U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003
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.)
201 MAIN STREET, SUITE 1455
FORT WORTH, TX 76102
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(817) 348-8717
--------------
(REGISTRANT'S EXECUTIVE OFFICE TELEPHONE NUMBER)
101 WEST 6TH STREET, SUITE 401
AUSTIN, TEXAS 78701
------------------------------------------
(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 |_| 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, 856,772,301 shares issued and outstanding as of June 22, 2004.
Transitional Small Business Disclosure Format (check one): Yes |_| No |_|
1
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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 March 31, 2003 3
Condensed Consolidated Statements of Operations (unaudited) for the Three months Ended March 31, 5
2003 and 2002
Condensed Consolidated Statements of Cash Flows (unaudited) for the Three months Ended March 31, 6
2003 and 2002
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 19
Item 3. Evaluation of Disclosure Controls and Procedures 35
PART II OTHER INFORMATION
Item 1. Legal Proceedings 36
Item 2. Changes in Securities and Use of Proceeds 37
Item 3. Defaults Under Senior Securities 43
Item 4. Submission of Matters To A Vote Of Security Holders 43
Item 5. Other Information 43
Item 6. Exhibits and Reports on Form 8-K 43
Signatures 47
2
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
VERTICAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
MARCH 31,
2003 DECEMBER 31,
(UNAUDITED) 2002
----------- -----------
ASSETS
Current Assets
Cash $ 1,565,259 946,035
Restricted cash 8,537 284,357
Pledged Cash -- 650,000
Securities available for sale 2,812 2,812
Accounts receivable, net of allowance for bad debts of $142,945
and $129,252 1,424,058 2,058,306
Other receivable 98,505 98,505
Receivables from officers and employees 166,963 158,264
Deferred tax asset- current portion 70,000 70,000
Prepaid expenses 67,223 76,855
Total Current Assets 3,403,357 4,345,134
Property and equipment, net of accumulated depreciation 325,749 367,858
Goodwill and other intangibles, net 5,749,437 6,002,683
Deferred tax asset 415,800 366,000
Deposits and other 9,000 4,000
----------- -----------
Total Assets $ 9,903,343 11,085,675
=========== ===========
LIABILITIES, CONVERTIBLE PREFERRED STOCK AND STOCKHOLDER'S EQUITY/ (DEFICIT)
Current liabilities
Accounts payable and accrued liabilities $ 3,450,633 3,416,027
Deferred Revenue 2,529,633 2,568,840
Payable to officers 6,306 50,464
Accrued Federal/State Tax 610,000 480,000
Convertible Debt current portion 20,000 --
Current portion-notes payable 4,717,470 2,650,971
----------- -----------
Total current liabilities 11,334,042 9,166,302
Convertible debt 80,000 205,000
Accrued dividends 1,263,712 1.113,712
Note payable, net of discount and current portion -- 3,001,712
----------- -----------
Total liabilities 12,677,754 13,486,726
=========== ===========
See accompanying notes to the condensed consolidated financial statements
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ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
VERTICAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET (CONTINUED)
MARCH 31,
2003 DECEMBER 31,
(UNAUDITED) 2002
----------- -----------
Series B 10% Convertible Preferred stock; $0.001 Par Value; 375,000
Shares authorized; 7,200 shares issued and outstanding 45,000 45,000
Series D 15% Convertible Preferred stock; $0.001 Par Value; 300,000
Shares authorized; 25,000 shares issued and outstanding 156,250 156,250
Minority interest 370,915 299,283
Stockholders' Equity/(Deficit)
Common Stock; $.00001 par value; 1,000,000,000 shares authorized
756,877,221 and 726,884,934 issued and outstanding 7,570 7,270
Series A 4% Convertible Cumulative Preferred stock; $0.001 par value;
250,000 shares authorized; 50,000 shares issued and outstanding 50 50
Series C 4% Convertible Preferred stock; $100.00 par value; 200,000
shares authorized; 72,500 issued and 50,000 outstanding 350,000 350,000
Additional paid-in-capital 25,812,114 25,687,963
Accumulated deficit (29,584,679) (28,946,867)
Accumulated other comprehensive income/(loss) 68,369 --
----------- -----------
Total Stockholders' equity/(deficit) (3,346,576) (2,901,584)
Total liabilities and stockholders' equity/(deficit) $ 9,903,343 11,085,675
=========== ===========
See accompanying notes to the condensed consolidated financial statements
4
VERTICAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED
MARCH 31,
----------------------------
2003 2002
(UNAUDITED) (UNAUDITED)
----------- -----------
Revenues
Licensing and maintenance $ 1,482,867 $ 1,250,555
Software Development -- 6,800
Consulting Services 464,287 271,860
Other (1,756) 32,547
----------- -----------
Total Revenues 1,945,398 1,561,762
Selling, general and administrative expenses 2,177,677 3,300,803
----------- -----------
Operating loss (232,279) (1,739,041)
Interest income 3,452 9,967
Interest expense (107,153) (156,351)
----------- -----------
Net loss before minority interest and income taxes (335,980) (1,885,425)
Provision for taxes (80,200) --
Net loss before minority interest (416,180) (1,885,425)
Minority interest in income of subsidiary (71,632) --
----------- -----------
Net loss (487,812) (1,885,425)
Dividend applicable to preferred stock (150,000) (150,006)
Net loss applicable to common stockholders $ (637,812) $(2,035,431)
=========== ===========
Basic and diluted loss per share $ (0.00) $ (0.00)
=========== ===========
Basic and diluted weighted average of common shares outstanding 751,345,173 618,802,533
=========== ===========
Comprehensive loss and its components consist of the following:
Net loss $ (487,812) $(1,885,425)
Translation adjustments 68,369 (9,191)
----------- -----------
Comprehensive loss $ (419,443) $(1,894,616)
=========== ===========
- --------------------------------------------------------------------------------
See accompanying notes to the condensed consolidated financial statements
5
VERTICAL COMPUTER SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED
MARCH 31,
----------------------------
2003 2002
----------- -----------
Cash flows from operating activities:
Net loss $ (487,812) $(1,885,425)
Adjustments to reconcile net loss to net cash
used in operating activities:
Minority interest in net income of subsidiary 71,632 --
Depreciation and amortization 310,949 134,685
Stock compensation 19,451 241,187
Bad Debt expense 13,693 103,650
Write-off fixed assets -- 42,022
Write-off goodwill and investments -- 770,305
Write down marketable securities -- 95,500
Deferred income taxes (49,800) --
Changes in operating assets and liabilities:
Accounts receivable 620,555 (170,489)
Other receivable -- 370,000
Receivable from officers and employees (8,699) --
Prepaid expenses 4,632 (32,536)
Accounts payable and accrued liabilities 34,604 673,844
Deferred Revenue (39,207) (10,248)
Income tax payable 130,000 --
Payable to officers (44,158) --
----------- -----------
Net cash provided by operating activities: 575,840 332,495
Cash flow from investing activities:
Related party receivable -- 5,132
Purchase of equipment (15,594) --
----------- -----------
Net cash provided by (used in) investing activities (15,594) 5,132
Cash flow from financing activities:
Release of pledged cash 650,000 --
Release of restricted cash 275,820 --
Repayment of notes payable (925,820) (544,711)
----------- -----------
Net cash used in financing activities -- (544,711)
Effect of changes in exchange rates on cash 58,978 (18,190)
Net increase (decrease) in cash and cash equivalents, 619,224 (225,274)
Cash and cash equivalents, beginning of period 946,035 845,459
----------- -----------
Cash and cash equivalents, end of period $ 1,565,259 $ 620,185
----------- -----------
Supplemental disclosure of cash flow information: Cash paid for the period:
Interest $ 90,258 $ 98,112
See accompanying notes to condensed financial statements
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, 2002.
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. Negative shareholders' equity at March 31, 2003 was
$3,346,576. Additionally, at March 31, 2003, the Company had negative working
capital of approximately $7.9 million (although it includes deferred revenue of
approximately $2.5 million) and has defaulted on several of its debt
obligations. These conditions raise substantial doubt about the Company's
ability to continue as a going concern.
Management of the Company is continuing its efforts to secure funds
through equity and/or debt instruments for its operations, expansion and
possible acquisitions, mergers, joint ventures, and/or other business
combinations. In April 2003, the Equity Line of Credit Agreement executed in
August 2001 was cancelled and the Company entered into a new Equity Line of
Credit Agreement with Cornell Capital Partners, L.P (Cornell). Under this new
agreement, the Company may issue and sell to Cornell Capital Partners common
stock for a total purchase price of up to $10.0 million. In accordance with the
new agreement, the Company will be entitled to commence drawing down on the
equity line of credit upon the effectiveness of a Registration Statement
registering the shares to be issued under this new agreement. The Company will
require additional fund for its operations and pay down its liabilities, as well
as finance its expansion plans consistent with the Company's anticipated changes
in operations and infrastructure. However, there can be no assurance that the
Company will be able to secure additional funds and that if such funds are
available, whether the terms or conditions would be acceptable to the Company
and whether the Company will be able to turn into a profitable position and
generate positive operating cash flow. The consolidated financial statements
contain no adjustment for the outcome of this uncertainty.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior periods to
conform to the current period presentation.
NOTE 2 - COMMON AND PREFERRED STOCK TRANSACTIONS
In January 2003, the Company's subsidiary, Government Internet Systems,
Inc. (GIS) retained David Kinney to serve as CTO. The Company issued five-year
warrants to purchase 500,000 shares of the Company's common stock at an exercise
price of $0.01 in connection with retaining this executive. The warrants, at the
time of issuance, had an estimated fair market value of $2,441 (valued using the
Black-Scholes valuation model). In the event that GIS achieves certain sales
targets or receives $2.5 million in financing, Kinney has the option to become a
salaried employee for 2 years at an annual salary of $125,000.
In January 2003, the Company, acting as the majority shareholder of
Government Internet Systems, Inc., a subsidiary of the Company, retained the
services of Basil Nikas as a Director of GIS for 250 shares of the 25,000 shares
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of the outstanding common stock of GIS, subject to a buyback agreement between
the Company and the director. The value of these shares is nominal. In addition,
the Company issued five-year warrants to purchase 250,000 shares of the
Company's common stock at an exercise price of $0.01 in connection with
retaining this director. The warrants were issued at an estimated fair market
value of $1,672 (valued using the Black-Scholes valuation model).
In January 2003, the remaining $50,000 of principal of $125,000 in
debentures was converted into 12,853,470 shares of the Company's common stock.
These convertible debentures, issued on September 11, 2001, bear interest at 6%
per annum, were convertible into shares of the Company's common stock at either
120% of the closing bid price on the date of agreement or 80% of the three
lowest closing bid prices 20 days prior to the conversion. The debentures were
convertible at the option of the holder at any time after the purchase.
Principal and interest were originally due at maturity on September 1, 2006.
In January 2003, the remaining $55,000 of principal of $140,000 in
debentures was converted into 14,138,817 shares of the Company's common stock.
These convertible debentures, issued on October 5, 2001, bear interest at 6% per
annum, were convertible into shares of the Company's common stock at either 120%
of the closing bid price on the date of agreement or 80% of the three lowest
closing bid prices 20 days prior to the conversion. The debentures were
convertible at the option of the holder at any time after the purchase.
Principal and interest were originally due at maturity on October 5, 2006. The
accrued interest is currently outstanding.
In February 2003, the Company and its wholly owned subsidiary, Enfacet,
Inc., agreed to amend the stock purchase agreement. Pursuant to the amendment,
the Company may substitute 400 common shares for each share of Preferred "C"
Stock of the Company (up to 12,000,000 shares of common stock of the Company) in
connection with purchase of Enfacet, Inc. The Company may cancel any Preferred
"C" Stock of the Company for which common stock is substituted or as otherwise
specified in the agreement. In April 2003, the Company issued 3,000,000 shares
of common stock of the Company with the Rule 144 restrictive legend to former
employees and consultants of Enfacet, Inc. for services. These 3,000,000 shares
were issued in connection with this agreement and the Company cancelled 7,500
shares of Preferred "C" Stock that were issued to the Company's subsidiary, but
held by the Company. In February 2004, the Company cancelled 22,500 shares of
Preferred "C" Stock of the Company.
In March 2003, the Company, acting as the majority shareholder of
Government Internet Systems, Inc., a subsidiary of the Company, retained the
services of Thomas Beeson as a Director of GIS for 250 shares of the 25,000
shares of the outstanding common stock of GIS, subject to a buyback agreement
between the Company and the director. The value of these shares is nominal. In
addition, the Company issued five-year warrants to purchase 250,000 shares of
the Company's common stock at an exercise price of $0.01 in connection with
retaining this director. The warrants were issued at an estimated fair market
value of $645 (valued using the Black-Scholes valuation model).
NOTE 3 - NOTES PAYABLE
The note payable to Coast Business Credit ("Coast"), issued by Now
Solutions, Inc., in the principal amount of $5,500,000 bearing interest at prime
plus 1.5% with a minimum interest of 8.5% per annum, monthly payment of $91,500
of principal, plus interest, due April 28, 2006 (as amended below), is secured
with all of the assets of Now Solutions and a $1,500,000 security deposit by the
Company to guarantee the first 36 payments of the loan and is subject to various
loan covenants. In March 2003, Coast was taken over by the FDIC and WAMCO 31,
Ltd., purchased the loan. As of June 22, 2004, the outstanding principal balance
due on the $5.5 million note is $1,304,766. In August 2003, WAMCO 31, Ltd.
agreed to extend the due date of the note from February 28, 2004 to August 28,
2004. . In June 2004, the parties agreed to amend the terms of the note and the
loan. Pursuant to the amendment, the interest was changed to 9% per annum and
the $1,304,766 outstanding principal balance shall be payable as follows: (a)
$91,667 principal per month, plus interest commencing on June 30, 2004 and
continuing on each succeeding month through September 30, 2004; (b) $7,500
principal per month, plus interest, commencing on October 31, 2004 and
continuing on each succeeding month through January 31, 2005; (c) providing that
Now Solutions has achieved revenues of $7.5 million and EBITDA (Earnings Before
Interest, Taxes, Depreciation & Amortization) of not less than $2,200,000 for
the fiscal year 2004, $7,500 principal per month, plus interest, commencing on
February 28, 2005 and continuing on the last day of each succeeding month until
June 30, 2005; and (d) $91,667 principal per month plus interest, commencing on
July 31, 2005 and continuing on each succeeding month until the note is paid. In
the event Now Solutions does not qualify for reduced payments, the note will be
payable in the amount of $91,667 principal per month, plus interest, commencing
on February 28, 2005 and continuing on the last day of each succeeding month
until the note is paid. In connection with the amendment, Now Solutions is
required to pay WAMCO 31 5% of Now Solutions' revenues in excess of $8 million
up to a maximum of $250,000, beginning in the fiscal year that commences January
1, 2005. Also in connection with the amendment, the Company issued warrants to
purchase 3,000,000 shares of the common stock Company at an exercise price of
8
$0.03 per share or at the holder's election, by surrendering an amount of common
stock equal to or greater than (but only if by a factional share) the required
aggregate exercise price, in which the holder would receive an amount of common
stock to which it would otherwise be entitled upon such exercise, less the
surrendered shares. The holder may also utilize a combination of either of the
foregoing methods. The warrants are subject to "piggy back" registration rights
and a leak-out provision. The Company's remaining pledge balance of $650,000 was
offset against the loan balance in lieu of a $650,000 promissory note from Now
Solutions to the Company. In September 2003, the $650,000 note was split into
two notes in the amounts of $215,000 and $435,000. These notes are due on
December 31, 2004 with the same interest rate and terms as the $5,500,000 note,
with monthly interest payments commencing July 1, 2003. The $435,000 note has
been paid down by Now Solutions and the Company pledged its interest in a
$215,000 note issued by Now Solutions to the Company to secure a $50,000 loan
made by Victor Weber to the Company as well as $150,000 in loans made by Weber
to the Company in December 2002 through July 2003. Weber elected to make this
assignment in January 2004. Except for the $215,000 note, which was assigned to
Weber, all other notes and debt under loans made by Weber were cancelled. The
Company has made all interests payments as of June 22, 2004.
The note payable to Ross issued by Now Solutions in the amount of
$1,000,000, is unsecured and non-interest bearing. The note was recorded at a
discount (which will be amortized over the life of the note); payments of
$250,000 and $750,000 were due in February 2002 and 2003, respectively. Since
payments were not received within three days from the due date, the note now
bears interest at 10% per annum. In 2002, Now Solutions offset $250,000 payment
through its receivable from Ross. See also Note 4, Litigation, for subsequent
event. At March 31, 2003, the past due balance of the note outstanding was
$750,000 and the unamortized discount was zero.
In March 2003, in connection with a settlement agreement between the
Company and M.S. Farrell & Co. concerning claims by each party, the Company
issued a promissory note in the principal amount of $23,030 bearing interest at
a rate of 12% per annum to a member of M.S. Farrell & Co. The Company and M.S.
Farrell & Co. had entered into a consulting agreement in July 2001. The note is
payable in installment payments of $2,500 per month beginning in July 2003 until
the principal, and all interest, fees, charges, and other amounts owing
hereunder have been paid in full. The note is currently delinquent.
The note payable to a third party lender in the amount of a $239,004
bears interest at 13% per annum and is unsecured, with a $56,000 payment made in
December 2002, commencing with monthly payments of $7,500 beginning in March
2003. This note was issued in 2002 to replace a $211,137 note issued in August
2001, bearing interest at 12% per annum. In March 2003, the $239,004 note was
amended so that the Company would pay the interest and expenses incurred by the
lender for a third party loan secured on the lender's behalf and the Company
agreed to begin making monthly payments of $7,500, beginning on June 1, 2003. In
August 2003, the Company obtained an extension and waiver of default for a
$239,004 note issued by the Company in August 2002. In December 2003, in
connection with the issuance of a $30,000 debenture to the third party, the
payments due under the note were extended. Pursuant to the extension, the
Company is required to make monthly installment payments of $7,500, beginning on
February 1, 2004, until the balance under the note has been paid. The note is
currently delinquent and the debenture has not been redeemed.
The note payable in the amount of $50,000 to a third party lender,
bearing no interest, secured by a limited interest in the Company's deposit
pledge account on behalf of Now Solutions, was issued in June 2002 and was
originally due in January 2003. In March 2003 the parties amended the note.
Pursuant to this amendment, the parties agreed to accrue interest beginning in
October 2002 at 12% per annum. The parties also agreed that the Company would
make monthly payments of accrued interest payments beginning in April 2003 and
monthly principal payment of $5,000 beginning in July 2003. 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. In August 2003, the Company
obtained an extension and waiver of default for a $50,000 note issued by the
Company to a third party in June 2002. Pursuant to the waiver and extension, the
Company is required to make monthly installment payments of $7,500 beginning on
November 15, 2003 until the balance under the note has been paid. The note is
currently delinquent.
The note payable in the amount of $50,000 to a third party lender,
bearing interest at the rate of 12% per annum, secured by a limited interest in
the Company's deposit pledge account on behalf of Now Solutions, was issued in
June 2002 and was originally due in January 2003. In connection with the loan,
the Company issued three-year warrants to purchase 1,500,000 shares of its
common stock at a price of $0.004 per share. In March 2003, the parties entered
into an amendment, whereby the parties agreed to pay accrued interest in the
amount of $4,200 for this note and to extend the maturity date to June 1, 2004.
Beginning in July 2003, the above interest payments were to be replaced with a
monthly installment payment of $5,000, with the initial payments applied first
to the $25,000 note (discussed below) and then to the $50,000 note. In August
2003, the Company obtained an extension and waivers of default for two notes of
$50,000 and $25,000 issued by the Company to a third party in June and August
2002, respectively. Pursuant to the extension, the Company was required to make
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monthly accrued interest payments for each respective note beginning on October
15, 2003, and, beginning on January 15, 2004, the above monthly interest
payments were to be replaced with a monthly installment payment of $5,000, which
is to be made until the balances owned under these notes have been paid. The
note is currently delinquent.
