Attached files
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EX-4.5 - VERTICAL COMPUTER SYSTEMS INC | v180929_ex4-5.htm |
EX-31.2 - VERTICAL COMPUTER SYSTEMS INC | v180929_ex31-2.htm |
EX-32.1 - VERTICAL COMPUTER SYSTEMS INC | v180929_ex32-1.htm |
EX-32.2 - VERTICAL COMPUTER SYSTEMS INC | v180929_ex32-2.htm |
EX-31.1 - VERTICAL COMPUTER SYSTEMS INC | v180929_ex31-1.htm |
EX-21.1 - VERTICAL COMPUTER SYSTEMS INC | v180929_ex21-1.htm |
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, 2009
¨ 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 Small Business Issuer 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¨ Nox
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¨ Nox
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. Yesx 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 files. Yes¨ No¨
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§ 229.405 of this chapter) is not contained in this form, and
will not be contained, to the best of the registrant’s knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or amendment to this Form 10-K. Yesx 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. (Check one):
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¨ Nox
Issuer’s
revenues for fiscal year ended December 31,
2009: $5,399,812
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 June 30,
2009: $17,460,666.
As of
April 14, 2010, the issuer had 998,935,151 shares of common stock, par value
$.00001, issued and outstanding.
Documents
incorporated by reference: None
VERTICAL
COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
FORM
10-K
FOR
THE FISCAL YEAR ENDED DECEMBER 31, 2009
TABLE OF
CONTENTS
PART
I
|
2
|
Item
1. Business
|
2
|
Item
1A. Risk Factors
|
10
|
Item
2. Properties
|
13
|
Item
3. Legal Proceedings
|
13
|
item
4. Reserved
|
|
PART
II
|
15
|
Item
5. Market For Registrant’s Common Equity, Related Stockholder
Matters, and Issuer Purchases of Equity Securities
|
15
|
Item
6. Selected Financial Data
|
|
Item
7. Management’s Discussion and Analysis of Financial Condition
and Results of Operations
|
17
|
Item
7A. Quantitative and Qualitative Disclosures About Market
Risk
|
25
|
Item
8. Financial Statements and Supplementary Data
|
25
|
Item
9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
|
25
|
Item
9A (T). Controls and Procedures
|
25
|
Item
9B. Other Information
|
27
|
PART
III
|
28
|
Item
10. Directors, Executive Officers and Corporate Governance
|
28
|
Item
11. Executive Compensation
|
31
|
Item
12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
|
33
|
Item
13. Certain Relationships and Related Transactions, and Director
Independence
|
34
|
Item
14. Principal Accountant Fees and Services
|
36
|
PART
IV
|
37
|
Item
15. Exhibits And Financial Statement Schedules
|
37
|
SIGNATURES
|
40
|
CONSOLIDATED
FINANCIAL STATEMENTS
|
||
Exhibit 31.1
|
Section
302 Certification by Chief Executive Officer
|
|
Exhibit 31.2
|
Section
302 Certification by Chief Financial Officer
|
|
Exhibit 32.1
|
Section
906 Certification by Chief Executive Officer
|
|
Exhibit 32.2
|
Section
906 Certification by Chief Financial Officer
|
1
PART
I
Item
1. Business
Forward-Looking Statements and
Associated
Risks. This Report contains forward-looking statements. Such
forward-looking statements include statements regarding, among other things, (a)
our projected sales and profitability, (b) our growth strategies, (c)
anticipated trends in our industry, (d) our future financing plans, (e) our
anticipated needs for working capital, and (f) the benefits related to ownership
of our common stock. Forward-looking statements, which involve
assumptions and describe our future plans, strategies, and expectations, are
generally identifiable by use of the words “may,” “will,” “should,” “expect,” “anticipate,” “estimate,” “believe,” “intend,” or “project” or the negative
of these words or other variations on these words or comparable
terminology. This information may involve known and unknown risks,
uncertainties, and other factors that may cause our actual results, performance,
or achievements to be materially different from the future results, performance,
or achievements expressed or implied by any forward-looking statements. These
statements may be found under “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” and “Business,” as well as in
this Report generally. Actual events or results may differ materially
from those discussed in forward-looking statements as a result of various
factors, including, without limitation, the risks outlined under “Risk Factors” and matters
described in this Report generally. In light of these risks and
uncertainties, there can be no assurance that the forward-looking statements
contained in this Report will in fact occur as projected.
Background
Vertical
Computer Systems, Inc. (“Vertical”, 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”).
We
presently market several software products, including the following: HRMS
emPath® 6.4 (“emPath®”) and
ResponseFlash™. In addition, we are finalizing the development of a
point-of-sale software solution known as “PASS”, a time and
attendance software by our subsidiary Priority Times Systems, Inc. (“PTS”), and an FLSA
(Fair Labor Standards Act) payroll software based upon emPath® geared to meeting
requirements for city, county fire , sheriffs and police departments that will
be distributed by our subsidiary Taladin, Inc. (“Taladin”). For
a description of these products, please see the section entitled “Software
Services” under “Business Overview”. We are actively pursuing the
licensing of our intellectual properties, including SiteFlash™, the Emily® XML
Broker and the Emily® XML Enabler Agent.
NOW
Solutions, Inc. (“NOW
Solutions”), a wholly owned subsidiary of the Company, is selling emPath®
in the United States and Canadian markets both as a software solution as well as
a new Software-as-a-Service (“SaaS”)
offering. For a description of our new delivery model for emPath®,
please see the section entitled “Software Services” under “Business
Overview”.
Business
Overview
We are a
multi-national provider of Internet core technologies, administrative software,
and software services through our distribution network with operations or sales
in the United States, Canada and Brazil. Our primary Internet core technologies
include SiteFlash™, ResponseFlash™, Emily® XML Enabler Agent, Emily® XML Broker,
which can be an alternative to Web services, and the Emily® XML Scripting
Language, which can be used to build Web services. Our 6718103 patent
(transmission of images over a single filament of fiber optic cable (fiber optic
patent)) is in OptVision Research, Inc. (“OptVision Research”).
Our main administrative software product, emPath®, which is designed to handle
complex Payroll and Human Resources challenges, is marketed by NOW
Solutions. We have other administrative software in various stages of
developments which will be marketed through different Company subsidiaries
including PTS, Vertical Healthcare Solutions, Inc. (“VHS”), Taladin, and
Government Internet Systems Inc. (“GIS”).
In 2009,
we acquired rights from Emerald Software Group (“Emerald”) to market
AllegroHR onboarding and offboarding software solutions as well as staff service
requests and personnel action notices applications, including the right to
market these products as a private label offering. Also in 2009, we
acquired PTS, a software company that was completing the development of a time
and attendance software solution known as “Priority Time” for
use by employers to improve efficiency of their workforce.
2
A
substantial effort was made in the development of the underlying emPath® product
and its SaaS offering platform, which will allow us to finalize and launch our
new module-based initiative whereby certain payroll/human resource modules can
be marketed independently from emPath® or bundled as a comprehensive solution. A
key objective of the module development initiative is to enable new modules to
be sold to a smaller customer base (25 to 500 employee companies) in a simple
standardized version that has full functionality and benefits of a total
enterprise solution, while maintaining scalability in order to meet the needs of
and to compete for the largest corporate customers and government entities,
which often have complex payroll rules.
We
attempt to acquire marketing or licensing rights for products which, in our
belief, are best of breed; are profitable or on the path to profitability; are
complementary to our other software offerings; and provide cross-product
distribution channels. 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 we believe is
capable of penetrating multiple sectors through cross-promotion.
Our
current products address the following market segments:
MARKET
|
PRODUCT
|
OWNERSHIP/
LICENSOR
|
LICENSEE
|
|||
Human
Resources and Payroll
|
emPath®
|
NOW
Solutions
|
|
|||
Pharmacies
and medical practices
|
SiteFlash™
|
Vertical
|
VHS
|
|||
Government
Sector- Emergency Response
|
ResponseFlash™
|
Vertical
|
GIS
|
|||
Pharmacies
and medical practices
|
PASS
|
Vertical
|
VHS
|
|||
Software
development units
|
Emily®
|
Vertical
|
VHS
|
|||
Human
Resources and Payroll
|
AllegroHR
|
Emerald
Software Group
|
NOW
Solutions
|
|||
Time
and Attendance
|
PriorityTime
|
Priority
Time Systems
|
Administrative
Software
Our
primary administrative software technology is emPath®, a human resources/payroll
software, which is developed, marketed and maintained by our wholly-owned
subsidiary, NOW Solutions. Our administrative software is Web-based,
meaning that it can be accessed on the Internet, and is currently being offered
as a SaaS or as a software license.
In 2009,
we completed the enablement of emPath® for web services and improvements for its
SaaS offering, and are finalizing a new workflow engine. We also implemented a
new strategy of development of HR/payroll related modules that can be sold
separately or bundled with emPath®. These new features, when coupled
with experience gained with the product by the Brazil-based development staff
(over the past three years), have substantially facilitated faster product
development with our platform. In addition, we have significantly improved the
scalability of emPath® to meet the needs of small businesses as well as very
large enterprise clients. We are also finalizing our emPath® for Small Business
SaaS offering utilizing emPath®’s powerful payroll component to provide private
label contracting as well as distribution opportunities through existing payroll
providers in their local markets.
With the
additional development efforts in respect of the Priority Time software, we
anticipate marketing Priority Time through PTS as a separate module in 2010, as
well as bundling it with emPath®, which we intend to market to emPath®’s
existing customer base.
We
believe that our administrative software services provide customers with upfront
cost savings and productivity increases for everyday operations, including
competitive set-up charges and implementation times.
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.
3
Our
primary core internet 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. This unique ability is patented (U.S. Patent number
6,826,744) and has many applications in the Web arena. SiteFlash™
architectural concepts enable integration with existing technological components
within many organizations. Additional key features that differentiate
SiteFlash™ from other products 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).
We offer
SiteFlash™ as a stand-alone product and also as a technology platform for
products targeted at specific vertical markets. The SiteFlash™
technology focuses on content management, e-commerce, and workflow and has led
to the development of three additional software application products:
ResponseFlash™, NewsFlash™ and AffiliateFlash™. Initially, GIS will
focus on marketing ResponseFlash™, a Web-based emergency communication system,
in the Homeland Security area to all government sectors excluding public
education (i.e., schools, colleges, and universities).
We have
converted our SiteFlash™ product to offer it in a SaaS
configuration. We intend to concentrate our initial marketing efforts
in the affiliate, government and publishing markets.
In July
2008, we settled an infringement claim we had initiated in federal court against
Microsoft. We are waiting for the issuance of the Continuation Patent for U.S.
Patent No. 6,826,744 (which SiteFlash™ is based upon) before we engage with new
licensees because we believe the Continuation Patent provides better protection
for this intellectual property asset.
The
second core Internet technology we have developed is the patent-pending 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
core Internet 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 allows a disparate and distributed database to be viewed
and updated as if it was a single large database. This unique ability
is patented (U.S. Patent number 7,076,521). 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, at this time, pursuing opportunities
to deploy the technology in industries such as the government and health
insurance markets.
Software
Services
In addition to its standard emPath®
offering, NOW Solutions has been providing a new delivery model:
software-as-a-service, or simply “SaaS”. SaaS is a software application delivery
model where a software company both develops and operates/hosts the application
for use by its customers over the Internet. It is a low-cost way for businesses
to obtain the same benefits of commercially licensed, internally operated
software, without the associated complexity and high start-up costs. The term
"SaaS" has become the industry adopted reference term, generally replacing the
earlier terms "On-Demand" and "ASP" (Application Service Provider). After
completing the testing of its emPath® SaaS model to ensure a robust and
competitive solution, NOW Solutions is now marketing its SaaS offering of
emPath® to existing and new clients. This delivery 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, NOW Solutions is completing its new
“emPath® for Small Business” offering.
4
The
Company stopped marketing IA (formerly ImmuneApp) and StatePointPlus®, which we
had marketed individually or collectively as a managed baseline
solution. IA is a security software program and StatePointPlus® is an
intelligent system baseline management patented technology. However, while we
have been in discussions and negotiations concerning the licensing rights for
these products, we have not resolved a number of outstanding issues at this
time.
Business
Operations and Units
Our
business operations are grouped into the following units: NOW
Solutions, GIS, Vertical Internet Solutions, Inc. (“VIS”), EnFacet, Inc.
(“EnFacet”),
Globalfare.com, Inc. (“Globalfare”),
Pointmail.com, Inc. (“Pointmail”), Taladin,
OptVision Research, VHS, PTS, minority and other limited interests, joint
ventures, and strategic partnerships. Each of these divisions is
discussed below.
NOW Solutions, Inc.
NOW
Solutions, a Delaware corporation, is a wholly-owned subsidiary of the
Company.
NOW Solutions specializes in
end-to-end, fully integrated human resources and payroll
solutions. NOW Solutions has clients ranging from private businesses
to government agencies, who typically employ 200 or more
employees. NOW Solutions currently markets emPath®, which handles
complex human resources and payroll situations where the clients may have
employees from different unions, multiple state locations, and intricate
compensation structures. We believe that the competitive advantage of emPath® is
its speed of implementation through a formula-builder technology, which allows
quick customization of payroll rules and calculations without any programming.
NOW Solutions’ product suite is targeted to address the needs of management in
today’s dynamic business environment and gives organizations a user friendly,
multi-lingual (i.e., English, Canadian French, Spanish, Portuguese and Chinese)
and flexible software solution, without the multi-million dollar implementation
and support budgets of the major competitors.
NOW Solutions has converted some of its
existing customers to its SaaS model and is in the process of developing methods
to introduce its SaaS offering, particularly its “emPath® for Small Business”
SaaS through distributors. Additionally, NOW Solutions has embarked on a new
strategy of licensing HR products complementary to its existing suite of
products that can be sold as a separate product or integrated with emPath®,
which is greatly facilitated by emPath®’s Web Services integration. The first
products which are part of this initiative consist of “onboarding” and
“offboarding” software, which were obtained through NOW Solutions’ agreement
with Emerald Software Group and resulted in an immediate sale to one of its
existing customers.
The
existing revenue model of NOW Solutions is based primarily upon four components:
licensing fees, SaaS fees, professional consulting services, and renewable
maintenance fees. Under the SaaS delivery model, NOW Solutions
typically collects monthly fees.
For the
12 months ended December 31, 2009, NOW Solutions had approximately $1,110,298 of
total assets, revenues of approximately $5,394,778 and net income of
approximately $5,353,785.
Taladin,
Inc.
Taladin,
a Texas corporation, is a wholly-owned subsidiary of the Company. In
November 2005, Taladin and NOW Solutions entered into a license agreement
whereby Taladin received the exclusive rights to commercially exploit emPath®
for use by the United States federal, state and local governments and agencies
in exchange for a license fee and royalties. Taladin has developed a
module for emPath® to meet federal payroll guidelines for law enforcement and
fire departments but the finalization of the module was put on hold while final
testing was performed and the underlying emPath® SaaS platform was
finalized.
For the
12 months ended December 31, 2009, Taladin had no material assets, no revenues
and a net loss of approximately $41,072.
OptVision
Research, Inc.
OptVision
Research, a Texas corporation, is a wholly-owned subsidiary of the Company and
was created to support the development of our fiber optic patent through either
direct investment or government grants.
5
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. We are in the process of attempting to
secure funding from the Federal Government for development of the
patent.
For the
12 months ended December 31, 2009, OptVision had no material assets, no revenues
and a net loss of approximately $9,886.
Vertical
Healthcare Solutions, Inc.
VHS, a
Texas corporation, is a wholly-owned subsidiary of the Company. In
May 2008, Robert Farias assigned Point-of-Sale software (“PASS”) technology to
the Company. In addition, VHS and Mr. Farias entered into a
distributor agreement for PASS whereby Mr. Farias would market PASS to his
existing clients. In October 2008, VHS entered into a consulting
agreement with Farias-Jett (a sole proprietorship of Mr. Farias), and an
employment agreement with Mr. Farias. Significant upgrades have been completed
on the PASS software and VHS has some pharmacies beta testing this product. PASS
is being adapted to meet the needs for physicians for a secondary
market. On December 17, 2009, Sigis (the “Special Interest Group for
IIAS Standards”) certified that PASS met the requirements by the IRS for IIAS
COMPLIANT POINT OF SALE SYSTEM.
For the
12 months ended December 31, 2009, VHS had no material assets, no material
revenues, and a net loss of approximately $212,287.
Priority
Time Systems, Inc.
PTS is a
Nevada corporation. On June 15, 2009, we purchased 90% of the common
stock of PTS from a shareholder of PTS. The purchase price was
$63,000, of which $25,000 was paid at execution with the balance of the purchase
price to be paid in equal monthly installments over a 12-month period beginning
in August 2009. In connection with this agreement, we also agreed to
retain the selling shareholder as a consultant of PTS beginning in July 2009. In
addition, we also entered into a shareholder agreement with the other
shareholder of PTS whereby we have the option to purchase the remaining 10% of
the common shares of PTS stock at any time after 3 years from the date of our
purchase of the 90% block. The shareholder agreement also provides
for the licensing terms of PTS products to our other subsidiaries.
PTS has
been developing Priority Time, a time and attendance product that we intend to
offer as a standalone product as well as an integrated product with emPath®. We
are finalizing the completion of the Priority Time product.
As part
of the PTS acquisition, the Company retained two highly experienced executives
within PTS with years of experience and success in the independent marketing and
sales of time and attendance software solutions.
For the
12 months ended December 31, 2009, PTS had assets of approximately $88,489, no
material revenues and a net loss of approximately $98,484.
Government
Internet Systems, Inc.
Our 81.5%
owned subsidiary, GIS, a Nevada corporation, was formerly named Emily®
Solutions, Inc. Vertical licensed ResponseFlash™ to GIS to market and
distribute this technology to government entities (excluding state universities
and schools) in the United States. GIS seeks to enter into agreements
to distribute other non-Company products particularly in the Homeland Security
sector. We are in the process of submitting proposals to various city, county
and state governments. We are currently seeking funding through
grants.
For the
12 months ended December 31, 2009, GIS had no assets and no material revenue or
expenses.
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, 2009, VIS had no material assets and no material
revenue or expenses.
6
EnFacet,
Inc.
EnFacet, a Texas corporation, is a
wholly-owned subsidiary of the Company. EnFacet is currently inactive and we
have no plans regarding this subsidiary.
For the 12 months ended December 31,
2009, EnFacet had no material assets, no revenues and no expenses.
Globalfare.com
Globalfare,
a Nevada corporation, is a wholly-owned subsidiary of the
Company. Globalfare is currently inactive and we currently have no
plans regarding this subsidiary.
For the
12 months ended December 31, 2009, Globalfare.com had no assets, no revenues and
no expenses.
Pointmail.com,
Inc.
Pointmail,
a California corporation, is a wholly-owned subsidiary of the Company. Pointmail
is currently inactive and we currently have no plans regarding this subsidiary
or its technology.
For the
12 months ended December 31, 2009, Pointmail.com had no assets, no revenues and
no expenses.
Minority
Interests and Royalty Interests
iNet Purchasing,
Inc.
In April
2000, we acquired a 2.5% minority interest in iNet and were entitled to a
royalty on all iNet transactions for up to 40 years. iNet is a
developer of Internet-based procurement services targeted at the specific needs
of public sector purchasing in the state and local government arena through
PublicBuy.net. In November 2001, we entered into a license agreement
with iNet, pursuant to which the Emily® software and technology were licensed
for use in connection with iNet’s e-procurement system in Texas, Maine, and
Idaho in exchange for a 20% commission on subscription fees. In April
2005, iNet Purchasing was acquired by SicommNet. We are in the
process of reviewing our rights pursuant to the SicommNet ownership of iNet
Purchasing, Inc.
