U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-28685
VERTICAL COMPUTER SYSTEMS, INC.
(EXACT NAME OF SMALL BUSINESS ISSUER AS SPECIFIED IN ITS CHARTER)
DELAWARE 65-0393635
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
6336 WILSHIRE BOULEVARD
LOS ANGELES, CALIFORNIA 90048
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(323) 658-4211
(ISSUER'S TELEPHONE NUMBER)
SCIENTIFIC FUEL TECHNOLOGY, INC.
--------------------------------
(FORMER NAME OF SMALL BUSINESS ISSUER)
1203 HEALING WATERS, LAS VEGAS, NV 89031
----------------------------------------
(FORMER ADDRESS OF SMALL BUSINESS ISSUER)
Indicate by check whether the issuer: (1) filed all reports required to be filed
by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or
for such shorter period that the Company was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
State the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date: Common Stock, par value $.00001 per
share, 724,884,934 shares issued and outstanding as of December 5, 2002.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
1
VERTICAL COMPUTERS SYSTEMS, INC. AND SUBSIDIARIES
INDEX TO FORM 10-QSB
PART I FINANCIAL INFORMATION Page
Item 1. Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheet (unaudited) as of September 30, 2002 3
Condensed Consolidated Statements of Operations (unaudited) for the Three and Nine months Ended 5
September 30, 2002 and 2001
Condensed Consolidated Statements of Stockholders' Equity (unaudited) for the Nine months Ended 6
September 30, 2002
Condensed Consolidated Statements of Cash Flows (unaudited) for the Nine months Ended
September 30, 2002 and 2001 8
Notes to Condensed Consolidated Financial Statements 10
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 19
Item 3. Evaluation of Disclosure Controls and Procedures 25
PART II OTHER INFORMATION
Item 1. Legal Proceedings 27
Item 2. Changes in Securities and Use of Proceeds 27
Item 3. Defaults Under Senior Securities 32
Item 4. Submission of Matters To A Vote Of Security Holders 32
Item 5. Other Information 32
Item 6. Exhibits and Reports on Form 8-K 32
Signatures 44
Certifications 45
2
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
VERTICAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
September 30,
2002
- ---------------------------------------------------------------------------------------------------
Assets
Current Assets
Cash $ 848,322
Restricted cash 1,500,000
Securities available for sale 3,688
Accounts receivable, net of allowance for bad debts of $98,352 1,880,601
Other receivable 10,833
Employee receivables 148,065
Prepaid expenses and other assets 154,272
- ---------------------------------------------------------------------------------------------------
Total Current Assets 4,545,781
Property and equipment, net of accumulated depreciation 1,088,501
Goodwill and other intangibles, net 5,586,053
Deposits and other 5,270
- ---------------------------------------------------------------------------------------------------
Total Assets $ 11,225,606
===================================================================================================
Liabilities, Convertible Preferred Stock and Stockholder's Equity Deficit
Current liabilities
Accounts payable and accrued liabilities $ 4,000,586
Deferred revenue 2,184,685
Payables to officers 79,584
Accrued dividends 963,712
Current portion-notes payable 2,815,881
- ---------------------------------------------------------------------------------------------------
Total current liabilities 10,044,448
Convertible debt 355,000
Note payable, net of discount and current portion 3,103,777
- ---------------------------------------------------------------------------------------------------
Total liabilities 13,503,225
===================================================================================================
3
VERTICAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET (CONTINUED)
Series B 10% Convertible Preferred stock; $0.001 Par Value; 375,000 45,000
Shares authorized; 7,200 shares issued and outstanding
Series D 15% Convertible Preferred stock; $0.001 Par Value; 300,000 156,250
Shares authorized; 25,000 shares issued and outstanding
Minority interest 180,628
Stockholders' Deficit
Common Stock; $.00001 par value; 1,000,000,000 shares authorized 6,579
657,720,575 issued and outstanding
Series A 4% Convertible Cumulative Preferred stock; $0.001 par value; 50
250,000 shares authorized; 50,000 shares issued and outstanding
Series A Preferred Stock; par value $0.001; 750,000 shares authorized; 0
no shares issued and outstanding
Series C 4% Convertible Preferred stock; $100.00 par value; 200,000
shares authorized; 80,000 shares issued and outstanding
of which 30,000 are issued to a subsidiary of the Company 350,000
Series C Preferred stock; par value $0.001; 175,000 shares authorized; 0
no shares issued and outstanding
Notes Payable Officer 331,296
Additional paid-in-capital 25,126,016
Accumulated deficit (28,438,869)
Accumulated other comprehensive loss (34,569)
- ---------------------------------------------------------------------------------------------------
Total Stockholders' deficit (2,659,497)
- ---------------------------------------------------------------------------------------------------
Total liabilities and stockholders' deficit $ 11,225,606
===================================================================================================
See accompanying notes to the condensed consolidated financial statements
4
VERTICAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE 3 AND 6 MONTHS ENDED SEPTEMBER 30, 2002
For the Three Months ended For the Nine Months ended
September 30, September 30,
2002 2001 2002 2001
--------------- ---------------- ----------------- ---------------
Revenues
Licensing and maintenance $ 1,848,563 $ 255,257 $ 4,744,295 $ 1,182,798
Software development - - 42,200 -
Consulting services 418,269 63,878 983,742 849,455
Other 9,701 670,675 129,328 331,879
--------------- ---------------- ----------------- ---------------
Total Revenues 2,276,533 989,810 5,899,565 2,364,132
Selling, general and administrative expenses 2,368,910 5,140,974 7,936,826 11,186,558
--------------- ---------------- ----------------- ---------------
Operating income (loss) (92,377) (4,151,164) (2,037,261) (8,822,426)
Interest income 13,063 14,433 33,074 119,433
Interest expense (160,803) (153,786) (485,146) (347,272)
--------------- ---------------- ----------------- ---------------
Net loss before minority interest and income (240,117) (4,290,517) (2,489,333 (9,050,265)
taxes
Minority interest in (income) loss of
subsidiary (83,733) 185,294 (180,628) 400,005
--------------- ---------------- ----------------- ---------------
Net loss before income taxes (323,850) (4,105,223) (2,669,961) (8,650,260)
--------------- ---------------- ----------------- ---------------
Provision for income taxes (296,245) - (296,245) -
--------------- ---------------- ----------------- ---------------
Net loss (620,095) (4,105,223) (2,966,206) (8,650,260)
--------------- ---------------- ----------------- ---------------
Dividend applicable to preferred stock (150,000) (14,400) (450,006) (196,846)
Net loss applicable to common stockholders $ (770,095) $ (4,119,623) $ (3,416,212) $ (8,847,106)
=============== ============= ================= =============
Basic and diluted loss per share $ (0.00) $ (0.01) $ (0.01) $ (0.02)
=============== ============= ================= =============
Basic and diluted weighted average of common
shares
Outstanding 630,844,395 590,174,993 623,246,978 578,530,002
=============== ================ ================= ===============
Comprehensive income (loss) and its components
consist of the following:
Net loss $ (620,095) $ (4,105,223) $ (2,966,206) $ (8,650,260)
Loss on securities available for sale - (144,000) - (192,000)
Loss on foreign currency translation (25,379) - (34,569) -
--------------- ---------------- ----------------- ---------------
Comprehensive loss $ (645,474) $ (4,249,223) $ (3,000,775) $ (8,842,260)
=============== ================ ================= ===============
See accompanying notes to the condensed consolidated financial statements
5
VERTICAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002
Common Stock Series A Series C Note
--------------------------- --------------------- ------------------------ Payable
Shares Amount Shares Amount Shares Amount to Officers
--------------- ----------- -------- ------------ ----------- -------------------------
Balance, December 31, 2001 615,191,422 $ 6,153 50,000 $ 50 50,000 $ 350,000 $ 0
=============== =========== ======== ============ =========== =========== =============
Shares issued for financing fee
to Cornell Capital (Note 2) 12,500,000 125
Proceeds from sales of Officer's
common stock collateralizing a
note payable, to be repaid by
issuing replacement shares (Notes
2 and 3) 450,000
Issuance of replacement shares of
common stock to officers to
reimburse for note payable (Notes
2 and 3) 19,751,000 198 (118,704)
Proceeds from sales of common
Stock to Equitilink (Note 2) 3,000,000 30
Conversion of debentures 2,278,153 23
Issuance of common stock for
For investor relations 5,000,000 50
Preferred stock dividends
Issuance of warrants for
consulting services (Note 2)
Issuance of warrants for
iNet option agreement (Note 2)
Issuance of warrants for
with notes payable (Note 2)
Issuance of warrants for
employee retention (Note 2)
Write-off Subscriptions Receivable
Comprehensive Loss:
Net loss
Foreign Currency Translation
--------------- ----------- -------- ------------ ----------- -------------------------
Balance, September 30, 2002 657,720,575 $ 6,579 50,000 $ 50 50,000 $ 350,000 $ 331,296
=============== =========== ======== ============ =========== =========================
See accompanying notes to condensed financial statements
6
VERTICAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 (CONTINUED)
Additional
Subscription Paid-in Comprehensive Accumulated
Receivable Capital Income Deficit Total
---------------- ----------------- ------------------- ----------------- --------------
Balance, December 31, 2001 $ (2,000) $ 24,670,149 $ 0 $ (25,022,657) $ 1,695
================ ================= =================== ================= ==============
Shares issued for financing fee
to Cornell Capital (Note 2) 199,875 200,000
Proceeds from sales of Officer's
common stock collateralizing a
note payable, to be repaid by
issuing replacement shares (Notes
2 & 3) 450,000
Issuance of replacement shares of
common stock to officers to
reimburse for note payable (Notes
2 & 3) 118,506 -
Proceeds from sales of common
Stock to Equitilink (Note 2) 17,070 17,100
Conversion of debentures 10,631 10,654
Issuance of common stock for
for investor relations 23,450 23,500
Preferred stock dividends (450,006) (450,006)
Issuance of warrants for
consulting services (Note 2) 22,885 22,885
Issuance of warrants for
iNet option agreement (Note 2) 35,712 35,712
Issuance of warrants for
with notes payable (Note 2) 13,640 13,640
Issuance of warrants for
employee retention (Note 2) 16,098 16,098
Write-off Subscriptions Receivable 2,000 (2,000) 0
Comprehensive Loss:
Net loss (2,966,206) (2,966,206)
Foreign Currency Translation (34,569) (34,569)
---------------- ----------------- ------------------- ----------------- --------------
Balance, September 30, 2002 $ 0 $ 25,126,016 $ (34,569) $ (28,438,869) $ (2,659,497)
================ ================= =================== ================= ==============
See accompanying notes to condensed financial statements
7
VERTICAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002
For the nine months ended September 30,
2002 2001
------------------- --------------------
Cash flows from operating activities
Net loss $ (2,966,206) $ (8,650,260)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Minority interest in net income (loss) of Subsidiary 180,628 (214,294)
Depreciation and amortization 992,911 126,302
Amortization of note discount 51,976 22,578
Officer notes payable replacement shares 118,704 -
Conversion of debentures 10,654 -
Non-employee compensation expense - 511,660
Employee compensation expense 16,098 -
Professional services 46,385 -
Fees associated with Notes Payable 374,318 -
Fees associated with sale of common stock 2,100 -
Issuance of warrants for iNet option 35,712 -
Allowance for bad debts 98,352 -
Write off fixed assets 42,022 -
Write off of investments 870,359 -
Write down marketable securities (34,323) -
Unrealized Gain/(loss) on Change in
Foreign Currency Translation (34,569) -
Changes in operating assets and liabilities:
Accounts receivable (937,352) (1,577,354)
Other receivable 408,656
Receivable related party (103,179) 11,630
Prepaids (76,394) (15,536)
Deposits 15,237 6,445
Accounts payable and accrued liabilities 2,154,279 605,035
Deferred Revenue (58,691) 1,817,442
Dividends payable - -
------------------- --------------------
Net cash provided by (used in) operating activities: 1,207,677 (7,356,352)
Cash flow from investing activities:
Capitalization and Acquisitions - (5,907,840)
Fair value of warrants given in acquisition - 798,500
Purchase of equipment (134,452) (328,486)
Purchase of investments - (292,750)
------------------- --------------------
Net cash used in investing activities (134,452) (5,730,576)
8
VERTICAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 (CONTINUED)
Cash flow from financing activities:
Pledge of Cash deposit for bank Loan - (1,561,870)
Process from issuance of convertible debentures 100,000 -
Payment of convertible debentures (10,000) -
Payment of Note Payable (1,610,031) (274,562)
Proceeds from issuance of Notes Payable - 5,500,000
Issuance of Notes Payable, net of discount 434,670 870,146
Proceeds from sale of common stock 15,000 -
------------------- --------------------
Net cash provided by (used in) financing activities (1,070,362) 4,533,714
Net increase (decrease) in cash and cash equivalents, 2,863 (8,553,214)
Cash and cash equivalents, beginning of quarter 845,459 5,598,812
------------------- --------------------
Cash and cash equivalents, end of quarter $ 848,322 $ (2,954,402)
=================== ====================
Supplemental disclosures of cash flow information:
Cash paid during the year period:
Interest $ 271,113 $ 282,902
Income taxes $ - $ -
=================== ====================
See accompanying notes to condensed financial statements
9
VERTICAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-QSB and 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 consolidated condensed
financial statements reflect all adjustments that, in the opinion of the
management of Vertical Computer Systems, Inc. ("Vertical") and 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, 2001.
GOING CONCERN UNCERTAINTY
The accompanying condensed consolidated financial statements 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. Additionally, at September 30, 2002, the Company has
negative working capital of $5,498,667. These factors raise substantial doubt
about the Company's ability to continue as a going concern. The report of the
Company's Independent Certified Public Accountants for the year ended December
31, 2001 financial statements included an explanatory paragraph expressing
substantial doubt about the Company's ability to continue as a going concern.
In October 2002, the Company entered into an agreement with the lender of NOW
Solutions, a 60% owned subsidiary of Vertical whereby $383,333 has been released
from the deposit account, and $91,667 will be released per month commencing
October 31, 2002, provided that NOW Solutions makes the preceding monthly
payment on the principal and NOW Solutions is not in default of or has cured
certain covenants under the Loan Agreement. The Company believes, that in
conjunction with the removal of NOW's technical default and the expectation of
continued profitability from NOW Solutions (NOW has a net profit of $ 566,866
for the nine months ended September 30, 2002), that it can launch a number of
products, services and other revenue generating programs. The Company is
focusing its efforts on launching a number of products in the United States
based upon its proprietary technology. Furthermore, the Company is exploring
certain opportunities with a number of companies to participate in the marketing
of its products. The exact results of these opportunities are unknown at this
time.
Additionally, the Company has a $10,000,000 equity line commitment, which is
subject to the Company's ability to register the shares to be issued under the
equity line with the Securities and Exchange Commission. The Company's ability
to register with the Securities and Exchange Commission will not occur until the
Company determines that it is in compliance with all other previous SEC filings.
The Company is continuing its efforts to secure working capital for operations,
expansion and possible acquisitions, mergers, joint ventures, and/or other
business combinations. However, there can be no assurance that the Company will
be able to secure additional capital, or that if such capital is available,
whether the terms or conditions would be acceptable to the Company. The
condensed consolidated financial statements contain no adjustment for the
outcome of this uncertainty.
10
NOTE 2 - COMMON AND PREFERRED STOCK TRANSACTIONS
In January 2002, the Company and Strategic Marketing Alliance agreed to
terminate the Company's interest in WorldBridge in consideration for credit on
the Company's account with Strategic Marketing whereby Strategic Marketing will
continue to provide consulting services through 2002. In addition, Strategic
Marketing will receive 3-year warrants to purchase stock equal to $5,000 per
month, based on a strike price formula of $0.01 plus the previous average five
day market price on the date of issuance. These warrants will be issued in lieu
of the warrants specified in the original consulting agreement, dated as of
November 2000, with Strategic Marketing beginning in February 2002. For the nine
months ended September 30, 2002, the Company issued warrants to purchase 420,455
shares of common stock. The fair market value for these shares, as of the date
of issuance, was $1,103. During the nine months ended September 30, 2002, the
Company accrued $13,897 relating to the consulting agreement.
