Item 1. Business
Forward-Looking Statements and Associated Risks. This Report contains forward-looking statements. Such forward-looking statements include statements regarding, among other things, (a) our projected sales and profitability, (b) our growth strategies, (c) anticipated trends in our industry, (d) our future financing plans, (e) our anticipated needs for working capital, and (f) the benefits related to ownership of our common stock. Forward-looking statements, which involve assumptions and describe our future plans, strategies, and expectations, are generally identifiable by use of the words “may,” “will,” “should,” “expect,” “anticipate,” “estimate,” “believe,” “intend,” or “project” or the negative of these words or other variations on these words or comparable terminology. This information may involve known and unknown risks, uncertainties, and other factors that may cause our actual results, performance, or achievements to be materially different from the future results, performance, or achievements expressed or implied by any forward-looking statements. These statements may be found under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business,” as well as in this Report generally. Actual events or results may differ materially from those discussed in forward-looking statements as a result of various factors, including, without limitation, the risks outlined under “Risk Factors” and matters described in this Report generally. In light of these risks and uncertainties, there can be no assurance that the forward-looking statements contained in this Report will in fact occur as projected.
Background
Vertical Computer Systems, Inc. (“Vertical”, “VCSY”, the “Company”, the “Registrant”, “we”, “our”, or “us”) was incorporated in the State of Delaware in March 1992. We operated as a non-reporting public shell company until October 1999, at which time we acquired all the outstanding capital stock of Externet World, Inc., an Internet service provider and became an operating entity. In April 2000, we acquired 100% of the outstanding common stock of Scientific Fuel Technology, Inc. (“SFT”), a company with no operations. Also in April 2000, we merged SFT into our company, as a consequence of which the outstanding shares of SFT were cancelled, Vertical became the surviving entity, and we assumed SFT’s reporting obligations pursuant to Rule 12g-3(a) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
Business Overview
We are a global provider of application software, cloud-based and software services, Internet core technologies, and intellectual property assets through our distribution network with operations or sales in the United States, Canada and Brazil.
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 and 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.
We are in the process of developing and preparing to launch applications and products utilizing our Emily™ mobile platform (please refer to the “Internet Core Technologies” section for more details) as well as other related technology in the mobile market.
Administrative Software
Our main administrative application software, emPath®, which is designed to handle complex payroll and human resources challenges, is developed, marketed and maintained by NOW Solutions. emPath® is natively Web-based which means that the application can easily be accessed with a web browser. NOW Solutions, a 75% owned subsidiary, is selling emPath® in the United States and Canadian markets both as a software solution and a Software-as-a-Service (“SaaS”) offering, also known as Cloud-based offering. For a description of our cloud computing model for emPath®, please see the section entitled “Cloud-based services” below.
In 2010, we completed the workflow engine for emPath® and continued improvements for its cloud computing model. We also implemented our new strategy of developing certain HR/payroll related modules that can be sold separately from emPath® or bundled with emPath® as a comprehensive solution. These new features, when coupled with experience gained with the product by the Brazil-based development staff (over the past eight years), have substantially facilitated faster product development. In addition, we have significantly improved the scalability of emPath® to meet the needs of small businesses as well as very large enterprise clients.
Our continuous effort to improve our emPath® product and its cloud-based offering has allowed us to finalize and launch our new module-based initiative under which certain payroll/human resource modules can be marketed independently from emPath® or bundled into a comprehensive solution. A key objective of the module development initiative has been to enable new modules to be sold to a smaller customer base (companies with 25 to 500 employees) in a simple standardized version. This version will have full functionality and all the 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 also have a global payroll initiative to launch emPath® internationally.
Our time and attendance software, PTS™, was designed with the flexibility to meet the needs of a simple small business requirements as well as the most complex union-intensive clients through a rule-based time policy system coupled with a dashboardlet™ feature for presentations of information supporting numerous databases including Oracle, DB2 and SQL. For a description of this feature, please see the section entitled “Internet Core Technologies” below.
PTS™ will be marketed as a stand-alone best-of-breed solution through Priority Time Systems, Inc. (“Priority Time”) as well as an integrated module within emPath®, which we are marketing to emPath®’s existing customer base. Our initial marketing efforts are focused on the United States and Canadian markets.
SnAPPnet™ is currently marketed as a best-of breed standalone solution through SnAPPnet, Inc. We are in the process of integrating this product with emPath® so it can also be sold to NOW Solutions’ customers as an emPath® module.
We have other administrative software in various stages of development which will be marketed through our subsidiaries including Priority Time, Vertical Healthcare Solutions, Inc. (“VHS”), Taladin, Inc., (“Taladin”), and Government Internet Systems Inc. (“GIS”).
We believe that our administrative software solutions, which offer lower set-up fees and faster implementation times compared to competing products, provide customers with significant upfront cost savings and substantial increases in productivity for administration of everyday operations.
Cloud-based services
In addition to our standard software licensing model, where the software is deployed, hosted and maintained internally by the customer, we are offering customers with an alternate delivery method: software-as-a-service, or simply “cloud-based.” Cloud-based is a software delivery model where the company develops, operates, and hosts the application in data centers for use by its customers over the Internet.
A cloud-based service is a cost-effective, reliable and secure way for businesses to obtain the same benefits of commercially licensed, internally operated software, without the associated complexity and high start-up costs of deploying the software in-house or the need to dedicate IT people on staff to monitor and upgrade such a system.
After completing the testing of its emPath® cloud-based model to ensure a robust and competitive solution, NOW Solutions began selling that offering 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 and as a result of our initial sales to customers with complex payroll, NOW Solutions has created a tailored cloud-based offering which provides these types of customers the cost benefits of a cloud computing model while meeting their complex requirements. We are also continuing to upgrade emPath® for our cloud computing offering utilizing emPath®’s powerful payroll component to provide private label contracting as well as distribution opportunities through existing payroll providers in their local markets.
PTS™, our time and attendance software, will also be offered as a cloud-based solution, as both a standalone product (through Priority Time and VHS) and an integrated module with emPath® (through NOW Solutions).
SnAPPnet™, a physician credentialing application, is currently offered as a cloud-based solution. We are in the process of developing a registered nurse module of SnAPPnet™. In addition, we are adding some key new features to the software application as well as doing a design review to meet other potential markets for credentialing and markets in need of automated fillable forms. We are marketing SnAPPnet™ directly to hospitals and plan to offer it through VHS to physicians in the United States and to NOW Solutions’ existing customer base.
In addition, we have converted our SiteFlash™ product to offer it in a cloud-based configuration. We intend to concentrate our initial marketing efforts in the affiliate, government and publishing markets as well as utilizing SiteFlash™ for internal development projects. For a description of SiteFlash™, please see the section entitled “Internet Core Technologies” below.
Software Services
In addition to the application software and cloud-based services, we offer a full range of software services that include professional services, maintenance, custom maintenance and managed services.
Internet Core Technologies
Internet core technologies provide the software foundation to support internet-based platforms for the delivery of individual software products that can be sold independently or combined with other software products for rapid deployment of all software products throughout our distribution system. We continue to develop specialized software applications that can be utilized in new products.
Our primary patented internet core technology is SiteFlash™. The SiteFlash™ technology utilizes XML and publishes content on the Web, enabling the user to build and efficiently operate websites with the unique ability to separate form, function, and content. SiteFlash™ uses an advanced component-based structure to separate, parse, and store the various components of even the most complex web pages, permitting these components to be named, organized, filed and eventually redeployed onto the web pages of a website. Once all of the components of a web page are converted into “objects,” they can be grouped, as required by the user, into the three main types of web page components: content, form and function. Content includes text, pictures or multimedia. Form includes graphics and website colors, layout and design. Function includes the activities performed by or actions executed on the website. In this way, each element of a website created using SiteFlash™ is interchangeable with any other similar element, and these elements may be grouped together in almost any combination to create complex websites. This separation of form, function, and content also allows for the rapid creation of affiliated websites. SiteFlash™ architectural concepts enable integration with existing technological components within many organizations. Additional key features of SiteFlash™’s are its affiliation/syndication capability, its multi-lingual capability, and its multi-modal framework (enabling use on any output device, including wireless devices such as smart phones, as well as cellular phones and other devices with Internet capability).
SiteFlash™ can be offered 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™. In addition to a cloud-based offering, we are in the process of using SiteFlash™ as an internal component, along with some other company technology, in a new application which will be called the Physicians Bridge, and be marketed through VHS.
The second patented Internet core technology we have developed is the Emily™ XML scripting language, a Markup Language Executive (MLE), which is Java compatible. XML is a flexible way to create common information formats and share both the format and the data on the World Wide Web, intranets, and elsewhere. The Emily™ Framework was developed to be an engineering package comparable to other Web development tools, such as Allaire Cold Fusion™ or Microsoft FrontPage™. The primary component of the Emily™ Framework is the Emily XML scripting language, a programming language that runs on Windows™, Linux and several UNIX platforms. The Emily™ Framework is used to create Web-based applications that communicate via XML and HTTP. HTTP is the set of rules for exchanging files (text, graphic images, sound, video, and other multimedia files) on the Web.
The third patented Internet core technology we have developed is the combination of three components: the Emily™ XML Broker, the Emily™ XML Agent and the Emily™ XML Portal. This technology has been featured as an alternative to Web Services in the 4th Edition of the XML Handbook, by Dr. Charles Goldfarb, considered the father of XML and inventor of all markup languages. We are upgrading this technology for use in a new application we are developing simultaneously.
The fourth Internet core technology is a web server software that was licensed to the Company. This technology was acquired with the intent to modify it and use it, along with the Emily™ technology and new patent pending technology, as a basis to create a new product called the Emily™ Mobile Platform (“Emily™ Mobile Platform”). We plan to launch a personal private mobile communications channel, known as Ploinks™, utilizing the Emily™ Mobile Platform through our subsidiary, Ploinks, Inc. in 2015.
In addition, in the summer of 2010, we elected to utilize a new software development platform which we used for PTS™ and also created “dashboardletsTM” (a proprietary tool for business intelligence) allowing the scalability to meet large and/or complex customer requirements. In addition, this development platform will be used to develop other modules for the Company’s software solutions and to support SnAPPnet™ and certain portions of emPath®.
Intellectual Property Assets
Our SiteFlash technology is a System and Method for Generating Web sites in an Arbitrary Object Framework. This unique ability is patented under U.S. Patent No. 6,826,744 and continuation patent U.S. Patent No. 7,716,629 as well as a continuation patent (U.S. Patent No. 8,949,780) of U.S. Patent No. 7,716,629.
Our Emily™ core technology allows a disparate and distributed database to be viewed and updated as if it was a single large database. This unique ability is patented under U.S. Patent No. 7,076,521.
Our Emily™ XML scripting language, coupled with other Company technology, is the basis for development of mobile applications. This unique ability is patented under U.S. Patent No. 8,578,266.
We also have our fiber optic patent (for transmission of images over a single filament of fiber optic cable) under U.S Patent No. 6718103.
Finally, we have our tiny web server and other mobile technologies, which are patent-pending.
Market Segments
Our current products address the following market segments:
MARKET
PRODUCT
OWNERSHIP/LICENSOR
LICENSEE
Human Resources and Payroll
emPath®
NOW Solutions
VHS (a), Taladin (b)
Government Sector- Emergency Response
ResponseFlash™
Vertical
GIS (b)
Software development units
Emily™
Vertical
VHS(a)
Content Management Framework
SiteFlash™
Vertical
Unifocus(c)
Time and Attendance
PTS™
Priority Time
VHS (a), NOW Solutions (d)
Healthcare Credentialing
SnAPPnet™
SnAPPnet, Inc.
VHS (a) , NOW Solutions (d)
Emily™ Mobile Platform
Ploinks™
Vertical
Ploinks, Inc.(e)
(a)Physician market (including medical clinics but not including hospitals)
(b)Government market
(c)Hospitality market (including hotels, fast food chains, theme parks, restaurant chains, but not including casinos)
(d)Clients of NOW Solutions
(e)Communications for individual consumers
Business Operations and Units
Our business operations are grouped into the following units: NOW Solutions, Ploinks, Inc., Taladin, VHS, Priority Time Systems, SnAPPnet, Inc., GIS, Vertical do Brasil, and other subsidiaries with minimal or no activity and other limited interests. Each of these divisions is discussed below.
NOW Solutions, Inc.
NOW Solutions, a Delaware corporation, is a 75% owned subsidiary of the Company. NOW Solutions specializes in end-to-end, fully integrated human resources and payroll solutions. NOW Solutions has clients in the United States and Canada ranging from private businesses to government agencies, who typically employ 500 or more employees. NOW Solutions currently markets emPath®, a payroll and human resources and payroll solution. emPath® meets the needs for clients who have complex payroll where they may have employees from different unions, multiple locations in different states (U.S.) and provinces (Canada), and intricate compensation structures. We believe that the competitive advantage of emPath® is its speed of implementation through a formula-builder technology, which provides customers with rapid customization of payroll rules and calculations without the need for any programming expertise. NOW Solutions’ product suite is targeted to address the needs of management in today’s dynamic business environment and gives organizations a user-friendly, flexible, multi-lingual (i.e., English, Canadian French, Spanish, Portuguese, and Chinese) software solution, without the multi-million dollar implementation and support budgets typically required to use the payroll and HR products of major competitors.
NOW Solutions has converted some of its existing customers to its cloud-based model and is in the process of developing methods to introduce its cloud-based offering (supporting MS SQL, Oracle and DB2 databases) through distributors in the United States. During the conversion of one of our large complex customers and in discussions with other similar complex customers, we determined that there was a critical need and opportunity in providing a solution we are labeling “tailored cloud-based”, which can fulfill our customers unique requirements while giving them the benefits of a cloud-based offering.
Additionally, NOW Solutions has embarked on a strategy of developing and licensing HR products complementary to its existing suite of products that can be sold separately or integrated as emPath® modules, which has been greatly facilitated by emPath®’s Web Services integration. PTS™ is the first product to be integrated within the emPath® solution. PTS™ was officially introduced at NOW Solutions’ user conference in November 2011 and was presented to a number of customers who had expressed interest in purchasing once beta testing of one of NOW Solutions’ hospitals client (which is the basis for a time and attendance solution tailored to the medical industry) is completed. NOW Solutions is currently finalizing the integration of PTS™ with emPath®. The second product is SnAPPnet™, which is in the in the process of being upgraded to expand the utility of the product beyond traditional credentialing software so that it can be used by HR departments of NOW Solutions’ existing customer to create and administer fillable forms routinely used for employees.
NOW Solutions has also finalized its business plan to expand into the global payroll market, utilizing its existing expertise gained from offering a comprehensive payroll/HR solution to customers with employees throughout the United States and Canada.
The revenue model of NOW Solutions is based upon five components: licensing and renewable annual maintenance fees, cloud-based fees, professional consulting services, and managed services. Under the cloud-based delivery model, NOW Solutions typically collects monthly fees.
For the 12 months ended December 31, 2014, NOW Solutions had approximately $658,542 of total assets, revenues of approximately $4,484,923 and net income of approximately $628,621.
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. However, the completion of this module has been delayed until final testing has been performed and the emPath®’s integration with PTS™ has been finalized.
For the 12 months ended December 31, 2014, Taladin had no material assets, no revenues and a net loss of approximately $99.
Ploinks, Inc.
Ploinks, Inc., a Texas corporation (formerly OptVision Research, Inc.), is a wholly-owned subsidiary of the Company.
Vertical has licensed its Emily Mobile Platform to Ploinks, Inc., for use by consumers as a personal private communication channel.
For the 12 months ended December 31, 2014, Ploinks, Inc. had no material assets, no revenues and a net loss of approximately $292.
Vertical Healthcare Solutions, Inc.
VHS, a Texas corporation, is a wholly-owned subsidiary of the Company. VHS will market a new platform called the “Physicians Bridge”, which will be the basis for marketing applications to physicians utilizing other Vertical technologies and products which were licensed for the physician market by Vertical to VHS in 2010. Vertical will license its Emily Mobile Platform to VHS to be utilized as a communication channel between physicians as well as a communication channel between physicians and patients.
For the 12 months ended December 31, 2014, VHS had no material assets, no material revenues, and a net loss of approximately $163,387.
Priority Time Systems, Inc.
Priority Time, a Nevada corporation, is an 80% owned subsidiary of the Company. On June 15, 2009, we purchased 90% of the common stock of Priority Time from a shareholder of Priority Time. In addition, we entered into a shareholder agreement with the selling shareholder of Priority Time whereby we have the option to purchase the remaining 10% of the common shares of Priority Time stock at any time after 3 years from the date of our purchase of our 90% interest. The shareholder agreement also provides for the licensing terms of Priority Time products to our other subsidiaries.
Priority Time has been developing PTS™, a time and attendance product that we will offer both as a standalone product and as an integrated module within emPath®. In late spring 2010, we elected to stop development of PTS™ in its then-current form and switched to a new development platform. That new platform allowed us to create a cloud-based solution that utilizes a rule-based system, which will better meet the needs of NOW Solutions’ most complex customers and more easily create a time and attendance product for vertical markets (i.e. medical, government, casinos, and hospitality).
PTS™ was developed to meet the unique and complex requirements of NOW Solutions’ customers, particularly for the medical and government markets, who provided us with specifications for an ideal time and attendance program. The most critical need of complex customers was robust flexibility which led to the creation, from the ground up, of a rule-based time and attendance application, allowing users to make for immediate changes within the application while also providing a state-of-the-art reporting ability to senior executives. The result also led to a new development platform as well as another application called “dashboardletsTM.” PTS™ will be commercially available once a major emPath® update is completed and its integration with emPath® finalized.
For the 12 months ended December 31, 2014, Priority Time had no material assets, no material revenues and a net loss of approximately $829,454.
SnAPPnet, Inc.
SnAPPnet, Inc., a Texas corporation, is an 80% owned subsidiary of the Company. On May 21, 2010, SnAPPnet, Inc. purchased substantially all the assets of Pelican Applications, LLC (“Pelican”) in exchange for $5,335 cash, 100,000 shares of Series B Convertible Preferred Stock of VHS, and other contingent consideration. The assets acquired included a software application product known as SnAPPnet™ which is currently used for physician credentialing, as well as Pelican’s entire customer base. We intend to utilize the SnAPPnet™ software to expand its offering to physicians, and to adapt the software to meet the needs of NOW Solutions’ hospital clients who may need a credentialing product for nurses.
In 2012, we added a new feature that was requested by two of our hospital clients. That feature is presently being beta tested. A redesign is planned to create the flexibility to meet the requirements of automated fillable forms for HR departments of NOW Solutions’ customers as well as traditional credentialing needs for physicians and nurses.
For the 12 months ended December 31, 2014, SnAPPnet, Inc. had assets of approximately $56,260, revenues of approximately $128,832 and a net loss of approximately $101,004.
Government Internet Systems, Inc.
GIS, a Nevada corporation is our 84.5% owned subsidiary. Vertical licensed ResponseFlash™ to GIS in order to market and distribute this technology to government entities (excluding state universities and schools) in the United States. We are in the process of reviewing the marketing objectives and products for GIS.
For the 12 months ended December 31, 2014, GIS had no assets, no material revenue and net loss of approximately $10,766.
Vertical do Brasil
Our 100% owned subsidiary, Vertical do Brasil, a Brasilian company, houses a software development team that performs services on behalf of the Company and its subsidiaries.
For the 12 months ended December 31, 2014, Vertical do Brasil had assets of approximately $3,614, no revenues and net loss of approximately $99,250.
The following corporations are inactive:
Vertical Internet Solutions, Inc.
VIS, a California corporation, is a wholly-owned subsidiary of the Company. VIS is inactive and we currently have no plans regarding this subsidiary.
For the 12 months ended December 31, 2014, VIS had no material assets, no material revenue and no expenses.
EnFacet, Inc.
EnFacet, a Texas corporation, is a wholly-owned subsidiary of the Company. EnFacet is inactive and we currently have no plans regarding this subsidiary.
For the 12 months ended December 31, 2014, EnFacet had no material assets, no material revenue and no expenses.
Globalfare.com
Globalfare, a Nevada corporation, is a wholly-owned subsidiary of the Company. Globalfare is inactive and we currently have no plans regarding this subsidiary.
