U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB/A
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended September 30, 2001.
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)
The Company is amending its 10-QSB, since a review has been completed by the
Company's Independent Certified Public Accountants.
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 registrant 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, 615,191,422 shares issued and outstanding as of December 19, 2001.
Transitional Small Business Disclosure Format (check one): Yes |_| No |X|
VERTICAL COMPUTERS SYSTEMS, INC. AND SUBSIDIARIES
INDEX TO FORM 10-QSB/A
PART I FINANCIAL INFORMATION Page
Item 1. Condensed Consolidated Financial Statements:
Report of Independent Certified Public Accountants 3
Condensed Consolidated Balance Sheets (unaudited) as of
September 30, 2001 4
Condensed Consolidated Statements of Operations (unaudited)
for the Three and Nine Months Ended September 30, 2001 and 2000 6
Condensed Consolidated Statements of Cash Flows (unaudited) for
The Nine Months Ended September 30, 2001 and 2000 7
Notes to Condensed Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 13
PART II OTHER INFORMATION
Item 1 Legal Proceedings 26
Item 2 Changes in Securities and Use of Proceeds 26
Item 3 Defaults Under Senior Securities 28
Item 4. Submission of Matters To A Vote Of Security Holders 28
Item 5 Other Information 28
Item 6. Exhibits and Reports on Form 8-K 29
2
Report of Independent Certified Public Accountants
Vertical Computer Systems, Inc.
Los Angeles, CA
We have reviewed the accompany condensed consolidated financial statements of
Vertical Computer Systems, Inc. as of September 30, 2001, and for the
three-month and nine-month periods then ended. These financial statements are
the responsibility of the company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquires of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with auditing standards generally accepted in the United States of America, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to the accompanying financial statements for them to be in
conformity with accounting principals generally accepted in the United States of
America.
The accompanying condensed consolidated financial statements have been prepared
assuming the Company will continue as a going concern. As discussed in Note 1 to
the condensed consolidated financial statements, the Company has suffered
recurring operating losses that raise substantial doubt about its ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note 1. The condensed consolidated financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
/s/ BDO Seidman, LLP
Los Angeles, CA
December 19, 2001
3
Item 1. Condensed Consolidated Financial Statements
VERTICAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED)
September 30,
2001
- --------------------------------------------------------------------------------
Assets
Current Assets
Cash $ 781,946
Restricted cash 1,552,527
Securities available for sale 528,000
Accounts receivable, net of allowance for bad
debts of $43,650 1,098,702
Receivable from officers and employees 3,796
Prepaid expenses 52,596
- --------------------------------------------------------------------------------
Total current assets 4,017,567
Property and equipment, net of accumulated depreciation 1,073,785
Goodwill and other intangibles, net 6,503,759
Deposits 70,507
- --------------------------------------------------------------------------------
Total assets $11,665,618
================================================================================
Liabilities, Convertible Preferred Stock and Stockholders' Equity
Current liabilities
Accounts payable and accrued
liabilities $ 1,185,333
Deferred revenue 1,811,886
Accrued dividends 34,891
Current portion - notes payable 5,215,938
- --------------------------------------------------------------------------------
Total current liabilities 8,248,048
Convertible debt 125,000
Note payable, net of discount and
current portion 1,212,505
- --------------------------------------------------------------------------------
Total liabilities $ 9,585,553
================================================================================
See accompanying notes to the condensed consolidated financial statements
4
VERTICAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
September 30,
2001
- -----------------------------------------------------------------------------------------------
Commitments and contingencies
Series B 10% Convertible Preferred stock; $0.001 par value; 375,000
Shares authorized; 7,200 shares issued and outstanding
at September 30, 2001 45,000
Series D 15% Convertible Preferred stock; $0.001 par value; 300,000
Shares authorized; 25,000 shares issued and outstanding
at September 30, 2001 156,250
Minority interest 267,000
Stockholders' Equity
Common stock; $0.00001 par value;
1,000,000,000 shares authorized; 594,967,965 and shares
issued and outstanding at September 30, 2001 5,950
Series A 4% Convertible Cumulative Preferred stock; $0.001 par value;
250,000 shares authorized; 50,000 shares issued and outstanding at
September 30, 2001 50
Series A Preferred stock; par value $0.001; 750,000 shares authorized; No
shares issued and outstanding at September 30, 2001 --
Series C 4% Cumulative Convertible Preferred Stock; par value $0.001;
200,000 shares authorized; 30,000 shares issued and outstanding to a
subsidiary of the Company at September 30, 2001 --
Series C Preferred stock; par value $0.001; 175,000 shares authorized; no
shares issued and outstanding at September 30, 2001 --
Subscription receivable (2,000)
Additional paid-in capital 25,506,125
Accumulated deficit (24,126,310)
Accumulated other comprehensive income 228,000
- -----------------------------------------------------------------------------------------------
Total stockholders' equity 1,611,815
- -----------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 11,665,618
===============================================================================================
See accompanying notes to the condensed consolidated financial statements
5
VERTICAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
-------------------------------- --------------------------------
2001 2000 2001 2000
------------- ------------- ------------- -------------
Revenues:
Maintenance $ 255,257 $ -- $ 1,182,798 $ --
Consulting services 63,878 -- 849,455 --
Other 670,675 6,833 331,879 54,886
------------- ------------- ------------- -------------
Total revenues $ 989,810 $ 6,833 $ 2,364,132 $ 54,886
Selling, general and administrative expenses 5,140,974 1,353,621 11,186,558 3,022,682
------------- ------------- ------------- -------------
Operating loss (4,151,164) (1,346,788) (8,822,426) (2,967,796)
Interest income 14,433 114,516 119,433 274,594
Interest expense (153,786) (5,668) (347,272) (19,225)
Gain on sale of asset -- 838,252 -- 838,252
------------- ------------- ------------- -------------
Net loss before minority interest (4,290,517) (399,688) (9,050,265) (1,874,175)
Minority interest in loss of subsidiary 185,294 -- 400,005 --
------------- ------------- ------------- -------------
Net loss (4,105,223) (399,688) (8,650,260) (1,874,175)
Dividend applicable to preferred stock (14,400) -- (196,846) --
------------- ------------- ------------- -------------
Net loss applicable to common stockholders' $ (4,119,623) $ (399,688) $ (8,847,106) $ (1,874,175)
============= ============= ============= =============
Basic and diluted loss per common share $ (0.01) $ (0.01) $ (0.02) $ (0.01)
============= ============= ============= =============
Basic and diluted weighted average of common
shares outstanding 590,174,993 782,405,794 578,530,002 728,576,772
============= ============= ============= =============
Comprehensive loss and its components
consist of the following:
Net loss $ (4,105,223) $ (399,688) $ (8,650,260) $ (1,874,175)
Loss on securities available for sale (144,000) -- (192,000) --
------------- ------------- ------------- -------------
Comprehensive loss $ (4,249,223) $ (399,688) $ (8,842,260) $ (1,874,175)
============= ============= ============= =============
See accompanying notes to condensed consolidated financial statements.