As of
December 31, 2009, all of the iNet investments and advances paid for royalties
were fully reserved. There have been no revenues or expenses in
relation to the investments for the twelve months ended December 31,
2009.
TranStar Systems,
Inc.
TranStar Systems, Inc.
(“TranStar”),
based in Claremont, California, is a systems integrator and consulting firm that
is establishing an e-business platform. That platform is mainly focused on
multiple-application smart card based solutions for credit, debit, payroll debit
cards and other high volume informational transactions with a large customer
base. We are entitled to receive 3% of any transaction fees and any
other revenues generated by TranStar in perpetuity, although no royalties have
been received from TranStar as of April 14, 2010. Although TranStar
put its smart card and payroll debit card business on hold in 2009, we have a
distribution agreement with the President of TranStar to market our products,
including emPath®.
Strategic
Alliances and Software Distributors
InfiniTek
Corporation. In July 2008,
InfiniTek Corporation (“InfiniTek”), which is
a Microsoft Dynamics NAV distributor, entered into consulting and distribution
agreements with the Company and its subsidiaries. Microsoft Dynamics
NAV (formerly Navision) is a complete enterprise resource planning (ERP)
solution that is an integrated financial, manufacturing, supply chain
management, sales and marketing, project management, and human resources
product. Under the consulting agreements, InfiniTek was to provide software
application and development services to us, including the development of a
product called “NavPath” which is an
integration tool to connect emPath® to Navision. InfiniTek was also to provide
marketing services on behalf of Taladin for the FLSA (Fair Labor Standards Act)
compliant payroll product. In addition, NOW Solutions and InfiniTek entered into
a distribution agreement whereby InfiniTek was authorized on a non-exclusive
basis to market NOW Solutions’ emPath® HR/Payroll product in the United
States. In November 2009, a dispute that had arisen between InfiniTek
and the Company was not resolved and we sued InfiniTek on November 18, 2009. All
agreements were cancelled except for the distribution agreement. Please see
Legal Proceedings in Item 3 for more details.
7
Farias-Jett. In August 2008, NOW
Solutions entered into a hosted service provider agreement with Farias-Jett for
emPath® so that Farias-Jett can market emPath® for Small
Business SaaS product to its existing customer base. In 2009, Farias-Jett was
active in providing input and beta testing for this offering.
Emerald Software
Group. In February 2009, NOW Solutions entered into an
agreement with Emerald to market its AllegroHR products with NOW Solutions’
emPath® Payroll/HRMS software solution and to sell it
separately. AllegroHR consists of onboarding and offboarding software
solutions as well as staff service request and personnel action notices
applications. NOW Solutions can distribute AllegroHR under a private
label version. Throughout 2009, Emerald worked closely with the
Company in utilizing emPath®’s web services to provide an integrated solution
for emPath®’s first on-boarding customer.
Competition
We have
substantial competition from software and hardware vendors, system integrators,
and multinational corporations focused upon information technology and security.
In the realm of administrative software, NOW Solutions’ competitors include
Oracle, Lawson, Cyborg /Hewitt, Kronos, DLGL, Ultimate and SAP. Our competitors
for emPath® for Small Business include ADP, Ceridian, and Quicken. Our
competitors in the network security sector include Tripwire, McAfee, Symantec,
Cisco, Computer Associates, and Microsoft. Our competitors have longer operating
histories, greater name recognition, larger customer bases and significantly
greater financial, technical and marketing resources than we do. 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 technologies that can be utilized in
our offerings.
|
|
2.
|
NOW
Solutions has an outstanding customer support department that has
supported for a number of years large complex entities, many of which are
leaders in their respective
industries.
|
|
3.
|
emPath®’s
inherent strengths include its formula builder, the use of one single data
base, 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.
|
Strategic
Overview
The
Company’s product portfolio reflects a number of unique characteristics and
advantages that have been developed or acquired over time. Yet until the final
resolution of the litigation with Ross Systems, Inc. (“Ross”) in the fall of
2009, we were unable to devote our full resources to maximize the benefit of our
various technologies. Currently, we are actively pursuing the strategy of (a)
further developing the technologies owned by the Company and its subsidiaries
and (b) combining all the technologies owned by the Company and its subsidiaries
into viable products offerings.
The key
components of our strategy are:
|
1.
|
A
strong, profitable subsidiary, NOW Solutions, that has a
highly-referenceable client base, including companies that are leaders in
their industries and users of emPath® for over 10 years for their payroll
and human resource needs.
|
|
2.
|
A
portfolio of patented technologies that can be licensed to third parties
or utilized internally to strengthen our existing and projected product
offerings.
|
|
3.
|
Development
of compatible partners and acquisition or licensing of products that
complement our existing offerings.
|
8
The
software development leg of our strategy is twofold. The first lies in
continuing to develop the ability to compete with the large ERP providers like
SAP and Oracle in providing complex best-of-breed alternatives offerings at more
cost effective solutions. The second is to continue developing our intellectual
property internally for mass market, best-of-breed solutions offered as a SaaS
offering 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 government programs for cost
savings.
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
with best-of-breed products that complement our business units. The
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 the opportunity exists to
cross-promote/market their products. We are also identifying complementary
products from third parties which we can private label and sell with our
existing products or sell separately.
Proprietary
Rights
We rely
upon a combination of contract provisions and patent, copyright, trademark and
trade secret laws to protect our proprietary rights in our 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 agreements with
employees and consultants. NOW Solutions’ emPath® software technology is
protected by copyright and trademark.
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. This patent is the
foundation of our product, SiteFlash™, and forms the basis of the
ResponseFlash™, NewsFlash™ and AffiliateFlash™ products.
On March 22, 2010, we received a Notice
of Allowance from the USPTO for a continuation patent of U.S. Patent No.
6,826,744. Notice of Allowance means that all pending new claims have
been approved for issuance in a patent. The patent should issue
within approximately three months and will increase the scope of the original
patent by adding 32 new claims to the original 53 claims.
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. In addition, we have also filed for a patent related to the Emily®
XML scripting language. This patent application was published in February 2003
and is still pending.
Although
we intend to protect our 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 and 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.
9
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 14, 2010, we had 26 full-time and 3 part-time employees, of which 26 are
employed at NOW Solutions (17 are employed in the United States and 9 in
Canada), and 11 consultants (7 in Brazil). We are not a party to any
collective bargaining agreements.
Item
1A. Risk Factors
Risk
Factors Related to Our Business, Operating Results and Financial
Condition
We are
subject to various risks that may materially harm our business, financial
condition and results of operations. You should carefully consider
the risks and uncertainties described below and the other information in this
filing before deciding to purchase our common stock. If any of these
risks or uncertainties actually occurs, our business, financial condition or
operating results could be materially harmed. In that case, the
trading price of our common stock could decline and you could lose all or part
of your investment.
We
Have Historically Incurred Losses and May Continue to Do So in the
Future
While we
had a profit of $3,504,538 for the year ended December 31, 2009 and a small
profit of $195,333 for the year ended December 31, 2008, we have historically
incurred losses. Our profit for the year ended December 31, 2009 was primarily
due to our collecting the judgment awarded to us against Ross. Our profit
for the year ended December 31, 2008 was primarily based on our settlement with
Microsoft for the patent infringement lawsuit we initiated. 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, 2009 and 2008. This paragraph states that our
recurring operating 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 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 12 months ended December
31, 2009 and 2008 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. Negative shareholders’ equity at December 31, 2009 was
$21.6 million. Additionally, at December 31, 2009, we had negative
working capital of approximately $10.2 million (although it includes
deferred revenue of approximately $2.4 million) and have defaulted on several of
our debt obligations. These conditions raise substantial doubt about
our ability to continue as a going concern.
10
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 viable products,
other products for which we have marketing rights, as well as increased revenues
from NOW Solutions products and the successful launch of our new solutions by
our subsidiaries (such as emPath® for Small Business, PASS, and Priority Time),
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 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 ceased.
We
Have a Working Capital Deficit, Which Means That Our Current Assets on December
31, 2009 Were Not Sufficient to Satisfy Our Current Liabilities on That
Date
We had a
working capital deficit of approximately $10.2 million at December 31, 2009,
which means that our current liabilities exceeded our current assets by
approximately $10.2 million (although it includes deferred revenue of
approximately $2.4 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, 2009 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™ and Emily®
technology;
|
|
·
|
the
demand for NOW Solutions’
emPath® product;
|
|
·
|
the
demand for VHS’ PASS product
|
|
·
|
the
demand for PTS’ Time and Attendance
product
|
|
·
|
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;
and
|
|
·
|
general
economic conditions and economic conditions specific to the Internet and
Internet media.
|
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.
11
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 “Software-as-a-Service” 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.
We
May Have Difficulty Managing Our Growth and Integrating Recently Acquired
Companies.
Our
recent growth through acquisitions and licensing of new solutions, coupled with
the development effort, 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 our original SiteFlash™ and Emily® technology products and Internet
content, 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.
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.
12
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:
|
·
|
With
a price of less than $5.00 per
share;
|
|
·
|
That
are not traded on a recognized national
exchange;
|
|
·
|
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
|
|
·
|
In
issuers with net tangible assets less than $2 million (if the issuer has
been in continuous operation for at least three years) or $5 million
(if in continuous operation for less than three years), or with average
revenues of less than $6 million for the last three
years.
|
Broker/dealers
dealing in penny stocks are required to provide potential investors with a
document disclosing the risks of penny stocks. Moreover,
broker/dealers are required to determine whether an investment in a penny stock
is a suitable investment for a prospective investor. These
requirements may reduce the potential market for our common stock by reducing
the number of potential investors. This may make it more difficult
for investors in our common stock to sell shares to third parties or to
otherwise dispose of them. This could cause our stock price to
decline.
Item
2. Properties
The
Company and NOW Solution’s headquarters are currently located at 101 West Renner
Road, Suite 300, Richardson, Texas, and comprises approximately 2,576 square
feet. In addition, NOW Solutions has offices at 6707 Brentwood Stair
Rd., Suite 226, Fort Worth, Texas 76112, which comprises 1,703 square feet, 6205
Airport Road, Building A, Suite 300, Mississauga, Ontario, Canada,
which comprises 710 square feet, and Avenida N. Sra. De Copacabana, 895, Suite
901, Copacabana, Rio de Janeiro, Brazil, which comprises 1,200 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 Texas
headquarters.
Item
3. Legal Proceedings
We are
involved in the following ongoing legal matters:
In
February 2003, we sued Ross on behalf of our subsidiary NOW Solutions in New
York Supreme Court (the “Vertical Action”) in
connection with the acquisition of certain assets of Ross for the recovery of
unpaid maintenance fees due to NOW Solutions pursuant to an asset purchase
agreement. NOW Solutions claimed a total amount of approximately
$3,562,000 and an offset against the $750,000 remaining on the purchase money
note, plus other damages. In conjunction with our claim, NOW
Solutions withheld payment on the remaining $750,000 note, due in February
2003.
In March
2004, Ross sued NOW Solutions in the New York Supreme Court (the “Ross Action”) to
collect the $750,000 note payable plus interest and attorneys’
fees. On October 11, 2007 a judgment concerning the Vertical Action
and the Ross Action was entered for NOW Solutions (the “Judgment”) in the
amount of $3,151,216, which consisted of $1,279,483 for NOW Solutions’ claims
(after deducting $664,000 for Ross’ claim), $912,464 in attorneys’ fees and
expenses, and $865,361 for accrued interest. Ross appealed the
Judgment, which was affirmed by the appellate court.
On March
24, 2009, NOW Solutions applied for and received Ross’ cash deposit of
$3,151,216 that was held by the New York City Department of Finance, which had
accrued $133,424 in interest. The net proceeds of the cash deposit
collected by NOW Solutions were $873,444, after deducting $2,345,502 in
outstanding attorneys’ fees and costs (including a $992,723 promissory note
issued to Wolman Blair PLLC) and $65,693 in fees and interest charged by New
York City Department of Finance on the cash deposit.
13
On
September 15, 2009, NOW Solutions executed a settlement agreement with Ross in
connection with the outstanding monies (accrued interest, attorney fees and
expenses) owed by Ross to NOW Solutions. Pursuant to the terms of the
settlement agreement, Ross made a $390,468 payment to NOW Solutions and a
$144,532 payment to the Internal Revenue Service (“IRS”) on behalf of
the Company which is reported as part of the “Gain on settlement of litigation”
in the consolidated statements of operations. All litigation with
Ross has been resolved.
In August
2004, Arglen obtained a default judgment against the Company for a past due
$600,000 promissory note, plus fees and interest. We agreed to pay
Arglen $713,489. As of December 31, 2008, we had paid all principal
due under the payout agreement. In February 2009, the Company and
Arglen agreed to settle a dispute concerning accrued interest regarding the
payout agreement. Under the terms of the settlement, we paid Arglen
$60,000. This matter has been resolved.
On April
18, 2007, we filed suit for patent infringement against Microsoft Corp. in the
United States District Court for the Eastern District of Texas. We claimed that
the Microsoft.Net System infringes U.S. Patent No. 6,826,744. In July
2008, we settled our patent infringement claim against Microsoft
Corporation. Pursuant to the confidential settlement agreement, we
granted to Microsoft a non-exclusive, fully paid-up license under the patent
which was the subject of the legal proceeding. The proceeds from the
license were included in revenue.
The IRS
had a claim for unpaid Employment (Form 941) taxes and Federal Unemployment
(Form 940) taxes for the period December 31, 2001 through December 31,
2005. We paid $200,000 of the principal amount of the unpaid payroll
taxes in September 2008. In September 2009, the lien held by the IRS
against us in the amount of $144,532 was satisfied. This matter has
been resolved.
In August
2009, Parker Shumaker & Mills, LLP (“PSM”) filed a lawsuit
in Los Angeles Superior Court to collect the outstanding balance of $51,238
under a promissory note issued by the Company to PSM in the principal amount of
$75,000, plus interest at 6% per annum, late fees and attorneys’
fees. We issued the $75,000 note in connection with a settlement in
October 2005 with PSM. In December 2009, we entered into a settlement
agreement and stipulated judgment with PSM whereby the parties agreed to a
judgment balance of $68,500, which included principal, accrued interest, late
fees and attorneys’ fees, and we agreed to make monthly installment
payments. Bill Mills is a Director of the Company and a partner of
PSM, which was formerly known as Parker Mills, LLP (the successor entity to
Parker Mills Morin, LLP and Parker Mills & Patel, LLP).
On
November 18, 2009, we sued InfiniTek for breach of contract and other claims
when a dispute between the Company and InfiniTek was not
resolved. All agreements were cancelled in 2009 except for the
distribution agreement. We attempted unsuccessfully to resolve the issue with
InfiniTek via mediation. Our lawsuit was amended on March 30th and the
distribution agreement has been cancelled.
In the
opinion of management, the ultimate resolution of any pending matters may have a
significant effect on our financial position, operations or cash
flows. Also, we in the future may become involved in other legal
actions that may have a significant effect on our financial position, operations
or cash flows.
Item
4. Reserved
14
PART
II
Item
5. Market For Registrant’s Common Equity, Related Stockholder
Matters, and Issuer Purchases of Equity Securities
Our
common equity is quoted on the Over-The-Counter Bulletin Board (the “OTCBB”) under the
symbol “VCSY”.
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, 2009
|
$ | 0.0290 | $ | 0.0160 | ||||
Quarter
Ended September 30, 2009
|
$ | 0.0410 | $ | 0.0190 | ||||
Quarter
Ended June 30, 2009
|
$ | 0.0260 | $ | 0.0180 | ||||
Quarter
Ended March 31, 2009
|
$ | 0.0400 | $ | 0.0210 | ||||
Quarter
Ended December 31, 2008
|
$ | 0.1050 | $ | 0.0220 | ||||
Quarter
Ended September 30, 2008
|
$ | 0.08300 | $ | 0.0140 | ||||
Quarter
Ended June 30, 2008
|
$ | 0.020 | $ | 0.0130 | ||||
Quarter
Ended March 31, 2008
|
$ | 0.0200 | $ | 0.0120 |
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 4, 2010, there were approximately 1,804 holders of record of our common
stock.
Equity
Securities Under Compensation Plans
We had
the following securities authorized for issuance under equity compensation plans
(which include individual agreements) as of December 31, 2009:
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(1)
|
- | - | - | ||||||||||
Equity
compensation plans not approved by security holders
|
|||||||||||||
Stock
Options (2)
|
- | - | - | ||||||||||
Warrants
(3)
|
15,000,000 | $ | 0.020 | - | |||||||||
Unvested
Restricted Stock Awards (4)
|
683,333 | $ | 0.018 | - | |||||||||
Total
|
15,683,333 | $ | 0.019 | - |
15
|
(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)
|
The
Stock Option Plan expired December 15,
2009.
|
|
(3)
|
Warrants
to purchase 15,000,000 shares of our common stock were issued to Robert
Farias under three separate warrant agreements. These warrants
were cancelled pursuant to an agreement with Mr. Farias in March
2010. For additional details, please refer to “Subsequent
Events” in Note 15 of the Notes to the Financial Statements. Other than
individual agreements, we have not approved any equity compensation plan
with regard to warrants.
|
|
(4)
|
The
683,333 shares of restricted stock that had not vested at December 31,
2009 were issued in connection with individual restricted stock agreements
executed in 2007 with employees of the Company and NOW
Solutions. Of the 683,333 unvested shares at December 31, 2009,
416,667 have vested through April 14,
2010.
|
Dividends
We have
outstanding 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 $588,000 for each of the years ended December 31,
2009 and 2008. Our Board of Directors did not declare and did not pay
any dividends on our outstanding shares of Series A Preferred Stock or Series C
Preferred Stock during 2009 or 2008 and has not declared or paid any dividends
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 in the near future. For additional
information concerning dividends, please see Item 7, Management’s Discussion and
Analysis of Financial Condition and Results of Operations.
Unregistered
Sales of Securities
During
the last two years, we issued the following unregistered
securities:
In
January 2008, we issued 250,000 unregistered shares of our common
stock (at a fair-market value of $3,750) to a third party lender in
connection with extending the maturity dates of two promissory notes issued by
GIS in November 2002 in the amounts of $40,000 and $60,000,
respectively.
In
February 2008, we issued 500,000 unregistered shares of our common stock (at a
fair market value of $9,000) to a third party lender in connection with
refinancing a $50,000 promissory note issued in June 2002 as well as accrued
interest, fees, and expenses incurred in connection with the
refinancing.
In
February 2008, MRC pledged 3,000,000 shares of our common stock as collateral on
a $96,946 note issued in February 2008 to a third party lender. MRC
is a corporation controlled by the W5 Family Trust. Mr. Wade, the
President and CEO of the Company, is the trustee of the W5 Family Trust. In
November 2008, the lender sold 1,500,000 shares of the pledged stock for
$118,167, of which $103,555 was applied to outstanding debt claimed by the
lender including interest, penalties & attorney’s fees. The
remaining $14,612 was returned to MRC representing the amount of shares oversold
by the lender. Of the 1,500,000 shares sold by the lender, the
Company is obligated to reimburse MRC with 1,309,983 shares within 1 year of the
sales of the pledged shares.