For the 12 months ended December 31, 2014, Globalfare had no assets, no material revenue and no expenses.
Pointmail.com, Inc.
Pointmail, a California corporation, is a wholly-owned subsidiary of the Company. Pointmail is inactive and we currently have no plans regarding this subsidiary.
For the 12 months ended December 31, 2014, Pointmail had no assets, no revenues and no expenses.
Competition
We face substantial competition from software and hardware vendors, system integrators, and multinational corporations focused upon information technology and security.
In the realm of application software, NOW Solutions’ competitors include Oracle, Lawson, Cyborg /Hewitt, Kronos, DLGL, Ultimate and SAP. Our cloud-based emPath® competes with ADP, Ceridian, Ultimate Software and Quicken. However, while NOW Solutions competes with these companies, our payroll product is utilized by our many of our customers in conjunction with many of these companies’ other modules.
Priority Time’s competitors include Kronos, NOVAtime Technology, Asure Software, Insperity (formerly known as Administaff), and Qqest Software Systems.
SnAPPnet, Inc. competes with several small and mid-sized competitors in the healthcare credentialing business sector. SnAPPnet’s competitors include EchoApps (Heathline Systems), Win/Staff PRO-FILE (Win/Staff), Medkinetics Pro (Medkinetics), IntelliAppsSE (Intellisoft Group, Inc.), OneAPP (Sy.Med) and CACTUS Software.
Ploinks, Inc. competes with Facebook, Twitter, Snapchat, Viber, Tango, WhatsApp and other social media services.
Our primary competitors have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical and marketing resources than we do. However, we have a number of large complex clients including cities and counties in the United States that have been users of our Payroll/HRMS software for many years (10 -25 years) and are highly referenceable. We cannot guarantee that we will be able to compete successfully against current or future competitors or that competitive pressure will not have a material and adverse effect on our financial position, results of operations and cash flows.
Our ability to compete will also depend upon our ability to continually improve our products and services, the enhancements we develop, the quality of our customer service, and the ease of use, performance, price and reliability of our products and services.
We believe, however, that we possess certain competitive advantages for the following reasons:
1.We have a number of proprietary patented technologies that can be utilized in our offerings.
2.NOW Solutions has an outstanding customer support department that has supported large complex entities for a number of years, and many of these large entities are leaders in their respective industries.
3.emPath®’s inherent strengths include its formula builder, the use of one single database (where competing products may use two or more), and a strong, highly identifiable customer base it can reference.
4.emPath® is built on a state-of-the-art Microsoft.net platform, allowing for rapid software development and interoperability with other software packages.
5.Our new development platform, including the dashboardlet™ feature; will provide a consistent business intelligence tool across our products’ line.
6.We can cross-promote applications between companies.
7.emPath® supports a global platform with one database for both payroll and HR and an international clients’ base beyond the U.S. and Canada.
8.Our new Emily™ Mobile Platform, coupled with our specialized Emily™ scripting language, offers a structure for the development of applications geared towards the mobile market.
Strategic Overview
The Company’s product portfolio reflects a number of unique characteristics and advantages that have been developed or acquired over time. At present, we are actively pursuing the strategy of (a) further developing the technologies owned by the Company and our subsidiaries and (b) combining all the technologies owned by the Company and our subsidiaries into viable product offerings.
The key components of our strategy are to:
1.Leverage our strong, profitable subsidiary, NOW Solutions, that has a highly-referenceable client base, including companies that are leaders in their industries and have been users of emPath® and its predecessor product for over 25 years for their payroll and human resource needs.
2.Develop a portfolio of patented technologies that can be licensed to third parties or utilized internally to strengthen our existing and projected product offerings.
3.Build a network of compatible partners and acquisition or licensing of products that complement our existing offerings.
4.Maximize the unique features of our new software development platform to launch our new PTS™ and SnAPPnet™ products as well as other products to NOW Solutions’ customer base and, at the same time, have those customers assist us in development of product specifications for their own vertical markets.
5.Build and integrate new commercially viable products utilizing our patented technology and other administration software.
6.Expand the reach of emPath® internationally beyond the U.S. and Canada utilizing non-competitive local distributors in foreign countries.
7.Combine the Company’s mobile strategy with other traditional services providing comprehensive and cost-effective solutions.
The software development leg of our strategy is two-fold. The first is to further enhance our existing solutions and develop new products in order to better compete with the large ERP providers like SAP and Oracle by providing complex best-of-breed alternative offerings that are more cost effective solutions. The second is to continue developing our intellectual property internally for mass market, best-of-breed solutions offered as cloud-based solutions that incorporate the advantages of our complex solutions. In each such instance, the software development leg of our strategy will be augmented by exploring solutions that can be linked to federal and state government programs for cost savings.
Our new mobile strategy is intended to make us a dominant player in the mobile space for the private communication sector that also serves as a complement to the social media market, as well as providing solutions in the healthcare and corporate markets. The goal is to become a provider with an all-in-one solution incorporating technology between a mobile device and different data storage units.
One key to the success of our strategies is to leverage our core capabilities, by entering into co-marketing agreements with other companies, particularly those who offer best-of-breed products that complement our product offerings. Our objective is to enter into distinct co-marketing agreements whereby each business unit will have a separate agreement with the co-marketing partner for its particular target market. To supplement this approach, our business units will enter into agreements with each other where they can more successfully cross-promote and market their respective products. We are also identifying complementary products from third parties which we can private label and sell as part of our existing product offering or separately.
Proprietary Rights
We rely upon a combination of patent, copyright, trademark, trade secret laws, and contract provisions and to protect our proprietary rights in our technologies, products and services. We distribute our products and services under agreements that grant users or customers a license to use our products and services and rely upon the protections afforded by the copyright laws to protect against the unauthorized reproduction of our products. In addition, we protect our trade secrets and other proprietary information through confidentiality agreements with employees, consultants and other business partners. emPath®, PTS™, SnAPPnet™, and PASS™ are protected by copyright and trademark.
Our patent portfolio consists of the following technologies and related products:
The USPTO granted us a patent (No. 6,718,103) for an invention for “Transmission of Images over a Single Filament Fiber Optic Cable” in April 2004. This patent is in a theoretical stage only and is intended to be used for transmitting images on fiber optics that might improve in orders of magnitude today’s capacity of fiber optics to transmit images and data.
The USPTO granted us a patent (No. 6,826,744) for an invention for “System and Method for Generating Web Sites in an Arbitrary Object Framework” on November 30, 2004. On May 11, 2010, we were granted a continuation patent (U.S. Patent No. 7,716,629) of U.S. Patent No. 6,826,744 by the USPTO. All pending new claims were granted in the continuation patent for U.S. Patent No. 7,716,629, which has increased the scope of the original patent by adding 32 new claims to the original 53 claims. On February 3, 2015, we were granted a continuation patent (U.S. Patent No. 8,949,780) of U.S. Patent No. 7,716,629. All pending new claims were granted in the continuation patent for U.S. Patent No. 8,949,780, which has increased the scope of the continuation patent and the original patent by adding 24 new claims.
Together, these patents are the foundation of our SiteFlash™ platform, and form the basis of the ResponseFlash™, NewsFlash™ and AffiliateFlash™ products.
The USPTO granted us a patent (No. 7,076,521) for an invention for a “Web-based collaborative data collection system” on July 11, 2006. This patent covers various aspects of the Emily™ XML Enabler Agent and the Emily™ XML Broker.
The USPTO granted us a patent (No. 8,578,266) for a “Method and System for Providing a Framework for Processing Markup Language Documents” on November 5, 2013. This patent covers the Emily™ scripting language.
We also have several patent-pending software technologies and licensed software:
In 2010, we filed an application for a patent titled “System and Method for Running a Web Server on a Mobile Internet Device,” which is still pending.
In 2011, we filed two provisional applications for patents relating to our patent application filed in 2010 and these have been replaced with non-provisional patent applications which were filed in 2012, which are still pending.
In 2013, we filed six patent applications (including provisional patent applications).
In 2014, we filed two provisional patent applications.
As of the date of this Report, we have filed three patent applications in 2015.
The Company acquired rights for U.S. Patent No. 8,903,371 (cellular telephone system and method), which was issued on December 2, 2014 under an assignment from Luiz Valdetaro, a co-inventor who is also an employee and the Chief Technology Officer of the Company.
Although we intend to protect our intellectual property rights as described above, there can be no assurance that these measures will be successful. Policing unauthorized use of our products and services is difficult and the steps taken may not prevent the misappropriation of our technology intellectual property rights. In addition, effective patent, trademark, trade secret and copyright protection may be unavailable or limited in certain foreign countries. We seek to protect the source code of some of our products as trade secrets and as unpublished copyright works. Source code for certain products has been or will be published in order to obtain patent protection or to register copyright in such source code. We believe that our products, trademarks and other proprietary rights do not infringe on the proprietary rights of third parties. There can be no assurance that third parties will not assert infringement claims against us in the future with respect to current or future features or content of services or products or, if so asserted that any such claims will not result in litigation or require us to enter into royalty arrangements.
Regulatory Environment; Public Policy
In the United States and most countries in which we conduct our operations, we are generally not regulated other than pursuant to laws applicable to businesses in general and value-added services specifically. In some countries, we are subject to specific laws regulating the availability of certain material related to, or to the obtaining of, personal information. Adverse developments in the legal or regulatory environment relating to the interactive online services and Internet industry in the United States, Canada, Europe, Asia, Latin America or elsewhere could have a material adverse effect on our business, financial condition and operating results. A number of legislative and regulatory proposals from various international bodies and foreign and domestic governments in the areas of telecommunications regulation, particularly related to the infrastructures on which the Internet rests, access charges, encryption standards and related export controls, content regulation, consumer protection, advertising, intellectual property, privacy, electronic commerce, and taxation, tariff and other trade barriers, among others, have been adopted or are now under consideration. We are unable at this time to predict which, if any, of the proposals under consideration may be adopted and, with respect to proposals that have been or will be adopted, whether they will have a beneficial or an adverse effect on our business, financial condition and operating results.
Employees
As of April 15, 2015, we had 21 full-time and 5 part-time employees (19 are employed in the United States and 7 in Canada), and 3 full time consultants. We are not a party to any collective bargaining agreements.
Item 1A.
Item 1A. Risk Factors
Risk Factors Related to Our Business, Operating Results and Financial Condition
We are subject to various risks that may materially harm our business, financial condition and results of operations. You should carefully consider the risks and uncertainties described below and the other information in this filing before deciding to purchase our common stock. If any of these risks or uncertainties actually occurs, our business, financial condition or operating results could be materially harmed. In that case, the trading price of our common stock could decline and you could lose all or part of your investment.
We Have Historically Incurred Losses and May Continue to Do So in the Future.
We had a net loss of $1,450,822 and $2,602,811 for the years ended December 31, 2014 and 2013, respectively, and have historically incurred losses. Accordingly, we have and may continue to experience significant liquidity and cash flow problems because our operations are not profitable. No assurances can be given that we will be successful in reaching or maintaining profitable operations.
We Have Been Subject to a Going Concern Opinion from Our Independent Auditors, Which Means That We May Not Be Able to Continue Operations Unless We Obtain Additional Funding.
The report of our independent registered public accounting firm included an explanatory paragraph in connection with our financial statements for the years ended December 31, 2014 and 2013. This paragraph states that our recurring net losses, negative working capital and accumulated deficit, the substantial funds used in our operations and the need to raise additional funds to accomplish our objectives raise substantial doubt about our ability to continue as a going concern. Our ability to develop our business plan and to continue as a going concern depends upon our ability to raise capital, to succeed in the licensing of our intellectual property and to achieve improved operating results. Our financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Our Ability to Continue as a Going Concern Is Dependent on Our Ability to Raise Additional Funds and to Establish Profitable Operations.
The accompanying consolidated financial statements for the years ended December 31, 2014 and 2013 have been prepared assuming that we will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.
The carrying amounts of assets and liabilities presented in the financial statements do not purport to represent realizable or settlement values. We have suffered significant recurring operating losses, used substantial funds in our operations, and need to raise additional funds to accomplish our objectives. Stockholders’ deficit at December 31, 2014 was $26.5 million. Additionally, at December 31, 2014, we had negative working capital of approximately $17.3 million (although it includes deferred revenue of approximately $2.3 million) and have defaulted on all of our debt obligations. These conditions raise substantial doubt about our ability to continue as a going concern.
Our Success Depends On Our Ability to Generate Sufficient Revenues to Pay for the Expenses of Our Operations.
We believe that our success will depend upon our ability to generate revenues from our SiteFlash™ and Emily™ technology products through licensing and development of commercially viable products, as well as increased revenues from NOW Solutions’ products and services as well as the successful launch of our new products by our subsidiaries (such as SnAPPnet™, and PTS™, Emily™ and web server applications), none of which can be assured. Our ability to generate revenues is subject to substantial uncertainty and our inability to generate sufficient revenues to support our operations and debt repayment could require us to curtail or suspend operations. Such an event would likely result in a decline in our stock price.
Our Success Depends On Our Ability to Obtain Additional Capital.
We have funding that is expected to be sufficient to fund our present operations for three months. However, we will need significant additional funding in order to complete our business plan objectives. Accordingly, we will have to rely upon additional external financing sources to meet our cash requirements. Management will continue to seek additional funding in the form of equity or debt to meet our cash requirements. Other than common or preferred stock in our subsidiaries, we do not have any common stock available to issue to raise money. However, there is no guarantee we will raise sufficient capital to execute our business plan. In the event that we are unable to raise sufficient capital, our business plan will have to be substantially modified and operations curtailed or suspended.
We Have a Working Capital Deficit, Which Means That Our Current Assets on December 31, 2014 Were Not Sufficient to Satisfy Our Current Liabilities on That Date.
We had a working capital deficit of approximately $17.3 million at December 31, 2014, which means that our current liabilities exceeded our current assets by approximately $17.3 million (although it includes deferred revenue of approximately $2.3 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, 2014 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™ technologies;
·the demand for administrative software products and services: emPath®; PTS™, and SnAPPnet™
·introduction of new products and services by us and our competitors;
·costs incurred with respect to acquisitions;
·price competition or pricing changes in the industry;
·technical difficulties or system failures;
·general economic conditions and economic conditions specific to the Internet and Internet media; and
·the licensing of our intellectual property.
We Face Product Development Risks Due to Rapid Changes in Our Industry. Failure to Keep Pace with These Changes Could Harm Our Business and Financial Results.
The markets for our products are characterized by rapid technological developments, continually-evolving industry trends and standards and ongoing changes in customer requirements. Our success depends on our ability to timely and effectively keep pace with these developments.
Keeping Pace with Industry Changes.
We must enhance and expand our product offerings to reflect industry trends, new technologies and new operating environments as they become increasingly important to customer deployments. We must continue to expand our business models beyond traditional software licensing and subscription models, including, by way of example, use of cloud based offering as an increasingly important method and business model for the delivery of applications. We must also continuously work to ensure that our products meet changing industry certifications and standards. Failure to keep pace with any changes that are important to our customers could cause us to lose customers and could have a negative impact on our business and financial results.
Impact of Product Development Delays or Competitive Announcements.
Our ability to adapt to changes can be hampered by product development delays. We may experience delays in product development as we have at times in the past. Complex products like ours may contain undetected errors or version compatibility problems, particularly when first released, which could delay or adversely impact market acceptance. We may also experience delays or unforeseen costs associated with integrating products we acquire with products we develop because we may be unfamiliar with errors or compatibility issues of products we did not develop ourselves. We may choose not to deliver a partially-developed product, thereby increasing our development costs without a corresponding benefit. This could negatively impact our business.
Our Failure to Maintain and Increase Acceptance of Our Cloud-Offerings Would Inhibit Our Growth Or Cause a Significant Decline in Our Revenues.
Our future success depends on maintaining and increasing acceptance of our Cloud-based offering, particularly, of emPath® and PTS™. Any decrease in the demand for these products would have a material adverse effect on our business, operating results and financial condition and would place a significant strain on our management and operations.
If We Are Unable to Make Periodic Updates for Our Products Concerning Changes in Tax Laws and Other Regulations on a Timely Basis Acceptance of Our Products in the Market could Be Adversely Affected And Our Revenues Would Decline.
Products like emPath® are affected by changes in tax laws and regulations, and we must generally update such products on an annual or periodic basis to maintain their accuracy and competitiveness. We cannot be certain we will be able to release these updates on a timely basis in the future. Any failure to do so could have a material adverse effect on the acceptance of our products. Additionally, any significant changes in tax laws or regulations applicable to such products could require us to make significant investments in modifications of these products, leading to significant and unexpected costs.
Errors and Defects in Our Software Could Affect Sales of Our Products.
The software products we offer may contain undetected errors, defects, or failures when first introduced or as new versions are released. Testing of software products presents many challenges since it is difficult to anticipate and simulate the wide range of software computing environments in which our customers use these products. While we test our products extensively, from time-to- time, we have discovered errors or defects in our products. These defects and errors may result in any of the following:
·Delays in the release of our new products, versions and upgrades
·Increased costs to fix such defects and errors, in turn leading to a strain on our software development resources
·Design modifications of the product
·A decrease in customer satisfaction with, our products and a decrease in sales, and a loss of existing and potential customers
Even after our products are tested by us and by current and prospective customers, errors and defects may be discovered after the commercial release has commenced, which may result in loss of or delay in market acceptance which could have a material adverse impact upon our business, operating results and financial condition.
Our software products may be vulnerable to break-ins and similar disruptive problems; addressing these issues may be expensive and require a significant amount of our resources.
We have included security features in our products that are intended to protect the privacy and integrity of customer data. Despite the existence of these security features, our software products may be vulnerable to break-ins and similar disruptive problems. Addressing these evolving security issues may be expensive and require a significant amount of our resources.
The Sale and Support of Software Products and the Performance of Related Services by Us Entail the Risk of Product or Service Liability Claims, Which Could Significantly Affect Our Financial Results.
Customers use our products in connection with the preparation and filing of tax returns and other regulatory reports. If any of our products contain errors that produce inaccurate results upon which users rely, or cause users to misfile or fail to file required information, we could be subject to liability claims from users. Our Cloud-based usage licenses and maintenance renewal agreements with our customers typically contain provisions intended to limit our liability to such claims, but such provisions may not be effective in doing so. These contractual limitations may not be legally enforceable and may not afford us with adequate protection against product liability claims in certain jurisdictions. If a successful claim for product or service liability was brought against us, this could result in substantial cost to us and divert management’s attention from our operations.
International Operations of Our Business Subject Us to Additional Risks in Those Foreign Countries.
Our international operations are subject to additional risks, which increase our exposure to foreign laws and regulations. Over time, our international operations may grow and increase their significance to our business. Sales to international customers subject our business to a number of risks, including foreign currency fluctuations, unexpected changes in regulatory requirements related to software, international political and economic instability, international tax laws, compliance with multiple, changing, and possibly conflicting governmental laws and regulations, and difficulty in staffing and managing foreign operations,. In addition, there may be weaker protection for our intellectual property abroad than in the United States, and we may have difficulties in enforcing such rights abroad. If we are not able to comply with foreign laws and regulations, which are often complex and subject to variation and unexpected changes, we could incur unexpected costs and potentially become involved in litigation. . In addition, in the event sales to any of our customers outside of the United States are delayed or canceled because of any of the risks described above, our revenues may be negatively impacted.
Security and Privacy Breaches Could Adversely Impact Our Business.
For services such as our cloud-based offerings, we may electronically store personal information about our clients and their employees. We take security measures to protect against the unauthorized access and disclosure of such information. However, there is no guarantee the precautions we take will be successful in protecting against all security breaches that may result in unauthorized access to such information. If our security measures are breached or if our services are subject to attacks that degrade or deny the ability of our clients to access our services, we may incur significant financial, legal, and regulatory exposure.
Privacy Concerns Could Result in Changes of Regulations or Laws That Affect Our Business.
Personal privacy is a significant issue in the United States as well as in other countries where our customers operate. Consequently, we are subject to regulations concerning the use of personal information we collect. Changes to regulations or laws affecting privacy that apply to our business could impose additional costs and potential liability on us and could also limit our use and disclosure of such information. If we are required to change our business activities or revise or eliminate services, our business could be adversely affected.
