance for deferred tax assets, impairment of long-lived assets and intangible and the valuation of warrants and restricted stock grants. Actual results could materially differ from those estimates.
Cash Reimbursements
We record reimbursement by our customers for out-of-pocket expense as part of consulting services revenue in accordance with the guidance related to income statement characterization of reimbursements received for out of pocket expense incurred.
Reclassifications
Certain reclassifications have been made to the prior periods to conform to the current period presentation.
Recently Issued Accounting Pronouncements
The Company does not expect the adoption of any recently issued accounting pronouncements to have a material impact on the Company’s financial position, operations or cash flows.
Note 2. Going Concern Uncertainty
The accompanying consolidated financial statements for 2016 and 2015 have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.
The carrying amounts of assets and liabilities presented in the consolidated financial statements do not purport to represent realizable or settlement values. As of December 31, 2016, the Company had negative working capital of approximately $20.6 million and defaulted on several of its debt obligations. The company also incurred net losses in 2016 and 2015. These conditions raise substantial doubt about the Company’s ability to continue as a going concern.
Management is continuing its efforts to attempt to secure funds through equity and/or debt instruments for our operations, expansion and possible acquisitions, mergers, joint ventures, and/or other business combinations. The Company will require additional funds to pay down its liabilities, as well as finance its expansion plans consistent with anticipated changes in operations and infrastructure. However, there can be no assurance that the Company will be able to secure additional funds and that if such funds are available, whether the terms or conditions would be acceptable to the Company and whether the Company will be able to turn into a profitable position and generate positive operating cash flow. The consolidated financial statements contain no adjustment for the outcome of this uncertainty.
Note 3. Related Party Transactions
In March 2015, pursuant to an indemnity and reimbursement agreement executed between Mr. Valdetaro and the Company, we issued 1,000,000 shares of our common stock with the Rule 144 restrictive legend to reimburse Mr. Valdetaro for 1,000,000 shares of common stock transferred to Lakeshore on the Company’s behalf in connection with an extension granted by Lakeshore in August 2013. The issuance of these shares eliminated the derivative liability associated with the value of these shares. The fair market value of these shares on the date of issuance was $38,000 and resulted in the resolution of derivative liabilities and a loss on derivative liabilities of $26,000.
In March 2015, pursuant to two indemnity and reimbursement agreements executed between Mountain Reservoir Corporation (“MRC”) and the Company, we issued a total of 2,809,983 shares of our common stock with the Rule 144 restrictive legend to reimburse MRC. Of these shares, the Company was obligated to reimburse MRC with 1,309,983 shares of common stock that had been pledged by MRC and sold by a third-party lender in 2009, 500,000 shares of common stock that had been wrongfully converted by the same lender in 2014, and 1,000,000 shares of common stock that had been transferred to another third-party lender in 2013 on the Company’s behalf for a loan made by the lender. MRC assigned its claim against the third-party lender for the lender’s wrongful conversion of 500,000 common shares to the Company and we are pursuing the claim in the third-party lender’s bankruptcy proceeding. The issuance of these shares eliminated the derivative liability associated with the value of these shares. The fair market value of these shares on the date of issuance was $112,399 of which $92,399 resulted in the resolution of derivative liabilities and a loss on derivative liabilities of $64,680 and $20,000 was recognized as stock reimbursement expense during the twelve months ended December 31, 2015.
| F-12 |
In May 2016, the Company and William Mills entered into an agreement under which the Company issued 5,000,000 shares of the Company’s common stock with the Rule 144 restrictive legend to Mr. Mills in exchange for the cancellation of $100,000 in fees owed for services rendered by Mr. Mills as a Director and Secretary of the Company. The fair market value of the shares was $100,000. Mr. Mills is a partner of Parker Mills and the Secretary and a Director of the Company.
On June 30, 2016, the Company amended an agreement (originally entered into in July 2010) with certain former and current employees of the Company, concerning the deferral of payroll claims of approximately $883,190 for salary earned from 2012 to June 30, 2016 and $1,652,113 for salary earned from 2001 to 2012, which remain unpaid and is reflected as a current liability on the Company’s consolidated financial statements.
Pursuant to the terms of the amended agreement, each current and former employee who is a party to the agreement (the “Employee(s)”) agreed to defer payment of salary from the date of the agreement (“Salary Deferral”) for a period of three months for salary earned from July 1, 2012 to June 30, 2016 and for a period of six months for salary earned from 2001 to June 30, 2012. In consideration for the Salary Deferral, the Company issued a total 3,500,000 shares of the Company’s common stock with the Rule 144 restrictive legend (at a fair market value of $78,750) and agreed to pay each Employee a sum equal to the amount of unpaid salary at December 31, 2003 plus the amount of unpaid salary at the end of any calendar year after 2003 in which such salary was earned, plus a bonus (the “Bonus”) of nine percent interest, compounded annually until such time as the unpaid salary has been paid in full. The Company and the Employees have agreed that the Bonus will be paid from amounts anticipated to be paid to the Company in respect of specified intellectual property assets of the Company.
In order to effect the payments due under this agreement, the Company assigned to the Employees a twenty percent interest in any net proceeds (gross proceeds less attorney’s fees and direct costs) derived from infringement claims and any license fees paid by a subsidiary of the Company or third party to the Company regarding (a) U.S. patent #6,826,744 and U.S. patent #7,716,629 (plus any continuation patents) on Adhesive Software’s SiteFlash™ Technology, (b) U.S. patent #7,076,521 (plus any continuation patents) in respect of “Web-Based Collaborative Data Collection System”, and (c) U.S. patent U.S. Patent No. #8,578,266 and #9,405,736 (plus any continuation patents) in respect to “Method and System for Automatically Downloading and Storing Markup Language Documents into a Folder Based Data Structure,” and (d) any license payments made (i) by a subsidiary of the Company to the Company in connection with a licensing or distribution agreement between the Company and such subsidiary or (ii) by third party to the Company in connection with a licensing or distribution agreement between the Company and a third party
Under the terms of this agreement, the Bonus is contingent on payment of unpaid wages. In addition, the Bonus is contingent upon generating revenues from the sources of the twenty percent interests in net proceeds assigned to the current and former employees. The interests that were assigned under the agreement for net proceeds consist of the underlying patents of the SiteFlash™ and Emily™ technologies and licensing under distribution and licensing agreements between the Company and subsidiaries and between the Company and third parties. Currently, there is no foreseeable income to be generated from these sources to which a twenty percent interest can reasonably be projected or otherwise applies to. There is no pending litigation regarding any of these patents. In addition, with respect to any licenses from Vertical to its subsidiaries, the licenses of technology underlying these patents were for a three percent royalty on gross revenues. If there were income, any payments under this agreement would likely be minimal. Currently, there is no income being generated from licensing. No subsidiary is currently offering a product to the market using these licensed technologies nor does Vertical have any agreement to license these technologies to a third party.
Since payment of the Bonus is contingent upon first paying all unpaid salary and there are no foreseeable revenues to pay the twenty percent interest in these technologies, it is doubtful at the present time that any Bonus will be paid and therefore the Bonus was not accrued as of December 31, 2016 as this contingent liability is considered remote. Cumulative bonus interest through December 31, 2016 is $3,816,659.
As of December 31, 2016, and 2015, the Company had accounts payable to related parties in an aggregate amount of $139,546 and $108,379, respectively.