In January 2002, the Company and Taurus Global LLC agreed to extend a consulting
services agreement for nine months. In consideration of Taurus Global's
services, the Company agreed to pay a monthly fee of $12,500 and issued an
additional 100,000 warrants on the same terms as the July 2001 consulting
services agreement. The warrants have vested and are exercisable for five years
from issuance at a strike price equal to the fair market value of the Company's
common stock on the day of grant. The warrants were valued at $1,240 and were
expensed when issued. The Company has the option to pay the monthly fee in
common stock valued at 95% of the average closing price 3 trading days prior to
issuance. During the nine months ended September 30, 2002 the Company accrued
$74,400 relating to the monthly fee. In the event the proceeds of the stock
result in greater than a 20% profit or loss for the monthly fee, Taurus or the
Company, as the case may be, shall pay the difference in profit or loss, as
applicable, at the end of the term. The Company may buyback any unsold shares of
stock at any time.
In January 2002, the Company executed indemnity and reimbursement agreements
with Mountain Reservoir Corporation to cover the 10,450,000 shares of stock
pledged by Mountain Reservoir Corporation with regard to notes issued by the
Company in October and November 2001 in the amount of $100,000 for each note,
whereby the Company would reimburse Mountain Reservoir Corporation with a number
of shares equal to any shares sold as collateral to cover the default of the
loans. Mountain Reservoir Corp. is a corporation controlled by the W5 Family
Trust, of which Mr. Wade is a trustee. Mr. Wade is President of the Company.
During October 2002, the notes and the related indemnity and reimbursement
agreement were cancelled and a new $181,584 note was issued by the Company for
the amount due under the cancelled notes, which was secured by a new pledge
agreement between the lender and Mountain Reservoir Corporation whereby Mountain
Reservoir Corporation pledged 10,450,000 shares of common stock.
In January 2002, the Company executed separate indemnity and reimbursement
agreements with Mountain Reservoir Corporation and Mr. Valdetaro to cover their
respective 36,303,932 and 15,000,000 shares of common stock pledged by Mountain
Reservoir Corporation and Valdetaro in connection with the $425,000 note issued
in December 2001, whereby the Company would reimburse Mountain Reservoir
Corporation and Valdetaro with the respective number of shares equal to any
shares sold as collateral to cover the default of any loan. Mountain Reservoir
Corp. is a corporation controlled by the W5 Family Trust, of which Mr. Wade is a
trustee. Mr. Wade is President of the Company. Mr. Valdetaro is the Chief
Technology Officer of the Company. The Company has been informed by the lender
that 19,751,000 shares of the collateral were sold for $254,382, the remaining
31,552,932 shares were transferred to two third parties. The lender has also
informed the Company that these two third parties have sold all of the stock,
the debt was satisfied as of April 1, 2002, and the note has been cancelled. In
November 2002, Mountain Reservoir Corporation and Valdetaro assigned any
remaining right, title, and interest in the 36,303,932 and 15,000,000 shares of
common stock to the Company. The Company has calculated and fully reserved
excess proceeds from the sale of the collateralized common stock of $170,000,
pending receipt of a full accounting from the lender.
In March 2002, Vertical Computer issued 12,500,000 shares of common stock for
the remaining fee in connection with the Equity Line of Credit. The fair market
value of these shares at the date of issuance was $200,000. To date, no shares
have been purchased under the Equity Line of Credit.
In March 2002, the Company executed an agreement to issue a $100,000 convertible
debenture. In April 2002, the funds were received and the issuance of debenture
became effective. The debenture accrues interest at 5% per annum and is due
March 2004. The debenture is convertible into shares of common stock at either
120% of the closing bid price on the date of agreement or 80% of the lowest
closing bid price 5 days prior to the conversion. The debenture is convertible
at the option of the holder, any time after purchase. The holder of the
debentures is a third-party individual. As of September 30, 2002, no conversions
have taken place.
11
For the three months ended March 31, 2002, the Company issued 1,167,857 warrants
to purchase shares of its common stock to one marketing consultant for services.
The fair market value of these warrants at the date of issuance was $3,132.
For the three months ended June 30, 2002, the Company issued warrants to two
consultants to purchase a total of 1,500,000 shares of common stock at a strike
price of $0.005. The fair value of these warrants at the date of issuance of
each grant of warrants was $3,565.
In April 2002, a $180,000 note that bears interest at 12% per annum, which
Vertical issued in August 2001 and which was due February 2002, was amended such
that the amount on the note was increased to $211,136 and the maturity date was
extended so that the note was payable in August 2002. To secure the loan, the
Company pledged third party securities of eResource Capital Group that it holds.
In August 2002, the $211,136 note along with $25,368 in accrued interest and
fees (as amended) was cancelled and a $236,504 note was issued that bears
interest at 13% per annum, has three payments of $7,500 due on October 1,
November 1, and November 15, 2002 and monthly payments of $7,500, beginning on
December 1, 2002 and continuing thereafter until all principal and interest then
outstanding under the note has been paid. In November and December 2002, the
parties subsequently amended the $236,504 note. Pursuant to these amendments,
the Company has made a $65,000 payment in December 2002 and will make monthly
installment payments in the amount of $7,500 each month beginning in March 2003.
In April 2002, the Company entered into an amendment agreement concerning a
$100,000 promissory note that Vertical issued in October 2001, which bears
interest at 12% per annum and was due in February 2002. Pursuant to the
amendment, Vertical and the third party waived any default, and Vertical sold
400,000 shares of eResource Capital Group stock, which Vertical had pledged
pursuant to the Stock Pledge Agreement as collateral. The Company further agreed
to use the proceeds of the eResource Capital Group sales of stock to reduce the
obligations under the note accordingly. Pursuant to this amendment, the Company
made payments of $31,500 and $8,500, and agreed to make ten (10) installment
payments of $6,000 beginning on April 15, 2002, and continuing until all
principal then outstanding with interest, amounts owed and then unpaid by June
2002. In October 2002, this note was cancelled and the amounts payable under
this note and the $100,000 note issued in November 2001 were incorporated into a
new $181,584 note that the Company issued in October 2002 (see Note 9).
In April 2002, the Company entered into an amendment agreement concerning a
$100,000 promissory note that Vertical issued in November 2001 that bears
interest at 12% and was due in February 2002. Pursuant to the amendment,
Vertical and the third party agreed waive any default and Vertical agreed to
make monthly installment payments in the amount of $7,500 each on the fifteenth
day of each month, beginning in May 2002. Pursuant to this amendment, all
principal then outstanding, and all interest, was due by the end of September
2002. In October 2002, this note was cancelled and the amounts payable under
this note and the $100,000 note issued in October 2001 were incorporated into a
new $181,584 note that the Company issued in October 2002 (see Note 9).
In April 2002, the Company entered into an amendment agreement concerning the
$280,000 note issued in connection with the purchase of various intangible
assets by Vertical that bears interest at 4% per annum. Pursuant to the terms of
the amendment, Vertical and the third party agreed to extend the date for which
the remaining three $5,000 installment payments would be due to the first day of
each month, beginning in May 2002 and the time to pay all remaining $10,000
installments was extended so that each $10,000 installment would be due and
payable on the first day of each month beginning on August 1, 2002, until the
principal and interest has been paid in full. All unpaid amounts are due
September 2004. In June 2002, this note was further amended, to extend the date
for which the remaining three $5,000 installment payments would be due to the
first day of each month, beginning in July 2002, and all remaining $10,000
installments were extended so that each $10,000 installment would be due and
payable on the first day of each month beginning on October 1, 2002. In
connection with the amendment, the Company agreed to register the common shares
underlying the 50,000 shares of Series C Preferred Stock that were issued to a
third party in connection with the purchase of the SiteFlash technology.
Pursuant to an option agreement with iNet Purchasing, Inc. ("iNet"), which was
entered into in December 2001, the Company had an option to purchase additional
interest in iNet by April 2002, whereby the Company could obtain an aggregate
56% ownership interest in iNet. In accordance with the option agreement, the
Company was required to pay $140,000 in four equal monthly installments
beginning in December 2001 and grant stock options to three iNet employees,
Basil Nikas, Robin Mattern, and Wayne Savage, in the amount of 1,500,000,
1,500,000, and 500,000 shares, respectively. The Company has paid a total of
$131,282 and intends to offset the remaining balance against amounts owed by
iNet pending a final accounting. The options are vested, have a strike price of
$0.010, and must be exercised within 3 years from the date of issuance. Pursuant
to the terms of the Stock Purchase Agreement and the Stockholders Agreements, if
the Company exercised the option to obtain a majority interest in iNet by April
2002, the Company was required to pay to iNet $860,000 in cash or marketable
securities (pending any potential offsets), issue 70,000 shares of Series "C"
Preferred Stock, and issue additional 3-year warrants and options, as the case
12
may be, to purchase an additional 6,000,000 common stock shares each to Nikas
and Mattern and 2,000,000 common stock shares to Savage, at a strike price of
$0.025. The Company would need to raise additional capital in order to pay the
cash portion of the exercise price. The fair market value of these warrants at
the date of grant was $35,713. Of these warrants and options, the Company issued
1,500,000 warrants to Nikas and Mattern and 500,000 warrants to Savage in
January 2002. In the event that the Company does not acquire a majority interest
in iNet Purchasing, Inc., these options and warrants will be automatically be
cancelled. Under the terms of the option, iNet was required to deliver certain
financial and non-financial information. This information was never delivered
and the Company is holding the warrants issued in January until a resolution is
reached. The Company is seeking an extension of the exercise date to allow iNet
to deliver the required information and to allow the Company an opportunity to
review the information and to make an informed investment decision, as well as
to allow both parties to resolve the issues of monies owed by iNet to the
Company and vice versa. Discussions thus far with iNet have not resulted in a
resolution of this matter.
In June 2002, the Company issued a $50,000 note, which is due January 2003 and
bears no interest. In connection with the note, the Company issued three year
warrants to purchase 1,200,000 shares of its common stock at a price of $0.003
per share. The warrants vested immediately and are exercisable for three years
from issuance. The fair value of the warrants was $2,291 (valued using the
Black-Scholes valuation model). The Company also pledged a limited interest in a
deposit account in the event the Company defaults on the loan.
In June 2002, the Company issued a $50,000 note bearing interest of 12%, which
is due January 2003. In connection with the note, the Company issued three year
warrants to purchase 1,500,000 shares of its common stock at a price of $0.004
per share. The warrants vested immediately and are exercisable for three years
from issuance. The fair market value of the warrants was $3,818 (valued using
the Black-Scholes valuation model). The Company also pledged a limited interest
in a deposit account in the event the Company defaults on the loan.
In June 2002, the Company issued 3 year warrants to purchase 3,000,000 shares of
its common stock to two employees at an average share price of $0.012. The fair
market value of these warrants on the date of issuance of each grant is $3,565.
In July 1, 2002, the Company entered into a two-year employment agreement with
Aubrey McAuley, whereby McAuley would provide services in the capacity of
Executive VP, Product Development and Sales Support. McAuley will be paid an
annual salary of $120,000 and a bonus as determined in accordance with the
agreement. In addition, the agreement contains certain performing incentives
whereby McAuley can earn 7,500 shares of Series "C" preferred stock of the pool
of 30,000 shares of Series "C" preferred stock, which were reserved in
connection with the purchase of Company's subsidiary, Enfacet, Inc.. These
shares of Series "C" preferred stock may be converted into 3,000,000 shares of
Company's common stock. The Company is required to register the underlying
shares of common stock. In the event the employment agreement is terminated,
then McAuley may convert his employment agreement into a subcontractor
agreement. As of September 30, 2002, management's opinion is that the shares of
7,500 Series "C" preferred stock have not been earned and accordingly the shares
have not been issued.
In July 2002, the Company retained the services of Equitilink, Inc. to provide
investor relations services. As compensation, the Company issued 5,000,000
shares of Company's common stock with the Rule 144 restrictive legend with a
fair market value of $23,500.
In August 2002, the Company issued a $25,000 note to a third party, which was
due in August 2002 and bears interest at a rate of 12%. The note is secured by
10,000,000 shares of common stock of Vertical Computer that is owned by Mountain
Reservoir Corporation, to cover any shortfall in the event of default. Mountain
Reservoir Corp. is a corporation controlled by the W5 Family Trust. Mr. Wade,
the President and CEO of Vertical Computer Systems, is the trustee of the W5
Family Trust. The Company made a $12,500 payment on the note and the parties
have agreed to extend the maturity date for the remaining balance to December
2002.
In August 2002, the Company retained a consultant to provide investment services
on behalf of the Company. Upon execution of the agreement, the Company issued
warrants to purchase 500,000 shares of common stock at a share price of $0.015,
which expire in August 2005, and vest immediately. The fair market value of the
warrant issued was $5,467 (valued using the Black-Scholes method). The
consultant is also entitled to 2.5% of any cash funds raised and in the event
the consultant raises $1,500,000, the Company will issue warrants to purchase
2.0 million shares of common stock, based on 90% of the average closing price
for the five previous trading days prior to the closing date of the transaction.
13
In August 2002, the Company agreed with a third party lender to loan the Company
$60,000. The lender has currently loaned the Company $31,859. The Company had
agreed to issue warrants to purchase 6 million shares of the Company's common
stock at a strike price of $0.005 per share in connection with funding the total
amount of the loan. The lender has not fully funded the loan and the parties are
negotiating the terms to the loan. In connection with the loan, the Company also
agreed to compensate a third party with a finder's fee with warrants to purchase
Company common stock based on the amount of money actually loaned to the
Company.
In August 2002, the Company issued an $8,000 note, which is due February 2003
and bears interest at a rate of 10% in consideration of a loan from Luiz
Valdetaro, the Chief Technology Officer of the Company. In connection with the
note, the Company issued three year warrants to purchase 1,000,000 shares of its
common stock at a price of $0.005 per share. The warrants vested immediately and
were issued at a fair market value of $9,316 (valued using the Black-Scholes
valuation model). The Company also pledged a limited interest in a deposit
account in the event the Company defaults on the loan.
In September 2002, the Company amended an agreement to retain the services of
Stephen Rossetti to provide services in the capacity of Executive V.P.,
Governmental Affairs, in consideration for 3 year warrants to purchase 1,000,000
shares of its common stock at a share price of $0.012, $30,000 for services
rendered through August 31, 2002, and $5,000 per month for a period of one year.
The warrants were issued at a fair market value of $6,191 (valued using the
Black-Scholes valuation model).
In September 2002, the Company issued 3 year warrants to purchase 1,750,000
shares of the Company's common stock at a strike price of $0.006 per shares to
two consultants in connection with accounting services provided to the Company.
The fair market value of the warrants issued was $13,845 (valued using the
Black-Scholes valuation model).
In September 2002, the Company issued 5,774,704 shares of common stock to Luiz
Valdetaro, the Chief Technology Officer of the Company, and 13,976,296 shares of
common stock to Mountain Reservoir Corporation. These shares were issued in
connection with indemnity and reimbursement agreements between the Company and
Mountain Reservoir Corporation and Mr. Valdetaro, respectively, to replace their
respective 36,303,932 and 15,000,000 shares of common stock pledged by Mountain
Reservoir Corporation and Valdetaro in connection with the $425,000 note issued
in December 2001 and accrued interest. The combined 19,751,000 common shares of
the Company Stock had a fair market value of $118,000 on September 23, 2002, the
date of issuance.
In September 2002, the Company issued a promissory note in the amount of $13,000
to a third party lender bearing interest at 8% due in October 2002, and warrants
to purchase 250,000 shares of Company common stock at a strike price of $0.008
per share in consideration for a loan in the amount of $12,500 with a commitment
fee of $500. In connection with the loan, the Company also issued warrants to
purchase 250,000 shares of Company common stock at a strike price of $0.008 per
share to a third party as a finder's fee. The warrants were issued at a fair
market value of $7,531 (valued using the Black-Scholes valuation model).
In September 2002, Equitilink, whom the Company retained to provide the
company's investor relations services, purchased 3,000,000 shares of the
Company's common stock for a total of $17,100 at the fair market value price of
$0.005 per share. The shares are subject to the Rule 144 Restriction.
In September 2002, a debenture of $10,000 principal and $631 interest was
converted into 2,278,153 shares of the Company's common stock. This conversion
was in connection with $265,000 in debentures issued by the Company to third
party holders in September and October 2001.