We May Have Difficulty Managing Our Growth and Integrating Recently Acquired Companies.
Our recent growth through acquisitions and licensing of new solutions, coupled with our development efforts to create new commercially viable products and improve existing ones, has placed a significant strain on our managerial, operational, and financial resources. To manage our growth, we must continue to implement and improve our operational and financial systems and to expand, train, and manage our employee base. Any inability to manage growth effectively could have a material adverse effect on our business, operating results, and financial condition. Further, acquisition transactions are accompanied by a number of risks, including the following:
·the difficulty of assimilating the operations and personnel of the acquired companies;
·the potential disruption of our ongoing business and distraction of management;
·the difficulty of incorporating acquired technology or content and rights into our products and media properties;
·the correct assessment of the relative percentages of in-process research and development expense which needs to be immediately written off as compared to the amount which must be amortized over the appropriate life of the asset;
·the failure to successfully develop an acquired in-process technology resulting in the impairment of amounts currently capitalized as intangible assets;
·unanticipated expenses related to technology integration;
·the maintenance of uniform standards, controls, procedures and policies;
·the impairment of relationships with employees and customers as a result of any integration of new personnel; and
·the potential unknown liabilities associated with acquired businesses.
We may not be successful in addressing these risks or any other problems encountered in connection with acquisitions. Our failure to address these risks could negatively affect our business operations through lost opportunities, revenues or profits, any of which would likely result in a lower stock price.
Our Success Depends On Our Ability to Protect Our Proprietary Technology.
Our success is dependent, in part, upon our ability to protect and leverage the value of proprietary technology, including our patented SiteFlash™ and Emily™, our patent-pending technologies and administrative software solutions like emPath®, PTS™, and SnAPPnet™, as well as our trade secrets, trade names, trademarks, service marks, domain names and other proprietary rights we either currently have or may have in the future. Given the uncertain application of existing trademark laws to the Internet and copyright laws to software development, there can be no assurance that existing laws will provide adequate protection for our technologies, sites or domain names. Policing unauthorized use of our technologies, content and other intellectual property rights entails significant expenses and could otherwise be difficult or impossible to do given the global nature of the Internet and our potential markets.
If Demand for Our Products Grow Quickly, We May Lack the Capacity Needed to Meet Demand or We May Be Required to Increase Our Capital Spending Significantly.
Our current plans may not be sufficient to meet our capacity needs for the foreseeable future or may not be implemented quickly enough to meet growing demand. Moreover, if we make significant capital expenditures to increase capacity and demand does not increase as we expect, these expenditures would adversely affect our profitability and return on capital.
Our Stock Price Has Historically Been Volatile, Which May Make It More Difficult for Shareholders to Resell Shares When They Choose To At Prices They Find Attractive.
The trading price of our common stock has been and may continue to be subject to wide fluctuations. The stock price may fluctuate in response to a number of events and factors, such as quarterly variations in operating results, announcements of technological innovations or new products and media properties by us or our competitors, changes in financial estimates and recommendations by securities analysts, the operating and stock price performance of other companies that investors may deem comparable, and news reports relating to trends in our markets. In addition, the stock market in general, and the market prices for Internet-related and technology-related companies in particular, have experienced extreme volatility that often has been unrelated to the operating performance of such companies. These broad market and industry fluctuations may adversely affect the price of our stock, regardless of our operating performance.
Our Common Stock Is Deemed To Be “Penny Stock,” Which May Make It More Difficult for Investors to Sell Their Shares Due To Suitability Requirements.
Our common stock is deemed to be “penny stock” as that term is defined in Rule 3a51-1 promulgated under the Exchange Act. Penny stocks are stocks:
1.With a price of less than $5.00 per share;
2.That are not traded on a recognized national exchange;
3.Whose prices are not quoted on the NASDAQ automated quotation system (NASDAQ listed stock must have a price of not less than $5.00 per share); or
4.In issuers with net tangible assets less than $2 million (if the issuer has been in continuous operation for at least three years) or $5 million (if in continuous operation for less than three years), or with average revenues of less than $6 million for the last three years.
Broker/dealers dealing in penny stocks are required to provide potential investors with a document disclosing the risks of penny stocks. Moreover, broker/dealers are required to determine whether an investment in a penny stock is a suitable investment for a prospective investor. These requirements may reduce the potential market for our common stock by reducing the number of potential investors. This may make it more difficult for investors in our common stock to sell shares to third parties or to otherwise dispose of them. This could cause our stock price to decline.
Item 2.
Item 2. Properties
The Company and NOW Solutions’ headquarters are currently located at 101 West Renner Road, Suite 300, Richardson, Texas, and comprise approximately 4,000 square feet. NOW Solutions has other offices at 6205 Airport Road, Building B, Suite 214, Mississauga, Ontario, Canada, which comprises 793 square feet, 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 Richardson, Texas headquarters.
Item 3.
Item 3. Legal Proceedings
We are involved in the following ongoing legal matters:
On November 18, 2009, we sued InfiniTek Corporation (“InfiniTek”) in the Texas State District Court in Fort Worth, Texas for breach of contract and other claims (the “Texas Action”) seeking equitable relief and unspecified damages when a dispute between the Company and InfiniTek was not resolved. All agreements with InfiniTek have been cancelled. On January 15, 2010, InfiniTek filed a counter-claim for non-payment of amounts billed. InfiniTek claimed it was owed $195,000 plus lost opportunity costs of not less than $220,000.
On April 7, 2010, we were served with a lawsuit filed by InfiniTek in the California Superior Court in Riverside, California seeking damages in excess of $76,303 for breach of contract and lost profit (the “California Action”). This lawsuit related to one of the causes of action and the same set of underlying facts, as those in the Texas legal action. On May 7, 2010, we filed a motion to dismiss this action. On July 14, 2010, the court denied our motion. On August 13, 2010, we filed an answer to InfiniTek’s complaint, including a denial and affirmative defenses.
On December 31, 2011, the Company and InfiniTek entered into a settlement agreement whereby the Texas Action and the California Action were both dismissed. Pursuant to the terms of the settlement agreement, Vertical agreed to pay InfiniTek $82,500 in three equal installments with the last payment due by or before August 5, 2012. Upon full payment, InfiniTek shall transfer and assign ownership of the NAVPath software developed by InfiniTek for use with NOW Solutions emPath® software application and Microsoft Dynamics NAV (formerly Navision) business solution platform. The amounts in dispute were included in our accounts payable and accrued liabilities and have been adjusted to the settlement amount of $82,500 at December 31, 2011. The Company has made $37,500 in payments due under the settlement agreement as of November 16, 2012 and each party is alleging the other party is in breach of the settlement agreement. We are currently seeking to resolve all disputes with InfiniTek.
On November 15, 2010, we filed a lawsuit in the Federal District Court for the Eastern District of Texas (the “Vertical Action”) against Interwoven, Inc. ("Interwoven"), LG Electronics MobileComm U.S.A., Inc., LG Electronics, Inc., Samsung Electronics Co., Ltd. and Samsung Electronics America, Inc. (collectively, the "Defendants"). We sued the Defendants for patent infringement claims under United States Patent No. 6,826,744 (“System and Method for Generating Web Sites in an Arbitrary Object Framework”) and United States Patent No. 7,716,629 (“System and Method for Generating Web Sites in an Arbitrary Object Framework”) (collectively the “the Patents-in-Suit”), both of which are owned by the Company. We seek an award of monetary damages and other relief. The case is styled Vertical Computer Systems, Inc. v Interwoven, Inc., LG Electronics Mobilecomm U.S.A., Inc., No. 2:10-CV-00490.
On November 17, 2010, we were served with a lawsuit filed on October 14, 2010 by Interwoven in the United States District Court for the Northern District of California (the “Interwoven Action”). This lawsuit was instituted as a complaint for declaratory judgment, in which Interwoven requested that the court find that no valid and enforceable claim of either of the two patents referenced above has been infringed by Interwoven. The case is styled Interwoven, Inc. v Vertical Computer Systems, Inc. No. 3:10-CV-4645-RS.
On January 11, 2011, Samsung Electronics Co., Ltd. and Samsung Electronics America, Inc. (“Samsung”) filed a lawsuit in the United States District Court for the Northern District of California seeking to consolidate its lawsuit with the Interwoven Action. This case is styled Samsung Electronics Co., Ltd. and Samsung Electronics America, Inc., v. Vertical Computer Systems, Inc., No. 3:11-CV-00189-RS.
On May 2, 2011, the United States District Court for the Northern District of California denied Vertical’s renewed motion to transfer the Interwoven Action to the Eastern District of Texas and granted Vertical's motion to transfer the lawsuit filed by Samsung in the Northern District of California to the Eastern district in Texas. On May 11, 2011, the United States District Court for the Eastern District of Texas granted Interwoven’s motion to transfer the case to the Northern District of California with respect to Interwoven and denied Samsung’s motion to transfer its case to the Northern district.
On December 30, 2011, the United States District Court for the Northern District of California issued a claims construction order in the Interwoven Action concerning the terms found in the claims of the Patents-in-Suit.
On October 12, 2012, the United States Patent and Trademark Office (“USPTO”) issued an ex parte reexamination certificate of United States Patent No. 7,716,629. In the ex parte reexamination certificate, Claims 21-36, 29, 30, and 32 were confirmed; Claims 1, 8, 11, 13, 28 and 31 were determined to be patentable as amended, Claims 2-6, 9, 10, 12, 14-17, 19 and 20, which were dependent on an amended claim, were determined to be patentable, and claims 7, 18 and 27 were not reexamined.
On October 25, 2012, the USPTO notified the Company of its intent to issue an ex parte reexamination certificate concerning the ex parte reexamination of United States Patent No. 6,826,744. In the notice of intent to issue ex parte reexamination certificate, the USPTO notified that the prosecution on the merits is closed in this ex parte reexamination proceeding and indicated that Claims 6, 8, 19, 22, 30, 32, 41, 44, 50, 51 were confirmed; Claims 1 and 26 were cancelled; Claims 12-17, 20, 34-39, 42 and 43 are not subject to reexamination; newly presented Claims 54-57 are patentable and continuation of patent claims amended: 2-5, 7, 9-11, 18, 21, 23-25, 27-29, 31, 33, 40, 45-49, 52 and 53.
On January 4, 2013, the United States District Court for the Northern District of California in the Interwoven Action denied Interwoven’s motion for summary judgment for unenforceability and invalidity of the Patents-in-Suit in its entirety.
On July 17, 2013, the United States District Court for the Northern District of California in the Interwoven Action ruled on Interwoven’s motion for summary judgment with respect to infringement and damages concerning the Patents-in-Suit. The court denied Interwoven’s motion for summary judgment on the issue of direct infringement and granted summary judgment in favor of Interwoven with respect to infringement on the doctrine of equivalents and with respect to indirect infringement. The court also granted in part and denied in part Interwoven’s motion to exclude certain expert witness testimony.
On September 16, 2013, the United States District Court for the Eastern District of Texas issued a claims construction order in the Vertical Action concerning the terms found in the claims of the Patents-in-Suit. On December 12, the Company settled the patent infringement claim that the Company initiated in federal court against LG. Pursuant to the confidential settlement agreement, the Company has granted to LG a non-exclusive, fully paid-up license under the two patents (“Patents-in-Suit”) with any continuation patents of the Patents-in-Suit and any other continuation patents with the same priority claim as the Patents-in-Suit.
On December 12, 2013, the Company settled its patent infringement claim against LG Electronics. Pursuant to the confidential settlement agreement, the Company granted to LG Electronics a non-exclusive, fully paid-up license under the Patents-in-Suit which were the subject of the legal proceeding. The litigation concerning the Patents-in-Suit with LG has been resolved.
On March 20, 2014, the Company settled the patent infringement claim that the Company initiated in federal court against Samsung. Pursuant to the confidential settlement agreement, the Company has granted to Samsung a non-exclusive, fully paid-up license under the Patents-in-Suit with any continuation patents of the Patents-in-Suit and any other patents with the same priority claim as the Patents-in-Suit. The litigation concerning the Patents-in-Suit with Samsung has been resolved.
On May 8, 2014, the Company settled the patent infringement claim that the Company initiated in federal court against Interwoven. Pursuant to the confidential settlement agreement, the Company has granted to Interwoven and its subsidiaries, affiliates and parent companies (which include Autonomy Corporation PLC and Hewlett-Packard Company, Inc.), a non-exclusive, fully paid-up license to the Patents-in-Suit with any continuation patents of the Patents-in-Suit and any other patents with the same priority claim as the Patents-in-Suit. The Interwoven Action has been resolved.
On July 8, 2011, we were served with a lawsuit in the Texas State District Court in Dallas, Texas by Clark Consulting Services, Inc. (“CCS”) for breach of contract and other claims. CCS was seeking damages from us in excess of $133,750 plus attorney’s fees and interest. On August 8, 2011, we filed an answer denying CCS’s claims and setting forth affirmative defenses. In December 2011, the Company and CCS entered into a settlement agreement whereby the lawsuit was dismissed. Pursuant to the terms of the settlement agreement, the Company agreed to pay CCS $134,000, which was to be paid in installment payments. Due to the Company’s failure to make timely payments, an additional $60,000 was added to the outstanding balance. On October 26, 2012, we entered into an agreement under which we agreed to make monthly payments of $5,000 and pay the outstanding balance plus attorney’s fees and costs by February 1, 2013. As of December 31, 2012, the settlement amount of $149,000 has been included in accounts payable and accrued liabilities. During 2013, the parties entered into several agreements to extend the date by which the Company has to pay off the balance of the settlement amount whereby. Under these agreements, the Company agreed to make monthly payments of $10,000 (of which $2,500 of each payment would be applied as late fees) beginning in February 2013 through November 2013 until the outstanding balance has been paid. As of November 17, 2014, all payments have been made and this matter has been resolved.
On October 11, 2012, Micro Focus (US), Inc. (“Micro Focus”) filed a lawsuit against NOW Solutions in the United States District Court for the southern division district of Maryland alleging breaches of its contractual obligations under an independent software agreement and copyright infringement. On January 28, 2013, NOW Solutions and Micro Focus entered into a settlement agreement whereby NOW Solutions agreed to pay Micro Focus $420,000, of which $70,000 in installment payments were made with the outstanding balance due on April 30, 2013. In connection with the settlement, the Company entered into a guaranty agreement with Micro Focus concerning NOW Solutions’ obligations under the promissory note. The Company did not make the $375,000 payment due to Micro Focus. On May 15, 2013, Vertical was served with a lawsuit in the Circuit Court for Montgomery County, Maryland by Micro Focus concerning the guaranty by Vertical to Micro Focus concerning NOW Solutions’ failure to make payment of the outstanding balance due under the promissory note. On July 3, 2013, NOW Solutions was served with a lawsuit for a confessed judgment in the Circuit Court for Montgomery County, Maryland by Micro Focus concerning NOW Solutions’ failure to make payment of the outstanding balance due under the promissory note. On January 15, 2014, the Company and NOW Solutions consented to a judgment in the amount of $350,000, plus $36,000 in accrued interest and attorney’s fees in the amount of $80,000, plus accrued interest at the rate of 10% per annum until paid. As of December 31, 2014, all payments have been made and this matter has been resolved.
On February 4, 2014, Victor Weber filed a lawsuit against Vertical Mountain Reservoir Corporation (“MRC”), and Richard Wade in the District Court of Clark County, Nevada for failure to make payment of the outstanding balance due under a $275,000 promissory note issued by Vertical to Mr. Weber. The plaintiff seeks payment of the principal balance due under the note $275,000, default interest at the rate of 18% per annum, attorney’s fees and court costs, and punitive damages. On July 24 2014, the court granted plaintiff’s motion for summary judgment against defendants. The judgment was filed on September 18, 2014. We are currently seeking to resolve this matter with Mr. Weber. Mr. Wade is the President and CEO of Vertical and the President of MRC. MRC is a corporation controlled by the W5 Family Trust. Mr. Wade is the trustee of the W5 Family Trust.
On October 20, 2014, Michael T. Galvan and Michelle Bates (“Galvan & Bates”) filed a lawsuit in the Court of Chancery in the State of Delaware seeking to have the court compel the Company to hold a shareholder meeting for the purpose of electing all directors of the Company, designating the time and place of a meeting and other details reasonably necessary to hold such a meeting, attorney costs and fees (including reasonable attorney’s fees), and such other relief as the court deems proper. Galvan and Bates are stockholders of the Company. This case is styled Michael T. Galvan and Michelle Bates v. Vertical Computer Systems, Inc., No. 10234. The Company held an annual meeting of shareholders on February 25, 2015. This matter is resolved.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
Our common equity is traded on the OTC Markets and quoted on the OTCQB under the symbol “VCSY.” The OTCQB may also be referred to as “OTCMKTS” or “Other OTC”.
The following is the range of high and low closing bid prices of our stock, for the periods indicated below.
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 15, 2015, there were 1,846 holders of record of VCSY common stock.
Equity Securities Under Compensation Plans
We had no securities authorized for issuance under equity compensation plans (which include individual agreements) as of December 31, 2014.
We do not have any equity compensation plans (i.e., stock option plans or restricted stock plans) that have been approved by security holders.
We did not issue any warrants to purchase VCSY common stock in 2014.
Dividends
We have outstanding shares of Series A and Series C 4% Convertible Cumulative Preferred stock that accrue dividends (if such dividends are declared) at a rate of 4% on a semi-annual basis. The total dividends applicable to Series A and Series C Preferred Stock were $588,000 for each of the years ended December 31, 2014 and 2013. Our Board of Directors did not declare any dividends on our outstanding shares of Series A or Series C Preferred Stock during 2014 or 2013, nor has the Company paid any dividends on our outstanding shares of Series A or Series C Preferred Stock since 2001. We intend to retain future earnings, if any, to provide funds for use in the operation and expansion of our businesses. Accordingly, we do not anticipate paying cash dividends on any of our capital stock, including preferred stock, in the near future. For additional information concerning dividends, please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7.
Unregistered Sales of Securities
During the last two years, we issued the following unregistered securities:
In July 2013, the Company issued 500,000 shares of VCSY common stock to a third party lender in connection with a loan of $150,000 by the lender, The fair-market value of these shares was valued at $19,700.
During the year ended December 31, 2013, the Company cancelled 1,500,000 previously issued common shares of the Company that had been granted to a third party lender.
During the year ended December 31, 2013, 1,500,000 shares of VCSY common stock were issued to consultants of the Company. The fair-market value of these shares was valued at $45,000.
During the year ended December 31, 2013, 2,050,000 shares of VCSY common stock granted to employees and consultants of the Company, valued at $55,226 vested.
During the year ended December 31, 2014, 550,000 common shares granted to employees of the Company and a consultant of the Company vested. Stock compensation that was previously accrued totaling $10,226 was reclassified from accrued liabilities to stockholders’ equity associated with these shares vested.
During the year ended December 31, 2014, the Company granted 200,000 common shares to an employee of the Company. The shares vested immediately upon grant and the fair value of the shares was determined to be $3,200. The fair value was expensed in full during the year ended December 31, 2014.
In February 2015, the Company amended its certificate of incorporation in the state of Delaware to increase the authorized number of shares of common stock to 2,000,000,000 shares of common stock.
In March 2015, the Company issued a total 3,809,983 shares of our common stock to reimburse an officer of the Company and a company controlled by another officer of the Company in connection with indemnity and reimbursement agreements entered into with the Company. The Company was obligated to reimburse these 3,809,983 shares in connection with 1,309,983 shares sold under a stock pledge agreement with a third party lender, 500,000 shares and wrongfully converted by the same lender and 2,000,000 shares transferred to two other third party lenders on the Company’s behalf.
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.
Item 6. Selected Financial Data
Not applicable.
Item 7.
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.
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 2014, the Company wrote off $771,251 of previously capitalized software costs related to its 70% owned subsidiary, Priority Time Systems. During the year ended December 31, 2014, $478,876 of internal costs were capitalized related to its Ploinks™ software application. During the year ended December 31, 2013, $163,367 of internal costs were capitalized.
