Item 310
of
Regulation S-B. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. The accompanying unaudited condensed consolidated
financial statements reflect all adjustments that, in the opinion of the
management of Vertical Computer Systems, Inc. and its subsidiaries
(collectively, the “Company”),
are considered necessary for a fair presentation of the financial position,
results of operations, and cash flows for the periods presented. The results
of
operations for such periods are not necessarily indicative of the results
expected for the full fiscal year or for any future period. The accompanying
financial statements should be read in conjunction with the audited consolidated
financial statements of the Company included in the Company’s Form 10-KSB for
the year ended December 31, 2006.
Stock-Based
Compensation
Effective
January 1, 2004, the Company adopted the fair value provisions of Statement
of
Financial Accounting Standards (“SFAS”)
No.
123 for share based payments to employees. In accordance with transition
provisions under SFAS No. 148, the Company has adopted the prospective method
for transitional recognition.
Effective
January 1, 2006, the Company adopted SFAS 123(R) using the modified prospective
method, which requires measurement of compensation cost for all stock-based
awards at fair value on date of grant and recognition of compensation over
the
service period for awards expected to vest. The fair value of restricted stock
and restricted stock units is determined based on the number of shares granted
and the quoted price of our common stock, and the fair value of stock options
is
determined using the Black-Scholes valuation model, which is consistent with
our
valuation techniques previously utilized for options in footnote disclosures
required under SFAS 123, Accounting for Stock Based Compensation, as amended
by
SFAS 148, Accounting for Stock-Based Compensation — Transition and Disclosure.
The estimation of stock awards that will ultimately vest requires judgment,
and
to the extent actual results or updated estimates differ from the Company’s
current estimates, such amounts will be recorded as a cumulative adjustment
in
the period estimates are revised.
Because
the fair value recognition provisions of SFAS No. 123, Stock-Based
Compensation, and SFAS No. 123(R) were materially consistent under the
Company’s equity plans, the adoption of SFAS No. 123(R) did not have a
significant impact on the Company’s financial position or the Company’s results
of operations.
Going
Concern Uncertainty
The
accompanying condensed
consolidated
financial statements for the three and nine months ended September 30, 2007
and
2006, 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 financial statements
do not purport to represent realizable or settlement values. The Company has
suffered significant recurring operating losses, used substantial funds in
its
operations, and needs to raise additional funds to accomplish its objectives.
Negative
stockholders’ equity at September 30, 2007 was approximately $19 million.
Additionally,
at September
30, 2007,
the
Company had negative working capital of approximately $12.4 million (although
it
includes deferred revenue of approximately $2.1 million) and has defaulted
or is
delinquent on several of its debt obligations. These conditions raise
substantial doubt about the Company’s ability to continue as a going concern.
Management
of the Company is continuing its efforts to attempt to secure funds through
equity and/or debt instruments for its operations, expansion and possible
acquisitions, mergers, joint ventures, and/or other business combinations.
The
Company will require additional funds for its operations and to pay down its
liabilities, as well as finance its expansion plans consistent with the
Company’s anticipated changes in operations and infrastructure. In addition, the
Company was awarded a judgment of $3,151,216 relating to the recent lawsuit
won
by the Company against Ross Systems Inc. (“Ross”).
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 or collect on the Ross judgment. The
condensed consolidated financial statements contain no adjustment for the
outcome of this uncertainty.
Furthermore,
the Company is exploring certain opportunities with a number of companies to
participate in co-marketing of each other’s products. The Company is proceeding
to license its intellectual property and filed suit for patent infringement
against Microsoft (for more details, see Note 4, “Legal Proceedings”). The exact
results of these opportunities are unknown at this time.
Note
2 - Common and Preferred Stock Transactions
In
March
2007, Mountain Reservoir Corporation (“MRC”)
and
Victor Weber entered into a pledge agreement, whereby the MRC pledged 10,000,000
shares of common stock of the Company to secure the principal payments and
interest payments on the $300,000 Note and interest payments on the $200,000
Note. MRC is a corporation controlled by the W5 Family Trust. Mr. Wade, the
President and CEO of the Company, is the trustee of the W5 Family Trust. Mr.