Related Party Notes Payable
| December 31, | ||||||||
| 2016 | 2015 | |||||||
| Notes payable bearing interest at 10% to 15% per annum. Of these notes payable $208,242 and $338,243 were in default at December 31, 2016 and 2015, respectively. | $ | 208,242 | $ | 338,243 | ||||
| Convertible debenture bearing interest at 10% per annum, due one year from date of issuance. Net of unamortized discount of $20,798 for 2015. | $ | 100,000 | $ | 79,202 | ||||
| Total notes payable to related parties | 308,242 | 417,445 | ||||||
| Current maturities | (308,242 | ) | (417,445 | ) | ||||
| Long-term portion of notes payable to related parties | $ | - | $ | - | ||||
The following table reflects our related party debt activity for the years ended December 31, 2016 and 2015:
| December 31, 2014 | $ | 348,666 | ||
| Borrowings from related parties | 100,000 | |||
| Payments to related parties | (10,423 | ) | ||
| Debt discounts due to stock and warrants issued with debt | (20,798 | ) | ||
| December 31, 2015 | 417,445 | |||
| Common shares issued for debt principal | (130,000 | ) | ||
| Amortization of debt discounts due to stock and warrants issued with debt | 20,797 | |||
| December 31, 2016 | $ | 308,242 |
| F-13 |
During the year ended December 31, 2015, the Company issued a convertible debenture in the principal amount of $100,000 to Parker Mills, LLP (“Parker Mills”). The debt accrues interest at 10% per annum and is due one year from the date of issuance. Beginning six months after issuance of the debenture, the holder of the debenture may convert the debenture into shares of common stock at a price per share of 80% of the average per share price of the Company’s common stock for the 5 trading days preceding the notice of conversion date using the 3 lowest closing prices. In connection with the loan, the Company also issued a total of 1,000,000 shares of common stock of the Company to the lender and 3-year warrants under which the lender may purchase in aggregate a total of 1,000,000 unregistered shares of common stock of the Company at a purchase price of $0.10 per share. In connection with the issuance of common stock and warrants, the Company recorded a discount of $20,798 against the face value of the loans based on the relative fair market value of the common stock and warrants. William Mills is a partner of Parker Mills and the Secretary and a Director of the Company. This convertible debenture is in default. For additional details on litigation concerning this convertible note, please see “Litigation” in Note 12.
Note 4. Derivative Liabilities and Fair Value Measurements
Derivative liabilities
During the year ended December 31, 2015, the Company issued shares of our common stock pursuant to the terms of indemnity and reimbursement agreements between the Company and Mr. Valdetaro, the CTO of the Company and MRC. For additional details on these transactions, please see the transactions in March 2015 under “Common and Preferred Stock in Note 10.
These contractual commitments to replace all 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 December 31, 2016 and 2015, the aggregate fair value of the derivative liabilities was $1,014,192 and $0, respectively.
During the years ended December 31, 2016 and 2015, the Company entered into several loan agreements with third party lenders and a related party lender under which certain convertible debentures (which are convertible into shares of the Company’s common stock) and warrants to purchase shares of the Company’s common stock were issued. During the year ended December 31, 2016, the Company entered into subscription agreements with third parties to purchase shares of the Company’s Series A Preferred Stock (which are convertible the Company’s common stock) and warrants to purchase shares of the Company’s common stock. For additional details regarding these transactions, please see the 2015 and 2016 summaries for convertible debentures and subscription agreements under “Common and Preferred Stock” in Note 10.
During 2016, certain notes issued by the Company became convertible and qualified as derivative liabilities under ASC 815. In addition, the outstanding common stock warrants associated with the notes became tainted and were required to be accounted for as derivative liabilities under ASC 815.
For the year ended December 31, 2016 and 2015, the aggregate change in the fair value of derivative liabilities was a loss of $268,728 and $78,680, respectively.
The valuation of our embedded derivatives is determined by using the Black-Scholes Option Pricing Model. As such, our derivative liabilities have been classified as Level 3.
The Company estimated the fair value of the derivative liabilities using the Black-Scholes option pricing model and the following key assumptions during 2016:
| 2016 | |||
| Expected dividends | 0 | % | |
| Expected terms (years) | 0.16 – 3.04 | ||
| Volatility | 101% - 139 | % | |
| Risk-free rate | 0.36% - 161 | % |
| F-14 |
Fair value measurements
FASB ASC 820, Fair Value Measurements and Disclosures, defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. FASB ASC 820 describes three levels of inputs that may be used to measure fair value:
Level 1 – Quoted prices in active markets for identical assets or liabilities.
Level 2 – Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 – Unobservable inputs that are supported by little or no market activity and that are financial instruments whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant judgment or estimation.
If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level of input that is significant to the fair value measurement of the instrument.
The following table provides a summary of the fair value of our derivative liabilities as of December 31, 2016 and December 31, 2015:
| Fair value measurements on a recurring basis | ||||||||||||
| Level 1 | Level 2 | Level 3 | ||||||||||
| As of December 31, 2016: | ||||||||||||
| Liabilities | ||||||||||||
| Derivatives | $ | - | $ | - | $ | 1,014,192 | ||||||
| As of December 31, 2015: | ||||||||||||
| Liabilities | ||||||||||||
| Derivatives | $ | - | $ | - | $ | - | ||||||
The estimated fair value of short-term financial instruments, including cash, accounts receivable, accounts payable and accrued liabilities and deferred revenue approximates their carrying value due to their short-term nature. The estimated fair value of our long-term borrowings approximates carrying value since the related rates of interest approximate current market rates.
The below table presents the change in the fair value of the derivative liabilities during the year ended December 31, 2016:
| Fair value as of December 31, 2015 | - | |||
| Additions recognized as debt discounts | $ | 741,583 | ||
| Additions reclassified from equity | 50,557 | |||
| Additions recognized in equity financing | 4,005 | |||
| Reduction due to settlement upon conversion | (50,681 | ) | ||
| Loss on change in fair value of derivatives | 268,728 | |||
| Fair value as of December 31, 2016 | $ | 1,014,192 |
| F-15 |
Note 5. Property and Equipment
Property and equipment consist of the following as of December 31, 2016 and 2015:
| 2016 | 2015 | |||||||
| Equipment (3-5 year life) | $ | 915,280 | $ | 908,086 | ||||
| Leasehold improvements (5 year life) | 87,714 | 87,714 | ||||||
| Furniture and fixtures (3-5 year life) | 45,500 | 45,184 | ||||||
| Total | 1,048,494 | 1,040,984 | ||||||
| Accumulated depreciation | (1,043,397 | ) | (1,038,609 | ) | ||||
| $ | 5,097 | $ | 2,375 | |||||
Depreciation expense for 2016 and 2015 was $1,083 and $20,795, respectively.
Note 6. Intangible Assets
Intangible assets consisted of the following as of December 31, 2016 and 2015:
| 2016 | 2015 | |||||||
| Capitalized software development | $ | - | $ | 1,174,972 | ||||
| Acquired software (5 year life) | 304,003 | 303,902 | ||||||
| Customer list (5 year life) | 2,200 | 2,200 | ||||||
| Trademark | 5,000 | 5,000 | ||||||
| Website (5 year life) | 15,000 | 15,000 | ||||||
| Total | 326,203 | 1,501,074 | ||||||
| Accumulated amortization | (319,513 | ) | (319,413 | ) | ||||
| $ | 6,690 | $ | 1,181,661 | |||||
Amortization expense for 2016 and 2015 was $0 and $17,617, respectively.
During 2016, the Company capitalized an aggregate of $246,184 related to software development and wrote off $1,421,155 of impaired software development costs related to its Ploinks™ software application, which included the $246,184.
During 2015, the Company capitalized $541,300 of software development costs related to its Ploinks™ software application.