NOTE 3 - NOTES PAYABLE
In February 2002, the Company became delinquent on a $425,000 note payable to a
third party lender, which the Company had executed in December 2001. The note
accrues interest at 12% per annum and was due January 31, 2002. The note was
secured by 36,303,932 shares of common stock of the Company that is owned by
Mountain Reservoir Corporation, and 15,000,000 shares of common stock of the
Company that is owned by Mr. Valdetaro, the Company's Chief Technology Officer,
to cover any shortfall in the event of default. Mountain Reservoir Corp. 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 January 2001, the
Company executed separate indemnity and reimbursement agreements with Mountain
Reservoir Corporation and Mr. Valdetaro to cover their pledges of 36,303,932 and
15,000,000 shares of common stock, respectively. Pursuant to these agreements,
the Company agreed to reimburse Mountain Reservoir and Mr. Valdetaro in the
Company's common stock for any shares sold as collateral to cover the default of
any loan. The collateral of stock was transferred to the lender's account and is
in the process of being sold to cover the amounts currently due. The Company has
been informed by the lender that during February and March 2002, 19,751,000
14
shares of the collateral were sold for $254,382. On April 1, 2002, 31,552,932
shares were transferred to two third parties. The lender has also informed the
Company that these two third parties have sold all of the stock, the debt was
satisfied as of April 1, 2002, and the note was cancelled as paid in full. Per
the terms of the loan agreement any excess proceeds from sales of the common
stock were to be returned to the Company. Management has calculated that amount
to be approximately $170,000, based on the fair market value of the common stock
on April 1, 2002. The Company has been unable to obtain a refund or a full
accounting under the terms of the agreement and, as such, has fully reserved the
calculated receivable.
In November 2002, Mountain Reservoir Corporation and Valdetaro assigned any
remaining right, title, and interest in the 36,303,932 and 15,000,000 shares of
common stock to the Company. In September 2002, the Company issued 5,774,704
shares of common stock to Luiz Valdetaro, the Chief Technology Officer of the
Company, and 13,976,296 shares of common stock to Mountain Reservoir Corporation
(see Note 2). In October 2002, the Company issued 9,225,296 shares of common
stock to Luiz Valdetaro, the Chief Technology Officer of the Company, and
22,327,630 shares of common stock to Mountain Reservoir Corporation (See Note
9).
NOTE 4 - LEGAL PROCEEDINGS
We are, from time to time, involved in various lawsuits generally incidental to
our business operations, consisting primarily of collection actions and vendor
disputes. In the opinion of management, the ultimate resolution of these
matters, if any, will not have a significant effect on the financial position,
operations or cash flows of the Company. The Company's litigation is summarized
below.
In April 2002, the Company received a letter from Arglen Acquisitions LLC, a
member of NOW Solutions LLC, accusing the Company of defaulting on its
obligations under NOW Solutions' Operating Agreement by failing to obtain a
waiver of default from NOW Solutions' lender, Coast Business Credit. The letter
further stated that the default had triggered the dissolution of NOW Solutions,
and authorized Arglen Acquisitions to acquire the Company's ownership interest
in NOW Solutions at a discounted price. On May 8, 2002, the Company demanded
arbitration from Arglen Acquisitions seeking to enforce its rights under the
Operating Agreement. On May 9, 2002, Arglen Acquisitions filed a Demand for
Arbitration and Statement of Claim against the Company. In its demand, Arglen
Acquisitions alleged that the Company is in default of its obligations under the
Operating Agreement. Arglen is seeking to enjoin the Company from appointing a
fifth member of the executive committee of NOW Solutions and other actions, as
well as seeking specific performance of the default provisions of the Operating
Agreement, including the right to purchase the Company's interest in NOW
Solutions. The Company is defending its rights and is asserting its own claims
against Arglen Acquisitions. Arglen filed a motion for a preliminary injunction
in July 2002 to prohibit the Company from taking certain actions concerning NOW
Solutions including an attempt to enjoin the Company from taking control of the
executive committee of NOW Solutions. In August, the Company prevailed on four
of the five motions and remains in control of the executive committee. The only
restriction until the outcome of arbitration is the Company is not allowed to
increase its management fee or any other monies other than for reimbursement for
direct expenses incurred by the Company on behalf of NOW Solutions. The Company
believes that Arglen's allegations are without merit.
The Company's subsidiary, NOW Solutions, LLC ("NOW") recently learned of an
alleged employment agreement between NOW and Garry Gyselen ("Gyselen") whereby
Gyselen would be engaged for a term of 3 years at a salary of $150,000 per
annum. The agreement was executed by Gyselen, acting in the capacity of Chairman
on behalf of NOW and Gyselen, signing on his own personal behalf as the
executive. The agreement is undated. NOW's corporate legal counsel has informed
NOW Solutions' management and its executive committee that the employment
agreement is invalid in their legal opinion. Gyselen, in his own declaration of
the preliminary injunction, declares that the employment agreement is "entirely
inoperative." Gyselen has not provided NOW with any written acknowledgment
confirming that the agreement is null and void.
NOTE 5--NEW ACCOUNTING PRONOUNCEMENTS
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities, which addresses accounting for restructuring and
similar costs. SFAS No. 146 supersedes previous accounting guidance, principally
Emerging Issues Task Force (EITF) Issue No. 94-3. The Company will adopt the
provisions of SFAS No. 146 for restructuring activities initiated after December
31, 2002. SFAS No. 146 requires that the liability for costs associated with an
exit or disposal activity be recognized when the liability is incurred. Under
EITF No. 94-3, a liability for an exit cost was recognized at the date of a
companys commitment to an exit plan. SFAS No. 146 also establishes that the
liability should initially be measured and recorded at fair value. Accordingly,
SFAS No. 146 may affect the timing of recognizing future restructuring costs as
well as the amount recognized.
15
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.
This statement eliminates the current requirement that gains and losses on debt
extinguishment must be classified as extraordinary items in the income
statement. Instead, such gains and losses will be classified as extraordinary
items only if they are deemed to be unusual and infrequent, in accordance with
the current GAAP criteria for extraordinary classification. In addition, SFAS
145 eliminates an inconsistency in lease accounting by requiring that
modifications of capital leases that result in reclassification as operating
leases be accounted for consistent with sale-leaseback accounting rules. The
statement also contains other nonsubstantive corrections to authoritative
accounting literature. The changes related to debt extinguishment will be
effective for fiscal years beginning after May 15, 2002, and the changes related
to lease accounting will be effective for transactions occurring after May 15,
2002. Adoption of this standard will not have any immediate effect on the
Company consolidated financial statements.
In August 2001, FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations. SFAS No. 143 requires the fair value of a liability for an asset
retirement obligation to be recognized in the period in which it is incurred if
a reasonable estimate of fair value can be made. The associated asset retirement
costs are capitalized as part of the carrying amount of the long-lived asset.
SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The
Company believes the adoption of this Statement will have no material impact on
its financial statements.
NOTE 6 - ADOPTION OF SFAS NO. 142, "GOODWILL AND OTHER INTANGIBLE ASSETS"
The Company adopted Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets" ("SFAS 142") on February 1, 2002. In
accordance with the requirements of SFAS 142, during the three months ended
September 30, 2002, the Company:
o Evaluated the balance of goodwill and other intangible assets recorded on
the condensed consolidated balance sheet as of February 1, 2002. No
reclassifications were required to be made in order to conform to the new
criteria for recognition.
o Determined that there were no intangible assets (other than goodwill) with
indefinite useful lives.
o Determined that the Company's goodwill is related to one reporting unit,
NOW Solutions, LLC, to be used to test for goodwill impairment in
accordance with SFAS 142. The Company has not completed a transitional
goodwill impairment test.
o As required under SFAS No. 142, with effect from January 1, 2002, the
Company eliminated the amortization of goodwill. The following table
represents a reconciliation of net loss and per share data that would have
been reported had the new rules been in effect during the three and nine
months ended September 30, 2001 (in thousands, except per share data):
THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001
------------- -------------
Reported net loss $(459) $ (4,105)
Add back goodwill amortization, net of tax -- 165
------------- -------------
Adjusted net loss $(459) $ (3,940)
Reported basic and diluted net loss per $ (0.00) $ (0.01)
common share
Goodwill amortization, net of tax -- 0.00
------------- -------------
Adjusted net loss $ (0.00) $ (0.00)
16
NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001
------------- -------------
Reported net loss $(2,806) $ (8,650)
Add back goodwill amortization, net of tax -- 494
------------- -------------
Adjusted net loss $(2,806) $(8,156)
------------- -------------
Reported basic and diluted net loss per $ (0.01) $ (0.02)
common share
Goodwill amortization, net of tax -- 0.00
------------- -------------
Adjusted net loss $ (0.00) $ (0.00)
------------- -------------
NOTE 7 - NON-CASH FINANCING ACTIVITIES
In February 2001, the Company acquired a 60% interest in NOW Solutions, LLC
("NOW"), a company that develops and maintains human resource software, in
exchange for $1,000,000. Pursuant to the terms of the operating agreement, the
Company's interest will be reduced to 51% over three years as employees of NOW
Solutions will be entitled to receive shares of NOW Solutions' common stock.
Also, in February 2001, NOW purchased the human resource software assets of Ross
Systems, Inc. ("Ross") in exchange for $5,100,000 and a promissory note due to
Ross for $1,000,000. The Ross note does not bear interest and has payment
requirements of $250,000 and $750,000 due February 2002 and 2003, respectively.
NOW Solutions had a receivable from Ross that was offset against the $250,000
payment for February 2002, and has an additional $11,000 to offset against the
future payment. In addition, the agreement calls for various earnout provisions
to be paid to Ross if certain sales levels are achieved by NOW during the two
years subsequent to the purchase.
NOW acquired a $5,500,000 note payable to finance the Ross acquisition. The note
bears interest at prime plus one and a half (Prime was 6% at September 30, 2001)
and has an interest rate floor of 8.5%. The Note payable is due the earlier of
February 2006 or if terminated, by either party, in accordance with the terms of
the agreement. The note calls for monthly principal payments of $91,500 plus
interest. The Company entered into a declining pledge agreement whereby the
Company guaranteed $1,500,000 of the note.
Arglen Acquisition, LLC ("Arglen") facilitated the NOW transactions and acquired
a 30% interest in NOW for services provided and received warrants of the Company
to purchase 5% of the total outstanding stock of the Company, for an exercise
price of $0.08. The warrants are anti-dilutive, with a third of the warrants
vesting upon grant and the remaining warrants vesting equally in one and two
years from the grant date. All warrants are exercisable five years from the
vesting date.
The NOW purchase was accounted for under the purchase method of accounting, with
the cash paid to Ross, note payable due to Ross, $667,000 for Arglen's 30%
interest in NOW and $798,000 for the value of the warrants issued to Arglen
(valued using the Black-Scholes valuation model), all included as part of the
purchase price. The Company and NOW recognized approximately $7,066,000 of
goodwill and other intangible assets in connection with the purchase.
NOW is consolidated with the Company for financial reporting purposes, with
minority interest being recognized for the 40% interest. Of the remaining
minority interest, 5% is held by a consultant who facilitated the NOW
transactions and 5% is reserved for the employees.
In March 2002, the Company issued 12,500,000 shares of common stock for the
remaining fee in connection with the Equity Line of Credit. The fair market
value of these shares at the date of issuance was $200,000. To date, no shares
have been purchased under the Equity Line of Credit.
In July 2002, the Company issued 5,000,000 shares of its common stock to
Equitilink at a fair market value of $23,450 for investor services.
17
In September 2002, the Company recorded the cancellation of the remaining
$195,618 principal balance due on the defaulted $425,000 note payable, as a note
payable to shareholders. In September 2002, the Company issued 5,774,704 shares
of common stock to Luiz Valdetaro, the Chief Technology Officer of the Company,
and 13,976,296 shares of common stock to Mountain Reservoir Corporation (see
Note 2). In October 2002, the Company issued 9,225,296 shares of common stock to
Luiz Valdetaro, the Chief Technology Officer of the Company, and 22,327,630
shares of common stock to Mountain Reservoir Corporation (See Note 9). Mountain
Reservoir Corp. is a corporation controlled by the W5 Family Trust, of which Mr.
Wade is a trustee. Mr. Wade is President of the Company. Mr. Valdetaro is the
Chief Technology Officer of the Company.
NOTE 8 - INCOME TAXES
The Company has accrued income taxes in relation to its subsidiary, Now
Solutions.
NOTE 9 - SUBSEQUENT EVENTS
In October 2002, the Company's 60% majority-owned subsidiary, NOW Solutions,
L.L.C. ("NOW Solutions") and its lender agreed to amend the Loan and Security
Agreement, dated February 28, 2001 (the "Loan Agreement"). Also in October 2002,
the Company and the Lender agreed to amend the Deposit Account Pledge Agreement,
dated February 28, 2001 (the "Pledge Agreement"). In these amendments, the
lender agreed to waive certain defaults by NOW Solutions under the Loan
Agreement and Pledge Agreement, including non-compliance with financial
covenants and non-delivery of financial statements, and to modify the financial
covenants. In exchange, the Company agreed to amend the provisions of the Pledge
Agreement related to its ability to withdraw amounts pledged to the lender as
collateral. Under the amended terms of the Pledge Agreement, Vertical was
entitled to withdraw $383,333 from the deposit account, plus $91,667 per month
commencing October 31, 2002, provided that: (a) NOW Solutions has made the
preceding monthly payment on the principal and (b) NOW Solutions is not in
default of or has not cured certain covenants under the Loan Agreement.
In October 2002, the Company entered into an agreement to cancel two $100,000
notes payable and the underlying collateral agreements with a third party,
executed in October and November 2001, and issue a $181,583.70 promissory note
at 12% interest per annum payable as follows: (i) an initial installment of
$10,000 payable upon execution; (ii) six (6) monthly payments of $5,000 per
month beginning November 5, 2002 and (iii) $10,000 payments per month beginning
May 15, 2003 until all amounts under the note have been paid in full. The note
is secured by a pledge against the loan by the Mountain Reservoir Corp., to sell
up to 10,450,000 shares of common stock owned by Mountain Reservoir Corp. to
cover any shortfall as well as certain assets of the Company. Mountain Reservoir
Corporation 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.
Additionally, and in connection with the cancellation of the notes and the
issuance of the revised loan, Vertical has agreed to give Paradigm Sales certain
rights in connection with the common stock represented by 12,500 shares of the
50,000 shares of Vertical's Class C Preferred Stock, held by Paradigm Sales,
pursuant to that certain Asset Purchase Agreement, dated November 14, 2001 by
and between Vertical and Paradigm for the purchase of the Adhesive Software
assets, Vertical has agreed to give Paradigm the right to sell and Vertical
agreed to redeem the underlying common stock represented by 12,500 shares of
Vertical's Class C Preferred Stock at a price of $0.04 per share, which shall be
exercisable on 10 days notices on March 17, 2003. In the event Vertical does not
purchase the stock within 10 days notice of the put Vertical shall issue an
additional 2,500 shares of its Class C Preferred Stock. Vertical shall have the
option of redeeming, at anytime prior to March 17, 2003, Paradigm's holdings of
Vertical Common Stock represented by the Vertical Preferred Stock at a price of
$0.06 per share ("Call").
In October 2002, the Company issued 9,225,296 shares of common stock to Luiz
Valdetaro, the Chief Technology Officer of the Company, and 22,327,630 shares of
common stock to Mountain Reservoir Corporation. These shares were issued in
connection with indemnity and reimbursement agreements between the Company and
Mountain Reservoir Corporation and Mr. Valdetaro, respectively in connection
with the $425,000 note issued in December 2001, whereby the Company would
reimburse Mountain Reservoir Corporation and Valdetaro with the respective
number of shares of the Company stock equal to any shares sold as collateral to
cover the default of any loan. With the issuance of these shares, Mountain
Reservoir Corporation and Mr. Valdetaro have received their full reimbursement
of shares, in the amounts they initially pledged on behalf of the Company, or
36,303,932 and 15,000,000 shares, respectively. In November 2002, Mountain
Reservoir Corporation and Mr. Valdetaro assigned any additional rights they had
in the stock collateral to the Company. The Company is currently pursuing these
rights with the lender to obtain a specific accounting and a refund of any
monies that may be due to the Company.
In October 2002, Emily Solutions, Inc., a Nevada corporation, changed its name
to Government Internet Systems, Inc. by amending its articles of incorporation.
In November 2002, Richard Wade, Laurent Tetard, and Luiz Valdetaro resigned in
their capacities as Directors and President, Secretary and Treasurer,
respectively, of Government Internet Systems, Inc ("GIS")., and were replaced by
Directors Stephen Rossetti and Victor Weber. Rossetti also became Chairman and
CEO and Weber became President and Treasurer of GIS.
18
In November 2002, in connection with an agreement between Government Internet
Systems, Inc. ("GIS")(formally Emily Solutions, Inc.), a wholly-owned subsidiary
of the Company, and Defense Solutions, L.L.C., whereby Defense Solutions agreed
to assist in the marketing of the its web based emergency response management
products and services to federal, state, and local governments of the United
States in exchange for one seat on GIS's Board of Directors, and a 15%
commission on all contracts and first year maintenance fees (less any third
party royalties) from any United State's government, non-government or
commercial enterprise or organization resulting from a contact initiated by
Defense Solutions, the Company issued 3 year warrants to purchase 4,000,000
shares of the Company's common stock at a strike price of $0.075.