In March 2008, the Company and MRC
amended the indemnity and reimbursement agreement (entered into in April 2007)
whereby the Company agreed to reimburse and indemnify MRC for additional shares
pledged as collateral in connection with a $96,946 note. MRC is a
corporation controlled by the W5 Family Trust. Mr. Wade, the
President and CEO of the Company, is the trustee of the W5 Family
Trust.
In May
2008, we issued 1,000,000 shares of our common stock to Victor Weber that were
granted in connection with a $100,000 loan made by Mr. Weber to NOW Solutions in
October 2006. These shares were accounted for in our 10-KSB for the
year ended December 31, 2006.
In
September 2008, we issued 250,000 shares of our common stock (at a fair-market
value of $3,500) to a third party consultant in connection with a services
agreement.
16
In
November 2008, we issued 750,000 shares of our common stock to a third party
consultant whereby all of the shares will vest in 6 months from the date of
execution of the restricted stock agreement.
During
the year ended December 31, 2008, we issued 250,000 unregistered shares of our
common stock to a director of the Company pursuant to a restricted stock
agreement that provides for the shares to vest on the 1-year anniversary date of
the agreement.
In
January 2010, the Company and MRC amended the indemnity and reimbursement
agreement (originally entered into in April 2007) whereby the Company agreed to
reimburse and indemnify MRC for 16,976,296 shares pledged in November 2009 as
collateral in connection with a $150,000 note. MRC is a corporation
controlled by the W5 Family Trust. Mr. Wade, the President and CEO of
the Company, is the trustee of the W5 Family Trust.
In March
2010, the Company and Robert Farias entered into an agreement whereby Mr. Farias
agreed to cancel warrants to purchase 15,000,000 common shares and $100,000 in
debt and to waive his rights to convert 37,500 shares of our Series C Preferred
Stock into 15,000,000 common shares in exchange for the Company’s transfer to
Mr. Farias of 610,000 shares of VHS Series A Preferred Stock owned by the
Company. Mr. Farias is an employee of VHS and a Director of NOW
Solutions. For more details, please refer to Subsequent Events in Note 15 of the
Notes to the Financial Statements.
In March
2010, the Company and MRC entered into an amendment of an indemnity and
reimbursement agreement whereby the obligation to reimburse MRC with 10,000,000
common shares that were loaned to the Company in March 2008 was cancelled in
exchange for the Company’s transfer to MRC of 300,000 shares of VHS Series A
Preferred Stock owned by the Company. MRC is a corporation controlled
by the W5 Family Trust. Mr. Wade, our President and CEO, is the trustee of the
W5 Family Trust. For more details, please refer to Subsequent Events
in Note 15 of the Notes to the Financial Statements.
In March
2010, the Company and Luiz Valdetaro entered into an amendment of two indemnity
and reimbursement agreements whereby the obligation to reimburse Mr. Valdetaro
in respect of an aggregate 3,000,000 common shares that were transferred to
third parties on behalf of the Company (in connection with certain extensions of
loans of the Company in April 2008) was cancelled in exchange for the Company’s
transfer to Mr. Valdetaro of 90,000 shares of VHS Series A Preferred Stock owned
by the Company. Mr. Valdetaro is our Chief Technology
Officer. For more details, please refer to Subsequent Events in Note
15 of the Notes to the Financial Statements.
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
and its subsidiaries included in Item 8 of this Report, and the cautionary
statements and risk factors included in Item 1A of this Report.
17
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, 2009, $30,870 of
internal costs were capitalized. During the year ended December 31,
2008, no costs were capitalized.
Revenue Recognition
Our revenue recognition policies are in
accordance with standards on software revenue recognition, which includes
guidance on revenue arrangements with multiple deliverables and arrangements
that include the right to use of software stored on another entity’s
hardware.
In the case of non-software
arrangements, we apply the guidance on revenue arrangements with multiple
deliverables and wherein multiple elements are allocated to each element based
on the element’s relative fair value. Revenue allocated to separate elements is
recognized for each element in accordance with our accounting policies described
below. If we cannot account for items included in a multiple-element arrangement
as separate units of accounting, they are combined and accounted for as a single
unit of accounting and generally recognized as the undelivered items or services
are provided to the customer.
Consulting. We provide
consulting services, primarily implementation and training services, to our
clients using a time and materials pricing methodology. The Company prices its
delivery of consulting services on a time and materials basis where the customer
is either charged an agreed-upon daily rate plus out-of-pocket expenses or an
hourly rate plus out-of-pocket expenses. In this case, the Company is paid fees
and other amounts generally on a monthly basis or upon the completion of the
deliverable service and recognizes revenue as the services are
performed.
Software
License. We sell concurrent perpetual software licenses to our
customers. The license gives the customer the right to use the software without
regard to a specific term. We recognize the license revenue upon
execution of a contract and delivery of the software, provided the license fee
is fixed and determinable, no significant production, modification or
customization of the software is required and collection is considered probable
by management. When the software license arrangement requires the Company to
provide consulting services that are essential to the functionality of the
software, the product license revenue is recognized upon the acceptance by the
customer and consulting fees are recognized as services are
performed.
Software
licenses are generally sold as part of a multiple-element arrangement that may
include maintenance and, under a separate agreement, consulting services. The
consulting services are generally performed by the Company, but the customer may
use a third-party to perform 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.
18
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.
Software as a Service (“SaaS”). 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 SaaS. 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 SaaS can enter into an agreement to purchase a
software license at any time. We generate revenue from SaaS as the customer
utilizes the software over the Internet.
We will
provide consulting services to customers in conjunction with SaaS. 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 SaaS 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 SaaS 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 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. The Company uses the Black-Scholes option valuation model to
estimate the fair value of its stock options at the date of
grant. Historical data is used to estimate the expected price
volatility, the expected option life and the expected forfeiture
rate. The risk-free rate is based on the U.S. Treasury yield curve in
effect at the time of grant for the estimated life of the
option. Determining the appropriate fair value model and calculating
the fair value of share-based payment awards requires the input of subjective
assumptions. The assumptions used in calculating the fair value of
share-based payment awards represent management’s best estimates, but these
estimates involve inherent uncertainties and the application of management
judgment. As a result, if factors change and the Company uses
different assumptions, the stock-based compensation expense could be materially
different in the future. See Note 11 of the Consolidated Financial
Statements for a further discussion of stock-based
compensation.
19
Valuation
of the Embedded and Warrant Derivatives
The valuation of our embedded
derivatives and warrant derivatives are determined primarily by the
Black-Scholes option pricing model and the Lattice 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. A warrant derivative liability is determined in accordance with
the guidance on derivative financial instruments indexed to, and potentially
settled in, a company’s own stock. Based on this guidance, warrants
which are determined to be classified as derivative liabilities 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.
To determine the fair value of our
embedded derivatives, management evaluates assumptions regarding the probability
of certain future events. Other factors used to determine fair value include our
period end stock price, historical stock volatility, risk free interest rate and
derivative term. 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
During
the third quarter of 2009, we adopted The FASB Accounting Standards
Codification (ASC or Codification) and the Hierarchy of Generally Accepted
Accounting Principles (GAAP) which establishes the Codification as the
sole source for authoritative U.S. GAAP and will supersede all accounting
standards in U.S. GAAP, aside from those issued by the SEC. The adoption of the
Codification did not have an impact on our results of operations, cash flows or
financial position. Since the adoption of the Accounting Standards Codification
(ASC) our notes to the consolidated financial statements will no longer
make reference to Statement of Financial Accounting Standards (SFAS) or
other U.S. GAAP pronouncements.
Effective
January 1, 2009, we adopted new accounting guidance for determining whether an
instrument or an embedded feature is indexed to our own stock. The
new guidance provides that an entity should use a two-step approach to evaluate
whether an equity-linked financial instrument (or embedded feature) is indexed
to its own stock, including evaluating the instrument’s contingent exercise and
settlement provisions. The adoption of this guidance did not have an
impact on our consolidated financial statements.
Effective
January 1, 2009, we adopted new accounting guidance for convertible debt
instruments that may be settled in cash upon conversion (including partial cash
settlement), which applies to convertible debt that includes a cash conversion
feature. Under this guidance, the liability and equity components of convertible
debt instruments within the scope of this pronouncement shall be separately
accounted for in a manner that will reflect the entity’s nonconvertible debt
borrowing rate when interest cost is recognized in subsequent periods. We
examined our convertible debt instruments and preferred stock for applicability
under this new guidance and have concluded that there was no impact to our
consolidated financial statements as our convertible debt and preferred stock
were not within the scope of this guidance.
We
adopted new accounting guidance on January 1, 2009 which required entities to
provide expanded disclosures about derivative instruments and hedging activities
including (1) the ways in which an entity uses derivatives, (2) the accounting
for derivatives and hedging activities, and (3) the impact that derivatives have
(or could have) on an entity’s financial position, financial performance, and
cash flows. As of December 31, 2009, the Company has a derivative liability of
$484,859 related to the outstanding warrants, convertible debt and stock
derivative liability. The derivatives instruments were not entered
into as hedging activities, and the change in value of the liability is included
in the accompanying consolidated statement of operations.
20
On
January 1, 2009, we adopted new accounting guidance on fair value
measurements. This new guidance defines fair value, establishes a
framework for measuring fair value in generally accepted accounting principles,
and expands disclosures about fair value measurements. The adoption
of this standard did not have an impact on our consolidated financial
statements. See Note 5 of the Notes to the Financial Statements for
additional information regarding our financial assets and liabilities measured
at fair value on a recurring basis.
In June
2009, we adopted new guidance which requires disclosures about fair value of
financial instruments in interim as well as in annual financial statements.
There was no impact on our consolidated financial statements. See Note 5 of the
Notes to the Financial Statements for more details.
Due to
the acquisition of Priority Time Systems, Inc. (see Note 3 of the Notes to the
Financial Statements), we implemented a new accounting standard
that changed the accounting for and reporting of minority interest
(now called non-controlling interest) in the consolidated financial statements.
The adoption of this standard has resulted in the classification of
non-controlling interest to a separate component of stockholders’ equity on the
accompanying consolidated balance sheets. Additionally, net loss attributable to
non-controlling interest is shown separately from net loss in the consolidated
statements of operations.
Effective
June 30, 2009, we implemented FASB ASC 855, Subsequent Events. This
standard establishes general standards of accounting for and disclosure of
events that occur after the balance sheet date but before financial statements
are issued. The adoption of ASC 855 did not impact our consolidated financial
statements. We evaluated all events or transactions that occurred after December
31, 2009 up through the date we issued these financial
statements. For a discussion of subsequent events, see Note 15 of the
Notes to the Financial Statements.
Results
of Operations
Year
ended December 31, 2009 Compared To Year Ended December 31, 2008
Total
Revenues. We had total revenues of $5,399,812 and $8,257,987
for the years ended December 31, 2009 and 2008, respectively. The
decrease in total revenue was $2,858,175 for the year ended December 31, 2009,
representing a 34.6% decrease compared to the total revenue for the year ended
December 31, 2008. The decrease in revenue was due to the sale of a
one-time license for certain patents for $2,900,000 in
2008. Excluding the impact of the one-time sale, revenues increased
slightly by $41,825 or 0.5%. Of the $5,399,812 and $8,257,987 total
revenues for the years ended December 31, 2009 and 2008, respectively,
$5,399,812 and $5,325,605 of such amounts was related to the business operations
of NOW Solutions, a wholly-owned subsidiary of the Company.
The
revenues from licenses and software primarily consist of fees we bill for new
payroll and human resources (“HR”) software
licenses and licenses fees for patents and technology we own. The
decrease in license and software revenue from 2008 to 2009 was $2,741,306,
primarily due to licensing some of our patents in 2008 for a one-time license
fee of $2,900,000. We did increase licensing for our payroll and HR
software in 2009 by adding a customer and selling additional licenses and
modules to existing customers.
The
software maintenance revenue is generated from existing customers of our payroll
and HR software who continue to need or want tax updates, customer support, and
software enhancements and fixes. This revenue declined by $282,099 or
5.9% from the year ended December 31, 2008 to the same period in
2009. The revenue decline is due to customers who no longer renew
their maintenance and pricing pressure we experienced with customers with
economic difficulties, partially offset by increases in the maintenance fees we
bill our customers.
Consulting
revenue for the year ended December 31, 2009 increased by $40,475 from the same
period in the prior year, representing approximately a 9.8%
increase. This increase was due to the sale of payroll and HR
software in 2009 for which the customer requested consulting support for
implementation and training. We also had more consulting work in 2009
due to the sale of additional modules of our payroll and HR software to existing
customers who also requested consulting support for
implementation. Consulting revenues traditionally lag behind software
license revenues, as the implementation of new software sales takes several
months.
Hosting
and SaaS revenue increased $46,452 or 50.8% for the year ended December 31, 2009
compared to the same period in 2008. The increase is due to the
effect of having existing customers from 2008 for a full year in 2009 and the
effect of an additional customer in Canada. This revenue stream is
relatively new for us and we continue to refine our marketing and sales approach
for customers who need this type of solution to their payroll and HR needs to
increase this business.
21
Other
revenues, consisting primarily of reimbursable travel expenses and fees related
to user conferences, increased by $78,303 or 167.7% for the year ended December
31, 2009 compared to the same period for 2008. The increase is mainly
attributed to attendance fees charged for a NOW Solutions user conference held
approximately every other year.
Cost of
Revenues. We had direct costs associated with the above
revenues of $1,565,372 for the year ended December 31, 2009 compared to
$1,159,319 for the same period of 2008, representing an increase of
$406,053 or 35.0%. These direct costs are primarily related to costs
associated with providing customer support, professional services and the user
conference. The cost increases included the cost of the NOW Solutions
user conference ($74,008), increased license fees to third party software
vendors for software embedded in our products ($53,749), higher costs associated
with the hosting and SaaS revenue ($39,272), and higher customer support costs
due to an increase in salaries, fringe benefits and travel, as well as one-time
costs associated with relocating the customer support offices
($164,789). The remaining increase was primarily due to increased
salary and fringe benefit expenses for our internal consultants and payments to
third parties.
Selling, General
and Administrative Expenses. We had selling, general and
administrative expenses of $4,886,583 and $6,435,651 for the years ended
December 31, 2009 and 2008, respectively. The total selling, general
and administrative expenses for the year ended December 31, 2009 decreased
by $1,549,068 compared to the selling, general and administrative expenses
for the year ended December 31, 2008, representing approximately a 24.1%
decrease. The decrease was primarily due to non-recurring legal costs
in 2008 of approximately $1,367,000 associated with the Microsoft settlement, a
reduction in loan commitment fees and loan costs of approximately $44,000, net
and lower salaries, benefits and travel costs associated with a reduction of one
employee. Higher costs related to obtaining the proceeds from the
litigation settlement with Ross offset part of the lower costs, and were
one-time costs in 2009 of approximately $76,800.
Bad Debt
Expense. We had bad debt recovery for 2009 of $124,642
compared to bad debt expense of $13,820 in 2008. The recovery was due
to the adjustments to the trade receivables bad debt allowance due to
collections of receivables from 2007 and 2008 during the year ended December 31,
2009. These collections of past-due accounts receivable resulted in
the adjustment in 2009.
Gain on
Settlement of Trade Payables. In July 2009, we settled an
outstanding trade payable with a law firm by purchasing all the outstanding
uncollected receivables of the firm from the bankruptcy trustee. The
$121,020 gain on the settlement in 2009 was the net of the open outstanding
payable, less the purchase price. A third party law firm represented
us in this matter. In 2008, we had a one-time gain on settlement of
trade payables of $514,518 for the year ended December 31, 2008. The
gain was a result of our review of trade payables for those items in which the
statute of limitations had been exceeded and no legal liability
existed. Our review included the determination of the dates of
receipt of goods and services, the last activity with the vendor, the applicable
statute of limitations, and a search for applicable liens or
judgments. For those payables that met all the above
requirements, we removed the liability and recorded the gain on settlement as
required under FASB ASC860 Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities.
Operating Income
(Loss). We had an operating loss of $848,104 for the year
ended December 31, 2009 compared to operating income of $1,105,940 for the year
ended December 31, 2008, a decrease of $1,954,044. Excluding the
impact of the one-time Microsoft settlement that provided $1,533,000 of
operating income for the year ended December 31, 2008, operating income in 2008
would have been an operating loss of approximately $427,060. The
remaining decline in operating income was due to the small increase in revenues
(excluding the Microsoft revenue), higher cost of revenues, lower selling
general and administrative costs (excluding the impact of the Microsoft
revenue), and lower bad debt expenses.
Loss on
Derivative Liability. We have existing derivative liabilities
related to common stock loaned to the Company by two executives and embedded
derivative liabilities on convertible debt and outstanding options and
warrants. This liability is adjusted each quarter for changes in the
market value of the Company’s stock and other items that impact the valuation of
the derivatives. 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 $51,190 and $38,530
for the years ended December 31, 2009 and 2008, respectively. In
March 2010, subsequent to the balance sheet date, we negotiated agreements with
the two executives and one of the holders of warrants and some of our
outstanding Series C 4% Convertible Cumulative Preferred stock that will
eliminate the associated derivative liabilities for these financial instruments
that are convertible into our common stock. For more details, please
refer to “Subsequent Events” in Note 15 of the Notes to the Financial
Statements.
Interest
Expense. We
had interest expense of $538,683 and $874,635 for the years ended December 31,
2009 and 2008, respectively. Interest expense decreased for the year
ended December 31, 2009 by $335,952, representing a decline of approximately
38.4%, compared to interest expense for the year ended December 31,
2008. The decrease was the result of paying down the principal on
certain loans and lower amounts of default interest on debt in technical
default, most of which was paid in full in 2009.
22
Gain on
Settlement of Litigation. On March 24, 2009, NOW Solutions
applied for and received the cash deposit of Ross that was held by the New York
City Department of Finance. These funds had been deposited by Ross to
stay enforcement of the judgment awarded to NOW Solutions in the action of Ross
Systems, Inc. v. NOW Solutions. The stay was vacated by operation of
law after the judgment was affirmed by the New York, Appellate Division on
February 11, 2009. On September 24, 2009, we received the final
settlement from Ross of $535,000 for additional interest and legal fees incurred
to respond to their appeal. The gain is the total of the gross
proceeds from the judgment (excluding interest income) plus the note payable to
Ross and interest that had been accrued on the note. We also had
a receivable from Ross for certain funds due us after the acquisition was
completed that was also written off. However, that receivable had
been fully reserved, so there was no income impact from the write-off of the
receivable.
Interest
Income. As a result of the award from Ross which resulted in
the gain described above, we also received $133,424 of interest income on the
funds deposited by Ross with the New York Appellate Court system, which is
reflected as interest income for the year ended December 31,
2009. Interest income for the year ended December 31, 2008 was
$2,558, and was related to bank interest earned on the net proceeds from the
Microsoft settlement.
Net Income.
We had net income of $3,504,538 and $195,333 for the years ended December
31, 2009 and 2008, respectively. The net income for 2009 was due to
the factors discussed above, but the primary drivers for the income were the
gain on settlement of the Ross litigation of $4,799,093 and the associated
interest income of $133,424. Net income for 2008 was also impacted by
one-time items including the Microsoft settlement and the gain on settlement of
trade payables. Excluding the impact of these one-time items for the
years ended December 31, 2009 and 2008, we would have had a net loss of
$1,549,149 and $1,852,185, respectively. The recurring improvement is
related to the items discussed above, but is essentially the impact of higher
cost of revenues, lower selling general and administrative expenses, the
improvement in bad debt expense and the reduction in interest
expense.
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, 2009 and 2008, the total
dividends applicable to Series A and Series C Preferred Stock (from prior years)
were $588,000 each year. The Company did not declare or pay any
dividends in 2009 or 2008.