Weber is the President and a Director of Government Internet Systems, Inc.,
a
subsidiary of the Company, and a member of CW International, LLC (“CWI”).
In
April
2007, Luiz Valdetaro, on behalf of the Company, transferred 2,000,000
unrestricted shares of common stock of the Company owned by Mr. Valdetaro to
an
officer of Tara Financial in exchange for waiving the defaults and extending
the
payment terms on notes payable in the amounts of $438,795, $350,560, $955,103
and $450,000 issued to Tara Financial by the Company, NOW Solutions, and Taladin
in February 2006. Mr. Valdetaro is the Chief Technology Officer of the Company.
Also in April 2007, in connection with the transfer, the Company entered into
an
indemnity and reimbursement agreement to reimburse Mr. Valdetaro with 2,000,000
shares within one year and pay for all costs associated with the transfer of
shares to Tara Financial and the reimbursement of shares to Mr. Valdetaro.
In
connection with a $40,000 loan from Clark Consulting Group, Inc. (“CCS”)
to the
Company, Mr. Valdetaro, on behalf of the Company, transferred 1,000,000
unrestricted shares of common stock of the Company owned by Mr. Valdetaro to
CCS. The Company is also obligated to arrange for a pledge of 1,000,000 shares
of common stock of the Company to secure the loan. Mr. Valdetaro is the Chief
Technology Officer of the Company. Also in April 2007, in connection with the
transfer of shares to CCS, the Company entered into an indemnity and
reimbursement agreement to reimburse Mr. Valdetaro with 1,000,000 shares within
one year and pay for all costs associated with the transfer of shares to CCS
and
the reimbursement of shares to Mr. Valdetaro.
In
April
2007, the Company and MRC entered into an indemnity and reimbursement agreement
for transfer and pledges of shares of common stock of the Company. Pursuant
to
the agreement, MRC loaned the Company 10,000,000 shares of common stock of
the
Company in order for the Company to meet current obligations concerning stock
the Company has been obligated to issue and deliver. In connection with the
loan
of shares to the Company, the Company agreed to reimburse MRC with up to
10,000,000 shares of common stock of the Company and pay for all costs
associated with such transfer and the reimbursement of shares to MRC within
one
year. In addition, in the event that any of the shares of common stock of the
Company pledged by MRC on behalf of the Company in connection with promissory
notes issued by the Company (or its subsidiaries, as applicable) are sold to
cover a default under the respective note, the Company agreed to reimburse
MRC
with a number of shares equal to the number of shares sold to cover the default
under the respective note within 1 year, and to reimburse MRC for all costs
associated with such sales and the reimbursement of shares to MRC related to
such sales.
In
April
2007, the Company issued 4,250,000 shares of common stock of the Company in
connection with the exercise of warrants and an agreement executed in 2006.
All
of the foregoing shares were previously accounted for in the 10-KSB Report
for
the period ended December 31, 2006.
During
the nine months ended September 30, 2007, warrants to purchase 5,250,001 shares
of common stock of the Company at a price of $0.025
to
$0.10 per share expired.
During
the nine months ended September 30, 2007, the Company issued 3,750,000
unregistered shares of common stock of the Company to employees and a consultant
of the Company and NOW Solutions pursuant to restricted stock agreements
executed in 2007 that provide for the shares to vest up to three years in equal
installments at the anniversary date of the agreement.
During
the nine months ended September 30, 2007, 3,689,292 unregistered shares of
common stock of the Company issued to employees of the Company and Now Solutions
vested. These shares were issued pursuant to restricted stock agreements
executed in 2005, 2006, and 2007.
During
the nine months ended September 30, 2007, 184,521
unregistered shares of the common stock of the Company were cancelled. These
shares had been issued pursuant to restricted stock agreements with employees
of
Now Solutions executed in 2005 and 2006.
For
an
update on common stock transactions since September 30, 2007, please see
“Subsequent Events” in Note 7.