In October and November 2002, $170,000 principal and $1,341 interest of
debentures were converted into 35,611,428 shares of the Company's common stock.
This conversion was in connection with $265,000 in debentures issued by the
Company to third party holders in September and October 2001.
In December 2002, the Company issued warrants to purchase 6,600,000 shares of
its common stock to six employees at an average share price of $0.0100. The
warrants vest in equal amounts on a monthly basis over a one (1) year period so
long as the holder of the warrants is employed by the Company. The fair market
value of the warrants on the date of issuance of each grant is $36,300.
In December 2002, the Company issued a $65,000 note to a Victor Weber bearing
interest at 13% per annum. The note is due in March 2003 and also provides that
the minimum accrued interest payments will be no less than $2,500. Weber is a
Director, President and Treasurer of the Company's subsidiary Government
Internet Systems, Inc., a Nevada corporation.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion is a summary of the key factors management considers
necessary or useful in reviewing the Company's results of operations, liquidity
and capital resources. The following discussion and analysis should be read
together with the Condensed Consolidated Financial Statements of Vertical
Computer Systems, Inc. and Subsidiaries and the notes to the Condensed
Consolidated Condensed Financial Statements included elsewhere in this Form
10-QSB.
This discussion summarizes the significant factors affecting the consolidated
operating results, financial condition and liquidity and cash flows of Vertical
Computer Systems, Inc. and Subsidiaries for the three and nine months ended
September 30, 2002. Except for historical information, the matters discussed in
this Management's Discussion and Analysis of Financial Condition and Results of
Operations are forward looking statements that involve risks and uncertainties
and are based upon judgments concerning various factors that are beyond our
control. Actual results could differ materially from those projected in the
forward-looking statements as a result of, among other things, those factors
identified in the Company's Form 10-KSB for the year ended December 31, 2001.
OVERVIEW
The Company maintains its primary focus on developing its proprietary Emily
technology, Web services, Underpinning Web Technologies, and other products such
as ResponseFlash and UniversityFlash. Its subsidiary NOW Solutions continues to
develop its services and products in order to grow its customer base.
Additionally, the Company continues to build its global network of Local Country
Partners toward developing an international network of Bridges that will serve
as distribution platforms throughout the world for its proprietary and licensed
technologies, goods and services.
In June 2002, Apollo Industries, Inc., of which Vertical owns approximately 30%,
changed is name to TranStar Services, Inc.
In September 2002, First Serve Entertainment and Vijay Amritraj have agreed to
terminate their business relationship and are proceeding to formalize a mutually
acceptable settlement agreement. First Serve Entertainment was the joint venture
by which the Company and Vijay Amritraj developed and launched the India Bridge.
On October 17, 2002, the Company's wholly-owned subsidiary, Emily Solutions,
Inc., a Nevada corporation, changed the name of the corporation to Government
Internet Systems, Inc. ("GIS") by amending its articles of incorporation. The
Company intends to license its proprietary technology to GIS so that GIS will
market and distribute this technology to government entities of the United
States, beginning initially with ResponseFlash. Emily web technology, including
the Emily XML Enabler Agent and the Emily Broker applications, will be marketed
to non-government agencies and further developed by Vertical Internet Solutions,
Inc., a wholly-owned subsidiary of the Company.
On November 11, 2002, Richard Wade, Laurent Tetard, and Luiz Valdetaro resigned
in their capacities as Directors and President, Secretary and Treasurer,
respectively, of Government Internet Systems ("GIS"), and were replaced by
Directors Stephen Rossetti and Victor Weber. Rossetti also became Chairman and
CEO and Weber became President and Treasurer of Government Internet Systems,
Inc. The Company anticipates compensating the Directors and Officers of GIS with
ownership interest in GIS and executives with salaries once GIS is funded or has
generated adequate sales.
19
On November 15, 2002, GIS, a wholly-owned subsidiary of the Company, and Defense
Solutions, L.L.C., entered into an agreement whereby Defense Solutions agreed to
assist in the marketing of the its web based emergency response management
products and services to federal, state, and local governments of the United
States in exchange for one seat on GIS's Board of Directors, and a 15%
commission on all contracts and first year maintenance fees (less any third
party royalties) from any United State's government, non-government or
commercial enterprise or organization resulting from a contact initiated by
Defense Solutions. In connection with this agreement, the Company issued 3 year
warrants to purchase 4,000,000 shares of the Company's common stock at a strike
price of $0.075.
RESULTS OF OPERATIONS
THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2002 COMPARED TO THE THREE
AND NINE MONTHS ENDED SEPTEMBER 30, 2001
TOTAL REVENUES. The Company had total revenues of $2,276,000 in the three months
ended September 30, 2002. This is an increase of $1,286,000 primarily due to a
$1,600,000 increase in software sales in conjunction with NOW Solutions' emPath
version 6, full allocation of maintenance revenue compared to the previous year,
a $354,000 increase in consulting services, offset by a $661,000 decline in
other. Total revenues primarily consist of software license and consulting and
maintenance fees. All but $13,000 of these revenues relate to the business
operations of NOW Solutions, a subsidiary in which the Company acquired a 60%
interest in February 2001.
Total Revenues for the nine months ended September 30, 2002 increased $3,536,000
from $2,364,000 to $5,900,000. The increase was primarily due to the inclusion
of NOW Solutions for a full 3 quarters for the nine months ended September 30,
2002 as compared to 2001, plus the increase in NOW Solutions total revenues as
described above.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. The Company had selling, general
and administrative expenses of $2,369,000 and $5,141,000 in the three months
ended September 30, 2002 and 2001, respectively. The decrease of $2,772,000 was
primarily attributable to the reduction of these expenses in Vertical Computer
Systems, Inc. which reduced labor, outside consulting fees, expenses involving
the companies international partners, the discontinuance of amortization of
goodwill and a reduction in depreciation expense as a result of fixed assets
written off, as well as the virtual ceasing of operations of two of the
Company's wholly owned subsidiaries, Globalfare and Pointmail, as part of a
global cost cutting and restructuring efforts, offset by a slight increase in
NOW Solutions' correlating costs due to the increase in NOW's sales and
operations. Selling, general and administrative expenses for the nine months
ended September 30, 2002 decreased $3,250,000 to $7,937,000 compared to
$11,187,000. The net decrease is primarily comprised of the results of the net
cost cutting measures described above offset by the write down of approximately
$720,000 of goodwill associated with Enfacet and two additional months of
operations of NOW Solutions compared to the nine months ended September 30,
2002.
OPERATING INCOME (LOSS). The Company had an operating loss of $(92,377) compared
to a loss of $(4,151,000) for the three months ended September 30, 2002 and
2001, respectively. The $4,059,000 decrease in loss is primarily related to the
$1,286,000 increase in revenues coupled with the $2,772,000 decrease in selling,
general, and administrative expenses as described above.
The $138,000 increase in interest expense for the nine months ended September
30, 2002 is attributable to the debt incurred as part of the asset purchase of
NOW solutions as well as the debt assumed as part of the Enfacet purchase and
the increase in notes and debentures payable to fund the operations of Vertical
and its wholly-owned subsidiaries.
The minority interest in income/(loss) of subsidiary was an income of $84,000
compared to a loss of $(185,000) for the three months ended September 30, 2002
and 2001, respectively. The $269,000 change from a loss to a gain is
attributable to the $209,000 net income on NOW Solutions for the three months
ended September 30, 2002. The $581,000 net change from a loss to a gain in the
minority interest in income/(loss) of subsidiary for the nine months ended
September 30, 2002 was primarily attributable to the $567,000 in income from NOW
compared to a loss of $(406,000) for the nine months ended September 30, 2001.
The increase in income tax expense is due to the accrual of taxes for NOW
Solutions, LLC that might be owed for taxes depending upon the validity of a
purported tax election regarding NOW Solutions, LLC tax filing status. The
effective tax rate of NOW Solutions is 34%.
20
NET LOSS. The Company had a net loss of $620,095 and $4,105,000 in the three
months ended September 30, 2002 and 2001 respectively. The $3,485,000 decrease
in net loss was primarily due to the profitability of NOW and the reduction of
selling, general and administrative expenses as discussed above.
The $5,684,000 reduction in net loss for the nine months ended September 30,
2002 when compared to the same period in the prior year was primarily due to the
profitability of NOW and the reduction of selling, general and administrative
expenses as discussed above.
The $253,000 increase in dividends for the nine months ended September 30, 2002
is due to a full quarter accrual for Series A and the addition of 50,000 Series
C issued during November 2001. No dividends were paid in the nine months ended
September 30, 2002.
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS. The Company had a net loss
applicable to common stockholders of $770,000 and $4,120,000 in the three months
ended September 30, 2002 and 2001, respectively. The $3,510,000 decrease of the
net loss applicable to common stockholders is primarily due to the profitability
of NOW and the reduction of selling, general and administrative expenses as
discussed above.
The reduction in net loss applicable to common stockholders of $5,431,000 for
the nine months ended September 30, 2002 when compared to the same period in the
prior year was primarily due to the profitability of NOW and the reduction of
selling, general and administrative expenses as discussed above.
LIQUIDITY AND CAPITAL RESOURCES
Presently, the Company is dependent on external cash to fund its operations. The
Company's primary need for cash during the next twelve months consists of
working capital needs, as well as cash to pay deferred compensation, to repay
loans coming due. In order to meet its obligations, the Company will need to
raise cash from the sale of securities or from borrowings. Any cash generated
from NOW Solutions' business operations is not available to finance the
Company's business operations. Other than the Equity Line of Credit discussed
below, the Company does not currently have any commitments for such capital, and
no assurances can be given that such capital will be available when needed or on
favorable terms, if at all. As of September 30, 2002, the Company had
unrestricted cash of $848,000, substantially all of which is held by NOW
Solutions, a 60% subsidiary of the Company. This cash is not available for use
by the Company. During October 2002, the lender released the restriction on the
$1,500,000 of cash held as collateral against the NOW note payable. To date,
$565,667 funds have been released and the remaining will be released in monthly
draw downs of $91,167. The Company needs to raise cash in order to continue
operations. The Company's primary need for cash is to fund operations until its
operations generate sufficient capital to meet these obligations. In addition,
the Company needs cash to satisfy its current liabilities of $2.5 million
(excluding NOW Solutions, which believes it has sufficient working capital to
meet its the current liabilities).
The amount of $2,754,938 represents NOW Solutions' portion of $3,103,777 of the
Company's notes payable. Thirty days prior to February 28, 2004, either NOW
Solutions or the lender may cancel the balance of the $5,500,000 note payable
acquired by NOW Solutions owed at that date (in connection with the purchase of
human resource software assets of Ross Systems, Inc.), in which case, NOW
Solutions would have to pay $2,196,000.
NOW Solutions, an entity in which the Company has a 60% ownership interest,
believes it has adequate working capital to fund its current operations for the
next 12 months. Debt service for the next twelve months will be approximately
$1,848,000 in principal and interest. NOW is current in all its principal and
interest payments.
To date, the Company has primarily generated revenues from licensing and
maintenance agreements from NOW Solutions ("NOW"), its 60% majority owned
subsidiary. The Company does not receive these revenues and, therefore, they are
not available to the Company as a source of cash.
For the nine months ended September 30, 2002, the Company had a net increase in
cash and cash equivalents of $3,000. The net increase was primarily the result
of the profitability of NOW and the cost-cutting measures as described above.
21
The Company is continuing its efforts to secure working capital for operations,
expansion and possible acquisitions, mergers, joint ventures, and/or other
business combinations. However, there can be no assurance that the Company will
be able to secure additional capital, or that if such capital is available,
whether the terms or conditions would be acceptable to the Company.
Furthermore, the Company is exploring certain opportunities with a number of
companies to participate in the marketing of its products. The exact results of
these opportunities are unknown at this time.In September 30, 2002, the Company
was informed that $254,000 of a delinquent note payable was repaid via proceeds
from sales of 19,751,000 of the Company's common stock owned by officers of the
Company and used as collateral to secure the a $425,000 note payable. The
officers are to be repaid with replacement shares.
In September 2002, a debenture with an outstanding balance of $10,631 was
converted into 2,278,153 shares of the Company's common stock. This conversion
was in connection with $265,000 in debentures issued by the Company to third
party holders in September and October 2001.
In October and November 2002, $170,000 principal and $1,341 interest of
debentures were converted into 35,611,428 shares of the Company's common stock.
This conversion was in connection with $265,000 in debentures issued by the
Company to third party holders in September and October 2001.
In October 2002, the Company's 60% majority-owned subsidiary, NOW Solutions,
L.L.C. ("NOW Solutions") and its lender agreed to amend the Loan and Security
Agreement, dated February 28, 2001 (the "Loan Agreement"). Also in October 2002,
the Company and the Lender agreed to amend the Deposit Account Pledge Agreement,
dated February 28, 2001 (the "Pledge Agreement"). In these amendments, the
lender agreed to waive certain defaults by NOW Solutions under the Loan
Agreement and Pledge Agreement, including non-compliance with financial
covenants and non-delivery of financial statements, and to modify the financial
covenants. All payments to the lender have been made. In exchange, the Company
agreed to amend the provisions of the Pledge Agreement related to its ability to
withdraw amounts pledged to the lender as collateral. Under the amended terms of
the Pledge Agreement, Vertical was entitled to withdraw $383,333 from the
deposit account, plus $91,667 per month commencing October 31, 2002, provided
that: (a) NOW Solutions makes the preceding monthly payment on the principal and
(b) NOW Solutions is not in default of or has not cured certain covenants under
the Loan Agreement.
Additionally, the Company has a $10,000,000 equity line commitment, which is
subject to the Company's ability to register the shares to be issued under the
equity line with the Securities and Exchange Commission. The Company's ability
to register with the Securities and Exchange Commission will not occur until the
Company determines that it is in compliance with all other previous SEC filings.
The Company will require additional capital to fund operations and pay down its
liabilities, as well as fund its expansion plans consistent with the Company's
anticipated changes in operations and infrastructure. The Company has paid the
$400,000 fee associated with the Equity Line of Credit agreement by issuance of
19,697,857 shares of common stock.
GOING CONCERN UNCERTAINTY
The accompanying condensed consolidated financial statements for the nine months
ended September 30, 2002, 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, has approximately $934,333 of its cash deposit
presently restricted (as of December 9, 2002) as collateral for a loan on behalf
of its subsidiary NOW Solutions, LLC and needs to raise additional funds to
accomplish its objectives. Additionally, at September 30, 2002, the Company had
negative working capital of approximately $5,499,000. The report of the
Company's Independent Certified Public Accountants for the December 2001
financial statements included an explanatory paragraph expressing substantial
doubt about the Company's ability to continue as a going concern.
MARKET RISKS
The Company anticipates that it will have activities in foreign countries in
future periods. These operations will expose the Company to a variety of
financial and market risks, including the effects of changes in foreign currency
exchange rates and interest rates. As of September 30, 2002, there are no
material gains or losses requiring separate disclosure.
22
DIVIDENDS
The Company had outstanding Series A and C 4% Convertible Cumulative Preferred
stock that accrues dividends at a rate of 4% on a semi-annual basis.
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 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 product's total estimated revenues
method, 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.
LONG-LIVED ASSETS
Long-lived assets, such as property and equipment, are evaluated for impairment
when events or changes in circumstances indicate that the carrying amount of the
assets may not be recoverable through the estimated undiscounted future cash
flows from the use of these assets. When any such impairment exists, the related
assets are written down to fair value.
REVENUE RECOGNITION
For the Company's various services, revenue is generally recognized when
services are rendered. In accordance with Statement of Position 97-2, "Software
Revenue Recognition", ("SOP 97-2"), the Company recognizes revenue on sales of
its payroll software products when the following criteria are met: (i)
persuasive evidence of an arrangement exists, (ii) delivery has occurred and the
system is functional, (iii) the vendor's fee is fixed or determinable and (iv)
collectability is probable.
Service revenues are recognized ratably over the contractual period or as the
services are provided.
Deferred revenue on maintenance contracts represent cash received in advance or
accounts receivable from system service consulting sales, which is recognized
over the life of the contract.