Revenue Recognition
Our revenue recognition policies are in accordance with standards on software revenue recognition, which include guidance on revenue arrangements with multiple deliverables and arrangements that include the right to use of software stored on another entity’s hardware.
In the case of non-software arrangements, we apply the guidance on revenue arrangements with multiple deliverables and wherein multiple elements are allocated to each element based on the element’s relative fair value. Revenue allocated to separate elements is recognized for each element in accordance with our accounting policies described below. If we cannot account for items included in a multiple-element arrangement as separate units of accounting, they are combined and accounted for as a single unit of accounting and generally recognized as the undelivered items or services are provided to the customer.
Consulting. We provide consulting services, primarily implementation and training services, to our clients using a time and materials pricing methodology. The Company prices its delivery of consulting services on a time and materials basis where the customer is either charged an agreed-upon daily rate plus out-of-pocket expenses or an hourly rate plus out-of-pocket expenses. In this case, the Company is paid fees and other amounts generally on a monthly basis or upon the completion of the deliverable service and recognizes revenue as the services are performed.
Software License. We sell concurrent perpetual software licenses to our customers. The license gives the customer the right to use the software without regard to a specific term. We recognize the license revenue upon execution of a contract and delivery of the software, provided the license fee is fixed and determinable, no significant production, modification or customization of the software is required and collection is considered probable by management. When the software license arrangement requires the Company to provide consulting services that are essential to the functionality of the software, the product license revenue is recognized upon the acceptance by the customer and consulting fees are recognized as services are performed.
Software licenses are generally sold as part of a multiple-element arrangement that may include maintenance and, under a separate agreement, consulting services. The consulting services are generally performed by the Company, but the customer may use a third-party to perform the consulting services. We consider these separate agreements as being negotiated as a package. The Company determines whether there is vendor specific objective evidence of fair value (‘‘VSOEFV’’) for each element identified in the arrangement, to determine whether the total arrangement fees can be allocated to each element. If VSOEFV exists for each element, the total arrangement fee is allocated based on the relative fair value of each element. In cases where there is not VSOEFV for each element, or if it is determined that services are essential to the functionality of the software being delivered, we initially defer revenue recognition of the software license fees until VSOEFV is established or the services are performed. However, if VSOEFV is determinable for all of the undelivered elements, and assuming the undelivered elements are not essential to the delivered elements, we will defer recognition of the full fair value related to the undelivered elements and recognize the remaining portion of the arrangement value through application of the residual method. Where VSOEFV has not been established for certain undelivered elements, revenue for all elements is deferred until those elements have been delivered or their fair values have been determined. Evidence of VSOEFV is determined for software products based on actual sales prices for the product sold to a similar class of customer and based on pricing strategies set forth in the Company’s standard pricing list. Evidence of VSOEFV for consulting services is based upon standard billing rates and the estimated level of effort for individuals expected to perform the related services. The Company establishes VSOEFV for maintenance agreements using the percentage method such that VSOEFV for maintenance is a percentage of the license fee charged annually for a specific software product, which in most instances is 18% of the portion of arrangement fees allocated to the software license element.
Maintenance Revenue. In connection with the sale of a software license, a customer may elect to purchase software maintenance services. Most of the customers that purchase software licenses from us also purchase software maintenance services. These maintenance services are typically renewed on an annual basis. We charge an annual maintenance fee, which is typically a percentage of the initial software license fee and may be increased from the prior year amount based on inflation or other agreed upon percentage. The annual maintenance fee generally is paid to the Company at the beginning of the maintenance period, and we recognize these revenues ratably over the term of the related contract.
While most of our customers pay for their annual maintenance at the beginning of the maintenance period, a few customers have payment terms that allow them to pay for their annual maintenance on a quarterly or monthly basis. If the annual maintenance fee is not paid at the beginning of the maintenance period (or at the beginning of the quarter or month for those few maintenance customers), we will ratably recognize the maintenance revenue if management believes the collection of the maintenance fee is imminent. Otherwise, we will defer revenue recognition until the time that the maintenance fee is paid by the customer. We normally continue to provide maintenance service while awaiting payment from customers. When the payment is received, revenue is recognized for the period that revenue was previously deferred. This may result in volatility in software maintenance revenue from period to period.
Cloud-based offering. We have contracted with a third party to provide new and existing customers with a hosting facility providing all infrastructure and allowing us to offer our currently sold software, emPath®, on a service basis. However, a contractual right to take possession of the software license or run it on another party’s hardware is not granted to the customer. We refer to the delivery method to give functionality to new customers utilizing this service as cloud-based. Since the customer is not given contractual right to take possession of the software, the scope of ASC 350-40 does not apply. A customer using cloud-based software can enter into an agreement to purchase a software license at any time. We generate revenue from cloud-based offering as the customer utilizes the software over the Internet.
We will provide consulting services to customers in conjunction with the cloud-based offering. The rate for such service is based on standard hourly or daily billing rates. The consulting revenue is recognized as services are performed. Customers utilizing their own computer to access cloud-based functionality are charged a fee equal to the number of employees paid each month multiplied by an agreed-upon rate per employee. The revenue is recognized as the cloud-based services are rendered each month.
Allowances for Doubtful Accounts
The Company maintains allowances for doubtful accounts, for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. We review delinquent accounts at least quarterly to identify potential doubtful accounts, and together with customer follow-up, estimate the amounts of potential losses.
Deferred Taxes
The Company records a valuation allowance to reduce the deferred tax assets to the amount that management believes is more likely than not to be realized in the foreseeable future, based on estimates of foreseeable future taxable income and taking into consideration historical operating information. In the event management estimates that the Company will not be able to realize all or part of its net deferred tax assets in the foreseeable future, a valuation allowance is recorded through a charge to income in the period such determination is made. Likewise, should management estimate that the Company will be able to realize its deferred tax assets in the future in excess of its net recorded assets, an adjustment to reduce the valuation allowance would increase income in the period such determination is made.
Stock-Based Compensation Expense
We account for share-based compensation in accordance with the provisions of share-based payments, which require measurement of compensation cost for all stock-based awards at fair value on date of grant and recognition of compensation over the service period for awards expected to vest. The fair value of restricted stock and restricted stock units is determined based on the number of shares issued and the quoted price of our common stock. See Note 10 of the Consolidated Financial Statements for a further discussion of stock-based compensation.
Valuation of the Embedded and Warrant Derivatives
The valuation of our embedded derivatives is determined by using the Company’s quoted stock price. An embedded derivative is a derivative instrument that is embedded within another contract, which under a convertible note (the host contract) includes the right to convert the note by the holder, certain default redemption right premiums and a change of control premium (payable in cash if a fundamental change occurs). In accordance with the guidance on derivative instruments, embedded derivatives are marked-to-market each reporting period, with a corresponding non-cash gain or loss charged to the current period. The practical effect of this has been that when our stock price increases so does our derivative liability, resulting in a non-cash loss that reduces our earnings and earnings per share. When our stock price declines, we record a non-cash gain, increasing our earnings and earnings per share.
The fair value recorded for the derivative liability varies from period to period. This variability may result in the actual derivative liability for a period either above or below the estimates recorded on our consolidated financial statements, resulting in significant fluctuations in other income (expense) because of the corresponding non-cash gain or loss recorded.
Recently Issued Accounting Pronouncements
The Company does not expect the adoption of any recently issued accounting pronouncements to have a significant impact on the Company’s consolidated financial statements.
Results of Operations
Year ended December 31, 2014 Compared To Year Ended December 31, 2013
Total Revenues. We had total revenues of $7,435,502 and $6,057,026 for the years ended December 31, 2014 and 2013, respectively. The increase in total revenue was $1,378,476 for the year ended December 31, 2014, representing a 22.8% increase compared to the total revenue for the year ended December 31, 2013. The increase in revenue was primarily due to a $2,600,000 software patent license issued in 2014 compared to $750,000 in 2013, partially offset by a $339,812 decrease in software maintenance and a $30,056 decrease in cloud-based offerings. Of the $7,435,502 and $6,057,026 total revenues for the years ended December 31, 2014 and 2013, respectively, $4,484,923 and $5,201,633 of such amounts were related to the business operations of NOW Solutions, a 75% owned subsidiary of the Company.
The revenues from licenses and software primarily consist of fees we bill for NOW Solutions’ new payroll and human resources (“PRHR”) software licenses and licenses fees for patents and technology we own. The increase in license and software revenue from 2014 to 2013 was $1,777,640 which was due to increased sales of our PRHR software and licensing fees for patents and technology in 2014 to new or existing customers.
Software maintenance revenue is generated from existing customers of our PRHR software who want the continued benefit of tax updates, customer support, and software enhancements. Software maintenance revenue decreased by $339,812 or 7.9% from the year ended December 31, 2013 to the same period in 2014. The decrease was due to the loss of customer contracts and the effect of unfavorable currency exchange rates on our Canadian maintenance revenue.
Consulting revenue for the year ended December 31, 2014 decreased by $5,463 from the same period in the prior year, representing a 1.4% decrease. This decrease was due to the effect of unfavorable currency exchange rates on our Canadian consulting revenue.
Cloud-based revenue decreased $30,056 or 7.0% for the year ended December 31, 2014 compared to the same period in 2013. The decrease was primarily related to customer user base adjustments during 2014 and the effect of unfavorable currency exchange rates on our Canadian cloud-based revenue.
Other revenues, consisting primarily of reimbursable travel expenses, decreased by $23,833 or 26.9% for the year ended December 31, 2014 compared to the same period for 2013. The decrease was mainly attributable to lower reimbursable travel in 2014 due to decreased consultant travel.
Cost of Revenues. We had direct costs associated with the above revenues of $2,159,870 for the year ended December 31, 2014 compared to $2,445,628 for the same period of 2013, representing a decrease of $285,758 or 11.7%. These direct costs are primarily related to costs providing customer support, professional services, software upgrades and enhancements. The decrease in direct costs is primarily related to a decrease in payroll costs, consultant travel and rent for the year ended December 31, 2014 compared to the same period for 2013.
Selling, General and Administrative Expenses. We had selling, general and administrative expenses of $5,035,088 and $3,398,244 for the years ended December 31, 2014 and 2013, respectively. The total selling, general and administrative expenses for the year ended December 31, 2014 increased by $1,636,844 compared to the selling, general and administrative expenses for the year ended December 31, 2013, representing a 48.2% increase. The increase was primarily due to an increase in legal expenses to prosecute patent infringement on the Company’s intellectual property, increased royalties related to licensing of our patented intellectual property and increased payroll and health insurance costs.
Bad Debt Expense. We had net bad debt expense of $42,492 for 2014 compared to bad debt expense of $51,955 in 2013. The 2014 and 2013 expense were related to a reserve for several customer accounts greater than 90 days past due.
Impairment of software costs. For the year ended December 31, 2014, $771,251 of capitalized software development costs were considered impaired.
Gain on Settlement of Liabilities. For the year ended December 31, 2013, there was a $334,100 gain on settlement of liabilities as a result of our review of trade payables, accrued liabilities and notes payable for those items in which the statute of limitations had been exceeded and no legal liability existed.
Operating Income (Loss). We had an operating loss of $618,077 for the year ended December 31, 2014 compared to operating income of $441,952 for the year ended December 31, 2013, a difference of $1,060,029. The difference between 2014 and 2013 is primarily a result of higher revenues and gross profit offset by higher selling, general and administrative expense, the 2014 impairment of software development costs and a 2013 gain on settlement of trade payables.
Gain/loss on Derivative Liability. Derivative liabilities are adjusted each quarter for changes in the market value of the Company’s common stock. In general, as our stock price increases, the derivative liability increases, resulting in a loss. As our stock price decreases, the derivative liability decreases, resulting in a gain. The gain on derivative liability was $211,621 for the year ended December 31, 2014 compared to a loss on derivative liability of $231,901 for the year ended December 31, 2013. The change of $443,522 was a result of a decrease in the Company’s stock price at December 31, 2014 compared to December 31, 2013.
Interest Expense. We had interest expense of $933,529 and $832,949 for the years ended December 31, 2014 and 2013, respectively. Interest expense increased for the year ended December 31, 2014 by $100,580, representing an increase of 12.1%, compared to interest expense for the year ended December 31, 2013. The increase was a result of interest on new borrowings, higher interest on loans in default and interest on accounts payable balances.
Interest Income. Interest income for the year ended December 31, 2014 was $19 compared to $24 for the year ended December 31, 2013.
Forbearance Fees. Forbearance fees relate to fees charged by our lenders on loans in default. Forbearance fees for the year ended December 31, 2014 were $197,156 compared to $327,867 for the same period in 2013. The decrease in forbearance relates to our senior secured debt for NOW Solutions.
Loss on Loan Remedy Resulting From Issuance of Noncontrolling Interest. Loss on loan remedy resulting from issuance of noncontrolling interest was $1,457,240 for the year ended December 31, 2013. The expense relates to issuance of 25% of NOW Solutions, Inc. stock to our senior secured lenders.
Net Loss. We had a net loss of $1,450,822 for the year ended December 31, 2014 compared to a net loss of $2,602,811 for the year ended December 31, 2013. The net loss for 2014 was primarily due to an operating loss of $618,077 increased by $197,156 of forbearance fees and $933,529 of interest expense, partially offset by a gain on derivative liabilities. The net loss for 2013 was primarily due to operating income of $441,952 reduced by loss on derivative liabilities of $231,901, forbearance fees of $327,867, loss on non-controlling interest of $1,457,240 and interest expense of $832,949.
Income Tax Provision. We had an income tax benefit of $86,300 for the year ended December 31, 2014. The benefit is related to income tax expense of $166,675 for NOW Solutions, a 75% owned subsidiary of the Company, foreign tax expense for NOW Solutions of $14,867 offset by the settlement of foreign taxes from previous years for NOW Solutions of $267,842. Income tax expense of $194,830 for the year ended December 31, 2013 was related to foreign taxes of NOW Solutions. For 2014, since the company owns less than 80% of NOW Solutions, VCSY’s tax loss carry-forwards cannot be utilized to offset NOW Solutions, Inc.’s taxable income. Income taxes in previous years were not accrued as VCSY owned 100% and was able to utilize its tax loss carry-forwards to offset NOW Solutions’ taxable income.
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, 2014 and 2013, 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 2014 or 2013.
Net Loss Applicable to Common Stockholders. We had net loss attributed to common stockholders of $2,070,836 and $3,081,614 for the years ended December 31, 2014 and 2013, respectively. Net loss applicable to common stockholders for the year ended December 31, 2014 decreased by $1,010,778 compared to December 31, 2013. The decrease in the net loss applicable to common stockholders was due to the combination of factors described above in “Net Loss.”
Net Loss Per Share. The Company had a net loss per share of $0.00 and $0.00 for the years ended December 31, 2014 and 2013, respectively.
Financial Condition, Liquidity, Capital Resources and Recent Developments
At December 31, 2014, we had non-restricted cash-on-hand of $117,866 compared to $162,709 at December 31, 2013.
Net cash used in operating activities for the year ended December 31, 2014 was $134,350 compared to net cash used in operating activities of $469,040 for the year ended December 31, 2013.
A large portion of our cash and revenue comes from software maintenance. When we bill and collect for software maintenance, we record a liability in deferred revenue and recognize income ratably over the maintenance period. During 2014, our deferred maintenance revenue (a liability) increased slightly from $2,317,989 to $2,321,044.
Our accounts receivable decreased from $562,831 at December 31, 2013 to $560,879 at December 31, 2014 (net of allowance for bad debts). The decrease in receivables of $1,952 was due to faster year-end collections of NOW Solutions’ receivables.
Accounts payable and accrued liabilities increased from $9,787,515 at December 31, 2013 to $10,696,070 at December 31, 2014. The increase of $908,555 was primarily related to increases in accrued executive payroll, payroll taxes and penalties, and interest on notes payable. The balance in accounts payable and accrued liabilities is approximately 19.0 times the balance in accounts receivable. This is one of the reasons we do not have sufficient funds available to fund our operations and repay our debt obligations under their existing terms, as described below.
.
Net cash used in investing activities for the year ended December 31, 2014 was $486,967 consisting of the purchase of equipment and software of $8,091 and the development of software products of $478,876.
Net cash provided by financing activities for the year ended December 31, 2014 was $43,267, consisting of borrowings on notes payable of $451,282 and borrowings on related party debt of $25,500. This was somewhat offset by repayments of notes payable of $418,294, payments of related party debt of $20,992 and a decrease in bank overdrafts of $5,771.
The total change in cash and cash equivalents for the year ended December 31, 2014 when compared to the year ended December 31, 2012 was a decrease of $44,843.
As of the date of the filing of this Report, we do not have sufficient funds available to fund our operations and repay our debt obligations under their existing terms. Therefore, we need to raise additional funds through selling securities, obtaining loans, renegotiating the terms of our existing debt, increasing sales of our products and services and/or succeed in licensing our intellectual property. Our inability to raise such funds or renegotiate the terms of our existing debt will significantly jeopardize our ability to continue operations.
Contractual Obligations and Commercial Commitments
As of December 31, 2014, the following contractual obligations and commercial commitments were outstanding:
Of the above notes payable, the default status is as follows:
Going Concern Uncertainty
We had a net loss of $1,450,822 and $2,602,811 for the years ended December 31, 2014 and 2013, respectively, and have historically incurred losses. In addition, we had a working capital deficit of approximately $17.3 million at December 31, 2014. The foregoing raises substantial doubt about our ability to continue as a going concern.
Management is continuing its efforts to attempt to secure funds through equity and/or debt instruments for our operations, expansion and possible acquisitions, mergers, joint ventures, and/or other business combinations. We will require additional funds to pay down our liabilities, as well as finance our expansion plans consistent with our anticipated changes in operations and infrastructure. However, there can be no assurance that we will be able to secure additional funds and that if such funds are available, whether the terms or conditions would be acceptable to us and whether we will be able to turn into a profitable position and generate positive operating cash flow. The consolidated financial statements contain no adjustment for the outcome of this uncertainty.
Furthermore, we are exploring certain opportunities with a number of companies to participate in co-marketing of each other’s products. We are proceeding to license our intellectual property to third parties. The exact results of our opportunities to license our intellectual property to other parties are unknown at this time.
Off-Balance Sheet Arrangements.
None.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
None.
Item 8.
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, 2014 and 2013, which are attached to this Report.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, principally our chief executive officer (who is also currently serving as our Principal Accounting Officer), evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our management concluded that our disclosure controls and procedures as of the end of the period covered by this report were not effective such that the information required to be disclosed by us in reports filed under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding disclosure. In particular, we have identified the material weaknesses described below.
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act for the Company.
In order to ensure whether our internal control over financial reporting is effective, management has assessed such controls for its financial reporting as of December 31, 2014. 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, 2014:
●There is an over-reliance upon independent financial reporting consultants for review of critical accounting areas and disclosures and material non-standard transactions.
●There is a lack of sufficient accounting staff due to the size of the Company which results in a lack of segregation of duties necessary for a good system of internal control.
●There is a lack of control procedures that include multiple levels of supervision and review. Certain parts of the work of our chief financial officer are not monitored or reviewed.
●Consolidation and currency translations are performed manually.
The absence of adequate segregation of duties may have an effect on the systems which we use in the evaluating and processing of certain accounts and areas and in the posting and recording of journal entries into certain accounts, as described below:
○Although we implemented a new accounting system effective January 1, 2009 that allows for the consolidation of the various entities in Vertical Computer Systems along with the translation from local currency to reporting currency, the system needs to be refined in order to perform currency translations accurately. As a result, we continue to performing our consolidation and currency translations manually. This will be remediated once funds become available to effectively implement needed system changes.
○Improving the control and oversight of the duties relating to the systems we use in the evaluation and processing of certain accounts and areas in the posting and recording of journal entries into certain accounts (in which material weaknesses have been identified as described above). This improvement should include reviews by management of the accounting processes as well as a reorganization of some of the accounting functions. In January 2010, we contracted with a consulting firm to assess our internal controls over financial reporting and propose improvements that can be implemented given our size and number of employees. The company has not yet implemented these improvements in their entirety as of the filing of this report due to employee turnover and resource limitations.
○Improving the segregation of duties relating to the processing of accounts and the recording of journal entries into certain accounts. The company has recently increased the size of its accounting staff which will allow for needed segregation of duties within the organization. As of the date of this report, the company is evaluating and reorganizing the duties of its accounting staff in order to address this internal control weakness.