Net Income
(Loss) Applicable to
Common Stockholders. We had net income attributed to common
stockholders of $2,916,538 and a net loss applicable to common stockholders of
$392,667 for the years ended December 31, 2009 and 2008, respectively. Net
income applicable to common stockholders for the year ended December 31, 2009
increased by $3,309,205 compared to the net loss applicable to common
stockholders for the year ended December 31, 2008. The increase in the net
income applicable to common stockholders was due to the combination of factors
described above in “Net Income.”
Net Income (Loss)
Per Share. The Company had a net income per share of $0.00 and
a net loss per share of $0.00 for the years ended December 31, 2009 and 2008,
respectively.
Financial
Condition, Liquidity, Capital Resources and Recent Developments
At
December 31, 2009, we had non-restricted cash-on-hand of $229,738 compared to
$255,774 at December 31, 2008.
Net cash
provided by operating activities for the year ended December 31, 2009 was
$1,651,116 compared to $445,379 for the year ended December 31,
2008. We collected cash from our customers totaling $5,175,342 and
cash from litigation settlement of $3,819,640 (including interest income of
$133,424). We used the cash to pay for salaries, benefits, payroll
taxes and payroll fees of $3,497,239, attorney fees of $847,868, professional
fees and third party consultants of $493,265, interest expense of $1,071,381,
taxes (including sales tax and VAT) of $377,389, and other regular trade
payables of $1,056,724.
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. At the end of fiscal 2008, we lost several
software maintenance contracts and renegotiated pricing for maintenance with a
few customers experiencing economic difficulties in 2009, resulting in a decline
in our maintenance revenue. At December 31, 2009 we were able to
increase pricing on maintenance contracts and keep our existing maintenance
clients, allowing our deferred maintenance revenue (a liability) to increase
slightly from $2,359,394 to $2,404,681.
23
Our
accounts receivable increased from $277,592 at December 31, 2008 to $783,219 at
December 31, 2009 (net of allowance for bad debts). The increase in
receivables of $505,627 was due to our ability to keep most of our software
maintenance clients that are billed near year-end, the billing for new software
licenses in December 2009 ($195,010) and the reduction in the allowance for bad
debt ($282,687).
Accounts
payable and accrued liabilities declined from $7,354,544 at December 31, 2008 to
$6,397,578 at December 31, 2009. The decline of $956,966 was due to
writing off a payable purchased from the bankruptcy trustee of $121,020 and
utilizing some of the proceeds from the Ross litigation to pay past due payables
to attorneys and other vendors who had not been paid on a more current basis, as
well as liabilities we were contractually obligated to pay from the proceeds of
the Ross litigation settlement. The balance in accounts payable and
accrued liabilities is over 8 times the balance in accounts
receivable. This is one of the reasons why we do not have sufficient
funds available to fund our operations and repay our debt obligations under
their existing terms, as described below.
Net cash
used in investing activities for the year ended December 31, 2009 was $78,016,
consisting of the purchase of equipment and software and a 90% interest in
Priority Time Systems, whose business is developing timekeeping software to be
sold either as a stand-alone module or as a module of NOW Solutions’ payroll and
HR software product.
Net cash
used in financing activities for the year ended December 31, 2009 was
$1,357,262, consisting of repayments of notes payable of $1,677,262 and issuance
of new notes payable of $320,000. Most of the funds used to repay
these notes payable came from the Ross settlement proceeds.
The total
change in cash and cash equivalents for the year ended December 31, 2009 when
compared to the year ended December 31, 2008 was a decrease of
$26,036.
As of the date of the filing of this
Report, we do not have sufficient funds available to fund our operations and
repay our debt obligations under their existing terms. Therefore, we
need to raise additional funds through selling securities, obtaining loans,
renegotiating the terms of our existing debt and/or increasing sales of our
products and services. 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, 2009, the following contractual obligations and commercial
commitments were outstanding:
Balance
at
|
Due
in Next Five Years
|
|||||||||||||||||||||||
Contractual
Obligations
|
12/31/09
|
2010
|
2011
|
2012
|
2013
|
2014+
|
||||||||||||||||||
Notes
payable
|
$ | 3,421,841 | $ | 1,956,756 | $ | 181,835 | $ | 126,730 | $ | 143,500 | $ | 1,013,020 | ||||||||||||
Convertible
debts
|
40,000 | 40,000 | - | - | - | - | ||||||||||||||||||
Operating
lease
|
484,730 | 87,881 | 89,176 | 91,222 | 93,269 | 123,182 | ||||||||||||||||||
Total
|
$ | 3,946,571 | $ | 2,084,637 | $ | 271,011 | $ | 217,952 | $ | 236,769 | $ | 1,136,202 |
Of the
above notes payable of $3,421,841, the default status is as
follows:
2009
|
2008
|
|||||||
In
default
|
$ | 2,670,051 | $ | 3,039,754 | ||||
Current
|
751,790 | 2,315,655 | ||||||
Total
Notes Payable
|
$ | 3,421,841 | $ | 5,355,409 |
24
For an update on the refinancing of the
notes payable since fiscal year-end, please refer to “Subsequent Events” under
Note 15 of the Notes to Consolidated Financial Statements.
Going
Concern Uncertainty
While we
had a profit of $3,504,538 for the year ended December 31, 2009 and a small
profit of $195,333 for the year ended December 31, 2008, we have historically
incurred losses. In addition, we had a working capital deficit of
approximately $10.2 million at December 31, 2009. 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. In July 2008, the Company and Microsoft settled our
lawsuit for patent infringement (for more details, see Item 3, “Legal
Proceedings” and “Internet Core Technologies under Item 1, “Business”). The
exact results of our opportunities to license our intellectual 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, 2009 and 2008, which are attached to this
Report.
Item
9. Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure
None
Item
9A (T). Controls and Procedures
Evaluation of Disclosure Controls and
Procedures
Our
management, principally our chief financial officer and chief executive officer,
evaluated the effectiveness of our disclosure controls and procedures as of the
end of the period covered by this report. Based on that evaluation,
our management concluded that our disclosure controls and procedures as of the
end of the period covered by this report were not effective such that the
information required to be disclosed by us in reports filed under the Securities
Exchange Act of 1934 is (i) recorded, processed, summarized and reported within
the time periods specified in the SEC’s rules and forms and (ii) accumulated and
communicated to our management, including our chief executive officer and chief
financial officer, as appropriate to allow timely decisions regarding
disclosure. In particular, we have identified the following material
weakness of our internal controls:
|
-
|
There
is an over-reliance upon independent financial reporting consultants for
review of critical accounting areas and disclosures and material
non-standard transactions.
|
25
|
-
|
There
is a lack of sufficient accounting staff due to the size of the Company
which results in a lack of segregation of duties necessary for a good
system of internal control.
|
Management’s Annual Report on Internal
Control over Financial Reporting
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 Securities
and Exchange Act of 1934, as amended) 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, 2009. 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, 2009:
There is
an absence of adequate segregation of duties relating to oversight and
management of our systems. This resulted primarily from the fact that
certain parts of the work of our chief financial officer are not monitored or
reviewed. 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:
|
o
|
Financial
statements closing process – There was a material weakness in the process
of closing and consolidating our financial statements which resulted from
the fact that the process is manual and two of our entities have
functional currencies that are not the US Dollar. This
translation to US Dollars is also manual and does not have reporting that
allows for detailed review of each account. Although our chief
financial officer performs much of this process (starting with processing
the trial balance, through the evaluation and implementation of policies
and accounting issues), the complete production of consolidated financial
statements is not reviewed in detail by anyone
else.
|
|
o
|
Treasury
and cash process – There was a material weakness in the sub-process of
debt management which resulted from the fact that our chief financial
officer manages, evaluates, records and discloses all matters which relate
to debts, debt issuance and renegotiation expenses, interest, etc., and
the work of our chief financial officer is not reviewed in detail by
anyone else. Further, our chief financial officer relied upon
financial reporting consultants as it relates to the accounting for loan
renegotiation and loan termination
costs.
|
|
o
|
Equity
instruments – There was a material weakness in the sub-process related to
evaluating debt and equity instruments with conversion privileges to
determine whether or not the instruments had embedded derivative
components. There was a material weakness in the sub-process
related to evaluating certain equity instrument transactions and the
accounting treatment for these non-standard transactions. Both
of these resulted from the fact that our chief financial officer relies
heavily upon financial reporting consultants as it relates to derivative
and non-standard equity
transactions.
|
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,
2009, 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:
|
o
|
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.
|
26
|
o
|
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.
|
|
o
|
Improving
the segregation of duties relating to the processing of accounts and the
recording of journal entries into certain accounts. This improvement is
expected to come based on recommendations from the consulting firm
assessing our internal controls over financial
reporting.
|
This annual report does not include an
attestation report of our public accounting firm regarding internal control over
financial reporting. Management’s report was not subject to
attestation by our registered public accounting firm pursuant to temporary rules
of the Securities and Exchange Commission that permit us to provide only
management’s report in this annual report.
Item
9B. Other Information
None.
27
PART
III
Item
10. Directors, Executive Officers and Corporate Governance
Our
present directors and executive officers are as follows:
Name
|
Age
|
Position
|
Tenure
|
|||
Richard
S. Wade
|
66
|
President,
Chief Executive Officer and Director
|
10
years
|
|||
William
K. Mills
|
51
|
Secretary
and Director
|
10
years
|
|||
David
Braun
|
|
50
|
|
Chief
Financial Officer
|
|
3
years
|
Richard
S. Wade, President, Chief Executive Officer and Director, 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, 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
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.
David
Braun, Chief Financial Officer of VCSY and NOW Solutions
David
Braun is an accountant with over 25 years experience in a wide variety of
accounting and finance roles. His career includes public accounting,
large company internal audit, financial analysis, mergers and acquisitions, SEC
reporting, general accounting and consolidations of both domestic and
international companies. Most recently he was the Corporate
Controller for a plastics injection molding company with plants in the United
States, Mexico and Ireland. Prior to that, he worked for a healthcare
provider where he was responsible for managing 24 employees with accounting
responsibility for over 200 clinics. Previous experience includes
working for a large chemicals manufacturing company where he assisted in
implementing a worldwide version of SAP and created a finance shared services
group for the US and Canada. He is a CPA and a graduate of the
University of Texas at Austin.
28
Significant
Employees of the Company
Luiz
Valdetaro, Chief Technology Officer, 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.
Significant
Employees of NOW Solutions, Inc.
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.
Dorothy
Spotts, Vice President of Services and Support
Ms.
Spotts joined Ross Systems in April 1991 as a Support Analyst in the Customer
Support Department progressing to Operations Manager. Subsequently,
she attained the position of Manager of Integration Services in September
1997. In March 1999, she was promoted to Director of Integration
Services and then became Director of Professional Services in July
2000. Ms. Spotts’ responsibilities include the overall management of
Application Consulting, Integration Services and Customer
Support. Ms. Spotts graduated with a BBA from the University of Texas
at Austin.
Laurent
Tetard, Executive Vice President of International Operations
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.
Robert
Sterpin, Vice President of Sales, Canada & U.S. Midwest
Mr.
Sterpin joined NOW Solutions in 2003. He has a varied background in sales and
sales management starting his career with DEC (HP) and working for several major
corporations such as IBM and Cincom Systems. Mr. Sterpin spent almost 5 years at
Ross Systems where he was Vice President Canada and the U.S. Mid West for their
ERP software product suite. Prior to joining NOW Solutions, he was Vice
President Sales & Marketing for a systems integration/ consulting firm. Mr.
Sterpin majored in Science at the University of Toronto.
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.
29
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 2009.
Code
of Ethics
We have
adopted a Code of Ethics that applies to our Principal Executive Officer,
Principal Accounting Officer and other persons performing similar functions, as
well as all of our other employees and directors. This Code of Ethics
was filed as Exhibit 14.1 to the Form 10-KSB filed for the year ended
December 31, 2003 and was updated in January 2008 with the new address for our
corporate headquarters. 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.
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:
(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; and
(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, 2009. 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.
30
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, 2009 and 2008 to our highest paid executive officers and employees,
who were employed by us during 2009. 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 earned a total annual salary and bonus for any of these
years in excess of $100,000.
SUMMARY
COMPENSATION TABLE
The below
table shows information of compensation of the named officers for the last two
fiscal years:
Annual
Compensation
|
Long-Term
Compensation
|
|||||||||||||||||||||||||||||
Awards
|
Payouts
|
|||||||||||||||||||||||||||||
Name
and
Principal
Position
|
Year
|
Salary
|
Bonus
|
Other
Annual
Compensation
|
Restricted
Stock
Award(s)
|
Options/
SARs
|
LTIP
Payouts
|
All
Other
Compen-
sation
|
||||||||||||||||||||||
($)
|
($)
|
($)
|
($)
|
(#)
|
($)
|
($)
|
||||||||||||||||||||||||
Richard Wade,(1)
|
2009
|
$ | 300,000 |
(1)
|
- | - | - | - | - | - | ||||||||||||||||||||
President
and Chief
|
2008
|
$ | 300,000 | - | - | - | - | - | - | |||||||||||||||||||||
Executive
Officer
|
||||||||||||||||||||||||||||||
- | - | - | - | - | ||||||||||||||||||||||||||
David
Braun
|
2009
|
$ | 130,000 | - | - | - | - | - | ||||||||||||||||||||||
Chief
Financial Officer
|
2008
|
$ | 130,000 | - | - | - | - | - | ||||||||||||||||||||||
Luiz Valdetaro, (2)
|
2009
|
$ | 150,000 | - | - | - | - | - | - | |||||||||||||||||||||
Chief
Technology
|
2008
|
$ | 150,000 | - | - | - | - | - | - | |||||||||||||||||||||
Officer
|
||||||||||||||||||||||||||||||
James Salz (3)
|
2009
|
$ | 110,000 | - | - | - | - | - | - | |||||||||||||||||||||
Corporate
Counsel
|
2008
|
$ | 107,500 | - | - | - | - | - | - |
No stock
options were exercised by the named executive officers during the fiscal year
ended December 31, 2009 or 2008.
(1)
|
Mr.
Wade deferred $25,000, $150,000, $150,000, $154,097, $47,218, $155,270 and
$300,000 of his salary in 2008, 2007, 2006, 2005, 2004, 2003 and 2002,
respectively.
|
(2)
|
Mr.
Valdetaro deferred $23,750, $25,000, $50,269, $86,766, $150,000, and
$137,500 of his salary in 2007, 2006, 2005, 2004 2003, and 2002,
respectively.
|
(3)
|
Mr.
Salz deferred $48,345, $55,000 and $58,333 of his salary in 2004, 2003,
and 2002 respectively.
|
31
Narrative
Disclosure to Summary Compensation Table
Compensation
for our key executives is comprised of three main components: base salary,
annual performance-based cash bonus and long-term equity awards. We do not
target a specific weighting of these three components or use a prescribed
formula to establish pay levels. Rather, the board of directors considers
changes in the business, external market factors and our financial position each
year when determining pay levels and allocating between long-term and current
compensation for the named executive officers.
Cash
compensation is comprised of base salary and an annual performance-based cash
bonus opportunity. The board of directors generally seeks to set a named
executive officer’s targeted total cash compensation opportunity within a range
that is the average of the applicable peer company and/or general industry
compensation survey data, adjusted as appropriate for individual performance and
internal pay equity and labor market conditions.
Where we
have included an equity component as part of our compensation package, we do so
because we believe that equity-based compensation aligns the long-term interests
of our named executive officers with those of stockholders.
These
cash and equity compensation components of pay are supplemented by various
benefit plans that provide health benefits, which are substantially the same as
the benefits provided to all of our U.S. based employees. The Company
also provides life, accident, and disability voluntary benefit plans, which are
plans where employees generally make most or all of the contributions toward the
respective benefit plan.
Employment
Agreements with Executive Officers
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. Mr. Wade is also entitled to an
annual bonus from a bonus pool for executives equal to 5% of our taxable income
(without deduction for depreciation). Mr. Wade’s share of the bonus
pool is equal to the percentage of his annual base compensation to the total of
the combined annual base compensation of all executives in the
pool. 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. Mr. Wade deferred $25,000 of his
salary in 2008.
Outstanding
Equity Awards
The below
table shows information of outstanding equity awards of the named officers at
the end of 2009:
OUTSTANDING
EQUITY AWARDS AT FISCAL YEAR-END
(2009)
|
||||||||||||||||||||||||||||||||||||
Option
Awards(1)
|
Stock
Awards
|
|||||||||||||||||||||||||||||||||||
Name
|
Number
of
Securities
Underlying
Unexercised
Options
(#)
Exercisable
|
Number
of
Securities
Underlying
Unexercised
Options
(#)
non-
exercisable
|
Equity
Incentive
Plan
Awards:
Number
of
Securities
Underlying
Unexercised
Unearned
Options
(#)
|
Option
Exercise
Price
($)
|
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
($)
|
Equity
Incentive
Plan
Awards:
Number
of
Unearned
Shares,
Units
or
Other
Rights
That
Have
Not
Vested
(#)
|
Equity
Incentive
Plan
Awards:
Market
or
Payout
Value
of
Unearned
Shares,
Units
or
Other
Rights That
Have
Not
Vested
($)
|
|||||||||||||||||||||||||||
|
||||||||||||||||||||||||||||||||||||
David
Braun
Chief Financial
Officer (2)
|
- | - | - | - | 266,667 | - | - |
32
|
(1)
|
In
December 2009, a stock option plan (the “Stock Option Plan”) whereby we
could grant both Incentive Stock Options (within the meaning of Section
422 and the Internal Revenue Code of 1986, as amended) and non-statutory
options, expired.
|
|
(2)
|
Pursuant
to a restricted stock agreement with the Company, Mr. Braun, the CFO of
the Company, was issued 800,000 unregistered shares of our common stock
(at a fair market value of $16,800 in March 2007 based upon the total
number of shares granted and the share price on the date of the grant),
vesting over three years in three equal installments, of which 533,333
shares had vested at December 31, 2009. As of April 14, 2010,
all shares have vested.
|
Narrative
Disclosure to Outstanding Equity Awards at Fiscal Year End Table
Stock Option Plan. The Stock
Option Plan, whereby we were able to issue up to 50,000,000 shares (adjusted
post stock split) has expired. We issued no stock options to any employees or
any other parties in 2009 and do not have any stock options
outstanding.
Stock Awards. The
common stock issued to Mr. Braun is granted on the same terms as the stock
issued to other employees of the Company and its subsidiaries. The
restricted stock agreements generally provide for the stock to vest over a 1 or
3 year period. In the event the employee is terminated without cause,
a portion of the remaining unvested stock will vest on a pro-rata
basis.
For
further information regarding securities authorized for issuance under Equity
Compensation Plans, and the equity compensation plan information table, please
see Part II, “Item 5: Market for Common Equity and Related Stockholder
Matters.”
Director
Compensation
The below
table provides compensation for all non-employee directors in 2009:
DIRECTOR COMPENSATION
|
||||||||||||||||||||||||||||
Name
|
Fees
Earned
or
Paid in
Cash
|
Stock
Awards
|
Option
Awards
|
Non-Equity
Incentive
Plan
Compensation
|
Nonqualified
Deferred
Compensation
Earnings
|
All
Other
Compensation
|
Total
|
|||||||||||||||||||||
($)
|
($)
|
($)
|
($)
|
($)
|
(#)
|
($)
|
||||||||||||||||||||||
William
Mills
|
30,000 |
(1)
|
- | - | - | - | 30,000 |
(1)
|
In
February 2008, we issued 250,000 shares of our common stock to Mr. Mills
pursuant to a restricted stock agreement which provided for vesting at 1
year. All of these shares had vested at December 31,
2009. .
|
Narrative
Disclosure to Director Compensation Table
No
options or warrants were granted as director compensation during the fiscal
years ended 2008 or 2009. Non-employee directors are entitled to
receive $2,500 per month in 2008 and 2009. Mr. Mills was issued
250,000 shares of our common stock in February 2008. All of these
shares have vested.