Note 7. Accounts Payable and Accrued Expenses
Accounts payable and accrued liabilities consist of the following:
| 2016 | 2015 | |||||||
| Accounts payable | $ | 2,613,942 | $ | 2,709,381 | ||||
| Accrued payroll | 2,734,024 | 2,703,165 | ||||||
| Accrued payroll tax and penalties | 2,309,970 | 1,928,822 | ||||||
| Accrued interest | 3,371,112 | 2,424,178 | ||||||
| Accrued taxes | 598,684 | 499,102 | ||||||
| Accrued liabilities - other | 447,566 | 272,326 | ||||||
| $ | 12,075,298 | $ | 10,536,974 | |||||
Accrued payroll primarily consists of deferred compensation for several executives who agreed to defer a portion of their salaries due to cash flow constraints. Accrued payroll tax and penalties relate to unpaid payroll taxes, interest and penalties for NOW Solutions, Inc. and for certain non-functioning subsidiaries, The Internal Revenue Service has made a claim for payroll taxes owed of approximately $1.2 million and has garnished certain receivables from U.S. customers. Accrued taxes primarily consist of U.S. sales tax, Canadian GST, Canadian income tax and U.S. income tax. Accrued liabilities – other primarily consists of accrued rent, board of director fees, unbilled professional and consulting fees, and other accrued expenses.
| F-16 |
Note 8. Notes Payable and Convertible Debts
The following table reflects our third-party debt activity, including our convertible debt, for the years ended December 31, 2016 and 2015:
| December 31, 2014 | $ | 4,575,239 | ||
| Repayments of third party notes | (132,848 | ) | ||
| Borrowings from third parties | 1,135,333 | |||
| Stock issued for debt payments | (258,552 | ) | ||
| Debt discounts due to stock and warrants issued with debt | (190,985 | ) | ||
| Amortization of debt discounts | 80,864 | |||
| Conversion of accrued interest to debt principal | 188,552 | |||
| Currency translation | (583 | ) | ||
| December 31, 2015 | 5,397,020 | |||
| Repayments of third party notes | (113,699 | ) | ||
| Borrowings from third parties | 885,000 | |||
| Conversion of convertible debt principal to common stock | (74,297 | ) | ||
| Debt discounts due to stock and warrants issued with debt | (872,196 | ) | ||
| Amortization of debt discounts | 627,542 | |||
| Attorney fees added to note principal | 3,500 | |||
| Currency translation | 275 | |||
| December 31, 2016 | $ | 5,853,145 |
During the year ended December 31, 2015, the Company and its subsidiaries borrowed an aggregate of $555,333 from various third party lenders and issued several unsecured notes payable in the same amounts to the lenders, which bear interest at 10%-12% per annum. Of these notes, $132,848 was repaid at December 31, 2015.
During the year ended December 31, 2015, the Company issued convertible promissory notes and debentures in the aggregate principal amount of $580,000 to various third party lenders for loans made to the Company in the same amount. The debts accrue interest at 10% per annum and are due one year from the date of issuance. Beginning six months after issuance of the respective debenture, the holder of the debenture may convert the debenture into shares of common stock at a price per share of either (a) 80% of the average per share price of the Company’s common stock for the 5 trading days preceding the notice of conversion date using the 3 lowest closing prices or (b) 75% of the average per share closing bid price of the Company’s common stock during the 10 trading days prior to the notice of conversion date using the lowest 5 closing bid prices per share (which shall not be lower than $0.03 per share). In connection with the loans, the Company also issued a total of 6,500,000 shares of common stock of the Company to the lenders and 3-5 year warrants under which each lender may purchase in aggregate a total of 5,800,000 unregistered shares of common stock of the Company at a purchase price of between $0.05-$0.10 per share (of which one warrant for 800,000 shares included a cashless warrant exercise provision). These warrants were issued to the lenders in connection with these loans made to the Company. In connection with the issuance of common stock and warrants, the Company recorded a discount of $161,735 against the face value of the loans based on the relative fair market value of the common stock and warrants. The discount is being amortized over twelve months and $51,614 of amortization expense was recognized for the year ended December 31, 2015.
During the year ended December 31, 2016, the Company issued convertible debentures in the aggregate principal amount of $715,000 to various third party lenders for loans made to the Company in the same amount. The debts accrue interest at 10% per annum and are due one year from the date of issuance. Beginning six months after issuance of the respective debentures and provided that the lowest closing price of the common stock for each of the 5 trading days immediately preceding the conversion date has been $0.03 or higher, the holder of the respective debenture may convert the debenture into shares of common stock at a price per share of 80% of the average per share price of the Company’s common stock for the 5 trading days preceding the notice of conversion date using the 3 lowest closing prices. In connection with the loans, the Company also issued a total of 7,150,000 shares of common stock of the Company to the lenders with the Rule 144 restrictive legend and 3 year warrants under which each lender may purchase in aggregate a total of 7,150,000 unregistered shares of common stock of the Company at a purchase price of $0.10 per share. In connection with the issuance of shares of common stock and warrants, the Company recorded a discount of $186,967 against the face value of the loans based on the relative fair market value of the common stock and full fair market value of the warrants. The warrants are accounted for as derivative liabilities. The discount is being amortized over twelve months and $105,597 of amortization expense was recognized for the year ended December 31, 2016.
| F-17 |
During the year ended December 31, 2016, $82,001 of principal, interest and fees under a convertible note were converted into 5,914,783 unrestricted common shares of the Company.
Lakeshore Financing
On January 9, 2013, NOW Solutions completed a financing transaction in the aggregate amount of $1,759,150, which amount was utilized to pay off existing indebtedness of the Company and NOW Solutions to Tara Financial Services and Robert Farias, a former employee of the Company, and all security interests granted to Tara Financial Services and Mr. Farias were cancelled.
In connection with this financing, the Company and several of its subsidiaries entered into a loan agreement (the “Loan Agreement”), dated as of January 9, 2013 with Lakeshore Investment, LLC (“Lakeshore”) under which NOW Solutions issued a secured 10-year promissory note (the “Lakeshore Note”) bearing interest at 11% per annum to Lakeshore in the amount of $1,759,150 payable in equal monthly installments of $24,232 until January 31, 2022. Upon the payment of any prepayment principal amounts, the monthly installment payments shall be proportionately adjusted proportionately on an amortized rata basis.
The Lakeshore Note is secured by the assets of the Company’s subsidiaries, NOW Solutions, Priority Time, SnAPPnet, Inc. (“SnAPPnet”) and the Company’s SiteFlash™ technology and cross-collateralized. Upon the aggregate principal payment of $290,000 toward the Lakeshore Note, the Company has the option to have Lakeshore release either the Priority Time collateral or the SiteFlash™ collateral. Upon payment of the aggregate principal of $590,000 toward the Lakeshore Note, Lakeshore shall release either the Priority Time collateral or the SiteFlash™ collateral (whichever is remaining). Upon payment of the aggregate principal of $890,000 toward the Lakeshore Note, Lakeshore shall release the SnAPPnet collateral and upon full payment of the Lakeshore Note, Lakeshore shall release the NOW Solutions collateral.
As additional consideration for the loan, the Company granted a 5% interest in Net Claim Proceeds (less any attorney’s fees and direct costs) from any litigation or settlement proceeds related to the SiteFlash™ technology to Lakeshore which was increased to 8% under an amendment to the Loan Agreement in 2013. In addition, until the Note is paid in full, NOW Solutions agreed to pay a Lakeshore royalty of 6% of its annual gross revenues in excess of $5 million dollars up to a maximum of $1,759,150. Management has estimated the fair value of the royalty to be nominal as of its issuance date and no royalty was owed as of September 30, 2015 or December 31, 2014.