STOCK-BASED COMPENSATION
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-based
Compensation" SFAS 123, establishes a fair value method of accounting for
stock-based compensation plans and for transactions in which a company acquires
goods or services from non-employees in exchange for equity instruments. The
Company has adopted this accounting standard. SFAS 123 also gives the option to
account for stock-based employee compensation in accordance with Accounting
Principles Board Opinion No. 25 (APB 25), "Accounting for Stock issued to
Employees," or SFAS 123. The Company elected to follow APB 25, which measures
compensation cost for employee stock options as the excess, if any, of the fair
market price of the Company's stock at the measurement date over the amount an
employee must pay to acquire stock.
INVESTMENTS
Investments in entities in which the Company exercises significant influence,
but does not control, are accounted for using the equity method of accounting in
accordance with Accounting Principles Board Opinion No. 18 "The Equity Method of
Accounting for Investments in Common Stock". Investments in securities with a
readily determinable market value in which the Company does not exercise
significant influence, does not have control, and does not plan on selling in
the near term are accounted for as available for sale securities in accordance
with Statement of Financial Accounting Standard No. 115 "Accounting for Certain
Investments in Debt and Equity Securities".
23
NEW ACCOUNTING PRONOUNCEMENTS
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities, which addresses accounting for restructuring and
similar costs. SFAS No. 146 supersedes previous accounting guidance, principally
Emerging Issues Task Force (EITF) Issue No. 94-3. The Company will adopt the
provisions of SFAS No. 146 for restructuring activities initiated after December
31, 2002. SFAS No. 146 requires that the liability for costs associated with an
exit or disposal activity be recognized when the liability is incurred. Under
EITF No. 94-3, a liability for an exit cost was recognized at the date of a
companys commitment to an exit plan. SFAS No. 146 also establishes that the
liability should initially be measured and recorded at fair value. Accordingly,
SFAS No. 146 may affect the timing of recognizing future restructuring costs as
well as the amount recognized.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.
This statement eliminates the current requirement that gains and losses on debt
extinguishment must be classified as extraordinary items in the income
statement. Instead, such gains and losses will be classified as extraordinary
items only if they are deemed to be unusual and infrequent, in accordance with
the current GAAP criteria for extraordinary classification. In addition, SFAS
145 eliminates an inconsistency in lease accounting by requiring that
modifications of capital leases that result in reclassification as operating
leases be accounted for consistent with sale-leaseback accounting rules. The
statement also contains other nonsubstantive corrections to authoritative
accounting literature. The changes related to debt extinguishment will be
effective for fiscal years beginning after May 15, 2002, and the changes related
to lease accounting will be effective for transactions occurring after May 15,
2002. Adoption of this standard will not have any immediate effect on the
Company consolidated financial statements.
In August 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations. SFAS No. 143 requires the fair value of a liability for an asset
retirement obligation to be recognized in the period in which it is incurred if
a reasonable estimate of fair value can be made. The associated asset retirement
costs are capitalized as part of the carrying amount of the long-lived asset.
SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The
Company believes the adoption of this Statement will have no material impact on
its financial statements.
The Company adopted Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets" ("SFAS 142") on February 1, 2002. In
accordance with the requirements of SFAS 142, during the nine months ended
September 30, 2002, the Company:
o Evaluated the balance of goodwill and other intangible assets recorded on
the condensed consolidated balance sheet as of February 1, 2002. No
reclassifications were required to be made in order to conform to the new
criteria for recognition.
o Determined that there were no intangible assets (other than goodwill) with
indefinite useful lives.
o Determined that the Company's goodwill is related to one reporting unit,
NOW Solutions, LLC, to be used to test for goodwill impairment in
accordance with SFAS 142. The Company has not completed a transitional
goodwill impairment test.
o As required under SFAS No. 142, with effect from January 1, 2002, the
Company eliminated the amortization of goodwill. The following table
represents a reconciliation of net loss and per share data that would have
been reported had the new rules been in effect during the three and nine
months ended September 30, 2001 (in thousands, except per share data):
24
THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001
------------- -------------
Reported net loss $(459) $(4,105)
Add back goodwill amortization, net of tax -- 165
------------- -------------
Adjusted net loss $(459) $(3,940)
------------- -------------
Reported basic and diluted net loss $(0.00) $ (0.01)
per common share
Goodwill amortization, net of tax -- 0.00
------------- -------------
Adjusted net loss $ (0.00) $ (0.00)
------------- -------------
NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001
------------- -------------
Reported net loss $(2,806) $ (8,650)
Add back goodwill amortization, net of tax -- 494
------------- -------------
Adjusted net loss $(2,806) $(8,156)
------------- -------------
Reported basic and diluted net loss per $ (0.01) $ (0.02)
common share
Goodwill amortization, net of tax -- 0.00
------------- -------------
Adjusted net loss $ (0.00) $ (0.00)
------------- -------------
ITEM 3. EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
QUARTERLY EVALUATION OF DISCLOSURE CONTROLS AND INTERNAL CONTROLS. Within
the 90 days prior to the date of this Quarterly Report on Form 10-QSB, the
Company evaluated the effectiveness of the design and operation of its
"disclosure controls and procedures" (Disclosure Controls), and its "internal
controls and procedures for financial reporting" (Internal Controls). This
evaluation (the Controls Evaluation) was done under the supervision and with the
participation of management, including the Chief Executive Officer (CEO) and
acting Chief Financial Officer (CFO). Rules adopted by the SEC require that in
this section of the Quarterly Report we present the conclusion of the CEO and
acting CFO about the effectiveness of our Disclosure Controls and Internal
Controls based on and as of the date of the Controls Evaluation.
CEO AND CFO CERTIFICATIONS. Appearing immediately following the Signatures
section of this Quarterly Report there are two separate forms of
"Certifications" of the CEO and acting CFO. The first form of Certification is
required in accord with Section 302 of the Sarbanes-Oxley Act of 2002 (the
Section 302 Certification). This section of the Quarterly Report which you are
currently reading is the information concerning the Controls Evaluation referred
to in the Section 302 Certifications and this information should be read in
conjunction with the Section 302 Certifications for a more complete
understanding of the topics presented.
DISCLOSURE CONTROLS AND INTERNAL CONTROLS. Disclosure Controls are
procedures that are designed with the objective of ensuring that information
required to be disclosed in our reports filed under the Securities Exchange Act
of 1934 (Exchange Act), such as this Quarterly Report, is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission's (SEC) rules and forms. Disclosure Controls are also
designed with the objective of ensuring that such information is accumulated and
communicated to our management, including the CEO and acting CFO, as appropriate
to allow timely decisions regarding required disclosure. Internal Controls are
procedures which are designed with the objective of providing reasonable
assurance that (1) our transactions are properly authorized; (2) our assets are
safeguarded against unauthorized or improper use; and (3) our transactions are
properly recorded and reported, all to permit the preparation of our financial
statements in conformity with generally accepted accounting principles.
25
LIMITATIONS ON THE EFFECTIVENESS OF CONTROLS. The company's management,
including the CEO and acting CFO, does not expect that our Disclosure Controls
or our Internal Controls will prevent all error and all fraud. A control system,
no matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further,
the design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control systems, no evaluation
of controls can provide absolute assurance that all control issues and instances
of fraud, if any, within the company have been detected. These inherent
limitations include the realities that judgments in decision-making can be
faulty, and that breakdowns can occur because of simple error or mistake.
Additionally, controls can be circumvented by the individual acts of some
persons, by collusion of two or more people, or by management override of the
control. The design of any system of controls also is based in part upon certain
assumptions about the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under all potential
future conditions; over time, control may become inadequate because of changes
in conditions, or the degree of compliance with the policies or procedures may
deteriorate. Because of the inherent limitations in a cost-effective control
system, misstatements due to error or fraud may occur and not be detected.
SCOPE OF THE CONTROLS EVALUATION. The CEO/CFO's evaluation of our
Disclosure Controls and our Internal Controls included a review of the controls'
objectives and design, the controls' implementation by the company and the
effect of the controls on the information generated for use in this Quarterly
Report. In the course of the Controls Evaluation, we sought to identify data
errors, controls problems or acts of fraud and to confirm that appropriate
corrective action, including process improvements, were being undertaken. This
type of evaluation will be done on a quarterly basis so that the conclusions
concerning controls effectiveness can be reported in our Quarterly Reports on
Form 10-QSB and Annual Report on Form 10-KSB. The overall goals of these various
evaluation activities are to monitor our Disclosure Controls and our Internal
Controls and to make modifications as necessary; our intent in this regard is
that the Disclosure Controls and the Internal Controls will be maintained as
dynamic systems that change (including with improvements and corrections) as
conditions warrant.
Among other matters, we sought in our evaluation to determine whether there
were any "significant deficiencies" or "material weaknesses" in the company's
Internal Controls, or whether the company had identified any acts of fraud
involving personnel who have a significant role in the company's Internal
Controls. This information was important both for the Controls Evaluation
generally and because items 5 and 6 in the Section 302 Certifications of the CEO
and acting CFO require that the CEO and acting CFO discloses that information to
our Board and to our independent auditors and to report on related matters in
this section of the Quarterly Report. In the professional auditing literature,
"significant deficiencies" are referred to as "reportable conditions"; these are
control issues that could have a significant adverse effect on the ability to
record, process, summarize and report financial data in the financial
statements. A "material weakness" is defined in the auditing literature as a
particularly serious reportable condition where the internal control does not
reduce to a relatively low level the risk that misstatements caused by error or
fraud may occur in amounts that would be material in relation to the financial
statements and not be detected within a timely period by employees in the normal
course of performing their assigned functions. We also sought to deal with other
controls matters in the Controls Evaluation, and in each case if a problem was
identified, we considered what revision, improvement and/or correction to make
in accord with our on-going procedures.
In accord with SEC requirements, the CEO and acting CFO notes that, since
the date of the Controls Evaluation to the date of this Quarterly Report, there
have been no significant changes in Internal Controls or in other factors that
could significantly affect Internal Controls, including any corrective actions
with regard to significant deficiencies and material weaknesses.
CONCLUSIONS. Based upon the Controls Evaluation, our CEO and acting CFO has
concluded that, subject to the limitations noted above, our Disclosure Controls
are effective to ensure that material information relating to the Company is
made known to management, including the CEO and acting CFO, particularly during
the period when our periodic reports are being prepared, and that our Internal
Controls are effective to provide reasonable assurance that our financial
statements are fairly presented in conformity with generally accepted accounting
principles.
26
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are, from time to time, involved in various lawsuits generally incidental to
our business operations, consisting primarily of collection actions and vendor
disputes. In the opinion of management, the ultimate resolution of these
matters, if any, will not have a significant effect on the financial position,
operations or cash flows of the Company. The Company's litigation is summarized
below.
The Company is currently involved in a dispute between itself and Arglen
Acquisitions concerning its subsidiary NOW Solutions, LLC. On April 12, 2002,
the Company received a letter from Arglen Acquisitions LLC, a member of NOW
Solutions LLC, accusing the Company of defaulting on its obligations under NOW
Solutions' Operating Agreement by failing to obtain a waiver of default from NOW
Solutions' lender, Coast Business Credit. The letter further stated that the
default has triggered the dissolution of NOW Solutions, and authorizes Arglen
Acquisitions to acquire the Company's ownership interest in NOW Solutions at a
discounted price. On May 8, 2002, the Company demanded arbitration from Arglen
Acquisitions seeking to enforce its rights under the Operating Agreement. On May
9, 2002, Arglen Acquisitions filed a Demand for Arbitration and Statement of
Claim against the Company. In its demand, Arglen Acquisitions alleged that the
Company is in default of its obligations under the Operating Agreement. Arglen
is seeking to enjoin the Company from appointing a fifth member of the Executive
Committee of NOW Solutions and other actions, as well as seeking specific
performance of the default provisions of the Operating Agreement, including the
right to purchase the Company's interest in NOW Solutions. In August, the
Company prevailed on four of the five motions and remains in control of the
executive committee. The only restriction until the outcome of arbitration is
the Company is not allowed to increase its management fees or any other monies
other than for reimbursement for direct expenses incurred by the Company on
behalf of NOW Solutions. The Company believes that Arglen's allegations are
without merit and that the Company will prevail on all five motions.
The Company's subsidiary, NOW Solutions, LLC ("NOW") recently learned of an
alleged employment agreement between NOW and Garry Gyselen ("Gyselen") whereby
Gyselen would be engaged for a term of 3 years at a salary of $150,000 per
annum. The agreement was executed by Gyselen, acting in the capacity of Chairman
on behalf of NOW and Gyselen, signing on his own personal behalf as the
executive. The agreement is undated. NOW's corporate legal counsel has informed
NOW Solutions' management and its executive committee that the employment
agreement is invalid in their legal opinion. Gyselen, in his own declaration of
the preliminary injunction, declares that the employment agreement is "entirely
inoperative." Gyselen has not provided NOW with any written acknowledgment
confirming that the agreement is null and void.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In January 2002, the Company and Strategic Marketing Alliance agreed to
terminate the Company's interest in WorldBridge in consideration for credit on
the Company's account with Strategic Marketing whereby Strategic Marketing will
continue to provide consulting services through 2002. In addition, Strategic
Marketing will receive 3-year warrants to purchase stock equal to $5,000 per
month, based on a strike price formula of $0.01 plus the previous average five
day market price on the date of issuance. These warrants will be issued in lieu
of the warrants specified in the original consulting agreement, dated as of
November 2000, with Strategic Marketing beginning in February 2002. For the nine
months ended September 30, 2002, the Company issued warrants to purchase 420,455
shares of common stock. The fair market value for these shares, as of the date
of issuance, was $1,103. During the nine months ended September 30, 2002, the
Company accrued $13,897 relating to the consulting agreement.
In January 2002, the Company and Taurus Global LLC agreed to extend a consulting
services agreement for nine months. In consideration of Taurus Global's
services, the Company agreed to pay a monthly fee of $12,500 and issued an
additional 100,000 warrants on the same terms as the July 2001 consulting
services agreement. The warrants have vested and are exercisable for five years
from issuance at a strike price equal to the fair market value of the Company's
common stock on the day of grant. The warrants were valued at $1,240 and were
expensed when issued. The Company has the option to pay the monthly fee in
common stock valued at 95% of the average closing price 3 trading days prior to
issuance. During the nine months ended September 30, 2002 the Company accrued
$74,400 relating to the monthly fee. In the event the proceeds of the stock
result in greater than a 20% profit or loss for the monthly fee, Taurus or the
Company, as the case may be, shall pay the difference in profit or loss, as
27
applicable, at the end of the term. The Company may buyback any unsold shares of
stock at any time.
In January 2002, the Company executed indemnity and reimbursement agreements
with Mountain Reservoir Corporation to cover the 10,450,000 shares of stock
pledged by Mountain Reservoir Corporation with regard to notes issued by the
Company in October and November 2001 in the amount of $100,000 for each note,
whereby the Company would reimburse Mountain Reservoir Corporation with a number
of shares equal to any shares sold as collateral to cover the default of the
loans. Mountain Reservoir Corp. is a corporation controlled by the W5 Family
Trust, of which Mr. Wade is a trustee. Mr. Wade is President of the Company.
During October 2002, the notes and the related indemnity and reimbursement
agreement were cancelled and a new $181,584 note was issued by the Company for
the amount due under the cancelled notes, which was secured by a new pledge
agreement between the lender and Mountain Reservoir Corporation whereby Mountain
Reservoir Corporation pledged 10,450,000 shares of common stock.
In January 2002, the Company executed separate indemnity and reimbursement
agreements with Mountain Reservoir Corporation and Mr. Valdetaro to cover their
respective 36,303,932 and 15,000,000 shares of common stock pledged by Mountain
Reservoir Corporation and Valdetaro in connection with the $425,000 note issued
in December 2001, whereby the Company would reimburse Mountain Reservoir
Corporation and Valdetaro with the respective number of shares equal to any
shares sold as collateral to cover the default of any loan. Mountain Reservoir
Corp. is a corporation controlled by the W5 Family Trust, of which Mr. Wade is a
trustee. Mr. Wade is President of the Company. Mr. Valdetaro is the Chief
Technology Officer of the Company. The Company has been informed by the lender
that 19,751,000 shares of the collateral were sold for $254,382.07, the
remaining 31,552,932 shares were transferred to two third parties. The lender
has also informed the Company that these two third parties have sold all of the
stock, the debt was satisfied as of April 1, 2002, and the note has been
cancelled. In November 2002, Mountain Reservoir Corporation and Valdetaro
assigned any remaining right, title, and interest in the 36,303,932 and
15,000,000 shares of common stock to the Company. The Company has calculated and
fully reserved excess proceeds from the sale of the collateralized common stock
of $170,000, pending receipt of a full accounting from the lender.