6
VERTICAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000
(Unaudited)
Nine Months Ended September 30,
2001 2000
-------------------------------
Cash Flows From Operating activities
Net loss $(8,650,260) ($1,874,175)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 1,094,583 75,526
Minority Interest in Subsidiary (400,005) --
Non-employee compensation expense
and stock issued for services 1,883,380 505,803
Allowance for bad debt 43,659 (14,900)
Gain on sale of subsidiary -- (863,252)
Write off for investments 367,788 --
Changes in operating assets and liabilities:
Accounts receivable (617,918) 36,681
Receivable for related party 17,834 (1,068,767)
Prepaids (10,747) (134,334)
Deposits (1,443) (7,783)
Other assets 35,000 16,469
Accounts Payable 625,314 (71,992)
Deferred revenue 1,811,886 --
-----------------------------
Net cash used in operating activities (3,800,929) (3,400,724)
Cash flow from investing activities:
Restriction of cash for debt guarantee (1,500,000) --
Purchase of equipment -- (822,458)
Proceeds paid for investments -- (650,000)
Proceeds paid for securities available for sale -- (300,000)
Proceeds received from sale of subsidiary, net of restricted
cash -- 575,779
Purchase of payroll division 498,741 --
-----------------------------
Net cas used in investing activities (1,001,259) (1,196,679)
Cash Flow from financing activities:
Proceeds from issuance of Series A Preferred Stock -- 9,000,000
Proceeds from exercise of warrants -- 1,700,000
Proceeds form stock options exercised -- 92,204
Proceeds from Convertible Debt 125,000 --
Payment of note payable (457,500) (10,000)
Proceeds from note payable 317,822 --
-----------------------------
Net Cash provided by (used in) financing activities (14,678) 10,782,204
Net increase (decrease) in cash (4,816,866) 6,184,801
Cash and cash equivalents, beginning of period 5,598,812 210,924
-----------------------------
Cash and cash equivalents, end of period $ 781,946 $ 6,395,725
=============================
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 282,902 $ 19,225
Income Taxes $ -- $ --
See accompany notes to the condensed consolidated financial statements
7
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. 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, 2000.
Going Concern Uncertainty
The accompanying 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 report of the Company's Independent Certified Public Accountants for
the December 31, 2000 financial statements included an explanatory paragraph
expressing substantial doubt about the Company's ability to continue as a going
concern.
At this point in time, the Company has generated revenue, however it continues
to suffer operating losses. The Company believes it can launch a number of
products, services and other revenue generating programs. Additionally, the
Company believes its three existing international in-country partners have the
ability and resources to market its products concurrently in their respective
country of origin.
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.
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
consolidated financial statements contain no adjustment for the outcome of this
uncertainty.
8
Note 2 - Common and Preferred Stock Transactions
On July 11, 2001, the Company entered into two consulting agreements, in which
the Company agreed to issue approximately $200,000 in common stock to each
consultant for business advisory services. 20% of the common stock was due on
the agreement date, with an additional 20% due on the 30th and 60th day
subsequent to the agreement date and the remaining 40% due on the 90th day
subsequent to the agreement date. The number of shares to be issued to each
consultant will be determined on the date each consulting fee is due. These
shares were registered pursuant to the Form S-8 filed on July 13, 2001. The
Company is also obligated to issue warrants to purchase 500,000 shares of
Company's common stock to each consultant. As of September 30, 2001 the Company
has issued 10,081,152 shares of its common stock in exchange for the consulting
services provided and 1,000,000 warrants. 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. As of September
30, 2001, the Company recognized approximately $248,000 in consulting expenses
in relation to the common stock issued and $10,000 for the value of the warrants
(the warrants were valued using the black-scholes valuation model).
In August 2001, the Company issued $125,000 of convertible debentures. The debt
accrues interest at 6% per annum and is due October 2006. 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 3 lowest closing bid prices 20 days prior
to the conversion. The debenture is convertible at the option of the holder, any
time after purchase. The Company has recognized $31,250 as interest expense in
relation to the beneficial feature conversion of the debentures. As of September
30, 2001 no conversions have taken place.
In August 2001, the Company issued a $180,000 note, which is due February 2002
and bears interest at 12% per annum. In connection with the note, the Company
issued 500,000 warrants to purchase shares of its common stock and pledged third
party securities owned by the Company and available for sale as collateral for
the note. The warrants vested immediately and are exercisable for three years
from issuance. The value of the warrants, $5,000 (valued using the black-scholes
valuation model) has been deferred and will be amortized over the term of the
loan.
In August 2001, the Company entered into an Equity Line of Credit agreement,
whereby up to $10,000,000 of the Company's common stock may be purchased. The
shares must be registered before sale and the shares can be purchased at 95% of
the closing bid price, on the date of purchase. The equity line of credit
contains a fee of $400,000 payable in common stock. As of September 30, 2001,
the Company issued 7,142,857 shares of common stock or $200,000 (fair market
value of shares issued) of the fee and accrued for the remaining portion, which
is to be paid the earlier of the registration of shares that are to be issued in
connection with the Equity Line of Credit or six months. Also, as of September
30, 2001 no shares have been purchased.
In August 2001, the Company issued 30,000 shares of its Series C 4% Cumulative
Convertible Preferred Stock to acquire 100% of the outstanding common stock of
Enfacet, Inc. ("Enfacet"), a Company involved in the development of website
management software. The Series C 4% convertible stock eliminates on
consolidation, since the shares were issued to Enfacet. As per the agreement,
Enfacet shall distribute 15,000 shares to those employees still employed by
Enfacet, one year from the anniversary date of the agreement. At that time the
remaining shares may be used by Enfacet to acquire additional funding. The fair
value of the liabilities assumed by the Company approximated $428,000, which was
off set by assets with an approximate fair value of the same amount.
The Series C 4% Cumulative Convertible Preferred Stock is convertible into
shares of the Company's common stock at a ratio of one to four hundred.
Dividends on the stock are cumulative and accrue on a quarterly basis. In the
event of a voluntary or involuntary liquidation, the Series C 4% shareholders
are entitled to a liquidation preference of $100 per share.
9
Throughout the third quarter of fiscal 2001, the Company issued 5,036,449 shares
of its common stock or $186,350 (fair market value of shares issued), to various
legal, investment and marketing consultants for services rendered. These shares
were registered pursuant to the Form S-8 filed on July 13, 2001.
Note 3 - Acquisition
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 $1,000,0000. 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.
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 $1,500,0000 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 thirds 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, which is
being amortized over a 3 to 8 year period.
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.
Note 4 - Notes Payable
NOW Solutions, LLC has been notified by a lender that it is in default of
certain covenants in the loan agreement, in which the Company has pledged a $1.5
million deposit as collateral pursuant to the declining pledge agreement. This
deposit is reflected as restricted cash on the balance sheets.
10
Note 5 - Legal Proceedings
The Company is, from time to time, involved in various lawsuits generally
incidental to its 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.
In addition, the Company is involved in two additional litigated matters. The
case entitled, Margaret Greco, et al., v. Vertical Computer Systems, Inc., filed
in United States District Court for the Eastern District of New York (Case No.
00 Civ. 6551 (DRH), involves allegations that the plaintiffs sustained damage as
a result of an alleged improper rescission of a subscription agreement based on
a November 1999 private placement memorandum. Plaintiffs seek damages based on
the alleged increase in value of the stock since the private placement. The
matter is open and the Company is vigorously defending this action.
A second matter, entitled La Societe Francaise de Casinos v. Vertical Computer
Systems, Inc., was filed in Los Angeles County, California, Superior Court, on
January 19, 2001. This action was filed by a former customer of Externet World,
Inc., a former wholly owned subsidiary, which claimed that the Company is liable
to it for in excess of $500,000 in costs allegedly paid for an Internet casino
software package to be developed and maintained by Externet World. The plaintiff
also alleges that the Company has breached an agreement to pay the disputed sums
flowing out of its October 2000 settlement of litigated matters with two former
shareholders of the Company. The Company executed a Settlement and Mutual
General Release Agreement on July 20, 2001. Pursuant to the settlement
agreement, the Company received all right, title, and interest in and to the
internet gaming software package developed by Externet World and Casino in
exchange for payment of $400,000 by the Company to Casino, and payment of state
and federal taxes on behalf of Externet World. Only a few nominal and
non-contested matters remain open regarding (a) payment of state taxes and (b)
transfer of domain names. Those issues should be resolved by January 31, 2002.