As a result of these material weaknesses in our internal control over financial reporting, our management concluded that our internal control over financial reporting as of December 31, 2014, was not effective based on the criteria set forth by COSO in Internal Control - Integrated Framework. A material weakness in internal control over financial reporting is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.
Management’s Plan for Remediation of Material Weaknesses
In light of the conclusion that our internal control over financial reporting was not effective, our management is in the process of implementing a plan intended to remediate such ineffectiveness and to strengthen our internal controls over financial reporting through the implementation of certain remedial measures, which include:
○We have implemented a new accounting system effective January 1, 2009 that allows for the consolidation of the various entities in Vertical Computer Systems along with the translation from local currency to reporting currency. Although the system eliminates many of the manual steps in translation and consolidation, many of the steps continue to be manual. This system also allows for some automation for recording software maintenance revenue and the recording of the deferred revenue liability account. This automation improves the accuracy of these accounts and is no longer considered a material weakness.
○Improving the control and oversight of the duties relating to the systems we use in the evaluation and processing of certain accounts and areas in the posting and recording of journal entries into certain accounts (in which material weaknesses have been identified as described above). This improvement should include reviews by management of the accounting processes as well as a reorganization of some of the accounting functions. In January 2010, we contracted with a consulting firm to assess our internal controls over financial reporting and propose improvements that can be implemented given our size and number of employees.
○Improving the segregation of duties relating to the processing of accounts and the recording of journal entries into certain accounts. This improvement is expected to come based on recommendations from the consulting firm assessing our internal controls over financial reporting.
This annual report does not include an attestation report of our public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Our present directors and executive officers are as follows:
Name
Age
Position
Tenure
Richard S. Wade
President, Chief Executive Officer and Director
14 years
William K. Mills
Secretary and Director
14 years
Richard S. Wade, President, Chief Executive Officer (Principal Executive Officer and Principal Accounting Officer) and Director of VCSY, Chairman and Director of NOW Solutions
Richard S. Wade is President, CEO and Chairman of the Board of the Company and has been a director since October 1999. Before coming to Externet World, Inc. in mid-1999, and then transitioning to what is now the Company in late 1999, Mr. Wade held a number of executive positions with companies in the Pacific Rim from 1983 through early 1999, including the position of Chief Operating Officer of Struthers Industries, Inc., a public company in the business of wireless applications. Prior to these executive positions, Mr. Wade spent over 10 years with Duty Free Shoppers, Inc., culminating in his attaining the positions of president of their Mid-Pacific Division and then president of their U.S. Division. Prior to that, Mr. Wade was a CPA and staff auditor with Peat, Marwick & Mitchell. Over the course of his career, Mr. Wade has accumulated experience in retail operations, distribution, international operations, and financial matters. The breadth of Mr. Wade’s managerial and operational experience led the Board of Directors to believe this individual is qualified to serve as a director of the Company. Mr. Wade earned his Bachelor of Science in Accounting at Brigham Young University, a Master of Science in Business Policy from Columbia University Business School and received a certificate of recognition from the government of Guam.
William K. Mills, Secretary and Director of VCSY
William K. Mills has been a director since December 2000. Mr. Mills is a founding partner of Parker Shumaker Mills, LLP (formerly Parker Mills, LLP) where he specializes in complex commercial business representations, including transactional and litigation matters, such as legal malpractice, intellectual property and general corporate and governmental representations since 1995. Between 1991 and 1994, Mr. Mills was a senior attorney and partner with Lewis, D’Amato, Brisbois & Bisgaard, prior to which he was a senior attorney with Radcliff & West from 1989 to 1991, senior associate with Buchalter, Nemer Fields & Younger from 1987 to 1991 and an attorney with Daniels, Baratta & Fine from 1982 to 1987. Mr. Mills holds a J.D. from UCLA Law School and an A.B. in American Government from Harvard College. Active in professional and community organizations, Mr. Mills has served as General Counsel to the California Association of Black Lawyers, a member of the Los Angeles County Bar Judicial Appointments Committee, and a Board Member of the John M. Langston Bar Association. Mr. Mills has also served on the boards of the Didi Hirsch Mental Health Foundation, the United Way’s Los Angeles Metropolitan Region Board, the Los Angeles City Ethics Commission, and the Los Angeles County Judicial Procedures Commission. The breadth of Mr. Mills’ professional and legal experience led the Board of Directors to believe this individual is qualified to serve as a director of the Company.
Significant Employees of the Company
Luiz Valdetaro, Chief Technology Officer of VCSY and NOW Solutions, Director of NOW Solutions
Prior to joining the Company, Mr. Valdetaro was previously a consultant (1993-1997) and Chief Technology Officer (1997-1999) of Diversified Data Resources, a software company. Prior to that, Mr. Valdetaro was a Senior Systems Engineer for System/One and EDS, after System/One was acquired by EDS. Prior to that, Mr. Valdetaro was a senior systems engineer for Bank of America. Mr. Valdetaro is a graduate of Pontific Catholic University, Rio de Janeiro, Brazil with a B.S. in Electronic Engineering and a M.S. in Systems Engineering.
Laurent Tetard, Chief Operating Officer-SaaS
Mr. Tetard joined the Company in 1999, where he oversaw business development, managed software design projects and handled daily operations. His responsibilities included working with clients and strategic partners to develop business plans, implement strategies and methodologies to support software development. Combining his education and experience, Mr. Tetard has specialized in managing design, implementation, documentation and installation of Internet compatible applications. From 1994 to 1996, Mr. Tetard was a Public Relations Officer with the French Air Force, in Toulouse, France. Earlier in his career, he completed a thesis in collaboration with the French Aeronautics and Space Research Center (“ONERA”) and served engineering internships at Aerospatiale, France. Mr. Tetard is an honor’s graduate of the noted French Ecole Nationale Superieure D’arts et Metiers (“ENSAM”), with a BS in Engineering and a MS in Multidisciplinary Engineering.
Harold Frazier, Jr., Director of Mobile Software Development
Harold Frazier, Jr. serves as the Director of Mobile Software Development of Vertical Computer Systems, Inc. He graduated from the University of Michigan, Ann Arbor with a B.S. in Computer Science. Since 2004, Mr. Frazier has focused on creating enterprise mobile software solutions in the education, social media, security, automotive and medical industries.
Significant Employees of NOW Solutions
Marianne M. Franklin, President and Chief Executive Officer
Marianne M. Franklin is President and Chief Executive Officer of NOW Solutions. Ms. Franklin brings her experience in the payroll and human resources industry, which included over eight years working at Ross Systems, most recently as Vice President of North American sales. Prior to this function, Ms. Franklin was Director of Ross’ HR/Payroll Canadian Sales. Ms. Franklin’s background also includes two years with ADP and 13 years in the banking industry, working with payroll products.
Jamie Patterson, Director of Software Development
Mr. Patterson joined the Company in 2006, originally as the Quality Assurance Manager, after working as an independent contractor for the company for three years. In 2000, he joined the Hewlett-Packard Company as a Research and Development Software Engineer. From 1992 to 2000 he worked for Ross Systems starting as a Support Analyst in the Customer Support Department. In 1993 he began developing software in the Integration Services department and Product Development department. Prior to Ross Systems, he worked as an IT engineer and software developer supporting a payroll application. Mr. Patterson is a graduate of University of Texas at Arlington with a Masters of Computer Science and Engineering degree and from the University of Washington with a B.S. in Civil Engineering.
Compliance with Section 16(a) of the Exchange Act
Section 16(a) of the Exchange Act requires the Company’s officers and directors, and persons who own more than 10% of a registered class of the Company's equity securities, to file reports of ownership and changes in ownership with the SEC. Officers, directors and greater than 10% stockholders are required by SEC regulations to furnish the Company with copies of all Section 16(a) forms they file.
To the best of the Company's knowledge, based solely on review of the copies of such forms furnished to it, or written representations that no other forms were required, the Company believes that all Section 16(a) filing requirements applicable to its officers, directors and greater than 10% stockholders were complied with during 2011.
Code of Ethics
We have adopted a Code of Ethics that applies to our Principal Executive Officer, Principal Accounting Officer and other persons performing executive functions, as well as all other employees and directors of the Company and its subsidiaries. Our Code of Ethics is filed as Exhibit 14.1 to this Report, and is available at our Internet website located at http://www.vcsy.com/investor.
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; or
(4) being found by a court of competent jurisdiction (in a civil action), the SEC or the Commodities Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended or vacated.
Board of Directors Meetings and Subcommittees.
Meetings. Our Board of Directors held several meetings during the fiscal year ended December 31, 2014. All board actions were completed through unanimous written consents.
Audit Committee and Financial Expert. Our Board of Directors (the “Board”) does not have a separate audit committee. Although Mr. Wade (a member of the Board) has the qualifications of an “audit committee financial expert” as defined in Item 407(d)(5), Mr. Wade would not be deemed independent since he is an employee of the Company. At this point, we do not intend to establish a separate audit committee as this function will be performed by our full Board of Directors.
Compensation Committee. As all our executive officers are currently under employment agreements or are at-will employees, we do not have a separate compensation committee. At this point, we do not intend to establish a separate compensation committee as this function will be performed by our full Board of Directors.
Nominating Committee. We do not currently have a separate nominating committee as this function is performed by our full Board of Directors.
Shareholder Communication. We communicate regularly with shareholders through press releases, as well as annual, quarterly, and current (Form 8-K) reports. Our Chief Executive Officer addresses investor concerns on an on-going basis. Interested parties, including shareholders and other security holders, may communicate directly with our Board of Directors or with individual directors by writing to our Chief Executive Officer at 101 W. Renner Road, Suite 300, Richardson, TX 75082.
Item 11.
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, 2014 and 2013 to our highest paid executive officers and employees, who were employed by us during 2013 and 2014. No restricted stock awards, long-term incentive plan payouts or other types of compensation, other than the compensation identified in the chart below, were paid to these executive officers during these fiscal years. Except as set forth below, no other executive officer of Vertical earned a total annual salary and bonus for any of these years in excess of $100,000.
SUMMARY COMPENSATION TABLE
The below table shows information of compensation of the named officers for fiscal years ended December 31, 2013 and December 31, 2014 :
No stock options were exercised by the named executive officers during the fiscal year ended December 31, 2014 or 2013.
(1)Mr. Wade deferred $881,688 of salary earned during the period from 2002 through 2008, as adjusted in connection with an agreement to defer payroll claims between the Company and certain employees of the Company executed in 2010. For 2012, 2013, and 2014, the Company accrued unpaid salary for Mr. Wade of $63,500, $37,500, and $25,000 respectively.
(2)Mr. Valdetaro deferred $467,071 of salary earned during the period from 2002 through 2007, as adjusted in connection with an agreement to defer payroll claims between the Company and certain employees of the Company executed in 2010. For 2012, 2013, and 2014, the Company accrued unpaid salary for Mr. Valdetaro of $41,667, $66,667, and $41,667 respectively.
(3)Prior to 2012, Mr. Tetard served as the Executive Vice President of International Operations of NOW Solutions. Mr. Tetard deferred $98,438 of salary earned during the period from 2002 through 2007, as adjusted in connection with an agreement to defer payroll claims between the Company and certain employees of the Company executed in 2010. For 2012, 2013, and 2014., the Company accrued unpaid salary for Mr. Tetard of $20,625. Mr. Tetard was granted 600,000 unregistered shares of VCSY common stock (at a fair market value of $13,500 based upon the total number of shares issued and the share price on the date of the issuance), vesting in equal installments over a two-year period, of which 600,000 shares had vested as of December 31, 2014. Mr. Tetard was also granted 15,000 shares of Series B Preferred Shares of VHS which vest over a two year period in equal installments (at a fair market value which is nominal).
(4)Mr. Salz deferred $185,914 of salary earned during the period from 2002 through 2007, as adjusted in connection with an agreement to defer payroll claims between the Company and certain employees of the Company executed in 2010. For 2012, 2013, and 2014, the Company accrued unpaid salary for Mr. Salz of $27,498, $55,000, and $73,336, respectively. Pursuant to a restricted stock agreement with the Company in March 2012, Mr. Salz was granted 600,000 unregistered shares of VCSY common stock (at a fair market value of $10,200) based upon the total number of shares issued and the share price on the date of the issuance), vesting in equal installments over a two-year period, of which 600,000 shares had vested as of December 31, 2014. Mr. Salz was also granted 15,000 shares of Series B Preferred Shares of VHS which vest over a two year period in equal installments (at a fair market value which is nominal). Mr. Salz was granted 200,000 shares of unregistered shares of VCSY common stock (at a fair market value of $3,200 based upon the total number of shares issued and the share price on the date of the issuance) that have vested.
No options or warrants held by executive officers or directors were granted or exercised during the fiscal years ended December 31, 2014 and 2013.
In December 2001, we executed an employment agreement with Richard Wade pursuant to which Mr. Wade serves as Chief Executive Officer and President of the Company. The agreement currently renews on annual basis unless terminated by either party. Under the agreement, Mr. Wade receives an annual base salary of $300,000 In the event the agreement is terminated by Mr. Wade’s death, his estate shall be entitled to compensation accrued to the time of death plus the lesser of one year’s base compensation or the compensation due through the remainder of the employment term. In the event of termination by the Company without cause, Mr. Wade would receive base compensation for the remainder of the employment term.
In January 2012, we executed an employment agreement with Luiz Valdetaro to serve as Chief Technology Officer of the Company and its subsidiaries. The initial term of the agreement was 2 years and renews on annual basis unless terminated by either party. Under the agreement, Mr. Valdetaro receives an annual base salary of $200,000. In the event the employment agreement is terminated by Mr. Valdetaro’s death, his estate shall be entitled to compensation accrued to the time of death plus the lesser of one year’s base compensation or the compensation due for the lesser of 12 months or through the remainder of the employment term. In the event of termination by the Company without cause, Mr. Valdetaro would receive base compensation for no less than six months of the remainder of the employment term. Mr. Valdetaro may also terminate his employment for good reason and shall be entitled to continued health insurance benefits and base compensation at the rate in effect at the time of his termination for good reason through the end of twelve months after which his employment is terminated for good reason.
In February 2012, we executed an employment agreement with Laurent Tetard to serve as Chief Operating Officer-SaaS of the Company and its subsidiaries. The initial term of the agreement was 2 years and renews on annual basis unless terminated by either party. Under the agreement, Mr. Tetard receives an annual base salary of $165,000. In the event the employment agreement is terminated by Mr. Tetard’s death, his estate shall be entitled to compensation accrued to the time of death plus the lesser of one year’s base compensation or the compensation due for the lesser of 12 months or through the remainder of the employment term. In the event of termination by the Company without cause, Mr. Tetard would receive base compensation for no less than six months of the remainder of the employment term. Mr. Tetard may also terminate his employment for good reason and shall be entitled to continued health insurance benefits and base compensation at the rate in effect at the time of his termination for good reason through the end of twelve months after which his employment is terminated for good reason. In connection with the employment agreement, the Company issued Mr. Tetard 600,000 shares of its common stock at a fair market value of $13,500 and VHS issued 15,000 shares of Series B Preferred Stock of VHS at a fair market value which is nominal.
All executives are entitled to an annual bonus from a bonus pool for executives equal to 5% of the Company taxable income before net operating loss deduction and special deductions from the federal tax return filed. Each executive’s share of the bonus pool is equal to the percentage of their annual base compensation to the total of the combined annual base compensation of all executives in the pool.
Outstanding Equity Awards
There were no outstanding equity awards of the named officers at the end of 2014
Narrative Disclosure to Outstanding Equity Awards at Fiscal Year End
Stock Option Plan. The Company has no formal stock option plan and has issued no stock options or warrants to any employees or to any other parties and do not have any stock options outstanding.
Stock Awards. The Company’s restricted stock agreements generally provide for the stock to vest 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.
COMPENSATION OF DIRECTORS
We do not pay any compensation to our employee directors for their service on the Board. However, we do pay our non-employee directors as indicated below. The below table provides compensation for all non-employee directors in 2014:
Narrative Disclosure to Director Compensation Table
Non-employee directors are entitled to receive $3,500 per month in 2014 and 2013.
Reimbursement of Expenses
The Company reimburses travel expenses of members for their attendance at Board meetings.
Compensation Risks Assessment
As required by rules adopted by the SEC, management has made an assessment of the Company’s compensation policies and practices with respect to all employees to determine whether risks arising from those policies and practices are reasonably likely to have a material adverse effect on the Company. In doing so, management considered various features and elements of the compensation policies and practices that discourage excessive or unnecessary risk taking. As a result of the assessment, the Company has determined that its compensation policies and practices do not create risks that are reasonably likely to have a material adverse effect on the Company.
Item 12.
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 15, 2015, by each of our directors and executive officers and any person or entity known by us to be the beneficial owner of more than 5% of the outstanding shares of common stock. The table also shows the beneficial ownership of our stock by all directors and executive officers as a group. The table includes the number of shares subject to outstanding options and warrants to purchase shares of common stock. The percentages are based on 1,003,545,134 shares of common stock outstanding as of April 15, 2015, together with options, warrants or other securities convertible or exchangeable by the beneficial owners into shares of common stock within 60 days of April 15, 2015.
* Less than 1%.
(1)The address of each director and officer is c/o Vertical Computer Systems, Inc., 101 West Renner Road, Suite 300, Richardson, TX 75082.
(2)Includes 74,932,543 shares owned by MRC. MRC has pledged approximately 55,000,000 common shares as collateral to secure various promissory notes issued in the aggregate principal amount of approximately $1,290,000. In addition, Mr. Wade and MRC have personally guaranteed the payment of a $275,000 Note issued in March 2012 whereby, Mr. Wade and MRC are obligated to sell common shares owned by Wade and/or MRC in the event payments are not made. Mr. Wade is the President and CEO of the Company. MRC is a corporation controlled by the W5 Family Trust and Mr. Wade is the trustee of the W5 Family Trust.
(3)Includes 33,333 shares of VCSY common stock owned by Parker, Shumaker & Mills, L.L.P. (“PSM”). William Mills is a Director of the Company and a partner of PSM.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Certain Relationships and Related Transactions
In November 2009, the obligation to reimburse MRC with 1,309,983 common shares of the Company stock became due pursuant to the Indemnity and Reimbursement Agreement between MRC and the Company. This obligation was made in connection with the sale of 1,500,000 shares of our common stock in 2008 pledged by MRC to secure a $96,946 promissory note issued to a third party lender. MRC is controlled by the W5 Family Trust, and Mr. Richard Wade, the President and CEO of the Company, is the trustee of the W5 Family Trust.
In July 2011, the Company and Robert Farias, a former employee of the Company, agreed to cancel $364,679 of outstanding debt owed to Mr. Farias and in exchange for such cancellation; the Company issued two notes with principal of $274,679 and $90,000, respectively. Beginning February 1, 2012, the interest rate increased to 10% on the outstanding balance of principal and accrued interest accrued through January 31, 2012 under the respective note. Also in February 2012, NOW Solutions granted Mr. Farias a junior security interest in all of its assets to secure the obligations under the $274,679 note in consideration of a personal guarantee made by Mr. Farias to secure the obligations under a note in the principal amount of $105,300 issued to Lakeshore Investment, LLC for a loan to NOW Solutions. On January 9, 2013, the Company paid off these notes owed to Robert Farias and the security interest granted to Robert Farias was cancelled.
In August 2013, Luiz Valdetaro, on behalf of the Company, transferred 1,000,000 unrestricted shares of our common stock owned by Mr. Valdetaro to Lakeshore in exchange for an extension to having common shares of NOW Solutions returned, representing a 25% interest the Company was obligated to transfer to Lakeshore. The fair-market value of these shares was valued at $47,000. Also in August 2013, in connection with the transfer, the Company entered into an indemnity and reimbursement agreement to reimburse Mr. Valdetaro with 1,000,000 shares of our common stock within one year and pay for all costs associated with the transfer of shares to Lakeshore and the reimbursement of shares to Mr. Valdetaro. Mr. Valdetaro is the Chief Technology Officer of the Company.