In December 2014, the Company and Lakeshore entered into an amendment of the Lakeshore Note and the Loan Agreement. Under the terms of the amendment, NOW Solutions agreed to make $2,500 weekly advance payments to Lakeshore to be applied to the 25% dividend of NOW Solutions’ net income after taxes in connection with Lakeshore’s 25% minority ownership interest in NOW Solutions. Within 10 business days after the Company files its periodic reports with the SEC, NOW Solutions will also make quarterly payment advances to Lakeshore based on 60% of Lakeshore’s 25% share of NOW Solutions estimated quarterly net income after taxes, less any weekly payment advances received by Lakeshore during the then-applicable quarter and the weekly $2,500 payments shall be increased or decreased based only upon any increases or decreases of maintenance and cloud-based offering fees during the then-completed quarter (but will not decrease below a minimum of $2,500 per week). NOW Solutions shall pay Lakeshore the balance of Lakeshore’s 25% of NOW’s yearly net income after taxes (less any advances) within 10 business days after the Company files it annual 10-K report with the SEC and any payments in excess of Lakeshore’s 25% of NOW yearly profit shall be credited towards future weekly advance payments. The Company also agreed to pay attorney fees of $40,000 and paid fees of $80,000 to a former consultant and employee of the Company who is a member of Lakeshore. In consideration of the extension to cure the default under the Lakeshore Note and the Loan Agreement, the Company transferred a 20% ownership interest in two subsidiaries to Lakeshore: Priority Time Systems, Inc., and in SnAPPnet, Inc.. This resulted in an additional non-controlling interest recognized in the equity of the Company of $391,920 and $99,210 for Priority Time Systems, Inc. and SnAPPnet, Inc., respectively, during 2014. The Company had an option to buy back Lakeshore’s ownership interest in NOW Solutions, Priority Time and SnAPPnet, Inc. (which expired on January 31, 2015).
In July 2015, we entered into an agreement with Lakeshore to amend the terms of the Loan Agreement and the Lakeshore Note. Under the terms of the amendment, the Company issued 13,000,000 common shares with the Rule 144 restrictive legend, resulting in a forbearance loss of $455,000 and Ploinks agreed to issue 3,000,000 common shares of its stock to Lakeshore. The fair value of the Ploinks shares was determined to be nominal. Also in July 2015, the Company further amended the Lakeshore Note and the Loan Agreement with Lakeshore. Pursuant to this Agreement, the Company issued 2,000,000 shares of its common stock with the Rule 144 restrictive legend resulting in a forbearance loss of $54,200 and paid $15,000 to Lakeshore as forbearance fees.
| F-18 |
In August 2015, we entered into an agreement with Lakeshore to amend the terms of the Loan Agreement and the Lakeshore Note. Under the terms of the amendment, the Company issued 7,000,000 shares of its common stock with the Rule 144 restrictive legend resulting in a forbearance loss of $175,700 and Ploinks agreed to issue 2,000,000 common shares of its stock to Lakeshore. The fair value of the Ploinks shares was determined to be nominal.
Under the August 2015 agreement, the Company also agreed to make a $500,000 payment for amounts due to Lakeshore under the Lakeshore Note and the Loan Agreement. In the event that the Company did not make the Lakeshore $500,000 payment on or before August 21, 2015, then Lakeshore in lieu of the $500,000 payment, would obtain a purchase option (the “2015 Purchase Option”) to purchase an additional 250 shares of NOW Solutions common stock for a total purchase price of $950,000. In addition, since the Company did not make the $500,000 payment to Lakeshore on or before August 21, 2015, no further payment on the Note was due until January 1, 2016 at which time the Note plus all accrued interest were recalculated and the Note was re-amortized under the same interest rate and terms as the Note and the maturity date of the Note was extended 10 years from January 1, 2016.
In October 2015, Lakeshore provided notice to the Company of its intent to exercise the 2015 Purchase Option concerning the purchase of additional common shares of NOW Solutions. Lakeshore did not make the payment due by December 31, 2015 to purchase an additional ownership interest in NOW Solutions and as a consequence the 2015 Purchase Option expired.
During the year ended December 31, 2016 and 2015, the Company, through its subsidiary, paid Lakeshore $295,000 and $125,000, respectively, towards dividends owed.
The Lakeshore note is in default and the Company is currently evaluating solutions to resolve all issues with Lakeshore.
| December 31 | December 31 | |||||||
| 2016 | 2015 | |||||||
| Third Party Notes Payable | ||||||||
| Unsecured notes payable issued to third party lenders bearing interest at rates between 10% and 15% per annum and are past due their original maturity dates. Of these notes, $1,570,368 and $1,560,103 were in default or non-performing as of December 31, 2016 and 2015, respectively. | $ | 1,830,377 | $ | 1,770,103 | ||||
| Secured notes payable issued to third party lenders, bearing interest at 10% to 18% per annum. These notes are secured by stock pledges by MRC totaling 33,976,296 common shares. Of these notes $1,025,449 and $310,449 were in default or non-performing at December 31, 2016 and 2015, respectively. | 1,025,449 | 1,025,449 | ||||||
| Secured notes payable issued to third party lenders, bearing interest at 11% to 18% per annum. These notes are secured by certain technology owned by the Company, supporting its Emily product. Of these notes $470,860 were in default or non-performing at December 31, 2016 and 2015. | 470,860 | 470,860 | ||||||
| Secured note payable issued to Lakeshore, bearing interest at 11% per annum. The note is secured by all of the assets of NOW Solutions, Priority Time, and SnAPPnet, Inc. as well as the SiteFlash™ technology. This note was in default or non-performing at December 31, 2016 and 2015. | 1,627,031 | 1,630,729 | ||||||
| Total notes payable to third parties | 4,953,717 | 4,897,141 | ||||||
| Current maturities | 4,953,717 | 4,897,141 | ||||||
| Long-term portion of notes payable to third parties | $ | - | $ | - | ||||
| F-19 |
Certain notes payable also contain provisions requiring additional principal reductions in the event sales by NOW Solutions exceed certain financial thresholds or the Company receives proceeds from infringement claims regarding U.S. Patent #6,826,744, U.S. Patent #7,716,629 and U.S. Patent #8,949,780.
Third Party Convertible Promissory Notes and Debentures
Third party convertible promissory notes and debentures consist of the following:
| December 31, 2016 | December 31, 2015 | |||||||
| In December 2003, we issued a debenture in the amount of $30,000 to a third party. The debt accrues interest at 13% per annum and was due December 2005. The holder may convert the debenture into shares of common stock at 100% of the closing price. | $ | 30,000 | $ | 30,000 | ||||
| Convertible debentures to various third party lenders for loans made to the Company in the aggregate amount of $1,224,213 net of unamortized discounts of $354,785. The debts accrue interest at 10% per annum and are due one year from the date of issuance. Beginning six months after issuance of the respective debenture, the holder of the debenture may convert the debenture into shares of common stock at a price per share of either (a) 80% of the average per share price of the Company’s common stock for the 5 trading days preceding the notice of conversion date using the 3 lowest closing prices or (b) 75% of the average per share closing bid price of the Company’s common stock during the 10 trading days prior to the notice of conversion date using the lowest 5 closing bid prices per share (which shall not be lower than $0.03 per share). At December 31, 2016, $70,787 of note principal (net of attorney fees) was converted into 5,914,783 shares of the company’s common stock. | 869,428 | 469,879 | ||||||
| Total convertible debentures | 899,428 | 499,879 | ||||||
| Current maturities | (899,428 | ) | (499,879 | ) | ||||
| Long-term portion of convertible debentures | $ | - | $ | - | ||||
Future minimum payments for third party, related party, and convertible debentures for the next five years are as follows:
| Year | Amount | |||
| 2017 | $ | 6,516,172 | ||
| 2018 | - | |||
| 2019 | - | |||
| 2020 | - | |||
| 2021+ | - | |||
| Total notes payable | 6,516,172 | |||
| Unamortized discounts | (354,785 | ) | ||
| Notes payable, net of discounts | $ | 6,161,387 | ||
For additional transactions involving notes payable after December 31, 2016, please see “Subsequent Events” in Note 12.
| F-20 |
Note 9. Income Taxes
We account for income taxes using the asset and liability method of accounting for income taxes. Deferred income taxes are recognized for the tax consequences of “temporary differences” by applying enacted statutory tax rate applicable to future years to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities and result primarily form differences in methods used to amortize intangible assets. A valuation allowance is provided when management cannot determine whether it is more likely than not that the deferred tax asset will be realized. The effect on deferred income taxes of the change in tax rates is recognized in income in the period that includes the enactment date. The difference between the statutory tax rate and the effective tax rate is the valuation allowance.