In March 2002, Vertical Computer issued 12,500,000 shares of common stock for
the remaining fee in connection with the Equity Line of Credit. The fair market
value of these shares at the date of issuance was $200,000. To date, no shares
have been purchased under the Equity Line of Credit.
In March 2002, the Company executed an agreement to issue a $100,000 convertible
debenture. In April 2002, the funds were received and the issuance of debenture
became effective. The debenture accrues interest at 5% per annum and is due
March 2004. The debenture is convertible into shares of common stock at either
120% of the closing bid price on the date of agreement or 80% of the lowest
closing bid price 5 days prior to the conversion. The debenture is convertible
at the option of the holder, any time after purchase. The holder of the
debentures is a third-party individual. As of September 30, 2002, no conversions
have taken place.
For the three months ended March 31, 2002, the Company issued 1,167,857 warrants
to purchase shares of its common stock to one marketing consultant for services.
The fair market value of these warrants at the date of issuance $3,132.
For the three months ended June 30, 2002, the Company issued warrants to two
consultants to purchase a total of 1,500,000 shares of common stock at a strike
price of $0.005. The fair value of these warrants at the date of issuance of
each grant of warrants was $3,565.
In April 2002, a $180,000 note that bears interest at 12% per annum, which
Vertical issued in August 2001 and which was due February 2002, was amended such
that the amount on the note was increased to $211,136 and the maturity date was
extended so that the note was payable in August 2002. To secure the loan, the
Company pledged third party securities of eResource Capital Group that it holds.
In August 2002, the $211,136 note along with $25,368 in accrued interest and
fees (as amended) was cancelled and a $236,504 note was issued that bears
interest at 13% per annum, has three payments of $7,500 due on October 1,
November 1, and November 15, 2002 and monthly payments of $7,500, beginning on
December 1, 2002 and continuing thereafter until all principal and interest then
outstanding under the note has been paid. In November and December 2002, the
parties subsequently amended the $236,504 note. Pursuant to these amendments,
the Company has made a $65,000 payment in December 2002 and will make monthly
installment payments in the amount of $7,500 each month beginning in March 2003.
In April 2002, the Company entered into an amendment agreement concerning a
$100,000 promissory note that Vertical issued in October 2001, which bears
interest at 12% per annum and was due in February 2002. Pursuant to the
amendment, Vertical and the third party waived any default, and Vertical sold
400,000 shares of eResource Capital Group stock, which Vertical had pledged
28
pursuant to the Stock Pledge Agreement as collateral. The Company further agreed
to use the proceeds of the eResource Capital Group sales of stock to reduce the
obligations under the note accordingly. Pursuant to this amendment, the Company
made payments of $31,500 and $8,500, and agreed to make ten (10) installment
payments of $6,000 beginning on April 15, 2002, and continuing until all
principal then outstanding with interest, amounts owed and then unpaid by June
2002. In October 2002, this note was cancelled and the amounts payable under
this note and the $100,000 note issued in November 2001 were incorporated into a
new $181,584 note that the Company issued in October 2002.
In April 2002, the Company entered into an amendment agreement concerning a
$100,000 promissory note that Vertical issued in November 2001 that bears
interest at 12% and was due in February 2002. Pursuant to the amendment,
Vertical and the third party agreed waive any default and Vertical agreed to
make monthly installment payments in the amount of $7,500 each on the fifteenth
day of each month, beginning in May 2002. Pursuant to this amendment, all
principal then outstanding, and all interest, was due by the end of September
2002. In October 2002, this note was cancelled and the amounts payable under
this note and the $100,000 note issued in October 2001 were incorporated into a
new $181,584 note that the Company issued in October 2002.
In April 2002, the Company entered into an amendment agreement concerning the
$280,000 note issued in connection with the purchase of various intangible
assets by Vertical that bears interest at 4% per annum. Pursuant to the terms of
the amendment, Vertical and the third party agreed to extend the date for which
the remaining three $5,000 installment payments would be due to the first day of
each month, beginning in May 2002 and the time to pay all remaining $10,000
installments was extended so that each $10,000 installment would be due and
payable on the first day of each month beginning on August 1, 2002, until the
principal and interest has been paid in full. All unpaid amounts are due
September 2004. In June 2002, this note was further amended, to extend the date
for which the remaining three $5,000 installment payments would be due to the
first day of each month, beginning in July 2002, and all remaining $10,000
installments were extended so that each $10,000 installment would be due and
payable on the first day of each month beginning on October 1, 2002. In
connection with the amendment, the Company agreed to register the common shares
underlying the 50,000 shares of Series C Preferred Stock that were issued to a
third party in connection with the purchase of the SiteFlash technology.
Pursuant to an option agreement with iNet Purchasing, Inc. ("iNet"), which was
entered into in December 2001, the Company had an option to purchase additional
interest in iNet by April 2002, whereby the Company could obtain an aggregate
56% ownership interest in iNet. In accordance with the option agreement, the
Company was required to pay $140,000 in four equal monthly installments
beginning in December 2001 and grant stock options to three iNet employees,
Basil Nikas, Robin Mattern, and Wayne Savage, in the amount of 1,500,000,
1,500,000, and 500,000 shares, respectively. The Company has paid a total of
$131,282 and intends to offset the remaining balance against amounts owed by
iNet pending a final accounting. The options are vested, have a strike price of
$0.010, and must be exercised within 3 years from the date of issuance. Pursuant
to the terms of the Stock Purchase Agreement and the Stockholders Agreements, if
the Company exercised the option to obtain a majority interest in iNet by April
2002, the Company was required to pay to iNet $860,000 in cash or marketable
securities (pending any potential offsets), issue 70,000 shares of Series "C"
Preferred Stock, and issue additional 3-year warrants and options, as the case
may be, to purchase an additional 6,000,000 common stock shares each to Nikas
and Mattern and 2,000,000 common stock shares to Savage, at a strike price of
$0.025. The Company would need to raise additional capital in order to pay the
cash portion of the exercise price. The fair market value of these warrants at
the date of grant was $35,713. Of these warrants and options, the Company issued
1,500,000 warrants to Nikas and Mattern and 500,000 warrants to Savage in
January 2002. In the event that the Company does not acquire a majority interest
in iNet Purchasing, Inc., these options and warrants will be automatically be
cancelled. Under the terms of the option, iNet was required to deliver certain
financial and non-financial information. This information was never delivered
and the Company is holding the warrants issued in January until a resolution is
reached. The Company is seeking an extension of the exercise date to allow iNet
to deliver the required information and to allow the Company an opportunity to
review the information and to make an informed investment decision, as well as
to allow both parties to resolve the issues of monies owed by iNet to the
Company and vice versa. Discussions thus far with iNet have not resulted in a
resolution of this matter.
In June 2002, the Company issued a $50,000 note, which is due January 2003 and
bears no interest. In connection with the note, the Company issued three year
warrants to purchase 1,200,000 shares of its common stock at a price of $0.003
per share. The warrants vested immediately and are exercisable for three years
from issuance. The fair value of the warrants was $2,291 (valued using the
Black-Scholes valuation model). The Company also pledged a limited interest in a
deposit account in the event the Company defaults on the loan.
In June 2002, the Company issued a $50,000 note bearing interest of 12%, which
is due January 2003. In connection with the note, the Company issued three year
warrants to purchase 1,500,000 shares of its common stock at a price of $0.004
per share. The warrants vested immediately and are exercisable for three years
from issuance. The fair market value of the warrants was $3,818 (valued using
29
the Black-Scholes valuation model). The Company also pledged a limited interest
in a deposit account in the event the Company defaults on the loan.
In June 2002, the Company issued 3 year warrants to purchase 3,000,000 shares of
its common stock to two employees at an average share price of $0.012. The fair
market value of these warrants on the date of issuance of each grant is $3,565.
In July 1, 2002, the Company entered into a two year employment agreement with
Aubrey McAuley, whereby McAuley would provide services in the capacity of
Executive VP, Product Development and Sales Support. McAuley will be paid an
annual salary of $120,000 and a bonus as determined in accordance with the
agreement. In addition, the agreement contains certain performing incentives
whereby McAuley can earn 7,500 shares of Series "C" preferred stock of the pool
of 30,000 shares of Series "C" preferred stock, which were reserved in
connection with the purchase of Company's subsidiary, Enfacet, Inc.. These
shares of Series "C" preferred stock may be converted into 3,000,000 shares of
Company's common stock. The Company is required to register the underlying
shares of common stock. In the event the employment agreement is terminated,
then McAuley may convert his employment agreement into a subcontractor
agreement. As of September 30, 2002, management's opinion is that the shares of
7,500 Series "C" preferred stock have not been earned and accordingly the shares
have not been issued.
In July 2002, the Company retained the services of Equitilink, Inc. to provide
investor relations services. As compensation, the Company issued 5,000,000
shares of Company's common stock with the Rule 144 restrictive legend with a
fair market value of $23,500.
In August 2002, the Company issued a $25,000 note to a third party, which was
due in August 2002 and bears interest at a rate of 12%. The note is secured by
10,000,000 shares of common stock of Vertical Computer that is owned by Mountain
Reservoir Corporation, to cover any shortfall in the event of default. Mountain
Reservoir Corp. is a corporation controlled by the W5 Family Trust. Mr. Wade,
the President and CEO of Vertical Computer Systems, is the trustee of the W5
Family Trust. The Company made a $12,500 payment on the note and the parties
have agreed to extend the maturity date for the remaining balance to December
2002.
In August 2002, the Company retained a consultant to provide investment services
on behalf of the Company. Upon execution of the agreement, the Company issued
warrants to purchase 500,000 shares of common stock at a share price of $0.015,
which expire in August 2005, and vest immediately. The fair market value of the
warrant issued was $5,467 (valued using the Black-Scholes method). The
consultant is also entitled to 2.5% of any cash funds raised and in the event
the consultant raises $1,500,000, the Company will issue warrants to purchase
2.0 million shares of common stock, based on 90% of the average closing price
for the five previous trading days prior to the closing date of the transaction.
In August 2002, the Company agreed with a third party lender to loan the Company
$60,000. The lender has currently loaned the Company $31,859. The Company had
agreed to issue warrants to purchase 6 million shares of the Company's common
stock at a strike price of $0.005 per share in connection with funding the total
amount of the loan. The lender has not fully funded the loan and the parties are
negotiating the terms to the loan. In connection with the loan, the Company also
agreed to compensate a third party with a finders fee with warrants to purchase
Company common stock based on the amount of money actually loaned to the
Company.
In August 2002, the Company issued a $8,000 note, which is due February 2003 and
bears interest at a rate of 10% in consideration of a loan from Luiz Valdetaro,
the Chief Technology Officer of the Company. In connection with the note, the
Company issued three year warrants to purchase 1,000,000 shares of its common
stock at a price of $0.005 per share. The warrants vested immediately and were
issued at a fair market value of $9,316 (valued using the Black-Scholes
valuation model). The Company also pledged a limited interest in a deposit
account in the event the Company defaults on the loan.
In September 2002, the Company amended an agreement to retain the services of
Stephen Rossetti to provide services in the capacity of Executive V.P.,
Governmental Affairs, in consideration for 3 year warrants to purchase 1,000,000
shares of its common stock at a share price of $0.012, $30,000 for services
rendered through August 31, 2002, and $5,000 per month for a period of one year.
The warrants were issued at a fair market value of $6,191 (valued using the
Black-Scholes valuation model).
In September 2002, the Company issued 3 year warrants to purchase 1,750,000
shares of the Company's common stock at a strike price of $0.006 per shares to
two consultants in connection with accounting services provided to the Company.
The fair market value of the warrants issued was $13,845 (valued using the
Black-Scholes valuation model).
30
In September 2002, the Company issued 5,774,704 shares of common stock to Luiz
Valdetaro, the Chief Technology Officer of the Company, and 13,976,296 shares of
common stock to Mountain Reservoir Corporation. These shares were issued in
connection with indemnity and reimbursement agreements between the Company and
Mountain Reservoir Corporation and Mr. Valdetaro, respectively, to replace their
respective 36,303,932 and 15,000,000 shares of common stock pledged by Mountain
Reservoir Corporation and Valdetaro in connection with the $425,000 note issued
in December 2001 and accrued interest. The combined 19,751,000 common shares of
the Company Stock had a fair market value of $118,000 on September 23, 2002, the
date of issuance.
In September 2002, the Company issued a promissory note in the amount of $13,000
to a third party lender bearing interest at 8% due in October 2002, and warrants
to purchase 250,000 shares of Company common stock at a strike price of $0.008
per share in consideration for a loan in the amount of $12,500 with a commitment
fee of $500. In connection with the loan, the Company also issued warrants to
purchase 250,000 shares of Company common stock at a strike price of $0.008 per
share to a third party as a finder's fee. The warrants were issued at a fair
market value of $7,531 (valued using the Black-Scholes valuation model).
In September 2002, Equitilink, whom the Company retained to provide the
company's investor relations services, purchased 3,000,000 shares of the
Company's common stock for a total of $17,100 at the fair market value price of
$0.005 per share. The shares are subject to the Rule 144 Restriction.
In September 2002, a debenture with an outstanding balance of $10,631 of was
converted into 2,278,153 shares of the Company's common stock. This conversion
was in connection with $265,000 in debentures issued by the Company to third
party holders in September and October 2001.
In October 2002, the Company entered into an agreement to cancel two $100,000
notes payable and the underlying collateral agreements with a third party,
executed in October and November 2001, and issue a $181,583.70 promissory note
at 12% interest per annum payable as follows: (i) an initial installment of
$10,000 payable upon execution; (ii) six (6) monthly payments of $5,000 per
month beginning November 5, 2002 and (iii) $10,000 payments per month beginning
May 15, 2003 until all amounts under the note have been paid in full. The note
is secured by a pledge against the loan by the Mountain Reservoir Corp., to sell
up to 10,450,000 shares of common stock owned by Mountain Reservoir Corp. to
cover any shortfall as well as certain assets of the Company. Mountain Reservoir
Corporation 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.
Additionally, and in connection with the cancellation of the notes and the
issuance of the revised loan, Vertical has agreed to give Paradigm Sales certain
rights in connection with the common stock represented by 12,500 shares of the
50,000 shares of Vertical's Class C Preferred Stock, held by Paradigm Sales,
pursuant to that certain Asset Purchase Agreement, dated November 14, 2001 by
and between Vertical and Paradigm for the purchase of the Adhesive Software
assets, Vertical has agreed to give Paradigm the right to sell and Vertical
agreed to redeem the underlying common stock represented by 12,500 shares of
Vertical's Class C Preferred Stock at a price of $0.04 per share, which shall be
exercisable on 10 days notices on March 17, 2003. In the event Vertical does not
purchase the stock within 10 days notice of the put Vertical shall issue an
additional 2,500 shares of its Class C Preferred Stock. Vertical shall have the
option of redeeming, at anytime prior to March 17, 2003, Paradigm's holdings of
Vertical Common Stock represented by the Vertical Preferred Stock at a price of
$0.06 per share ("Call").
In October 2002, the Company issued 9,225,296 shares of common stock to Luiz
Valdetaro, the Chief Technology Officer of the Company, and 22,327,630 shares of
common stock to Mountain Reservoir Corporation. These shares were issued in
connection with indemnity and reimbursement agreements between the Company and
Mountain Reservoir Corporation and Mr. Valdetaro, respectively in connection
with the $425,000 note issued in December 2001, whereby the Company would
reimburse Mountain Reservoir Corporation and Valdetaro with the respective
number of shares of the Company stock equal to any shares sold as collateral to
cover the default of any loan. With the issuance of these shares, Mountain
Reservoir Corporation and Mr. Valdetaro have received their full reimbursement
of shares, in the amounts they initially pledged on behalf of the Company, or
36,303,932 and 15,000,000 shares, respectively. In November 2002, Mountain
Reservoir Corporation and Mr. Valdetaro assigned any additional rights they had
in the stock collateral to the Company. The Company is currently pursuing these
rights with the lender to obtain a specific accounting and a refund of any
monies that may be due to the Company.
In October and November 2002, $170,000 principal and $1,341 interest of
debentures were converted into 35,611,428 shares of the Company's common stock.
This conversion was in connection with $265,000 in debentures issued by the
Company to third party holders in September and October 2001.