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 14, 2010, 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 998,935,151
shares of common stock outstanding as of April 14, 2010, together with options,
warrants or other securities convertible or exchangeable by the beneficial
owners into shares of common stock within 60 days of April 14,
2010.
33
Title
of
Class
|
Name
and Address of Beneficial Owner(1)
|
Shares
of
Common Stock Beneficially
Owned
|
Percent
of
Class
|
|||||||
Common
|
Richard
Wade
|
95,190,206 |
(2)
|
9.53 | % | |||||
Common
|
William
K. Mills
|
283,333 |
(3)
|
* | ||||||
Common
|
David
Braun
|
1,000,000 |
(4)
|
* | ||||||
Common
|
All
Directors and Executive Officers as a group
(3
persons)
|
96,473,539 | 9.66 | % |
*
|
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
88,870,050 shares owned by MRC,
a corporation controlled by the W5 Family Trust, of which Richard W. Wade
is a trustee. MRC pledged 10,000,000 shares of our common stock
as collateral on a $25,000 note issued in August 2002. MRC
pledged 4,000,000 and 3,000,000 shares of our common stock as collateral
on a $60,000 note and a $40,000 note, respectively, that were issued by us
in November 2003. MRC pledged 5,000,000 shares of our common
stock as collateral on a $200,000 note issued in October 2006 to Mr.
Weber. Also in October 2006, MRC pledged 5,000,000 shares of
our common stock as collateral on a $215,000 note issued by NOW Solutions
to us and assigned to Mr. Weber in October 2005. MRC pledged
10,000,000 shares of our common stock as collateral on a $300,000 note
issued in March 2007 to Mr. Weber and as collateral on the interest
payments due under the $200,000 note issued in October 2006. MRC pledged
3,000,000 shares of our common stock as collateral on a $96,946 note
issued in February 2008 to a third party lender. In
November 2008, the lender sold 1,500,000 shares for $118,167, of which
$103,555 was applied to outstanding debt claimed by the lender including
interest, penalties & attorney’s fees and the remaining $14,612 was
returned to MRC representing the amount of shares oversold by the
lender. Of the 1,500,000 shares sold by the lender, we are
currently obligated to reimburse MRC with 1,309,983 common
shares. In March 2010, the Company and MRC entered into an
amendment of an indemnity and reimbursement agreement whereby the
obligation to reimburse MRC with 10,000,000 common shares that were loaned
to the Company in March 2008 was cancelled in exchange for the Company’s
transfer of 300,000 shares VHS Series A Preferred Stock owned by the
Company to MRC. For more details, please refer to “Subsequent Events” in
Note 15 of the Notes to the Financial Statements. MRC is a corporation
controlled by the W5 Family Trust. Mr. Wade, our President and CEO, is the
trustee of the W5 Family Trust.
|
(3)
|
Includes
250,000 shares of our common stock issued in February 2008 by us to Mr.
Mills pursuant to a restricted stock agreement in connection with services
as a director and officer of the Company. All of these shares
have vested
|
|
.
|
(4)
|
Includes
800,000 shares of our common stock issued in March 2007 by us to Mr. Braun
pursuant to a restricted stock agreement in connection with services as an
officer of the Company. All of these shares have
vested. Also includes 200,000 shares of our common stock that
were issued pursuant to a restricted stock agreement that vested in
2007.
|
Item
13. Certain Relationships and Related Transactions, and Director
Independence
Certain
Relationships and Related Transactions
In
February 2008, MRC pledged 3,000,000 shares of our common stock to secure a
$96,946 promissory note issued to a third party lender. In
November 2008, the lender sold 1,500,000 shares of the pledged stock for
$118,167, of which $103,555 was applied to outstanding debt claimed by the
lender including interest, penalties & attorney’s fees. The
remaining $14,612 was returned to MRC representing the amount of shares oversold
by the lender. Of the 1,500,000 shares sold by the lender, the
Company became obligated to reimburse MRC with 1,309,983 shares in November 2009
(within 1 year of the sales of the pledged shares). For additional
details on the $96,946 note and the pledge of stock, please see “Notes
Payable” under Note 8 in the Notes to Consolidated Financial
Statements.
In May
2008, Robert Farias assigned the rights to PASS to us pursuant to an agreement,
which was sublicensed to VHS. VHS and Farias-Jett, a sole proprietorship of Mr.
Farias, entered into a distributor agreement for PASS whereby Mr. Farias would
market PASS to his existing clients. In October 2008, VHS entered
into a consulting agreement with Farias-Jett and an employment agreement with
Mr. Farias. Also in October 2008, NOW Solutions entered into a hosted
service provider agreement with Robert Farias for emPath®. Robert Farias is an
employee of VHS and a director of NOW Solutions.
34
In
February 2009, Robert Farias notified us of his intent to exercise warrants
to purchase 15,000,000 shares of our common stock at an average exercise price
of $0.02 per share. In March 2010, the Company and Robert Farias
entered into an agreement whereby Mr. Farias agreed to cancel warrants to
purchase 15,000,000 common shares and $100,000 in debt and to waive his rights
to convert 37,500 shares of our Series C Preferred Stock into 15,000,000 common
shares in exchange for the Company’s transfer to Mr. Farias of 610,000 shares of
VHS Series A Preferred Stock owned by the Company. Mr. Farias is an
employee of VHS and a Director of NOW Solutions. For more details,
please refer to “Subsequent Events” in Note 15 of the Notes to the Financial
Statements.
In
December 2009, we entered into a settlement agreement and stipulated judgment
with PSM in connection with a lawsuit filed in August 2009, whereby the parties
agreed to a judgment balance of $68,500, which included principal, accrued
interest, late fees and attorneys’ fees, and we agreed to make monthly
installment payments. Bill Mills is a Director of the Company and a
partner of PSM, which was formerly known as Parker Mills, LLP (the successor
entity to Parker Mills Morin, LLP and Parker Mills & Patel,
LLP). For additional details, please see “Litigation” under
Note 14 in the Notes to the Consolidated Financial Statements.
In January 2010, the Company and MRC
amended the indemnity and reimbursement agreement (originally entered into in
April 2007) whereby the Company agreed to reimburse and indemnify MRC for
16,976,296 shares pledged in November 2009 as collateral in connection with a
$150,000 note. MRC is a corporation controlled by the W5 Family
Trust. Mr. Wade, the President and CEO of the Company, is the trustee
of the W5 Family Trust.
In March
2010, the Company and MRC entered into an amendment of an indemnity and
reimbursement agreement whereby the obligation to reimburse MRC with 10,000,000
common shares that were loaned to the Company in March 2008 was cancelled in
exchange for the Company’s transfer to MRC of 300,000 shares of VHS Series A
Preferred Stock owned by the Company. MRC is a corporation controlled
by the W5 Family Trust. Mr. Wade, our President and CEO, is the trustee of the
W5 Family Trust. For more details, please refer to “Subsequent
Events” in Note 15 of the Notes to the Financial Statements.
In March
2010, the Company and Luiz Valdetaro entered into an amendment of two indemnity
and reimbursement agreements whereby the obligation to reimburse Mr. Valdetaro
in respect of an aggregate 3,000,000 common shares that were transferred to
third parties on behalf of the Company (in connection with certain extensions of
loans of the Company in April 2008) was cancelled in exchange for the Company’s
transfer of 90,000 shares of VHS Series A Preferred Stock owned by the
Company. Mr. Valdetaro is our Chief Technology
Officer. For more details, please refer to “Subsequent Events” in
Note 15 of the Notes to the Financial Statements.
Director
Independence; Board Leadership Structure
The
Company’s common stock is quoted through the OTC Bulletin Board
System. 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.
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.
35
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 $123,750 and
$167,815 for the audit of our annual financial statements for 2009 and 2008,
which included the reviews of the financial statements in our Forms 10-QSB
for the applicable fiscal years.
Tax
Fees. The principal accounting firm of MaloneBailey did not
provide any tax services in 2009 and 2008. The aggregate fees billed
in the fiscal years ended 2009 and 2008 for professional services rendered by
Hartman, Leito, and Bolt, LLP for tax advice, tax planning and tax return
preparation were $18,872 and $22,100. In addition, BDO Dunwoody LLP in Toronto
billed $8,851 and $12,592 in Canadian dollars for tax advice, tax planning and
tax return preparation for the years ended 2009 and 2008,
respectively. Dickstein Shapiro Moran & Oshinsky LLP billed
$26,482 and $28,842 and for tax advice and tax planning for the years ended 2009
and 2008, respectively
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 2009 and 2008.
36
PART
IV
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-KSB filed on April
14, 2006
|
||
3.1
|
Original
Unamended Certificate of Incorporation of Vertical Computer Systems, Inc.
(f/k/a Xenogen Technology, Inc.)
|
Incorporated
by reference to Exhibit 3.1 to the Company’s Form 10-KSB filed on April
14, 2006
|
||
3.2
|
Certificate
of Amendment of Certificate of Incorporation (change name to Vertical
Computer Systems, Inc.)
|
Incorporated
by reference to Exhibit 3.2 to the Company’s Form 10-KSB filed on April
14, 2006
|
||
3.3
|
Certificate
of Amendment of Certificate of Incorporation (2000)
|
Incorporated
by reference to Exhibit 3.3 to the Company’s Form 10-KSB filed on April
14, 2006
|
||
3.4
|
Amended
and Restated By-Laws of the Company
|
Incorporated
by reference to Exhibit 3.4 to the Company’s Form 10-KSB filed on April
14, 2006
|
||
4.1
|
Certificate
of Designation of 4% Cumulative Redeemable Series A Preferred
Stock
|
Incorporated
by reference to Exhibit 4.1 to the Company’s Form 10-KSB filed on April
14, 2006
|
||
4.2
|
Certificate
of Designation of 10% Cumulative Redeemable Series B Preferred
Stock
|
Incorporated
by reference to Exhibit 4.2 to the Company’s Form 10-KSB filed on April
14, 2006
|
||
4.3
|
Certificate
of Designation of 4% Cumulative Redeemable Series C Preferred
Stock
|
Incorporated
by reference to Exhibit 4.3 to the Company’s Form 10-KSB filed on April
14, 2006
|
||
4.4
|
Certificate
of Designation of 15% Cumulative Redeemable Series D Preferred
Stock
|
Incorporated
by reference to Exhibit 4.4 to the Company’s Form 10-KSB filed on April
14, 2006
|
||
4.5
|
Form
of Warrant
|
Provided
herewith
|
||
4.6
|
Form
of Restricted Stock Agreement
|
Incorporated
by reference to Exhibit 4.7 to the Company’s Form 10-KSB filed on April
14, 2006
|
||
10.1
|
1999
Stock Option Plan of the Company
|
Incorporated
by reference to Exhibit 10.1 to the Company’s Form 10-KSB filed on April
14, 2006
|
||
10.2
|
Promissory
Note, dated August 30, 2002, between the Company and a third party
lender
|
Incorporated
by reference to Exhibit 10.2 to the Company’s Form 10-KSB filed
on April 17, 2007
|
||
10.3
|
Form
of Debenture
|
Incorporated
by reference to Exhibit 10.3 to the Company’s Form 10-KSB filed
on April 17, 2007
|
||
10.4
|
Employment
Agreement as of December 1, 2001 between the Company and Richard
Wade
|
Incorporated
by reference to Exhibit 10.6 to the Company’s Form 10-KSB filed
on April 17, 2007
|
37
Exhibit
No.
|
Description
|
Location
|
||
10.5
|
Letter
Payout Agreement, dated August 24, 2004 entered into by the
Company.
|
Incorporated
by reference to Exhibit 99.1 to the Company’s Form 8-K filed on August 31,
2005
|
||
10.6
|
Form
of Agreed Judgment
|
Incorporated
by reference to Exhibit 99.2 to the Company’s Form 8-K filed on August 31,
2005
|
||
10.7
|
Settlement
Agreement and Promissory Note, dated October 19, 2005 between the Company
and Parker Mills Morin, LLP
|
Incorporated
by reference to Exhibit 10.41 to the Company’s Form 10-KSB filed on April
14, 2006
|
||
10.8
|
Amended
and Restated Term Secured Promissory Note in the principal amount of
$600,000.00, payable by NOW Solutions to Taladin, Inc.
|
Incorporated
by reference to Exhibit 10.1 to the Company’s Form 8-K filed on February
24, 2006
|
||
10.9
|
Secured
Term Promissory Note in the principal amount of $450,000.00, payable by
Taladin, Inc. to Tara Financial Services, Inc.
|
Incorporated
by reference to Exhibit 10.2 to the Company’s Form 8-K filed on February
24, 2006
|
||
10.10
|
Secured
Term Promissory Note in the principal amount of $150,000.00, payable by
Taladin, Inc. to Strategic Growth Partners, Inc.
|
Incorporated
by reference to Exhibit 10.3 to the Company’s Form 8-K filed on February
24, 2006
|
||
10.11
|
Agreement
dated as of February 13, 2006 among Tara Financial Services, Inc., as
lender, NOW Solutions, the Company, Robert Farias, and Robert
Mokhtarian
|
Incorporated
by reference to Exhibit 10.4 to the Company’s Form 8-K filed on February
24, 2006
|
||
10.12
|
Secured
Term Promissory Note in the principal amount of $359,559.90,
payable by NOW Solutions to Tara Financial Services, Inc.
|
Incorporated
by reference to Exhibit 10.5 to the Company’s Form 8-K filed on February
24, 2006
|
||
10.13
|
Secured
Term Promissory Note in the principal amount of $438,795.31,
payable by the Company to Tara Financial Services, Inc.
|
Incorporated
by reference to Exhibit 10.6 to the Company’s Form 8-K filed on February
24, 2006
|
||
10.14
|
Secured
Term Promissory Note in the principal amount of $955,103.30,
payable by NOW Solutions to Tara Financial Services, Inc.
|
Incorporated
by reference to Exhibit 10.7 to the Company’s Form 8-K filed on February
24, 2006
|
||
10.15
|
Secured
Term Promissory Note, dated October 27, 2006, in the principal amount of
$100,000, payable by Taladin to Victor T. Weber.
|
Incorporated
by reference to Exhibit 10.46 to the Company’s Form 10-KSB
filed on April 17, 2007
|
||
14.1
|
Code
of Ethics
|
Incorporated
by reference to Exhibit 21.1 to the Company’s Form 10-KSB filed
on April 22, 2008
|
||
21.1
|
Subsidiaries
of the Company
|
Provided
herewith
|
38
Exhibit
No.
|
Description
|
Location
|
||
31.1
|
Certification
of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002, dated April 14, 2010
|
Provided
herewith
|
||
31.2
|
Certification
of Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002, dated April 14, 2010
|
Provided
herewith
|
||
32.1
|
Certification
of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, dated April 14, 2010
|
Provided
herewith
|
||
32.2
|
|
Certification
of Chief Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, dated April 14, 2010
|
|
Provided
herewith
|
39
SIGNATURES
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
14, 2010
|
By:
|
/s/ Richard Wade | |
Richard
Wade, President and
|
|||
Chief
Executive Officer
|
|||
April
14, 2010
|
By:
|
/s/ David Braun | |
David
Braun
|
|||
Chief
Financial 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
14, 2010
|
By:
|
/s/ Richard Wade | |
Richard
Wade, Director
|
|||
April
14, 2010
|
By:
|
/s/ William Mills | |
William
Mills, Director
|
40
VERTICAL
COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS
Report
of Independent Registered Public Accounting Firm
|
F-2
|
|
Consolidated
Financial Statements
|
||
Consolidated
Balance Sheets
|
F-3
|
|
Consolidated
Statements of Operations
|
F-4
|
|
Consolidated
Statements of Stockholders’ Deficit
|
F-5
|
|
Consolidated
Statements of Cash Flows
|
F-7
|
|
Notes
to Consolidated Financial Statements
|
F-8
|
F-1
Report
of Independent Registered Public Accounting Firm
Board of
Directors
Vertical
Computer Systems, Inc.
Richardson,
Texas
We have
audited the accompanying consolidated balance sheets of Vertical Computer
Systems, Inc. as of December 31, 2009 and December 31, 2008 and the related
consolidated statements of operations, 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 financial statements referred to above present fairly, in all
material respects, the financial position of Vertical Computer Systems, Inc. as
of December 31, 2009 and December 31, 2008 and the results of operations and
cash flows for the years then ended, in conformity with accounting principles
generally accepted in the United States of America.
The
accompanying financial statements have been prepared assuming that Vertical
Computer Systems, Inc. will continue as a going concern. As discussed in Note 2
to the financial statements, Vertical Computer Systems, Inc. suffered losses
from operations 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 financial statements
do not include any adjustments that might result from the outcome of this
uncertainty.
MaloneBailey,
LLP
www.malone-bailey.com
Houston,
Texas
April 14,
2010
F-2
VERTICAL
COMPUTER SYSTEMS, INC.
CONSOLIDATED
BALANCE SHEETS
December 31,
|
December 31,
|
|||||||
2009
|
2008
|
|||||||
Assets
|
||||||||
Current
assets:
|
||||||||
Cash
|
$ | 229,738 | $ | 255,774 | ||||
Accounts
receivable, net of allowance for bad debts of $30,594 and
$313,281
|
783,219 | 277,592 | ||||||
Employee
receivables, net of allowance for doubtful accounts of
$13,820
|
7,380 | 9,183 | ||||||
Prepaid
expenses and other current assets
|
67,830 | 59,551 | ||||||
Total
current assets
|
1,088,167 | 602,100 | ||||||
Property
and equipment, net of accumulated depreciation of $967,520 and
$1,024,064
|
30,973 | 59,311 | ||||||
Intangible
assets
|
109,731 | - | ||||||
Deposits
and other assets
|
12,533 | 19,705 | ||||||
Total
assets
|
$ | 1,241,404 | $ | 681,116 | ||||
Liabilities
and Stockholder’s Deficit
|
||||||||
Current
liabilities:
|
||||||||
Accounts
payable and accrued liabilities
|
$ | 6,397,575 | $ | 7,354,544 | ||||
Deferred
revenue
|
2,404,680 | 2,359,394 | ||||||
Derivative
liabilities
|
484,859 | 433,669 | ||||||
Current
portion-convertible debentures
|
40,000 | 40,000 | ||||||
Current
portion-notes payable
|
1,596,853 | 3,289,515 | ||||||
Current
portion-notes payable to related parties
|
359,903 | 284,356 | ||||||
Total
current liabilities
|
11,283,870 | 13,761,478 | ||||||
Non-current
portion – notes payable
|
1,405,302 | 1,781,538 | ||||||
Non-current
portion – notes payable to related parties
|
59,783 | - | ||||||
Total
liabilities
|
12,748,955 | 15,543,016 | ||||||
Series
A 4% Convertible Cumulative Preferred stock; $0.001 par value; 250,000
shares authorized; 48,500 shares issued and outstanding;
|
9,700,000 | 9,700,000 | ||||||
Series
B 10% Convertible Cumulative Preferred stock; $0.001 par value; 375,000
shares authorized; 7,200 shares issued and outstanding;
|
246 | 246 | ||||||
Series
C 4% Convertible Cumulative Preferred stock; $100 par value; 200,000
shares authorized; 50,000 shares issued and outstanding;
|
350,000 | 350,000 | ||||||
Series
D 15% Convertible Cumulative Preferred stock; $0.001 par value; 300,000
shares authorized; 25,000 shares issued and outstanding;
|
852 | 852 | ||||||
10,051,098 | 10,051,098 | |||||||
Stockholders’
Deficit
|
||||||||
Common
stock: $.00001 par value, 1,000,000,000 shares authorized 998,251,818 and
995,668,482 shares issued and outstanding
|
9,983 | 9,957 | ||||||
Additional
paid-in capital
|
18,630,472 | 18,535,965 | ||||||
Accumulated
deficit
|
(40,155,719 | ) | (43,660,257 | ) | ||||
Accumulated
other comprehensive income – foreign currency translation
|
(40,537 | ) | 201,337 | |||||
Total
Vertical Computer Systems, Inc. stockholders’ deficit
|
(21,555,801 | ) | (24,912,998 | ) | ||||
Noncontrolling
interest
|
(2,848 | ) | - | |||||
Total
stockholders’ deficit
|
(21,558,649 | ) | (24,912,998 | ) | ||||
Total
liabilities and stockholders’ deficit
|
$ | 1,241,404 | $ | 681,116 |
See
accompanying notes to consolidated financial statements
F-3
VERTICAL
COMPUTER SYSTEMS, INC.