Note 6 - New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board finalized FASB Statements
No. 141, Business Combinations (SFAS 141), and No. 142, Goodwill and Other
Intangible Assets (SFAS 142). SFAS 141 requires the use of the purchase method
of accounting and prohibits the use of the pooling-of-interests method of
accounting for business combinations initiated after June 30, 2001. SFAS 141
also requires that the Company recognize acquired intangible assets apart from
goodwill if the acquired intangible assets meet certain criteria. SFAS 141
applies to all business combinations initiated after June 30, 2001 and for
purchase business combinations completed on or after July 1, 2001. It also
requires, upon adoption of SFAS 142, that the Company reclassify the carrying
amounts of intangible assets and goodwill based on the criteria in SFAS 141.
SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that the Company identify reporting units for the
purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in
fiscal years beginning after December 15, 2001 to all goodwill and other
intangible assets recognized at that date, regardless of when those assets were
initially recognized. SFAS 142 requires the Company to complete a transitional
goodwill impairment test six months from the date of adoption. The Company is
also required to reassess the useful lives of other intangible assets within the
first interim quarter after adoption of SFAS 142.
11
Some of the Company's previous business combinations were accounted for using
the purchase method of accounting. As of September 30, 2001, the net carrying
amount of goodwill and other intangible assets is $6,071,759. Currently, the
Company is assessing but has not yet determined how the adoption of SFAS 141 and
SFAS 142 will impact its financial position and results of operations.
SFAS 143, Accounting for Asset Retirement Obligations, was issued in June 2001
and is effective for fiscal years beginning after June 15, 2002. SFAS 143
requires that any legal obligation related to the retirement of long-lived
assets be quantified and recorded as a liability with the associated asset
retirement cost capitalized on the balance sheet in the period it is incurred
when a reasonable estimate of the fair value of the liability can be made.
SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets, was
issued in August 2001 and is effective for fiscal years beginning after December
15, 2001. SFAS 144 provides a single, comprehensive accounting model for
impairment and disposal of long-lived assets and discontinued operations.
SFAS 143 and SFAS 144 will be adopted on their effective dates, and adoption is
not expected to result in any material effects on the Corporation's financial
statements.
Note 7 - Subsequent Events
In October 2001 the Company executed a $100,000 promissory note. The note bears
interest at 12% per annum and all unpaid principal and interest is due February
2002. The note is secured by third party securities owned by the Company which
the Company intends to sell in order to repay the loan and by a pledge against
the loan by the President of the Company to sell up to 5,225,00 shares of common
stock owned by the President to cover any shortfall.
In October 2001 the Company agreed to reduce its interest in Worldbridge
Webscasting, LLC from 51% to 49%, in consideration for extending the Company's
obligation to make a capital contribution pursuant to the Operating Agreement in
the amount of $100,000 up to and including January 15, 2002. In the event the
Company does not make payment by January 15, 2002, the Company's interest shall
be further reduced from 49% to 25%.
In November 2001 the Company executed a $100,000 promissory note. The note bears
interest at 12% per annum and all unpaid principal and interest is due February
2002. The note is secured by third party securities owned by the Company which
the Company intends to sell to repay the loan and by a pledge against the loan
by the President of the Company to sell up to 5,225,00 shares of common stock
owned by the President to cover any shortfall.
Also in November 2001 the Company purchased various assets of Adhesive Software,
Inc. for $100,000, 50,000 shares of the Company's Series C 4% Convertible
Preferred Stock and a promissory note of $280,000. The note bears interest at 4%
per annum and has average monthly principal and interest payments of $9,375
through out the term of the note. All unpaid amounts are due June 2004. The note
is secured by certain assets of the Company is reserved as collateral.
Also in November 2001 the Company also entered into a license agreement with
iNET whereby the Company licensed its Emily software and technology for use in
connection with iNet's e-procurement system in Texas, Maine, and Idaho in
exchange for a 20% commission of subscription fees and the ability to market all
subscription fees (except for Texas QISV vendors) as well as a joint marketing
effort to sell the Company's Emily Agent to all vendors whereby the Company
retains 100% of the $495 sales price.
12
The Company has issued 20,223,458 shares of common stock as payment for services
rendered by consultants and vendors which were registered on a form Form S-8
which was filed on November 8, 2001.
In December 2001, the Company executed a $425,000 note payable with a third
party. The Company received proceeds of $300,000 and paid a commitment fee of
$125,000. The fee accrues interest at 12% per annum and is due January 31, 2002.
The note is secured by 36,303,932 shares of common stock of the Company that is
owned and controlled by the President of the Company, Richard Wade, and
15,000,000 shares of common stock of the Company that is owned by its Chief
Technology Officer, Luiz Valdetaro, to cover any shortfall in the event of
default
As of December 19, 2001, the Company issued stock options to its employees for
2,740,000 shares pursuant to the Incentive Stock Option Plan, dated December 16,
1999.
As of December 19, 2001, warrants to purchase 1,657,250 shares of common stock
at an average price of $0.023 were granted since September 30, 2001; all of
those were unexercised and outstanding as of December 19, 2001.
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 Consolidated Condensed Financial Statements of Vertical
Computer Systems, Inc. and Subsidiaries and the notes to the Consolidated
Condensed Financial Statements included elsewhere in this Form 10-QSB/A.
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, 2001 and September 30, 2000. 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,
the factors described below under the caption "Cautionary Statements and Risk
Factors."
OVERVIEW
Vertical Computer Systems, Inc. (OTC.BB: VCSY) is a multinational provider of
Web services, underpinning Web technologies, and Administrative Software
Services through a global partner distribution network. Web services involve the
outsourcing of administrative services software via the Internet. Underpinning
Web technologies are the foundation technologies used to build Web services.
Administrative Software Services are software products, such as human resources
or procurement that provide the basic functionality of any operational entity.
The Company acquires and operates companies whose products, in the Company's
belief: (1) are proven and best of the breed, (2) on the path to profitability,
(3) complement each other, and (4) provide cross-product distribution channels.
The Company's business model combines complementary, integrated Web services, a
multinational distribution system of local partners, and underpinning Web
technologies to create a distribution matrix that it believes are capable of
penetrating multiple sectors through cross promotion. The Company's different
Administrative Software Services provide cross distribution channels for each
other, the Global Partners System provides worldwide distribution channels, and
the underpinning Web technologies permit the rapid development and deployment of
all systems.
13
Web services
Web services encompasses a full range of services from the simple Web-unique
application of instant messaging to complex administrative services such as
accounting packages converted into an application service provider model. An
application service provider or "ASP" is a company that offers individuals or
enterprises access over the Internet to applications and related services that
would otherwise have to be located in their own personal or enterprise
computers.