The provision of income taxes consists of the following for the years ended December 31, 2016 and 2015:
| Years Ended December 31, | ||||||||
| 2016 | 2015 | |||||||
| Current | ||||||||
| Federal | 73,016 | - | ||||||
| State | - | - | ||||||
| Foreign | 13,362 | (571,980 | ) | |||||
| 86,378 | (571,980 | ) | ||||||
During 2016, the Company recorded an income tax provision of $86,378 related to income taxes for NOW Solutions, a 75% owned subsidiary of the Company. During 2015, the Company recorded an income tax benefit of $571,980 related to the settlement of previously recorded income taxes for the NOW Solutions in Canada.
Temporary difference between the financial statement carrying amount and tax bases of assets and liabilities that give rise to deferred tax assets relate to the following:
| December 31, 2016 | December 31, 2015 | |||||||
| Net operating loss carry-forward | $ | 10,255,000 | $ | 8,331,000 | ||||
| Reserves | 512,000 | 537,000 | ||||||
| Accrued vacation | 38,000 | 37,000 | ||||||
| Deferred compensation | 892,000 | 882,000 | ||||||
| Deferred revenue | 610,000 | - | ||||||
| 12,307,000 | 9,787,000 | |||||||
| Valuation allowance | (12,307,000 | ) | (9,787,000 | ) | ||||
| $ | - | $ | - | |||||
At December 31, 2016 and December 31, 2015, VCSY had available net operating loss carry-forwards of approximately $20.6 million and $24.0 million, respectively. At December 31, 2016 and 2015, NOW Solutions had available net operating loss carry-forwards of approximately $281,000. These net operating loss carry-forwards expire in varying amounts through 2031.
The benefit for income taxes differs from the amount computed by applying the U.S. federal income tax rate of 34% to loss before income taxes as follows for the years ended December 31, 2016 and 2015:
| 2016 | 2015 | |||||||
| U.S. federal income tax expense at statutory rates | (1,852,199 | ) | (1,113,702 | ) | ||||
| Permanent differences | 5,719 | 553,709 | ||||||
| Settlement of foreign income tax | - | (581,622 | ) | |||||
| Foreign income tax expense | 13,362 | 9,642 | ||||||
| Change in valuation allowance | 1,919,496 | 559,993 | ||||||
| 86,378 | (571,980 | ) | ||||||
| F-21 |
During 2015, Canada Revenue Agency began garnishing NOW Solutions Canada customer receivables in order to pay down debts owed to them for income tax and goods and services tax (“GST”). The customer accounts receivable payments were applied directly to the taxes owed. As of December 31, 2016, all garnishments were removed and debts have been paid.
Open tax years for U.S. federal income taxes for VCSY are 2012, 2013, 2014, 2015 and 2016. Open tax years for U.S. federal income taxes for NOW Solutions are 2013, 2014, 2015 and 2016.
Note 10. Common and Preferred Stock
Terms of Common and Preferred Stock
Common Stock. The authorized capital stock of the Company consists of 2,000,000,000 shares of common stock, par value $0.00001 per share, of which 1,167,841,439 were issued and 1,127,841,439 were outstanding at December 31, 2016 and 1,114,601,656 were issued and 1,084,601,656 were outstanding at December 31, 2015. Each share of our common stock entitles the holder to one vote on each matter submitted to a vote of our stockholders, including the election of directors. There is no cumulative voting and there are no redemption or sinking fund provisions related to the common stock. Stockholders of our common stock have no preemptive, conversion or other subscription rights.
Series A Cumulative Convertible Preferred Stock. We have authorized the issuance of 250,000 shares of Series A 4% Cumulative Convertible Preferred Stock (“Series A Preferred Stock”), of which there are 51,500 shares issued and outstanding at December 31, 2016 and 48,500 shares issued and outstanding at December 31, 2015. Holders of these shares of Series A Preferred Stock are entitled to vote on an as-converted basis with the holders of common stock, except that the holders are entitled to vote as a separate class on any matters affecting the Series A Preferred Stock stockholders, on the sale of the business, the increase in the number of directors, the payment of a dividend on any junior stock, and the issuance of any stock that is on parity or senior to the Series A Preferred Stock. Each share of Series A Preferred Stock is entitled to 500 votes per share. Dividends accrue at an annual rate of 4% of the liquidation preference and are payable quarterly subject to the board’s discretion. Each share of Series A Preferred Stock is convertible into 500 shares of common stock of the Company. In the event of liquidation, each share of Series A Preferred Stock will be entitled to a preference of $200, plus accrued but unpaid dividends, prior to the holders of any junior class of stock.
Series B 10% Cumulative Convertible Preferred Stock. We have authorized the issuance of 375,000 shares of Series B 10% Cumulative Convertible Redeemable Preferred Stock (“Series B Preferred Stock”), of which there are 7,200 shares outstanding at December 31, 2016 and December 31, 2015. Holders of Series B Preferred Stock are not entitled to vote on matters presented to the stockholders, except as otherwise required by law. Cash or stock dividends accrue cumulatively at an annual rate of 10% per annum on March 15 and September 15 of each year and are payable subject to the board’s discretion. Each share of Series B Preferred Stock is convertible into 3.788 shares of common stock of the Company. The shares of Series B Preferred Stock are redeemable at a rate of $6.25 per share, or $45,000 if all outstanding shares are redeemed. In the event of liquidation, each share will be entitled to a preference of all dividends accrued and unpaid on each share up to the date fixed for distribution to any holders of any class of common stock.
Series C 4% Cumulative Convertible Preferred Stock. We have authorized the issuance of 200,000 shares of Series C 4% Cumulative Convertible Preferred Stock (“Series C Preferred Stock”), of which there are 50,000 shares outstanding at December 31, 2016 and December 31, 2015. Holders of Series C Preferred Stock are not entitled to vote on matters presented to the stockholders, except as otherwise required by law. Cash dividends accrue at an annual rate of 4% of the liquidation preference and are payable quarterly subject to the board’s discretion. Each share of Series C Preferred Stock is convertible into 400 shares of common stock of the Company; however, of the 50,000 shares of the Company’s Series “C” Cumulative Convertible Preferred Stock that are outstanding, the holder of 37,500 shares waived the conversion rights associated with these shares pursuant to an agreement in 2010. In the event of liquidation, each share will be entitled to a preference of all dividends accrued and unpaid on each share up to the date fixed for distribution to any holder of any class of common stock. In the event of liquidation, each share of Series C Preferred Stock will be entitled to a preference of $100, plus accrued but unpaid dividends, prior to the holders of any junior class of stock.