The note payable in the amount of $25,000 to a third party lender,
bearing interest at 12% per annum, secured by 10,000,000 shares of the Company's
common stock that are owned by Mountain Reservoir Corporation, controlled by W5
Family Trust, of which Richard Wade (CEO of the Company) is trustee, was issued
in August 2002 and was originally due in December 2002. In March 2003, the
parties entered into an amendment. Pursuant to the amendment, the Company agreed
to pay accrued interest in the amount of $1,170 for this $25,000 note. Beginning
in July 2003, the Company was required to make monthly payments of $5,000 with
the initial payments applied first to the $25,000 note and then to the $50,000
(discussed above) note issued. The Company is in default subsequent to April 1,
2003. In August 2003, the Company obtained an extension and waivers of default
for two notes of $50,000 and $25,000 issued by the Company to a third party in
June and August 2002, respectively. Pursuant to the extension, the Company was
required to make monthly accrued interest payments for each respective note
beginning on October 15, 2003, and, beginning on January 15, 2004, the above
monthly interest payments were to be replaced with a monthly installment payment
of $5,000, which is to be made until the balances owned under these notes have
been paid. The note is currently delinquent.
The Company amended two notes payable it had issued to Victor Weber in
the amount of $65,000 and $45,000 in March 2003. These notes were issued in
December 2002, bearing interest at 13% per annum, were unsecured, and were due
in March 2003. In March 2003, the due date for payment of principal and interest
of these notes was extended to July 1, 2003. In July 2003, the Company and
Victor Weber amended the terms of certain loans made by Weber to the Company in
the aggregate amount of $150,000. Pursuant to their agreement, Weber cancelled
the $65,000 and $45,000 notes payable as well as other outstanding debt, and the
Company issued two promissory notes in the amounts of $100,000 and $40,000. The
$100,000 promissory note bears interest at 13% per annum and is payable in
monthly accrued interest payments beginning August 1, 2003, and a final payment
of all principal and remaining interest by March 31, 2004. The $40,000
promissory note bears interest at 13% per annum and is payable in monthly
installment payments beginning August 1, 2003, and consisting of an $8,000
principal payment plus the interest accrued in the previous month. In
consideration of the loans made to the Company and for services rendered on
behalf of the Company, the Company paid a $250 commitment fee to Weber and
issued 8,000,000 shares of common stock of the Company to Weber. The stock is
subject to Rule 144 restrictions. In August 2003, the Company obtained
extensions and waivers of default for two notes of $100,000 and $40,000 issued
by the Company to Victor Weber on July 1, 2003. Pursuant to these extensions,
the Company had until October 1, 2003 to become current in its payments. In
September 2003, Weber agreed to loan the Company $50,000. In exchange, the
Company issued a $50,000 note bearing interest at 13%, and due March 31, 2004.
In connection with the loan, the Company pledged its interest in a $215,000 note
issued by Now Solutions to the Company to secure this loan as well as $150,000
in loans from Weber to the Company from December 2002 through July 2003.
Pursuant to the Company pledge, Weber has the option to have the Company assign
the $215,000 note issued by Now Solutions to Weber provided that Weber forgives
all of the Company's outstanding debt and cancels all underlying notes in
connection with the debt. Weber elected to make this assignment in January 2004.
Except for the $215,000 note, which was assigned to Weber, all other notes and
debt under loans made by Weber were cancelled. The Company has made all
interests payments as of June 22, 2004. Victor Weber is a Director and President
of Government Internet Systems, Inc., a subsidiary of the Company.
The note payable in the amount of $84,000 issued by EnFacet to Robert
Farias, bearing interest at 8% per annum, unsecured, was issued on June 1, 2001,
with principal and interest due on June 1, 2002. In March 2003, both parties
entered into an agreement to amend the note. Pursuant to the amendment, the due
date of the note was extended to March 17, 2004 in exchange for increasing the
interest rate from 8% to 12% at which interest will be accrued from the date the
note was issued. In addition, EnFacet is required to make monthly payments of
$1,000 commencing in April 2003. In February 2004, the Company and Robert Farias
waived any defaults on the note and agreed that the note will be payable as
follows: once Vertical's subsidiary, Now Solutions, has paid off the entire
balance due under the $500,000 note issued by Now Solutions to Farias on
February 13, 2004, sixteen percent (16%) of any remaining amounts from the final
$91,500 installment payment on the $500,000 note shall be applied to the $84,000
note. Thereafter, Vertical or, at Vertical's option, Now Solutions, shall
continue to make monthly principal payments of $14,640 beginning on the first
day of the following month until all monies due under the $84,000 note has been
paid. In connection with the amendment, Now Solutions entered into a security
agreement with the lender to guarantee the note. The security interest of Now
Solutions' assets on the secured promissory note will be junior to Now
Solutions' present indebtedness to WAMCO 31 Ltd, Arglen Acquisitions, LLC and
Robert Farias in connection with the $500,000 note. The Company appointed Robert
Farias as a director of Now Solutions, a 100% owned subsidiary of the Company,
in June 2003.
The note payable in the amount of $280,000, bearing interest at 4% per
annum and issued to Robert Farias on October 31, 2001, was amended by the
parties in March 2003. Pursuant to the amendment, the payment of principal would
10
be paid in monthly installment in the amount of $5,000, which was to be replaced
with monthly payments of $10,000 beginning in January 2004. All interest would
be due on the day the principal is paid in full. In exchange for the extensions,
the interest rate will accrue at the rate of 12% from the date the note was
issued. In February 2004, the Company and Robert Farias amended the $280,000
note issued to Mr. Farias on October 31, 2001 and the $181,583 note issued to
Mr. Farias on October 17, 2002. Any default on these notes was waived, and the
Company agreed to make the following payments on these notes, which will be
applied to the notes as follows: (i) $20,000, which was paid toward the $181,583
note on February 20, 2004; (ii) fifty percent (50%) of the remaining past-due
amounts by March 20, 2004; and (iii) the all remaining past-due amounts to bring
the notes current by April 20, 2004. In the event the Company does not pay the
amounts in a timely manner, then all amounts still owing under these notes will
be considered in default and the following shall apply: (i) all such remaining
amounts will be added to the secured loan amounts and will be subject to the
security interest and pledge agreements under the $84,000 promissory note issued
by the Company's subsidiary, Enfacet, to Mr. Farias on June 1, 2001; (ii) the
$14,640 monthly payments to be made under the $84,000 note will be applied to
the $280,000 and $181,583 notes until these notes are paid in full; and (iii)
with respect to cash proceeds Now Solutions receives due to a capital infusion
or upfront licensing fees from a reseller that is outside its normal scope of
business (i.e, not part of software sales in the regular course of business),
Now Solutions is required to pay 50% of such proceeds remaining after the
$500,000 note payable issued by Now Solutions to Mr. Farias on February 13, 2004
has been paid in full toward the $280,000 and $181,583 notes if the Company is
not current in its payments. The $280,000 note is secured by SiteFlash
technology owned by the Company. The Company appointed Robert Farias as a
director of Now Solutions, a 100% owned subsidiary of the Company, in June 2003.
These notes are delinquent.
NOTE 4 - 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 addition, the Company is involved in the following additional
ongoing matters:
In December 2003, the Company settled its dispute with Arglen
Acquisitions, LLC ("Arglen"), a minority partner of Now Solutions, regarding
issues related to Now Solutions. The settlement resolved various allegations by
the Company and Arglen concerning violations of Now Solutions' Operating
Agreement. In February 2004, the parties completed the closing of the
settlement. The arbitration has been dismissed and any actions with respect to
Arglen and Gary Gyselen and the Company and its related parties, including Now
Solutions, were also dismissed, except that the California Superior Court, Los
Angeles County retained jurisdiction regarding the terms of the settlement
between the parties. Pursuant to the terms of the settlement, the Company
purchased Arglen's interest in Now Solutions for $1.4 million as follows: (a)
$800,000 which was paid at the closing and (b) $600,000, pursuant to a
non-interest bearing secured promissory note providing for payments of $200,000
in April 2004, $100,000 in June 2004, and $300,000 in September 2004, which was
issued at closing. The security interest of Now Solutions' assets on the secured
promissory note is junior to Now Solutions' present indebtedness to WAMCO 31,
Ltd. In addition, at closing, the Company cancelled 80,763,943 warrants held by
Arglen and issued to Arglen 20,000,000 shares of the common stock of the Company
(at a fair market value of $280,000), which is subject to Rule 144 regulation
with "leak out" provisions. The Company is obligated to file a registration
statement within 180 days of the closing date covering the resale of the shares
by Arglen. If the Company does not file a timely registration statement, the
Company is obligated to issue an additional 5,000,000 shares and file its
registration statement no later than December 31, 2004. The note has not been
paid and in April 2004, Arglen gave notice of default and acceleration. On June
17, 2004, Arglen noticed a motion in the action encaptioned Arglen Acquisitions,
LLC v. Vertical Computer Systems, Inc. Superior Court of the State of
California, County of Los Angeles. Pursuant to the motion, Arglen requests a
judgment for $600,000.00 interest and attorneys fees against the Company as
joint obligor on the promissory note to Arglen. The motion is scheduled to be
heard on August 13, 2004. The Company is taking appropriate action to defend the
motion.
At March 31, 2003, the Company had cash-on-hand of $1,565,259. Now
Solutions' cash-on-hand was not available to fund the Company's operations due
to a court order obtained by Arglen and bank covenants in connection with legal
proceedings concerning Now Solutions. The Company settled with Arglen in
December 2003. The settlement closed in February 2004, and the Company and
Arglen dismissed all claims with respect to one another. As a result, the
cash-on-hand of Now Solutions is now available to fund the Company's operations.
In February 2003, the Company filed a lawsuit and a derivative action
in New York Supreme Court Case against defendants Ross Systems, Inc. ("Ross"),
Arglen Acquisitions, LLC ("Arglen"), James Patrick Tinley ("Tinley"), and Garry
Gyselen ("Gyselen"). The Company filed a derivative action on behalf of its
subsidiary Now Solutions when Arglen refused to authorize a lawsuit against any
parties who were alleged to have acted against the best interest of Now
Solutions. In conjunction with the Company's claim, Now Solutions is withholding
11
its payments on the remaining $750,000 note that was due in February 2003
against the unpaid maintenance fees and gave notice in February 2003 to Ross of
Now Solutions' claim of offset. Now Solutions has claimed a total amount of
approximately $3,562,000 to offset against the note, plus other damages.
Plaintiff's original claims sought damages and equitable relief arising out of
actions of the defendants constituting breach of contract, fraud, conspiracy and
breach of fiduciary duty in connection with certain transactions entered into
between Ross and Now Solutions; Ross and Arglen; Arglen and Now Solutions;
Gyselen and Now Solutions; and the Company and Arglen. The action concerned
offsets of payment on note payable to Ross by the maintenance fee charged by Now
Solutions to Ross to which Now Solutions was entitled per the asset purchase
agreement between Now Solutions and Ross regarding the HRIS assets Now Solutions
purchased from Ross in 2001, an undisclosed transaction between Ross and Gyselen
around the time of the purchase of these assets, and the failure of Gyselen to
enforce the offset provisions which caused Coast to declare Now Solutions in
default of a loan covenant in 2001 (which has since been cured). The portion of
the lawsuit involving Arglen and Gyselen was settled in December 2003 and,
pursuant to the settlement, was dismissed in February 2004. The court has
dismissed the entire action against Ross and Tinley. The Company has appealed
the decision with regard to its claim for breach of contract for Ross' failure
to give the proper maintenance fee adjustment. On June 1, 2004, the appeal was
submitted to the court for decision.
In March 2003, Ross commenced an action in Supreme Court, Westchester
County (New York State) by filing a motion for summary judgment in lieu of
complaint against Now Solutions to collect the note payable in the amount of
$750,000 plus 10% interest. In August 2003, the Westchester County Supreme Court
denied the motion and dismissed Ross's action without prejudice. In October 2003
the motion of Ross for reargument was denied. Ross has appealed the August 2003
court order, but subsequently abandoned its appeal.
In March 2004, Ross commenced an action in the Supreme Court, New York
County (New York State) by filing a motion for summary judgment in lieu of
complaint against Now Solutions to collect the note payable in the amount of
$750,000 plus 10% interest and attorneys fees. Now Solutions filed its
opposition to Ross' motion, which was submitted to the court for decision on May
20, 2004. No decision has been rendered as of June 15, 2004.
In March 2004, Ross commenced an action in the Court of Chancery, State
of Delaware by filing a summons and complaint against the Company, Now Solutions
and Arglen alleging a fraudulent transfer in connection with the Company's
payment of moneys to Arglen pursuant to the settlement dated December 2003. The
Company and Now Solutions have filed a motion to stay the Delaware action
pending the resolution of the parties' rights in Supreme Court, New York County
and Appellate Division.
On December 21, 2001, the Company entered into an option agreement with
iNet Purchasing ("iNet") to purchase an additional interest in iNet under which
the Company would obtain an aggregate 56% ownership interest in iNet pursuant to
the Stock Purchase Agreement and the Stockholder's Agreements. 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 three-year stock
options to three iNet executives, Basil Nikas, Robin Mattern, and Wayne Savage,
in the amount of 1,500,000, 1,500,000, and 500,000 shares of the Company's
common stock, respectively. These stock options were issued in 2001. At December
31, 2002, the Company had 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 $0.01, 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 is required to
pay to iNet $860,000 in cash or marketable securities (pending any potential
offsets). The Company would need to raise additional capital in order to pay the
cash portion of the exercise price, which is $860,000. In addition, in order to
exercise the option, the Company must issue 70,000 shares of Series C preferred
stock and grant additional three-year warrants and options, as the case may be,
to purchase an additional 6,000,000 shares of the Company's common stock each to
Nikas and Mattern and 2,000,000 shares of the Company's common stock to Savage,
at a strike price of $0.025 per share. Of these warrants and options, the
Company issued but did not deliver 1,500,000 warrants each to Mr. Nikas and Mr.
Mattern and 500,000 warrants to Mr. Savage in January 2002. The fair market
value of these warrants at the date of grant was $35,713. In the event that the
Company does not acquire a majority interest in iNet, these options and warrants
will automatically be cancelled. Under the terms of the option, iNet is required
to deliver certain financial and non-financial information. This information was
never delivered and the Company is holding the warrants issued in January 2002
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.
12
Note 5 - NEW ACCOUNTING PRONOUNCEMENTS
In April 2002, FASB issued Statement No. 145 (SFAS No. 145),
"Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement
No. 13, and Technical Corrections" effective on or after May 15, 2002. This
Statement rescinds SFAS No. 4 and an amendment of that Statement, and SFAS No.
64. This Statement also rescinds SFAS No. 44. This Statement amends SFAS No. 13,
to eliminate an inconsistency between the required accounting for certain lease
modifications that have economic effects that are similar to sale-leaseback
transactions. This Statement also amends other existing authoritative
pronouncements to make various technical corrections, clarify meanings or
describe their applicability under changed conditions. The Company adopted SFAS
No 145 as of December 31, 2002 and the adoption of SFAS No. 145 did not have a
material effect on the Company's financial position or results of operations.
In December 2002, FASB issued Statement No. 148 (SFAS No. 148),
"Accounting for Stock-Based Compensation -- Transition and Disclosure -- an
amendment of FASB Statement No. 123." SFAS No. 148 amends SFAS No. 123,
"Accounting for Stock-Based Compensation," to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, SFAS No. 148 amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. SFAS No 148 is effective for the Company's financial statements for the
year ending after December 15, 2002. As permitted by SFAS No. 148, the Company
has elected to retain the intrinsic value method of accounting for stock-based
awards granted to employees. Accordingly, the adoption of SFAS No. 148 did not
have a material effect on the Company's financial position or results of
operations.
In June 2002, FASB issued Statement No. 146 (SFAS No. 146), "Accounting
for Costs Associated with Exit or Disposal Activities," effective for activities
that are initiated after December 31, 2002, with early application encouraged.
This Statement addresses financial accounting and reporting for costs associated
with exit or disposal activities and nullifies Emerging Issues Task Force (EITF)
Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." The Company adopted SFAS No. 146 as of January 1, 2003 and the
adoption of SFAS No. 146 did not have a material effect on the Company's
financial position or results of operations.
In November 2002, FASB issued Interpretation No. 45 ("FIN No. 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN No. 45 expands on the
accounting guidance of Statements No. 5, 57, and 107 and incorporates without
change the provisions of FASB Interpretation No. 34, which is being superseded.
FIN No. 45 will affect leasing transactions involving residual guarantees,
vendor and manufacturer guarantees, and tax and environmental indemnities. All
such guarantees will need to be disclosed in the notes to the financial
statements starting with the period ending after December 15, 2002. For
guarantees issued after December 31, 2002, the fair value of the obligation must
be reported on the balance sheet. Existing guarantees will be grandfathered and
will not be recognized on the balance sheet. The adoption of FIN No. 45 did not
have a material impact on the Company's financial statements.
NEW ACCOUNTING PRONOUNCEMENTS NOT ADOPTED YET
In May 2003, FASB issued Statement No. 150 (SFAS No. 150), "Accounting
for Certain Instruments with Characteristics of Both Liabilities and Equity."
SFAS No. 150 establishes standards on the classification and measurement of
financial instruments with characteristics of both liabilities and equity. SFAS
No. 150 will be effective for financial instruments entered into or modified
after May 31, 2003 and otherwise is effective beginning July 1, 2003. The
Company is in the process of assessing the effect of SFAS No. 150 on the
Company's consolidated financials statements.
In January 2003, FASB issued FASB Interpretation No. 46 (FIN No. 46),
"Consolidation of Variable Interest Entities," an interpretation of Accounting
Research Bulletin No. 51, "Consolidated Financial Statements." FIN No. 46
explains how to identify variable interest entities and how an enterprise
assesses its interest in a variable entity to decide whether to consolidate that
entity. FIN No. 46 requires existing unconsolidated variable interest entities
to be consolidated by their primary beneficiaries if the entities do not
effectively disperse risks among parties involved. FIN No. 46 is effective
immediately for variable interest entities after January 31, 2003, and to
variable interest entities in which an enterprise obtained an interest after
that date. FIN No. 46 applies in the first fiscal year or interim period
beginning after June 15, 2003, to variable interest entities in which an
enterprise holds a variable interest that it acquired before February 1, 2003.
The adoption of FIN No. 46 is not expected to have a material effect on the
Company's financial position and result of operations.
13
NOTE 6 - SUBSEQUENT EVENTS
In April 2003, the Company and the third party seller of the SiteFlash
technology agreed to amend the put and call agreement of October 2002, which was
made in connection with the amendment of the $280,000 note issued in October
2001. Pursuant to this amendment, the Company issued 1,000,000 shares of common
stock of the Company in lieu of issuing 2,500 shares of Class C Preferred Stock
of the Company to the third party when the Company did not purchase the
underlying common stock represented by 12,500 shares of Class C Preferred Stock
of the Company in March 2003. The Company issued the 1,000,000 shares in April
2003.
In April 2003, the Company issued five-year warrants to purchase
5,000,000 shares of common stock of the Company at an exercise price of $0.01
per share to Wolman, Babbitt, & King for legal services rendered to The Company.
The warrants, at the time of issuance, had an estimated fair market value of
$15,009 (valued using the Black-Scholes valuation model).
In April 2003, the Company and Mike Radlovic (Radlovic) entered into an
agreement whereby Radlovic would purchase the Company's interest in TranStar
Systems, Inc. (TranStar), formerly Apollo Industries, Inc. In October 2000, the
Company had agreed to provide $250,000 in funding to TranStar in exchange for a
30% equity interest. Pursuant to the agreement, the Company transferred all of
its ownership representing 3,000,000 shares of TranStar common stock to
Radlovic. In consideration of the sale, Radlovic issued a $250,000 note bearing
interest at 10% per annum due in April 2007. The note is secured by 5,000,000
shares of TranStar common stock owned by Radlovic. Radlovic is the President and
CEO of TranStar.