The Company's Web services derive from a full range of (i) Administrative
Software Services controlled by the Company that will be converted into
specialized Web services and (ii) Web services the Company has developed
independently or acquired. The Company's ownership interest is typically a
controlling interest. In most cases, the administrative service will retain its
historic client-server based customer even though it developed a Web service for
those same customers and new customers. The Company's current Web services
address the following market segments:
WEB
MARKET PRODUCT SERVICES OWNERSHIP VCSY %
Application Platform Bridges Yes VCSY 100%
Database connect XML Emily Agent Yes VCSY 100%
Emily XML Scripting Language EMILY Yes VCSY 100%
Publishing Content NewsFlash No VCSY 100%
Higher Education VarsityFlash No VCSY 100%
Franchises/Independent Agent AffiliateFlash Yes VCSY 100%
Emergency Management ResponseFlash Yes VCSY 100%
Public Sector e-Procurement Service INet Yes INetPurchasing 2.5%
Human Resources HRIS No NOW Solutions 60%
Webcasting Webcast Yes WorldBridge 49%
Webcasting Services
Travel Globalfare Yes VCSY 100%
Smart Cards ApolloSmart Yes VCSY 30%
Underpinning Web Technologies
Underpinning Web technologies provide the software foundation to support (1)
internet based platforms for the delivery of Web services; (2) individual
software products that can be sold independently or combined with another
software product; and (3) rapid deployment of all Web services and software
products throughout the Company's distribution system.
The Company's first underpinning Web technology is the patent pending Emily
Extensible Markup Language or Emily XML. Extensible Markup Language or XML is a
flexible way to create common information formats and share both the format and
the date on the World Wide Web, intranets, and elsewhere. For example, computer
makers might agree on a standard or common way to describe the information about
a computer product (processor speed, memory size, and so forth) and then
describe the product information format with XML. Such a standard way of
describing data would enable a user to send an intelligent agent (a program) to
each computer maker's Web site, gather data, and then make a valid comparison.
XML can be used by any individual or group of individuals or companies that
wants to share information in a consistent way. Emily XML has recently been
upgraded to be Java compatible. Java is a programming language expressly
designed for use in the distributed environment of the Internet. Java can be
used to create complete applications that may run on a single computer or be
distributed among servers and clients in a network. Utilizing Emily, the Company
developed two products, the Emily Agent and Broker, which are now jointly
marketed with iNetPurchasing as part of the State of Texas' new e-procurement
system. Dr. Charles Goldfarb, recognized as the Father of Markup Languages, has
included a chapter on Emily and its application, relative to the State of Texas
procurement system, in the 4th Edition of the XML Handbook. The Emily XML
Automation Toolkit for Java is currently in its final testing phase, in
preparation for release in the first quarter of 2002.
14
The Company's second underpinning Web technology is SiteFlash. The SiteFlash
technology utilizes XML and publishes on the Web, enabling the user to build and
efficiently operate Web services with the unique ability to separate form,
function, and content on the Web. This unique ability is patent pending and has
vast application in the web arena. SiteFlash technology is being used in higher
education (e.g.,California State University), newspapers (e.g., La Opinion), and
consulting Organizations (eg. Infotec). The Company believes the SiteFlash
architectural concepts enable easy integration with existing technological
components the in any organization. Additional key features that differentiate
SiteFlash from other products are its affiliation/syndication capability, its
multi-lingual capability and its multi-modal (any output device including PDAs,
wireless phones, etc) framework. The Company offers SiteFlash as a stand-alone
product and also as a development product for selective in vertical markets,
such as NewsFlash and VarsityFlash.
Administrative Software Services
Administrative Software Services as adapted to an ASP model on the Web are a
sub-set of Web services. These services include procurement, scheduling, travel
management, payroll, financial and other common functions. All of the Company's
Administrative Software Services are Web enabled, meaning that they can be
accessed on the Internet. Exploratory analysis is being done to develop an ASP
application for Human Resource Information Service (HRIS) Application Software.
The Company believes that its Administrative Software Services provide upfront
cost savings and productivity increases for everyday operations with competitive
set-up charges and implementation times less than competitors.
The Company is developing a portfolio of ASP Administrative Software Services in
initial deployment stages with iNetPurchasing with three states under contract.
The key is limited up-front charges coupled with an on-going transaction fee.
Global Partners System
The Company's Global Partners System is intended to create export markets for a
product or service. The Global Partners System has partners in three countries
through Phase I. The Company's initial strategy is to develop Web service
applications in one of the original Global Partner's countries to demonstrate
the strength of the distribution system. The foreign partnership has the option
either to market the Web service directly or to subcontract the Web service to a
local entity with particular expertise in that particular field. The ultimate
objective is to demonstrate the strength of the local partner when marketing the
best-of-breed Web service in that respective country by competitively selling
its products against competitive products from major companies.
Marketing
Each of the Company's business units has distinct marketing strategies for their
niche markets. The Company, as a strategic marketing element, plans to increase
the growth rates of these individual business units by enabling them to leverage
each other's strengths in their segments, as well as to exploit the network of
customers, vendors, and support agencies that the Company has built.
In the past two years, the Company has built an international distribution
system offering Web services and underpinning Web technologies from its own
platform. Upon expansion, the Company intends to incorporate third party
products and services into its worldwide distribution platform while selling its
own services to these third parties. The Company has obtained a significant base
of Web services and underpinning Web technologies that are ready to go to
market.
15
Currently, the Company's marketing effort focuses upon several sectors, though
the United States government has become a focus for the following reasons: (1)
Companies which the Company controls have significant governmental clients that
created the potential to cross promote Web services; (2) the underpinning Web
technologies are well-suited to the emerging governmental environment that
demands the capability for cross-agency and federal/state/and local interface;
and (3) the increased security environment caused by the terrorist attacks of
September 11, 2001 necessitate improvements in secure communications and agency
to agency contacts that are easily enabled by the Company's technology.
Depending on the circumstances, the Company's marketing strategy is to obtain
federal government contracts through its existing relationships or to be a
subcontractor for a particular service to one of the major federal government
prime contractors. For local and state government entities, the Company intends
to cross-market to its existing client base. Overall, the marketing strategy
entails building a strong international distribution base by which the Company
hopes to attract the best-of-breed smaller Web services from companies without
international distribution to market and commercially exploit their Web services
on the Company's own platform and as well as for distribution to governmental
entities.
SUBSIDIARIES, ASSETS, AND PARTNERSHIPS
Below is a description of the Company's key subsidiaries, assets and
partnerships.
EMILY SOLUTIONS
The Company acquired the rights to Emily Solutions Web technology in December
1999. Emily Solutions' work platform, "the Emily Framework", consists of
executable programs, files, configuration data and documentation needed to
create Web-based applications that intercommunicate via XML (Extensible Markup
Language) and HTTP. HTTP or the the Hypertext Transfer Protocol is the set of
rules for exchanging files (text, graphic images, sound, video, and other
multimedia files) on the World Wide Web. The Emily Framework was developed to be
an engineering package comparable to other Web development tools such as Allaire
Cold Fusion or Microsoft Frontpage. The primary component of the Emily Framework
is MLE (Markup Language Executive), a programming language that already runs on
Windows NT, Windows 2000, Linux and several UNIX platforms. MLE is developed to
be both a complement and an alternative to Java on the server side.
In addition, the Company developed the Emily broker application, used now as the
interface between Publicbuy.Net e-procurement system for the state of Texas. As
part of the agreement between iNet Purchasing and the Company, the Emily XML
Enabler Agent will be offered as an optional product to expedite the interface
at a price of $495. This arrangement will also be applicable for the
PublicBuy.Net e-procurement contracts for Maine and Idaho. The Emily scripting
language has been enabled to work on Java and the option is being explored to
launch the Emily scripting language as part of a Java tool kit in the next two
months.
ZAPQUOTE, S.A.
In March 2000 the Company entered into two joint ventures with ZAP Quote, S.A.,
Brazil's second largest provider of real time financial information for Brazil's
financial markets. ZAP Quote, S.A., established in 1985, has used its
proprietary wireless technology to become the fastest growing company for
financial news and information based in Brazil. ZAP Quote, S.A. also has a major
position in providing back office software to many of Brazil's major financial
institutions.