In October 2013, MRC pledged 1,000,000 shares of our common stock to secure a $50,000 loan made to the Company by a third party lender. The Company is obligated to replace these shares if these shares are transferred to the lender. This note is currently in default and therefore these shares have been classified as a derivative liability as of December 31, 2014 became past due. The initial fair value of these shares was determined to be $72,000 as of December 9, 2013.
Also in October 2013, MRC transferred 1,000,000 unrestricted shares of our common stock owned by MRC to a third party lender in connection with a $100,000 loan to the Company. The fair-market value of these shares was valued at $85,000. Also in October 2013, in connection with the transfer, the Company entered into an indemnity and reimbursement agreement to reimburse MRC with 1,000,000 shares of our common stock within one year and pay for all costs associated with the transfer of shares to the lender and the reimbursement of shares to MRC. 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 August 2014, in connection with a $50,000 note payable issued to a third party lender by the Company, MRC amended a stock pledge agreement previously entered into with the lender under which MRC had pledged 16,976,296 common shares to secure payment of this note and another note issued to the lender.
During the year ended December 31, 2014, the Company borrowed $25,500 from an employee of the Company. The note is unsecured, bears interest at 11% per annum and is due on demand.
As of December 31, 2014 and 2013, the Company had accounts payable to two employees and one consultant in an aggregate amount of $36,333 and $23,594, respectively. The payables are unsecured, non-interest bearing and due on demand.
In March 2015, pursuant to an indemnity and reimbursement agreement executed between Mr. Valdetaro and the Company we issued 1,000,000 shares of our common stock to reimburse Mr. Valdetaro for 1,000,000 shares of common stock transferred to Lakeshore on the Company’s behalf in connection with an extension granted by Lakeshore in August 2013.
In March 2015, pursuant to two indemnity and reimbursement agreements executed between MRC and the Company, we issued a total of 2,809,983 shares of our common stock to reimburse MRC. Of these shares, the Company was obligated to reimburse MRC with, 1,309,983 shares of common stock had been pledged by MRC and sold by a third party lender in 2009 in connection with a $96,946 promissory note, 500,000 shares of common stock had been wrongfully converted by the same lender in 2014, and 1,000,000 shares of common stock had been transferred to another third party lender in October 2013 on the Company’s behalf for a $100,000 loan made by the lender to the Company. MRC has assigned its claim against the third party lender for the lender’s wrongful conversion of 500,000 common shares to the Company and we are pursuing the claim in the third party lender’s bankruptcy proceeding.
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.
Item 14.
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 $80,000 and $82,273 for the audit of our annual financial statements for 2014 and 2013, which included the reviews of the financial statements in our Forms 10-Q for the applicable fiscal years.
Tax Fees. The principal accounting firm of MaloneBailey did not provide any tax services in 2014 and 2013.
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 2014 and 2013.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
The following documents are filed as part of this report:
a.Exhibits:
Exhibit No.
Description
Location
2.1
Certificate of Ownership and Merger Merging Scientific Fuel Technology, Inc. into Vertical Computer Systems, Inc.
Incorporated by reference to Exhibit 2.1 to the Company’s Form 10-K filed on April 15, 2011
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-K filed on April 15, 2011
3.2
Certificate of Amendment of Certificate of Incorporation (changed name to Vertical Computer Systems, Inc.)
Incorporated by reference to Exhibit 3.2 to the Company’s Form 10-K filed on April 15, 2011
3.3
Certificate of Amendment of Certificate of Incorporation (2000)
Incorporated by reference to Exhibit 3.3 to the Company’s Form 10-K filed on April 15, 2011
3.4
Certificate of Amendment of Certificate of Incorporation
Incorporated by reference to Exhibit 3.1 to the Company’s Form 8-K filed on February 27, 2015
3.5
Amended and Restated By-Laws of the Company
Incorporated by reference to Exhibit 3.1 to the Company’s Form 8-K filed on January 13, 2015
4.1
Certificate of Designation of 4% Cumulative Redeemable Series A Preferred Stock
Incorporated by reference to Exhibit 4.1 to the Company’s Form 10-K filed on April 15, 2011
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-K filed on April 15, 2011
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-K filed on April 15, 2011
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-K filed on April 15, 2011
4.5
Form of Restricted Stock Agreement
Incorporated by reference to Exhibit 4.5 to the Company’s Form 10-K filed on April 15, 2011
10.1
Form of Debenture
Incorporated by reference to Exhibit 10.1 to the Company’s Form 10-K filed on April 15, 2011
10.2
Employment Agreement between the Company and Richard Wade
Incorporated by reference to Exhibit 10.2 to the Company’s Form 10-K filed on April 15, 2011
10.3
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 10.7 to the Company’s Form 10-K filed on April 15, 2011
10.4
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 10.8 to the Company’s Form 10-K filed on April 15, 2011
10.5
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 10.9 to the Company’s Form 10-K filed on April 15, 2011
10.6
License Agreement between the Company and Microidea Software Development, LLC.
Incorporated by reference to Exhibit 10.12 to the Company’s Form 10-K filed on April 15, 2011
10.7
Secured Term Promissory Note in the principal amount of $1,759,150 payable by NOW Solutions to Lakeshore Investment, LLC.
Incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed on January 15, 2013
14.1
Code of Ethics
Incorporated by reference to Exhibit 14.1 to the Company’s Form 10-K filed on April 15, 2011
21.1
Subsidiaries of the Company
Provided herewith
31.1
Certification of Principal Executive Officer and Principal Accounting Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated April 15, 2015
Provided herewith
32.1
Certification of Principal Executive Officer and Principal Accounting Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, dated April 15, 2015
Provided herewith
101.INS*
XBRL Instance Document
Provided herewith
101.SCH*
XBRL Taxonomy Extension Schema
Provided herewith
101.CAL *
XBRL Taxonomy Extension Calculation Linkbase
Provided herewith
101.DEF*
XBRL Taxonomy Extension Definition Linkbase
Provided herewith
101.LAB*
XBRL Taxonomy Extension Label Linkbase
Provided herewith
101.PRE*
XBRL Taxonomy Extension Presentation Linkbase
Provided herewith
* Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
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 15, 2015 By: /s/ Richard Wade
Richard Wade,
President and Chief Executive Officer
(Principal Executive Officer and
Principal Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
VERTICAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
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. and its subsidiaries (collectively, the “Company”) as of December 31, 2014 and 2013 and the related consolidated statements of operations and comprehensive income (loss), stockholders’ deficit, and cash flows for each of the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform an audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Vertical Computer Systems, Inc. and its subsidiaries as of December 31, 2014 and 2013 and the consolidated results of their operations and their cash flows for each of the years then ended, in conformity with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company suffered net losses and has a working capital deficiency, which raises substantial doubt about its ability to continue as a going concern. Management’s plans regarding those matters also are described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ MaloneBailey, LLP
www.malonebailey.com
Houston, Texas
April 15, 2015
VERTICAL COMPUTER SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
VERTICAL COMPUTER SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
AND OTHER COMPREHENSIVE INCOME (LOSS)
See accompanying notes to consolidated financial statements.
VERTICAL COMPUTER SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ DEFICIT
YEARS ENDED DECEMBER 31, 2014 AND 2013
See accompanying notes to consolidated financial statements.
VERTICAL COMPUTER SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements.
VERTICAL COMPUTER SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Organization, Basis of Presentation and Significant Accounting Policies
Nature of Business
Vertical Computer Systems, Inc. was incorporated in Delaware in March 1992. We are a multinational provider of application software, software services, Internet core technologies, and derivative software application products through our distribution network. Our business model combines complementary, integrated software products, internet core technologies, and a multinational distribution system of partners, in order to create a distribution matrix that is capable of penetrating multiple sectors through cross selling our products and services. We operate one business segment.
Basis of Presentation
The consolidated financial statements include the accounts of the Company and its subsidiaries (collectively, “our”, “we”, the “Company” or “VCSY”, as applicable). NOW Solutions, a 75% owned subsidiary, and SnAPPnet, Inc. (“SnAPPnet”), a 80% owned subsidiary of Vertical, currently maintain daily business operations, EnFacet, Inc. (“ENF”), Globalfare.com, Inc. (“GFI”), Pointmail.com, Inc. (“PMI”) and Vertical Internet Solutions, Inc. (“VIS”), each of which is inactive and Vertical Healthcare Solutions, Inc. (“VHS”), Ploinks, Inc. (“Ploinks”) (formerly, OptVision Research, Inc.), Taladin, Inc. (“Taladin”), and Vertical do Brasil, each of which has minor activities, are all wholly-owned subsidiaries of Vertical. Government Internet Systems, Inc. (“GIS”), an 84.5% owned subsidiary, and Priority Time Systems, Inc. (“Priority Time”) a 70% owned subsidiary, are entities with minor activities. To date, we have generated revenues primarily from software licenses, software as a service, consulting fees and maintenance agreements from NOW Solutions and SnAPPnet and patent licenses from Vertical Computer Systems, the parent company.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its subsidiaries. Equity investments in which we exercise significant influence, but do not control and are not the primary beneficiary, are accounted for using the equity method of accounting. Investments in which we do not exercise significant influence over the investee are accounted for using the cost method of accounting. All intercompany accounts and transactions have been eliminated. We currently have no investments accounted for using the equity or cost methods of accounting.
Cash and Cash Equivalents
Cash equivalents are highly liquid investments with an original maturity of three months or less.
Revenue Recognition
Our revenue recognition policies are in accordance with standards on software revenue recognition, which includes guidance on revenue arrangements with multiple deliverables and arrangements that include the right to use of software stored on another entity’s hardware.
In the case of non-software arrangements, we apply the guidance on revenue arrangements with multiple deliverables and wherein multiple elements are allocated to each element based on the element’s relative fair value. Revenue allocated to separate elements is recognized for each element in accordance with our accounting policies described below. If we cannot account for items included in a multiple-element arrangement as separate units of accounting, they are combined and accounted for as a single unit of accounting and generally recognized as the undelivered items or services are provided to the customer.
Consulting. We provide consulting services, primarily implementation and training services, to our clients using a time and materials pricing methodology. The Company prices its delivery of consulting services on a time and materials basis where the customer is either charged an agreed-upon daily rate plus out-of-pocket expenses or an hourly rate plus out-of-pocket expenses. In this case, the Company is paid fees and other amounts generally on a monthly basis or upon the completion of the deliverable service and recognizes revenue as the services are performed.
Software License. We sell concurrent perpetual software licenses to our customers. The license gives the customer the right to use the software without regard to a specific term. We recognize the license revenue upon execution of a contract and delivery of the software, provided the license fee is fixed and determinable, no significant production, modification or customization of the software is required and collection is considered probable by management. When the software license arrangement requires the Company to provide consulting services that are essential to the functionality of the software, the product license revenue is recognized upon the acceptance by the customer and consulting fees are recognized as services are performed.
Software licenses are generally sold as part of a multiple element arrangement that may include maintenance and, under a separate agreement, consulting services. The consulting services are generally performed by the Company, but the customer may use a third-party to perform those. We consider these separate agreements as being negotiated as a package. The Company determines whether there is vendor specific objective evidence of fair value (‘‘VSOEFV’’) for each element identified in the arrangement to determine whether the total arrangement fees can be allocated to each element. If VSOEFV exists for each element, the total arrangement fee is allocated based on the relative fair value of each element. In cases where there is not VSOEFV for each element, or if it is determined that services are essential to the functionality of the software being delivered, we initially defer revenue recognition of the software license fees until VSOEFV is established or the services are performed. However, if VSOEFV is determinable for all of the undelivered elements, and assuming the undelivered elements are not essential to the delivered elements, we will defer recognition of the full fair value related to the undelivered elements and recognize the remaining portion of the arrangement value through application of the residual method. Where VSOEFV has not been established for certain undelivered elements, revenue for all elements is deferred until those elements have been delivered or their fair values have been determined. Evidence of VSOEFV is determined for software products based on actual sales prices for the product sold to a similar class of customer and based on pricing strategies set forth in the Company’s standard pricing list. Evidence of VSOEFV for consulting services is based upon standard billing rates and the estimated level of effort for individuals expected to perform the related services. The Company establishes VSOEFV for maintenance agreements using the percentage method such that VSOEFV for maintenance is a percentage of the license fee charged annually for a specific software product, which in most instances is 18% of the portion of arrangement fees allocated to the software license element.
Maintenance Revenue. In connection with the sale of a software license, a customer may elect to purchase software maintenance services. Most of the customers that purchase software licenses from us also purchase software maintenance services. These maintenance services are typically renewed on an annual basis. We charge an annual maintenance fee, which is typically a percentage of the initial software license fee and may be increased from the prior year amount based on inflation or other agreed upon percentage. The annual maintenance fee generally is paid to the Company at the beginning of the maintenance period, and we recognize these revenues ratably over the term of the related contract.
While most of our customers pay for their annual maintenance at the beginning of the maintenance period, a few customers have payment terms that allow them to pay for their annual maintenance on a quarterly or monthly basis. If the annual maintenance fee is not paid at the beginning of the maintenance period (or at the beginning of the quarter or month for those few maintenance customers), we will ratably recognize the maintenance revenue if management believes the collection of the maintenance fee is imminent. Otherwise, we will defer revenue recognition until the time that the maintenance fee is paid by the customer. We normally continue to provide maintenance service while awaiting payment from customers. When the payment is received, revenue is recognized for the period that revenue was previously deferred. This may result in volatility in software maintenance revenue from period to period.
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® and SnAPPnet™, on a service basis. However, a contractual right to take possession of the software license or run it on another party’s hardware is not granted to the customer. We refer to the delivery method to give functionality to new customers utilizing this service as 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.
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.
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 2014, the Company wrote off $771,251 of previously capitalized software costs related to its 70% owned subsidiary, Priority Time Systems.
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 2014 and 2013, there was no impairment of long-lived assets.
Stock-based Compensation
We account for share-based compensation in accordance with the provisions of share-based payments, which requires measurement of compensation cost for all stock-based awards at fair value on date of grant and recognition of compensation over the service period for awards expected to vest. The fair value of restricted stock and restricted stock units is determined based on the number of shares granted and the quoted price of our common stock. Equity instruments issued to other than employees are valued at the earlier of a commitment date or upon completion of the services, based on the fair value of the equity instruments, and are recognized as expense over the service period.
Allowance for Doubtful Accounts
We establish an allowance for bad debts through a review of several factors including historical collection experience, current aging status of the customer accounts, and financial condition of our customers. We do not generally require collateral for our accounts receivable. Our allowance for doubtful accounts was $97,419 and $83,326 as of December 31, 2014 and 2013, respectively.
Income Taxes
We provide for income taxes in accordance with the asset and liability method of accounting for income taxes.
Under the asset and liability method, deferred income taxes are recognized for the tax consequences of “temporary differences” by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities. A valuation allowance is provided when management cannot determine whether it is more likely than not the deferred tax asset will be realized. The effect on deferred income taxes of a change in tax rates is recognized in income in the period that includes the enactment date.
Since January 1, 2007, we account for uncertain tax positions in accordance with the authoritative guidance issued by the Financial Accounting Standards Board (“FASB”) on income taxes which addresses how we should recognize, measure and present in our financial statements uncertain tax positions that have been taken or are expected to be taken in a tax return. Pursuant to this guidance, we can recognize a tax benefit only if it is “more likely than not” that a particular tax position will be sustained upon examination or audit. To the extent the “more likely than not” standard has been satisfied, the benefit associated with a tax position is measured as the largest amount that is greater than 50% likely of being realized upon settlement. No liability for unrecognized tax benefits was recorded as of December 31, 2014 and 2013.
Earnings per Share
Basic earnings per share is calculated by dividing net income (loss) available to common stockholders by the weighted average number of shares of the Company’s common stock outstanding during the period. “Diluted earnings per share” reflects the potential dilution that could occur if our share-based awards and convertible securities were exercised or converted into common stock. The dilutive effect of our share-based awards is computed using the treasury stock method, which assumes all share-based awards are exercised and the hypothetical proceeds from exercise are used to purchase common stock at the average market price during the period. The incremental shares (difference between shares assumed to be issued versus purchased), to the extent they would have been dilutive, are included in the denominator of the diluted EPS calculation. The dilutive effect of our convertible preferred stock and convertible debentures is computed using the if-converted method, which assumes conversion at the beginning of the year.
The following represents a reconciliation of the numerators and denominators of the basic and diluted earnings per share computation:
As of December 31, 2014 and 2013, common stock equivalents related to the convertible debt, preferred stock and stock derivative liabilities totaling 33,681,957 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. For additional information, please see Note 4 - Derivative Liabilities and Fair Value Measurements.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of financial statements and the reported amounts of revenue and expenses during the reporting period. Among the more significant estimates included in these financial statements are the estimated allowance for doubtful accounts receivable, valuation allowance for deferred tax assets, impairment of long-lived assets and intangible and the valuation of warrants and restricted stock grants. Actual results could materially differ from those estimates.
Cash Reimbursements
We record reimbursement by our customers for out-of-pocket expense as part of consulting services revenue in accordance with the guidance related to income statement characterization of reimbursements received for out of pocket expense incurred.
Reclassifications
Certain reclassifications have been made to the prior periods to conform to the current period presentation.
Recently Issued Accounting Pronouncements
The Company does not expect the adoption of any recently issued accounting pronouncements to have a material impact on the Company’s financial position, operations or cash flows.
Note 2. Going Concern Uncertainty
The accompanying consolidated financial statements for 2014 and 2013 have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.
The carrying amounts of assets and liabilities presented in the consolidated financial statements do not purport to represent realizable or settlement values. As of December 31, 2014, the Company had negative working capital of approximately $17.3 million and defaulted on several of its debt obligations. The company also incurred net losses in 2014 and 2013. These conditions raise substantial doubt about the Company’s ability to continue as a going concern.
Management is continuing its efforts to attempt to secure funds through equity and/or debt instruments for our operations, expansion and possible acquisitions, mergers, joint ventures, and/or other business combinations. The Company will require additional funds to pay down its liabilities, as well as finance its expansion plans consistent with anticipated changes in operations and infrastructure. However, there can be no assurance that the Company will be able to secure additional funds and that if such funds are available, whether the terms or conditions would be acceptable to the Company and whether the Company will be able to turn into a profitable position and generate positive operating cash flow. The consolidated financial statements contain no adjustment for the outcome of this uncertainty.
Note 3. Related Party Transactions
In November 2009, the obligation to reimburse Mountain Reservoir Corporation (“MRC”) with 1,309,983 common shares of the Company stock became due pursuant to the Indemnity and Reimbursement Agreement between MRC and the Company. This reimbursement obligation was accounted for as a derivative liability (see Note 4). This obligation was made in connection with the sale of 1,500,000 shares of our common stock in 2008 pledged by MRC to secure a $96,946 promissory note issued to a third party lender. MRC is controlled by the W5 Family Trust, and Mr. Richard Wade, the President and CEO of the Company, is the trustee of the W5 Family Trust.
In July 2011, the Company and Robert Farias, a former employee of the Company, agreed to cancel $364,679 of outstanding debt owed to Mr. Farias and in exchange for such cancellation; the Company issued two notes with principal of $274,679 and $90,000, respectively. Beginning February 1, 2012, the interest rate increased to 10% on the outstanding balance of principal and accrued interest accrued through January 31, 2012 under the respective note. Also in February 2012, NOW Solutions granted Mr. Farias a junior security interest in all of its assets to secure the obligations under the $274,679 note in consideration of a personal guarantee made by Mr. Farias to secure the obligations under a note in the principal amount of $105,300 issued to Lakeshore Investment, LLC for a loan to NOW Solutions. On January 9, 2013, the Company paid off these notes owed to Robert Farias and the security interest granted to Robert Farias was cancelled.
In August 2013, Luiz Valdetaro, on behalf of the Company, transferred 1,000,000 unrestricted shares of our common stock owned by Mr. Valdetaro to Lakeshore in exchange for an extension to having common shares of NOW Solutions returned, representing a 25% interest the Company was obligated to transfer to Lakeshore. The fair-market value of these shares was valued at $47,000 and expensed as forbearance fees. Also in August 2013, in connection with the transfer, the Company entered into an indemnity and reimbursement agreement to reimburse Mr. Valdetaro with 1,000,000 shares of our common stock within one year and pay for all costs associated with the transfer of shares to Lakeshore and the reimbursement of shares to Mr. Valdetaro. Mr. Valdetaro is the Chief Technology Officer of the Company. This reimbursement obligation was accounted for as a derivative liability (see Note 4).