In April 2003, the Company and TranStar Systems, Inc. (TranStar) agreed
to amend two $24,000 promissory notes bearing interest at 10%, dated April 19
and May 8, 2001, and a royalty agreement, dated October 14, 2000 whereby
TranStar had agreed to pay a royalty of 2% of all transaction fees up to
$275,000 and 1% up to $3,000,000. Pursuant to the agreement, the due date for
the two $24,000 notes was extended to April 5, 2006 in exchange for increasing
the royalty rate in the royalty agreement to 3% of any transaction fees and any
other revenues generated in perpetuity. The collateral to secure the note,
consisting of 1,000,000 shares of TranStar common stock, and the underlying
security agreements remain in full force and effect. In connection with the
agreement, TranStar also released and indemnified the Company from any
obligations owed to TranStar or any third party.
In April 2003, the Company issued a $25,000 promissory note bearing
interest at 10% per annum to a consultant of the Company's subsidiary, EnFacet,
Inc., for past services rendered. The note is payable in monthly $1,000
installments beginning in May 2003 to be replaced by $2,000 monthly installments
beginning in October 2003. The note is currently delinquent.
In April 2003, the Company issued 1,100,000 shares of common stock to a
third party consultant and extended 750,000 options and 750,000 warrants that
vested in November 2001 at an exercise price of $0.025 per share for an
additional one-year in connection with consulting services. The extension of the
options and warrants had an estimated fair market value of $6,396 (valued using
the Black-Scholes valuation model).
In April 2003, the Equity Line of Credit agreement entered into in
August 2001 was cancelled and a new Equity Line of Credit Agreement was executed
between the Company and Cornell, whereby up to $10,000,000 worth of the
Company's common stock may be purchased. The shares must be registered before
the sale, and the shares can be purchased at 99% of the lowest closing bid price
during the 5 days trading days after the Company requests an advance, but not
less than the minimum advance price per share set by the Company and provide in
the notice requesting an advance. The Equity Line of Credit Agreement contains a
commitment fee of $190,000, payable in a convertible debenture, which was issued
to Cornell, and a placement fee of $10,000, payable to the third party placement
agent. The debenture may be redeemed for 100% of the any portion of the
principal that has not been converted by the holder as of the date of the notice
of redemption. The debenture provides that after 180 days the holder may convert
any portion of the principal at 100% of the lowest closing bid price 3 days
prior to conversion. In addition, the Company shall pay $500 in legal,
administrative and escrow fees and a 2% commitment fee of each advance to
Cornell. In July 2003, the Company issued 2,049,180 shares of common stock as
payment of the $10,000 placement fee. As of June 22, 2004, no debentures have
been converted.
In April 2003, the Company issued $200,000 of convertible debentures to
Cornell. The debt accrues interest at 5% per annum and is due April 2006. The
holder may convert the debenture into shares of common stock at either $0.03 or
80 % of the lowest closing bid price for the 5 trading days prior to the
conversion. In accordance with the beneficial conversion feature, the Company
recognized deemed interest expense of $50,000.
14
In April 2003, the Company issued, but did not deliver, 3,000,000
shares of common stock of the Company to a third party lender in anticipation of
finalizing the terms of the loan made by the lender. The lender had initially
agreed to loan the Company $60,000 but only $31,859 was funded. The Company
intends to deliver the stock once the terms of the loan are finalized.
In April 2003, $40,000 of principal of $100,000 in debentures was
converted into 10,245,900 shares of the Company's common stock. These
convertible debentures, issued on March 29, 2002, bearing interest at 5% per
annum, were convertible into shares of the Company's common stock at either 120%
of the closing bid price on the date of agreement or 80% of the lowest closing
bid prices 5 days prior to the conversion. The debentures were convertible at
the option of the holder at any time after the purchase. Principal and interest
were originally due at maturity on March 28, 2004.
In May 2003, the Company issued two promissory notes, each for a
principal amount of $17,500, bearing no interest to two third party lenders in
consideration of two loans in the aggregate amount of $30,000. The notes were
due in June 2003. The Company has pledged distributions of funds owed to it by
its subsidiary Now Solutions toward payment of the loan. In connection with the
notes the Company paid a commitment fee of $2,500 on each note and issued
five-year warrants to purchase 250,000 shares of common stock of the Company at
an exercise price of $0.0075 per share to each lender. The warrants were issued
at an estimated fair market value of $2,440 (valued using the Black-Scholes
valuation model). In connection with these loans, the Company also issued
five-year warrants to purchase 250,000 shares of common stock of the Company at
an exercise price of $0.0075 per share to a third party consultant. The warrants
were issued at an estimated fair market value of $1,220 (valued using the
Black-Scholes valuation model). In February 2004, the parties amended the terms
of the loans. The lenders waived any default on the note and in exchange the
Company agreed to issue 500,000 shares of the Company common stock to each
lender (at a total fair market value of $14,000), which are subject to Rule 144
Regulation, and to pay $8,750 by March 31, 2004 and $8,750 plus all accrued
interest by April 30, 2004 under each note. The stock issued to each lender is
subject to "piggy back" registration rights and a "leak out" agreement. These
notes are currently in default.
In May 2003, the Company issued a $7,500 promissory note bearing
interest at twelve percent (12%), due in June 2003, to Stephen Rossetti in
connection with a loan in the same amount. The note is currently delinquent. Mr.
Rossetti is the CEO and a Director of Government Internet Systems, Inc., a
subsidiary of the Company.
In June 2003, the Company retained the services of Equitilink, Inc. to
provide investor relations services. As compensation, the Company issued
15,000,000 shares of Company's common stock with the Rule 144 restrictive legend
with a fair market value of $60,000.
In June 2003, the Company and a third party lender entered into an
agreement whereby the Company was loaned $90,000. In exchange the Company issued
a $90,000 note bearing interest at 10%, and due March 31, 2004. The Company
pledged a limited interest in $90,000 of the $435,000 note issued by Now
Solutions to the Company to secure the loan. In connection with the loan, the
lender waived the default of a $350,000 note issued by EnFacet in August 2001, a
100% subsidiary of the Company, and extended the maturity date of this note to
March 31, 2004. In return, the Company increased the interest rate of the
$350,000 note from 8% to 10% beginning July 1, 2003. In February 2004, the
parties amended the terms of the notes. Pursuant to the amendment, the parties
waived any defaults on the notes and agreed that the notes will be payable as
follows: Once Vertical's subsidiary, Now Solutions, has paid off the entire
balance due under the $500,000 Note issued by Now Solutions to Farias on
February 13, 2004, 84% of any remaining amounts from the final $ 91,500
installment payment on the $500,000 note issued by Now Solutions to Robert
Farias on February 13, 2004, shall be applied to the $350,000 and $90,000 notes
on a pro-rata basis. Thereafter, the Company shall continue to make monthly
principal payments of $76,860 applied on a pro-rata basis to the $350,000 and
$90,000 notes until all monies due under these notes have been paid. In
connection with the amendment, Now Solutions entered into a security agreement
with the lender to guarantee the note. The security interest of Now Solutions'
assets on the secured promissory note will be junior to Now Solutions' present
indebtedness to WAMCO 31, Ltd, Arglen, and Robert Farias in connection with the
$500,000 note.
In July 2003, the Company issued 8,000,000 shares of common stock of
the Company to Victor Weber in connection with $60,000 in loans made and
services rendered to the Company. The stock is subject to Rule 144 restrictions.
Victor Weber is a Director and President of Government Internet Systems, Inc., a
subsidiary of the Company. The fair market value of these shares was $40,000.
In October 2003, the Company agreed to issue 2% ownership interest of
its subsidiary, Government Internet Systems, Inc. to a third party in connection
with a loan of $60,000 to GIS, which issued the note on November 5, 2003, in
amount of $60,000 to the lender once all funds are received. In connection with
the loan, the lender will be entitled to receive a 2% royalty on net sales of
products by GIS in the United States up to $300,000 and the Company issued
1,000,000 shares of Company's common stock with the Rule 144 restrictive legend
15
(with a fair market value of $5,000). The note will bear interest at 10% per
annum, is due November 5, 2004, and is secured by 4,000,000 shares of common
stock of the Company that were owned by Mountain Reservoir Corporation. 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. The
Company currently owns 89% of Government Internet Systems, Inc., and will issue
a 2% ownership interest from its share of stock in GIS.
In November 2003, the Company agreed to issue a 1.5% ownership interest
of its subsidiary, Government Internet Systems, Inc. to a third party in
connection with a loan of $40,000 to GIS, which issued the note on November 19,
2003, in amount of $40,000 to the lender once all funds are received. In
connection with the loan, the lender will be entitled to receive a 1.5% royalty
on net sales of products by GIS up to $200,000 and the Company issued 1,000,000
shares of Company's common stock with the Rule 144 restrictive legend (with a
fair market value of $4,000). The note will bear interest at 10% per annum, is
due November 19, 2004, and is secured by 3,000,000 shares of common stock of the
Company that were owned by Mountain Reservoir Corporation. 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. The
Company currently owns 89% of Government Internet Systems, Inc., and will issue
a 1.5% ownership interest from its share of stock in GIS.
In December 2003, the Company issued a debenture in the amount of
$30,000 to a third party. The Company received net proceeds of $26,000 for the
debenture. The debt accrues interest at 5% per annum and is due December 2005.
The holder may convert the debenture into shares of common stock at 100% of the
lowest closing price for the 5 trading days prior to the conversion. As of June
22, 2004, no conversions have taken place. In connection with the issuance of a
$30,000 debenture to the third party and the Company's agreement to redeem the
debenture by February 1, 2004, the payments due under a note payable to the
third party in the amount of $239,004, bearing interest at 13% per annum, were
extended. Pursuant to the extension, the Company is required to make monthly
installment payments of $7,500, beginning on February 1, 2004, until the balance
under the note has been paid. The note is currently delinquent and the debenture
has not been redeemed.
In December 2003, $20,000 of principal of $100,000 in debentures and
$1,726 in interest was redeemed for a total of $25,726, which includes a 20%
premium on the principal. This convertible debenture, originally issued on March
29, 2002, bearing interest at 5% per annum, was convertible into shares of the
Company's common stock at either 120% of the closing bid price on the date of
agreement or 80% of the lowest closing bid prices 5 days prior to the
conversion. The debentures were convertible at the option of the holder at any
time after the purchase.
During the three months ended June 30, 2003, incentive stock options to
purchase 210,000 shares of common stock of the Company at share prices ranging
from $0.45 to $0.47 per share expired.
During the three months ended June 30, 2003, non-statutory stock
options stock options to purchase 3,300,000 shares of common stock of the
Company at share prices ranging from $0.47 to $1.25 per share expired.
During the three months ended September 30, 2003, incentive stock
options to purchase 265,000 shares of common stock of the Company at a share
price of $0.47 per share expired.
During the three months ended December 31, 2003, non statutory stock
options to purchase 10,000,000 shares of common stock of the Company at a share
price of $0.001-$0.025 per share expired.
During the three months ended December 31, 2003, incentive stock
options to purchase 2,025,000 shares of common stock of the Company at a share
price of $0.025 to $0.48 per share expired.
During the three months ended December 31, 2003, warrants to purchase
45,455 shares of common stock of the Company at a share price of $0.11 per share
expired.
In January 2004, the Company issued 1,500,000 shares of common stock of
the Company with the Rule 144 restrictive legend to two consultants for services
(at a fair-market value of $4,500). The Company has agreed to "piggy-back"
registration rights with respect to the stock.
In January 2004, the Company purchased the 5% membership interest in
Now Solutions from Stephen Parnes for $75,000 and 1,000,000 shares of common
stock of the Company (at a fair market value of $3,000). The Company also paid
Mr. Parnes' legal fees in the amount of $2,000. The stock is subject to Rule 144
Regulation with "piggy-back" registration rights and subject to a "leak-out"
agreement.
16
In January 2004, the Company issued 10,000,000 shares of common stock
of the Company with the Rule 144 restrictive legend (at a fair market value of
$30,000) with "piggy-back" registration rights and subject to a "leak-out"
agreement to Wolman, Babbit, and King in connection with legal services provided
to the Company.
In January 2004, the Company retained two individuals for consulting
services. In exchange for these services, the Company agreed to issue a total of
4,000,000 shares of common stock of the Company with the Rule 144 restrictive
legend (at a fair market value of $12,000) with "piggy-back" registration rights
stock and subject to a "leak out" agreement.
In January 2004, the Company agreed to issue 1,000,000 shares of the
Company's common stock (at a fair market value of $3,000), subject to Rule 144
regulation and with "piggy back" registration rights, in connection with a
$10,000 loan made by Jim Salz to the Company in June 2003. In addition the
Company issued a promissory note for $10,000 bearing interest at 10%, which is
due in April 30, 2004. Mr. Salz is the Company's corporate counsel. In April
2004, the due date on the note was extended to August 1, 2004.
In February 2004, $10,000 of principal of $100,000 in debentures and
$925 in interest was redeemed for a total of $10,925. This convertible
debenture, originally issued on March 29, 2002, bearing interest at 5% per
annum, was convertible into shares of the Company's common stock at either 120%
of the closing bid price on the date of agreement or 80% of the lowest closing
bid prices 5 days prior to the conversion. The debentures were convertible at
the option of the holder at any time after the purchase.
In February 2004, Robert Farias loaned $500,000 to Now Solutions, the
Company's wholly-owned subsidiary and received a $500,000 promissory note from
Now Solutions, secured by its assets and a 5% royalty on any sales by Now
Solutions of over $8,000,000 per year up to $500,000. The note bears interest at
10% per annum and Now Solutions is required to make monthly interest payments
for all interest accrued in the previous month on the first day of each month
beginning April 1, 2004 and beginning on October 1, 2004 and continuing on the
first day of every month thereafter, monthly principal payments of $91,500 plus
interest until the note has been paid in full. In the event Now Solutions
receives cash proceeds due to a capital infusion or upfront licensing fees from
a reseller that is outside its normal scope of business (i.e, not part of
software sales in the regular course of business), Now Solutions is required to
pay 50% of such proceeds remaining toward payment of the $500,000 note. In
connection with the loan, the Company issued (i) 5 year warrants to purchase
5,000,000 shares of common stock at a $0.01 per share; (ii) 5 year warrants to
purchase 5,000,000 shares of Vertical common stock at a $0.02 per share; (iii) 5
year warrants to purchase 5,000,000 shares of Vertical common stock at a $0.03
per share, (iv) 5,000,000 shares of Vertical common stock subject to Rule 144
Regulation (at a fair market value of $75,000), and (v) an additional 5,000,000
shares of Vertical common stock in the event that $250,000 was not paid toward
the loan on or before March 15, 2004, which were issued (at a fair market value
of $120,000). All of the foregoing warrants and stock are subject to Rule 144
regulation and "piggy-back" registration rights. In addition, the Company also
pledged a 30% ownership interest in Now Solutions to ensure the making of the
$500,000 loan to Now Solutions. In connection with the amendment, Now Solutions
entered into a security agreement with the lender to guarantee the note. The
security interest of Now Solutions' assets on the secured promissory note will
be junior to Now Solutions' present indebtedness to WAMCO 31, Ltd and Arglen.
The Company appointed Robert Farias as a director of Now Solutions, a 100% owned
subsidiary of the Company, in June 2003.
In February 2004, the Company purchased a 21% ownership interest in
MedData Solutions, Inc. from Robert Farias. In exchange, the Company issued
9,000,000 shares of the common stock of the Company (at a fair market value of
$135,000), which shall be subject to Rule 144 Regulation and have "piggy-back"
registration rights. The Company appointed Robert Farias as a director of Now
Solutions, a 100% owned subsidiary of the Company, in June 2003.
In February 2004, the Company completed the closing of its settlement
with Arglen. Pursuant to the terms of the settlement, the Company purchased
Arglen's interest in Now Solutions for $1.4 million as follows: (a) $800,000,
which was paid at the closing and (b) $600,000, pursuant to a non-interest
bearing secured promissory note providing for payments of $200,000 in April
2004, $100,000 in June 2004, and $300,000 in September 2004, which was issued at
closing. The security interest of Now Solutions' assets on the secured
promissory note will be junior to Now Solutions' present indebtedness to WAMCO
31, Ltd. In addition, at closing, the Company cancelled 80,763,943 warrants held
by Arglen and issued to Arglen 20,000,000 shares of its the common stock of the
Company (at a fair market value of $280,000), which is subject to Rule 144
regulation with "leak out" provisions. The Company is obligated to file a
registration statement within 180 days of the closing date covering the resale
of the shares by Arglen. If the Company does not file a timely registration
statement, the Company is obligated to issue an additional 5,000,000 shares and
file its registration statement no later than December 31, 2004. The note is
currently delinquent.
17
In March 2004, the Company and Sheri Pantermuehl agreed to the terms of
a 2 year employment agreement, whereby Ms. Pantermuehl agreed to provide
services as the Chief Financial Officer for the Company and its subsidiary Now
Solutions, LLC. Pursuant to the employment agreement, the Company shall pay Ms.
Pantermuehl a base salary of $125,000 per annum. In connection with the
agreement, the Company agreed to grant 5 year incentive stock options to
purchase 2,500,000 shares of common stock of the Company within 45 business days
at an exercise price on the date of issuance. The stock options were issued in
April 2004 at a strike price of $0.014 per share. In addition, Now Solutions
issued 1.5% of so-called "phantom stock" of Now Solutions to Ms. Pantermuehl.
In March 2004, Now Solutions, LLC was converted into a corporation
named Now Solutions, Inc.
For the three months ended March 31, 2004, the Company granted 5 year
incentive stock options to two employees of Now Solutions to purchase a total of
3,000,000 shares of common stock of the Company at an exercise price of $0.01
per share, which are subject to "leak out" provisions. The stock options were
issued in connection with employment agreements executed in January 2004.
For the three months ended March 31, 2004, two employees shall receive
a total of 3% ownership interest of "phantom" stock in Now Solutions in
connection with employment agreements executed in January 2004.
During the three months ended March 31, 2004, warrants to purchase
432,069 shares of common stock of the Company at an average share price of
$0.096 expired.
During the three months ended March 31, 2004, incentive stock options
to purchase 1,275,000 shares of the Company at a price of $0.086 per share
expired.
During the three months ended March 31, 2004, non-incentive stock
options to purchase 750,000 shares of the Company at a price of $0.086 per share
expired.
In April 2004, the United States Patent and Trademark Office granted a
patent (No. 6,718,103) for an invention for "Transmission of Images over a
Single Filament Fiber Optic Cable".
In June 2004, the Company and its subsidiary Now Solutions, agreed with
a third party consultant to provide governmental relations services concerning
the state and local governments of the state of Texas. In connection with the
agreement, the Company issued 5 year warrants to purchase 250,000 shares of VCSY
stock at an exercise price of $0.025 per share.
In June 2004, the Company and its subsidiary Now Solutions, agreed with
a third party consultant services concerning the solicitation and preparation of
government grants. In connection with the agreement, the Company agreed to issue
250,000 shares of common stock of the Company, which is subject to Rule 144
regulation and vests as follows: 90,000 shares after 30 days from the execution
of this agreement, (b) 80,000 shares after 60 days from the execution of the
agreement, and (c) 80,000 shares after 90 days from the execution of the
agreement.
From April 1, 2004 to June 22, 2004, warrants to purchase 6,319,699
shares of the common stock of the Company at an average price of $0.052 per
share expired.
From April 1, 2004 to June 22, 2004, incentive stock options to
purchase 925,000 shares of the Company at a price of $0.037 per share expired.
From April 1, 2004 to June 22, 2004, non-incentive stock options to
purchase 750,000 shares of the Company at a price of $0.041 per share expired.