Note
3 - Notes Payable
|
September
30, 2007
|
December
31, 2006
|
||||||
|
Note
payable to Ross
issued by NOW Solutions in the amount of $1,000,000. The note was
unsecured and non-interest bearing. The note was recorded at a
discount
(which was amortized over the life of the note), payments of $250,000
and
$750,000 to be due in February 2002 and 2003, respectively. If
a payment
was not received within three days from the due date, the note
would begin
to bear interest at 10% per annum. In 2002, NOW Solutions offset
$250,000
payment through its receivable from Ross in terms of the agreement
between
NOW Solutions and Ross. In April 2007, the Company prevailed in
a lawsuit
against Ross and the balance of this note was deducted from the
Company’s
award from its breach of contract claim. For more details on legal
proceedings between the Company, NOW Solutions and Ross, please
refer to
“Legal Proceedings” under Note 4.
|
750,000
|
750,000
|
|||||
|
|
|
|
|||||
|
Note
payable in the amount of $31,859 to a third-party lender, bearing
interest
at an amount to be negotiated, principal and interest due on
demand.
|
31,859
|
31,859
|
|||||
|
|
|
|
|||||
|
Notes
payable in the amount of $27,000 to a third-party, payable upon
demand.
|
27,000
|
27,000
|
|||||
|
|
|
|
|||||
|
Note
payable to a third-party lender in the amount of a $239,004 bearing
interest at 13% per annum and unsecured, with a $65,000 payment
made in
December 2002. This note was issued in 2002 to replace the note
of
$211,137 issued in August 2001 to a third-party lender. In March
2003, the
note was amended and the Company agreed to pay the interest and
expenses
responsible by the lender for a third-party loan secured on the
lender’s
behalf instead of paying to the lender and the Company agreed to
begin
making monthly payment of $7,500, beginning on June 1, 2003, until
the balance under the note has been paid. The note is in
default.
|
161,504
|
161,504
|
|||||
|
Note
payable in the amount of $50,000 to a third-party lender, bearing
interest
at 12% per annum. In May 2005, the Company and a third party lender
amended the terms of the note. The Company agreed to commence monthly
payments to the lender of $2,500 in June 2005, which would be raised
to
$4,000 beginning in October 2005, and to pay the lender’s reasonable
attorney’s fees. The Company is in default.
|
35,568
|
35,568
|
|||||
|
September
30, 2007
|
December
31, 2006
|
||||||
|
Note
payable in the amount of $50,000 to a third-party lender, bearing
interest
at the rate of 12% per annum. The parties amended the terms of
the note so
that the Company would begin making monthly installment payments
of $5,000
in July 2003, with the payments first applied to the $25,000 note
(issued
below) and then to the $50,000 note. The note has been in default
since
April 1, 2003.
|
50,000
|
50,000
|
|||||
|
|
|
|
|||||
|
Note
payable in the amount of $25,000 to a third-party lender, bearing
interest
at 12% per annum, secured by 10,000,000 shares of the Company’s common
stock that are owned by MRC due in December 2002. 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. The parties amended
the
terms of the note so that the Company would begin making monthly
installment payments of $5,000 in July 2003, with the payments
first
applied to the $25,000 note and then to the $50,000 (the above)
note
issued. The note has been in default since April 1, 2003.
|
12,583
|
12,583
|
|||||
|
|
|
|
|||||
|
Note
payable in the amount of $215,000 issued by NOW Solutions to the
Company
was assigned to Victor Weber in January 2004 in connection with
canceling
notes issued to Weber and expenses paid by Weber on behalf of the
Company
that were included in trade accounts payable in the aggregate amount
of
$215,000. In October 2006, the parties amended the note. The note
provides
for monthly payments made from gross revenues of new sales of emPath
by
NOW Solutions and Taladin. In March 2007, the payment dates for
this note
were extended by sixty (60) days. The note is due October 27, 2007.
In
connection with the note, MRC pledged 5,000,000 shares of common
stock of
the Company to secure the note to the Company. 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. Mr. Weber is the
President
and a Director of GIS, a subsidiary of the Company, and
a member of CWI.