In October 2013, MRC pledged 1,000,000 shares of our common stock to secure a $50,000 loan made to the Company by a third party lender. The Company is obligated to replace these shares if these shares are transferred to the lender. This debt is currently in default and therefore these shares have been classified as a derivative liability as of December 31, 2014 when it became past due. The initial fair value of these shares was determined to be $72,000 as of December 9, 2013 (See Note 4).
Also in October 2013, MRC transferred 1,000,000 restricted shares of our common stock owned by MRC to a third party lender in connection with a $100,000 loan to the Company. The fair-market value of these shares was valued at $85,000 of which the relative fair value of $44,444 was recorded as a discount to the associated note. Also in October 2013, in connection with the transfer, the Company entered into an indemnity and reimbursement agreement to reimburse MRC with 1,000,000 shares of our common stock within one year and pay for all costs associated with the transfer of shares to the lender and the reimbursement of shares to MRC. This reimbursement obligation was accounted for as a derivative liability (see Note 4).
In August 2014, in connection with a $50,000 note payable issued to a third party lender by the Company, MRC amended a stock pledge agreement previously entered into with the lender under which MRC had pledged 16,976,296 common shares to secure payment of this note and another note issued to the lender.
As of December 31, 2014 and 2013, the Company had accounts payable to two employees and one consultant in an aggregate amount of $36,333 and $23,594, respectively. The payables are unsecured, non-interest bearing and due on demand.
For additional transactions involving Related Party Transactions after December 31, 2014, please see “Subsequent Events” in Note 13.
Related Party Notes Payable
The following table reflects our related party debt activity for the years ended December 31, 2014 and 2013:
During the year ended December 31, 2014, the Company borrowed $25,500 from an Officer of the Company. The note is unsecured, bears interest at 11% per annum and is due on demand.
Note 4. 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. In connection with the pledge of stock, we signed an agreement to replace these shares within one year. Subsequent to this agreement, 1,309,983 shares of this stock were sold to satisfy the debt owed to the lender.
In August 2013, an officer of the Company transferred 1,000,000 shares of common stock owned by him to our senior secured lenders in connection with an option and forbearance (see Note 8). In connection with the transfer of the stock, the Company signed an agreement to replace these shares. The initial fair value of these shares was determined to be $47,000 as of August 28, 2013.
In October 2013, one of our officers transferred 1,000,000 shares of common stock (through a company he controls) on behalf of the Company to a third party lender in consideration of a $100,000 loan made to the Company. In connection with the transfer of the stock, the Company signed an agreement to replace these shares. The initial fair value of these shares was determined to be $85,000 as of October 31, 2013.
In December 2013, a note payable secured by 1,000,000 shares of common stock pledged by an officer of the company (through a company he controls) to secure payment of a $50,000 loan by a third party lender to the Company became past due. In connection with the pledge of stock, we are obligated to replace these shares if the shares were transferred to the lender. This note is currently in default and therefore these shares have been classified as a derivative liability as of December 31, 2014. As the Company does not have sufficient authorized stock to issue these shares, they were recorded as derivative liabilities. The initial fair value of these shares was determined to be $72,000 as of December 9, 2013.
These contractual commitments to replace all of the pledged shares was evaluated under FASB ASC 815-40, Derivatives and Hedging and was determined to have characteristics of a liability and therefore constituted a derivative liability under the above guidance. Each reporting period, this derivative liability is marked-to-market with the non-cash gain or loss recorded in the period as a gain or loss on derivatives. At December 31, 2014 and 2013, the aggregate fair value of the derivative liabilities was $51,719 and $263,340, respectively.
The aggregate change in the fair value of derivative liabilities was a gain of $211,621 for the year ended December 31, 2014. For the year ended December 31, 2013 there was a $231,901 loss related to the change in the fair value of derivative liabilities.
The valuation of our embedded derivatives is determined by using the VCSY stock price at December 31, 2014 and 2013. As such, our derivative liabilities have been classified as Level 1.
Fair value measurements
FASB ASC 820, Fair Value Measurements and Disclosures, defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. FASB ASC 820 describes three levels of inputs that may be used to measure fair value:
Level 1 - Quoted prices in active markets for identical assets or liabilities.
Level 2 - Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 - Unobservable inputs that are supported by little or no market activity and that are financial instruments whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant judgment or estimation.
If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level of input that is significant to the fair value measurement of the instrument.
The following table provides a summary of the fair value of our derivative liabilities as of December 31, 2014 and December 31, 2013:
The estimated fair value of short-term financial instruments, including cash, accounts receivable, accounts payable and accrued liabilities and deferred revenue approximates their carrying value due to their short-term nature. The estimated fair value of our long-term borrowings approximates carrying value since the related rates of interest approximate current market rates.
For additional transactions involving Derivative Liabilities and Fair Value Measurements after December 31, 2014, including the increase in authorized shares of common stock of the Company to 2,000,000,000 shares, please see “Subsequent Events” in Note 13.
Note 5. Property and Equipment
Property and equipment consist of the following as of December 31, 2014 and 2013:
Depreciation expense for 2014 and 2013 was $2,598 and $11,067, respectively.
Note 6. Intangible Assets
Intangible assets consisted of the following as of December 31, 2014 and 2013:
Amortization expense for 2014 and 2013 was $42,280 and $42,280, respectively.
During 2014, the Company wrote off $771,251 of previously capitalized software costs related to its 70% owned subsidiary, Priority Time Systems, and capitalized $478,876 of software development costs related to its Ploinks™ software application.
Note 7. Accounts Payable and Accrued Expenses
Accounts payable and accrued liabilities consist of the following:
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 for non-functioning subsidiaries and employer payroll taxes on accrued payroll. Accrued taxes primarily consist of unpaid sales and use taxes, VAT and other accrued taxes.
Note 8. Notes Payable and Convertible Debts
The following table reflects our third party debt activity, including our convertible debt, for the years ended December 31, 2014 and 2013:
In July 2013, a third party lender loaned VHS $150,000. Pursuant to the loan agreement, VHS issued a promissory note bearing interest at 10% per annum to the lender in the amount of $150,000 payable in 90 days from the date VHS received funds. Under the terms of the agreement, VHS is obligated to pay a $5,000 commitment fee no later than the date the note becomes due. In consideration of the loan, the Company issued 5,000 shares of VHS Series B Preferred Stock (fair value determined to be nominal) and granted 500,000 shares of VCSY common stock (relative fair value determined to be $19,700) to the lender. The value of the common shares of $19,700 and the accrued $5,000 commitment fee was recorded as a debt discount that is being amortized over the life of the note using the effective interest rate method. During the year ended December 31, 2013, the entire discount of $24,700 was amortized into interest expense.
In October 2013, a third party lender loaned the Company $100,000, bearing interest at 11% per annum with a maturity date of December 20, 2013. In connection with the loan, MRC, controlled by an officer of the Company, transferred 1,000,000 shares common stock to the lender on behalf of the Company. The relative fair value of the shares was determined to be $44,444 and it was recorded as a discount to the associated note. During the year ended December 31, 2013, the entire discount of $44,444 was amortized into interest expense.
During the year ended December 31, 3013, in addition to the loans set forth above and the Lakeshore financing described below, the Company borrowed an aggregate of $305,000 from various third party lenders. These notes are unsecured, bear interest at 10%- 11% per annum and are due on demand or past due and in default.
During the year ended December 31, 2014, in addition to the loans set forth above and the Lakeshore financing described below, the Company borrowed an aggregate of $451,282 from various third party lenders and issued several notes payable in the same amounts to lender. Two notes were issued in the aggregate amount of $231,282, had interest rates of 12% per annum, included commitment fees of $22,000 and other payments of 133,000 owed to the lender under previous contractual obligations with the lender, and all amounts outstanding were paid in 2014. One note, issued in the amount of $50,000, bearing interest at the rate of 18% per annum, included a commitment fee of $2,000, was due in November 2014 and is secured by stock pledged by MRC. The remaining notes were issued in the aggregate amount of $170,000, were unsecured, bear interest at 11% per annum, and were due on demand or past due and in default. In connection with the $170,000 in notes issued during the year, the Company agreed to issue 100,000 shares of Series A Preferred Stock of its subsidiary, Ploinks, to the lender.
Lakeshore Financing
On January 9, 2013, NOW Solutions completed a financing transaction in the aggregate amount of $1,759,150, which amount was utilized to pay off existing indebtedness of the Company and NOW Solutions to Tara Financial Services and Robert Farias, a former employee of the Company, and all security interests granted to Tara Financial Services and Mr. Farias were cancelled.
In connection with this financing, the Company and several of its subsidiaries entered into a loan agreement (the “Loan Agreement”), dated as of January 9, 2013 with Lakeshore Investment, LLC (“Lakeshore”) under which NOW Solutions issued a secured 10-year promissory note (the “Lakeshore Note”) bearing interest at 11% per annum to Lakeshore in the amount of $1,759,150 payable in equal monthly installments of $24,232 until January 31, 2022. Upon the payment of any prepayment principal amounts, the monthly installment payments shall be proportionately adjusted proportionately on an amortized rata basis.
The Lakeshore Note is secured by the assets of the Company’s subsidiaries, NOW Solutions, Priority Time, SnAPPnet, Inc. (“SnAPPnet”) and the Company’s SiteFlash technology and cross-collateralized. Upon the aggregate principal payment of $290,000 toward the Lakeshore Note, the Company has the option to have Lakeshore release either the Priority Time collateral or the SiteFlash collateral. Upon payment of the aggregate principal of $590,000 toward the Lakeshore Note, Lakeshore shall release either the Priority Time collateral or the SiteFlash collateral (whichever is remaining). Upon payment of the aggregate principal of $890,000 toward the Lakeshore Note, Lakeshore shall release the SnAPPnet collateral and upon full payment of the Lakeshore Note, Lakeshore shall release the NOW Solutions collateral.
As additional consideration for the loan, the Company granted a 5% interest in Net Claim Proceeds (less any attorney’s fees and direct costs) from any litigation or settlement proceeds related to the SiteFlash technology to Lakeshore. In addition, until the Note is paid in full, NOW Solutions agreed to pay a Lakeshore royalty of 6% of its annual gross revenues in excess of $5 million dollars up to a maximum of $1,759,150. Management has estimated the fair value of the royalty to be nominal as of its issuance date. The Company has accrued $18,978 as of December 31, 2014 and 2013 related to this royalty.
Pursuant to the Loan Agreement, as amended, the Company also agreed to make certain principal payments toward the Lakeshore Note of (a) $90,000 by February 15, 2013, which was secured by 15% interest in the Company’s ownership of Priority Time and this payment was timely made to Lakeshore and (b) $600,000 by March 15, 2013, which was secured by 25% of the Company’s ownership interest in NOW Solutions and this payment was not made to Lakeshore. As of September 30, 2013, the common shares of NOW Solutions representing a 25% ownership interest in NOW Solutions were in Lakeshore’s possession, but Lakeshore had not taken action to transfer the shares in Lakeshore’s name due to forbearance agreements that have been entered into between March and August 2013. In connection with these forbearance agreements, the Company increased the 5% interest in Net Claim Proceeds to an 8% interest, paid a $100,000 transaction fee and made other payments including the issuance of 1,000,000 common shares valued at $47,000 and $5,000 weekly payments whereby such $5,000 payments are to be applied toward a bonus of 25% of NOW Solutions’ profits for the period that runs from March 15, 2013 through September 30, 2013. The aggregate forbearance fees paid to Lakeshore for the year ended December 31, 2014 and 2013 were $197,156 and $327,867, respectively. The last forbearance agreement expired on September 30, 2013 and on October 1, 2013, Lakeshore became a 25% minority owner of NOW Solutions. While there was an October 1, 2013 amendment to the Loan Agreement that the Company believed was in effect, whereby shares of common stock representing a 25% ownership interest of NOW Solutions (the “NOW shares”) in Lakeshore’s possession were to be returned to the Company, certain terms of the amendment were not fulfilled, resulting in the Company recognizing Lakeshore as the owner of the NOW Shares. The initial recognition of this noncontrolling interest in NOW Solutions resulted in a loss on loan remedy of $1,457,240 during the year ended December 31, 2013.
In December 2014, the Company and Lakeshore entered into an amendment of the Lakeshore Note and the Loan Agreement. Under the terms of the amendment, NOW Solutions agreed to make $2,500 weekly advance payments to Lakeshore to be applied to the 25% dividend of NOW Solutions’ net income after taxes. Within 10 business days after the Company files its periodic reports with the SEC, NOW Solutions will also make quarterly payment advances to Lakeshore based on 60% of Lakeshore’s 25% share of NOW Solutions estimated quarterly net income after taxes, less any weekly payment advances received by Lakeshore during the then-applicable quarter and the weekly $2,500 payments shall be increased or decreased based only upon any increases or decreases of maintenance and SaaS fees during the then-completed quarter (but will not decrease below a minimum of $2,500 per week). NOW Solutions shall pay Lakeshore the balance of Lakeshore’s 25% of NOW’s yearly net income after taxes (less any advances) within 10 business days after the Company files it annual 10-K report with the SEC and any payments in excess of Lakeshore’s 25% of NOW yearly profit shall be credited towards future weekly advance payments. The Company also agreed to pay attorney fees of $40,000 and pay $80,000 to a former consultant and employee of the Company who is a member of Lakeshore. In consideration of the extension to cure the default under the Note and Loan Agreement, the Company transferred a 20% ownership interest in Priority Time Systems, Inc., a 90% owned subsidiary of VCSY, and in SnAPPnet, Inc., a 100% owned subsidiary of VCSY, to Lakeshore. This resulted in an additional noncontrolling interest recognized in the equity of the Company of $391,920 and $99,210 for Priority Time Systems, Inc. and SnAPPnet, Inc., respectively, during 2014. The Company had an option to buy back Lakeshore’s ownership interest in NOW Solutions, Priority Time and SnAPPnet, Inc. (which expired on January 31, 2015). The Note is currently in default and the Company is in discussions with Lakeshore to cure the default and buy back Lakeshore’s ownership interests in our subsidiaries.
The total amortization expenses recorded on the debt discounts during the year ended December 31, 2013 was $69,144.
Certain notes payable also contain provisions requiring additional principal reductions in the event sales by NOW Solutions exceed certain financial thresholds or the Company receives proceeds from infringement claims regarding U.S. Patent #6,826,744, U.S. Patent #7,716,629 and U.S. Patent #8,949,780.
Future minimum payments for third party, related party, and convertible debentures for the next five years are as follows:
Convertible Debentures
Convertible debentures consist of the following:
For additional transactions involving notes payable after December 31, 2014, please see “Subsequent Events” in Note 13.
Note 9. Income Taxes
We account for income taxes using the asset and liability method of accounting for income taxes. Deferred income taxes are recognized for the tax consequences of “temporary differences” by applying enacted statutory tax rate applicable to future years to differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities and result primarily form differences in methods used to amortize intangible assets. A valuation allowance is provided when management cannot determine whether it is more likely than not that the deferred tax asset will be realized. The effect on deferred income taxes of the change in tax rates is recognized in income in the period that includes the enactment date. The difference between the statutory tax rate and the effective tax rate is the valuation allowance.
The provision of income taxes consists of the following for the years ended December 31, 2014 and 2013:
During 2014, the company recorded an income tax provision of $166,675 related to income taxes for NOW Solutions, a 75% owned subsidiary of the Company. Income taxes in previous years were not accrued as VCSY was able to utilize tax loss carry-forwards to offset NOW Solutions’ taxable income. As the company owns less than 80% of NOW Solutions, the Company is not allowed to file a consolidated income tax return and NOW Solutions cannot utilize VCSY’s tax loss carry-forwards.
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:
At December 31, 2014 and December 31, 2013, we had available net operating loss carry-forwards of approximately $22.0 million and $19.4 million. These net operating loss carry-forwards expire in varying amounts through 2033.
The benefit for income taxes differs from the amount computed by applying the U.S. federal income tax rate of 34% to loss before income taxes as follows for the years ended December 31, 2014 and 2013:
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 $0.00001 per share, of which 999,735,151 and 998,985,151 were issued and outstanding at December 31, 2014 and 2013, 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. Stockholders of our common stock have no preemptive, conversion or other subscription rights.
Series A Cumulative Convertible Preferred Stock. We have authorized the issuance of 250,000 shares of Series A 4% Cumulative Convertible Preferred Stock (“Series A Preferred Stock”), of which there are 48,500 shares outstanding at December 31, 2014 and 2013. Holders of these shares of Series A Preferred Stock are entitled to vote on an as-converted basis with the holders of common stock, except that the holders are entitled to vote as a separate class on any matters affecting the Series A Preferred Stock stockholders, on the sale of the business, the increase in the number of directors, the payment of a dividend on any junior stock, and the issuance of any stock that is on parity or senior to the Series A Preferred Stock. Each share of Series A Preferred Stock is entitled to 500 votes per share. Dividends accrue at an annual rate of 4% of the liquidation preference and are payable quarterly subject to the board’s discretion. Each share of Series A Preferred Stock is convertible into 500 shares of common stock of the Company. In the event of liquidation, each share of Series A Preferred Stock will be entitled to a preference of $200, plus accrued but unpaid dividends, prior to the holders of any junior class of stock.
Series B 10% Cumulative Convertible Preferred Stock. We have authorized the issuance of 375,000 shares of Series B 10% Cumulative Convertible Redeemable Preferred Stock (“Series B Preferred Stock”), of which there are 7,200 shares outstanding at December 31, 2014 and December 31, 2013. Holders of Series B Preferred Stock are not entitled to vote on matters presented to the stockholders, except as otherwise required by law. Cash or stock dividends accrue cumulatively at an annual rate of 10% per annum on March 15 and September 15 of each year and are payable subject to the board’s discretion. Each share of Series B Preferred Stock is convertible into 3.788 shares of common stock of the Company. The shares of Series B Preferred Stock are redeemable at a rate of $6.25 per share, or $45,000 if all outstanding shares are redeemed. In the event of liquidation, each share will be entitled to a preference of all dividends accrued and unpaid on each share up to the date fixed for distribution to any holders of any class of common stock.
Series C 4% Cumulative Convertible Preferred Stock. We have authorized the issuance of 200,000 shares of Series C 4% Cumulative Convertible Preferred Stock (“Series C Preferred Stock”), of which there are 50,000 shares outstanding at December 31, 2014 and December 31, 2013. Holders of Series C Preferred Stock are not entitled to vote on matters presented to the stockholders, except as otherwise required by law. Cash dividends accrue at an annual rate of 4% of the liquidation preference and are payable quarterly subject to the board’s discretion. Each share of Series C Preferred Stock is convertible into 400 shares of common stock of the Company; however , of the 50,000 shares of the Company’s Series “C” Cumulative Convertible Preferred Stock that are outstanding, the holder of 37,500 shares waived the conversion rights associated with these shares pursuant to an agreement in 2010. In the event of liquidation, each share will be entitled to a preference of all dividends accrued and unpaid on each share up to the date fixed for distribution to any holder of any class of common stock. In the event of liquidation, each share of Series C Preferred Stock will be entitled to a preference of $100, plus accrued but unpaid dividends, prior to the holders of any junior class of stock.
Series D 15% Cumulative Convertible Preferred Stock. We have authorized the issuance of 300,000 shares of Series D 15% Cumulative Convertible Redeemable Preferred Stock (“Series D Preferred Stock”), of which there were 25,000 shares outstanding at December 31, 2014 and December 31, 2013. Holders of these shares are not entitled to vote on matters presented to the stockholders, except as otherwise required by law. Cash dividends accrue cumulatively at an annual rate of 15% per annum on March 15 and September 15 of each year and are payable subject to the board’s discretion. Any aggregate deficiency shall be cumulative and shall be fully paid or set apart for payment before any dividend shall be paid or set apart for payment of any class of common stock. Each share of Series D Preferred Stock is convertible into 3.788 shares of common stock of the Company. The shares of Series D Preferred Stock are redeemable at a rate of $6.25 per share, or $156,250 if all outstanding shares are redeemed. In the event of liquidation, each share will be entitled to a preference of all dividends accrued and unpaid on each share up to the date fixed for distribution to any holders of any class of common stock.