For subsequent events concerning Notes Payable, including amendments to
promissory notes, please see Note 3,
For subsequent events concerning Legal Proceedings, please see Note 4.
18
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 and Notes of
Vertical Computer Systems, Inc. and Subsidiaries included in Item 1, and the
cautionary statements and risk factors included in this Item 2 of this Report.
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 months ended
March 31, 2003. 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, 2002.
The forward-looking information set forth in this Report is as of the date of
this filing, and the Company undertakes no duty to update this information. More
information about potential factors that could affect the Company's business and
financial results is included in the section in this Item 2 entitled "Cautionary
Statement and Risk Factors."
OVERVIEW
The Company is a multinational provider of administrative software,
internet core technologies, and derivative software application products through
its distribution network. The Company's main administrative software product is
emPath 6.2, which is developed and distributed by Now Solutions, Inc.,, the
Company's subsidiary. The Company's primary internet core technologies include
SiteFlash and the Emily XML Scripting Language, which can be used to build web
services. The Company attempts to acquire and operate companies whose products,
in the Company's belief: are proven and best of the breed; are profitable or on
the path to profitability; complement each other; and provide cross-product
distribution channels. The Company's ownership interest is typically a
controlling interest. The Company's business model combines complementary,
integrated software products, internet core technologies, and a multinational
distribution system of partners, in order to create a distribution matrix that
the Company believes is capable of penetrating multiple sectors through cross
promotion.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THREE MONTHS ENDED MARCH 31, 2002
TOTAL REVENUES. The Company had total revenues of $1,945,398 and
$1,561,762 in the three months ended March 31, 2003 and 2002, respectively. The
increase in total revenue was $383,636 for the three months ended March 31, 2003
representing approximately a 25% increase compared to the total revenue for the
three months ended March 31, 2002. Of the $1,945,398 in the three months ended
March 31, 2003 and the $1,561,762 in the three months ended March 31, 2002,
$1,927,783 and $1,552,262, respectively, was related to the business operations
of Now Solutions, a subsidiary in which the Company owns a 100% interest. The
Company acquired a 60% interest in Now Solutions in February 2001, 5% in January
2004, and the remaining 35% interest in February 2004.
The total revenues primarily consist of software licenses, consulting
and maintenance fees. The revenue from license and maintenance in the three
months ended 2003 increased by $232,312 from the same period in the prior year,
representing approximately 18.6% increase, due to the increase in customers Now
Solutions serves. There was no software development revenue in the three months
ended March 31, 2003, which resulted in a decrease of $6,800, from the same
period in the prior year. Consulting revenue in the three months ended March 31,
2003, increased by $192,427, from the same period in the prior year, which
represented approximately 70.8% increase, due to the regular increase in client
base. Other revenue in the three months ended March 31, 2003 decreased by
$34,303 from the same period in the prior year.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. The Company had selling,
general and administrative expenses of $2,177,677 and $3,300,803 in the three
months ended March 31, 2003 and 2002, respectively. The total operating expenses
in the three months ended March 31, 2003 decreased by $1,123,126 compared to the
operating expenses in the three months ended March 31, 2002, representing
approximately 34% decrease. Of the $2,177,677 in the three months ended March
19
31, 2003 and the $3,300,803 in the three months ended March 31, 2002, Now
Solutions accounted for $1,651,267 and $1,589,365, respectively.
The $1,123,126 of decrease was primarily attributable to decreases in
the following expenses: First, there was a decrease in expenses that were
incurred by Enfacet. During the first quarter of 2002 there was a charge in the
amount of $718,035 due to a Fair Market Value of Investment Adjustment. In
addition, operating expenses incurred by Vertical Systems decreased $459,851.
This was mainly attributable due to a reduction of approximately $80,000 in
payroll and related items. There was also a charge in the first quarter of 2002
in the amount of $82,295 due to a fair market value of investment adjustment for
the decrease attributable to securities held by the Company.
OPERATING LOSS. The Company had an operating loss of $232,279 and
$1,739,041 in the three months ended March 31, 2003 and 2002, respectively. The
operating loss decreased by $1,506,762 compared to the operating loss in the
three months ended March 31, 2002, representing a decrease of approximately
86.6%. The decrease was primarily attributable to the combination of an increase
in revenue of $383,636 and a decrease in the operating expenses of $1,123,126.
INTEREST EXPENSE. The Company had an interest expense of $107,153 and
$156,351 for the three months ended March 31, 2003 and 2002, respectively.
Interest expense decreased in 2003 by $49,198, representing a decrease of
approximately 31%, compared to the same type of expense in three months ended
March 31, 2002. The decrease was primarily related to the reduction of the Now
Solutions loan from Coast Business Credit.
MINORITY INTEREST. The minority interest as of March 31, 2003 was
$71,632 compared to $0 of minority interest as of March 31, 2002. The minority
interest was based upon 40% minority ownership in Now Solutions on net profit of
Now Solutions.
NET LOSS. The Company had a net loss of $487,812 and $1,885,425 as of
March 31, 2003 and 2002, respectively. Net loss as of March 31, 2003 decreased
by $1,397,613, representing a decrease of approximately 74%. The decrease of
$1,397,613 was primarily attributable to the combination of an increase in
revenue by approximately $383,636 and a decrease of operating expenses by
$1,123,126.
DIVIDENDS APPLICABLE TO PREFERRED STOCK. The Company has outstanding
Series A 4% convertible cumulative preferred stock that accrues dividends at a
rate of 4% on a semi-annual basis. The Company also has outstanding Series C 4%
convertible cumulated preferred stock that accrues dividends at a rate of 4% on
a quarterly basis. The total dividends applicable to Series A and Series C
preferred stock were $150,000 and $150,006 for the three months ended March 31,
2003 and 2002, respectively.
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS. The Company had a net loss
applicable to common stockholders of $637,812 and $2,035,431 three months ended
March 31, 2003 and 2002, respectively. Net loss applicable to common
stockholders decreased by $1,397,619, representing a decrease of approximately
69%, compared to the net loss applicable to common stockholders in the three
months ended March 31, 2002.
NET LOSS PER SHARE. The Company had a net loss per share of $0.00 and
$0.00 for the three months ended March 31, 2003 and 2002, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Net cash generated from operating activities for the three months ended
March 31, 2003 was $575,840. This positive cash flow was primarily related to a
net loss of $487,812 adjusted by total non-cash items of $365,925 (including
depreciation and amortization of $310,949, the largest item), a decrease in
accounts receivable of $620,555 and an increase in related party receivable of
$8,699, offset by increases in all liabilities items of approximately $81,239.
Since 1999, the Company has been entirely dependent on external cash to
support its operations. In the past three years, the Company has financed its
operations through the sale of securities, including common and preferred stock,
convertible debts, and notes payable.
At March 31, 2003, the Company had cash-on-hand of $1,565,259. Now
Solutions' cash-on-hand was not available to fund the Company's operations due
to a court order obtained by Arglen and bank covenants in connection with legal
proceedings concerning Now Solutions. The Company settled with Arglen in
December 2003. The settlement closed in February 2004, and the Company and
20
Arglen dismissed all claims with respect to one another. As a result, the
cash-on-hand of Now Solutions is now available to fund the Company's operations.
Since March 31, 2003, the Company has received gross proceeds of
$226,000 from the sale of convertible debentures as well as loans in the amount
of approximately $830,000. As of the date of this filing, the Company believes
that it had sufficient funds available to fund its operations for one month.
Thereafter, the Company will need to raise additional funds through selling
securities or obtaining additional loans. The Company's inability to raise such
funds will significantly jeopardize its ability to continue operations. The
Company's primary need for cash is to fund its ongoing operations until such
time that the sale of its products and services generate enough revenue to fund
operations. The Company's monthly cost of operations is approximately $75,000
(excluding the operations of Now Solutions, Inc.) consisting of salaries, rent,
insurance premiums, and professional fees (legal, accounting, and investor
relations). In addition to the monthly operating cost, the Company has principal
and interest payments due on notes payable. Below are the minimum principal
payments on notes payable of the Company as of June 22, 2004, including the year
of payment:
AMOUNT (INCLUDING NOW AMOUNT (EXCLUDING
AS OF SOLUTIONS) NOW SOLUTIONS)
-------------------- --------------------- ------------------
12/31/2003(Past Due) $ 1,634,212 $ 884,212
12/31/2004 1,379,500 230,000
Thereafter 2,264,683 985,000
-------------------- -------------------
Total $ 5,278,395 $ 2,099,212
==================== ===================
The Company does not have sufficient funds available to meet these
obligations. The Company will need to raise significant funds to meet these
obligations or make significant sales of its products. Other than the Equity
Line of Credit discussed below, the Company does not have any commitments for
funding. The Company continues to explore financing options. The Company's
independent accountants have issued a going concern opinion in its financial
statements that raise substantial doubt about the Company's ability to continue
as a going concern. This going concern opinion was issued due to the Company's
significant recurring operating losses, the substantial funds used in its
operations and the need to raise additional funds to meet its obligations. The
Company's ability to continue as a going concern is dependent on its ability to
raise additional funds and to establish profitable operations.
The note payable in the amount of $280,000, bearing interest at 4% per
annum and issued to Robert Farias on October 31, 2001, was amended by the
parties in March 2003. Pursuant to the amendment, the payment of principal would
be paid in monthly installment in the amount of $5,000, which were to be
replaced with monthly payments of $10,000 beginning in January 2004. All
interest would be due on the day the principal is paid in full. In exchange for
the extensions, the interest rate will accrue at the rate of 12% from the date
the note was issued. In February 2004, the Company and Robert Farias amended the
$280,000 note issued to Mr. Farias on October 31, 2001 and the $181,583 note
issued to Mr. Farias on October 17, 2002. Any default on these notes was waived,
and the Company agreed to make the following payments on these notes, which will
be applied pro-rata to the notes: (i) $20,000, which was paid toward the
$181,583 note on February 20, 2004; (ii) fifty percent (50%) of the remaining
past-due amounts by March 20, 2004; and (iii) the all remaining past-due amounts
to bring the notes current by April 20, 2004. In the event the Company does not
pay the amounts in a timely manner, then all amounts still owing under these
notes will be considered in default and the following shall apply: (i) all such
remaining amounts will be added to the secured loan amounts and will be subject
to the security interest and pledge agreements under the $84,000 promissory note
issued by the Company's subsidiary, Enfacet, to Mr. Farias on June 1, 2001; (ii)
the $14,640 monthly payments to be made under the $84,000 note will be applied
to the $280,000 and $181,583 notes until these notes are paid in full; and (iii)
with respect to cash proceeds Now Solutions receives due to a capital infusion
or upfront licensing fees from a reseller that is outside its normal scope of
business (i.e, not part of software sales in the regular course of business),
Now Solutions is required to pay 50% of such proceeds remaining after the
$500,000 note payable issued by Now Solutions to Mr. Farias on February 13, 2004
has been paid in full toward the $280,000 and $181,583 notes if the Company is
not current in its payments. The $280,000 note is secured by SiteFlash
technology owned by the Company. The Company appointed Robert Farias as a
director of Now Solutions, a 100% owned subsidiary of the Company, in June 2003.
These notes are delinquent.
In April 2003, a new Equity Line of Credit Agreement was executed
between the Company and Cornell , whereby up to $10,000,000 worth of the
Company's common stock may be purchased. Prior to the execution of the Equity
Line of Credit Agreement, the Company terminated the previous Equity Line of
Credit Agreement. The shares must be registered before the sale, and the shares
21
can be purchased at 99% of the lowest closing bid price during the 5 trading
days after the Company requests an advance, but not less than the minimum
advance price per share set by the Company. The Equity Line of Credit Agreement
contains a commitment fee of $190,000, payable in a convertible debenture, which
was issued to Cornell, and a placement fee of $10,000, payable to the third
party placement agent. The debenture may be redeemed for 100% of the any portion
of the principal that had not been converted by the holder as of the date of the
notice of redemption. The debenture provides that after 180 days, the holder may
convert any portion of the principal at 100% of the lowest closing bid price 3
days prior to conversion. In addition, the Company shall pay $500 in legal,
administrative and escrow fees and a 2% commitment fee of each advance to
Cornell. In July 2003, the Company issued 2,049,180 shares of common stock as
payment of the $10,000 placement fee. As of June 22, 2004, no debentures have
been converted.
In April 2003, the Company issued $200,000 of convertible debentures to
Cornell. The debt accrues interest at 5% per annum and is due April 2006. The
holder may convert the debenture into shares of common stock at either $0.03 or
80% of the lowest closing bid price for the 5 trading days prior to the
conversion. In accordance with the beneficial conversion feature, the Company
recognized deemed interest expense of $50,000. The debt accrues interest at 5%
per annum and is due April 2006. As of June 22, 2004, no debentures have been
converted.
In May 2003, the Company issued two promissory notes, each for a
principal amount of $17,500, bearing no interest to two third party lenders in
consideration of two loans in the aggregate amount of $30,000. The notes were
due in June 2003. The Company has pledged distributions of funds owed to it by
its subsidiary Now Solutions toward payment of the loan. In connection with the
notes the Company paid a commitment fee of $2,500 on each note and issued 5 year
warrants to purchase 250,000 shares of common stock of the Company at an
exercise price of $0.0075 per share to each lender. The warrants were issued at
an estimated fair market value of $2,440 (valued using the Black-Scholes
valuation model). In connection with these loans, The Company also issued 5 year
warrants to purchase 250,000 shares of common stock of the Company at an
exercise price of $0.0075 per share to a third party consultant. The warrants
were issued at an estimated fair market value of $1,220 (valued using the
Black-Scholes valuation model). In February 2004, the parties amended the terms
of the loans. The lenders waived any default on the note and in exchange the
Company agreed to issue 500,000 shares of the Company common stock to each
lender (at a total fair market value of $14,000), which are subject to Rule 144
Regulation, and to pay $8,750 by March 31, 2004 and $8,750 plus all accrued
interest by April 30, 2004 under each note. The stock issued to each lender is
subject to "piggy back" registration rights and a "leak out" agreement. These
notes are currently in default.
In June 2003, the Company and a third party lender entered into an
agreement whereby the Company was loaned $90,000. In exchange the Company issued
a $90,000 note bearing interest at 10%, and due March 31, 2004. The Company
pledged a limited interest in $90,000 of the $435,000 note issued by Now
Solutions to the Company to secure the loan. In connection with the loan, the
lender waived the default of a $350,000 note issued by EnFacet in August 2001, a
100% subsidiary of the Company, and extended the maturity date of this note to
March 31, 2004. In exchange, the Company increased the interest rate of the
$350,000 note from 8% to 10% beginning July 1, 2003. In February 2004, the
parties amended the terms of the notes. Pursuant to the amendment, the parties
waived any defaults on the notes and agreed that the notes will be payable as
follows: Once Vertical's subsidiary, Now Solutions, has paid off the entire
balance due under the $500,000 Note issued by Now Solutions to Farias on
February 13, 2004, 84% of any remaining amounts from the final $91,500
installment payment on the $500,000 note issued by Now Solutions to Robert
Farias on February 13, 2004, shall be applied to the $350,000 and $90,000 notes
on a pro-rata basis. Thereafter, the Company shall continue to make monthly
principal payments of $76,860 applied on a pro-rata basis to the $350,000 and
$90,000 notes until all monies due under these notes have been paid. In
connection with the amendment, Now Solutions entered into a security agreement
with the lender to guarantee the note. The security interest of Now Solutions'
assets on the secured promissory note will be junior to Now Solutions' present
indebtedness to WAMCO 31, Ltd, Arglen, and Robert Farias in connection with the
$500,000 note.
The Company amended two notes payable it had issued to Victor Weber in
the amount of $65,000 and $45,000 in March 2003. These notes were issued in
December 2002, bearing interest at 13% per annum, were unsecured, and were due
in March 2003. In March 2003, the due date for payment of principal and interest
of these notes was extended to July 1, 2003. In July 2003, the Company and
Victor Weber amended the terms of certain loans made by Weber to the Company in
the aggregate amount of $150,000. Pursuant to their agreement, Weber cancelled
the $65,000 and $45,000 notes payable as well as other outstanding debt, and the
Company issued two promissory notes in the amounts of $100,000 and $40,000. The
$100,000 promissory note bears interest at 13% per annum and is payable in
monthly accrued interest payments beginning August 1, 2003, and a final payment
of all principal and remaining interest by March 31, 2004. The $40,000
promissory note bears interest at 13% per annum and is payable in monthly
installment payments beginning August 1, 2003, and consisting of an $8,000
principal payment plus the interest accrued in the previous month. In
consideration of the loans made to the Company and for services rendered on
behalf of the Company, Vertical paid a $250 commitment fee to Weber and issued
8,000,000 shares of common stock of the Company to Weber. The stock is subject
to Rule 144 restrictions. In August 2003, the Company obtained extensions and
22
waivers of default for two notes of $100,000 and $40,000 issued by the Company
to Victor Weber on July 1, 2003. Pursuant to these extensions, the Company had
until October 1, 2003 to become current in its payments. In September 2003,
Weber agreed to loan the Company $50,000. In exchange, the Company issued a
$50,000 note bearing interest at 13%, and due March 31, 2004. In connection with
the loan, the Company pledged its interest in a $215,000 note issued by Now
Solutions to the Company to secure this loan as well as $150,000 in loans from
Weber to the Company from December 2002 through July 2003. Pursuant to the
Company pledge, Weber has the option to have the Company assign the $215,000
note issued by Now Solutions to Weber provided that Weber forgives all of the
Company's outstanding debt and cancels all underlying notes in connection with
the debt. Weber elected to make this assignment in January 2004. Except for the
$215,000 note, which was assigned to Weber, all other notes and debt under loans
made by Weber were cancelled. The Company has made all interests payments as of
June 22, 2004. Victor Weber is a Director and President of Government Internet
Systems, Inc., a subsidiary of the Company.
In August 2003, the Company obtained an extension and waiver of default
for a $50,000 note issued by the Company to a third party in June 2002. Pursuant
to the waiver, the Company's payment obligations were amended so that the
Company was required to begin making monthly installment payments of $7,500
beginning on November 15, 2003 until the balance under the note has been paid.
The note is currently delinquent.
In August 2003, the Company obtained an extension and waivers of
default for two notes of $50,000 and $25,000 issued by the Company to a third
party in June and August 2002, respectively. Pursuant to the extension, the
Company was required to make a payment of accrued interest for each respective
note on October 15, 2003, and monthly interest payments for all accrued interest
for both notes thereafter shall be made, and, beginning on January 15, 2004, the
foregoing interest payments shall be replaced with monthly installment payments
of $5,000 until the balances owned under these notes have been paid. The note is
currently delinquent.
In October 2003, the Company agreed to issue a 2% ownership interest of
its subsidiary, Government Internet Systems, Inc. to a third party in connection
with a loan of $60,000 to GIS, which issued the note on November 5, 2003, in
amount of $60,000 to the lender once all funds are received and the Company
issued 1,000,000 shares of Company's common stock with the Rule 144 restrictive
legend (with a fair market value of $5,000). In connection with the loan, the
lender will be entitled to receive a 2% royalty on net sales of products by GIS
in the United States up to $300,000. The note will bear interest at 10% per
annum, is due November 5, 2004, and is secured by 4,000,000 shares of common
stock of the Company that were owned by Mountain Reservoir Corporation. 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. The
Company currently owns 89% of Government Internet Systems, Inc., and will issue
a 2% ownership interest from its share of stock in GIS.
In November 2003, the Company agreed to issue a 1.5% ownership interest
of its subsidiary, Government Internet Systems, Inc. to a third party in
connection with a loan of $40,000 to GIS, which issued the note on November 19,
2003, in amount of $40,000 to the lender once all funds are received. In
connection with the loan, the lender will be entitled to receive a 1.5% royalty
on net sales of products by GIS up to $200,000 and the Company issued 1,000,000
shares of Company's common stock with the Rule 144 restrictive legend (with a
fair market value of $4,000). The note will bear interest at 10% per annum, is
due November 19, 2004, and is secured by 3,000,000 shares of common stock of the
Company that were owned by Mountain Reservoir Corporation. 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. The
Company currently owns 89% of Government Internet Systems, Inc., and will issue
a 1.5% ownership interest from its share of stock in GIS.