Series D 15% Cumulative Convertible Preferred Stock. We have authorized the issuance of 300,000 shares of Series D 15% Cumulative Convertible Redeemable Preferred Stock (“Series D Preferred Stock”), of which there were 25,000 shares outstanding at December 31, 2016 and December 31, 2015. Holders of these shares are not entitled to vote on matters presented to the stockholders, except as otherwise required by law. Cash dividends accrue cumulatively at an annual rate of 15% per annum on March 15 and September 15 of each year and are payable subject to the board’s discretion. Any aggregate deficiency shall be cumulative and shall be fully paid or set apart for payment before any dividend shall be paid or set apart for payment of any class of common stock. Each share of Series D Preferred Stock is convertible into 3.788 shares of common stock of the Company. The shares of Series D Preferred Stock are redeemable at a rate of $6.25 per share, or $156,250 if all outstanding shares are redeemed. In the event of liquidation, each share will be entitled to a preference of all dividends accrued and unpaid on each share up to the date fixed for distribution to any holders of any class of common stock.
| F-22 |
2016
Common Stock
In March 2016, the Company cancelled 1,000,000 unregistered shares of its common stock issued during 2015 to a third party lender under an agreement to amend certain promissory notes issued by the Company and NOW Solutions in the aggregate principal amount of $715,000. Under the amendment, the Company agreed to make $22,000 monthly payments and an additional $10,000 penalty if such monthly payment is not timely made.
In March 2016, the Company issued 10,000,000 shares of the Company’s common stock with the Rule 144 restrictive legend to its consolidated subsidiary Ploinks, Inc. These shares are held in treasury. In exchange, Ploinks, Inc. issued 5,000,000 of its common shares to the Company.
In April 2016, the Company and a third-party noteholder entered into an agreement under which the Company issued 5,000,000 shares of the Company’s common stock with the Rule 144 restrictive legend in exchange for the cancellation of $130,000 in principal owed under a note payable issued by NOW Solutions with a principal amount of $213,139. The fair market value of the shares was $92,500. A gain on debt extinguishment of $37,500 was recorded for the year ended December 31, 2016.
In May 2016, the Company and William Mills entered into an agreement under which the Company issued 5,000,000 shares of the Company’s common stock with the Rule 144 restrictive legend to Mr. Mills in exchange for the cancellation of $100,000 in fees owed for services rendered by Mr. Mills as a Director and Secretary of the Company. The fair market value of the shares was $100,000. Mr. Mills is a partner of Parker Mills and the Secretary and a Director of the Company.
In May 2016, the Company and a third party entered into an agreement under which the Company issued 1,500,000 shares of the Company’s common stock with the Rule 144 restrictive legend to the third party in lieu of paying $35,969 in fees, expenses, and interest owed to the third party for services rendered to the Company and its subsidiaries. The fair market value of the shares issued was $37,500. A loss on debt extinguishment of $1,531 was recorded for the year ended December 31, 2016.
In June 2016, the Company granted 3,500,000 unregistered shares of the Company’s common stock with the Rule 144 restrictive legend to employees and a former employee of the Company and its subsidiaries pursuant to an amended agreement to defer payroll. For additional details, please see “Related Party Transactions” in Note 3. The fair market value of the shares was $78,750.
During the year ended December 31, 2016, the Company issued 3,000,000 shares of the Company’s common stock with the Rule 144 restrictive legend to another third party for services rendered. The fair market value of the shares was $66,550 and was recorded as tax consulting fees for the year ended December 31, 2016.
During the year ended December 31, 2016, the Company issued convertible debentures in the aggregate principal amount of $715,000 to various third party lenders for loans made to the Company in the same amount. The debts accrue interest at 10% per annum and are due one year from the date of issuance. Beginning six months after issuance of the respective debentures and provided that the lowest closing price of the common stock for each of the 5 trading days immediately preceding the conversion date has been $0.03 or higher, the holder of the respective debenture may convert the debenture into shares of common stock at a price per share of 80% of the average per share price of the Company’s common stock for the 5 trading days preceding the notice of conversion date using the 3 lowest closing prices. In connection with the loans, the Company also issued a total of 7,150,000 shares of common stock of the Company to the lenders with the Rule 144 restrictive legend and 3 year warrants under which each lender may purchase in aggregate a total of 7,150,000 unregistered shares of common stock of the Company at a purchase price of $0.10 per share. In connection with the issuance of shares of common stock and warrants, the Company recorded a discount of $186,967 against the face value of the loans based on the relative fair market value of the common stock of $114,413 and the full fair market value of the warrants of $72,554. The warrants are accounted for as derivative liabilities. The discount is being amortized over twelve months and amortization expense was recognized for the year ended December 31, 2016.
| F-23 |
During the year ended December 31, 2016, $82,001 of principal, interest and fees under a convertible note issued in the principal amount of $80,000 were converted into 5,914,783 unrestricted common shares of the Company.
During the year ended December 31, 2016, the Company entered into subscription agreements under which third party subscribers purchased 3,000 shares of VCSY Series A Preferred Stock for $600,000. In connection with the purchase of the VCSY Series A Preferred Stock, the subscribers also received a total of 6,000,000 shares of common stock of the Company with the Rule 144 restrictive legend, 300,000 shares of common stock of Ploinks, Inc., 2-year warrants under which the subscribers may purchase an aggregate total of 450,000 unregistered shares of common stock of the Company at a purchase price of $0.10 per share and 2-year warrants under which the subscribers may purchase an aggregate total of 450,000 unregistered shares of common stock of the Company at a purchase price of $0.20 per share. The allocated fair market value of the VCSY Series A Preferred Stock issued to the subscribers was $366,499. Each share of VCSY Series A Preferred Stock is convertible into 500 shares of the Company’s common stock. The allocated fair market value of all common shares of the Company issued to the subscribers was $229,496. The allocated fair market value of all common shares of Ploinks, Inc. issued to the subscribers was $3,416. The fair market value of all warrants issued to the subscribers was $4,005 (which was calculated using the Black-Sholes model). The warrants were accounted for as derivative liabilities (see Note 4).
During the year ended December 31, 2016, the Company cancelled 200,000 previously awarded but unvested unregistered shares of the Company’s common stock issued to an employee of the Company when the employee resigned. This resulted in the reversal of previously recognized compensation expense of $1,145 during the year ended December 31, 2016.
During the year ended December 31, 2016, the Company granted 18,250,000 unregistered shares of its common stock pursuant to restricted stock agreements. Shares under restricted stock agreements typically vest over a period of 1-3 years in various installments and the fair value of the awards is being expensed over the vesting periods. The aggregate fair market value of the awards was determined to be $361,365. Stock compensation expense of $229,223 has been recorded for the year ended December 31, 2016 as additional paid-in capital.
Stock compensation expense for the amortization of restricted stock awards for VCSY stock was $229,223 for the year ended December 31, 2016. As of December 31, 2016, there were 13,125,000 shares of unvested VCSY common stock compensation awards to employees and consultants.
During the year ended December 31, 2016, 7,175,000 VCSY common shares issued under restricted stock agreements to employees of the Company were vested.
During the year ended December 31, 2016, the Company granted 150,000 shares of the common stock of Ploinks, Inc. to third party lenders in connection with 6-month extensions of convertible debentures in the principal amount of $500,000 issued in 2015. The aggregate fair market value of the awards was determined to be $16,200 and was recorded as debt discount, and amortized through the term of the note.
During the year ended December 31, 2016, Ploinks, Inc. granted 1,000,000 unregistered shares of the common stock of Ploinks, Inc. to an employee of the Company pursuant to a restricted stock agreement with Ploinks, Inc. These shares typically vest over 3 years in various installments and the fair value of the awards is being expensed over this vesting period. The aggregate fair market value of the awards was determined to be $108,000. Stock compensation expense of $70,800 has been recorded for the year ended December 31, 2016.