16
Both joint venture ownerships are held 50% by the Company and 50% by ZAP Quote,
S.A. The first joint venture was converted into a Brazilian corporation named
Vertical Zap S.A. in August 2000 with the Company owning 3,400 common shares and
Zap Quote owning 3,400 common shares of the 6,800 outstanding. The terms of
Vertical Zap S.A. require the Company to provide the latest in U.S. technology
and products while ZAP Quote, S.A. will add its expertise and familiarity with
the Brazilian financial and business communities along with the initial
financing for the project. As part of the Company's Global Partner's System,
Vertical Zap S.A developed and launched an internet distribution website or
"Bridge" to market and distribute the Company's Web services and underpinning
web technologies throughout Brazil.
The second joint venture, known as ZAP Vertical, has not been converted into a
corporation, but is developing a strategy to market and distribute ZAP Quote,
S.A.'s proprietary wireless financial applications in countries and territories
around the world, excluding South America.
As of September 30, 2001 all of the joint venture investments are fully
reserved. There have been no revenues or expenses in relation to the investments
for the 9 months ended September 30, 2001.
GLOBALFARE.COM
In May 2000 the Company acquired 100% of Globalfare.com ("Globalfare").
Headquartered in Las Vegas, Nevada, Globalfare is an e-commerce
business-to-consumer and business-to-business outlet whose aim is to seek out
and promote travel products from across the USA and around the world that are
the best values in terms of price, quality and selection.
Globalfare also offers a point of presence on the web for travelers looking for
the best buys available for travel within a relatively short time frame and for
those who are looking to plan vacations trips throughout the world during the
coming year. Globalfare's goal is to become the world's most complete online
travel service, and offer a comprehensive range of best-buy travel products;
excellent hotels to suit all budgets; and first-rate travel insurance at
reasonable costs, all with instant confirmation and the convenience of credit
card payment.
For the nine months ended September 30, 2001, Globalfare.com had assets of
$86,000, $102,538 in net revenues and a net loss of $449,532.
POINTMAIL.COM, INC.
In June 2000 the Company acquired 100% of Pointmail.com, Inc., which owned
proprietary, web-based e-mail software that enhances the Company's existing
"ThePostmaster.Net" Internet service.
ThePostmaster.Net is accessible world wide, offers a cross-platform e-mail
solution, and is cheaper and easier than using traditional e-mail programs.
ThePostmaster.Net is now a component of the Bridge technology and is also
presented as a stand-alone products at "thepostmaster.net".
For the nine months ended September 30, 2001, Pointmail.com had assets of
$78,000, no revenues and a net loss of $14,557.
17
iNETPURCHASING, INC.
The Company entered into two Limited Liability Company (LLC) agreements with
iNetPurchasing.com, Inc. (iNPI). Both joint venture ownerships are held 50% by
the Company and 50% by iNet Purchasing.com, Inc. One LLC, iNet Government
Services, LLC, calls for iNPI to market the Company's existing and developmental
products, including Emily, to state and local governments within the U.S. as
part of its comprehensive e-solutions bundle.
The second joint LLC, Vertical-iNet LLC, calls for the Company to
internationally market iNPI's online procurement services through the Company's
alliances abroad. The initial marketing targets will be foreign governments,
partly in response to certain standards set forth by the WorldBank, EximBank and
USAID requiring recipient nations to implement modern procurement procedures
before the release of funds. The Company will target international public and
private companies as well.
In May 2000 the Company invested $500,000, in consideration of 2.5% of iNPI's
outstanding shares and a royalty license, which provides for royalty payments to
the Company based upon iNPI's transactional fees. iNPI projects revenues
commencing in second quarter of 2002.
As of September 30, 2001 all of the iNet investments and advances paid for
royalties are reserved. There have been no revenues or expenses in relation to
the investments for the 9 months ended September 30, 2001.
NOW SOLUTIONS, LLC
In February 2001, NOW Solutions LLC ("NOW"), of which the Company owns a 60
percent majority interest, purchased the Renaissance CS(R) Human Resources and
Payroll ("HRIS/PAYROLL") assets from Ross Systems, Inc. (NASDAQ: ROSS). NOW
provides Human Resource Information Service (HRIS) Application Software.
Customers are primarily located in North America. NOW derives revenue from
software licenses, professional services consulting, and renewable maintenance
from approximately 175 customers.
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 $1,000,0000.
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.
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 and use
the excess amount for working capital. 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 $1,500,0000 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 thirds vesting equally in one and two years
from the grant date. All warrants are exercisable five years from the vesting
date.
18
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.
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, which is
being amortized over a 3 to 8 year period.
As of September 30, 2001 the NOW has approximately $5,597,000 of goodwill and
other intangible assets and for the 9 months ended September 30, 2001, NOW has
$2,329,987 of net revenue and a net loss of $1,006,794.
ENFACET, INC.
The Company acquired 100% of Enfacet, Inc. on August 21, 2001, for 30,000 shares
of Series C 4% Cumulative Convertible preferred stock. EnFacet is a software
products company that has web-based eBusiness software used by newspapers,
government agencies, universities and large franchises. EnFacet's products,
Newsflash (catering to the publishing industry and newspapers in particular) and
Site Flash (the affiliation/ syndication web product) are already accepted in
the marketplace and are based on award winning (Crossroads A-List for 2000 and
2001), patent pending technologies. The products are mature products in a
growing market, and provide for satisfying the enormous growth in the Internet
data, web sites and e-commerce.
For the 9 months ended September 30, 2001, Enfacet had $428,000 of assets and no
revenue or expenses.
APOLLO INDUSTRIES, INC.
Apollo Industries, Inc. ("Apollo") is a smart card-based financial transaction
and service solutions provider located in Los Angeles, California. On October
14, 2000, the Company agreed to provide $250,000 in funding to Apollo for the
enhancement of its ApolloSmart technology and development of its service
business in exchange for a 30% equity interest. Also on October 14, 2000, in
consideration for $25,000 from the Company, Apollo agreed to pay a royalty of 2%
of all transaction fees up to $275,000 and 1% up to $3,000,000. On April 19,
2001, Company loaned Apollo $24,000 which was due on June 30, 2001. On May 8,
2001, the Company loaned Apollo an additional $24,000 which was due on July 16,
2001. The loans are secured pursuant to a stock pledge in the amount of 500,000
shares for each of the two loans. Apollo is in default of the two loans. The
Company has not foreclosed on either loan and Apollo is in the process of
securing funding to repay both loans.
ApolloSmart technology will be used by the Company to offer consumers many
features from small-change transactions, banking and credit/debit spending,
computer security, Web-based shopping, and Internet voting up to assisting
enterprises around the world in implementing and expanding smart card usage.
As of September 30, 2001 all of the advances paid to Apollo for royalties have
been reserved for 100%. There has been no revenues and a net loss of $219,000
recorded in relation to Apollo for the 9 months ended September 30, 2001.
19
WORLDBRIDGE WEBCASTING SERVICES, LLC.
Worldbridge Webcasting Services, LLC, provides webcast services. As of September
30, 2001, all investments in Worldbridge has been reserved for 100%. There have
been no revenues or expenses in relation to the investments for the 9 months
ended September 30, 2001. In October 2001 the Company agreed to reduce its
interest in Worldbridge Webscasting, LLC from 51% to 49%, in consideration for
extending the Company's obligation to make a capital contribution pursuant to
the Operating Agreement in the amount of $100,000 up to and including January
15, 2002. In the event the Company does not make payment by January 15, 2002,
the Company's interest shall be further reduced from 49% to 25%.