In December 2003, the Company issued a debenture in the amount of
$30,000 to a third party. The Company received net proceeds of $26,000 for the
debenture. The debt accrues interest at 5% per annum and is due December 2005.
The holder may convert the debenture into shares of common stock at 100% of the
lowest closing price for the 5 trading days prior to the conversion. As of June
22, 2004, no conversions have taken place. In connection with the issuance of a
$30,000 debenture to the third party and the Company's agreement to redeem the
debenture by February 1, 2004, the payments due under a note payable to the
third party in the amount of $239,004, bearing interest at 13% per annum, were
extended. Pursuant to the extension, the Company is required to make monthly
installment payments of $7,500, beginning on February 1, 2004, until the balance
under the note has been paid. The note is currently delinquent and the debenture
has not been redeemed.
In February 2004, Robert Farias loaned $500,000 to Now Solutions, the
Company's wholly-owned subsidiary and received a $500,000 promissory note from
Now Solutions, secured by its assets and a 5% royalty on any sales by Now
Solutions of over $8,000,000 per year up to $500,000. The note bears interest at
10% per annum and Now Solutions is required to make monthly interest payments
for all interest accrued in the previous month on the first day of each month
23
beginning April 1, 2004 and beginning on October 1, 2004 and continuing on the
first day of every month thereafter, monthly principal payments of $91,500 plus
interest until the note has been paid in full. In the event Now Solutions
receives cash proceeds due to a capital infusion or upfront licensing fees from
a reseller that is outside its normal scope of business (i.e, not part of
software sales in the regular course of business), Now Solutions is required to
pay 50% of such proceeds remaining toward payment of the $500,000 note. In
connection with the loan, the Company issued (i) 5 year warrants to purchase
5,000,000 shares of common stock at a $0.01 per share; (ii) 5 year warrants to
purchase 5,000,000 shares of Vertical common stock at a $0.02 per share; (iii) 5
year warrants to purchase 5,000,000 shares of Vertical common stock at a $0.03
per share, (iv) 5,000,000 shares of Vertical common stock subject to Rule 144
Regulation (at a fair market value of $75,000), and (v) an additional 5,000,000
shares of Vertical common stock in the event that $250,000 was not paid toward
the loan on or before March 15, 2004, which were issued (at a fair market value
of $120,000). All of the foregoing warrants and stock are subject to Rule 144
regulation and "piggy-back" registration rights. In addition, the Company also
pledged a 30% ownership interest in Now Solutions to ensure the making of the
$500,000 loan to Now Solutions. In connection with the amendment, Now Solutions
entered into a security agreement with the lender to guarantee the note. The
security interest of Now Solutions' assets on the secured promissory note will
be junior to Now Solutions' present indebtedness to WAMCO 31, Ltd and Arglen.
The Company appointed Robert Farias as a director of Now Solutions, a 100% owned
subsidiary of the Company, in June 2003.
In connection with the purchase of the Human Resource Information
Application Software assets of Ross Systems, Inc., Now Solutions ("Now
Solutions") issued a promissory note to Ross Systems for $1 million and obtained
$5.5 million of notes payable. The $1 million note is due in two payments, the
first payment of $250,000 was due in February 2002 and the final payment of
$750,000 is due in February 2003. In February 2002, Now Solutions withheld its
payments on the remaining $750,000 note due in February 2003 against the unpaid
maintenance fees and gave notice in February 2003 to Ross Systems, Inc. (Ross)
of Now Solutions' claim of offset. Now Solutions has claimed a total amount of
approximately $3,562,000 to offset against the note. In March 2003, Ross
commenced an action in Supreme Court, Westchester County (New York State) by
filing a motion for summary judgment in lieu of complaint against Now Solutions
to collect the note payable in the amount of $750,000 plus 10% interest. In
August 2003, the Westchester County Supreme Court denied the motion and
dismissed Ross' action without prejudice. In October 2003 the motion of Ross for
reargument was denied. Ross has appealed the August 2003 court order. In March
2004, Ross commenced an action in the Supreme Court, New York County (New York
State) by filing a motion for summary judgment in lieu of complaint against Now
Solutions to collect the note payable in the amount of $750,000 plus 10%
interest. Now Solutions filed its opposition to Ross' motion, which was
submitted to the court for decision on May 20, 2004. No decision has been
rendered as of June 15, 2004.
In February 2003, the Company filed a lawsuit and a derivative action
in New York Supreme Court Case against defendants Ross Systems, Inc. ("Ross"),
Arglen Acquisitions, LLC ("Arglen"), James Patrick Tinley ("Tinley"), and Garry
Gyselen ("Gyselen"). The Company filed a derivative action on behalf of its
subsidiary Now Solutions when Arglen refused to authorize a lawsuit against any
parties who were alleged to have acted against the best interest of Now
Solutions. In conjunction with the Company's claim, Now Solutions is withholding
its payments on the remaining $750,000 note that was due in February 2003
against the unpaid maintenance fees and gave notice in February 2003 to Ross of
Now Solutions' claim of offset. Now Solutions has claimed a total amount of
approximately $3,562,000 to offset against the note, plus other damages.
Plaintiff's original claims sought damages and equitable relief arising out of
actions of the defendants constituting breach of contract, fraud, conspiracy and
breach of fiduciary duty in connection with certain transactions entered into
between Ross and Now Solutions; Ross and Arglen; Arglen and Now Solutions;
Gyselen and Now Solutions; and the Company and Arglen. The action concerned
offsets of payment on note payable to Ross by the maintenance fee charged by Now
Solutions to Ross to which Now Solutions was entitled per the asset purchase
agreement between Now Solutions and Ross regarding the HRIS assets Now Solutions
purchased from Ross in 2001, an undisclosed transaction between Ross and Gyselen
around the time of the purchase of these assets, and the failure of Gyselen to
enforce the offset provisions which caused Coast to declare Now Solutions in
default of a loan covenant in 2001 (which has since been cured). The portion of
the lawsuit involving Arglen and Gyselen was settled in December 2003 and,
pursuant to the settlement, was dismissed in February 2004. The court has
dismissed the entire against Ross and Tinley. The Company has appealed the
decision with regard to its claim for breach of contract for Ross' failure to
give the proper maintenance fee adjustment. On June 1, 2004, the appeal was
submitted to the court for decision.
The $5.5 million note payable, issued by Now Solutions to Coast and
purchased by WAMCO 31, Ltd., was amended in June 2004. Pursuant to the
amendment, the interest was changed to 9% per annum and the $1,304,766
outstanding principal balance shall be payable as follows: (a) $91,667 principal
per month, plus interest commencing on June 30, 2004 and continuing on each
succeeding month through September 30, 2004; (b) $7,500 principal per month,
plus interest, commencing on October 31, 2004 and continuing on each succeeding
month through January 31, 2005; (c) providing that Now Solutions has achieved
revenues of $7.5 million and EBITDA (Earnings Before Interest, Taxes,
Depreciation & Amortization) of not less than $2,200,000 for the fiscal year
2004, $7,500 principal per month, plus interest, commencing on February 28, 2005
24
and continuing on the last day of each succeeding month until June 30, 2005; and
(d) $91,667 principal per month plus interest, commencing on July 31, 2005 and
continuing on each succeeding month until the note is paid. In the event Now
Solutions does not qualify for reduced payments, the note will be payable in the
amount of $91,667 principal per month, plus interest, commencing on February 28,
2005 and continuing on the last day of each succeeding month until the note is
paid.
The Company had pledged a $1.5 million deposit as collateral pursuant
to a deposit pledge agreement to guarantee the first 24 payments of the loan to
finance the purchase of HRIS. In October 2002, Now Solutions and its lender,
Coast Business Credit ("Coast") 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, the Company was
entitled to withdraw $383,333 from the deposit account, plus $91,667 per month
commencing in October 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
February 2003, the Company was notified that Southern Pacific Bank went into
FDIC receivership. Coast Business Credit is a division of Southern Pacific Bank.
The FDIC froze $750,000, which was the remaining amount of the Company's deposit
account pledged on behalf of Now Solutions on the date of the notice. Of the
remaining $750,000, the Company received $100,000, which is that portion which
was insured by the FDIC. The uninsured portion of the remaining balance of the
deposit pledge account, which is $650,000, was applied to the outstanding debt
of the Coast loan to Now Solutions to reduce the monthly interest and loan
balance. In September 2003, Now Solutions issued two notes payable to the
Company with principal amounts of $215,000 and $435,000, respectively to replace
the previous $650,000 note payable. The interest on the notes for each month is
the highest Prime Rate in effect during said month, but in no event shall the
rate of interest charged on the balance due under the notes in any month be less
than 8.5% per annum. Pursuant to the terms of the notes, beginning on October 1,
2003 and continuing on the first day of every month thereafter, Now Solutions is
required to pay the previous month(s) accrued interest. The principal and all
amounts owing under the notes shall be due and payable no later than December
31, 2004; however the outstanding balance on the notes shall become due if
either the balance due under the original loan from Coast Business Credit is
refinanced by Now Solutions or the successor-in-interest bank to Coast Business
Credit permits earlier terms of payment by Now Solutions and agrees to waive any
potential default of any of Now Solutions ` covenants under the Loan and
Security Agreement (the "Coast Loan") between Now Solutions and Coast Business
Credit, dated February 28, 2001. The $435,000 note has been paid down by Now
Solutions and the Company pledged its interest in a $215,000 note issued by Now
Solutions to the Company to secure a $50,000 loan made by Victor Weber to the
Company as well as $150,000 in loans made by Weber to the Company made in
December 2002 through July 2003. Weber elected to make this assignment in
January 2004. Except for the $215,000 note, which was assigned to Weber, all
other notes and debt under loans made by Weber were cancelled. The Company has
made all interests payments as of June 22, 2004.
In December 2003, the Company settled its dispute with Arglen, a
minority partner of Now Solutions, regarding issues related to Now Solutions.
The settlement resolved various allegations by the Company and Arglen concerning
violations of Now Solutions' Operating Agreement. In February 2004, the parties
completed the closing of the settlement. The arbitration has been dismissed and
any actions with respect to Arglen and Gary Gyselen and the Company and its
related parties, including Now Solutions, were also dismissed. Pursuant to the
terms of the settlement, the Company purchased Arglen's interest in Now
Solutions for $1.4 million as follows: (a) $800,000 which was paid at the
closing and (b) $600,000, pursuant to a non-interest bearing secured promissory
note providing for payments of $200,000 in April 2004, $100,000 in June 2004,
and $300,000 in September 2004, which was issued at closing. The security
interest of Now Solutions' assets on the secured promissory note will be junior
to Now Solutions' present indebtedness to WAMCO 31, Ltd. In addition, at
closing, the Company cancelled 80,763,943 warrants held by Arglen and issued to
Arglen 20,000,000 shares of its the common stock of the Company (at a fair
market value of $280,000), which is subject to Rule 144 regulation with "leak
out" provisions. The Company is obligated to file a registration statement
within 180 days of the closing date covering the resale of the shares by Arglen.
If the Company does not file a timely registration statement, the Company is
obligated to issue an additional 5,000,000 shares and file its registration
statement no later than December 31, 2004. The note is currently delinquent. On
June 17, 2004, Arglen noticed a motion in the action encaptioned Arglen
Acquisitions, LLC v. Vertical Computer Systems, Inc. Superior Court of the State
of California, County of Los Angeles. Pursuant to the motion, Arglen requests a
judgment for $600,000.00 against the Company as joint obligor on a promissory
note to Arglen. The motion is scheduled to be heard on August 13, 2004. The
Company is taking appropriate action to defend the motion.
25
GOING CONCERN UNCERTAINTY
The accompanying condensed consolidated financial statements for the
three months ended March 31, 2003, have been prepared assuming that the Company
will continue as a going concern, which contemplates the realization of assets
and the satisfaction of liabilities in the normal course of business.
The carrying amounts of assets and liabilities presented in the
financial statements do not purport to represent realizable or settlement
values. The Company has suffered significant recurring operating losses, used
substantial funds in its operations, and needs to raise additional funds to
accomplish its objectives. Negative shareholders' equity at March 31, 2003 was
$3,346,576. Additionally, at March 31, 2003, the Company had negative working
capital of approximately $7.9 million (although it includes deferred revenue of
approximately $2.5 million) and has defaulted on several of its debt
obligations. These conditions raise substantial doubt about the Company's
ability to continue as a going concern.
Management of the Company is continuing its efforts to secure funds
through equity and/or debt instruments for its operations, expansion and
possible acquisitions, mergers, joint ventures, and/or other business
combinations. In April 2003, the Equity Line of Credit Agreement executed in
August 2001 was cancelled and the Company entered into a new Equity Line of
Credit Agreement with Cornell Capital Partners, L.P. Under this new agreement,
the Company may issue and sell to Cornell Capital Partners common stock for a
total purchase price of up to $10.0 million. In accordance with the new
agreement, the Company will be entitled to commence drawing down on the equity
line of credit upon the effectiveness of a Registration Statement registering
the shares to be issued under this new agreement. The Company will require
additional fund for its operations and pay down its liabilities, as well as
finance its expansion plans consistent with the Company's anticipated changes in
operations and infrastructure. However, there can be no assurance that the
Company will be able to secure additional funds and that if such funds are
available, whether the terms or conditions would be acceptable to the Company
and whether the Company will be able to turn into a profitable position and
generate positive operating cash flow. The consolidated financial statements
contain no adjustment for the outcome of this uncertainty.
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 March 31, 2003, there
are no material gains or losses requiring separate disclosure.
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.
RELATED PARTY TRANSACTIONS
In March 2003, the Company amended two notes payable it had issued to
Victor Weber in the amount of $65,000 and $45,000. These notes were issued in
December 2002, bearing interest at 13% per annum, were unsecured, and were due
in March 2003. In March 2003, the due date for payment of principal and interest
of these notes was extended to July 1, 2003. In July 2003, the Company and
Victor Weber amended the terms of certain loans made by Weber to the Company in
the aggregate amount of $150,000. Pursuant to their agreement, Weber cancelled
the $65,000 and $45,000 notes payable as well as other outstanding debt, and
Vertical issued two promissory notes in the amounts of $100,000 and $40,000. The
$100,000 promissory note bears interest at 13% per annum and is payable in
monthly accrued interest payments beginning August 1, 2003, and a final payment
of all principal and remaining interest by March 31, 2004. The $40,000
promissory note bears interest at 13% per annum and is payable in monthly
installment payments beginning August 1, 2003, and consisting of an $8,000
principal payment plus the interest accrued in the previous month. In
consideration of the loans made to the Company and for services rendered on
behalf of the Company, the Company paid a $250 commitment fee to Weber and
issued 8,000,000 shares of common stock of the Company to Weber. The stock is
subject to Rule 144 restrictions. In August 2003, the Company obtained
extensions and waivers of default for two notes of $100,000 and $40,000 issued
by the Company to Victor Weber on July 1, 2003. Pursuant to these extensions,
the Company had until October 1, 2003 to become current in its payments. In
September 2003, Weber agreed to loan the Company $50,000. In exchange, the
Company issued a $50,000 note bearing interest at 13%, and due March 31, 2004.
In connection with the loan, the Company pledged its interest in a $215,000 note
26
issued by Now Solutions to the Company to secure this loan as well as $150,000
in loans from Weber to the Company from December 2002 through July 2003.
Pursuant to the Company pledge, Weber has the option to have the Company assign
the $215,000 note issued by Now Solutions to Weber provided that Weber forgives
all of the Company's outstanding debt and cancels all underlying notes in
connection with the debt. Weber elected to make this assignment in January 2004.
Except for the $215,000 note, which was assigned to Weber, all other notes and
debt under loans made by Weber were cancelled. The Company has made all
interests payments as of June 22, 2004. Victor Weber is a Director and President
of Government Internet Systems, Inc., a subsidiary of the Company.
The note payable in the amount of $84,000 issued by EnFacet to Robert
Farias, bearing interest at 8% per annum, unsecured, was issued on June 1, 2001,
with principal and interest due on June 1, 2002. In March 2003, both parties
entered into an agreement to amend the note. Pursuant to the amendment, the due
date of the note was extended to March 17, 2004 in exchange for increasing the
interest rate from 8% to 12% at which interest will be accrued from the date the
note was issued. In addition, EnFacet is required to make monthly payments of
$1,000 commencing in April 2003. In February 2004, the Company and Robert Farias
waived any defaults on the note and agreed that the note will be payable as
follows: once Vertical's subsidiary, Now Solutions, has paid off the entire
balance due under the $500,000 note issued by Now Solutions to Farias on
February 13, 2004, sixteen percent (16%) of any remaining amounts from the final
$91,500 installment payment on the $500,000 note shall be applied to the $84,000
note. Thereafter, Vertical or, at Vertical's option, Now Solutions, shall
continue to make monthly principal payments of $14,640 beginning on the first
day of the following month until all monies due under the $84,000 note has been
paid. In connection with the amendment, Now Solutions entered into a security
agreement with the lender to guarantee the note. The security interest of Now
Solutions' assets on the secured promissory note will be junior to Now
Solutions' present indebtedness to WAMCO 31, Ltd, Arglen, and Robert Farias in
connection with the $500,000 note. The Company appointed Robert Farias as a
director of Now Solutions, a 100% owned subsidiary of the Company, in June 2003.
The note payable in the amount of $280,000, bearing interest at 4% per
annum and issued to Robert Farias on October 31, 2001, was amended by the
parties in March 2003. Pursuant to the amendment, the payment of principal would
be paid in monthly installment in the amount of $5,000, which were to be
replaced with monthly payments of $10,000 beginning in January 2004. All
interest would be due on the day the principal is paid in full. In exchange for
the extensions, the interest rate will accrue at the rate of 12% from the date
the note was issued. In February 2004, the Company and Robert Farias amended the
$280,000 note issued to Mr. Farias on October 31, 2001 and the $181,583 note
issued to Mr. Farias on October 17, 2002. Any default on these notes was waived,
and the Company agreed to make the following payments on these notes, which will
be applied pro-rata to the notes: (i) $20,000, which was paid toward the
$181,583 note on February 20, 2004; (ii) fifty percent (50%) of the remaining
past-due amounts by March 20, 2004; and (iii) the all remaining past-due amounts
to bring the notes current by April 20, 2004. In the event the Company does not
pay the amounts in a timely manner, then all amounts still owing under these
notes will be considered in default and the following shall apply: (i) all such
remaining amounts will be added to the secured loan amounts and will be subject
to the security interest and pledge agreements under the $84,000 promissory note
issued by the Company's subsidiary, Enfacet, to Mr. Farias on June 1, 2001; (ii)
the $14,640 monthly payments to be made under the $84,000 note will be applied
to the $280,000 and $181,583 notes until these notes are paid in full; and (iii)
with respect to cash proceeds Now Solutions receives due to a capital infusion
or upfront licensing fees from a reseller that is outside its normal scope of
business (i.e, not part of software sales in the regular course of business),
Now Solutions is required to pay 50% of such proceeds remaining after the
$500,000 note payable issued by Now Solutions to Mr. Farias on February 13, 2004
has been paid in full toward the $280,000 and $181,583 notes if the Company is
not current in its payments. The $280,000 note is secured by SiteFlash
technology owned by the Company. The Company appointed Robert Farias as a
director of Now Solutions, a 100% owned subsidiary of the Company, in June 2003.
These notes are delinquent.
In May 2003, the Company issued a $7,500 promissory note bearing
interest at twelve percent (12%), due in June 2003, to Stephen Rossetti in
connection with a loan in the same amount. The note is currently delinquent. Mr.