During the year ended December 31, 2016, the Company granted 4,286,000 unregistered shares of the common stock of Ploinks, Inc. to employees and consultants of the Company and its subsidiaries pursuant to restricted stock agreements with the Company. These shares typically vest over 3 years in various installments and the fair value of the awards is being expensed over this vesting period. The aggregate fair market value of the awards was determined to be $462,888. Stock compensation expense of $264,227 has been recorded for the year ended December 31, 2016. These shares were issued out of shares owned by VCSY.
During the year ended December 31, 2016, 2,332,001 unregistered shares of the common stock of Ploinks, Inc. to employees and consultants of the Company and its subsidiaries granted under restricted stock agreement vested.
During the year ended December 31, 2016, 133,334 unregistered shares of the common stock of Ploinks, Inc. granted to an employee of the Company under a restricted stock agreement were cancelled.
| F-24 |
Preferred Stock
For the year ended December 31, 2016, total dividends applicable to Series A and Series C Preferred Stock was $592,472. The Company did not declare or pay any dividends in 2016. Although no dividends have been declared, the cumulative total of preferred stock dividends due to these stockholders upon declaration was $9,488,184 as of December 31, 2016.
2015
Common Stock
In February 2015, the Company increased the number of its authorized shares of common stock to 2,000,000,000.
In March 2015, in connection with a $100,000 loan to Taladin, Ploinks, Inc. agreed to issue 1,000,000 shares of its common stock to the third-party lender. The fair value of these subsidiary shares was determined to be nominal.
In March 2015, pursuant to an indemnity and reimbursement agreement executed between Mr. Valdetaro and the Company, we issued 1,000,000 shares of our common stock to reimburse Mr. Valdetaro for 1,000,000 shares of common stock with the Rule 144 restrictive legend transferred to Lakeshore on the Company’s behalf in connection with an extension granted by Lakeshore in August 2013. The issuance of these shares eliminated the derivative liability associated with the value of these shares. The fair market value of these shares on the date of issuance was $38,000 and resulted in the resolution of derivative liabilities and a loss on derivative liabilities of $26,000.
In March 2015, pursuant to two indemnity and reimbursement agreements executed between Mountain Reservoir Corporation (“MRC”) and the Company, we issued a total of 2,809,983 shares of our common stock with the Rule 144 restrictive legend to reimburse MRC. Of these shares, the Company was obligated to reimburse MRC with 1,309,983 shares of common stock that had been pledged by MRC and sold by a third-party lender in 2009, 500,000 shares of common stock that had been wrongfully converted by the same lender in 2014, and 1,000,000 shares of common stock that had been transferred to another third-party lender in 2013 on the Company’s behalf for a loan made by the lender. MRC has assigned its claim against the third-party lender for the lender’s wrongful conversion of 500,000 common shares to the Company and we are pursuing the claim in the third-party lender’s bankruptcy proceeding. The issuance of these shares eliminated the derivative liability associated with the value of these shares. The fair market value of these shares on the date of issuance was $112,399 of which $92,399 resulted in the resolution of derivative liabilities and a loss on derivative liabilities of $64,680 and $20,000 was recognized as stock reimbursement expense during the twelve months ended December 31, 2015.
In June 2015, in connection with an amendment concerning certain promissory notes issued by the Company and NOW Solutions to Mr. Weber in the aggregate principal amount of $735,400, the Company issued 20,000,000 shares of its common stock with the Rule 144 restrictive legend to its subsidiary, Taladin, Inc., which pledged these shares to secure payment of certain notes payable issued to Weber. The previous pledge agreements between MRC and Mr. Weber were cancelled. These shares are held in treasury.
In June 2015, the Company issued 10,000,000 common shares with the Rule 144 restrictive legend to its consolidated subsidiary NOW Solutions. These shares are held in treasury.
During the year ended December 31, 2015, the Company granted 2,250,000 unregistered shares of its common stock to employees of the Company and its subsidiaries pursuant to restricted stock agreements with the Company. These shares typically vest over 3 years in equal installments and the fair value of the awards is being expensed over this vesting period. The aggregate fair market value of the awards was determined to be $54,750. Stock compensation expense of $19,616 has been recorded for the year ended December 31, 2015 as additional paid-in capital.
During the year ended December 31, 2015, the Company issued 36,500,000 unregistered shares of its common stock as forbearance fees and late fees to lenders in connection with loans made to the Company and its subsidiaries. The aggregate fair value of these shares was determined to be $1,050,900.
During the year ended December 31, 2015, the Company issued 35,556,522 unregistered shares of its common stock to lenders to pay off accrued principal and interest debt in the aggregate amount of $482,612 related to loan principal and interest made by these lenders to the Company and its subsidiaries and $20,000 related to attorney fees. The aggregate fair value of these shares was determined to be $895,913. Accordingly, the Company recorded a loss on debt extinguishment of $393,301.
| F-25 |
As of December 31, 2015, there were 2,250,000 unvested stock compensation awards
During the year ended December 31, 2015, the Company issued 9,000,000 unregistered shares of its common stock and 3-5 year warrants to purchase 6,800,000 shares of common stock at a purchase price between $0.05-$0.10 per share (of which one warrant for 800,000 shares included a cashless warrant exercise provision). These shares and warrants were granted to lenders in connection with loans made by these lenders to the Company and its subsidiaries in the aggregate principal amount of $745,333. The aggregate relative fair value of these shares was determined to be $211,783 (which includes $82,904 under the Black-Scholes formula), and was accounted for as a discount on the loans. Amortization expense is $80,864 during the year ended December 31, 2015 and unamortized discounts are $130,919.
During the year ended December 31, 2015, Ploinks, Inc. granted 800,000 unregistered shares of the common stock of Ploinks, Inc. to employees of the Company pursuant to restricted stock agreements with Ploinks, Inc. These shares typically vest over 3 years in various installments.
Preferred Stock
For the year ended December 31, 2015, total dividends applicable to Series A and Series C Preferred Stock was $588,000. The Company did not declare or pay any dividends in 2015. Although no dividends have been declared, the cumulative total of preferred stock dividends due to these stockholders upon declaration was $8,895,712 as of December 31, 2015.
Note 11. Option and Warrant Activity
Option and warrant activity years ended December 31, 2016 and 2015 is summarized as follows:
| Incentive Stock Options | Non-Statutory Stock Options | Warrants | Weighted Average Exercise Price | |||||||||||||
| Outstanding at December 31, 2014 | - | - | - | - | ||||||||||||
| Options/Warrants granted | - | - | 6,800,000 | $ | 0.091 | |||||||||||
| Options/Warrants exercised | - | - | - | - | ||||||||||||
| Options/Warrants expired/cancelled | - | - | - | - | ||||||||||||
| Outstanding at December 31, 2015 | - | - | 6,800,000 | $ | 0.091 | |||||||||||
| Options/Warrants granted | - | - | 8,050,000 | $ | 0.106 | |||||||||||
| Options/Warrants exercised | - | - | - | - | ||||||||||||
| Options/Warrants expired/cancelled | - | - | - | - | ||||||||||||
| Outstanding at December 31, 2016 | - | - | 14,850,000 | $ | 0.100 | |||||||||||
The weighted average remaining life of the outstanding warrants as of December 31, 2016 and 2015 was 2.48 and 2.73, respectively. The intrinsic value of the exercisable warrants as of December 31, 2016 and 2015 was $.0220 and $.0220.