The note is delinquent.
|
215,000
|
215,000
|
|||||
|
|
|
|
|||||
|
Note
payable in the amount $25,000 promissory note, bearing interest
at 10% per
annum, was issued in April 2003 to a consultant of the Company’s
subsidiary, EnFacet, Inc., for past services rendered. The note
is payable
in monthly $1,000 installments beginning in May 2003 to be replaced
by
$2,000 monthly installments beginning in October 2003. The note
is in
default.
|
25,000
|
25,000
|
|||||
|
|
|
|
|||||
|
Note
payable in the amount of $17,500, bearing no interest to a third-party
lender in consideration of a loan in the amount of $15,000, was
due in
June 2003. In connection with the note, the Company paid a commitment
fee
of $2,500. In
July 2006, the Company issued 250,000 unregistered shares of the
common
stock of the Company to the third-party lender pursuant to the
lender’s
exercise of warrants to purchase the shares for a total of $1,875.
The
purchase price was offset against monies owed under note payable.
This
note is in default.
|
11,000
|
11,000
|
|||||
|
|
|
|
|||||
|
Note
payable in the amount of $17,500, bearing no interest to a third-party
lender in consideration of a loan in the amount of $15,000, was
due in
June 2003. In July 2006, the Company issued 250,000 unregistered
shares of
the common stock of the Company to the third-party lender pursuant
to the
lender’s exercise of warrants to purchase the shares for a total of
$1,875. The purchase price was offset against monies owed under
note
payable. This note is in default.
|
11,000
|
11,000
|
|||||
|
|
|
|
|||||
|
Note
payable in the amount of $10,000 issued by EnFacet to a third-party
lender, bearing interest at 8% per annum, unsecured, with principal
and
interest due on June 1, 2002. EnFacet has been in default since
December 31, 2002.
|
10,000
|
10,000
|
|||||
|
|
|
|
|||||
|
Note
payable in the amount of $10,365 dated January 17, 2003 bearing
an interest of 10% per annum, with principal and interest due on
December
5, 2003. Payments of $3,000 were made on this note in 2003. This
note is
in default.
|
7,365
|
7,365
|
|||||
|
|
|
||||||
|
|
September
30, 2007
|
December
31, 2006
|
|||||
|
|
|
|
|||||
|
Note
payable in the amount of $23,030 dated March 21, 2003 bearing
an interest of 12% per annum, with principal and interest due on
April 21,
2004. This note is in default.
|
23,030
|
23,030
|
|||||
|
|
|
|
|||||
|
Note
payable in the amount of $60,000 issued by GIS to a third-party
dated
November 5, 2003, bearing an interest of 10% per annum, with principal
and
interest due on November 5, 2004. The note is secured by 4,000,000
shares
of common stock of the Company that are owned by 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. This note is in
default.
|
60,006
|
60,006
|
|||||
|
|
|
|
|||||
|
Note
payable in the amount of $40,000 issued by GIS to a third-party
dated
November 19, 2003, bearing an interest of 10% per annum, with principal
and interest due on November 19, 2004. The note is secured by 3,000,000
shares of common stock of the Company that are owned by 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. This
note is in
default.
|
40,000
|
40,000
|
|||||
|
|
|
|
|||||
|
Note
payable in the amount of $5,000 to Mr. James Salz, bearing interest
at 10%
per annum with principal and interest due on demand. Mr. Salz is
the
Company’s corporate counsel.
|
5,000
|
5,000
|
|||||
|
|
|
|
|||||
|
Note
payable in the amount of $10,000 to Mr. James Salz, bearing interest
at
10% per annum. Mr. Salz is the Company’s corporate counsel. The note is in
default.
|
10,000
|
10,000
|
|||||
|
|
|
|
|||||
|
Note
payable in the amount of $600,000 issued to Arglen Acquisitions,
LLC
(“Arglen”)
by the Company pursuant to the Company’s acquisition of Arglen’s 35%
interest in NOW Solutions. In
August 2004, Arglen obtained a default judgment the (“California
Judgment”)
in Los Angeles court for the outstanding principal, plus attorney’s fees
and interest at the rate of 10% per annum when the Company did
not make
payment under the note. In April 2005, Arglen filed a Notice of
Filing a
Foreign Judgment in Tarrant County, Texas. In August 2005, Company
entered
into an agreement with Arglen allowing payout terms to the Company
(the
“Payout
Agreement”)
and pursuant to which the Company agreed to enter into an Agreed
Judgment
for the Foreign Judgment in Tarrant County, Texas (the “Agreed
Judgment”).