In November 2002, in connection with an agreement between Government Internet
Systems, Inc. ("GIS")(formally Emily Solutions, Inc.), a wholly-owned subsidiary
of the Company, and Defense Solutions, L.L.C., whereby Defense Solutions agreed
31
to assist in the marketing of the its web based emergency response management
products and services to federal, state, and local governments of the United
States in exchange for one seat on GIS's Board of Directors, and a 15%
commission on all contracts and first year maintenance fees (less any third
party royalties) from any United State's government, non-government or
commercial enterprise or organization resulting from a contact initiated by
Defense Solutions, the Company issued 3 year warrants to purchase 4,000,000
shares of the Company's common stock at a strike price of $0.075.
ITEM 3. DEFAULT UNDER SENIOR SECURITIES
Pursuant to an option agreement with iNet Purchasing, Inc. ("iNet"), which was
entered into in December 2001, the Company had an option to purchase additional
interest in iNet by April 2002, whereby the Company could obtain an aggregate
56% ownership interest in iNet. In accordance with the option agreement, the
Company was required to pay $140,000 in four equal monthly installments
beginning in December 2001 and grant stock options to three iNet employees,
Basil Nikas, Robin Mattern, and Wayne Savage, in the amount of 1,500,000,
1,500,000, and 500,000 shares, respectively. The Company has paid a total of
$131,282 and intends to offset the remaining balance against amounts owed by
iNet pending a final accounting. The options are vested, have a strike price of
$0.010, and must be exercised within 3 years from the date of issuance. Pursuant
to the terms of the Stock Purchase Agreement and the Stockholders Agreements, if
the Company exercised the option to obtain a majority interest in iNet by April
2002, the Company was required to pay to iNet $860,000 in cash or marketable
securities (pending any potential offsets), issue 70,000 shares of Series "C"
Preferred Stock, and issue additional 3-year warrants and options, as the case
may be, to purchase an additional 6,000,000 common stock shares each to Nikas
and Mattern and 2,000,000 common stock shares to Savage, at a strike price of
$0.025. The Company would need to raise additional capital in order to pay the
cash portion of the exercise price. The fair market value of these warrants at
the date of grant was $35,713. Of these warrants and options, the Company issued
1,500,000 warrants to Nikas and Mattern and 500,000 warrants to Savage in
January 2002. In the event that the Company does not acquire a majority interest
in iNet Purchasing, Inc., these options and warrants will be automatically be
cancelled. Under the terms of the option, iNet was required to deliver certain
financial and non-financial information. This information was never delivered
and the Company is holding the warrants issued in January until a resolution is
reached. The Company is seeking an extension of the exercise date to allow iNet
to deliver the required information and to allow the Company an opportunity to
review the information and to make an informed investment decision, as well as
to allow both parties to resolve the issues of monies owed by iNet to the
Company and vice versa. Discussions thus far with iNet have not resulted in a
resolution of this matter.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are filed as part of this filing:
EXHIBIT NO. DESCRIPTION LOCATION
- ----------- ----------- --------
2.1 Certificate of Ownership and Merger Merging Incorporated by reference to Exhibit 1.1 to the
Scientific Fuel Technology, Inc. into Vertical Company's Form 8-K 12G3 filed on May 2, 2000
Computer Systems, Inc.
2.2 Stock Purchase Agreement dated April 5, 2000 between Incorporated by reference to Exhibit 2.2 to the
the Company and all the shareholders of Company's Form 10-KSB/A filed on May 17, 2001
Globalfare.com
2.3 Stockholders Agreement dated October 12, 2000 Incorporated by reference to Exhibit 2.3 to the
between the Company and Vijay Amritraj Company's Form 10-KSB/A filed on May 17, 2001
32
EXHIBIT NO. DESCRIPTION LOCATION
- ----------- ----------- --------
2.4 Vertical - iNPI LLC Operating Agreement dated Incorporated by reference to Exhibit 2.4 to the
April 26, 2000 Company's Form 10-KSB/A filed on May 17, 2001
2.5 INet Government Services LLC Operating Agreement Incorporated by reference to Exhibit 2.5 to the
dated April 28, 2000 Company's Form 10-KSB/A filed on May 17, 2001
3.1 Original Unamended Certificate of Incorporation of Incorporated by reference to Exhibit 1.2 to the
Vertical Computer Systems, Inc. (f/k/a Xenogen Company's Form 8-K 12G3 filed on May 2, 2000
Technology, Inc.)
3.2 Certificate of Amendment of Certificate of Incorporated by reference to Exhibit 3.2 to the
Incorporation (change name to Vertical Computer Company's Form 10-KSB/A filed on May 17, 2001
Systems, Inc.)
3.3 Certificate of Designation of 10% Cumulative Incorporated by reference to Exhibit 3.3 to the
Redeemable Series B Preferred Stock Company's Form 10-KSB/A filed on May 17, 2001
3.4 Certificate of Designation of 15% Cumulative Incorporated by reference to Exhibit 3.4 to the
Redeemable Series D Preferred Stock Company's Form 10-KSB/A filed on May 17, 2001
3.5 Certificate of Amendment of Certificate of Incorporated by reference to Exhibit 3.5 to the
Incorporation (2000) Company's Form 10-KSB/A filed on May 17, 2001
3.6 Certificate of Designation of 4% Cumulative Incorporated by reference to Exhibit 3.6 to the
Redeemable Series A Preferred Stock Company's Form 10-KSB/A filed on May 17, 2001
3.7 Amended and Restated Bylaws of the Company Incorporated by reference to Exhibit 3.7 to the
Company's Form 10-KSB/A filed on May 17, 2001
4.2 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.2 to the
and Ujjwal Bhowmik dated December 17, 1999 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.3 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.3 to the
and Juan Caballero dated December 17, 1999 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.4 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.4 to the
and Tawee Ekundomsin dated December 17, 1999 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.5 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.5 to the
and John R. Feeney dated December 20, 1999 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.6 Non-Statutory Stock Option Agreement between the Incorporated by reference to Exhibit 4.6 to the
Company and Julie M. Holmes Dated December 20, 1999 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.7 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.7 to the
and Laurent H. Tetard dated December 18, 1999 Company's Registration Statement on Form S-8 filed on
July 13, 2001
33
EXHIBIT NO. DESCRIPTION LOCATION
- ----------- ----------- --------
4.8 Non-Statutory Stock Option Agreement between the Incorporated by reference to Exhibit 4.8 to the
Company and Andre Bertrand dated December 16, 1999 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.9 Non-Statutory Stock Option Agreement between the Incorporated by reference to Exhibit 4.9 to the
Company and Jeff Davison dated December 16, 1999 Company's Registration Statement on
Form S-8 filed on July 13, 2001
4.10 Non-Statutory Stock Option Agreement between the Incorporated by referenced to Exhibit 4.10 to the
Company and Bee C. Lavery dated December 16, 1999 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.11 Non-Statutory Stock Option Agreement between the Incorporated by reference to Exhibit 4.11 to the
Company and Donn F. Morey dated December 16, 1999 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.12 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.12 to the
an Steve Lu dated December 19, 2000 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.13 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.13 to the
and Ujjwal Bhowmik dated February 5, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.14 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.14 to the
and Juan Caballero dated February 5, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.15 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.15 to the
and Tawee Ekundomsin dated February 5, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.16 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.16 to the
and John R. Feeney dated February 5, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.17 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.17 to the
and Laurent H. Tetard dated February 5, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.18 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.18 to the
and Diane Castillo dated February 5, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.19 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.19 to the
and Carlos Lomheim dated February 5, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.20 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.20 to the
and Alex Federico dated February 5, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.21 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.21 to the
and Jeannifer Caldona dated February 5, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
34
EXHIBIT NO. DESCRIPTION LOCATION
- ----------- ----------- --------
4.22 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.22 to the
and Geoffrey Golliher dated February 5, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.23 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.23 to the
and Feng Yu (Frank) Zhou dated February 5, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.24 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.24 to the
and Jennifer Kim dated February 5, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.25 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.25 to the
and Daniela Moura dated February 5, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.26 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.26 to the
and James Kim dated February 5, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.27 Non-Statutory Stock Option Agreement between the Incorporated by reference to Exhibit 4.27 to the
Company and Gary Freeman dated February 14, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.28 Non-Statutory Stock Option Agreement between the Incorporated by reference to Exhibit 4.28 to the
Company and William Mills dated February 5, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.29 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.29 to the
and Richard Wade dated February 5, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.30 Non-Statutory Stock Option Agreement between the Incorporated by reference to Exhibit 4.30 to the
Company and Terry Washburn dated February 5, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.31 Non-Statutory Stock Option Agreement between the Incorporated by reference to Exhibit 4.31 to the
Company and Vijay Amritraj dated June 5, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.32 Non-Statutory Stock Option Agreement between the Incorporated by reference to Exhibit 4.32 to the
Company and Munish Gupta dated June 5, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.33 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.33 to the
and Tawee Ekundomsin dated June 15, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.34 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.34 to the
and John R. Feeney dated June 15, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.35 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.35 to the
and Laurent Tetard dated June 15, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
35
EXHIBIT NO. DESCRIPTION LOCATION
- ----------- ----------- --------
4.36 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.36 to the
and Diane Castillo dated June 15, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.37 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.37 to the
and Geoffrey Golliher dated June 15, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.38 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.38 to the
and Frank Zhou dated June 15, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.39 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.39 to the
and Jennifer Kim dated June 15, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.40 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.40 to the
and James Kim dated June 15, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.41 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.40 to the
and James Kim dated June 15, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.42 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.42 to the
and Fabian Marta dated June 15, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.43 Incentive Stock Option Agreement between the Company Incorporated by reference to Exhibit 4.43 to the
and Daniela Moura dated June 15, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.44 Warrant Agreement between the Company and Phil Incorporated by reference to Exhibit 4.44 to the
Alexander dated October 23, 2000 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.45 Warrant Agreement between the Company and Phil Incorporated by reference to Exhibit 4.45 to the
Alexander dated October 23, 2000 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.46 Warrant Agreement between the Company and Michael Incorporated by reference to Exhibit 4.46 to the
Blum dated October 23, 2000 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.47 Warrant Agreement between the Company and Michael Incorporated by reference to Exhibit 4.47 to the
Blum dated October 23, 2000 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.48 Warrant Agreement between the Company and Gary Blum Incorporated by reference to Exhibit 4.48 to the
dated February 5, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.49 Warrant Agreement between the Company and Donald P. Incorporated by reference to Exhibit 4.49 to the
Hateley dated March 5, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
36
EXHIBIT NO. DESCRIPTION LOCATION
- ----------- ----------- --------
4.50 Warrant Agreement between the Company and Robert Incorporated by reference to Exhibit 4.50 to the
Wagman dated May 1, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.51 Warrant Agreement between the Company and Robert Incorporated by reference to Exhibit 4.51 to the
Wagman dated June 1, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.52 Warrant Agreement between the Company and Mark Incorporated by reference to Exhibit 4.52 to the
Kellner dated January 18, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.53 Warrant Agreement between the Company and Stephen Incorporated by reference to Exhibit 4.53 to the
Gunn dated April 9, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
4.54 Warrant Agreement between the Company and Gary L. Incorporated by reference to Exhibit 4.54 to the
Blum dated June 15, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
10.1 1999 Stock Option Plan of the Company Incorporated by reference to Exhibit 10.1 to the
Company's Form 10-KSB/A filed on May 17, 2001
10.2 Business Development and Marketing Agreement between Incorporated by reference to Exhibit 10.2 to the
the Company and Avenel Alliance, Inc. Company's Form 10-KSB/A filed on May 17, 2001
10.3 Marketing Agreement between the Company and Incorporated by reference to Exhibit 10.3 to the
Entertainment Marketing Group Company's Form 10-KSB/A filed on May 17, 2001
10.4 Employment Agreement between the Company and Richard Incorporated by reference to Exhibit 10.4 to the
Wade Company's Form 10-KSB/A filed on May 17, 2001
10.5 Agreement between the Company and Xatnu, Inc. dated Incorporated by reference to Exhibit 10.1 to the
October 16, 2000 Company's Registration Statement on Form S-8 filed on
July 13, 2001
10.6 Agreement between the Company and Xatnu, Inc. dated Incorporated by reference to Exhibit 10.2 to the
June 29, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
10.7 Agreement between the Company and Parker Mills Patel Incorporated by reference to Exhibit 10.3 to the
dated June 29, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
10.8 Agreement between the Company and Franklin Financial Incorporated by reference to Exhibit 10.4 to the
dated July 9, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
10.9 Agreement between the Company and Gary L. Blum, Esq. Incorporated by reference to Exhibit 10.5 to the
dated July 10, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
10.10 Agreement between the Company and Taurus Global, LLC Incorporated by reference to Exhibit 10.6 to the
dated July 9, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
37
EXHIBIT NO. DESCRIPTION LOCATION
- ----------- ----------- --------
10.11 Agreement between the Company and M.S. Farrell & Incorporated by reference to Exhibit 10.7 to the
Co., Inc. dated July 9, 2001 Company's Registration Statement on Form S-8 filed on
July 13, 2001
10.12 Letter Agreement dated as of February 23, 2001 Incorporated by reference to Exhibit 2.1 to the
between Arglen Acquisitions, LLC and the Company Company's 8-K filed on May 16, 2001
10.13 NOW Solutions, LLC Operating Agreement dated as of Incorporated by reference to Exhibit 2.2 to the
February 27, 2001 between Arglen Acquisitions LLC Company's 8-K filed on May 16, 2001
and the Company
10.14 Certificate of Designation of Vertical Computers, Incorporated by reference to Exhibit 3.1 to Company's
Inc. Series "C" 4% Cumulative Convertible Preferred Form 10-QSB/A filed on December 19, 2001
Stock
10.15 (a) Berche Promissory Note dated August 13, 2001 Incorporated by reference to Exhibit 10.1 to the
Company's Form 10-QSB/A filed on December 19,
(b) Berche Stock Pledge Agreement dated August 13, 2001
2001
(c) Berche Warrants dated August 13, 2001
10.16 Equity Line of Credit Agreement between the Company Incorporated by reference to Exhibit 10.2 to the
and Cornell Capital Partners, L.P. dated August 16, Company's Form 10-QSB/A filed on December 19, 2001
2001
10.17 Securities Purchase Agreement between the Company Incorporated by reference to Exhibit 10.3 to the
and third party buyers for $250,000 of Convertible Company's Form 10-QSB/A filed on December 19, 2001
Debentures
10.18 Enfacet, Inc. Stock Purchase Agreement dated Incorporated by reference to Exhibit 10.4 to the
August 21, 2001 Company's Form 10-QSB/A filed on December 19, 2001
10.19 Agreement between Enfacet and the Company dated Incorporated by reference to Exhibit 10.5 to the
August 24, 2001 Company's Form 10-QSB/A filed on December 19, 2001
10.20 Agreement between the Company and Chuck Ashman dated Incorporated by reference to Exhibit 10.1 to the
October 29, 2001 Company's Registration Statement on Form S-8 filed on
November 8, 2001
10.21 Agreement between the Company and Michael Blum dated Incorporated by reference to Exhibit 10.2 to the
October 29, 2001 Company's Registration Statement on Form S-8 filed on
November 8, 2001
10.22 Agreement between the Company and Gary Blum dated Incorporated by reference to Exhibit 10.3 to the
November 2, 2001 Company's Registration Statement on Form S-8 filed on
November 8, 2001
10.23 Agreement between the Company and Justin Davis dated Incorporated by reference to Exhibit 10.4 to the
October 29, 2001 Company's Registration Statement on Form S-8 filed on
November 8, 2001
38
EXHIBIT NO. DESCRIPTION LOCATION
- ----------- ----------- --------
10.24 Agreement between the Company and Allison Enderle Incorporated by reference to Exhibit 10.5 to the
dated October 29, 2001 Company's Registration Statement on Form S-8 filed on
November 8, 2001
10.25 Agreement between the Company and Robert Farias Incorporated by reference to Exhibit 10.6 to the
dated October 30, 2001 Company's Registration Statement on Form S-8 filed on
November 8, 2001
10.26 Agreement between the Company and Donald P. Hateley Incorporated by reference to Exhibit 10.7 to the
dated October 29, 2001 Company's Registration Statement on Form S-8 filed on
November 8, 2001
10.27 Agreement between the Company and Annette Keith Incorporated by reference to Exhibit 10.8 to the
dated October 29, 2001 Company's Registration Statement on Form S-8 filed on
November 8, 2001
10.28 Agreement between the Company and Aubrey McAuley Incorporated by reference to Exhibit 10.9 to the
dated October 29, 2001 Company's Registration Statement on Form S-8 filed on
November 8, 2001
10.29 Agreement between the Company and Tom McCloskey Incorporated by reference to Exhibit 10.10 to the
dated October 29, 2001 Company's Registration Statement on Form S-8 filed on
November 8, 2001
10.30 Agreement between the Company and William Mills Incorporated by reference to Exhibit 10.11 to the
dated October 29, 2001 Company's Registration Statement on Form S-8 filed on
November 8, 2001
10.31 Agreement between the Company and Leroy Molock dated Incorporated by reference to Exhibit 10.12 to the
October 29, 2001 Company's Registration Statement on Form S-8 filed on
November 8, 2001
10.32 Agreement between the Company and David Rezeieh Incorporated by reference to Exhibit 10.13 to the
dated October 29, 2001 Company's Registration Statement on Form S-8 filed on
November 8, 2001
10.33 Agreement between the Company and Steve Rossetti Incorporated by reference to Exhibit 10.14 to the
dated October 29, 2001 Company's Registration Statement on Form S-8 filed on
November 8, 2001
10.34 Agreement between the Company and Priyam Sharma Incorporated by reference to Exhibit 10.15 to the
dated November 2, 2001 Company's Registration Statement on Form S-8 filed on
November 8, 2001
10.35 Agreement between the Company and Jacob Stearns Incorporated by reference to Exhibit 10.16 to the
dated October 29, 2001 Company's Registration Statement on Form S-8 filed on
November 8, 2001
10.36 Agreement between the Company and Marilyn Stewart Incorporated by reference to Exhibit 10.17 to the
dated November 1, 2001 Company's Registration Statement on Form S-8 filed on
November 8, 2001
10.37 Agreement between the Company and Vasu Vijay dated Incorporated by reference to Exhibit 10.18 to the
October 29, 2001 Company's Registration Statement on Form S-8 filed on
November 8, 2001
39
EXHIBIT NO. DESCRIPTION LOCATION
- ----------- ----------- --------
10.38 Agreement between the Company and Vijay Armitraj Incorporated by reference to Exhibit 10.19 to the
dated October 29, 2001 Company's Registration Statement on Form S-8 filed on
November 8, 2001
10.39 Agreement between the Company and Taurus Global, LLC Incorporated by reference to Exhibit 10.20 to the
dated July 9, 2001 Company's Registration Statement on Form S-8 filed on
November 8, 2001
10.40 Agreement between the Company and M.S. Farrell & Incorporated by reference to Exhibit 10.21 to the
Co., Inc. dated July 9, 2001 Company's Registration Statement on Form S-8 filed on
November 8, 2001
10.41 Equity Line of Credit Agreement dated as of August Incorporated by reference to Exhibit 10.40 to the
2001, between the Company and Cornell Capital Company's Form 10-KSB A filed on May 20, 2002
Partners, L.P.