Note 12. Commitments and Contingencies
Commitments
We lease various office spaces which leases run from July 2016 through September 2018. We have future minimum rental payments as follows:
| F-26 |
| Years ending December 31, | Amount | |||
| 2017 | 82,649 | |||
| 2018 | 61,027 | |||
| 2019 | - | |||
| 2020 | - | |||
| 2021 | - | |||
| Total | $ | 143,676 | ||
Rental expense for the years ended December 31, 2016 and 2015 was $106,208 and $97,917, respectively.
Contingencies
On June 30, 2016, the Company amended an agreement (originally entered into in July 2010) with certain former and current employees of the Company, concerning the deferral of payroll claims of approximately $883,190 for salary earned from 2012 to June 30, 2016 and $1,652,113 for salary earned from 2001 to 2012, which remain unpaid and is reflected as a current liability on the Company’s consolidated financial statement.
Pursuant to the terms of the amended agreement, each current and former employee who is a party to the agreement (the “Employee(s)”) agreed to defer payment of salary from the date of the agreement (“Salary Deferral”) for a period of three months for salary earned from July 1, 2012 to June 30, 2016 and for a period of six months for salary earned from 2001 to June 30, 2012. In consideration for the Salary Deferral, the Company issued a total 3,500,000 shares of the Company’s common stock with the Rule 144 restrictive legend (at a fair market value of $78,750) and agreed to pay each Employee a sum equal to the amount of unpaid salary at December 31, 2003 plus the amount of unpaid salary at the end of any calendar year after 2003 in which such salary was earned, plus a Bonus of nine percent interest, compounded annually until such time as the unpaid salary has been paid in full. The Company and the Employees have agreed that the Bonus will be paid from amounts anticipated to be paid to the Company in respect of specified intellectual property assets of the Company.
In order to effect the payments due under this agreement, the Company assigned to the Employees a twenty percent interest in any net proceeds (gross proceeds less attorney’s fees and direct costs) derived from infringement claims and any license fees paid by a subsidiary of the Company or third party to the Company regarding (a) U.S. patent #6,826,744 and U.S. patent #7,716,629 (plus any continuation patents) on Adhesive Software’s SiteFlash™ Technology, (b) U.S. patent #7,076,521 (plus any continuation patents) in respect of “Web-Based Collaborative Data Collection System”, and (c) U.S. patent U.S. Patent No. #8,578,266 and #9,405,736 (plus any continuation patents) in respect to “Method and System for Automatically Downloading and Storing Markup Language Documents into a Folder Based Data Structure,” and (d) any license payments made (i) by a subsidiary of the Company to the Company in connection with a licensing or distribution agreement between the Company and such subsidiary or (ii) by third party to the Company in connection with a licensing or distribution agreement between the Company and a third party.
Under the terms of this agreement, the Bonus is contingent on payment of unpaid wages. In addition, the Bonus is contingent upon generating revenues from the sources of the twenty percent interests in net proceeds assigned to the current and former employees. The interests that were assigned under the agreement for net proceeds consist of the underlying patents of the SiteFlash™ and Emily™ technologies and licensing under distribution and licensing agreements between the Company and subsidiaries and between the Company and third parties. Currently, there is no foreseeable income to be generated from these sources to which a twenty percent interest can reasonably be projected or otherwise applies to. There is no pending litigation regarding any of these patents. In addition, with respect to any licenses from Vertical to its subsidiaries, the licenses of technology underlying these patents were for a three percent royalty on gross revenues. If there were income, any payments under this agreement would likely be minimal. Currently, there is no income being generated from licensing. No subsidiary is currently offering a product to the market using these licensed technologies nor does Vertical have any agreement to license these technologies to a third party.
Since payment of the Bonus is contingent upon first paying all unpaid salary and there are no foreseeable revenues to pay the twenty percent interest in these technologies, it is doubtful at the present time that any Bonus will be paid and therefore the Bonus was not accrued as of December 31, 2016 as this contingent liability is considered remote. Cumulative bonus interest through December 31, 2016 is $3,816,659.
Royalties
When we acquire rights to patents, licenses, or other intellectual property, we generally agree to pay royalties on any net sales of any products utilizing these rights. There were no sales of products requiring royalties in 2016 and 2015.
We also have royalty agreements associated with certain notes payable that provide a royalty when revenues exceed certain thresholds in addition to royalty agreements on subsidiary revenues pursuant to the terms of an acquisition agreement. For the years ended December 31, 2016 and 2015, we accrued royalties of $7,405 and $9,659, respectively, on revenues from subsidiaries.
Litigation
We are involved in the following ongoing legal matters:
On December 31, 2011, the Company and InfiniTek corporation (“InfiniTek”) entered into a settlement agreement to dismiss an action filed by the Company against InfiniTek in the Texas State District Court in Fort Worth, Texas, for breach of contract and other claims, a counter claim filed by InfiniTek against the Company for non-payment of amounts claimed the Company owed to InfiniTek, and an action filed by InfiniTek against the Company in California Superior Court in Riverside, California seeking damages for breach of contract and lost profit. Pursuant to the terms of the settlement agreement, Vertical agreed to pay InfiniTek $82,500 in three equal installments with the last payment due by or before August 5, 2012. Upon full payment, InfiniTek shall transfer and assign ownership of the NAVPath software developed by InfiniTek for use with NOW Solutions emPath® software application and Microsoft Dynamics NAV (formerly Navision) business solution platform. The amounts in dispute were included in our accounts payable and accrued liabilities and have been adjusted to the settlement amount of $82,500 at December 31, 2011. The Company has made $37,500 in payments due under the settlement agreement as of the date of this Report and each party is alleging the other party is in breach of the settlement agreement. We intend to resolve all disputes with InfiniTek.
On February 13, 2017, the Company was served with a complaint filed by Parker Mills in the Superior Court of the State of California, County of Los Angeles, Central District, for failure to make payment on the outstanding balance due under a $100,000 convertible debenture issued by the Company to Parker Mills. The plaintiff seeks payment of the principal balance due under the convertible debenture of $100,000, interest at the rate of 12% per annum, attorney’s fees and court costs. We intend to resolve this matter with Parker Mills. This case is styled Parker Mills, LLP v. Vertical Computer Systems, Inc., No. BC649122. William Mills is a partner of Parker Mills and the Secretary and a Director of the Company.
On April 12, 2017, NOW Solutions, Inc. was served with a Notice of Motion for Summary Judgment in Lieu of Complaint, which was filed by Derek Wolman in the Supreme Court of the State of New York in County of New York for failure to make outstanding payments on the outstanding balance due under one promissory note in the principal amount of $150,000 (issued on November 17, 2009) and one promissory note in the principal amount of $50,000 (issued on August 28, 2014), both of which were issued by NOW Solutions to Mr. Wolman. The plaintiff seeks a judgment totaling $282,299 (which includes principal and accrued interest), plus additional accrued interest from the date the complaint was filed, attorney’s fees and expenses. We intend to resolve this matter with Mr. Wolman. This case is styled Derek Wolman v. Now Solutions, Inc., No. 65/502/17.
Note 13. Subsequent Events
From January 1, 2017 to April 24, 2017, the Company granted 3,000,000 VCSY common shares pursuant to a stock award to an employee of the Company and its subsidiaries.
From January 1, 2017 to April 24, 2017, $10,000 of principal and interest under a convertible note issued in the principal amount of $80,000 was converted into 723,089 common shares.
From January 1, 2017 to April 24, 2017, 550,000 VCSY common shares issued under restricted stock agreements to employees and a consultant of the Company vested.
From January 1, 2017 to April 24, 2017, 200,001 shares of the common stock of Ploinks, Inc. issued under restricted stock agreements to consultants and employees of the Company vested.
| F-27 |