Rossetti is the CEO and a Director of Government Internet Systems, Inc., a
subsidiary of the Company.
In June 2003, James Salz loaned the company $10,000. In January 2004,
the Company agreed to issue 1,000,000 shares of the Company's common stock (at a
fair market value of $3,000), subject to Rule 144 regulation and with "piggy
back" registration rights, in connection with a $10,000 loan made by Jim Salz to
the Company in June 2003. In addition, the Company issued a promissory note for
$10,000 bearing interest at 10%, which is due in April 30, 2004. Mr. Salz is the
Company's corporate counsel. In April 2004, the due date on the note was
extended to August 1, 2004.
In February 2004, Robert Farias loaned $500,000 to Now Solutions, the
Company's wholly-owned subsidiary and received a $500,000 promissory note from
Now Solutions, secured by its assets and a 5% royalty on any sales by Now
Solutions of over $8,000,000 per year up to $500,000. The note bears interest at
10% per annum and Now Solutions is required to make monthly interest payments
27
for all interest accrued in the previous month on the first day of each month
beginning April 1, 2004 and beginning on October 1, 2004 and continuing on the
first day of every month thereafter, monthly principal payments of $91,500 plus
interest until the note has been paid in full. In the event Now Solutions
receives cash proceeds due to a capital infusion or upfront licensing fees from
a reseller that is outside its normal scope of business (i.e, not part of
software sales in the regular course of business), Now Solutions is required to
pay 50% of such proceeds remaining toward payment of the $500,000 note. In
connection with the loan, the Company issued (i) 5 year warrants to purchase
5,000,000 shares of common stock at a $0.01 per share; (ii) 5 year warrants to
purchase 5,000,000 shares of Vertical common stock at a $0.02 per share; (iii) 5
year warrants to purchase 5,000,000 shares of Vertical common stock at a $0.03
per share, (iv) 5,000,000 shares of Vertical common stock subject to Rule 144
Regulation (at a fair market value of $75,000), and (v) an additional 5,000,000
shares of Vertical common stock in the event that $250,000 was not paid toward
the loan on or before March 15, 2004, which were issued (at a fair market value
of $120,000). All of the foregoing warrants and stock are subject to Rule 144
regulation and "piggy-back" registration rights. In addition, the Company also
pledged a 30% ownership interest in Now Solutions to ensure the making of the
$500,000 loan to Now Solutions. In connection with the amendment, Now Solutions
entered into a security agreement with the lender to guarantee the note. The
security interest of Now Solutions' assets on the secured promissory note will
be junior to Now Solutions' present indebtedness to WAMCO 31, Ltd and Arglen.
The Company appointed Robert Farias as a director of Now Solutions, a 100% owned
subsidiary of the Company, in June 2003.
In February 2004, the Company purchased a 21% ownership interest in
MedData Solutions, Inc. from Robert Farias. In exchange, the Company issued
9,000,000 shares of the common stock of the Company (at a fair market value of
$135,000), which shall be subject to Rule 144 Regulation and have "piggy-back"
registration rights. The Company appointed Robert Farias as a director of Now
Solutions, a 100% owned subsidiary of the Company, in June 2003.
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 total estimated revenues by
the product, subject to an annual minimum based on straight-line amortization
over the product's estimated economic useful life, not to exceed five years. The
Company periodically reviews capitalized software costs for impairment where the
fair value is less than the carrying value. During the three months ended March
31, 2003 and 2002, no costs were capitalized.
IMPAIRMENT OF LONG-LIVED ASSETS
Effective January 1, 2002, the Company began applying the provisions of
Statement of Financial Accounting Standard No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"). SFAS No. 144
requires that long-lived assets be reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable through the estimated undiscounted cash flows expected to result
from the use and eventual disposition of the assets. Whenever any such
impairment exists, an impairment loss will be recognized for the amount by which
the carrying value exceeds the fair value. During 2002, the Company determined
that there was approximately $638,000 of impairment in goodwill, which was
located in Enfacet, Inc.
REVENUE RECOGNITION
Service revenue generated from professional consulting and training
services are recognized as the services are performed. Maintenance revenue,
including revenues bundled with original software product license revenues, are
deferred and recognized over the related contract period, generally twelve
months. The Company's revenue recognition policies are designed to comply with
American Institute of Certified Public Accountants Statement of Position 97-2,
"Software Revenue Recognition" (SOP 97-2) and with Emerging Issues Task Force
Issued No 00-21, "Revenue Arrangement with Multiple Deliverables."
28
Deferred revenue on maintenance contracts represent cash received in
advance or accounts receivable from systems, maintenance services, and
consulting sales, which is recognized over the life of the contact.
In accordance with SEC Staff Accounting Bulletin No. 101 "Revenue
Recognition in Financial Statements", the Company recognizes revenue from
license of computer software "up-front" provide that a non-cancelable license
agreement has been signed, the software and related documentation have been
shipped, there are no material uncertainties regarding customer acceptance,
collection of resulting receivable is deemed probable, and no significant other
vendor obligation exist.
STOCK-BASED COMPENSATION
The Company has adopted the intrinsic value method of accounting for
employee stock options as permitted by Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-based Compensation" (SFAS No. 123) and
discloses the pro forma effect on net loss and loss per share as if the fair
value based method had been applied. For equity instruments, including stock
options, issued to non-employees, the fair value of the equity instruments or
the fair value of the consideration received, whichever is more readily
determinable, is used to determine the value of services or goods received and
the corresponding charge to operations.
The following table illustrates the effect on net loss and loss per
share as if the Company had applied the fair value recognition provision of SFAS
No. 123 to stock-based employee compensation.
All stock options issued to employees have an exercise price not less
than the fair market value of the Company's common stock on the date of the
grant, and in accordance with accounting for such options utilizing the
intrinsic value method there is no related compensation expense recorded in the
Company's consolidated financial statements. Had compensation cost for
stock-based compensation been determined based on the fair value of the grant
dates consistent with the method of FASB 123, the Company's net loss and loss
per share for the three months ended March 31, 2003 and 2002 would have been
increased to the pro forma amounts presented:
2003 2002
----------- --------------
Net loss: as reported $ (487,812) $ (1,885,425)
Add: total stock based employee compensation expense determined under fair
value method for all awards -- --
Pro forma $ (487,812) $ (1,885,425)
Basic and diluted loss per common share $ (0.00) $ (0.00)
Pro forma $ (0.00) $ (0.00)
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".
NEW ACCOUNTING PRONOUNCEMENTS
In April 2002, FASB issued Statement No. 145 (SFAS No. 145), "Rescission
of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections" effective on or after May 15, 2002. This Statement
rescinds SFAS No. 4 and an amendment of that Statement, and SFAS No. 64. This
Statement also rescinds SFAS No. 44. This Statement amends SFAS No. 13, to
eliminate an inconsistency between the required accounting for certain lease
modifications that have economic effects that are similar to sale-leaseback
transactions. This Statement also amends other existing authoritative
pronouncements to make various technical corrections, clarify meanings or
describe their applicability under changed conditions. The Company adopted SFAS
No 145 as of December 31, 2002 and the adoption of SFAS No. 145 did not have a
material effect on the Company's financial position or results of operations.
In December 2002, FASB issued Statement No. 148 (SFAS No. 148),
"Accounting for Stock-Based Compensation Transition and Disclosure an amendment
of FASB Statement No. 123." SFAS No. 148 amends SFAS No. 123, "Accounting for
Stock-Based Compensation," to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, SFAS No. 148 amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results.
SFAS No 148 is effective for the Company's financial statements for the year
ending after December 15, 2002. As permitted by SFAS No. 148, the Company has
elected to retain the intrinsic value method of accounting for stock-based
awards granted to employees. Accordingly, the adoption of SFAS No. 148 did not
have a material effect on the Company's financial position or results of
operations.
In June 2002, FASB issued Statement No. 146 (SFAS No. 146), "Accounting
for Costs Associated with Exit or Disposal Activities," effective for activities
that are initiated after December 31, 2002, with early application encouraged.
This Statement addresses financial accounting and reporting for costs associated
with exit or disposal activities and nullifies Emerging Issues Task Force (EITF)
Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." The Company adopted SFAS No 146 as of January 1, 2003 and the
adoption of SFAS No. 146 did not have a material effect on the Company's
financial position or results of operations.
In November 2002, FASB issued Interpretation No. 45 ("FIN No. 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN No. 45 expands on the
accounting guidance of Statements No. 5, 57, and 107 and incorporates without
change the provisions of FASB Interpretation No. 34, which is being superseded.
FIN No. 45 will affect leasing transactions involving residual guarantees,
vendor and manufacturer guarantees, and tax and environmental indemnities. All
such guarantees will need to be disclosed in the notes to the financial
statements starting with the period ending after December 15, 2002. For
guarantees issued after December 31, 2002, the fair value of the obligation must
be reported on the balance sheet. Existing guarantees will be grandfathered and
will not be recognized on the balance sheet. The adoption of FIN No. 45 did not
have a material impact on the Company's financial statements.
NEW ACCOUNTING PRONOUNCEMENTS NOT ADOPTED YET
In May 2003, FASB issued Statement No. 150 (SFAS No. 150), "Accounting for
Certain Instruments with Characteristics of Both Liabilities and Equity." SFAS
No. 150 establishes standards on the classification and measurement of financial
instruments with characteristics of both liabilities and equity. SFAS No. 150
will be effective for financial instruments entered into or modified after May
31, 2003 and otherwise is effective beginning July 1, 2003. The Company is in
the process of assessing the effect of SFAS No. 150 on the Company's
consolidated financials statements.
In January 2003, FASB issued FASB Interpretation No. 46 (FIN No. 46),
"Consolidation of Variable Interest Entities," an interpretation of Accounting
Research Bulletin No. 51, "Consolidated Financial Statements." FIN No. 46
explains how to identify variable interest entities and how an enterprise
assesses its interest in a variable entity to decide whether to consolidate that
entity. FIN No. 46 requires existing unconsolidated variable interest entities
to be consolidated by their primary beneficiaries if the entities do not
effectively disperse risks among parties involved. FIN No. 46 is effective
immediately for variable interest entities after January 31, 2003, and to
variable interest entities in which an enterprise obtained an interest after
that date. FIN No. 46 applies in the first fiscal year or interim period
beginning after June 15, 2003, to variable interest entities in which an
enterprise holds a variable interest that it acquired before February 1, 2003.
The adoption of FIN No. 46 is not expected to have a material effect on the
Company's financial position and result of operations.
RISK FACTORS AFFECTING THE COMPANY'S BUSINESS, OPERATING RESULTS AND FINANCIAL
CONDITION
30
We are subject to various risks that may materially harm our business,
financial condition and results of operations. You should carefully consider the
risks and uncertainties described below and the other information in this filing
before deciding to purchase our common stock. If any of these risks or
uncertainties actually occurs, our business, financial condition or operating
results could be materially harmed. In that case, the trading price of our
common stock could decline and you could lose all or part of your investment.
WE HAVE HISTORICALLY INCURRED LOSSES AND MAY CONTINUE TO DO SO IN THE
FUTURE
We have historically incurred losses. In the three months ended March 31,
2003, and the year ended December 31, 2002, we had net losses applicable to
common shareholders of $(637,812) and $(3,924,210), respectively. Future losses
are likely to occur. Accordingly, we have and may continue to experience
significant liquidity and cash flow problems because our operations are not
profitable. No assurances can be given that we will be successful in reaching or
maintaining profitable operations.
WE HAVE BEEN SUBJECT TO A GOING CONCERN OPINION FROM OUR INDEPENDENT
AUDITORS, WHICH MEANS THAT WE MAY NOT BE ABLE TO CONTINUE OPERATIONS UNLESS WE
OBTAIN ADDITIONAL FUNDING
The report of our independent certified public accountants included an
explanatory paragraph in connection with our financial statements for the year
ended December 31, 2002. This paragraph states that our recurring operating
losses, the substantial funds used in our operations and the need to raise
additional funds to accomplish our objectives raise substantial doubt about our
ability to continue as a going concern. Our ability to develop our business plan
and to continue as a going concern depends upon our ability to raise capital and
to achieve improved operating results. Our financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
WE HAVE A LIMITED OPERATING HISTORY ON WHICH TO EVALUATE US
We have a limited operating history upon which an evaluation of our
business prospects can be based. Our business operations commenced in October
1999. Our prospects must be considered in light of the risks, expenses,
difficulties and uncertainties frequently encountered by emerging growth
companies in new and rapidly evolving markets for Internet based products and
services. Our success will depend, in part, on our ability to:
o attain profitable operations;
o enter into distribution relationships and strategic alliances to sell our
SiteFlash and Emily technology products and applications and build traffic
to our Web sites;
o effectively establish, develop and maintain relationships with sponsors
and other third parties;
o provide original and compelling products and services to Internet users;
o develop and upgrade our technology;
o effectively respond to competitive developments;
o continue to develop and extend our brand;
o effectively generate revenues through sponsored services and placements;
and
o attract and retain new qualified personnel.
We may not succeed in addressing these risks.
31
OUR SUCCESS DEPENDS ON OUR ABILITY TO GENERATE SUFFICIENT REVENUES TO PAY
FOR THE EXPENSES OF OUR OPERATIONS
We believe that our success will depend upon our ability to generate
revenues from sales of our SiteFlash and Emily technology products and
sponsorship and e-commerce fees from our Internet sites and increased revenues
from Now Solutions products, none of which can be assured. Our ability to
generate revenues is subject to substantial uncertainty and our inability to
generate sufficient revenues to support our operations could require us to
curtail or suspend operations. Such an event would likely result in a decline in
our stock price.
OUR SUCCESS DEPENDS ON OUR ABILITY TO OBTAIN ADDITIONAL CAPITAL
The Company has funding that is expected to be sufficient to fund its
present operations for one month. After one month, the Company's operations may
need to be curtailed or suspended if additional funding is not received. The
Company, however, will need significant additional funding in order to complete
its business plan objectives. Accordingly, the Company will have to rely upon
additional external financing sources to meet its cash requirements. Management
will continue to seek additional funding in the form of equity or debt to meet
its cash requirements. However, there is no guarantee the Company will raise
sufficient capital to execute its business plan. In the event that the Company
is unable to raise sufficient capital, our business plan will have to be
substantially modified and our operations curtailed or suspended.
WE HAVE A WORKING CAPITAL DEFICIT, WHICH MEANS THAT OUR CURRENT ASSETS ON
MARCH 31, 2003 WERE NOT SUFFICIENT TO SATISFY OUR CURRENT LIABILITIES ON
THAT DATE
We had a working capital deficit of approximately $7,900,000 at March 31,
2003, which means that our current liabilities exceeded our current assets by
approximately $7,900,000. Current assets are assets that are expected to be
converted into cash within one year and, therefore, may be used to pay current
liabilities as they become due. Our working capital deficit means that our
current assets on March 31, 2003 were not sufficient to satisfy all of our
current liabilities on that date.
OUR OPERATING RESULTS MAY FLUCTUATE BECAUSE OF A NUMBER OF FACTORS, MANY
OF WHICH ARE OUTSIDE OF OUR CONTROL
Our operating results may fluctuate significantly as a result of variety
of factors, many of which are outside of our control. These factors include,
among others:
o the demand for our SiteFlash and Emily technology;
o the demands for Now Solutions' emPath product;
o the level of usage of the Internet;
o the level of user traffic on our Web sites;
o seasonal trends and budgeting cycles in sponsorship;
o incurrence of costs relating to the development, operation and expansion
of our Internet operations;
o introduction of new products and services by us and our competitors;
o costs incurred with respect to acquisitions;
o price competition or pricing changes in the industry;
o technical difficulties or system failures; and
o general economic conditions and economic conditions specific to the
Internet and Internet media.
32
WE MAY HAVE DIFFICULTY MANAGING OUR GROWTH AND INTEGRATING RECENTLY
ACQUIRED COMPANIES
Our recent growth has placed a significant strain on our managerial,
operational, and financial resources. To manage our growth, we must continue to
implement and improve our operational and financial systems and to expand,
train, and manage our employee base. Any inability to manage growth effectively
could have a material adverse effect on our business, operating results, and
financial condition. As part of our business strategy, we have completed several
acquisitions and expect to enter into additional business combinations and
acquisitions. Acquisition transactions are accompanied by a number of risks,
including:
o the difficulty of assimilating the operations and personnel of the
acquired companies;
o the potential disruption of our ongoing business and distraction of
management;
o the difficulty of incorporating acquired technology or content and rights
into our products and media properties;
o the correct assessment of the relative percentages of in-process research
and development expense which needs to be immediately written off as
compared to the amount which must be amortized over the appropriate life
of the asset;
o the failure to successfully develop an acquired in-process technology
resulting in the impairment of amounts currently capitalized as intangible
assets;
o unanticipated expenses related to technology integration;
o the maintenance of uniform standards, controls, procedures and policies;
o the impairment of relationships with employees and customers as a result
of any integration of new management personnel; and
o the potential unknown liabilities associated with acquired businesses.
We may not be successful in addressing these risks or any other problems
encountered in connection with these acquisitions. Our failure to address these
risks could negatively affect our business operations through lost
opportunities, revenues or profits, any of which would likely result in a lower
stock price.
OUR SUCCESS DEPENDS ON OUR ABILITY TO PROTECT OUR PROPRIETARY TECHNOLOGY
Our success is dependent, in part, upon our ability to protect and
leverage the value of our original SiteFlash and Emily technology products and
Internet content, as well as our trade secrets, trade names, trademarks, service
marks, domain names and other proprietary rights we either currently have or may
have in the future. Given the uncertain application of existing trademark laws
to the Internet and copyright laws to software development, there can be no
assurance that existing laws will provide adequate protection for our
technologies, sites or domain names. Policing unauthorized use of our
technologies, content and other intellectual property rights entails significant
expenses and could otherwise be difficult or impossible to do given the global
nature of the Internet and our potential markets.
33
OUR STOCK PRICE HAS HISTORICALLY BEEN VOLATILE, WHICH MAY MAKE IT MORE
DIFFICULT FOR YOU TO RESELL SHARES WHEN YOU CHOOSE TO AT PRICES YOU FIND
ATTRACTIVE
The trading price of our common stock has been and may continue to be
subject to wide fluctuations. The stock price may fluctuate in response to a
number of events and factors, such as quarterly variations in operating results,
announcements of technological innovations or new products and media properties
by us or our competitors, changes in financial estimates and recommendations by
securities analysts, the operating and stock price performance of other
companies that investors may deem comparable, and news reports relating to
trends in our markets. In addition, the stock market in general, and the market
prices for Internet-related and technology-related companies in particular, have
experienced extreme volatility that often has been unrelated to the operating
performance of such companies. These broad market and industry fluctuations may
adversely affect the price of our stock, regardless of our operating
performance.
OUR COMMON STOCK IS DEEMED TO BE "PENNY STOCK," WHICH MAY MAKE IT MORE
DIFFICULT FOR INVESTORS TO SELL THEIR SHARES DUE TO SUITABILITY
REQUIREMENTS
Our common stock is deemed to be "penny stock" as that term is defined in
Rule 3a51-1 promulgated under the Securities Exchange Act of 1934. Penny stocks
are stock:
o With a price of less than $5.00 per share;
o That are not traded on a "recognized" national exchange;
o Whose prices are not quoted on the Nasdaq automated quotation system
(Nasdaq listed stock must still have a price of not less than $5.00 per
share); or
o In issuers with net tangible assets less than $2.0 million (if the issuer
has been in continuous operation for at least three years) or $5.0 million
(if in continuous operation for less than three years), or with average
revenues of less than $6.0 million for the last three years.
Broker/dealers dealing in penny stocks are required to provide potential
investors with a document disclosing the risks of penny stocks. Moreover,
broker/dealers are required to determine whether an investment in a penny stock
is a suitable investment for a prospective investor. These requirements may
reduce the potential market for our common stock by reducing the number of
potential investors. This may make it more difficult for investors in our common
stock to sell shares to third parties or to otherwise dispose of them. This
could cause our stock price to decline.