CONSOLIDATED
STATEMENTS OF OPERATIONS
Years ended December 31,
|
||||||||
2009
|
2008
|
|||||||
Revenues
|
||||||||
Licensing
and software
|
$ | 213,913 | $ | 2,955,219 | ||||
Software
maintenance
|
4,469,991 | 4,752,090 | ||||||
Consulting
services
|
453,027 | 412,552 | ||||||
Hosting
and Software as a Service
|
137,893 | 91,441 | ||||||
Other
|
124,988 | 46,685 | ||||||
Total
Revenues
|
5,399,812 | 8,257,987 | ||||||
Cost
of Revenues
|
1,565,372 | 1,159,319 | ||||||
Gross
Margin
|
3,834,440 | 7,098,668 | ||||||
Selling,
general and administrative expenses
|
4,886,583 | 6,435,651 | ||||||
Depreciation
and amortization
|
41,623 | 57,775 | ||||||
Bad
debt (recovery) expense
|
(124,642 | ) | 13,820 | |||||
Gain
on settlement of trade payables
|
(121,020 | ) | (514,518 | ) | ||||
Operating
expenses
|
4,682,544 | 5,992,728 | ||||||
Operating
income (loss)
|
(848,104 | ) | 1,105,940 | |||||
(Loss)
on derivative
|
(51,190 | ) | (38,530 | ) | ||||
Gain
on settlement of litigation
|
4,799,093 | - | ||||||
Interest
income
|
133,574 | 2,558 | ||||||
Interest
expense
|
(538,683 | ) | (874,635 | ) | ||||
Net
income
|
3,494,690 | 195,333 | ||||||
Net
loss attributable to noncontrolling interest
|
9,848 | - | ||||||
Net
income attributable to Vertical Computer Systems, Inc.
|
3,504,538 | 195,333 | ||||||
Dividend
applicable to preferred stock
|
(588,000 | ) | (588,000 | ) | ||||
Net
income (loss) applicable to common stockholders
|
$ | 2,916,538 | $ | (392,667 | ) | |||
Basic
and diluted loss per share
|
$ | 0.00 | $ | (0.00 | ) | |||
Basic
weighted average common shares outstanding
|
997,572,824 | 994,476,951 | ||||||
Diluted
weighted average common shares outstanding
|
1,003,039,623 | 994,476,951 | ||||||
Comprehensive
income:
|
||||||||
Net
income
|
$ | 3,494,690 | $ | 195,333 | ||||
Translation
adjustments
|
(241,874 | ) | 89,670 | |||||
Comprehensive
income
|
3,252,816 | 285,003 | ||||||
Comprehensive
loss attributable to noncontrolling interest
|
9,848 | - | ||||||
Comprehensive
income attributable to Vertical Computer Systems, Inc.
|
$ | 3,262,664 | $ | 285,003 |
See
accompanying notes to consolidated financial statements
F-4
VERTICAL
COMPUTER SYSTEMS, INC.
STATEMENTS
OF CONSOLIDATED STOCKHOLDERS’ DEFICIT
YEARS
ENDED DECEMBER 31, 2009 AND 2008
Additional
|
Other
|
|||||||||||||||||||||||
Common Stock
|
Paid-in
|
Accumulated
|
Comprehensive
|
|||||||||||||||||||||
Shares
|
Amount
|
Capital
|
Deficit
|
Income
|
Total
|
|||||||||||||||||||
Balances
at December 31, 2007
|
991,485,149 | $ | 9,915 | $ | 18,474,591 | $ | (43,855,590 | ) | $ | 111,667 | $ | (25,259,417 | ) | |||||||||||
Issuance
of restricted stock for services, net of cancellations
|
3,183,333 | 32 | 45,134 | - | - | 45,166 | ||||||||||||||||||
Shares
issued in association with renegotiated notes payable
|
750,000 | 7 | 12,743 | - | - | 12,750 | ||||||||||||||||||
Shares
issued for services
|
250,000 | 3 | 3,497 | - | - | 3,500 | ||||||||||||||||||
Other
comprehensive income translation adjustment
|
- | - | - | - | 89,670 | 89,670 | ||||||||||||||||||
Net
income
|
- | - | - | 195,333 | - | 195,333 | ||||||||||||||||||
Balances
at December 31, 2008
|
995,668,482 | $ | 9,957 | $ | 18,535,965 | $ | (43,660,257 | ) | $ | 201,337 | $ | (24,912,998 | ) |
See
accompanying notes to consolidated financial statements
F-5
VERTICAL
COMPUTER SYSTEMS, INC.
STATEMENTS
OF CONSOLIDATED STOCKHOLDERS’ DEFICIT
YEARS
ENDED DECEMBER 31, 2009 AND 2008
Additional
|
Other
|
Non-
|
||||||||||||||||||||||||||
Common Stock
|
Paid-in
|
Accumulated
|
Comprehensive
|
controlling
|
||||||||||||||||||||||||
Shares
|
Amount
|
Capital
|
Deficit
|
Interest
|
Interest
|
Total
|
||||||||||||||||||||||
Balances
at December 31, 2008
|
995,668,482 | $ | 9,957 | $ | 18,535,965 | $ | (43,660,257 | ) | $ | 201,337 | $ | - | $ | (24,912,998 | ) | |||||||||||||
Issuance
of restricted stock for services, net of forfeitures
|
2,583,336 | 26 | 94,507 | 94,533 | ||||||||||||||||||||||||
Noncontrolling
interest from acquisition of Priority Time Systems,
Inc.
|
7,000 | 7,000 | ||||||||||||||||||||||||||
Other
comprehensive income Translation adjustment
|
(241,874 | ) | (241,874 | ) | ||||||||||||||||||||||||
Net
income
|
3,504,538 | (9,848 | ) | 3,494,690 | ||||||||||||||||||||||||
Balances
at December 31, 2009
|
998,251,818 | $ | 9,983 | $ | 18,630,472 | $ | (40,155,719 | ) | $ | (40,537 | ) | $ | (2,848 | ) | $ | (21,558,649 | ) |
See
accompanying notes to consolidated financial statements
F-6
VERTICAL
COMPUTER SYSTEMS, INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
Years ended December 31,
|
||||||||
2009
|
2008
|
|||||||
Cash
flows from operating activities:
|
||||||||
Net
income
|
$ | 3,494,690 | $ | 195,333 | ||||
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
||||||||
Depreciation
and amortization
|
41,623 | 57,775 | ||||||
Amortization
of debt discount
|
16,812 | 22,416 | ||||||
Stock
compensation
|
94,533 | 59,370 | ||||||
Shares
issued for extended and renegotiated debt
|
- | 12,750 | ||||||
Non-cash
portion of gain on settlement of litigation
|
(1,112,877 | ) | - | |||||
Loss
on derivatives
|
51,190 | 38,530 | ||||||
Bad
debt (recovery) expense
|
(124,642 | ) | 13,820 | |||||
Gain
on settlement of trade payables
|
(121,020 | ) | (514,518 | ) | ||||
Changes
in operating assets and liabilities:
|
||||||||
Accounts
receivable
|
(380,985 | ) | 685,180 | |||||
Receivable
from officers and employees
|
1,803 | 2,411 | ||||||
Prepaid
expense and other assets
|
(1,107 | ) | (43,401 | ) | ||||
Accounts
payable and accrued liabilities
|
(354,190 | ) | 333,923 | |||||
Deferred
revenue
|
45,286 | (418,210 | ) | |||||
Net
cash provided by operating activities
|
1,651,116 | 445,379 | ||||||
Cash
flows from investing activities:
|
||||||||
Acquisition
of Priority Time Systems, Inc., net of cash received
|
(24,999 | ) | - | |||||
Purchase
of equipment
|
(53,017 | ) | (36,378 | ) | ||||
Net
cash used in investing activities
|
(78,016 | ) | (36,378 | ) | ||||
Cash
flows from financing activities:
|
||||||||
Payment
of notes payable
|
(1,677,262 | ) | (411,477 | ) | ||||
Proceeds
from issuance of notes payable
|
320,000 | 37,160 | ||||||
Net
cash used in financing activities
|
(1,357,262 | ) | (374,317 | ) | ||||
Effect
of changes in exchange rates on cash
|
(241,874 | ) | 89,670 | |||||
Net
increase in cash and cash equivalents,
|
(26,036 | ) | 124,354 | |||||
Cash
and cash equivalents, beginning of
period
|
255,774 | 131,420 | ||||||
Cash
and cash equivalents, end of period
|
$ | 229,738 | $ | 255,774 |
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 administrative 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
wholly subsidiaries, EnFacet, Inc. (“ENF”), Globalfare.com, Inc.
(“GFI”),
Pointmail.com, Inc. (“PMI”) and Vertical
Internet Solutions (“VIS”), all of which
are inactive; Vertical Healthcare Solutions (“VHS”), OptVision
Research, Inc. (“OVR”),Taladin, Inc.
(“Taladin”),
Government Internet Systems, Inc. (“GIS”), Priority Time
Systems, Inc. (“PTS”) a 90% owned
subsidiary, all entities with minor activities and NOW Solutions, Inc. (“NOW Solutions”). To
date, we have generated revenues primarily from software licenses, consulting
fees and maintenance agreements from NOW Solutions, our 100% owned
subsidiary, 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 method of accounting.
Cash
and Cash Equivalents
Cash
equivalents are highly liquid investments with an original maturity of three
months or less.
Revenue
Recognition
Our
revenue recognition policies are in accordance with standards on software
revenue recognition, which includes guidance on revenue arrangements with
multiple deliverables and arrangements that include the right to use of software
stored on another entity’s hardware.
In the
case of non-software arrangements, we apply the guidance on revenue arrangements
with multiple deliverables and wherein multiple elements are allocated to each
element based on the element’s relative fair value. Revenue allocated to
separate elements is recognized for each element in accordance with our
accounting policies described below. If we cannot account for items included in
a multiple-element arrangement as separate units of accounting, they are
combined and accounted for as a single unit of accounting and generally
recognized as the undelivered items or services are provided to the
customer.
Consulting. We provide
consulting services, primarily implementation and training services, to our
clients using a time and materials pricing methodology. The Company prices its
delivery of consulting services on a time and materials basis where the customer
is either charged an agreed-upon daily rate plus out-of-pocket expenses or an
hourly rate plus out-of-pocket expenses. In this case, the Company is paid fees
and other amounts generally on a monthly basis or upon the completion of the
deliverable service and recognizes revenue as the services are
performed.
Software
License. We sell concurrent perpetual software licenses to our
customers. The license gives the customer the right to use the software without
regard to a specific term. We recognize the license revenue upon
execution of a contract and delivery of the software, provided the license fee
is fixed and determinable, no significant production, modification or
customization of the software is required and collection is considered probable
by management. When the software license arrangement requires the Company to
provide consulting services that are essential to the functionality of the
software, the product license revenue is recognized upon the acceptance by the
customer and consulting fees are recognized as services are
performed.
F-8
VERTICAL
COMPUTER SYSTEMS, INC.
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.
Software as a Service (“SaaS”). 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 SaaS. 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 SaaS can enter into an agreement to purchase a
software license at any time. We generate revenue from SaaS as the
customer utilizes the software over the Internet.
We will
provide consulting services to customers in conjunction with SaaS. 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 the SaaS functionality, 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 SaaS services are rendered each
month.
F-9
VERTICAL
COMPUTER SYSTEMS, INC.
Valuation of the Embedded and Warrant Derivatives
The
valuation of our embedded derivatives and warrant derivatives is determined
primarily by the Black-Scholes option pricing model and the Lattice model. An
embedded derivative is a derivative instrument that is embedded within another
contract, which under the 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, these
embedded derivatives are marked-to-market each reporting period, with a
corresponding non-cash gain or loss charged to the current period. A warrant
derivative liability is determined in accordance with the guidance on derivative
financial instruments indexed to, and potentially settled in, a company’s own
stock. Based on this guidance, warrants which are determined to be classified as
derivative liabilities 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.
To
determine the fair value of our embedded derivatives, management evaluates
assumptions regarding the probability of certain future events. Other factors
used to determine fair value include our period end stock price, historical
stock volatility, risk free interest rate and derivative term. 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.
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.
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 2009 and 2008, there was no impairment of long-lived assets
due to the minimal value of such 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, and the fair value
of stock options is determined using the Black-Scholes valuation
model.
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
$30,594 and $313,281 as of December 31, 2009 and 2008,
respectively.
Included
in our allowance for doubtful accounts in 2008 is a full reserve for a $110,085
receivable related to an amount due from Ross (see the Litigation section under
Note 14).
F-10
VERTICAL
COMPUTER SYSTEMS, INC.
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 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, 2009 and
2008.
Earnings
Per Share
Basic earnings per share is calculated
by dividing net income 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, 2009
|
Year Ended December 31, 2008
|
|||||||||||||||||||||||
Net Income
(Numerator)
|
Shares
(Denominator)
|
Per Share
Amount
|
Net (Loss)
(Numerator)
|
Shares
(Denominator)
|
Per
Share
Amount
|
|||||||||||||||||||
Basic
EPS
|
$ | 2,916,538 | 997,572,824 | $ | 0.00 | $ | (392,677 | ) | 994,476,951 | $ | (0.00 | ) | ||||||||||||
Effect
of dilutive securities
|
||||||||||||||||||||||||
Warrants
& Restricted Stock
|
- | 5,466,799 | 0.00 | - | - | - | ||||||||||||||||||
Diluted
EPS
|
$ | 2,916,538 | 1,003,039,623 | $ | 0.00 | $ | (392,677 | ) | 994,476,951 | $ | (0.00 | ) |
As of
December 31, 2009, common stock equivalents related to the convertible
debentures, convertible debt and preferred stock and stock derivative liability
totaling 73,976,565 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 and cash equivalents,
accounts receivable 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. See Note 5 – Derivative instruments and
fair value measurements for additional information.
F-11
VERTICAL
COMPUTER SYSTEMS, INC.
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.
Recently
Issued Accounting Pronouncements
During
the third quarter of 2009, we adopted The FASB Accounting Standards
Codification (ASC or Codification) and the Hierarchy of Generally Accepted
Accounting Principles (GAAP) which establishes the Codification as the
sole source for authoritative U.S. GAAP and will supersede all accounting
standards in U.S. GAAP, aside from those issued by the SEC. The adoption of the
Codification did not have an impact on our results of operations, cash flows or
financial position. Since the adoption of the Accounting Standards Codification
(ASC) our notes to the consolidated financial statements will no longer
make reference to Statement of Financial Accounting Standards (SFAS) or
other U.S. GAAP pronouncements.
Effective
January 1, 2009, we adopted new accounting guidance for determining whether an
instrument or an embedded feature is indexed to our own stock. The
new guidance provides that an entity should use a two-step approach to evaluate
whether an equity-linked financial instrument (or embedded feature) is indexed
to its own stock, including evaluating the instrument’s contingent exercise and
settlement provisions. The adoption of this guidance did not have an
impact on our consolidated financial statements.
Effective
January 1, 2009, we adopted new accounting guidance for convertible debt
instruments that may be settled in cash upon conversion (including partial cash
settlement), which applies to convertible debt that includes a cash conversion
feature. Under this guidance, the liability and equity components of convertible
debt instruments within the scope of this pronouncement shall be separately
accounted for in a manner that will reflect the entity’s nonconvertible debt
borrowing rate when interest cost is recognized in subsequent periods. We
examined our convertible debt instruments and preferred stock for applicability
under this new guidance and have concluded that there was no impact to our
consolidated financial statements as our convertible debt and preferred stock
were not within the scope of this guidance.
We
adopted new accounting guidance on January 1, 2009 which required entities to
provide expanded disclosures about derivative instruments and hedging activities
including (1) the ways in which an entity uses derivatives, (2) the accounting
for derivatives and hedging activities, and (3) the impact that derivatives have
(or could have) on an entity’s financial position, financial performance, and
cash flows. As of December 31, 2009, the Company has a derivative liability of
$484,859 related to the outstanding warrants, convertible debt and stock
derivative liability. The derivatives instruments were not entered
into as hedging activities, and the change in value of the liability is included
in the accompanying consolidated statement of operations.
On
January 1, 2009, we adopted new accounting guidance on fair value
measurements. This new guidance defines fair value, establishes a
framework for measuring fair value in generally accepted accounting principles,
and expands disclosures about fair value measurements. The adoption
of this standard did not have an impact on our consolidated financial
statements. See Note 5 for additional information regarding our
financial assets and liabilities measured at fair value on a recurring
basis.
In June
2009, we adopted new guidance which requires disclosures about fair value of
financial instruments in interim as well as in annual financial statements.
There was no impact on our consolidated financial statements. See Note 5 for
more details.
F-12
VERTICAL
COMPUTER SYSTEMS, INC.
Due to
the acquisition of Priority Time Systems, Inc. (see Note 3), we implemented a
new accounting standard that changed the accounting for and reporting
of minority interest (now called non-controlling interest) in the consolidated
financial statements. The adoption of this standard has resulted in the
classification of non-controlling interest to a separate component of
stockholders’ equity on the accompanying consolidated balance sheets.
Additionally, net loss attributable to non-controlling interest is shown
separately from net loss in the consolidated statements of
operations.
Effective
June 30, 2009, we implemented FASB ASC 855, Subsequent Events. This
standard establishes general standards of accounting for and disclosure of
events that occur after the balance sheet date but before financial statements
are issued. The adoption of ASC 855 did not impact our consolidated financial
statements. We evaluated all events or transactions that occurred after December
31, 2009 up through the date we issued these financial
statements. For a discussion of subsequent events, see Note
15.
Reclassifications
Certain
reclassifications have been made to the prior periods to conform to the current
period presentation.
Note
2. Going Concern Uncertainty
The
accompanying consolidated financial statements for 2009 and 2008 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 we need to raise additional funds to accomplish our objectives.
Negative stockholders’ equity at December 31, 2009 was $21.6 million.
Additionally, at December 31, 2009, we had negative working capital of
approximately $10.2 million (although it includes deferred revenue of
approximately $2.4 million) and defaulted on several of our debt obligations.
These conditions raise substantial doubt about our ability to continue as a
going concern.