BRIDGES
The Company is developing a web-based distribution platform called Home Country
Gateways ("HGCs" or "Bridges") as part of its Global Partners System. These
Bridges represent an international distribution platform for the demonstration,
deployment and sale of Company's Web Services and underpinning Web technologies.
Currently, the Company has six Bridges in full operation, the World Bridge
(http://www.theworldbridge.com), the US Bridge (http://www.theUSbridge.com), the
Brazil Bridge (http://www.thebrazilbridge.com), the China Bridge
(http://www.thechinabridge.com), the India Bridge
(http://www.theindiabridge.com) and the Korea Bridge
(http://www.thekoreabridge.com). Additionally, bridges for each of the fifty
U.S. states, are either under construction or are being considered as future
sites.
These Bridges are targeted at individual audience segments and users, with
maximum personalization thanks to the underpinning Web technologies. A sample
segment is private expatriates living abroad, as well as those on government
service in the military or diplomatic corps. For example, 6 million U.S.
expatriates living abroad are able to better stay in touch with events in the US
and their home state(s) through the mix of products and services on the
USbridge.com and various state bridges.
The goal of the Bridges is to use them as a distribution platform for Web
Services. In the meantime, the Company moves toward the implementation of
structured subscription fees as goods, services and technology are added to the
Bridges. Later, these Bridges will also offer exclusive sponsorship
opportunities in a broad range of ways to effectively deliver companies'
messages and desired product information to millions of newfound consumers
worldwide.
These Bridges display Web Services like the Personal Information Management
system through a licensing agreement with WebAddressBook, whereby the Company
acquired a permanent license to utilize the source code for "WebAddressBook" in
October 2000. This system allows users to manage personal information such as
address book, calendar, contacts, bookmarks, note pads, files and tasks.
WebAddressBook is customizable, multi-language and user-friendly. It is a
full-featured customizable product that fits seamlessly into the Company's
existing infrastructure.
The Bridges continue to offer a free Internet messaging service through Webbe,
which is licensed and co-branded from a third party. The Company is currently
negotiating a renewal of this license. Webbe, essentially a highly personalized
Web browser, is a one-stop shop for Internet activity, and adds unique
communications tools to the Company's global network of Bridges.
As of September 30, 2001, the Company has no assets, revenues or expenses in
relation to the Bridges.
20
Results of Operations
Nine Months Ended September 30, 2001 Compared To Nine Months Ended September 30,
2000
Total Revenues. The Company had total revenues of $2,364,132 in the nine
months ended October 31, 2001. Total revenues primarily consist of software
license, consulting and maintenance fees. All of these revenues relate to the
business operations of NOW Solutions, a subsidiary in which the Company owns a
60% interest. The Company acquired the 60% interest in NOW Solutions in February
2001. As a result, The Company's operating results for the corresponding period
in the prior year excluded the results of operations of NOW Solutions. As such,
the Company had no revenues for the nine months ended September 30, 2000.
Selling, General and Administrative Expenses. The Company had selling,
general and administrative expenses of $11,186,558 and $3,022,682 in the nine
months ended September 30, 2001 and 2000, respectively. This increase of
$8,163,876 was primarily attributable to the operations of NOW Solutions, the
write off of certain investments, and the amortization of goodwill. For the nine
months ended September 30, 2001, selling, general and administrative expenses
consisted primarily of consulting fees of $678,014, marketing expenses of
$140,066, insurance premiums of $33,167, travel expenses of $68,031,
professional fees of $575,944 and employment expenses of $1,188,346.
Operating Loss. The Company had an operating loss of $8,822,426 and
$2,967,796 in the nine months ended September 30, 2001 and 2000, respectively.
This increase was primarily attributable to the increase in selling, general and
administrative expenses in the current period.
Minority Interest in Loss of Subsidiary. The minority interest in loss of
subsidiary was $400,005 and zero for the nine months ended September 30, 2001
and 2000, respectively. This increase was primarily attributable to the
Company's acquisition of its subsidiary NOW Solutions and the operating losses
incurred by NOW Solutions.
Net Loss. The Company had a net loss of $8,650,260 and $1,874,175 in the
nine months ended September 30, 2001 and 2000, respectively. This increase was
primarily attributable to the increase in selling, general and administrative
expenses, amortization of goodwill. Interest expense has increased by $328,047
over the previous year due to the additional debt incurred for the asset
purchase from Ross Systems, Inc. by NOW Solutions.
Dividends Applicable to Preferred Stock. The Company had outstanding
Series A 4% Convertible Cumulative Preferred stock that accrues dividends at a
rate of 4% on a semi-annual basis. The dividends applicable to this preferred
stock is $196,846 in the nine months ended September 30, 2001. The Company has
outstanding preferred stock that accrues dividends at a rate of four percent on
a quarterly basis if declared and these dividends are cumulative. These accrued
dividends are reflected in the dividends applicable to preferred stock.
Net Loss Applicable to Common Stockholders'. The Company had a net loss
applicable to common stockholders of $8,847,106 and $1,874,175 in the nine
months ended September 30, 2001 and 2000, respectively. This increase is
primarily attributable to an increase in selling, general and administrative
expenses, amortization of goodwill, and the increase in reserves for investments
as well as the dividends applicable to preferred stockholders. Interest expense
has increased by $328,047 over the previous year due to the additional debt
incurred for the asset purchase from Ross Systems, Inc. by NOW Solutions.
21
Liquidity And Equity Line Of Credit
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 repay loans in the amount of $805,000.
The Company currently has enough working capital (excluding cash held at
subsidiaries) to sustain operations for approximately 1 month. Thereafter, the
Company will need additional cash to fund its operations. In order to meet its
obligations, the Company will need to raise cash from the sale of securities or
loans. 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.
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. The management of NOW Solutions is currently working with its
lender to cure the covenant default. Debt service for the next twelve months
will be approximately $1,785,000 in principal and interest. NOW Solutions has a
renewable maintenance revenue base of approximately $4.2 million that will
provide adequate working capital for its operations. In addition, it is
management's opinion that Professional Services Consulting and Software Licenses
revenue will provide additional working capital to fund operations for the next
twelve months.
In February 2000 the Company through its subsidiary NOW Solutions
purchased the human resource software division of Ross Systems, Inc. in exchange
for $5,500,000 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. In addition, the loan agreement calls for
various earn-out provisions to be paid to Ross if certain sales levels are
achieved by NOW Solutions during the two years subsequent to the purchase. In
addition to the Ross note, NOW Solutions received a $5,500,000 note payable to
finance the purchase. The note bears interest at prime plus one and a half and
is due the earlier of February 2006 or if terminated, by either party, in
accordance with the terms of the loan agreement. The note calls for monthly
principal payments of $91,500, plus interest. Pursuant to the declining pledge
agreement, the Company guaranteed the note and provided a $1.5 million cash
deposit as collateral for the $5.5 million loan. The terms of the declining
pledge agreement provide that once the first 24 principal payments on the note
($2,200,000) have been paid in full, then the lender shall release the deposit
accounts from the pledge. In the event that NOW Solutions makes all principal
payments required to be paid under the note from March 2001 through October
2001, then the Company, subject to the lender's consent, may withdraw $33,333,
and, providing that NOW Solutions continues to make its monthly principal
payments, Company may withdraw $91,667 in each subsequent month as well as the
right to withdraw sums equal to the aggregate amounts stated in the consent to
withdrawal as submitted by lender. The lender has notified NOW Solutions that
NOW Solutions is in default of certain covenants of the loan agreement.
In August 2001 the Company borrowed $125,000 by issuing convertible debentures.
The debentures accrue interest at a rate of six percent per year and are due in
October 2006. The debenture is convertible at the holder's option into shares of
common stock at either 120% of the closing bid price on the date of the
debenture or 80% of the three lowest closing bid prices twenty days prior to the
conversion.