THE COMPANY WILL LIKELY EXPERIENCE LOSSES FOR THE FORESEEABLE FUTURE
Our lack of an extensive operating history makes prediction of future
operating results difficult. We believe that a comparison of our quarterly
results is not meaningful. As a result, you should not rely on the results for
any period as an indication of our future performance. Accordingly, there can be
no assurance that we will generate significant revenues or that we will attain a
level of profitability in the future. We currently intend to expand and improve
our Internet operations, fund increased advertising and marketing efforts,
expand and improve our Internet user support capabilities and develop new
internet technologies, products and services. As a result, we may experience
significant losses on a quarterly and annual basis.
THE COMPANY'S ABILITY TO CONTINUE AS A GOING CONCERN IS DEPENDENT ON ITS
ABILITY TO RAISE ADDITIONAL FUNDS AND TO ESTABLISH PROFITABLE OPERATIONS.
The accompanying consolidated financial statements for the three months
ended March 31, 2003 and 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.
34
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 March 31, 2003, the Company had stockholders'
deficit of $3.3 million and negative working capital of approximately $7.9
million (although it includes deferred revenue of approximately $2.5 million)
and has defaulted on several of its debt obligations. These conditions raise
substantial doubt about the Company's ability to continue as a going concern.
Management of the Company is continuing its efforts to secure funds
through equity and/or debt instruments for its operations, expansion and
possible acquisitions, mergers, joint ventures, and/or other business
combinations. The Company will require additional fund for its operations and
pay down its liabilities, as well as finance its expansion plans consistent with
the Company's anticipated changes in operations and infrastructure. However,
there can be no assurance that the Company will be able to secure additional
fund and that if such fund is available, whether the terms or conditions would
be acceptable to the Company and whether the Company will be able to turn into a
profitable position and generate positive operating cash flow. The consolidated
financial statements contain no adjustment for the outcome of this uncertainty.
ITEM 3. EVALUATION OF CONTROLS AND PROCEDURES
Based on their evaluation of the effectiveness of our disclosure controls
and procedures within 90 days of the filing date of this report, our Chief
Executive Officer and Chief Accounting Officer have concluded that the Company's
disclosure controls and procedures are effective for gathering, analyzing and
disclosing the information the Company required to disclose in the reports filed
under the Securities and Exchange Act of 1934. There have not been significant
changes in the Company's controls or in other factors that could significantly
affect these controls subsequent to the evaluation date.
Because the Company's 100% subsidiary, Now Solutions, Inc., generates over
90% of the Company's revenues, the Company, through its directors, engaged Craig
Hamilton and Company ("CHC") to make a detailed review of Now Solution's
complete financial functions in order to more effectively evaluate internal
controls and procedures. This report was completed in February 2003. In March
2003 Now Solutions retained CHC to implement the majority of its
recommendations, including one to ensure a standard charter of accounts for its
Canadian subsidiary that will more efficiently consolidate into the Company's
financial statements.
In June 2003 after Now Solutions and the mutually agreed separation
between Stephen Gunn, Now Solutions' former CFO and Now Solutions, CHC was
retained on a monthly basis to perform the monthly financial functions and
implement CHC's recommendations including the establishment of a standard
charter of accounts between Now Solutions and the Company. The Company retained
independent consultants to prepare its financial statements. In addition, the
Company employs in-house corporate counsel and outside SEC legal counsel to
assist in the Company's SEC reporting requirements. In March 2004, the Company
retained Sheri Pantermuehl to serve as the CFO of the Company and Now Solutions.
Ms. Pantermuehl is now responsible for preparing the financial statements of Now
Solutions and the Company.
35
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 addition, we are involved in the following additional ongoing matters.
In December 2003, the Company settled its dispute with Arglen
Acquisitions, LLC ("Arglen"), a minority partner of Now Solutions, regarding
issues related to Now Solutions. The settlement resolved various allegations by
the Company and Arglen concerning violations of Now Solutions' Operating
Agreement. In February 2004, the parties completed the closing of the
settlement. The arbitration has been dismissed and any actions with respect to
Arglen and Gary Gyselen and the Company and its related parties, including Now
Solutions, were also dismissed, except that the California Superior Court, Los
Angeles County retained jurisdiction regarding the terms of the settlement
between the parties. Pursuant to the terms of the settlement, the Company
purchased Arglen's interest in Now Solutions for $1.4 million as follows: (a)
$800,000 which was paid at the closing and (b) $600,000, pursuant to a
non-interest bearing secured promissory note providing for payments of $200,000
in April 2004, $100,000 in June 2004, and $300,000 in September 2004, which was
issued at closing. The security interest of Now Solutions' assets on the secured
promissory note is junior to Now Solutions' present indebtedness to WAMCO 31,
Ltd. In addition, at closing, the Company cancelled 80,763,943 warrants held by
Arglen and issued to Arglen 20,000,000 shares of the common stock of the Company
(at a fair market value of $280,000), which is subject to Rule 144 regulation
with "leak out" provisions. The Company is obligated to file a registration
statement within 180 days of the closing date covering the resale of the shares
by Arglen. If the Company does not file a timely registration statement, the
Company is obligated to issue an additional 5,000,000 shares and file its
registration statement no later than December 31, 2004. The note has not been
paid and in April 2004, Arglen gave notice of default and acceleration. On June
17, 2004, Arglen noticed a motion in the action encaptioned Arglen Acquisitions,
LLC v. Vertical Computer Systems, Inc. Superior Court of the State of
California, County of Los Angeles. Pursuant to the motion, Arglen requests a
judgment for $600,000.00 interest and attorneys fees against the Company as
joint obligor on the promissory note to Arglen. The motion is scheduled to be
heard on August 13, 2004. The Company is taking appropriate action to defend the
motion.
At March 31, 2003, the Company had cash-on-hand of $1,565,259. Now
Solutions' cash-on-hand was not available to fund the Company's operations due
to a court order obtained by Arglen and bank covenants in connection with legal
proceedings concerning Now Solutions. The Company settled with Arglen in
December 2003. The settlement closed in February 2004, and the Company and
Arglen dismissed all claims with respect to one another. As a result, the
cash-on-hand of Now Solutions is now available to fund the Company's operations.
In February 2003, the Company filed a lawsuit and a derivative action in
New York Supreme Court Case against defendants Ross Systems, Inc. ("Ross"),
Arglen Acquisitions, LLC ("Arglen"), James Patrick Tinley ("Tinley"), and Garry
Gyselen ("Gyselen"). The Company filed a derivative action on behalf of its
subsidiary Now Solutions when Arglen refused to authorize a lawsuit against any
parties who were alleged to have acted against the best interest of Now
Solutions. In conjunction with the Company's claim, Now Solutions is withholding
its payments on the remaining $750,000 note that was due in February 2003
against the unpaid maintenance fees and gave notice in February 2003 to Ross of
Now Solutions' claim of offset. Now Solutions has claimed a total amount of
approximately $3,562,000 to offset against the note, plus other damages.
Plaintiff's original claims sought damages and equitable relief arising out of
actions of the defendants constituting breach of contract, fraud, conspiracy and
breach of fiduciary duty in connection with certain transactions entered into
between Ross and Now Solutions; Ross and Arglen; Arglen and Now Solutions;
Gyselen and Now Solutions; and the Company and Arglen. The action concerned
offsets of payment on note payable to Ross by the maintenance fee charged by Now
Solutions to Ross to which Now Solutions was entitled per the asset purchase
agreement between Now Solutions and Ross regarding the HRIS assets Now Solutions
purchased from Ross in 2001, an undisclosed transaction between Ross and Gyselen
around the time of the purchase of these assets, and the failure of Gyselen to
enforce the offset provisions which caused Coast to declare Now Solutions in
default of a loan covenant in 2001 (which has since been cured). The portion of
the lawsuit involving Arglen and Gyselen was settled in December 2003 and,
pursuant to the settlement, was dismissed in February 2004. The court has
dismissed the entire action against Ross and Tinley. The Company has appealed
the decision with regard to its claim for breach of contract for Ross' failure
to give the proper maintenance fee adjustment. On June 1, 2004, the appeal was
submitted to the court for decision.
36
In March 2003, Ross commenced an action in Supreme Court, Westchester
County (New York State) by filing a motion for summary judgment in lieu of
complaint against Now Solutions to collect the note payable in the amount of
$750,000 plus 10% interest. In August 2003, the Westchester County Supreme Court
denied the motion and dismissed Ross's action without prejudice. In October 2003
the motion of Ross for reargument was denied. Ross has appealed the August 2003
court order, but subsequently abandoned its appeal.
In March 2004, Ross commenced an action in the Supreme Court, New York
County (New York State) by filing a motion for summary judgment in lieu of
complaint against Now Solutions to collect the note payable in the amount of
$750,000 plus 10% interest and attorneys fees. Now Solutions filed its
opposition to Ross' motion, which was submitted to the court for decision on May
20, 2004. No decision has been rendered as of June 15, 2004.
In March 2004, Ross commenced an action in the Court of Chancery, State of
Delaware by filing a summons and complaint against the Company, Now Solutions
and Arglen alleging a fraudulent transfer in connection with the Company's
payment of moneys to Arglen pursuant to the settlement dated December 2003. The
Company and Now Solutions have filed a motion to stay the Delaware action
pending the resolution of the parties' rights in Supreme Court, New York County
and Appellate Division.
On December 21, 2001, the Company entered into an option agreement with
iNet Purchasing ("iNet") to purchase an additional interest in iNet under which
the Company would obtain an aggregate 56% ownership interest in iNet pursuant to
the Stock Purchase Agreement and the Stockholder's Agreements. 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 three-year stock
options to three iNet executives, Basil Nikas, Robin Mattern, and Wayne Savage,
in the amount of 1,500,000, 1,500,000, and 500,000 shares of the Company's
common stock, respectively. These stock options were issued in 2001. At December
31, 2002, the Company had 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 $0.01, 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 is required to
pay to iNet $860,000 in cash or marketable securities (pending any potential
offsets). The Company would need to raise additional capital in order to pay the
cash portion of the exercise price, which is $860,000. In addition, in order to
exercise the option, the Company must issue 70,000 shares of Series C preferred
stock and grant additional three-year warrants and options, as the case may be,
to purchase an additional 6,000,000 shares of the Company's common stock each to
Nikas and Mattern and 2,000,000 shares of the Company's common stock to Savage,
at a strike price of $0.025 per share. Of these warrants and options, the
Company issued but did not deliver 1,500,000 warrants each to Mr. Nikas and Mr.
Mattern and 500,000 warrants to Mr. Savage in January 2002. The fair market
value of these warrants at the date of grant was $35,713. In the event that the
Company does not acquire a majority interest in iNet, these options and warrants
will automatically be cancelled. Under the terms of the option, iNet is required
to deliver certain financial and non-financial information. This information was
never delivered and the Company is holding the warrants issued in January 2002
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 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In January 2003, the Company's subsidiary, Government Internet Systems,
Inc. retained David Kinney to serve as CTO. The Company issued five year
warrants to purchase 500,000 shares of the Company's common stock at an exercise
price of $0.01 in connection with retaining this executive. The warrants, at the
time of issuance, had an estimated fair market value of $2,441 (valued using the
Black-Scholes valuation model). In the event that GIS achieves certain sales
targets or receives $2.5 million in financing, Kinney has the option to become a
salaried employee for 2 years at an annual salary of $125,000.
In January 2003, the Company, acting as the majority shareholder of
Government Internet Systems, Inc., a subsidiary of the Company, retained the
services of Basil Nikas as a Director of GIS for 250 shares of the 25,000 shares
of the outstanding common stock of GIS, subject to a buyback agreement between
the Company and the director. The value of these shares is nominal. In addition,
the Company issued five-year warrants to purchase 250,000 shares of the
Company's common stock at an exercise price of $0.01 in connection with
retaining this director. The warrants were issued at an estimated fair market
value of $1,672 (valued using the Black-Scholes valuation model).
37
In January 2003, the remaining $50,000 of principal of $125,000 in
debentures was converted into 12,853,470 shares of the Company's common stock.
These convertible debentures, issued on September 11, 2001, bearing interest at
6% per annum, were convertible into shares of the Company's common stock at
either 120% of the closing bid price on the date of agreement or 80% of the
three lowest closing bid prices 20 days prior to the conversion. The debentures
were convertible at the option of the holder at any time after the purchase.
Principal and interest were originally due at maturity on September 1, 2006.
In January 2003, the remaining $55,000 of principal of $140,000 in
debentures was converted into 14,138,817 shares of the Company's common stock.
These convertible debentures, issued on October 5, 2001, bearing interest at 6%
per annum, were convertible into shares of the Company's common stock at either
120% of the closing bid price on the date of agreement or 80% of the three
lowest closing bid prices 20 days prior to the conversion. The debentures were
convertible at the option of the holder at any time after the purchase.
Principal and interest were originally due at maturity on October 5, 2006. The
accrued interest is currently outstanding.
In February 2003, the Company and its wholly owned subsidiary, Enfacet,
Inc., agreed to amend the stock purchase agreement. Pursuant to the amendment,
the Company may substitute 400 common shares for each share of Preferred "C"
Stock of the Company (up to 12,000,000 shares of common stock of the Company) in
connection with purchase of Enfacet, Inc. The Company may cancel any Preferred
"C" Stock of the Company for which common stock is substituted or as otherwise
specified in the agreement. In April 2003, the Company issued 3,000,000 shares
of common stock of the Company with the Rule 144 restrictive legend to former
employees and consultants of Enfacet, Inc. for services. These 3,000,000 shares
were issued in connection with this agreement and the Company has cancelled 7500
shares of Preferred "C" Stock that were issued to the Company's subsidiary, but
held by the Company. In February 2004, the Company cancelled 22,500 shares of
Preferred "C" Stock of the Company .
In March 2003, the Company, acting as the majority shareholder of
Government Internet Systems, Inc., a subsidiary of the Company, retained the
services of Thomas Beeson as a Director of GIS for 250 shares of the 25,000
shares of the outstanding common stock of GIS, subject to a buyback agreement
between the Company and the director. The value of these shares is nominal. In
addition, the Company issued five year warrants to purchase 250,000 shares of
the Company's common stock at an exercise price of $0.01 in connection with
retaining this director. The warrants were issued at an estimated fair market
value of $645 (valued using the Black-Scholes valuation model).
In April 2003, the Company and the third party seller of the SiteFlash
technology agreed to amend the put and call agreement of October 2002, which was
made in connection with the amendment of the $280,000 note issued in October
2001. Pursuant to this amendment, the Company issued 1,000,000 shares of common
stock of the Company in lieu of issuing 2,500 shares of Class C Preferred Stock
of the Company to the third party when the Company did not purchase the
underlying common stock represented by 12,500 shares of Class C Preferred Stock
of the Company in March 2003. The Company issued the 1,000,000 common shares in
April 2003.
In April 2003, the Company issued 5 year warrants to purchase 5,000,000
shares of common stock of the Company at an exercise price of $0.01 per share to
Wolman, Babbitt, & King for legal services rendered to the Company. The
warrants, at the time of issuance, had an estimated fair market value of $15,009
(valued using the Black-Scholes valuation model).
In April 2003, the Company and Mike Radlovic (Radlovic) entered into an
agreement whereby Radlovic would purchase the Company's interest in TranStar
Systems, Inc. (TranStar), formerly Apollo Industries, Inc. In October 2000, the
Company had agreed to provide $250,000 in funding to TranStar in exchange for a
30% equity interest. Pursuant to the agreement, the Company transferred all of
its ownership representing 3,000,000 shares of TranStar common stock to
Radlovic. In consideration of the sale, Radlovic issued a $250,000 note bearing
interest at 10% per annum due in April 2007. The note is secured by 5,000,000
shares of TranStar common stock. Radlovic is the President and CEO of TranStar.
In April 2003, the Company and TranStar Systems, Inc. (TranStar) agreed to
amend two $24,000 promissory notes bearing interest at 10%, dated April 19 and
May 8, 2001, and a royalty agreement, dated October 14, 2000 whereby TranStar
had agreed to pay a royalty of 2% of all transaction fees up to $275,000 and 1%
up to $3,000,000. Pursuant to the agreement, the due date for the two $24,000
notes was extended to April 5, 2006 in exchange for increasing the royalty rate
in the royalty agreement to 3% of any transaction fees and any other revenues
generated in perpetuity. The collateral to secure the note, consisting of
1,000,000 shares of TranStar common stock, and the underlying security
agreements remain in full force and effect. In connection with the agreement,
TranStar also released and indemnified the Company from any obligations owed to
TranStar or any third party.
38
In April 2003, the Company issued 1,100,000 shares of common stock to a
third party consultant and extended 750,000 options and 750,000 warrants that
vested in November 2001 at an exercise price of $0.025 per share for an
additional 1 year in connection with consulting services. The extension of the
options and warrants had an estimated fair market value of $6,396 (valued using
the Black-Scholes valuation model).
In April 2003, the Equity Line of Credit agreement entered into in August
2001 was cancelled and a new Equity Line of Credit Agreement was executed
between the Company and Cornell, whereby up to $10,000,000 worth of the
Company's common stock may be purchased. The shares must be registered before
the sale, and the shares can be purchased at 99% of the lowest closing bid price
during the 5 days trading days after the Company requests an advance, but not
less than the minimum advance price per share set by the Company and provide in
the notice requesting an advance. The Equity Line of Credit Agreement contains a
commitment fee of $190,000, payable in a convertible debenture, which was to be
issued to Cornell, and a placement fee of $10,000, payable to the third party
placement agent. The debenture may be redeemed for 100% of the any portion of
the principal that has not been converted by the holder as of the date of the
notice of redemption. The debenture provides that after 180 days the holder may
convert any portion of the principal at 100% of the lowest closing bid price 3
days prior to conversion. In addition, the Company shall pay $500 in legal,
administrative and escrow fees and a 2% commitment fee of each advance to
Cornell Capital Partners, L.P. In July 2003, the Company issued 2,049,180 shares
of common stock as payment of the $10,000 placement fee. As of June 22, 2004, no
debentures have been converted.
In April 2003, the Company issued $200,000 of convertible debentures. The
debt accrues interest at 5% per annum and is due April 2006. The holder may
convert the debenture into shares of common stock at either $0.03 or 80% of the
lowest closing bid price for the 5 trading days prior to the conversion. In
accordance with the beneficial conversion feature, the Company recognized deemed
interest expense of $50,000. As of June 22, 2004, no debentures have been
converted.
In April 2003, the Company issued, but did not deliver, 3,000,000 shares
of common stock of the Company to a third party lender in anticipation of
finalizing the terms of the loan made by the lender. The lender had initially
agreed to loan the Company $60,000 but only $31,859 was funded. The Company
intends to deliver the stock once the terms of the loan are finalized.
In April 2003, $40,000 of principal of $100,000 in debentures was
converted into 10,245,900 shares of the Company's common stock. These
convertible debentures, issued on March 29, 2002, bearing interest at 5% per
annum, were convertible into shares of the Company's common stock at either 120%
of the closing bid price on the date of agreement or 80% of the lowest closing
bid prices 5 days prior to the conversion. The debentures were convertible at
the option of the holder at any time after the purchase. Principal and interest
were originally due at maturity on March 28, 2004.