Our
management is continuing its efforts to attempt to secure funds through equity
and/or debt instruments for our operations, expansion and possible acquisitions,
mergers, joint ventures, and/or other business combinations. 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.
Note
3. Acquisition
On June
15, 2009, we purchased 90% of the common stock of Priority Time Systems, Inc.
(“PTS”), a
Nevada corporation, from a shareholder of PTS. The purchase price was
$63,000, of which $25,000 was paid at execution with the balance of the purchase
price as a note payable to be paid in equal monthly installments over a 12-month
period beginning in August 2009. In connection with the agreement, we
also agreed to retain the selling shareholder as a consultant of PTS beginning
in July 2009. To secure our purchase of the PTS stock, we pledged
these shares of PTS stock purchased to the selling shareholder. In
addition, we also entered into a shareholder agreement with the other
shareholder of PTS whereby we have the option to purchase the remaining 10% of
the common shares of PTS stock at any time after 3 years from the date of our
purchase of the shares representing 90% of the common stock of
PTS. Under the terms of the shareholder agreement, the purchase price
will consist of a cash payment equal to the pro-rata number of shares of stock
owned by the other shareholder (relative to the total number of shares of common
stock issued by PTS) multiplied by 300% of PTS’s gross revenues for the previous
12 calendar months prior to the date that we provide written notice of our
intention to purchase these shares from the other shareholder. The
shareholder agreement also provides for the licensing terms of PTS products to
our other subsidiaries.
The
related purchase price was allocated to identifiable assets acquired and
liabilities assumed as follows:
Software
in development
|
$ | 70,000 | ||
Noncontrolling
interest
|
(7,000 | ) | ||
Total
net assets acquired
|
$ | 63,000 |
F-13
VERTICAL
COMPUTER SYSTEMS, INC.
Note
4. Related Party Transactions
In April
2008, the obligation to issue Luiz Valdetaro 2,000,000 common shares within one
year and to pay for any related costs came due. This obligation was
in connection with an indemnity and reimbursement agreement concerning the
transfer by Luiz Valdetaro, on behalf of the Company, of 2,000,000 shares of our
common stock owned by him to Tara Financial in exchange for waiving the defaults
and extending the payment terms on notes payable to Tara of $438,795, $350,560,
$955,103 and $450,000. Mr. Valdetaro is our Chief Technology Officer. For
transactions concerning this related party after December 31, 2009, please see
"Subsequent Events" under Note 15.
In April
2008, the obligation to issue Mr. Valdetaro 1,000,000 common shares within one
year and to pay for any related costs came due. This obligation was
in connection with an indemnity and reimbursement agreement concerning the
transfer by Mr. Valdetaro, on behalf of the Company, of 1,000,000 shares of our
common stock owned by him to Clark Consulting Services (“CCS”) in connection
with a $40,000 loan from CCS. For transactions concerning this related
party after December 31, 2009, please see "Subsequent Events" under Note
15.
In April
2008, the obligation to issue to Mountain Reservoir Corporation (“MRC”) 10,000,000
common shares within one year and to pay for any related costs came
due. This obligation was in connection with an indemnity and
reimbursement agreement concerning the transfer by MRC of 10,000,000 common
shares to the Company. For transactions concerning this related party after
December 31, 2009, please see "Subsequent Events" under Note 15.
In
February 2008, MRC pledged 3,000,000 shares of our common stock to secure a
$96,946 promissory note issued to a third party lender. In
November 2008, the lender sold 1,500,000 shares of the pledged stock for
$118,167, of which $103,555 was applied to outstanding debt claimed by the
lender including interest, penalties & attorney’s fees. The
remaining $14,612 was returned to MRC representing the amount of shares oversold
by the lender. Of the 1,500,000 shares sold by the lender, we became
obligated to reimburse MRC with 1,309,983 shares in November 2009 (within 1 year
of the sales of the pledged shares). For additional details on this
$96,946 note and the pledge of stock, please see “Notes Payable” under Note
8.
In May
2008, Robert Farias assigned the rights to a “point-of-sale” software technology
(“PASS”) to us
pursuant to an agreement, which was sublicensed to VHS. VHS and Farias-Jett, a
sole proprietorship of Mr. Farias, entered into a distributor agreement for PASS
whereby Mr. Farias would market PASS to his existing clients. In
October 2008, VHS entered into a consulting agreement with Farias-Jett and an
employment agreement with Mr. Farias. Also in October 2008, NOW
Solutions entered into a hosted service provider agreement with Robert Farias
for emPath®. As of December 31, 2009 and 2008, we have an outstanding liability
related to the above agreements of approximately $49,000 and $28,000,
respectively. Robert Farias is an employee of VHS and a director of
NOW Solutions.
In
February 2009, Robert Farias notified us of his intent to exercise warrants to
purchase 15,000,000 shares of our common stock at an average exercise price of
$0.02 per share. For transactions concerning this related party after December
31, 2009, please see “Subsequent Events” under Note 15.
In
December 2009, we entered into a settlement agreement and stipulated judgment
with PSM in connection with a lawsuit filed in August 2009, whereby the parties
agreed to a judgment balance of $68,500, which included principal, accrued
interest, late fees and attorneys’ fees, and we agreed to make monthly
installment payments. Bill Mills is a Director of the Company and a
partner of PSM, which was formerly known as Parker Mills, LLP (the successor
entity to Parker Mills Morin, LLP and Parker Mills & Patel,
LLP). For additional details, please refer to the “Litigation”
section under Note 14.
Note
5. Derivative liabilities and fair value measurements
Derivative
liabilities
During
2008, one of our officers pledged 3,000,000 shares of common stock (through a
company he controls) to secure the debt owed to a third party lender (see Note
4). 1,309,983 shares of this stock were sold to satisfy the debt owed
to the lender. In connection with the pledge of stock, we signed an
agreement to replace these shares within one year. These loans were evaluated
under FASB ASC 815-40, Derivatives and Hedging and were determined to have
characteristics of a liability and therefore derivative liabilities 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.
F-14
VERTICAL
COMPUTER SYSTEMS, INC.
During
2007, two of our officers loaned a total of 13 million shares of unrestricted
stock to the Company (see Note 4). This stock was used to satisfy certain
obligations of the Company. In connection with the loans, the Company signed an
agreement to replace the shares within one year. These loans were evaluated
under FASB ASC 815-40, Derivatives and Hedging and were determined to have
characteristics of a liability and therefore derivative liabilities 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.
During
2002 and 2003, we issued convertible debentures with a conversion features based
on the market value of the stock at the date of conversion. The conversion
features were evaluated under FASB ASC 815-40, Derivatives and Hedging and were
determined to have characteristics of a liability and therefore a derivative
liability under the above guidance. The conversion prices were
variable which caused the Company to conclude it was possible at some point in
the future to not have available the number of common shares required to share
settle all common stock equivalent instruments. This caused warrants
and all other convertible debt to also be classified as derivative liabilities.
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.
The
valuation of our embedded derivatives and warrant derivatives are determined
primarily by the Black-Scholes option pricing model and the Lattice model. As
such, our derivative liabilities have been classified as Level 2. To
determine the fair value of our derivatives, management evaluates assumptions
regarding the probability of certain future events. Other factors used to
determine fair value include our period end stock price ($0.024), historical
stock volatility (129%), risk free interest rate (1.14%) and derivative term
(generally 0.25 years).
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. Our derivative liabilities are classified as Level 2.
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 measured on a recurring basis:
|
Fair value measurements on a recurring
basis
December 31, 2009
|
|
||||||||||
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
||||
Liabilities
|
||||||||||||
Warrants
and convertible debentures
|
$
|
-
|
$
|
141,419
|
$
|
-
|
||||||
Stock
derivative – 13,000,000 shares
|
-
|
312,000
|
-
|
|||||||||
Stock
derivative – 1,309,983 shares
|
-
|
31,440
|
-
|
F-15
VERTICAL
COMPUTER SYSTEMS, INC.
Note
6. Property and Equipment
Property
and equipment consist of the following:
2009
|
2008
|
|||||||
Equipment (3-5
year life)
|
$ | 869,640 | $ | 952,403 | ||||
Leasehold
improvements (5 year life)
|
87,712 | 87,712 | ||||||
Furniture
and fixtures (3-5 year life)
|
41,141 | 43,260 | ||||||
Total
|
998,493 | 1,083,375 | ||||||
Accumulated
depreciation
|
(967,520 | ) | (1,024,064 | ) | ||||
$ | 30,973 | $ | 59,311 |
Depreciation
expense for 2009 and 2008 was $41,623 and $57,775, respectively.
Note
7. Accounts Payable and Accrued Expenses
Accounts
payable and accrued liabilities consist of the following:
2009
|
2008
|
|||||||
Accounts
payable
|
$ | 1,559,937 | $ | 2,004,944 | ||||
Accrued
payroll
|
2,117,394 | 2,153,786 | ||||||
Accrued
payroll tax and penalties
|
387,651 | 571,005 | ||||||
Accrued
interest
|
735,487 | 1,631,062 | ||||||
Accrued
taxes
|
609,540 | 402,745 | ||||||
Accrued
liabilities - Other
|
987,566 | 591,002 | ||||||
$ | 6,397,575 | $ | 7,354,544 |
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 liabilities – other primarily consists of accrued rent, board of
director fees, unbilled professional and consulting fees, and other accrued
expenses. Accrued payroll tax and penalties relate to unpaid payroll taxes,
interest and penalties for prior years. Accrued taxes primarily
consist of unpaid sales and use taxes, VAT and other accrued
taxes.
F-16
VERTICAL
COMPUTER SYSTEMS, INC.
Note
8. Notes Payable and Convertible Debts
December 31
|
December 31
|
|||||||
2009
|
2008
|
|||||||
Third Party Notes Payable
|
||||||||
Note
payable issued by NOW Solutions to Ross, unsecured and bearing interest at
10%. In September 2007, the court awarded a judgment against Ross that
exceeds this amount. As a result of the settlement of the Ross litigation,
we wrote off the outstanding balance. Refer to the Litigation
section under Note 14.
|
$ | - | $ | 750,000 | ||||
Note
payable of $992,723 to Wolman Blair, PLLC dated November 30, 2005. The
note is secured with the assets of NOW Solutions and bears a default
interest rate of 18%. In April 2007, the Company prevailed in a lawsuit
against Ross which they appealed. On March 24, 2009, NOW
Solutions applied for and received Ross’ cash deposit after the original
judgment was upheld. The cash deposit received was net of this
note payable. The effect was that the note was settled upon
receipt of the net judgment from Ross.
|
- | 992,723 | ||||||
Note
payable of $150,000 owed to SGP, dated February 13, 2006. The
note bears interest at 12% per annum. The note was secured by
all of the assets of NOW Solutions. During 2009, this note was
paid in full from the proceeds of the Ross litigation. For
additional details, please refer to the Litigation section under Note
14.
|
- | 95,388 | ||||||
Note
payable of $100,000 issued by Taladin to Mr. Weber, dated October 27,
2006. The note bears interest at 12% per annum. The
note was secured by all of the assets of NOW Solutions. During
2009, this note was paid in full from the proceeds of the Ross
litigation. For additional details, please refer to the
Litigation section under Note 14.
|
- | 60,630 | ||||||
Note
payable of $40,000 due to CCS, bearing interest at 12% per annum, and due
in July 2007. The note has been paid in full in
2009.
|
- | 26,804 | ||||||
Notes
payable issued to third parties unsecured and non-interest
bearing. Of these notes, $58,000 and $42,000 were
non-performing as of December 31, 2009 and 2008,
respectively.
|
88,000 | 42,000 | ||||||
Notes
payable issued to third parties in the aggregate principal amount of
$448,158 bearing interest at rates between 10% and 13% per annum and
unsecured. All these notes are in default or non-performing at December
31, 2009 and 2008.
|
376,522 | 385,572 | ||||||
Notes
payable issued to third party lenders, bearing interest at 10% to 12% per
annum, in an aggregate principal amount of $990,000. These
notes are secured by stock pledges by MRC totaling 53,976,296 common
shares. Of these notes $827,589 are in default or
non-performing at December 31, 2009 and 2008.
|
977,589 | 827,589 | ||||||
Note
payable of $450,000 to Tara Financial, dated February 13, 2006, bearing
interest at 12% per annum and is due on February 1, 2011 (the maturity
date). The $450,000 note payable by Taladin contains provisions requiring
additional principal reductions in the event sales by NOW Solutions exceed
certain financial thresholds or from net proceeds collected from any
judgment, settlement, or decree in favor of the Company with respect to
the pending Ross litigation. During 2009, pursuant to the terms of this
note, we paid $212,111 from net proceeds of the Ross litigation toward
this note. For additional details on the Ross litigation,
please refer to the Litigation section under Note 14. The $450,000 note
also contains a conversion option pursuant to which all or any portion of
the unpaid principal, plus interest, may be converted at the option of
Tara Financial, into shares of common stock of Taladin equal to a maximum
of 2.5% of Taladin’s outstanding common stock at the time of
conversion. The note is secured by all of the assets of NOW
Solutions and was in default at December 31, 2009.
|
55,993 | 300,471 | ||||||
Note
payable of $438,795 to Tara Financial, dated February 13, 2006, bearing
interest at 12% per annum and is due on February 1, 2018 (the maturity
date). The new note is secured by an interest in certain
technology developed by Adhesive Software and owned by the Company,
commonly known as “SiteFlash™”.
|
371,541 | 391,143 | ||||||
Notes
payable of $359,560 and $955,103 to Tara Financial, dated February 13,
2006, bearing interest at 12% per annum. The notes are due on
February 1, 2018 (the maturity date). These notes payable also
contains provisions requiring additional principal reductions in the event
sales by NOW Solutions exceed certain financial thresholds. The notes are
secured by all of the assets of NOW Solutions and were in default at
December 31, 2009.
|
1,132,510 | 1,198,733 | ||||||
Total
notes payable to third parties
|
3,002,155 | 5,071,053 | ||||||
Current
maturities
|
1,596,853 | 3,289,515 | ||||||
Long-term
portion of notes payable to third parties
|
$ | 1,405,302 | $ | 1,781,538 |
F-17
VERTICAL
COMPUTER SYSTEMS, INC.
Related Party Notes Payable
|
||||||||
Unsecured
notes payable issued to related parties in the aggregate principal amount
of $427,519. These notes bear interest at a rate of 10% to 12%
per annum. Of these notes payable, $213,139 was in default at
December 31, 2009 and 2008.
|
$ | 397,519 | $ | 228,139 | ||||
Note
payable of $75,000, bearing interest at 6% to the law firm Parker Shumaker
Mills (“PSM”), formerly
Parker Mills, was due on January 31, 2008. In March 2008, MRC
pledged 2,000,000 shares of our common stock to secure the
note. In December 2009, this note was superseded by a
settlement agreement and stipulated judgment with PSM for $68,500, which
is included in the above summary of unsecured notes payable issued to
related parties. For additional details on the settlement
agreement and stipulated judgment, please refer to the Litigation section
under Note 14.
|
- | 56,217 | ||||||
Note
payable of $63,000, non-interest bearing to a related party in connection
with the purchase of 90% of the common stock of PTS. The
Company pledged its 90% ownership in PTS to secure the
note. For additional details on the purchase of PTS, please see
Note 3.
|
22,167 | - | ||||||
Total
notes payable to related parties
|
419,686 | 284,356 | ||||||
Current
maturities
|
359,903 | 284,356 | ||||||
Long-term
portion of notes payable to related parties
|
$ | 59,783 | $ | - |
Future
minimum payments for the next five years are as follows:
Year
|
Amount
|
|||
2010
|
$ | 1,956,757 | ||
2011
|
181,835 | |||
2012
|
126,730 | |||
2013
|
143,500 | |||
2014
|
161,966 | |||
2015+
|
851,053 | |||
Total
notes payable
|
$ | 3,421,841 |
Convertible
Debentures
Convertible
debentures consist of the following:
December 31,
2009
|
December 31,
2008
|
|||||||
Convertible
debentures dated March 29, 2002, bearing interest at 5%, convertible into
shares of the Company’s common stock at the debt holder’s choice of either
120% of the closing bid price on the date of agreement or 80% of the
lowest closing bid price five days prior to the conversion. The debenture
is convertible at the option of the holder at any time after purchase.
Principal and interest were due at maturity on March 28, 2004. This
debenture was originally issued in the principal amount of
$100,000.
|
$ | 10,000 | $ | 10,000 | ||||
In
December 2003, we issued a debenture in the amount of $30,000 to a third
party. We received net proceeds of $26,000 for the debenture. The debt
accrues interest at 5% per annum and was due December 2005. The holder may
convert the debenture into shares of common stock at 100% of the closing
price for the preceding trading day after we receive notice of
conversion.
|
30,000 | 30,000 | ||||||
Total
convertible debentures
|
40,000 | 40,000 | ||||||
Current
maturities
|
40,000 | 40,000 | ||||||
Long-term
portion of convertible debentures
|
$ | - | $ | - |
F-18
VERTICAL
COMPUTER SYSTEMS, INC.
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.
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,
2009
|
December 31,
2008
|
|||||||
Net
operating loss carry-forward
|
$ | 6,789,000 | $ | 8,537,000 | ||||
Reserves
|
611,600 | 674,500 | ||||||
Accrued
vacation
|
68,000 | 64,000 | ||||||
Deferred
compensation
|
826,000 | 770,000 | ||||||
Deferred
revenue
|
778,000 | 800,000 | ||||||
Derivatives
|
211,000 | 173,000 | ||||||
9,283,600 | 11,018,500 | |||||||
Valuation
allowance
|
(9,283,600 | ) | (11,018,500 | ) | ||||
$ | - | $ | - |
At
December 31, 2009 and December 31, 2008, we had available net operating loss
carry-forwards of approximately $15.6 million and $21.4 million,
respectively. These net operating loss carry-forwards expire in
varying amounts through 2029 and 2012, respectively.
Note
10. Common and Preferred Stock
Terms
of Common and Preferred Stock
Common Stock. The authorized capital
stock of the Company consists of 1,000,000,000 shares of common stock, par value
$.00001 per share, of which 998,251,818 and 995,668,482 were
issued and outstanding at December 31, 2009 and December 31, 2008,
respectively. 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. Shareholders 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 48,500 shares outstanding at December 31,
2009 and December 31, 2008. 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 effecting the Series A Preferred Stock shareholders, 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.
F-19
VERTICAL
COMPUTER SYSTEMS, INC.
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, 2009 and December 31, 2008. Holders of Series B
Preferred Stock are not entitled to vote on matters presented to the
shareholders, 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,
2009 and December 31, 2008. Holders of Series C Preferred Stock are
not entitled to vote on matters presented to the shareholders, 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. 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, 2009 and December 31, 2008. Holders of these shares are
not entitled to vote on matters presented to the shareholders, 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. 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.
2009
Common
Stock
During
2009, 2,583,336 unregistered shares of common stock issued to employees and
consultants of the Company and NOW Solutions vested resulting in stock
compensation expense of $94,533. These shares were issued pursuant to
restricted stock agreements executed in 2006 – 2008. As of December
31, 2009, there was $4,777 of total unrecognized compensation costs related to
these stock awards. These costs are expected to be recognized over a
weighted average period of less than 1 year.
During
2009, 800,000 unregistered shares of common stock of the Company were forfeited
pursuant to restricted stock agreements between the Company and employees of NOW
Solutions. These shares were not vested at the date of forfeiture and
had never been issued.