Also in August 2001, the Company borrowed $180,000. The loan bears interest at a
rate of 12% per year and all unpaid principal and interest is due in February
2002. The Company pledged third party securities owned by the Company and
available for sale as collateral for the note as well as shares of the Company's
own common stock. In connection with the note, the Company issued 500,000
warrants to purchase shares of its common stock at an exercise price of $0.028.
The warrants have a term of three years from the date of issuance.
22
Also in August 2001, the Company entered into the Equity Line of Credit
Agreement with Cornell Capital Partners, L.P. Under the equity line, Cornell
Capital Partners is committed to purchase up to $10.0 million of the Company's
common stock over 36 months beginning on the effective date of the Company's
registration statement registering the sale of the shares by Cornell Capital
Partners. Under the equity line, the Company may request an advance by Cornell
Capital Partners. The number of shares of common stock that Cornell Capital
Partners will receive for each advance shall be determined by dividing the
amount of the advance by the purchase price. The purchase price is 95% of the
market price. The maximum advance amount will be equal to 150% of the average
daily volume of the Company's common stock multiplied by the purchase price. The
average daily volume shall be computed by using the forty trading days prior to
the advance notice date. The advance notice date is the date Cornell Capital
Partners receives a written notice from the Company requesting an advance amount
under the equity line. The market price is the lowest closing bid price of the
common stock over the five trading day period beginning on the first trading day
after an advance notice date. The Company may request an advance every six
trading days. Pursuant to the terms of the Equity Line of Credit Agreement, the
Company is required to register the shares to be issued to Cornell Capital
Partners financing under the Equity Line of Credit will become available after
such registration statement is declared effective by the SEC.
Upon each advance date, the Company will pay to Cornell Capital Partners an
amount equal to 4% of the amount of the advance. Cornell Capital Partners is
also entitled to a commitment fee of $400,000 payable in common stock. As of
September 30, 2001, the Company issued 7,142,857 shares of common stock or
$200,000 (i.e., the fair market value of shares issued) of the fee and accrued
for the remaining portion, which is to be paid the earlier of the registration
of shares that are to be issued in connection with the Equity Line of Credit or
six months. As of September 30, 2001 no shares have been purchased.
In October 2001, the Company borrowed $100,000 from a private investor. The loan
bears interest at 12% per annum and all unpaid principal and interest is due
February 2002. The note is secured by third party securities owned by the
Company and by a pledge against the loan by the President of the Company to sell
up to 5,225,00 shares of common stock owned by the President to cover any
shortfall. Also in October 2001, the Company agreed to reduce its interest in
Worldbridge Webscasting, LLC from 51% to 49% in consideration for extending the
Company's obligation to make a capital contribution in the amount of $100,000 to
January 15, 2001. In the event the Company does not make payment by January 15,
2002, its interest will be further reduced from 49% to 25%.
In November 2001, the Company borrowed $100,000 from a private investor. The
loan bears interest at 12% per annum and all unpaid principal and interest is
due February 2002. The note is secured by third party securities owned by the
Company and by a pledge against the loan by the President of the Company to sell
up to 5,225,00 shares of common stock owned by the President to cover any
shortfall. Also in November 2001, the Company purchased various assets of
Adhesive Software, Inc. for 50,000 shares of the Company's Series C 4%
Convertible Preferred Stock, a payment of $100,000 and a promissory note of
$280,000. The note bears interest at 4% per annum and has average monthly
principal and interest payments of $9,375 through the term of the note. All
unpaid amounts are due June 2004. The note is secured by certain assets of the
Company is reserved for issuance as collateral.
In December 2001, the Company executed a $425,000 note payable with a third
party. The Company received proceeds of $300,000 and paid a commitment fee of
$125,000. The fee accrues interest at 12% per annum and is due January 31, 2002.
The note is secured by 36,303,932 shares of common stock of the Company that is
owned and controlled by the President of the Company, Richard Wade, and
15,000,000 shares of common stock of the Company that is owned by its Chief
Technology Officer, Luiz Valdetaro, to cover any shortfall in the event of
default
23
Going Concern Uncertainty
The accompanying 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 report of the Company's Independent Certified Public Accountants for
the December 31, 2000 financial statements included an explanatory paragraph
expressing substantial doubt about the Company's ability to continue as a going
concern.
The Company is seeking additional funding and believes that this will result in
improved operating results. There can be no assurance, however, that the
Company, with the additional financing, will result in higher cash flows
provided by operations.
At this point in time, the Company has generated revenue, however it continues
to suffer operating losses. The Company believes it can launch a number of
products, services and other revenue generating programs. Additionally, the
Company believes its three existing international in-country partners have the
ability and resources to market its products concurrently in their respective
country of origin.
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.
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
consolidated financial statements contain no adjustment for the outcome of this
uncertainty.
24
New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board finalized FASB Statements
No. 141, Business Combinations (SFAS 141), and No. 142, Goodwill and Other
Intangible Assets (SFAS 142). SFAS 141 requires the use of the purchase method
of accounting and prohibits the use of the pooling-of-interests method of
accounting for business combinations initiated after June 30, 2001. SFAS 141
also requires that the Company recognize acquired intangible assets apart from
goodwill if the acquired intangible assets meet certain criteria. SFAS 141
applies to all business combinations initiated after June 30, 2001 and for
purchase business combinations completed on or after July 1, 2001. It also
requires, upon adoption of SFAS 142, that the Company reclassify the carrying
amounts of intangible assets and goodwill based on the criteria in SFAS 141.
SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that the Company identify reporting units for the
purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in
fiscal years beginning after December 15, 2001 to all goodwill and other
intangible assets recognized at that date, regardless of when those assets were
initially recognized. SFAS 142 requires the Company to complete a transitional
goodwill impairment test six months from the date of adoption. The Company is
also required to reassess the useful lives of other intangible assets within the
first interim quarter after adoption of SFAS 142.
Some of the Company's previous business combinations were accounted for using
the purchase method of accounting. As of September 30, 2001, the net carrying
amount of goodwill and other intangible assets is $6,071,759. Currently, the
Company is assessing but has not yet determined how the adoption of SFAS 141 and
SFAS 142 will impact its financial position and results of operations.
SFAS 143, Accounting for Asset Retirement Obligations, was issued in June 2001
and is effective for fiscal years beginning after June 15, 2002. SFAS 143
requires that any legal obligation related to the retirement of long-lived
assets be quantified and recorded as a liability with the associated asset
retirement cost capitalized on the balance sheet in the period it is incurred
when a reasonable estimate of the fair value of the liability can be made.
SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets, was
issued in August 2001 and is effective for fiscal years beginning after December
15, 2001.
SFAS 144 provides a single, comprehensive accounting model for impairment and
disposal of long-lived assets and discontinued operations.
SFAS 143 and SFAS 144 will be adopted on their effective dates, and adoption is
not expected to result in any material effects on the Corporation's financial
statements.
25
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
The Company is, from time to time, involved in various lawsuits generally
incidental to its 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.
In addition, the Company is involved in two additional litigated matters. The
case entitled, Margaret Greco, et al., v. Vertical Computer Systems, Inc., filed
in United States District Court for the Eastern District of New York (Case No.
00 Civ. 6551 (DRH)), involves allegations that the plaintiffs sustained damage
as a result of an alleged improper rescission of a subscription agreement based
on a November 1999 private placement memorandum. Plaintiffs seek damages based
on the alleged increase in value of the stock since the private placement. The
matter is open and the Company is vigorously defending this action.