Common Stock
During the year ended December 31, 2014, 550,000 common shares granted to employees of the Company and a consultant of the Company vested. Stock compensation that was previously accrued totaling $10,226 was reclassified from accrued liabilities to stockholders’ equity associated with these shares vested.
During the year ended December 31, 2014, the Company granted 200,000 common shares to an employee of the Company. The shares vested immediately upon grant and the fair value of the shares was determined to be $3,200. The fair value was expensed in full during the year ended December 31, 2014.
As of December 31, 2014, there were no outstanding, unvested stock compensation awards.
Preferred Stock
For the year ended December 31, 2014, total dividends applicable to Series A and Series C Preferred Stock was $588,000. The Company did not declare or pay any dividends in 2014. Although no dividends have been declared, the cumulative total of preferred stock dividends due to these stockholders upon declaration was $8,217,712 as of December 31, 2014.
Common Stock
In July 2013, the Company issued 500,000 shares of VCSY common stock to a third party lender in connection with a $150,000 loan to the Company. The relative fair value of the shares of $19,700 was recorded as a debt discount that is being amortized to interest expense over the life of the loan.
In August 2013, Luiz Valdetaro, the Chief Technology Officer of the Company, transferred 1,000,000 shares of VCSY common stock owned by him to Lakeshore (valued at $47,000) in connection with an option for Lakeshore to return shares of common stock of NOW Solutions in Lakeshore’s possession representing a 25% ownership interest in NOW Solutions (see “Option for the Return of Common Shares of NOW Solutions and Forbearance Agreement” in Note 8). The Company has recognized this transaction as a 1,000,000 share cancellation by Luiz Valdetaro, and a 1,000,000 share issuance to Lakeshore, valued at $47,000 and expensed as forbearance fees. The transfer of the 1,000,000 shares is included as common stock returned and cancelled in the consolidated statement of stockholders’ deficit.
Also, in August 2013, the Company and Luiz Valdetaro, the Chief Technology Officer of the Company, entered into an indemnity and reimbursement agreement whereby the Company agreed to reimburse and indemnify an officer of the Company for 1,000,000 shares of VCSY common stock owned by him that he transferred to Lakeshore on the Company’s behalf. Under the agreement, the Company is obligated to reimburse the officer with 1,000,000 shares of VCSY common stock within 1 year (see Note 4).
In October 2013, MRC pledged 1,000,000 shares of our common stock to secure a $50,000 loan made to the Company by a third party lender. The Company is obligated to replace these shares if these shares are transferred to the lender. This debt is currently in default and therefore these shares have been classified as a derivative liability as of December 31, 2014 when it became past due. The initial fair value of these shares was determined to be $72,000 as of December 9, 2013.
Also in October 2013, MRC transferred 1,000,000 restricted shares of our common stock owned by MRC to a third party lender in connection with a $100,000 loan to the Company. The fair-market value of these shares was valued at $85,000 of which the relative fair value of $44,444 was recorded as a discount to the associated note. The transfer of the 1,000,000 shares is included as common stock returned and cancelled in the consolidated statement of stockholders’ deficit. Also in October 2013, in connection with the transfer, the Company entered into an indemnity and reimbursement agreement to reimburse MRC with 1,000,000 shares of our common stock within one year and pay for all costs associated with the transfer of shares to the lender and the reimbursement of shares to MRC. This reimbursement obligation was accounted for as a derivative liability (see Note 4).
During the year ended December 31, 2013, the Company granted 1,500,000 unregistered shares of VCSY common stock to consultants of the Company pursuant to restricted stock agreements with the Company. These shares vested in six months on December 31, 2013 and the fair value of the awards was expensed over this vesting period. The aggregate fair value of the awards was determined to be $45,000. Stock compensation expense of $45,000 has been recorded for the year ended December 31, 2013.
During the year ended December 31, 2013, in addition to the 1,500,000 share award described above, 550,000 common shares granted to employees and consultants of the Company vested. Stock compensation that was previously accrued totaling $10,226 was reclassified from accrued liabilities to stockholders’ equity associated with these shares vesting. As of December 31, 2013, there was $8,276 of compensation costs included in accrued liabilities that will be reclassified to stockholders’ equity upon the vesting of the shares.
During the year ended December 31, 2013, the Company cancelled 1,500,000 previously issued common shares of the Company that had been granted to a third party lender.
Preferred Stock
For the year ended December 31, 2013, the total dividends applicable to Series A and Series C Preferred Stock was $588,000. The Company did not declare or pay any dividends in 2013. Although no dividends have been declared, the cumulative total of preferred stock dividends due to these stockholders upon declaration was $7,629,712 as of December 31 2013.
Available Shares
As of December 31, 2014, 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:
In addition, the Company has $30,000 in an outstanding convertible debenture that had been issued to a third party.
Accordingly, given the fact that the Company currently has 1,000,000,000 shares of common stock authorized, the Company could exceed its authorized shares of common stock by approximately 33,417,108 shares if all of the financial instruments described in the table above were exercised or converted into shares of common stock (excluding the $30,000 from the outstanding debenture noted above).
We have evaluated our convertible cumulative preferred stock under the guidance set out in FASB ASC 470-20 and have accordingly classified these shares as temporary equity in the consolidated balance sheets.
For additional transactions involving Common and Preferred Stock after December 31, 2014, including the increase in authorized shares of common stock of the Company to 2,000,000,000 shares, please see “Subsequent Events” in Note 13.
Note 11. Gain on Settlement of Current Liabilities
In 2013, the Company recorded a gain on settlement of liabilities of $334,100 as a result of our review of trade payables accrued liabilities and notes payable 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, former employee or note holder, and the applicable statute of limitations. 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.
Note 12. Commitments and Contingencies
Commitments
We lease various office spaces which leases run from October 2010 through June 2016. We have future minimum rental payments as follows:
Rental expense for the years ended December 31, 2014 and 2013 was $156,437 and $151,968, 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 2014 and 2013.
We also have royalty agreements associated with certain notes payable that provide a royalty when revenues exceed certain thresholds in addition to royalty agreements on subsidiary revenues pursuant to the terms of an acquisition agreement. For the years ended December 31, 2014 and 2013, we had royalties of $16,105 and $53,971, respectively, on revenues from subsidiaries.
Litigation
We are involved in the following ongoing legal matters:
On November 18, 2009, we sued InfiniTek Corporation (“InfiniTek”) in the Texas State District Court in Fort Worth, Texas for breach of contract and other claims (the “Texas Action”) seeking equitable relief and unspecified damages when a dispute between the Company and InfiniTek was not resolved. All agreements with InfiniTek have been cancelled. On January 15, 2010, InfiniTek filed a counter-claim for non-payment of amounts billed. InfiniTek claimed it was owed $195,000 plus lost opportunity costs of not less than $220,000.
On April 7, 2010, we were served with a lawsuit filed by InfiniTek in the California Superior Court in Riverside, California seeking damages in excess of $76,303 for breach of contract and lost profit (the “California Action”). This lawsuit related to one of the causes of action and the same set of underlying facts, as those in the Texas legal action. On May 7, 2010, we filed a motion to dismiss this action. On July 14, 2010, the court denied our motion. On August 13, 2010, we filed an answer to InfiniTek’s complaint, including a denial and affirmative defenses.
On December 31, 2011, the Company and InfiniTek entered into a settlement agreement whereby the Texas Action and the California Action were both dismissed. Pursuant to the terms of the settlement agreement, Vertical agreed to pay InfiniTek $82,500 in three equal installments with the last payment due by or before August 5, 2012. Upon full payment, InfiniTek shall transfer and assign ownership of the NAVPath software developed by InfiniTek for use with NOW Solutions emPath® software application and Microsoft Dynamics NAV (formerly Navision) business solution platform. The amounts in dispute were included in our accounts payable and accrued liabilities and have been adjusted to the settlement amount of $82,500 at December 31, 2011. The Company has made $37,500 in payments due under the settlement agreement as of November 16, 2012 and each party is alleging the other party is in breach of the settlement agreement. We are currently seeking to resolve all disputes with InfiniTek.
On November 15, 2010, we filed a lawsuit in the Federal District Court for the Eastern District of Texas (the “Vertical Action”) against Interwoven, Inc. ("Interwoven"), LG Electronics MobileComm U.S.A., Inc., LG Electronics, Inc., Samsung Electronics Co., Ltd. and Samsung Electronics America, Inc. (collectively, the "Defendants"). We sued the Defendants for patent infringement claims under United States Patent No. 6,826,744 (“System and Method for Generating Web Sites in an Arbitrary Object Framework”) and United States Patent No. 7,716,629 (“System and Method for Generating Web Sites in an Arbitrary Object Framework”) (collectively the “the Patents-in-Suit”), both of which are owned by the Company. We seek an award of monetary damages and other relief. The case is styled Vertical Computer Systems, Inc. v Interwoven, Inc., LG Electronics Mobilecomm U.S.A., Inc., No. 2:10-CV-00490.
On November 17, 2010, we were served with a lawsuit filed on October 14, 2010 by Interwoven in the United States District Court for the Northern District of California (the “Interwoven Action”). This lawsuit was instituted as a complaint for declaratory judgment, in which Interwoven requested that the court find that no valid and enforceable claim of either of the two patents referenced above has been infringed by Interwoven. The case is styled Interwoven, Inc. v Vertical Computer Systems, Inc. No. 3:10-CV-4645-RS.
On January 11, 2011, Samsung Electronics Co., Ltd. and Samsung Electronics America, Inc. (“Samsung”) filed a lawsuit in the United States District Court for the Northern District of California seeking to consolidate its lawsuit with the Interwoven Action. This case is styled Samsung Electronics Co., Ltd. and Samsung Electronics America, Inc., v. Vertical Computer Systems, Inc., No. 3:11-CV-00189-RS.
On May 2, 2011, the United States District Court for the Northern District of California denied Vertical’s renewed motion to transfer the Interwoven Action to the Eastern District of Texas and granted Vertical's motion to transfer the lawsuit filed by Samsung in the Northern District of California to the Eastern district in Texas. On May 11, 2011, the United States District Court for the Eastern District of Texas granted Interwoven’s motion to transfer the case to the Northern District of California with respect to Interwoven and denied Samsung’s motion to transfer its case to the Northern district.
On December 30, 2011, the United States District Court for the Northern District of California issued a claims construction order in the Interwoven Action concerning the terms found in the claims of the Patents-in-Suit.
On October 12, 2012, the United States Patent and Trademark Office (“USPTO”) issued an ex parte reexamination certificate of United States Patent No. 7,716,629. In the ex parte reexamination certificate, Claims 21-36, 29, 30, and 32 were confirmed; Claims 1, 8, 11, 13, 28 and 31 were determined to be patentable as amended, Claims 2-6, 9, 10, 12, 14-17, 19 and 20, which were dependent on an amended claim, were determined to be patentable, and claims 7, 18 and 27 were not reexamined.
On October 25, 2012, the USPTO notified the Company of its intent to issue an ex parte reexamination certificate concerning the ex parte reexamination of United States Patent No. 6,826,744. In the notice of intent to issue ex parte reexamination certificate, the USPTO notified that the prosecution on the merits is closed in this ex parte reexamination proceeding and indicated that Claims 6, 8, 19, 22, 30, 32, 41, 44, 50, 51 were confirmed; Claims 1 and 26 were cancelled; Claims 12-17, 20, 34-39, 42 and 43 are not subject to reexamination; newly presented Claims 54-57 are patentable and continuation of patent claims amended: 2-5, 7, 9-11, 18, 21, 23-25, 27-29, 31, 33, 40, 45-49, 52 and 53.
On January 4, 2013, the United States District Court for the Northern District of California in the Interwoven Action denied Interwoven’s motion for summary judgment for unenforceability and invalidity of the Patents-in-Suit in its entirety.
On July 17, 2013, the United States District Court for the Northern District of California in the Interwoven Action ruled on Interwoven’s motion for summary judgment with respect to infringement and damages concerning the Patents-in-Suit. The court denied Interwoven’s motion for summary judgment on the issue of direct infringement and granted summary judgment in favor of Interwoven with respect to infringement on the doctrine of equivalents and with respect to indirect infringement. The court also granted in part and denied in part Interwoven’s motion to exclude certain expert witness testimony.
On September 16, 2013, the United States District Court for the Eastern District of Texas issued a claims construction order in the Vertical Action concerning the terms found in the claims of the Patents-in-Suit. On December 12, the Company settled the patent infringement claim that the Company initiated in federal court against LG. Pursuant to the confidential settlement agreement, the Company has granted to LG a non-exclusive, fully paid-up license under the two patents (“Patents-in-Suit”) with any continuation patents of the Patents-in-Suit and any other continuation patents with the same priority claim as the Patents-in-Suit.
On December 12, 2013, the Company settled its patent infringement claim against LG Electronics. Pursuant to the confidential settlement agreement, the Company granted to LG Electronics a non-exclusive, fully paid-up license under the Patents-in-Suit which were the subject of the legal proceeding. The litigation concerning the Patents-in-Suit with LG has been resolved.
On March 20, 2014, the Company settled the patent infringement claim that the Company initiated in federal court against Samsung. Pursuant to the confidential settlement agreement, the Company has granted to Samsung a non-exclusive, fully paid-up license under the Patents-in-Suit with any continuation patents of the Patents-in-Suit and any other patents with the same priority claim as the Patents-in-Suit. The litigation concerning the Patents-in-Suit with Samsung has been resolved.
On May 8, 2014, the Company settled the patent infringement claim that the Company initiated in federal court against Interwoven. Pursuant to the confidential settlement agreement, the Company has granted to Interwoven and its subsidiaries, affiliates and parent companies (which include Autonomy Corporation PLC and Hewlett-Packard Company, Inc.), a non-exclusive, fully paid-up license to the Patents-in-Suit with any continuation patents of the Patents-in-Suit and any other patents with the same priority claim as the Patents-in-Suit. The Interwoven Action has been resolved.
On July 8, 2011, we were served with a lawsuit in the Texas State District Court in Dallas, Texas by Clark Consulting Services, Inc. (“CCS”) for breach of contract and other claims. CCS was seeking damages from us in excess of $133,750 plus attorney’s fees and interest. On August 8, 2011, we filed an answer denying CCS’s claims and setting forth affirmative defenses. In December 2011, the Company and CCS entered into a settlement agreement whereby the lawsuit was dismissed. Pursuant to the terms of the settlement agreement, the Company agreed to pay CCS $134,000, which was to be paid in installment payments. Due to the Company’s failure to make timely payments, an additional $60,000 was added to the outstanding balance. On October 26, 2012, we entered into an agreement under which we agreed to make monthly payments of $5,000 and pay the outstanding balance plus attorney’s fees and costs by February 1, 2013. As of December 31, 2012, the settlement amount of $149,000 has been included in accounts payable and accrued liabilities. During 2013, the parties entered into several agreements to extend the date by which the Company has to pay off the balance of the settlement amount whereby. Under these agreements, the Company agreed to make monthly payments of $10,000 (of which $2,500 of each payment would be applied as late fees) beginning in February 2013 through November 2013 until the outstanding balance has been paid. As of November 18, 2014, all payments have been made and this matter has been resolved.
On October 11, 2012, Micro Focus (US), Inc. (“Micro Focus”) filed a lawsuit against NOW Solutions in the United States District Court for the southern division district of Maryland alleging breaches of its contractual obligations under an independent software agreement and copyright infringement. On January 28, 2013, NOW Solutions and Micro Focus entered into a settlement agreement whereby NOW Solutions agreed to pay Micro Focus $420,000, of which $70,000 in installment payments were made with the outstanding balance due on April 30, 2013. In connection with the settlement, the Company entered into a guaranty agreement with Micro Focus concerning NOW Solutions’ obligations under the promissory note. The Company did not make the $375,000 payment due to Micro Focus. On May 15, 2013, Vertical was served with a lawsuit in the Circuit Court for Montgomery County, Maryland by Micro Focus concerning the guaranty by Vertical to Micro Focus concerning NOW Solutions’ failure to make payment of the outstanding balance due under the promissory note. On July 3, 2013, NOW Solutions was served with a lawsuit for a confessed judgment in the Circuit Court for Montgomery County, Maryland by Micro Focus concerning NOW Solutions’ failure to make payment of the outstanding balance due under the promissory note. On January 15, 2014, the Company and NOW Solutions consented to a judgment in the amount of $350,000, plus $36,000 in accrued interest and attorney’s fees in the amount of $80,000, plus accrued interest at the rate of 10% per annum until paid. As of November 18, 2014, all payments have been made and this matter has been resolved.
On February 4, 2014, Victor Weber filed a lawsuit against Vertical, Mountain Reservoir Corporation (“MRC”), and Richard Wade in the District Court of Clark County, Nevada for failure to make payment of the outstanding balance due under a $275,000 promissory note issued by Vertical to Mr. Weber. The plaintiff seeks payment of the principal balance due under the note $275,000, default interest at the rate of 18% per annum, attorney’s fees and court costs, and punitive damages. On July 24 2014, the court granted plaintiff’s motion for summary judgment against defendants. The judgment was filed on September 18, 2014. We are currently seeking to resolve this matter with Mr. Weber. Mr. Wade is the President and CEO of Vertical and the President of MRC. MRC is a corporation controlled by the W5 Family Trust. Mr. Wade is the trustee of the W5 Family Trust.
On October 20, 2014, Michael T. Galvan and Michelle Bates (“Galvan & Bates”) filed a lawsuit in the Court of Chancery in the State of Delaware seeking to have the court compel the Company to hold a shareholder meeting for the purpose of electing all directors of the Company, designating the time and place of a meeting and other details reasonably necessary to hold such a meeting, attorney costs and fees (including reasonable attorney’s fees), and such other relief as the court deems proper. Galvan and Bates are stockholders of the Company. This case is styled Michael T. Galvan and Michelle Bates v. Vertical Computer Systems, Inc., No. 10234.
Note 13. Subsequent Events
In February 2015, the Company had an annual shareholder meeting. In connection with the meeting, the stockholders of the Company approved certain actions of the Company, including approval of the two directors and approval of an amendment to increase the authorized shares of common stock of the Company to 2,000,000,000 shares of common stock. Also in February 2015, the Company filed an amendment of its certificate of incorporation in the state of Delaware to increase the authorized number of shares of common stock to 2,000,000,000 shares of common stock.
In February 2015, the Company was granted a continuation patent (U.S. Patent No. 8,949,780) of U.S. Patent No. 7,716,629 by the USPTO. All pending new claims were granted in the continuation patent for U.S. Patent No. 8,949,780, which has increased the scope of the continuation patent and the original patent by adding 24 new claims. U.S. Patent No. 7,716,629 is a continuation patent of U.S. Patent No. 6,826,744.
In February 2015, the Company and a third party lender entered into a loan agreement under which the lender loaned Vertical $100,000. Pursuant to the loan agreement, Taladin, Inc., a subsidiary of the Company, issued a promissory note in the principal amount of $100,000 bearing interest at 12% per annum and is due on demand.
In March 2015, pursuant to an indemnity and reimbursement agreement executed between Mr. Valdetaro and the Company we issued 1,000,000 shares of our common stock to reimburse Mr. Valdetaro for 1,000,000 shares of common stock transferred to Lakeshore on the Company’s behalf in connection with an extension granted by Lakeshore in August 2013.
In March 2015, pursuant to two indemnity and reimbursement agreements executed between MRC and the Company, we issued a total of 2,809,983 shares of our common stock to reimburse MRC, Of these shares the Company was obligated to reimburse MRC with, 1,309,983 shares of common stock had been pledged by MRC and sold by a third party lender in 2009, 500,000 shares of common stock had been wrongfully converted by the same lender in 2014, and 1,000,000 shares of common stock had been transferred to another third party lender in 2013 on the Company’s behalf for a loan made by the lender. MRC has assigned its claim against the third party lender for the lender’s wrongful conversion of 500,000 common shares to the Company and we are pursuing the claim in the third party lender’s bankruptcy proceeding.