In May 2003, the Company issued two promissory notes, each for a principal
amount of $17,500, bearing no interest to two third party lenders in
consideration of two loans in the aggregate amount of $30,000. The notes were
due in June 2003. The Company has pledged distributions of funds owed to it by
its subsidiary Now Solutions toward payment of the loan. In connection with the
notes the Company paid a commitment fee of $2,500 on each note and issued 5 year
warrants to purchase 250,000 shares of common stock of the Company at an
exercise price of $0.0075 per share to each lender. The warrants were issued at
an estimated fair market value of $2,440 (valued using the Black-Scholes
valuation model). In connection with these loans, The Company also issued 5 year
warrants to purchase 250,000 shares of common stock of the Company at an
exercise price of $0.0075 per share to a third party consultant. The warrants
were issued at an estimated fair market value of $1,220 (valued using the
Black-Scholes valuation model). In February 2004, the parties amended the terms
of the loans. The lenders waived any default on the note and in exchange the
Company agreed to issue 500,000 shares of the Company common stock to each
lender (at a total fair market value of $14,000), which are subject to Rule 144
Regulation, and to pay $8,750 by March 31, 2004 and $8,750 plus all accrued
interest by April 30, 2004 under each note. The stock issued to each lender is
subject to "piggy back" registration rights and a "leak out" agreement. These
notes are currently in default.
In June 2003, the Company retained the services of Equitilink, Inc. to
provide investor relations services. As compensation, the Company issued
15,000,000 shares of Company's common stock with the Rule 144 restrictive legend
with a fair market value of $60,000.
During the three months ended June 30, 2003, incentive stock options to
purchase 210,000 shares of common stock of the Company at share prices ranging
from $0.45 to $0.47 per share expired.
During the three months ended June 30, 2003, non-statutory stock options
to purchase 3,300,000 shares of common stock of the Company at share prices
ranging from $0.47 to $1.25 per share expired.
39
In July 2003, the Company issued 8,000,000 shares of common stock of the
Company to Victor Weber in connection with $150,000 in loans made to the
Company. The stock is subject to Rule 144 restrictions. Victor Weber is a
Director and President of Government Internet Systems, Inc., a subsidiary of the
Company. The fair market value of these shares was $40,000.
In October 2003, the Company agreed to issue a 2% ownership interest of
its subsidiary, Government Internet Systems, Inc. to a third party in connection
with a loan of $60,000 to GIS, which issued the note on November 5, 2003, in
amount of $60,000 to the lender once all funds are received. In connection with
the loan, the lender will be entitled to receive a 2% royalty on net sales of
products by GIS in the United States up to $300,000 and the Company issued
1,000,000 shares of Company's common stock with the Rule 144 restrictive legend
(with a fair market value of $5,000). The note will bear interest at 10% per
annum, is due November 5, 2004, and is secured by 4,000,000 shares of common
stock of the Company that were owned by Mountain Reservoir Corporation. 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. The
Company currently owns 89% of Government Internet Systems, Inc., and will issue
a 2% ownership interest from its share of stock in GIS.
In November 2003, the Company agreed to issue a 1.5% ownership interest of
its subsidiary, Government Internet Systems, Inc. to a third party in connection
with a loan of $40,000 to GIS, which issued the note on November 19, 2003, in
amount of $40,000 to the lender once all funds are received. In connection with
the loan, the lender will be entitled to receive a 1.5% royalty on net sales of
products by GIS in the United States up to $200,000 and the Company issued
1,000,000 shares of Company's common stock with the Rule 144 restrictive legend
(with a fair market value of $4,000). The note will bear interest at 10% per
annum, is due November 19, 2004, and is secured by 3,000,000 shares of common
stock of the Company that were owned by Mountain Reservoir Corporation. 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. The
Company currently owns 89% of Government Internet Systems, Inc., and will issue
a 1.5% ownership interest from its share of stock in GIS.
In December 2003, the Company issued a debenture in the amount of $30,000
to a third party. The Company received net proceeds of $26,000 for the
debenture. The debt accrues interest at 5% per annum and is due December 2005.
The holder may convert the debenture into shares of common stock at 100% of the
lowest closing price for the 5 trading days prior to the conversion. As of June
22, 2004, no conversions have taken place. In connection with the issuance of a
$30,000 debenture to the third party and the Company's agreement to redeem the
debenture by February 1, 2004, the payments due under a note payable to the
third party in the amount of $239,004, bearing interest at 13% per annum, were
extended. Pursuant to the extension, the Company is required to make monthly
installment payments of $7500, beginning on February 1, 2004, until the balance
under the note has been paid. The note is currently delinquent and the debenture
has not been redeemed.
In December 2003, $20,000 of principal of $100,000 in debentures and
$1,726 in interest was redeemed for a total of $25,726, which includes a 20%
premium on the principal. This convertible debenture, originally issued on March
29, 2002, bearing interest at 5% per annum, was convertible into shares of the
Company's common stock at either 120% of the closing bid price on the date of
agreement or 80% of the lowest closing bid prices 5 days prior to the
conversion. The debentures were convertible at the option of the holder at any
time after the purchase.
During the three months ended September 30, 2003, non-statutory stock
options to purchase 265,000 shares of common stock of the Company at a share
price of $0.47 per share expired.
During the three months ended December 31, 2003, non statutory stock
options to purchase 10,000,000 shares of common stock of the Company at a share
price of $0.001-$0.025 per share expired.
During the three months ended December 31, 2003, warrants to purchase
45,455 shares of common stock of the Company at a share price of $0.11 per share
expired.
In January 2004, the Company issued 1,500,000 shares of common stock of
the Company with the Rule 144 restrictive legend to two consultants for services
(at a fair-market value of $4,500). The Company has agreed to "piggy-back"
registration rights with respect to the stock.
40
In January 2004, the Company purchased the 5% membership interest in Now
Solutions from Stephen Parnes for $75,000 and 1,000,000 shares of common stock
of the Company (at a fair market value of $3,000). The Company also paid Mr.
Parnes' legal fees in the amount of $2,000. The stock is subject to Rule 144
Regulation with "piggy-back" registration rights and subject to a "leak-out"
agreement.
In January 2004, the Company issued 10,000,000 shares of common stock of
the Company with the Rule 144 restrictive legend (at a fair market value of
$30,000) with "piggy-back" registration rights and subject to a "leak-out"
agreement to Wolman, Babbit, and King in connection with legal services provided
to the Company.
In January 2004, the Company retained two individuals for consulting
services. In exchange for these services, the Company agreed to issue a total of
4,000,000 shares of common stock of the Company with the Rule 144 restrictive
legend (at a fair market value of $12,000) with "piggy-back" registration rights
stock and subject to a "leak out" agreement.
In January 2004, the Company agreed to issue 1,000,000 shares of the
Company's common stock (at a fair market value of $3,000), subject to Rule 144
regulation and with "piggy back" registration rights, in connection with a
$10,000 loan made by Jim Salz to the Company in June 2003. In addition, the
Company issued a promissory note for $10,000 bearing interest at 10%, which is
due in April 30, 2004. Mr. Salz is the Company's corporate counsel. In April
2004, the due date on the note was extended to August 1, 2004.
In February 2004, $10,000 of principal of $100,000 in debentures and $925
in interest was redeemed for a total of $10,925. This convertible debenture,
originally issued on March 29, 2002, bearing interest at 5% per annum, was
convertible into shares of the Company's common stock at either 120% of the
closing bid price on the date of agreement or 80% of the lowest closing bid
prices 5 days prior to the conversion. The debentures were convertible at the
option of the holder at any time after the purchase.
In February 2004, Robert Farias loaned $500,000 to Now Solutions, the
Company's wholly-owned subsidiary and received a $500,000 promissory note from
Now Solutions, secured by its assets and a 5% royalty on any sales by Now
Solutions of over $8,000,000 per year up to $500,000. The note bears interest at
10% per annum and Now Solutions is required to make monthly interest payments
for all interest accrued in the previous month on the first day of each month
beginning April 1, 2004 and beginning on October 1, 2004 and continuing on the
first day of every month thereafter, monthly principal payments of $91,500 plus
interest until the note has been paid in full. In the event Now Solutions
receives cash proceeds due to a capital infusion or upfront licensing fees from
a reseller that is outside its normal scope of business (i.e, not part of
software sales in the regular course of business), Now Solutions is required to
pay 50% of such proceeds remaining toward payment of the $500,000 note. In
connection with the loan, the Company issued (i) 5 year warrants to purchase
5,000,000 shares of common stock at a $0.01 per share; (ii) 5 year warrants to
purchase 5,000,000 shares of Vertical common stock at a $0.02 per share; (iii) 5
year warrants to purchase 5,000,000 shares of Vertical common stock at a $0.03
per share, (iv) 5,000,000 shares of Vertical common stock subject to Rule 144
Regulation (at a fair market value of $75,000), and (v) an additional 5,000,000
shares of Vertical common stock in the event that $250,000 was not paid toward
the loan on or before March 15, 2004, which were issued (at a fair market value
of $120,000). All of the foregoing warrants and stock are subject to Rule 144
regulation and "piggy-back" registration rights. In addition, the Company also
pledged a 30% ownership interest in Now Solutions to ensure the making of the
$500,000 loan to Now Solutions. In connection with the amendment, Now Solutions
entered into a security agreement with the lender to guarantee the note. The
security interest of Now Solutions' assets on the secured promissory note will
be junior to Now Solutions' present indebtedness to WAMCO 31, Ltd and Arglen.
The Company appointed Robert Farias as a director of Now Solutions, a 100% owned
subsidiary of the Company, in June 2003. In February 2004, the Company purchased
a 21% ownership interest in MedData Solutions, Inc. from Robert Farias. In
exchange, the Company issued 9,000,000 shares of the common stock of the Company
(at a fair market value of $135,000), which shall be subject to Rule 144
Regulation and have "piggy-back" registration rights. The Company appointed
Robert Farias as a director of Now Solutions, a 100% owned subsidiary of the
Company, in June 2003.
In February 2004, the Company completed the closing of its settlement with
Arglen. Pursuant to the terms of the settlement, the Company purchased Arglen's
interest in Now Solutions for $1.4 million as follows: (a) $800,000, which was
paid at the closing and (b) $600,000, pursuant to a non-interest bearing secured
promissory note providing for payments of $200,000 in April 2004, $100,000 in
June 2004, and $300,000 in September 2004, which was issued at closing. The
security interest of Now Solutions' assets on the secured promissory note will
be junior to Now Solutions' present indebtedness to WAMCO 31, Ltd. In addition,
at closing, the Company cancelled 80,763,943 warrants held by Arglen and issued
to Arglen 20,000,000 shares of its the common stock of the Company (at a fair
market value of $280,000), which is subject to Rule 144 regulation with "leak
out" provisions. The Company is obligated to file a registration statement
within 180 days of the closing date covering the resale of the shares by Arglen.
If the Company does not file a timely registration statement, the Company is
obligated to issue an additional 5,000,000 shares and file its registration
statement no later than December 31, 2004. The note is currently delinquent.
41
In March 2004, the Company and Sheri Pantermuehl agreed to the terms of a
2 year employment agreement, whereby Ms. Pantermuehl agreed to provide services
as the Chief Financial Officer for the Company and its subsidiary Now Solutions,
LLC. Pursuant to the employment agreement, the Company shall pay Ms. Pantermuehl
a base salary of $125,000 per annum. In connection with the agreement, the
Company agreed to grant 5 year incentive stock options to purchase 2,500,000
shares of common stock of the Company within 45 business days at an exercise
price on the date of issuance. The stock options were issued in April 2004 at a
strike price of $0.014 per share. In addition, Now Solutions issued 1.5% of
so-called "phantom stock" of Now Solutions to Ms. Pantermuehl.
For the three months ended March 31, 2004, the Company granted 5 year
incentive stock options to two employees of Now Solutions to purchase a total of
3,000,000 shares of common stock of the Company at an exercise price of $0.01
per share, which are subject to "leak out" provisions. The stock options were
issued in connection with employment agreements executed in January 2004.
For the three months ended March 31, 2004, two employees shall receive a
total of 3% ownership interest of "phantom" stock in Now Solutions in connection
with employment agreements executed in January 2004.
During the three months ended March 31, 2004, warrants to purchase 432,069
shares of common stock of the Company at an average share price of $0.096
expired.
During the three months ended March 31, 2004, incentive stock options to
purchase 1,275,000 shares of the Company at a price of $0.086 per share expired.
During the three months ended March 31, 2004, non-incentive stock options
to purchase 750,000 shares of the Company at a price of $0.086 per share
expired.
In June 2004, the Company and its subsidiary Now Solutions, agreed with a
third party consultant to provide governmental relations services concerning the
state and local governments of the state of Texas. In connection with the
agreement, the Company issued 5 year warrants to purchase 250,000 shares of VCSY
stock at an exercise price of $0.025 per share.
In June 2004, the Company and its subsidiary Now Solutions, agreed with a
third party consultant services concerning the solicitation and preparation of
government grants. In connection with the agreement, the Company agreed to issue
250,000 shares of common stock of the Company, which is subject to Rule 144
regulation and vests as follows: 90,000 shares after 30 days from the execution
of this agreement, (b) 80,000 shares after 60 days from the execution of the
agreement, and (c) 80,000 shares after 90 days from the execution of the
agreement.
In July 2003, the Company issued 8,000,000 shares of common stock of the
Company to Victor Weber in connection with $60,000 in loans made and services
rendered to the Company. The stock is subject to Rule 144 restrictions. Victor
Weber is a Director and President of Government Internet Systems, Inc., a
subsidiary of the Company. The fair market value of these shares was $40,000.
From April 1, 2004 to June 22, 2004, warrants to purchase 6,319,699 shares
of the common stock of the Company at an average price of $0.052 per share
expired.
From April 1, 2004 to June 22_, 2004, incentive stock options to purchase
925,000 shares of the Company at a price of $0.037 per share expired.
From April 1, 2004 to June 22_, 2004, non-incentive stock options to
purchase 750,000 shares of the Company at a price of $0.041 per share expired.
42
ITEM 3. DEFAULT UNDER SENIOR SECURITIES
The a non-interest bearing secured promissory note providing for payments
of $200,000 in April 2004, $100,000 in June 2004, and $300,000 in September
2004, issued by the Company and Now Solutions to Arglen in connection with the
settlement of litigation and the purchase by the Company of Arglen's interest in
Now Solutions is currently in default. The security interest of Now Solutions'
assets on the secured promissory note will be junior to Now Solutions' present
indebtedness to WAMCO 31, Ltd.
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
10.101 (a) Executive Agreement, dated January 8, 2003, Incorporated by reference to Exhibit 10.101 to the
between the Company's Subsidiary, GIS, and David Company's Form 10-KSB filed on August 7, 2003
Kinney
(b) Warrants, dated January 8, 2003 issued to David Kinney in
connection with Executive Agreement between the Company's
Subsidiary, GIS, and David Kinney
10.102 (a) Amendment to Stock Purchase Agreement, dated Incorporated Incorporated by reference to Exhibit 10.103 to the
by reference to Exhibit 10.102 to the February 1, 2003, Company's Form 10-KSB filed on August 7, 2003
between the Company and Enfacet Company's Form 10-KSB filed
on August 7, 2003
10.103 $200,000 Purchase of Convertible Debentures, dated
April 14, between the Company and third party
buyers
(a) Securities Purchase Agreement (for $200,000 of
Convertible Debentures)
(b) Form of Debenture
(c) Registration Rights Agreement
10.104 Equity Line of Credit Agreement, dated April 14, Incorporated by reference to Exhibit 10.104 to the
2003, between the Company and Cornell Capital Company's Form 10-KSB filed on August 7, 2003
Partners, L.P.
(a) Equity Line of Credit Agreement,
(b) Registration Rights Agreement
(c) Compensation Debenture
10.105 (a) Services agreement, dated April 10, 2003, Incorporated by reference to Exhibit 10.105 to the
between the Company and Vasu Vijay Company's Form 10-KSB filed on August 7, 2003
(b) Promissory note, dated April 10, 2003, issued by the
Company to Vasu Vijay
(c) Consulting Agreement, dated April 14 2003, between the
Company and Vasu Vijay
43
10.106 Stock Sale Agreement, dated April 11, 2003, Incorporated by
reference to Exhibit 10.106 to the between the Company and
Mike Radlovic Company's Form 10-KSB filed on August 7, 2003
(a) Stock Sale Agreement,
(b) Stock Pledge Agreement
(c) Promissory Note
10.107 Amendment Agreement, dated April 11, 2003, between Incorporated by reference to Exhibit 10.107 to the
TranStar Systems, Inc. and the Company, Company's Form 10-KSB filed on August 7, 2003
10.108 Loan Agreement, between the Company and a third Incorporated by reference to Exhibit 10.108 to the
party lender, dated May 9, 2003 Company's Form 10-KSB filed on August 7, 2003
(a) Term Sheet
(b) Promissory Note
(c) Warrants
10.109 Loan Agreement, between the Company and a third Incorporated by reference to Exhibit 10.109 to the
party lender, dated May 9, 2003 Company's Form 10-KSB filed on August 7, 2003
(a) Term Sheet
(b) Promissory Note
10.110 Equitilink Services Agreement, dated June 10, Attached herewith
2002, between the Company and Equitilink
10.111 Loan, agreement, between the Company and a third Attached herewith
party lender
(a) Term Sheet, dated June 25, 2003
(b) $90,000 note, dated June 26, 2003
(c) Pledge Agreement, dated June 26, 2003
10.112 Loan and Cancellation Agreement, dated July 1, Attached herewith
2003, between the Company and Victor Weber
(a) Term Sheet
(b) $100,000 Promissory Note
(c) $40,000 Promissory Note
10.113 Loan Agreement, dated September 4, 2003, between Attached herewith
the Company and Victor Weber
(a) Term Sheet
(b) $50,000 Promissory Note
10.114 $500,000 Farias Loan Agreement between Now Attached herewith
Solutions and the Company and Robert Farias, dated
February 13, 2004
44
(a) Loan Agreement
(b) Promissory Note, issued by Now Solutions
(c) Security Agreement between Robert Farias and Now
Solutions
(d) Ownership Pledge Agreement between Robert Farias and the
Company
10.115 Arglen Settlement between Arglen Acquisitions, LLC Attached herewith
and the Company
(a) Arglen Settlement Agreement, dated December 4,
2004
(b) Promissory Note, dated February 13, 2004, issued by Now
Solutions to the Arglen Acquisitions, LLC
(c) Security Agreement, dated February 13, 2004
10.116 Employment Agreement between Now Solutions, Inc. Attached herewith
and Vertical Computer Systems, Inc. and Sheri
Pantermuehl, dated March 1, 2004
21.1 Subsidiaries of the Company Incorporated by reference to Exhibit 21.1 to the
Company's Form 10-KSB filed on August 7, 2003
31.1 Attached herewith
(a) Certification of Chief Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002, dated June 22, 2004
(b) Certification of Chief Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002, dated June 22, 2004
32.1 (a) Certification of Chief Executive Officer Pursuant to Attached herewith
Section 906 of the Sarbanes-Oxley Act of 2002, dated June 22,
2004 (b)
(b) Certification of Chief Financial Officer Pursuant to Attached herewith
Section 906 of the Sarbanes-Oxley Act of 2002, dated June 22,
2004
(b) Reports on Form 8-K:
On September 8, 2003, the Company filed a report on Form 8-K for a change
of address for its principal executive offices to Austin, Texas.
On September 10, 2003, the Company filed a report on Form 8-K/A amending
the prior 8-K for a change of address for its principal executive offices to
Austin, Texas.
On January 28, 2004, the Company filed a report on Form 8K for its
settlement of legal proceedings with Arglen and the buyout of Arglen's minority
interest in the Company's subsidiary, Now Solutions.
On April 21, 2003, the Company filed a report on Form 8-K for a change of
address for its principal executive offices to Fort Worth, Texas.
45
On April 28, 2003, the Company filed a report on Form 8-K for the grant of
a patent by the United States Patent and Trademark Office (No. 6,718,103) for an
invention for "Transmission of Images over a Single Filament Fiber Optic Cable"
on April 6, 2004.
46
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: June 22, 2004 VERTICAL COMPUTER SYSTEMS, INC.
By: /s/ Richard Wade
Richard Wade
President and Chief Executive Officer
By: /s/ Sheri Pantermuehl
Sheri Pantermuehl
Chief Financial Officer
47