A second matter, entitled La Societe Francaise de Casinos v. Vertical Computer
Systems, Inc., was filed in Los Angeles County, California, Superior Court, on
January 19, 2001. This action was filed by a former customer of Externet World,
Inc., a former wholly owned subsidiary, which claimed that the Company is liable
to it for in excess of $500,000 in costs allegedly paid for an Internet casino
software package to be developed and maintained by Externet World. The plaintiff
also alleges that the Company has breached an agreement to pay the disputed sums
flowing out of its October 2000 settlement of litigated matters with two former
shareholders of the Company. The Company executed a Settlement and Mutual
General Release Agreement on July 20, 2001. Pursuant to the settlement
agreement, the Company received all right, title, and interest in and to the
internet gaming software package developed by Externet World and Casino in
exchange for payment of $400,000 by the Company to Casino, and payment of state
and federal taxes on behalf of Externet World. Only a few nominal and
non-contested matters remain open regarding (a) payment of state taxes and (b)
transfer of domain names. Those issues should be resolved by January 2002.
Item 2. Changes in Securities and Use of Proceeds
On July 11, 2001, the Company entered into two consulting
agreements, in which the Company agreed to issue approximately
$200,000 in common stock to each consultant for business advisory
services. 20% of the common stock was due on the agreement date,
with an additional 20% due on the 30th and 60th day subsequent to
the agreement date and the remaining 40% due on the 90th day
subsequent to the agreement date. The number of shares to be issued
to each consultant will be determined on the date each consulting
fee is due. These shares were registered pursuant to the Form S-8
filed on July 13, 2001. The Company is also obligated to issue
warrants to purchase 500,000 shares of Company's common stock to
each consultant. As of September 30, 2001 the Company has issued
10,081,152 shares of its common stock in exchange for the consulting
services provided and 1,000,000 warrants. 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. As of September 30, 2001, the Company recognized
approximately $248,000 in consulting expenses in relation to the
common stock issued and $10,000 for the value of the warrants (the
warrants were valued using the black-scholes valuation model).
26
In August 2001, the Company issued $125,000 of convertible
debentures. The debt accrues interest at 6% per annum and is due
October 2006. 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 3 lowest closing bid prices 20 days prior to
the conversion. The debenture is convertible at the option of the
holder, any time after purchase. The Company has recognized $31,250
as interest expense in relation to the beneficial feature conversion
of the debentures. As of September 30, 2001 no conversions have
taken place.
In August 2001, the Company issued a $180,000 note, which is due
February 2002 and bears interest at 12% per annum. In connection
with the note, the Company issued warrants to purchase 500,000
shares of its common stock. The Company pledged third party
securities owned by the Company and available for sale as collateral
for the note. The warrants vested immediately, have a strike price
of $0.028 per share and are exercisable for three years from
issuance. The value of the warrants, $5,000 (valued using the
black-scholes valuation model) has been deferred and will be
amortized over the term of the loan.
In August 2001, the Company entered into an Equity Line of Credit
agreement, whereby up to $10,000,000 of the Company's common stock
may be purchased. The shares must be registered before sale and the
shares can be purchased at 95% of the closing bid price, on the date
of purchase. The equity line of credit contains a fee of $400,000
payable in common stock. As of September 30, 2001, the Company
issued 7,142,857 shares of common stock or $200,000 (fair market
value of shares issued) of the fee and accrued for the remaining
portion, which is to be paid the earlier of the registration of
shares that are to be issued in connection with the Equity Line of
Credit or six months. Also, as of September 30, 2001 no shares have
been purchased.
In August 2001, the Company issued 30,000 shares of its Series C 4%
Cumulative Convertible Preferred Stock to acquire 100% of the
outstanding common stock of Enfacet, Inc. ("Enfacet"), a Company
involved in the development of website management software. The
Series C 4% convertible stock eliminates on consolidation, since the
shares were issued to Enfacet. As per the agreement, Enfacet shall
distribute 15,000 shares to those employees still employed by
Enfacet, one year from the anniversary date of the agreement. At
that time the remaining shares may be used by Enfacet to acquire
additional funding. The fair value of the liabilities assumed by the
Company approximated $428,000, which was off set by assets with an
approximate fair value of the same amount.
The Series C 4% Preferred Stock is convertible into shares of the
Company's common stock at a ratio of one to four hundred. Dividends
on the stock are cumulative and accrue on a quarterly basis. In the
event of a voluntary or involuntary liquidation, the Series C 4%
shareholders are entitled to a liquidation preference of $100 per
share.
In October 2001 the Company executed a $100,000 promissory note. The
note bears interest at 12% per annum and all unpaid principal and
interest is due February 2002. The note is secured by third party
securities owned by the Company which the Company intends to sell in
order to repay the loan and by a pledge against the loan by the
President of the Company, to sell up to 5,225,00 shares of common
stock owned by the President to cover any shortfall.
27
In November 2001 Company executed a $100,000 promissory note. The
note bears interest at 12% per annum and all unpaid principal and
interest is due February 2002. The note is secured by third party
securities owned by the Company which the Company intends to sell to
repay the loan and by a pledge against the loan by the President of
the Company, to sell up to 5,225,00 shares of common stock owned by
the President to cover any shortfall.
Also in November 2001 the Company purchased various assets of
Adhesive Software, Inc. for $100,000 and a promissory note of
$280,000. The note bears interest at 4% per annum and has average
monthly principal and interest payments of $9,375 through out the
term of the note. All unpaid amounts are due June 2004. The note is
secured by certain assets of the Company and 50,000 shares of the
Company's Series C 4% Convertible Preferred Stock is reserved as
collateral.
In December 2001, the Company executed a $425,000 note payable with
a third party. The Company received proceeds of $300,000 and paid a
commitment fee of $125,000. The fee accrues interest at 12% per
annum and is due January 31, 2002. The note is secured by 36,303,932
shares of common stock of the Company that is owned and controlled
by the President of the Company, Richard Wade, and 15,000,000 shares
of common stock of the Company that is owned by its Chief Technology
Officer, Luiz Valdetaro, to cover any shortfall in the event of
default.
As of December 19, 2001, warrants to purchase 1,657,250 shares of
common stock at an average price of $0.023 were granted since
September 30, 2001; all of those were unexercised and outstanding as
of December 19, 2001.
Item 3. Defaults Under Senior Securities
NOW Solutions, LLC has been notified by a lender that it is in
default of a loan agreement, in which the Company has pledged a $1.5
million deposit as collateral. This deposit is reflected as
restricted cash on the balance sheets.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
28
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
3.1 Certificate of Designation Of Vertical Computers, Inc.
Series "C" 4% Cumulative Convertible Preferred Stock
10.1 (a) Berche Promissory Note, dated August 13, 2001
(b) Berche Stock Pledge Agreement, dated August 13, 2001
(c) Berche Warrants, dated August 13, 2001
10.2 Equity Line Of Credit Agreement between Company and
Cornell Capital Partners, L.P, dated August 16, 2001.
10.3 Securities Purchase Agreement between Company and third
party buyers for $250,000 of Convertible Debentures,
dated August 16, 2001 10.4 Enfacet, Inc. Stock Purchase
Agreement, dated August 21, 2001
10.4 Enfacet, Inc. Stock Purchase Agreement, dated August 21,
2001
10.5 Agreement Between Enfacet and the Company, dated August
24, 2001
(b) Form 8-K
None.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: December 19, 2001 VERTICAL COMPUTER SYSTEMS, INC.
By: /s/ Richard Wade
Richard Wade
Its: President
By: /s/ Stephen R. Gunn
Stephen R. Gunn
Its: Chief Financial Officer
29