10.42 Registration Rights Agreement dated as of August Incorporated by reference to Exhibit 10.42 to the
2001 between the Company and the buyers identified Company's Form 10-KSB A filed on May 20, 2002
therein.
10.43 Escrow Agreement dated as of August 2001 among the Incorporated by reference to Exhibit 10.43 to the
Company, Yorkville Advisors Management, LLC and Company's Form 10-KSB A filed on May 20, 2002
First Union National Bank.
10.44 Form of Debenture Incorporated by reference to Exhibit 10.44 to the
Company's Form 10-KSB A filed on May 20, 2002
10.45 Securities Purchase Agreement dated as of August Incorporated by reference to Exhibit 10.45 to the
2001 among between the Company and the buyers Company's Form 10-KSB A filed on May 20, 2002
identified therein
10.46 Consulting Agreement dated as of August 2001 between Incorporated by reference to Exhibit 10.46 to the
the Company and Yorkville Advisors Management, LLC Company's Form 10-KSB A filed on May 20, 2002
10.47 Placement Agent Agreement dated as of August 2001 Incorporated by reference to Exhibit 10.47 to the
among the Company, Westrock Advisors, Inc. and Company's Form 10-KSB A filed on May 20, 2002
Cornell Capital Partners, L.P.
10.48 Registration Rights Agreement dated as of August Incorporated by reference to Exhibit 10.48 to the
2001 between the Company and Cornell Capital Company's Form 10-KSB A filed on May 20, 2002
Partners, L.P.
10.49 Escrow Agreement dated as of August 2001 among the Incorporated by reference to Exhibit 10.49 to the
Company, Cornell Capital Partners, L.P., Butler Company's Form 10-KSB A filed on May 20, 2002
Gonzalez LLP and First Union National Bank.
10.50 Warrant dated as of November 2001 given by the Incorporated by reference to Exhibit 10.50 to the
Company to Parker, Mills & Patel, LLP Company's Form 10-KSB A filed on May 20, 2002
10.51 Promissory Note dated as of November 2001 given by Incorporated by reference to Exhibit 10.51 to the
the Company to Parker, Mills & Patel, LLP Company's Form 10-KSB A filed on May 20, 2002
10.52 Promissory Note dated as of December 2001 given by Incorporated by reference to Exhibit 10.52 to the
the Company to Brighton Opportunity Fund, LP Company's Form 10-KSB A filed on May 20, 2002
40
EXHIBIT NO. DESCRIPTION LOCATION
- ----------- ----------- --------
10.53 Bridge loan dated as of December 2001 given by the Incorporated by reference to Exhibit 10.53 to the
Company to Brighton Opportunity Fund, LP Company's Form 10-KSB A filed on May 20, 2002
10.54 Option Agreement dated as of December 2001 given by Incorporated by reference to Exhibit 10.54 to the
the Company to iNetPurchasing, Inc. Company's Form 10-KSB A filed on May 20, 2002
10.55 Stock Pledge Agreement dated as of December 2001 Incorporated by reference to Exhibit 10.55 to the
given by Mountain Reservoir Corp. to Brighton Company's Form 10-KSB A filed on May 20, 2002
Opportunity Fund, LP
10.56 Option Agreement dated as of December 2001 given by Incorporated by reference to Exhibit 10.56 to the
the Company to Basil Nikas Company's Form 10-KSB A filed on May 20, 2002
10.57 Option Agreement dated as of December 2001 given by Incorporated by reference to Exhibit 10.57 to the
the Company to Robin Mattern Company's Form 10-KSB A filed on May 20, 2002
10.58 Option Agreement dated as of December 2001 given by Incorporated by reference to Exhibit 10.58 to the
the Company to Wayne Savage Company's Form 10-KSB A filed on May 20, 2002
10.59 Consulting Agreement dated as of January 2002 Incorporated by reference to Exhibit 10.59 to the
between the Company and Taurus Global, LLC Company's Form 10-KSB A filed on May 20, 2002
10.60 Reimbursement and Indemnity Agreement dated as of Incorporated by reference to Exhibit 10.60 to the
January 2002 between the Company and Luiz Claudio Company's Form 10-KSB A filed on May 20, 2002
Valdetaro Galvao e Mello
10.61 Stock Pledge Agreement dated as of December 2001 Incorporated by reference to Exhibit 10.61 to the
given by Luiz Claudio Valdetaro Galvao e Mello to Company's Form 10-KSB A filed on May 20, 2002
Brighton Opportunity Fund, LP
10.62 Amendment Agreement dated as of January 2002 between Incorporated by reference to Exhibit 10.62 to the
the Company and Strategic Media Alliance Company's Form 10-KSB A filed on May 20, 2002
10.63 Memorandum of Agreement dated as of January 2002 Incorporated by reference to Exhibit 10.63 to the
between the Company and Strategic Media Alliance Company's Form 10-KSB A filed on May 20, 2002
10.64 Service Agreement dated as of October 31, 2001 Incorporated by reference to Exhibit 10.64 to the
between the Company and Robert Farias Company's Form 10-KSB A filed on May 20, 2002
10.65 Promissory Note Agreement as of October 31, 2001 Incorporated by reference to Exhibit 10.65 to the
between the Company and Paradigm Sales, Inc. Company's Form 10-KSB A filed on May 20, 2002
10.66 Asset Pledge Agreement as of October 31, 2001 Incorporated by reference to Exhibit 10.66 to the
between the Company and Robert Farias Company's Form 10-KSB A filed on May 20, 2002
10.67 Letter Agreement as of October 31, 2001 between the Incorporated by reference to Exhibit 10.67 to the
Company and Robert Farias Company's Form 10-KSB A filed on May 20, 2002
10.68 Promissory Note Agreement as of October 31, 2001 Incorporated by reference to Exhibit 10.68 to the
between the Company and Robert Farias Company's Form 10-KSB A filed on May 20, 2002
10.69 Stock Pledge Agreement as of October 31, 2001 Incorporated by reference to Exhibit 10.69 to the
between the Company and Robert Farias Company's Form 10-KSB A filed on May 20, 2002
41
EXHIBIT NO. DESCRIPTION LOCATION
- ----------- ----------- --------
10.70 Stock Pledge Letter Agreement as of October 31, 2001 Incorporated by reference to Exhibit 10.70 to the
between the Company and Robert Farias Company's Form 10-KSB A filed on May 20, 2002
10.71 Promissory Note Agreement as of November 7, 2001 Incorporated by reference to Exhibit 10.71 to the
between the Company and Robert Farias Company's Form 10-KSB A filed on May 20, 2002
10.72 Employment Agreement as of December 1, 2001 between Incorporated by reference to Exhibit 10.72 to the
the Company and Richard Wade Company's Form 10-KSB A filed on May 20, 2002
10.73 Warrant Agreement as of December 19, 2001 between Incorporated by reference to Exhibit 10.73 to the
the Company and Richard Wade Company's Form 10-KSB A filed on May 20, 2002
10.74 Warrant Agreement as of December 19, 2001 between Incorporated by reference to Exhibit 10.74 to the
the Company and Richard Wade Company's Form 10-KSB A filed on May 20, 2002
10.75 Reimbursement and Indemnity Agreement as of January Incorporated by reference to Exhibit 10.75 to the
15, 2002 between the Company and Luiz Claudio Company's Form 10-KSB A filed on May 20, 2002
Valdetaro Galvao e Mello
10.76 Reimbursement and Indemnity Agreement as of January Incorporated by reference to Exhibit 10.76 to the
15, 2002 between the Company and Mountain Reservoir Company's Form 10-KSB A filed on May 20, 2002
Corporation
10.77 Reimbursement and Indemnity Agreement as of January Incorporated by reference to Exhibit 10.77 to the
15, 2002 between the Company and Mountain Reservoir Company's Form 10-KSB A filed on May 20, 2002
Corporation
10.78 Reimbursement and Indemnity Agreement as of January Incorporated by reference to Exhibit 10.78 to the
15, 2002 between the Company and Mountain Reservoir Company's Form 10-KSB A filed on May 20, 2002
Corporation
10.79 Letter Amendment Agreement as of April 5, 2002 Incorporated by reference to Exhibit 10.79 to the
between the Company and Robert Farias Company's Form 10-KSB A filed on May 20, 2002
10.80 Letter Amendment Agreement as of April 12, 2002 Incorporated by reference to Exhibit 10.80 to the
between the Company and the Anne Berche Trust Company's Form 10-KSB A filed on May 20, 2002
10.81 Asset Purchase Agreement dated November 14, 2001 Incorporated by reference to Exhibit 10.81 to the
between the Company and Paradigm Sales, Inc. Company's Form 10-KSB A filed on May 20, 2002
10.82 (a) Promissory Note, dated June 3, 2002, between the Incorporated by reference to Exhibit 10.82 to the
Company and Benjamin Company's Form 10-QSB filed on June 24, 2002
(b) Stock Pledge Agreement, dated June 3, 2002,
between the Company and Benjamin
(c) Benjamin Warrants, dated June 3, 2002, between
the Company and Benjamin
10.83 (a) Loos Promissory Note, dated June 24, 2002, Incorporated by reference to Exhibit 10.83 to the
between the Company and Loos Company's Form 10-QSB filed on September 25, 2002
(b) Loos Stock Pledge Agreement, dated June 24,
2002, between the Company and Loos
(c) Loos Warrants dated June 24, 2002, between the
Company and Loos
42
EXHIBIT NO. DESCRIPTION LOCATION
- ----------- ----------- --------
10.84 Second Amendment of Farias Services Documents and Incorporated by reference to Exhibit 10.84 to the
Note, between Robert Farias and Company, dated June Company's Form 10-QSB filed on September 25, 2002
25, 2003
10.85 Employment Agreement, dated July 1, 2002, between Incorporated by reference to Exhibit 10.85 to the
McAuley and the Company Company's Form 10-QSB filed on September 25, 2002
10.86 Equitilink Services Agreement, dated July 10, 2002, Incorporated by reference to Exhibit 10.86 to the
between the Company and Equitilink Company's Form 10-QSB filed on September 25, 2002
10.87 (a) Loos Promissory Note, dated August 7, 2002, Incorporated by reference to Exhibit 10.87 to the
between the Company and Loos Company's Form 10-QSB filed on September 25, 2002
(b) Loos Stock Pledge Agreement, dated August 7,
2002, between the Company and Loos
10.88 Agency Services Agreement dated, August 9, 2002, Incorporated by reference to Exhibit 10.88 to the
between the Company and Loos Company's Form 10-QSB filed on September 25, 2002
10.89 (a) Valdetaro Promissory Note, dated August 20, Incorporated by reference to Exhibit 10.89 to the
2002, between the Company and Valdetaro Company's Form 10-QSB filed on September 25, 2002
(b) Valdetaro Stock Pledge Agreement, dated August
20, 2002, between the Company and Valdetaro
(c) Valdetaro Warrants, dated August 20, 2002,
between the Company and Valdetaro
10.90 Amendment to Consulting Agreement, dated Incorporated by reference to Exhibit 10.90 to the
July 13, 2001, by and between the Company and Company's Form 10-QSB filed on September 25, 2002
Rossetti
10.91 Amendment Number Two to Deposit Account Pledge Incorporated by reference to Exhibit 10.91 to the
Agreement, dated October 16, 2002, between the Company's Form 8-K filed on October 23, 2002
Company and Coast Business Credit
10.92 Stock Purchase Agreement, dated September 26, 2002, Provided herewith
between the Company and Equitilink, LLC
10.93 (a) Farias Term Sheet dated October 17, 2002, Provided herewith
between the Company and Robert Farias
(b) Farias Promissory Note, dated October 17, 2002,
between the Company and Robert Farias
(c) Stock Pledge Agreement, dated October 17, 2002,
between Mountain Reservoir Corp. and Robert Farias
(d) Farias Put and Call Agreement, dated October 17,
2002, between the Company and Paradigm Sales
10.94 Services Agreement, dated November 15, 2002.between Provided herewith
Defense Solutions, LLC, and Company's subsidiary,
Government Internet Systems, Inc.
43
EXHIBIT NO. DESCRIPTION LOCATION
- ----------- ----------- --------
10.95 Weber Promissory Note, dated December 5, 2002, Provided herewith
between the Company and Victor Weber
(b) Reports on Form 8-K:
Form on 8-K filed on October 23, 2002, for amendment to Loan
and Security Agreement between the Company's subsidiary, NOW
Solutions L.L.C., and Coast Business Credit and amendment to
deposit account pledge agreement between the Company and
Coast Business Credit.
Form on 8-K filed on December 3, 2002, for amendment to
articles of incorporation to change name of the Company's
subsidiary, Emily Solutions, Inc. to Government Internet
Solutions and the appointment of new directors and officers
with respect to this entity.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
Date: December 10, 2002 VERTICAL COMPUTER SYSTEMS, INC.
By: /s/ Richard Wade
------------------------------------
Richard Wade, President,
Chief Executive Officer and
Acting Chief Financial Officer
(Principal Accounting Officer)
44
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Vertical Computer Systems, Inc.
(the "Company") on Form 10-QSB for the period ended September 30, 2002 as filed
with the Securities and Exchange Commission on the date hereof (the "Report"),
each of the undersigned, in the capacities and on the dates indicated below,
hereby certifies pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, that to his knowledge:
1. The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operation of the
Company.
Date: December 10, 2002
By: /s/ Richard Wade
------------------------------------
Richard Wade, President and
Chief Executive Officer
By: /s/ Richard Wade
------------------------------------
Richard Wade
Acting Chief Financial Officer
45
FORM OF OFFICER'S CERTIFICATE
PURSUANT TO SECTION 302
-----------------------
I, Richard Wade, Chief Executive Officer and Acting Chief Financial
Officer of Vertical Computer Systems, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Vertical
Computer Systems, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
in order to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
issuer as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rule 13a-14 and 15d-14) for the registrant and have:
a. Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b. Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date");
c. Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and to the audit
committee of the registrant's board of directors (or persons performing the
equivalent functions):
a. All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b. Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
December 10, 2002 /s/ Richard Wade
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Richard Wade
Chief Executive officer and
Acting Chief Financial Officer
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