Preferred
Stock
Although
no dividends have been declared, the cumulative total of preferred stock
dividends due to these shareholders upon declaration was $5,277,712 as of
December 31, 2009.
F-20
VERTICAL
COMPUTER SYSTEMS, INC.
2008
Common
Stock
During
2008, one of the officers of the Company pledged 3,000,000 shares of common
stock (through a company he controls) to secure the debt owed to a third party
lender (see Note 5). 1,309,983 shares of this stock were sold to satisfy the
debt owed to the lender. In connection with the pledge of stock, the
Company signed an agreement to replace these shares within one
year.
During
2008, the Company granted 1,250,000 unregistered shares of common stock of the
company to employees and consultants of the Company and NOW Solutions pursuant
to restricted stock agreements. 250,000 of these unrestricted shares vested
immediately with the remaining shares vesting over a period from six months to
one year, as provided.
During
2008, 500,000 unregistered shares of common stock of the Company were forfeited
pursuant to restricted stock agreements between the Company and employees of NOW
Solutions. These shares were not vested at the date of forfeiture and had never
been issued.
During
2008, 3,183,333 unregistered shares of common stock issued to employees and
consultants of the Company and NOW Solutions vested resulting in stock
compensation expense of $45,166. These shares were issued pursuant to restricted
stock agreements executed in 2005-2008. As of December 31, 2008, there was
$71,186 of total unrecognized compensation costs related to these stock
awards. These costs are expected to be recognized over a weighted
average period of 1.31 years.
Preferred
Stock
Although
no dividends have been declared, the cumulative total of preferred stock
dividends due to these shareholders upon declaration was $4,689,712 as of
December 31, 2008.
Note
11. Stock Options and Warrants
In
December 1999, we established a stock option plan allowing grants of both
Incentive Stock Options (within the meaning of Section 422 and the Internal
Revenue Code of 1986, as amended) and non-statutory options. We can issue up to
50,000,000 shares. Most options issued are non-assignable, non-transferable,
vested on the date of grant, and expire three to five years from the date of
grant. The plan expired December 15, 2009.
There
were no non-statutory stock options, incentive stock options or warrants granted
in 2009 or 2008.
Warrants
to purchase 250,000 and 6,250,000 common shares at $0.0075 to $0.025 per share
expired during 2009 and 2008, respectively.
In
February 2009, Robert Farias, a related party, notified us of his intent to
exercise warrants to purchase 15,000,000 shares of our common stock at an
average exercise price of $0.02 per share. These warrants have not
been exercised due to the unavailability of shares of common stock as described
in Note 15 – Subsequent Events. In March 2010, Robert Farias agreed
to exchange his warrants, along with waiving the conversion rights associated
with 37,500 shares of the Company’s Series “C” Cumulative Convertible Preferred
Stock and forgiveness of $100,000 of unsecured trade payables in exchange for
610,000 shares of Series A Preferred Stock of VHS. For additional
details, please see Note 15 – Subsequent Events.
Option
and warrant activities in 2008 and 2009 are summarized as follows:
Incentive Stock
Options
|
Non-Statutory
Stock Options
|
Warrants
|
Weighted
Average Exercise
Price
|
|||||||||||||
Outstanding
at 12/31/07
|
2,500,000 | - | 21,500,000 | 0.017 | ||||||||||||
Options/Warrants
granted
|
- | - | - | - | ||||||||||||
Options/Warrants
exercised
|
- | - | - | - | ||||||||||||
Options/Warrants
expired/cancelled
|
- | - | (6,250,000 | ) | 0.091 | |||||||||||
Outstanding
at 12/31/08
|
2,500,000 | - | 15,250,000 | 0.019 | ||||||||||||
Options/Warrants
granted
|
- | - | - | - | ||||||||||||
Options/Warrants
exercised
|
- | - | - | - | ||||||||||||
Options/Warrants
expired/cancelled
|
(2,500,000 | ) | - | ( 250,000 | ) | 0.015 | ||||||||||
Outstanding
at 12/31/09
|
- | - | 15,000,000 | 0.020 |
F-21
VERTICAL
COMPUTER SYSTEMS, INC.
Information
relating to warrants at December 31, 2009, summarized by exercise price, is as
follows:
Warrants/Options Outstanding
|
Exercisable
|
|||||||||||||||||||
Weighted
|
||||||||||||||||||||
Average
|
Weighted
|
Weighted
|
||||||||||||||||||
Remaining
|
Average
|
Average
|
||||||||||||||||||
Number
|
Contractual
|
Exercise
|
Number
|
Exercise
|
||||||||||||||||
Exercise Price Per Share
|
Outstanding
|
Life (Months)
|
Price
|
Exercisable
|
Price
|
|||||||||||||||
Warrants
|
||||||||||||||||||||
$0.01
- $0.03
|
15,000,000 | 3.00 | $ | 0.020 | 15,000,000 | $ | 0.020 | |||||||||||||
15,000,000 | 3.00 | $ | 0.020 | 15,000,000 | $ | 0.020 | ||||||||||||||
Grand
total
|
15,000,000 | 3.00 | $ | 0.020 | 15,000,000 | $ | 0.020 |
As of
December 31, 2009, the warrants have an intrinsic value of $90,000.
Note
12. Gain on Settlement of Current Liabilities
In
September 2009, we recorded a gain on settlement of trade payables of $121,020
as a result of purchasing the trade receivables of one of our vendors from the
bankruptcy trustee.
In June
2008, we recorded a gain on settlement of trade payables of $514,518 as a result
of our review of trade payables for those items in which the statute of
limitations has been exceeded and no legal liability exists. Our
review included the determination of the dates of receipt of goods and services,
the last activity with the vendor, the applicable statute of limitations, and a
search for applicable liens or judgments. For those payables that met
all the above requirements, we have removed the liability and recorded the gain
on settlement as required under the guidance on transfers and servicing of
financial assets and extinguishments of liabilities as we are relieved from
these liabilities as a matter of law.
Note
13. Supplemental Disclosure of Cash Flow Information
Supplemental
cash flow information for the years ended December 31, 2009 and 2008 are as
follows:
December
31,
|
||||||||
2009
|
2008
|
|||||||
Cash
paid for interest
|
$ | 1,071,381 | $ | 537,854 | ||||
Cash
paid for income taxes
|
$ | - | $ | - |
Non-cash
activities for the years ended December 31, 2009 and 2008 were as
follows:
December
31,
|
||||||||
2009
|
2008
|
|||||||
Conversion
of accounts payable and accrued liabilities to notes
payable
|
100,881 | 64,372 | ||||||
Issuance
of note for acquisition of PTS
|
38,000 | - | ||||||
Shares
loaned to the Company by stockholder to settle note
payable
|
- | 103,555 | ||||||
$ | 138,881 | $ | 167,927 |
F-22
VERTICAL
COMPUTER SYSTEMS, INC.
Note
14. Commitments and Contingencies
Commitments
We lease
various office spaces which leases run from October 2008 through May 2015. We
have future minimum rental payments as follows:
Years ending December 31,
|
Amount
|
|||
2010
|
$ | 87,881 | ||
2011
|
89,176 | |||
2012
|
91,222 | |||
2013
|
93,269 | |||
2014
|
93,330 | |||
Thereafter
|
29,852 | |||
Total
|
$ | 484,730 |
Rental
expense for the years ended December 31, 2009 and 2008 was $178,077 and
$191,263, respectively.
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 2009. In
2008, we paid $30,322 in royalties for revenue generated from the license sale
to Microsoft.
We also
have royalty agreements associated with certain notes payable that provide a
royalty when revenues exceed certain thresholds. These royalties are
generally provided as an incentive for making the loans. For the year
ended December 31, 2009, we had royalties of $23,748 due to total revenues
exceeding a base revenue. In 2008, there were no royalty fees
recognized for these agreements associated with notes payable.
Payroll
Taxes
We have
filed all payroll tax returns but have not made all related tax payments since
2003. We accrued the payroll tax payments and approximately $125,000 for any
related penalties and interest that may be assessed by the Internal Revenue
Service. NOW Solutions has filed all payroll tax returns and made all payroll
tax payments. For VCSY, the IRS had a claim for unpaid payroll taxes of $313,839
from 2001-2005. We paid $200,000 of the IRS claim during 2008 and
$144,532 was paid in 2009. As of December 31, 2009, the total payroll
taxes, penalties and interest that were due for VCSY had been satisfied. For
additional details, please see “Litigation” below.
Litigation
We are
involved in the following ongoing legal matters:
In
February 2003, we sued Ross on behalf of our subsidiary NOW Solutions in New
York Supreme Court (the “Vertical Action”) in
connection with the acquisition of certain assets of Ross for the recovery of
unpaid maintenance fees due to NOW Solutions pursuant to an asset purchase
agreement. NOW Solutions claimed a total amount of approximately
$3,562,000 and an offset against the $750,000 remaining on the purchase money
note, plus other damages. In conjunction with our claim, NOW
Solutions withheld payment on the remaining $750,000 note, due in February
2003.
In March
2004, Ross sued NOW Solutions in the New York Supreme Court (the “Ross Action”) to
collect the $750,000 note payable plus interest and attorneys’
fees. On October 11, 2007 a judgment concerning the Vertical Action
and the Ross Action was entered for NOW Solutions (the “Judgment”) in the
amount of $3,151,216, which consisted of $1,279,483 for NOW Solutions’ claims
(after deducting $664,000 for Ross’ claim), $912,464 in attorneys’ fees and
expenses, and $865,361 for accrued interest. Ross appealed the
Judgment, which was affirmed by the appellate court.
F-23
VERTICAL
COMPUTER SYSTEMS, INC.
On March
24, 2009, NOW Solutions applied for and received Ross’ cash deposit of
$3,151,216 that was held by the New York City Department of Finance, which had
accrued $133,424 in interest. The net proceeds of the cash deposit
collected by NOW Solutions were $873,444, after deducting $2,345,502 in
outstanding attorneys’ fees and costs (including a $992,723 promissory note
issued to Wolman Blair PLLC) and $65,693 in fees and interest charged by New
York City Department of Finance on the cash deposit.
On
September 15, 2009, NOW Solutions executed a settlement agreement with Ross in
connection with the outstanding monies (accrued interest, attorney fees and
expenses) owed by Ross to NOW Solutions. Pursuant to the terms of the settlement
agreement, Ross made a $390,468 payment to NOW Solutions and a $144,532 payment
to the Internal Revenue Service (“IRS”) on behalf of
the Company which is reported as part of the “Gain on settlement of litigation”
in the consolidated statements of operations. The litigation with
Ross has been resolved.
In August
2004, Arglen obtained a default judgment against the Company for a past due
$600,000 promissory note, plus fees and interest. We agreed to pay
Arglen $713,489. As of December 31, 2008, we had paid all principal
due under the payout agreement. In February 2009, the Company and
Arglen agreed to settle a dispute concerning accrued interest regarding the
payout agreement. Under the terms of the settlement, we paid Arglen
$60,000. This matter has been resolved.
On April
18, 2007, we filed suit for patent infringement against Microsoft Corp. in the
United States District Court for the Eastern District of Texas. We claimed that
the Microsoft.Net System infringes U.S. Patent No. 6,826,744. In July
2008, we settled our patent infringement claim against Microsoft
Corporation. Pursuant to the confidential settlement agreement, we
granted to Microsoft a non-exclusive, fully paid-up license under the patent
which was the subject of the legal proceeding. The proceeds from the
license were included in revenue.
The IRS
had a claim for unpaid Employment (Form 941) taxes and Federal Unemployment
(Form 940) taxes for the period December 31, 2001 through December 31,
2005. We paid $200,000 of the principal amount of the unpaid payroll
taxes in September 2008. In September 2009, the lien held by the IRS
against us in the amount of $144,532 was satisfied. This matter has
been resolved.
In August
2009, Parker Shumaker & Mills, LLP (“PSM”) filed a lawsuit
in Los Angeles Superior Court to collect the outstanding balance of $51,238
under a promissory note issued by the Company to PSM in the principal amount of
$75,000, plus interest at 6% per annum, late fees and attorneys’
fees. We issued the $75,000 note in connection with a settlement in
October 2005 with PSM. In December 2009, we entered into a settlement
agreement and stipulated judgment with PSM whereby the parties agreed to a
judgment balance of $68,500, which included principal, accrued interest, late
fees and attorneys’ fees, and we agreed to make monthly installment
payments. Bill Mills is a Director of the Company and a partner of
PSM, which was formerly known as Parker Mills, LLP (the successor entity to
Parker Mills Morin, LLP and Parker Mills & Patel, LLP).
On
November 18, 2009, we sued InfiniTek for breach of contract and other claims
when a dispute between the Company and InfiniTek was not
resolved. All agreements were cancelled in 2009 except for the
distribution agreement. We attempted unsuccessfully to resolve the issue with
InfiniTek via mediation. Our lawsuit was amended on March 30th and the
distribution agreement has been cancelled.
In the
opinion of management, the ultimate resolution of any pending matters may have a
significant effect on our financial position, operations or cash
flows.
Note
15. Subsequent Events
In
January 2010, the Company and MRC amended the indemnity and reimbursement
agreement (originally entered into in April 2007) whereby the Company agreed to
reimburse and indemnify MRC for 16,976,296 shares pledged in November 2009 as
collateral in connection with a $150,000 note. MRC is a corporation
controlled by the W5 Family Trust. Mr. Wade, the President and CEO of
the Company, is the trustee of the W5 Family Trust.
In March
2010, the Company and Robert Farias entered into an agreement whereby Mr. Farias
agreed to cancel warrants to purchase 15,000,000 common shares and $100,000 in
debt and to waive his rights to convert 37,500 shares of our Series C Preferred
Stock into 15,000,000 common shares in exchange for the Company’s transfer to
Mr. Farias of 610,000 shares of VHS Series A Preferred Stock owned by the
Company. Mr. Farias is an employee of VHS and a Director of NOW
Solutions.
F-24
VERTICAL
COMPUTER SYSTEMS, INC.
In March
2010, the Company and MRC entered into an amendment of an indemnity and
reimbursement agreement whereby the obligation to reimburse MRC with 10,000,000
common shares that were loaned to the Company in March 2008 was cancelled in
exchange for the Company’s transfer to MRC of 300,000 shares of VHS Series A
Preferred Stock owned by the Company. MRC is a corporation controlled
by the W5 Family Trust. Mr. Wade, our President and CEO, is the trustee of the
W5 Family Trust.
In March
2010, the Company and Luiz Valdetaro entered into an amendment of two indemnity
and reimbursement agreements whereby the obligation to reimburse Mr. Valdetaro
in respect of an aggregate 3,000,000 common shares that were transferred to
third parties on behalf of the Company (in connection with certain extensions of
loans of the Company in April 2008) was cancelled in exchange for the Company’s
transfer to Mr. Valdetaro of 90,000 shares of VHS Series A Preferred Stock owned
by the Company. Mr. Valdetaro is our Chief Technology
Officer.
Having
ended its responsibility to issue 43,000,000 shares of its common stock, the
Company has substantially reduced — but has not completely eliminated — a
significant financial exposure arising out of the commitment to issue shares of
common stock in an amount exceeding the number authorized by the Certificate of
Incorporation, as amended. The financial exposure related to the 43,000,000
common shares has been reflected in the Company’s financial statements as a
“derivative liability” and each reporting period, this derivative liability has
been marked-to-market, with the non-cash gain or loss recorded in the period as
a gain or loss on derivatives. See “Derivative Liabilities”
under the Consolidated Balance Sheets. “Loss on Derivative Liabilities” under
the Consolidated Statements of Operations, and the Note to the Consolidated
Financial Statements entitled “Derivative Instruments and Fair Value of
Financial Instruments.”
VHS is
presently a subsidiary of the Company and is a development stage
company. VHS has two classes of preferred stock:
|
(a)
|
The
Series A Convertible Preferred Stock is convertible into VHS common shares
at a ratio of three 3 common shares for one preferred share, has voting
rights, and has a cumulative annual dividend of $0.60 per
share.
|
|
(b)
|
The
Series B Convertible Preferred Stock is convertible into VHS common shares
at a ratio of 1 common share for one preferred share, is non-voting, and
has a cumulative annual dividend of $0.60 per share.
|
All
1,000,000 shares of the VHS Series A Convertible Preferred Stock that have been
authorized for issuance, were initially issued to the Company, and then were
exchanged for the Company’s obligations to the Recipients pursuant to
warrants and other contractual arrangements.
None of
the shares of VHS Series B Convertible Preferred Stock that have been
authorized for issuance have been issued as of the date this Report was
filed.
VHS has
authorized 10,000,000 common shares, of which 5,100,000 shares have been issued
to the Company and 4,000,000 shares have been reserved for the conversion of the
VHS Series A and Series B Preferred Stock.
The
Company has entered into a license and distribution agreement with VHS
concerning software owned or licensed by the Company (and its subsidiaries),
including Now’s Solutions’ emPath® and Priority Time Systems’ time and
attendance software application. The license and distribution
agreement authorizes VHS to distribute the software on an exclusive basis to the
following: (a) “free standing” private practices of physicians and “free
standing” outpatient clinics, (b) health clubs, and (c) pharmacies.
For
purposes of the Company’s license and distribution agreement with VHS, the
references to “free standing” are meant to encompass independent or
non-“provider” based practices and clinics. A “provider” based practice,
which is excluded from the Company’s license and distribution agreement with
VHS, means (a) any hospital or (b) entity that provides in-patient services
that are the functional equivalent of a hospital, outpatient clinics
under the direct control of such hospital or entity that typically bill Medicare
or private insurance companies as a “provider” rather than as a private practice
or other “free-standing” entity, military treatment facilities, community health
centers, and State or local public health clinics. For purposes of
the Company’s license and distribution agreement with VHS, physicians working in
a hospital setting are also excluded.
During
the first quarter of 2010, 416,667 of unregistered shares of common stock issued
to employees vested.
F-25
VERTICAL
COMPUTER SYSTEMS, INC.
Stock
Holders Equity, Stock Options and Warrants
For the
period from January 1, 2010 to April 14, 2010, the ownership of 416,667
unregistered shares of our common stock vested. These shares were issued
pursuant to restricted stock agreements with employees of the Company and NOW
Solutions executed in 2007.
As of the
Date of this Report for the year ended December 31, 2009, we have determined
that we currently have (i) the following shares of common stock issued, and (ii)
outstanding instruments which are convertible into the shares of common stock
indicated below in connection with stock options, warrants, and preferred shares
previously issued by the Company or agreements with the Company:
998,935,151
|
Common
Stock Issued
|
|
24,250,000
|
Common
Shares convertible from Preferred Series A stock (48,500 shares
outstanding)
|
|
27,274
|
Common
Shares convertible from Preferred Series B stock (7,200 shares
outstanding)
|
|
5,000,000
|
Common
Shares convertible from Preferred Series C (50,000 shares
outstanding)
|
|
94,700
|
Common
Shares convertible from Preferred Series D (25,000 shares
outstanding)
|
|
1,309,983
|
Common
Shares Company Is Obligated to Reimburse to officer of Company within 1
year for Pledged Shares
|
|
1,029,617,108
|
Total
Common Shares Outstanding and Accounted
For/Reserved
|
Accordingly,
given the fact that the Company currently has 1,000,000,000 shares of common
stock authorized, the Company could exceed its authorized shares of common stock
by approximately 30,000,000 shares if all of the financial instruments described
in the table above were exercised or converted into shares of common
stock.
We have
evaluated our convertible cumulative preferred stock under the guidance set out
in FASB ASC 470-20, Debt and have accordingly classified these shares as
temporary equity in the consolidated balance sheets.
F-26