The Agreed Judgment and Payout Agreement were entered into concerning
the
California Judgment and Arglen's notice of Filing a Foreign Judgment
in
Tarrant County, Texas, which were in connection with the 2003 settlement
agreement (the “2003
Settlement”).
Pursuant to the terms of the Agreed Judgment and the Payout Agreement,
the
Company agreed to pay Arglen a total of $713,489, which includes
principal
and accrued interest under the note, post judgment interest and
attorneys’
fees. Pursuant to the terms of the Payout Agreement, the Company
is
currently obligated to make monthly payments on the amount specified
above
of $25,000 or 10% of the Company's new sales, whichever is greater,
until
the remainder of the $713,489 is paid. In accordance with the Payout
Agreement, Arglen shall not execute the Agreed Judgment so long
as the
Company continues to make its payments as agreed. For
additional details, see Note 4, “Legal Proceedings”.
|
223,489
|
438,489
|
|||||
|
September
30, 2007
|
December
31, 2006
|
||||||
|
|
|
|
|||||
|
Note
payable in the amount of $75,000 issued by the Company, bearing
interest
at a rate of 6% to the law firm of Parker Mills Morin, LLP (“PMM”)
in October 2005. The note was issued in connection with a lawsuit
filed by
PMM to collect the outstanding balance of $23,974 due under the
promissory
note issued to them by the Company and for failure to pay fees
for
professional services in the amount of $89,930 rendered to the
Company,
plus interest. The $75,000 note has a maturity date of January
31, 2008
and shall be paid in equal monthly installments of $3,125, beginning
February 1, 2006 for a period of 24 months. Bill Mills is a Director
of
the Company and a partner of PMM. PMM is the successor entity to
Parker
Mills & Patel, LLP. The note is in default.
|
58,318
|
58,318
|
|||||
|
|
|
|
|||||
|
Note
payable in the amount of $992,723 issued by NOW Solutions, the
Company’s
wholly-owned subsidiary to Wolman Blair, PLLC on November 30, 2005.
The
note is secured with the assets of NOW Solutions and bears interest
at the
rate of 12% compounded annually. The note was issued in connection
with
refinancing outstanding legal fees and expenses (which where owed
pursuant
to the legal services retainer agreement), together with interest
accrued
as of the date the note was issued. The note is currently payable
as
follows: equal monthly installments of $40,000, each, commencing
March 1,
2006, and continuing on the first day of each month thereafter,
until
March 1, 2008, upon which date all outstanding principal and interest
shall be due. In connection with the loan, NOW Solutions entered
into a
security agreement with the lender to guarantee the note. In April
2007,
the Company prevailed in a lawsuit against Ross and the Company
is
entitled to collect attorney fees from Ross, which will be applied
to a
portion of this note. For more details on legal proceedings between
the
Company, NOW Solutions and Ross, please refer to “Legal Proceedings” under
Note 4. The note is in default.
|
992,723
|
992,
723
|
|||||
|
|
|
|
|||||
|
Note
payable in the amount of $450,000 issued by Taladin to Tara Financial,
dated February 13, 2006. The note bears interest at the rate of
12% per
annum. The note was issued in connection with refinancing whereby
Taladin
acquired the indebtedness of NOW Solutions to Wamco. The note is
secured
by Taladin’s first lien position on the assets of NOW Solutions. Tara
Financial, Strategic Growth Partners (“SGP”)
and Mr. Weber share the firs | |||||||